Solesence Inc (SLSN) 2007 Q3 法說會逐字稿

Good afternoon. My name is Jodie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Nanophase Technologies third quarter 2007 conference call. (OPERATOR INSTRUCTIONS)

During this conference call, the words expect, anticipate, plan, 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 that 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 conflicts, 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.

Thank you, Jodie. Welcome to Nanophase's conference call to review the third quarter of 2007. 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.

Jess?

Good afternoon, and thank you for your continuing support of Nanophase. This third quarter has certainly been one of surprises. We saw lower-than-expected revenue for the quarter, following an excellent Q2. We need to keep many factors in perspective while reviewing these results.

The previous quarter's outstanding growth was achieved just prior to the much-publicized slowdowns in the housing and mortgages markets. We believe this may have impacted our sales to the architectural coatings market.

That being said, Nanophase exits Q3 with an excellent long-term outlook and much to build upon. Joe will cover more of this in detail in terms of customer and market updates and our developing strategy.

As always, I'll discuss the financial results in approximate terms. For more details, please see the financial statements accompanying today's press release. We have added a supplementary schedule along with the press release to break out depreciation and equity compensation expense, both of which are non-cash items, in order not to bog down the call.

Third quarter of 2007 revenue amounted to $2.6 million, about 5% higher than last year's, with nine-month 2007 revenue reaching $9.6 million, or 41% higher than the same period last year. Due to Nanophase being a much different business today than it was last year, I will focus most of my attention on the nine-month comparisons, along with a few notable changes from the preceding quarter.

The reduction in volume from our architectural coatings customer in Q3 versus Q2 has had an outside impact on the financials for both the three- and nine-month 2007 periods. Where we had $1.7 million in revenue from this customer last quarter, we only had $550,000 in revenue for Q3.

Given that the cycle time from our shipping this material to it being incorporated into the end products is a matter of weeks, this decrease appears to be a statement on the outlook of the typical American regarding consumer spending in today's climate more than anything. We think this downturn is temporary, but have little concrete customer feedback to allow us to predict when volume will increase.

Still, for the nine months ended September 30th, 2007, we had $2.8 million in sales versus $1.6 million from the same period in 2006 from this customer, significant growth. We also note that Q3 of 2006 reflected 66% of the nine-month sales for this customer last year, while Q2 of this year reflected 61% of their nine-month sales for 2007.

While we don't have enough history to call a pattern here, we did experience nice year-over-year growth with this customer from 2006 to 2007, even given that last year's Q3 revenue concentration amounted to more than 50% of 2006's total revenue. We hope to develop a clearer view in the coming months.

The growth from BASF and from the expanding markets being reached through our relationship with BYK-Chemie showed increased revenue when compared with last year's third quarter of $350,000 and about $360,000, respectively.

For the nine-month period of '07, these customers showed revenue increases of $400,000 and $1.2 million, respectively, when compared to the same period in '06. For the recent nine months ended, BASF, our architectural coatings customer, and BYK-Chemie, accounted for 45%, 29% and 14% of total revenue, respectively.

For the recent quarter, BASF, our architectural coatings customer and BYK-Chemie accounted for 48%, 21% and 15% of total revenue, respectively.

Gross margins for Q3 amounted to 21% of revenue, versus 30% for Q3 of '06. Gross margins for the nine months ended September 30th amounted to 29% of revenue this year versus 23% for the same period last year.

Generally, we like the margin growth we've seen, but for this past quarter, margin has suffered mainly from lower revenue volume, which did not allow us to absorb fixed overhead, along with the Company having some excess direct labor that had been put in place to support the higher run rate that management had expected given Q2's record volume.

Product mix and market stage also figured in the lower margins realized.

While we built a good business with the BYK-Chemie business, we are shipping a wide variety of products in relatively small lots. This has led to a degree of near-term margin erosion.

As the demand within the umbrella of underlying BYK business grows and we see large quantities of each type of product within that group being shipped, margins should improve.

This situation is typical when building new business with the characteristics we see with the BYK-Chemie business, namely, a large catalogue of products, a lot of sampling and engineering of initial quantities from sample through pilot phase, and the building of product awareness in the marketplace.

As the product mix matures and stabilizes, we expect margins to grow. Still, given the external environment and its unknown impacts on the parts of our business that seem to track the housing markets, predicting a trend will be difficult for the balance of the year.

Moving down, R&D expenses were down 26% quarter-over-quarter and down 13% for the nine-month periods. The lion's share of these reductions were due to the completion of a PVS yield improvement project in 2006, which we expect to pay dividends going forward, and in the reduction and outside testing and new materials development done in 2007 relative to 2006.

