Solesence Inc (SLSN) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the fourth quarter 2007 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you have already done so, please press the pound key now, then press star, one again to ensure your question is registered.

The words expect, anticipates, plans, forecasts, 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.

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

Thank you. Welcome to Nanophase's conference call to review the fourth quarter annual results for 2007. Nanophase set year-over-year revenue growth records for each quarter of 2007 and for the year as a whole with 36% year-over-year revenue growth. The Company had a solid year and we're pleased you've taken the time to be with us today.

Jess Jankowski, Nanophase's CFO, and I will be hosting this session. Entering 2008, we're attempting to have a more thorough communication with investors and the investment community. We'd appreciate any feedback you might care to offer on this approach. We've provided more information than normal in our press release, along with an outlook for 2008, which is a new practice for Nanophase.

Our conference call today will also be slightly different. Jess will be discussing the business and financials along with most of the topics I have covered in the pass. I will be discussing Nanophase's competitive position entering 2008, along with the Company's goal to achieve greater levels of revenue growth and what measures we're taking to make this happen.

To begin our discussion, Jess.

Good afternoon. Thanks for your continuing support of Nanophase. I hope you'll all bear with me today, I'm on day five of a Z-Pak and I've been falling apart all week.

I'd like to start out with a recap of 2007, and some forward-looking statements regarding 2008 while limiting the details to financial discussion so that we can stay focused on the most important drivers of Nanophase's business. As always, numbers will be discussed in approximate terms.

2007 was another strong year for Nanophase. We grew 36% in top-line revenue, we've elevated and further improved the business model, and we took additional measures to reduce overhead to remain nimble going forward. 2007 also marks the third consecutive year the Company has grown revenue 30% or more.

We saw year-over-year growth from three of our four largest customers, with the fourth, Rohm and Haas, now anticipating a 70% increase from 2007 to 2008. The BYK-Chemie business experienced solid growth in 2007, accounting for 12% of total revenue, although it remains well below our initial expectations for the applications and markets being served.

Architectural coatings revenue grew over 55% from 2006. Our major customer in architectural coatings represented 25% of the Company's 2007 revenue. Outsized Q2 of 2007 volume for this customer, some portion of which we suspect was for initial stocking of retail locations, has made it difficult for management to predict volume trends for 2008.

We do know that our customers and ultimately the consumers of their products are pleased with the product introduction and performance, so we expect volume sales to continue on an ongoing basis.

Revenue volume for BSF, our market partner for sunscreen and personal care products, was up 18% in 2007. We expect growth and unit volume for 2008, but are unsure as to whether this will result in significant dollar revenue growth due to the impacts in reductions of raw materials pricing and the resulting reductions in surcharge revenue.

As discussed in our press release today, many of our sunscreen, personal care, and architectural product applications are subject to pricing that is influenced by commodity market-driven raw material costs. At current commodity pricing levels, approximately 500,000 or 4% of total 2007 revenue, represent surcharges that won't be repeated if today's commodity market conditions remain stable.

Given that we typically have not been able to recoup all of our costs with these surcharges, a secondary and positive impact of these cost reductions will be increases in variable margins, both in dollar and percentage terms.

Regarding our revenue outlook for 2008, two metrics are important to keep in mind. First, we expect annual growth of 5% to 15% for the year, taken as a whole. This total, at least given current market conditions, has been weighed down by the $500,000 reduction in revenue volume expected in '08 due to known commodity pricing reductions.

We also suspect the 2007 revenue was further increased due to inventory building, possibly by three customers, some of which may not be repeated in 2008. In total, we anticipate that Nanophase will have to make up about $1 million in revenues from 2007 surcharges and inventory built.

Second, as frustrating as it may be for our investors and analysts, Nanophase is still not established enough for quarterly trend and quarterly revenue estimates to track historical curves. Given economic conditions and customer inventory uncertainties, the first six months of 2008 may well be lower than the same period in 2007, revenue-wise.

Our expectation is that projected year-over-year growth for the full year will occur mainly in the second half of 2008. We are watching the first quarter inputs closely and even at this date do not have adequate visibility. At this point, it would not surprise management if first quarter 2008 turned out to be the weakest quarter of the year.

That being said, the last three quarters in 2008 should see less variability than we saw in 2007. Given the impact of things we can't control, we necessarily have some uncertainty at this time.

Regardless, we are at strong applications that have demonstrated the value proposition of engineered nanomaterial solutions and these will continue to grow. 2008 will be a good year, and a critical setup year for 2009.

Regarding our business model, let's take a quick look at Q2 of 2007. With $4.2 million in revenue on a product mix that we see as repeatable, we reached a 37% gross margin. We hit positive EBITDA but fell short of GAAP earnings by more than a penny. Management viewed this quarter as an excellent milestone and as a lesson on strategic focus.

We learned that we could achieve the margins that we had been predicting, and that such modeling was no longer an academic exercise. Through more thorough market analysis and focusing more on specific markets for future sales growth rather than specific target customers, we reconfirmed that it's likely that the best opportunities to achieve revenue growth and gross margin goals exist within the palette of materials that we currently make in volume.

