Solesence Inc (SLSN) 2006 Q4 法說會逐字稿

Good afternoon. My name is Holly, and I will be your conference operator today. At this time, I would like to welcome everyone to the Nanophase Technologies fourth quarter 2006 conference call. [OPERATOR INSTRUCTIONS].

During this conference call, 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 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 nanocrystalline materials, changes in development and distribution relationships, the impact of competitive products and technologies, possible disruption in commercial activities occasioned by terrorist activity and armed conflict, and other risks indicated in the Company's filings with the Securities and Exchange Commission. Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

I would now like to turn the conference over to Mr. Joe Cross, President and CEO of Nanophase. Thank you, Mr. Cross. You may begin your conference.

Welcome to Nanophase's conference call to review the fourth quarter and annual results for 2006. Nanophase set year over year double-digit revenue growth records for each quarter of 2006 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.

To begin our discussion, Jess will summarize the financial highlights of the quarter and the fiscal year.

Thank you for your continuing support of Nanophase. 2006 was an excellent year for us. Aside from the strong results, it has also served as a segue to a new phase in the Company's maturation. As I review the financial performance, I intend to only address significant areas comparing 2006 to 2005. All numbers for today's call will be in approximate terms for ease of discussion. For more details, please see the financials accompanying today's press release.

This year, I'd also like to discuss a few new metrics that highlight some important positive shifts in our business. Revenues for the fourth quarter were up 52% to $2.2 million versus about $1.4 million in 2005. 2006 revenues came in at almost $9 million versus $6.8 million for 2005, a 32% increase in total revenue that was clearly driven, first, by new product growth and then by growth from existing products. I'm also glad to tell you that each quarter's 2006 product revenue totals, the driver and most critical success metric of this business today, set a new record compared to their corresponding quarters from all previous years. If you recall, we set similar records throughout 2005. It's starting to happen. There's light at the end of the tunnel.

As most of you know, Nanophase has had one major customer, BASF, that has been responsible for the great majority of our sales over the past five years. This year, in 2006, sales to BASF accounted for 56% of total revenue while growing 13% from 2005 levels to $5 million. This also marks a new milestone. As a percentage of total revenue, however, this is down significantly compared to their average of 69% over the past five preceding years. So, now we see BASF's volume continuing to grow, along with our newer customers whose volume is growing even faster.

Our new architectural coatings customer accounted for 22%, or $2 million, of our $9 million in total revenue in 2006. We expect this customer to continue to expand, both in dollars and in percentage of revenue. Rohm and Haas accounted for 9% of total revenue, or about $850,000, in 2006, roughly the same as last year, as they continue their attack on new CMP applications, which have a fairly long adoption cycle. Although BYK Chemie, the division of ALTANA that most of our market attack has been focused on, has yet to represent significant sales volume, we expect 2007 to be the first year we experience enough market penetration to see them purchasing larger volumes of material. Based upon forecasts that they've given Nanophase, management expects them to become a million-dollar-plus customer this year.

The exciting part of this shift is that we're starting to see meaningful growth in new markets with new applications from several customers while BASF continues to grow in its existing markets. Joe will go into more detail regarding expected new growth for BASF and what we expect to see from BYK Chemie this year.

For Q4 of '06, and I say this mainly for the benefit of our analysts, BASF, our new architectural coatings customer and Rohm and Haas accounted for 53%, 17% and 14% of our quarterly revenue, respectively.

Gross margins for 2006 amounted to 22% of revenue versus 14% for 2005. In dollars, we had almost $1 million more in gross margin or gross profit and incremental revenue of $2.2 million. Looking closer, it shows we had an incremental gross margin of 44% on the additional sales.

Before going any further, I think it would be useful to quickly walk some of our newer shareholders through our profit model. Nanophase has a fixed manufacturing infrastructure that will support a multiple of current revenue. We could more than double 2006 volume without adding significantly to fixed overhead. The Company has been built this way to size the infrastructure at the minimum we think we can operate with, given the size and sophistication of the companies that we target as customers. We know that this has been a key factor in helping us to be responsive to our existing and new customer base. Nanophase has proven that it can deliver, and now we expect to reap more of those benefits as growing sales volume helps to absorb overhead. Beyond a certain volume, each new revenue dollar drops its variable margin or variable contribution, if you prefer, right to the bottom line.