The reduction in new materials development dovetails with the further commercialization of the BYK products and is also a byproduct of our continued strategic shift further toward market-driven products. Joe will add more color to this later. We also saw a reduction in salary expense resulting from this change in focus.

SG&A expenses were up 13% and 8% respectively, when comparing the three and nine-month periods in 2007 to those in 2006. The increases were due to added compensation mainly related to changes in the sales and marketing group, along with the consulting fees incurred to study materials and markets with an eye toward expanding our technologies.

We don't expect these consulting fees to be continued at a significant level. Joe will discuss this project further in a few minutes. These increases were offset by reductions in several other expense areas.

On a GAAP basis, as reported, Nanophase lost $0.05 per share in Q3 of 2007, versus $0.05 per share in Q3 of 2006, with nine-month losses improving from $0.20 per share in 2006 to $0.12 per share in 2007.

Analyzing the non-cash components of the nine-month '07 loss, we have depreciation and amortization of about $1.1 million. This depreciation and amortization, a regular component of our GAAP bottom line, amounted to about $0.055 per share of the $0.12 loss. Equity compensation, also a non-cash expense, amounted to $420,000 and contributed another $0.02 per share to loss.

In total, depreciation and equity compensation expense amounted to about 60% of the most recent nine-month loss.

Moving to the balance sheet highlights. Nanophase ended Q3 with $17.1 million of cash and investments. This puts Nanophase in a very strong and stable financial position. This balance includes the $10.6 million we raised this summer with Fidelity as a lead investor.

Fidelity announced that along with shares it has accumulated in the open market, it now owns more than 11% of Nanophase.

Moving on, Q3 inventories are up to $1.7 million, about 22% higher than last quarter. This increase largely relates to material for which we have orders and solid forecasts, but at a higher level than we would normally hope. In this case, as we have discussed, the change in demand from our architectural coating customer caught us off guard.

The equipment and lease-hold improvements amounted to about $525,000 for the quarter. As our view toward 2008 and beyond unfolds, we may need to add capital equipment and potentially floor space to support future demand. Much of this is product mix dependent and therefore difficult to schedule.

Of the $950,000 in capital expenditures so far this year, $550,000 relates to an additional dispersion line we put in place in anticipation of future product demand from BYK-Chemie.

On the liability side, the Company now has $1.8 million in total debt. All but $85,000 of this representing capital leases on lab equipment relates to the BYK-Chemie loan of $1.6 million, plus deferred revenue, plus related discounts. Again, given that the loan financing terms are very favorable to Nanophase, we are required under GAAP to adopt this special treatment.

Accounts payable have grown also, mainly in relation to the timing of payments for operational expenses and capital expenditures. We'd invite you to review our upcoming 10-Q, which we expect to be filed by November 9th. Thanks for your attention.

I'd like to turn things over to our President and CEO, Joseph Cross.

Thank you, Jess. The third quarter of 2007 represents the 11th consecutive quarter of record annual quarter-over-quarter revenue growth stretching back to 2005.

However, third quarter revenues were considerably below our expectations entering the quarter and quite disappointing to the Company. As we noted in the earnings release, we experienced an unexpected revenue shortfall in architectural coatings this quarter.

Direct feedback from our major customer in this market leads us to be believe that the reduction in demand is attributable to the dramatic downturn in the new housing market and a reduction in consumer spending in the do-it-yourself market.

Based on available recent public information, this view seems to coincide with reduced revenue expectations from homebuilders, do-it-yourself retailers and some other architectural coating companies. As we channel check in multiple locations with do-it-yourself retailers, we continue to hear positive statements and recommendations for the nanomaterial-enabled architectural coating.

In parallel, feedback from our major customer has been positive. Moreover, we are actively continuing new product development with this customer and other manufacturers in architectural coatings and products. The value proposition and performance advantage for architectural coatings is demonstrably real.

We continue to believe in nanomaterial market penetration and revenue growth in an estimated $40 billion architectural coating global market. We are, however, cautious over the near term, given the surprising falloff last quarter and uncertainty in near-term demand level. We have reduced operational costs appropriately and we're going forward with a leaner cost structure.

As Jess noted, we continue to see solid growth in our BYK-Chemie and BASF partnerships in the markets served, as well as other customer areas. The revenue shortfall in Q3 is attributable to an unexpected reduction in demand from one of our major customers due to economic factors affecting architectural coatings.

We are positive about the architectural coatings products and have rosy expectations for the long term. I will cover our market areas in more detail later in the conversation.

Before we leave the third quarter, I'd like to note the continuing operational improvements at Nanophase. We were again recertified to ISO 14001, the international environment standard, by an independent auditing firm. As a testimony to the Company's employee health and safety practices, we reached a new milestone in employee safety with over 800,000 hours worked without a lost-time accident. In a manufacturing company, this is quite an achievement, especially for one our size.

We also had a new production level in our continuing efforts for PVS reactor output improvements. Since 1999, we have now increased PVS reactor production rates in aggregate of about 1,900%, while improving product consistency and quality under Nanophase's Lean Six Sigma process. And we are not done. We'll do even more in the future.

The record of continuous improvement demonstrates a collective and individual commitment to excellence by the talent at Nanophase's team. This is a record stockholders should note.

After attending several investment conferences and large institutional investor meetings recently, it strikes me that it might be worthwhile to take some time summarizing our assessments of where we see the global adoption cycle of this new technology, where we believe Nanophase is in relation to potential global competition, and, lastly, but most importantly, outline some of the new tactics we are implementing to increase the Company's revenue ramp.

Relative to adoption, every new technology has an adoption cycle. For example, the cycle for something now as common as a TV was over 40 years. We believe that nanomaterials are still early in the adoption cycle for several reasons.

Globally, we are seeing what we term alpha adopters in Europe, the U.S., Japan and parts of Asia. In these areas, we are now seeing increasing product development activity, not R&D initiatives. And Nanophase has been getting increased interest and requests.

This year, we have seen a rise in inquiries and product development interest in Latin America and India, so we tend to believe that the adoption cycle is gathering momentum, but it is still early in a typical adoption cycle for a new technology. Obviously, the alpha adopters who are creating products or processes for nanomaterials are proving the value propositions in our markets and creating additional serious interest.

A clear example of this is architectural coatings. The current products are of interest to other architectural coating manufacturers. During the fourth quarter of 2006 and through the first half of this year, we contracted what we perceive as the leading research company in the nanotechnology industry to perform a global evaluation to assess our competitive position and also to determine if there were unknown opportunities that Nanophase should consider.

Based on their evaluation, buttressed by our own internal evaluation and comments from our customers and market partners, we believe that Nanophase has a global leadership position in total nanomaterials capability. We are one of the few companies who can produce discrete nanoparticles, and I emphasize discrete nanoparticles, in commercial quality and quantity.

We are one of the very few who can surface treat or engineer the nanoparticle surface and produce stable nanomaterial dispersions in commercial quality and quantity. I do not believe I could overemphasize the importance of service-engineering nanoparticles and especially dispersing nanoparticles for commercial market success.

We appear to have one of the broadest patent portfolios and know-how in the field. Also, based on this independent opinion, the Company has developed a reputation for operational excellence and performance in its customer base. Quoting from the report, "Nanophase's partners continually report satisfaction with the Company's products and especially its willingness to co-develop materials, a claim few other nanomaterial suppliers can make."

Based on this independent assessment, we believe Nanophase is well positioned on the global stage. From a marketing and sales perspective, there are a couple of points I'd like to make. First of all, the Company has grown revenue by 32% annually over the past few years.

Management firmly believes that we need to achieve at least 50% revenue growth per year, primarily by expanding our market and customer base. To routinely reach this level, we continue to believe that we have to improve Nanophase's marketing and sales organization, and simultaneously we have to improve our business development and sales processes.

We have taken and are continuing to take actions to address each of these areas directed to achieve in our 50% annual revenue growth goals. Relative to our marketing and sales organization, Nanophase hired Kevin Wenta as Executive Vice President of Sales and Marketing early in 2007.

Kevin has brought the needed leadership and fresh vision to drive the organization on forward revenue growth. As we assess the skill sets and effectiveness of our sales organization, we became convinced that changes were needed.

During April 2007, we added David Nelson as Vice President of Sales. David has an impressive background of successful business development and sales growth, most recently with Eastman Chemical. At this point in time, we're in the process of hiring another professional in sales and marketing to drive new market areas and opportunities.

We intend to staff this organization with the professional, results-oriented staff needed for the Company to reach its revenue growth goals. As we study and evaluate how to improve our business development and sales success rate, it has become evident we have to continue evolving and improving our process.

Viewed as part of a stage gate process, which is typically considered as five stages, running from zero to five, we believe that we have to improve the discovery phases, primarily stages one and two. To achieve our goals, we now believe that we have to extend our application of all initiatives to the end product or application. So viewed as a process that has evolved as we've learned, we have moved from our early practice of sending samples to customers, who would try to independently incorporate those into the end application and generally fail.

Customer failure in this regard, most often trying to disperse nanomaterials, and the why, is generally hard for us to ascertain and often leads to the customer just losing interest. From samples, we moved to trying to work collaboratively with customers to incorporate nanomaterials into their application, but relying on them to have the application knowledge and expertise to prove the value proposition and derive the application testing data to show performance improvement.