During 2006, we not only had a positive gross margin, but, in line with what we've been modeling, margin growth related largely to volume growth. The margin analyses we've done show that significant fixed cost increases are not required to drive expected near term increases in revenue. The business model is working.

What we need to do for 2008 and future growth remains to be seen, but we all certainly view these growth-related issues as good problems to have.

Again, for our analysts, we had about $952,000 in depreciation expense in cost of revenue for both 2006 and 2005 and $261,000 versus $236,000 quarter to quarter, respectively. Equity compensation, the relative impact of which I'll discuss at length later, did not materially affect cost of revenue for either period.

Moving down, R&D expenses were up 10% from 2005 to 2006. This increase was mainly composed of non-cash equity compensation expense and expenses relating to a yield improvement project. SG&A expenses grew significantly year over year, expanding 20%, or $880,000. Increases in non-cash equity compensation expense and legal fees, including the $150,000 patent write-offs, amounted to 70% of this variance. I'll discuss equity compensation expense issues further in a minute.

Regarding the patent write-offs, we have re-evaluated our patent strategy in light of the changes in the U.S. PTO rules and approach. These changes were not in place years ago when we initially capitalized these patent costs, and we don't expect these types of charges to become regular occurrences. Accrued compensation expense and benefits and recruiting and relocation expenses made up most of the balance of the increase, offset by savings in directors' and officers' [inaudible] insurance.

On a GAAP basis, as reported, Nanophase lost $0.28 per share in 2006 versus $0.30 per share in 2005, or $5.2 and $5.4 million, respectively. Analyzing the non-cash components of our 2006 loss in the year over year comparisons, we have depreciation at about $1.3 million companywide for both 2005 and 2006. Depreciation, a regular component of our GAAP bottom line, amounted to $0.07 per share of our 2006 loss. The patent write-offs amounted to $150,000, which largely reflects prior years' capitalized legal fees being expensed in 2006. This made up almost $0.01 per share of our loss, and, again, we don't expect this to be a regular event.

Equity compensation, a non-cash expense, amounted to $645,000 for 2006, a $572,000 increase over 2005. About $380,000, or two-thirds of this increase, related directly to the adoption of FAS 123R effective January 1, 2006. The balance reflected the required accounting for previously disclosed restricted stock grants, including $144,000 in directors' compensation paid in the form of equity in 2006. Equity compensation expense contributed $0.035 per share to the 2006 loss.

In total, depreciation, patent write-offs and equity compensation expense contributed to $0.11 per share, or 40% of the $0.28 per share loss for 2006, compared to $0.075 per share, or 25%, of the 2005 loss. For 2007, equity comp expense comparisons to 2006 should have far less variability once FAS 123R has been in place for both reporting periods.

Moving to the balance sheet highlights, Nanophase ended last year with $8.6 million in cash and investments. Equipment and leasehold improvements netted to $7.6 million in total, which included $2.2 million for capital additions in 2006. The bulk of this related to the additional dispersion line and NAS reactor financed via the November 2005 loan of $1.6 million from BYK Chemie to support increasing volume needs for 2007.

On the liability side, the Company now has about $1.8 million in total debt. All but $80,000 of this relates to the BYK Chemie loan of $1.6 million and related discounts and deferred revenue. The debt discount and offsetting deferred revenue referenced on the balance sheet relate to the required accounting treatment under APB21 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 were required under GAAP to adopt this treatment.

We'd also invite you to review our upcoming 10-K, which we expect to be filed in mid March. Thank you for your attention. I would like to turn things over to our President and CEO, Joseph Cross.

Today, I'd like to briefly review Nanophase's progress during 2006, both from the perspective of year over year improvement as well as a continuing foundation the Company is building for future revenue growth. Lastly, I'd like to discuss some of the Company's focus areas for 2007.

Operational improvement is a continuing emphasis at Nanophase, and we again made significant progress in 2006. We believe that operations, which include manufacturing, quality and engineering, are a core company competency and a major advantage in the marketplace.

Reviewing selected achievements, we implemented generation II of our patented NanoArc Synthesis technology, which increases production rates three to five times and allows fine commercial production across a broad material pallet of sub-25 nanometer particles with appreciably tighter distribution. Generation II allows the Company to produce nanoparticles for target markets, both with our market partners and new markets that Nanophase is targeting.

Again this year, we made significant progress evolving our technologies and processes, focused on continuous improvement for increasing reactor production rates, reducing variable manufacturing costs and continually improving product quality. During 2006, Nanophase's facilities were recertified to ISO 14001 2004, the internationally recognized environmental management standard, and recertified to ISO 9001 2000, the international recognized standard of manufacturing and quality excellence.

For the fifth 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 2006, Nanophase exceeded 700,000 hours without a lost time accident in manufacturing. This is an exceptional record for a company our size and demonstrates the Company's dedication to workplace safety in manufacturing.

Lastly, anticipating increasing volume during 2007 and 2008, the Company increased capacity and nanomaterial dispersions for architectural coatings. Additionally, utilizing the $1.6 million loan from BYK Chemie that we have discussed previously, we have also added NanoArc Synthesis, nanomaterial capacity and solvent dispersion capacity to meet increasing volume needs forecast for 2007.

Moving to revenue growth in 2006, again we were able to achieve double-digit year over year revenue growth in each quarter of 2006 and grow annual revenue 32% compared to 2005. As another measure, compared to product sales in 2004, product revenue in 2006 more than doubled. Despite rapidly escalating commodity costs during this past year, we were able to grow average gross margins over 50% compared to 2005. Again, comparing 2006 versus 2005, gross margin in dollars almost doubled in 2006.

While 2006 was a solid growth year, we have worked equally hard to position the revenue growth and opportunities for 2007. Considering 2007, we anticipate a busy and productive year. Focus areas for Nanophase in 2007 are continued revenue growth, continued gross margin expansion, certain key technical objectives related to process improvements, and increase new market business development. We continue to anticipate revenue growth from multiple markets and plan to continue evolving our technology and improving operations during 2007.

Let me outline major product areas where we currently anticipate revenue growth. After growing 24% in 2005 and 12% in 2006, we believe that BASF's original Z-Cote product for sunscreens and personal care will grow double-digit percentages during 2007 based on BASF forecasts. We also anticipate initial growth in the Z-Cote MAX product line launched in 2005 and the T-Lite MAX product launched in late 2006 as adoption begins in Asia and Europe. Keep in mind that Z-Cote and Z-Cote MAX are different products for distinctly different formulation chemistries. We also anticipate the potential launch of one new sunscreen product during 2007 in the Z-Cote MAX line. Assuming that this launch occurs, BASF and Nanophase will have four distinct sun care and personal care products during 2007 and entering 2008, all of which are expected to continue growing.

Relative to architectural coating revenue, which grew 3200% to $10 million during 2006, we anticipate continued growth during 2007. As you may recall, Behr used a kitchen and bath product with NanoGuard advertised as a mildew-resistant and antifungal paint around November of 2005. Following that, Behr released a basement and masonry waterproofing paint with NanoGuard. Beginning in mid 2006, Behr began rolling out an exterior stain product, Ultra Premium Plus with NanoGuard, which is advertised as a primer and paint in one step. Based on information from the customer, we believe that the rollout through Home Depot has been implemented in about 700 to 800 stores and has been well received. Behr has provided written estimates and forecasts to Nanophase for 2007, and we anticipate appreciable growth in architectural coating revenues as Behr continues rolling out its Ultra Premium Plus with NanoGuard line to the remainder of the approximate 2,200 Home Depot locations throughout 2007. Based on the schedule Behr has communicated to us, we believe that the rollout to all stores is scheduled to begin from the end of February through April and will be accompanied by a NanoGuard kickoff advertising campaign in the very near future. In addition to the current products, we are continuing new product development with Behr in certain areas to improve paint, stain and waterproofing performance. According to Behr, they plan to continue expanding the NanoGuard line. We continue to anticipate that architectural coatings, both through Behr and our market partner, BYK Chemie, will be a significant revenue growth area going forward.

Relative to BYK Chemie, based on their forecasts, we expect material revenue growth during 2007 and for the visible future horizon. Entering 2007, BYK Chemie is marketing approximately 20 NanoBYK commercial products manufactured by Nanophase for industrial coatings, architectural coatings, coil coatings and other additives.