This works in some cases, not in others, because many companies are reluctant to collaborate, and the process is often slow and cumbersome. To try to improve the success and speed the time to market, we have now extended application development to be able to test and quantify and prove product performance by nanomaterials that has been engineered exactly for the application or formulation.

In other words, we engineer a nanomaterials solution for a market segment, for example, paints or stain, based on market needs, and test the resultant performance improvement in commercially available products and take those results to the product companies. Let's review a specific example.

A new family of formulated nanoalumina for base dispersions for coating applications. It has long been the goal of paint manufacturers to improve the durability and wear of water-based paints, typically measured as resistance to abrasions or scratch resistance, to be equal to oil-based paints.

We believe that Nanophase's new formulated dispersions realize this goal. These new products deliver several property enhancements specifically relating to the paint-coating structure and the coating's ability to resist abrasion and wear.

Although the dispersions need to be ideally tailored to specific formulations for optimal performance, the formulated alumina dispersions typically yield the following abrasion resistance improvements -- 250% to 400% for water-based paints and 300% to 500% for oil-based paints.

These improvements are observed in most commercial formulations tested, but optimal results still require us to work directly with potential customers, since formulations in similar products vary greatly. But we believe this approach is key to improving stage one and two of the stage gate, solving a problem in the customer's own formulation and taking tested performance improvement to the customer.

We plan to formally announce this new application breakthrough shortly to the noted markets in specific customers. We also will use the same model for other markets and applications where we have the product and testing expertise.

Despite the unexpected near-term downturn in revenue for architectural coating products, we remain optimistic about growth in our current markets and those where we have initiated penetration.

Viewing specific market. Sunscreen and daily wear demand continues to grow in 2007 over 2006 at a rate similar to previous years. Given the new focus on full-spectrum UVA protection, which is about 90% of harmful radiation, such as a proposed FDA monograph and similar legislation in the EU, we are optimistic about increased adoption and growth for our nanomaterials going forward.

Zinc oxide is the only sunscreen agent that provides protection from UVB, short-wave UVA and long-wave UVA. We are working on an increasing number of new opportunities in the industrial and architectural coatings markets, and believe that both of these markets offer the opportunity for short-term and near-term revenue growth.

BYK-Chemie, our market partner for these markets, remains positive about growth over the next two to three years and is marketing their nano-enabled additives globally. Working with our market partner Rohm and Haas, we believe that we are seeing increased activity and adoption for their CMP slurry products used in our nanomaterials. Rohm and Haas is forecasting appreciable growth in Nanophase going forward.

Development efforts with the major OEM and electronic component and circuitry printing for flexible displays continues to progress and we have been informed should enter into the pilot production phase early next year.

We are also optimistic about a new marketing relationship with our Japanese partner, C.I. Kasei, a $750 million division of Itochu, which is a $22 billion global conglomerate in textiles, machinery, aerospace, electronics, energy, chemical, food and finance.

C.I. Kasei, who is viewed as a nano leader in Japan and Asia, has relationships with companies throughout Asia and presents the opportunity for Nanophase to establish a marketing presence and grow sales in Asia going forward.

In summary, while this past quarter's revenue was disappointing due to softness in one market from a major customer, management's commitment to aggressive revenue growth goals remains positive, and proactive actions are well under way to achieve these goals.

This concludes our prepared remarks and we're now available for questions.

(OPERATOR INSTRUCTIONS)

Your first question comes from Avinash Kant with Broadpoint Capital.

Good afternoon, Joe and Jess.

Hey, Avinash.

A few questions. In the past, you have experienced some sort of seasonality in the fourth quarter, given that you have had exposure to the sunscreen business and everything else. Now, given that it looks like the decline in the third quarter is pretty severe, do you expect further seasonality into the fourth quarter?

Relative to sunscreens or relative to architectural coatings?

Relative to the overall business. Do you think that the business from one of the customers, architectural coating customer, has come down so much that it will go up and that will be offset by the BASF decline maybe?

We are not seeing a decline in demand for sunscreens in the fourth quarter at this point in time.

So on a full-quarter revenue basis, historically you've had 10% to 15% decline in the fourth quarter versus the third quarter. Should we expect something like that for the fourth quarter, or because of the anomaly in the third quarter that may not happen this time?

Well, Avinash, as you recall last year, the actual revenue volume went up in the fourth quarter for BASF, so it's never a guarantee. I would say that we couldn't predict that one way or another, except to say that both BYK-Chemie and BASF have grown this year, and that it's just difficult to go into Q4.

As you could see, we got surprised on Q3 with our architectural coatings customer. It's just too hard to tell. I wouldn't say there's any guaranteed typical seasonality that's going to happen in Q4. It doesn't mean it's not going to happen. It's just we're not seeing that, necessarily.

Now, would you also think that given the fact that your architectural coating customer was ramping up and of course was doing a nationwide rollout, maybe they bought for their expansion, and maybe -- or is there some inventory of your material at your customers? Would that be the case?

That's not what we've been told. As you can imagine, we have met with our customer and talked with them constantly. I'm not an expert in this market, Avinash, but from what we have learned from this customer, they have no visibility at all relative to going forward.

When Harry and Sally walk into the do-it-yourself retailer and buy the architectural coating, they have salespeople who cover between three and five stores. As the inventory leaves the shelves, the salespeople put in orders, because they manage the inventory for the do-it-yourself retailer.

So there's not a forecast going forward. It's basically the demand that comes is based on how much is sold off the shelves. Okay? Our customer tells us they've seen a reduction in sales across their entire product line. So having no other intelligence than that, that's kind of what we tend to believe.

Okay, and now a few numbers that I wanted to double-check. Jess gave a few numbers in terms of what was the revenue from BASF. Could you give me the exact number on the revenue rather than percentages for the second quarter this year, current quarter, and the third quarter of previous year?

Give you the number instead of percentages?

Right. The numbers are so small, sometimes percentages don't give you the exact number.

Sure.

You don't expect him to have this memorized, do you, Avinash?

No, no, if he has it.

You're tough, Avinash.

Or I can do it -

BASF revenue for Q1 was $1.609 million, for Q2 was $1.481 million, for Q3 was $1.214 million.

In the current quarter, right, $1.214 million?

Yes. Architectural coating, you're looking for the current quarter number?

Yes, that was $0.55 million, I believe, right? $550,000 you said.

Yes.

Okay, and $1.7 million, right. What was the third quarter of last year for BASF? Do you have that number?

Yes, I do. It was $865,000.

Okay. Thank you so much. I'll let other people ask questions and get back in line. Thank you.

Thank you.

Your next question comes from the line of [Debeer Jayne] with Thomas Weisel.

Hi, this is Debeer Jayne calling in for Sandeep Matthew from Thomas Weisel. I just have a couple of questions. One was whether -- and this was regarding the architectural coatings customer. Could you give us some idea about the market for the architectural coatings customer in terms of breakup between the U.S. market and the rest of the world, or does it only cater to the U.S.?

We have information in that arena that we've been asked not to share. Our architectural coating customer is funny that way. The architectural coating customer right now sells primarily in the U.S. to a certain do-it-yourself retailer. The do-it-yourself retailer is now expanding into China and they are following that retailer.

Relative to their market share, we've been told the number, we've been asked not to divulge it, so I'd rather not.

Okay, that's fine. And the second question is regarding the FDA monograph that you had mentioned on UVB and UVA protection. Now, assuming that this monograph does become a rule, what sort of revenue benefits do you foresee in the future?

Actually, we have a meeting with BASF next week to discuss this. Frankly, the FDA monograph requires sunscreens to have UVA protections. There are many sunscreens on the market that do not have UVA protection.

So what they tend to offer is UVB protection, which is the ray that gets you sunburned. But the UVA protection, which is 90% of the radiation and causes all the effects you know it can cause, is absent and has been absent in most of these. So the FDA monograph, which again is still in the proposal stage, has not been solidified, is out for comment. Actually, we're providing comment and a lot of people are providing comment, has a one to five-star rating system I believe, with five stars I think being the best for UVA protection.

Whether that's adopted or not, we don't know. The legislation that's in the EU is much farther along, as we understand it, and it's essentially a done deal. We believe that this offers increased opportunity for our particular products through BASF. I think it will increase the adoption rate. I think it will definitely increase the demand for ingredients that provide UVA protection.

How much of that we can secure with our zinc oxide is harder to say at this point in time, and again, that's part of the discussion we're having with BASF next week.

Right, thanks a lot. That's it from my side.

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

Good afternoon, John and Jess. I have a question about the relations with this architectural coating customer? Is it exclusive relation? Are you limited from expanding with other customers in, let's say, Asia or Latin America?

I understand the relation of this situation with demand and problems with the housing market, but it's not yet at least a worldwide problem, so what are your chances to offer this kind of product to the customers in other areas? And the second question is, can you clarify if there is any inventory problem? Do you have responsibility for some or any product that was originally scheduled for shipments to this customer? Or the customer takes everything?

Let me try and -- Nick, if I missed something, tell me and I'll come back and answer it. With the architectural coating customer, we do not have an exclusive relationship. We are a sole source supplier to this customer. The formulation that we make for them is a dispersed nanoparticle in essentially water with other things.