As we have stated on previous conference calls, we believe that nanomaterials dispersions for these markets could be one of Nanophase's strongest revenue growth areas during 2007 and for the foreseeable future. We're beginning to see traction in several of these applications with recent new customer additions in the U.S., China and Europe. And we're quickly moving from laboratory and pilot quantities to volume manufacturing. Based on orders and shipments to date in 2007, revenue in the first quarter through BYK Chemie will be roughly equivalent to all of 2006.

BYK's forecasts to us cause us to believe that this trend should accelerate during 2007 with continuing new customer adoption and corresponding increasing volume ramps with new product introductions. We expect that the current ramp will consume much of the Company's attention and resources, especially over the next three to six months. It is possible that Nanophase may have to add capacity to meet forecasted demand. Should that be the case, we will plan to work with our market partner, BYK Chemie, to fund the required capital. Additionally, BYK Chemie and Nanophase have approximately 30 new laboratory nanomaterial-based products in various stages of application testing. We expect some of these to reach commercialization during 2007 and moving forward.

In summary, we believe that Nanophase is well positioned entering 2007. Potential revenue growth with our market partners, especially BASF and BYK Chemie, and our existing customer base is promising for 2007. Going forward, we have strengthened our business development and sales group by adding EVP of Sales and Marketing, Kevin Wenta, to drive these functions and improve our marketing and sales results to continue our revenue growth. Looking past the 2006 accounting charges and the write-down of patent costs, we believe that we made significant strides in cutting operational losses. 2006 was an important year for the Company as we materially increased revenues and began to reach critical mass in manufacturing volume in several areas. We also recognize that the Company must continue or even accelerate the product revenue growth rate experienced in 2006. We are optimistic that we can achieve this during 2007.

This concludes our prepared remarks. We're available for questions at this time.

Thank you. [OPERATOR INSTRUCTIONS]. Your first question comes from the line of [Richard Juba of Milke Ferguson Investments].

Sir, can you tell me when you think you might first be profitable?

I don't think we can predict that exactly. We believe that we will have increasingly improved financial performance in 2007, and we have internal goals, frankly, to that effect.

Okay. Thank you.

Your next question comes from the line of Nick Tishchenko of Global Grown Capital.

Joe, I have a couple of questions. The first one is - as a person who watches the growth of the Company, I'm more interested in operating results other than legal fees that you paid to the lawyers and other expenses. Could you please provide some data on the durations? What would be, let's say, gross margin if you take out all these costs? What would be, for instance, earnings per share if we would subtract all this additional cost.

If we took out the non-cash charges, earnings per share would have been impacted positively. That was $0.11, including the-- $0.11 was depreciation, patent write-offs, equity comp expense. It was about $0.11. Of that, $1.3 million was depreciation, which made up $0.07. So, about $0.04 for the legal fees-- or the patent charges and the equity comp charges.

It would be a very good idea, Jeff, if you would be able to publish this kind of information in your quarterly press releases. Also, can you tell me, please--?

Nick, are you talking more of like a pro forma?

Yes. It's a very good idea, because I want to see the development in the durations. I can add all these additional charges to match it with GAAP, but we are looking for the Company with such a growth potential and when everyone is thinking about cash flow breakeven and positive earnings per share, this is what we want to watch. We want to watch what is happening with the cash. We want to see what is happening with gross margins. We want to see what is drop down incremental revenues to gross margins and to profit margins. We'll deal with the legal fees and other stuff later.

Let us figure out how we can do that, Nick.

The second thing-- it would be very helpful if you, while reporting yearend numbers in the December quarter, would provide the quarterly numbers as well. You were talking about $0.11 [inaudible] non-cash expenses related to other stuff. I would also want to look into the quarterly numbers, or what would be a pro forma earnings for fourth calendar quarter 2006. It would be very helpful if you could provide this kind of information.

We'll see what we can do. Wouldn't that be available in the K?

Yes, but we want to decide what to do today and not wait for March. Usually, it's a good idea to put this kind of information into the quarterly release. By the way, congratulations with a pretty impressive performance.

[OPERATOR INSTRUCTIONS]. Your next question comes from the line of Andrew Braswell of Newbridge Security.

Just a couple of quick things. Actually, just a follow-up on the last question. I'll just second that. Obviously, we can go back and take the nine-month numbers and work backwards from the yearend numbers to figure out the fourth quarter, but, you know, it does-- we're lazy, us analysts.