This dispersion is tailored to their latex formulation. So whether it would work exactly as formulated in other paint manufacturers is unknown, but we probably would tend not to offer that exact formulation. However, we could offer similar formulations to paint manufacturers.

We actually have a European customer through BYK-Chemie. We have a second -- at least one other U.S. paint manufacturer to my knowledge through BYK-Chemie. And we are offering this, a similar product, not an exact product, but I would say a similar product, on a global basis at this time.

We're working with almost every major paint company I can think of at some level on putting nanomaterials, either zinc oxide or aluminum, primarily, in paints and there's active development in this area.

And you've given rough estimates when you can expect any, if not results, but any improvement in this just offering into the product?

Well, I talked a bit about that during my comments. We just finished a big round of testing on architectural coatings. We're going to be going to the market very shortly with that data. We're already contacting individual people we are working with in this market with this data. So we've already started the sales initiative.

Great, and the second was related to the subject of inventories, if there is such a problem for you.

We don't have a particular problem with our customer relative to inventory in our facility. We've actually seen a little bit of pickup in the order rates so far this quarter, so we're not too much worried about the inventory for architectural coatings.

Don't know if that pickup's going to hold. We just don't have any visibility at all, because we don't know until we get an order. They're not able to forecast, Nick. They just don't forecast, and I'm not an expert in the do-it-yourself market, but I've been told by people who think they are that this is pretty endemic to that marketplace.

Nick, typically what we do is if we build inventory, we try to make as much of it as possible unconverted inventory, regardless of what particular particle it is, so that whether it's dispersed or coated or put in different media -- the thing that takes us the longest time to do typically is to produce the particle or the powder.

So when our inventory creeps up, we have more material that's either raw material precursor or converted powder than we do a specific dispersion or a specific coated material for our customers.

So, if demand drops, yes, inventory is higher than it was last quarter, but the bulk of those increases are due to unconverted material that we are waiting to convert for various customers. And we do that intentionally, just so that we don't get in that condition where we're carrying loads and loads of material that we don't know what the outcome will be.

We typically have not been in a situation where we would have more than a quarter worth of inventory of just about anything on a major basis.

And to further elaborate that, Nick, on our manufacturing plans, we end this year with pretty lean inventory. So everything we have in inventory is pretty spoken for, we believe.

Thank you very much. That's very helpful.

Your next question comes from the line of Avinash Kant with Broadpoint Capital.

Yes, one more question, Joe. You talked a little bit about some progress on the CMP side of your business. What was that, specifically?

Well, Rohm and Haas -- let me phrase this properly. Rohm and Haas appears to be getting increased traction in the marketplace, okay? We had a meeting with them as recently as yesterday and the day before. They've asked for us to double our output in Q4 and they asked us to get ready to ship multiples -- I don't want to say what the multiple is, but it's a nice multiple, of this year's shipments next year.

And the reason we're having that discussion is there's a 13-week lead time on raw material. So they are apparently getting much better traction than we understood. We've seen the volumes go up, and the forecast for next year, frankly, is a very nice forecast.

And in his prepared remarks, Jess, did you talk about the revenues from Rohm and Haas in the current quarter?

No, I didn't.

Could you give us the current quarter or maybe the first nine months of Rohm and Haas this year? Or maybe if you could give all three quarters, that would be even better, if you have it.

The current quarter they will be a significant customer, so we will be disclosing that. It was about $285,000.

What, in last quarter?

In Q3.

In the Q3, right? Okay, how about in Q2 and Q1?

Jess Jankowski We won't be disclosing that, because they are not -- it wasn't at that level and it wasn't at a level of significance.

You to respect the fact that the only reason we're disclosing revenue numbers at all is if they're in that 10% of the quarterly revenue rate. All of these customers, even BASF, would prefer we just didn't disclose them at all. So that's all I'm willing to tell you.

Okay. So, Joe, when you're talking about growth next year, you're talking about from the annual level, right, on a quarterly basis from where you are at this point?

No, I'm talking on an annual basis, they're forecasting and told us to be prepared for a nice multiple over this year's production. And the fact that they doubled their order -- they've asked us to double the order rate in Q4, which we frankly don't know if we can do because there's a 13-week lead time for raw material --

Double the order rate of the Q3 level, right?

No, they've asked us to double the order rate for Q4, basically. And we're trying right this moment to decide if we can even achieve that. But the quantities they're forecasting for next year, again, is a multiple of this year, and it's a nice multiple.

That is doubling the order that exists right now for Q4, not what we had in Q3.

I see. I see. I see. That's what I'm trying to understand. Okay.

So if I'm thinking about the Q4 here, basically other than some traction maybe from Rohm and Haas, this will be the usual customers. Will any new customer be a part of Q4 revenues in a meaningful way?

Not an appreciable new customer.

Right.

You know what? I gave you the wrong number, Avinash. It was $140,000 Q3. I overstepped here.

Okay, $0.14 million. Okay, okay, in Q3, right?

Yes.

Okay, perfect. So, yes, so coming back to the thing, basically in the Q4 numbers we should not be thinking of any new customers coming in, in a big way, other than some upside from Rohm and Haas, and then we can have our own assumptions on how business is from BASF and the architectural coating customer.

Is BYK-Chemie going to be starting to ramp again in Q4, ramp in Q4? Or is that next year's story?

We expect reasonable revenue in Q4 from BYK-Chemie at this time. Relative to 2008, we will be meeting with them next year -- I'm sorry -- we'll be in Europe next week meeting with both BASF and BYK, talking about 2008. So until we have those conversations, I'd rather not speculate.

But BYK-Chemie, it looks like in the first three quarters of this year has been roughly around $380,000 on a quarterly basis? Is that--?

Jess is looking at the numbers.

It's about $1.350 million over the three quarters.

$1.350 million? And, if you don't mind, could you give me the Q1, Q2, Q3 from BYK for this year?

Q3 was $395,000.

Q3 was $395,000.

Q2 was $585,000.

Okay, and Q1?

Back into Q1, that would be about $370,000.

$370,000. Perfect. Thank you so much. That helps.

Your next question comes from the line of Walter Ramsley with Walrus Partners.

Hi, Joe, Jess, good afternoon.

Hey, Walter.

Hey, are the Sox going to pull us out tonight?

Well, we are very optimistic.

That's good. I hope Manny's a little bit more pumped than he's acting.

Manny is already hitting .500. I don't know how much more you want out of him.

I've got a few more questions about the architectural coatings. The customer that you're working with, are you satisfied with their marketing efforts at this point? I mean, I've gone to a few stores, I've heard reports from other people around the country, and it seems like it's kind of a low-key promotion.

Well, here's what we've been told. Our architectural coating customer started an advertising campaign and the first -- in two parts. The first part was to reestablish their brand. Our customer felt like they hadn't done a good job of that over the past couple of years from a consumer awareness standpoint. So they've been running radio, TV and print ads pretty heavy throughout the first half of the year to reestablish their brand, get their name in front of the consumer, let the consumer know they're the highest-rated paint in Consumer Reports.

And they went through that. They've also, at least in the store around here, Walter, there's a lot of brochures and -- I don't know what they're called -- the standup cardboard advertising in the stores relative to our product. The fact is, you walk in the door, there's the standup buy-some-of-this displays.

They were going to start a second phase, and actually this was going to be -- the total campaign was going to be the largest campaign in their history, frankly, is what they told us. But they told us recently that their sales have fallen off so much that they've had to scale back their marketing campaign.

So I don't know what that means, and so I don't know walking forward, frankly, how strong of a marketing campaign they are going to make. They were going to make -- actually, we are in discussions with them trying to find that out, because we're really curious, because the second part of the marketing campaign was specifically directed towards a product with our nanomaterial in it.

We don't know what they're going to do going forward at this point in time.

So did they ever get anything off the ground aimed at the commercial painting segment?

Well, I've seen a lot of advertisements from the general brand-building commercials they've been running. I mean, I've heard it on radio, I've seen it in print and actually seen it on TV in numerous times.

As far as the second half of their marketing campaign, I haven't seen anything that would be relevant to what they told us they were going to do. But they did tell us last time we talked to them that they'd pulled back their horns a bit on their marketing campaign from a money expenditure standpoint due to their sales being down.

Okay, and as far as the distribution, do you know if they made it throughout the entire chain?

To my knowledge, it's throughout the entire chain, to my knowledge.

And any feedback about the sell-through and --

Our customer is very happy with the sell-through. I have personally went to several of these stores. I have talked to the people in the paint department. They pretty much rave about this paint. They think it's one of the best paints they've got. It's the only paint that can be applied down to 30 degrees, apparently. That's what they told me, so that's all I know. And they're very pumped about it.

So everything I've heard talking to people in the stores -- I've even talked to a couple of store managers -- and so word of mouth, from what I'm hearing, is good. Word of mouth from the customer is good. So as far as we're concerned, there's not a problem with the product. It is a first year in the marketplace.

It still isn't probably well established, and there is a downturn out there, apparently. I mean, all the do-it-yourself retailers I'm aware of have (inaudible).

I'm just curious if the higher price is causing an even greater effect on your product.