Okay; you said that. We didn't.

Got you. Can you--? Just to clarify, that $150,000 of patent write-off - that was all in Q4. Correct?

No. It was Q1 and Q4.

Yes. $111,000 was in Q1, and $39,000 was in Q4.

Okay. So, $39,000 in Q4. So, out of that $395,000, the only element of that that is a one-time charge is related to the patent write-off, and that's $39,000.

In the fourth quarter?

In the fourth quarter.

Yes.

Okay. And, I know that you said it. Can you run one more time over for me, Jess, the Q4 revenue breakdown by the top three customers?

Sure. BASF was 53%. The architectural coatings customer was 17%. Rohm and Haas was 14%.

Jess, you can say it now; Joe was saying them, the architectural--

I know. I listen better to [inaudible].

I hear you. Thanks a lot for the help, and good talking to you.

We'll also have the scripts on the website in a couple of hours, probably.

Great. Thanks.

Your next question comes from the line of Tom Mancino of Marina Capital.

Good quarter, folks. Congratulations. Could you comment-- you made an allusion, Joe, to BYK Chemie-- if it ramps the way they've given some indication in May, you may have to add capacity beginning some time in midyear or third quarter. How do you measure capacity lumps in to support that? Would it be in increments of $0.5 to $1 million or reactors? Can you give us any size on how that might have to happen? Thank you.

Okay. I'll give you our current view. People need to understand, I think, that there's a difference between average capacity and burst capacity in a manufacturing environment. So, if somebody comes to us and they say they want to buy X amount over a year, well that's an average capacity kind of discussion. But we typically find, especially as new products are released and you go through scale up, much more capacity is needed for burst capacity. So, if you think about-- I've said this before on conference calls, but the coatings industry is a $60 billion global industry. Noveon just did a study, and they claim it's an $80 billion global industry. But, whatever it is, we believe there's a large segment of that that is available for nanomaterials. We've now-- we went from no products in that marketplace to 20 products being actively marketed. We're seeing excitement in adoption across the globe, actually in architectural coatings, the plastic and industrial coating additives.

So, what happens is that, for instance, we've got a huge chunk of orders coming in next week for this scale up, which we didn't know about until like two days before. So, we're trying to work with the customer to schedule this. But what we don't have for these particular kind of things is burst capacity.

So, relative to BYK's scale up, probably the equipment we're going to be lacking capacity on is the equipment we have for nanomaterial dispersions in water because we have growth in the Behr business that's considerable. We're probably going to need another NanoArc reactor. A lot of these products require 20 nanometer sizes of various nanomaterials, and that's our most viable production technique to do that. And we're going to have to enlarge our dispersion line that disperses nanoparticles and solvents. The volume has just increased well beyond what we or BYK thought in the initial planning stages.

Thank you. That's very helpful. Congratulations.

Your next question comes from the line of [Nicholas Pei], Private Investor.

I don't recall hearing in your comments reference to the 20 customers who have been testing polishing slurries and that category of potential product. Can you update us on that?

I'm not as-- I'll tell you the problem with this particular marketplace is Rohm and Haas has went through some management changes, frankly, Nick. We're not as up to speed on this as we need to be. We will be in a couple of weeks but not right this second. Basically, Rohm and Haas went through a fairly significant adoption cycle with [Chimonda, which used to be called Infinion]. All those plants are scaling up. Also, to my knowledge, there's two technology partners they have in Asia, which are very large facilities that are starting their scale up. So, from real wins, those are significant wins. Actually, a couple DRAM manufacturers are also starting up, which, to us, is really interesting because this product was never designed for DRAM. It was always designed for logic circuits and, specifically, ILD0STI and SON. So, I think Rohm and Haas is making progress.

I guess the reason I haven't talked about them is we're so focused on the other things right now that that's kind of what's driving our business.

Okay. Thanks very much.

At this time, there are no further questions. I'd like to turn the conference back over to management for closing remarks.

We'd like to thank you for attending our conference call. I think we had a very good year in '06, and we're looking forward to a very exciting year in '07. So, just stay tuned. Thank you for your time.

Thank you for participating in today's Nanophase Technologies conference call. We appreciate your participation. You may now disconnect.