Well, I'm not an expert in this, Walter, but it stands to reason to me. I mean, it's intuitively obvious that if there's a downturn in consumer spending, that premium-priced products will suffer more than less-premium-priced products.

I understand. So that with the marketing, you could overcome that potentially by pointing out that you don't need the primer and the extra time.

Yes, and we're trying to have that conversation with our customer, but appreciate that's like pushing a rope.

Okay, I see. And then back to the European company, BYK, are they like ready to roll with paint?

Yes, I think so. I mean, we had a conference call with them actually this Monday. I talked to the CFO of [LPNA] and the CEO of BYK-Chemie. They're very optimistic about this. They're very gung ho going forward. I mean, the [Alcana] CEO actually met with our Board at our July 31st Board meeting and showed a projection to the Board of what he expected our sales to be, I think it was through 2013.

And they're very aggressive with what they believe they can make happen, so they're very optimistic about this. I mean, they're selling this -- to my knowledge, they are actively selling on every continent I can think of.

Okay, and then just one last thing. Sorry to run on here, but the antimicrobial plastic product, is that going anywhere?

That's still in development.

Okay, thanks a lot.

Thank you.

(OPERATOR INSTRUCTIONS)

Your next question comes from the line of [James Liberman] with Merrill Lynch.

Hi, it's Jim Liberman. Greetings, gentlemen.

Hi, Jim.

Hi, thanks. So I understand how these new products and markets work, and this is certainly not totally unexpected to me, and actually I'm somewhat encouraged by the fact that you have so many more products out there that going forward, you can start to see various trends from several different products and not have to concentrate on one or two.

But can you comment on anything going on with the polyurethane side of the business?

I don't have a lot of market intelligence on that area, Jim. There is a polyurethane product out there right now with our product in it.

Is it something I might find in one of the stores, because I was looking to do my deck. That's why I was calling.

Actually, it's in one of the stores. I'm not supposed to tell you which one, but it's in one of the do-it-yourself retailers, okay? And our customers are just weird about us talking about our nanomaterials and their products, and I apologize for that, but that's just the world we live in. And it's out there right now. I think they call it a premium diamond product, if I recall that right. So you can kind of look for that on the shelves.

I saw it. I was in one of the do-it-yourself retailers over the weekend and saw it on the shelf.

Okay, and also, regarding -- what do you suppose looking forward do you think you're going to find your greatest growth in, say, two years out? Is there some sort of particular product area you still think is going to be the driving force?

I think from what I know at this moment, I still believe that architectural coatings and industrial coatings are our biggest growth area. There's just a lot of demand for in coatings that have increased wearability and increased durability, for coatings that will withstand UV degradation.

And these could be -- think of these as permanent coatings or temporary coatings. Because there's a lot of coating that are not classically coatings, in that they stay forever but they're a temporary coating. Say, a deck stain.

So a deck stain, if you've ever done this, lasts less than a year. So there's a lot of work going on between us and other companies trying to extend the life of deck stain up to two years.

In fact, we've recently purchased a piece of test equipment, a big thing called a QUV chamber, so we can run tests on formulations from potential customers on our nanomaterials to show that the polymer doesn't degrade under UV over an extended period of time.

So I think that's a growth area. I'm very encouraged with what Rohm and Haas is saying from a market traction standpoint, because I've always felt that should be a good market. That's a very good product for us to make. It's got a very good margin for us. So if they really take off the way they're talking they're going to take off, that's very exciting to us.

Always good to hear.

But I think industrial coatings and perhaps CMP -- I also suggest that it's quite possible, although we don't fully understand it right this minute, that the new UVA requirements could really kind of goose sales in the sunscreen arena.

And is that something that you think would be pushed aggressively by your marketing partner, or do you think it would come from some sort of legislation from, say, the FDA or something of that sort?

Well, the proposal's in front of the FDA now, Jim. And, frankly, Neutrogena, if you watch TV, they're announcing their first UVA product ever, because, again, most of the sunscreens historically, especially beachwear, had no UVA protection. So everybody is scrambling because if the FDA would ever approve this monograph, it takes companies months and months and months of formulation work and consumer testing and all that kind of stuff to change formulations.

So we're already having people talk to us and we're already seeing products being developed with increased UVA. So with or without the monograph passing, there are products now being developed to meet that monograph.

Well, it's very exciting, actually, with all the new products you've got out there, that things are finally beginning to start taking shape, and with this one quarter being a little disappointing, it's still quite encouraging looking forward. Thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS)

There are no further questions, sir, at this time.

We want to thank you for joining us today for the conference call and we'll all look forward to a better quarter next quarter. Thank you very much.

Thank you. This concludes today's conference call. You may now disconnect.