Through years of application development and through the honing of our coatings and dispersion technologies, we now believe we have everything we need to succeed. This means that we have to go deeper in product development to actually demonstrate performance and value in the application. We can't just rely on customers or market partners to do this.

This marks a developmental milestone in continuing to build products that the market wants, always via market pull, but we're now applying a finer filter. Also regarding Q2 of '07, all of us thought profitability should have been higher. As part of this refocusing we are able to eliminate some overhead in manufacturing and R&D as well as to continue to attack discretionary expenses.

As our revenue and product bases have solidified, we now see more opportunities to find initial efficiencies. Getting back to recap a few specifics, for 2007 BSF, our architectural coatings customer, and BYK-Chemie accounted for 49%, 25%, and 12% of total revenue respectively. We also achieved a 26% gross margin for 2007, which we expect to increase incrementally in this year while positioning Nanophase for greater margin realization going forward.

Note that in the second half of 2007, margins suffered 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 third quarter run rate that management had expected, given Q2's record volume and customer forecast and feedback at that time.

Product mix and market stage also figured in the lower margins realized. While we build the coatings business we're 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 the underlying coatings business grows and we see larger quantities of each type of product within that group being shipped, margins should improve.

This situation is typical when building new businesses with the characteristics we see with BYK-Chemie, namely a larger-than-optimal 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.

Much of the groundwork has now been laid. As I mentioned, we believe that we have reached a turning point in terms of our marketing and business development efforts that should allow us to better apply fewer resources to greater advantage.

Moving down, R&D expenses were down 17% from 2006. We expect that total R&D expenses for this year might increase slightly, but will remain well below 2006 levels. SG&A was up 2% in '07. We expect SG&A to remain roughly flat through 2008 with any net increases driven by the addition of more salespeople.

On a GAAP basis, as reported, Nanophase lost $0.18 per share in 2007 versus $0.28 per share in 2006. Analyzing the non-cash components of the '07 loss we have depreciating and amortization of about $1.4 million. This amount, a regular component of our GAAP bottom line, amounted to about $0.07 per share of the $0.18 loss. Equity compensation, also in that cash expense, amounted to $570,000 and contributed another $0.03 per share to the loss.

In total, depreciating and equality comp expense, both of which are non-cash items, amounted to about 55% or $0.10 per share of the $0.18-per-share 2007 loss. For more details, please see the financial statements accompanying today's press release.

We've added a supplementary schedule to break out depreciation and equality compensation expense by category in order not to bog down the call with details.

Before I move to the balance sheet highlights, I'd like to address a concern. There have been some rumblings among our shareholder base regarding the financial strength of Nanophase, particularly in light of recent stock volatility and equity market conditions.

I'd like to respond to these by reiterating that the Company's outlook remains solid. I want to be very clear here: we are in a strong cash position and we continue to operate the business within conservative parameters. Nanophase ended 2007 with $16.7 million in cash and investments. Additionally, cash burned from operations amounted to $1.6 million for the year and depending upon how quarterly volume ramps and impacts working capital we expect to further improve on this number for 2008.

Internally, our projections have us exiting the year with $14 million to $15 million in cash. Cash used in operations for 2008 should be similar or lower than in 2007, and we don't plan on any major capital spending this year.

The equipment and lease hold improvements amounted to about $1.2 million for '07, 50% of this related to an additional dispersion line we put in place in anticipation of future product demand from several coatings applications, and has the capacity to support expected growth for 2009.

Today, we don't anticipate material new capital expenditures for '08 beyond updating manufacturing R&D and IT infrastructure, and this will be done on an as-needed basis.

As our view beyond 2008 unfolds, we may need to add additional capital equipment and potentially floor space to support future demand on the line, but much of this is product mix dependent and therefore difficult to predict at this point.

Moving on, 2007 year-end inventories were up 18% to $1.1 million. This increase largely relates to material for which we have orders and solid forecasts, but at a higher level than we would normally hold. Management doesn't believe that there is significant exposure here.

On the liability side, the Company now has $1.8 million in total debt composed of the loan from BYK-Chemie and a small amount of capital leases. Accounts payable were down about 50%, mainly in relation to the timing of payments for operational expenses and capital expenditures.

To summarize the position of the Company today, I'd like to leave you with a few thoughts. Our customer base is solid. Our margins are growing. Our business model is working. We continue to attack costs. Our cash burn is at an all-time low. Our balance sheet is strong. We are positioning for more growth, and through application and end-market expansion we're better insulated from economic volatility than ever before.

For further detail, we invite you to review our upcoming 10-K, which we would expect to be filed by March 17th. Thanks for your attention. I'd like to turn things over to our president and CEO, Joseph Cross.

Thank you, Jess. Today we thought it might be beneficial to discuss our assessment of Nanophase's competitive position entering 2008 with as much of a global view as possible, followed by discussion revenue growth goals and measures that we're taking to achieve these.

Beginning with competitive position, during 2007 we contracted what we perceived as a 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 strategically 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 and 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're one of the very few who can surface treat or engineer the nanoparticle surface and produce stable, formulated nanomaterial dispersions in commercial quality and quantity. I do not believe I could overemphasize the importance of surface engineering nanoparticles and especially dispersing nanomaterials for commercial market success.

We appear to have one of the broadest patent portfolios and practical 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 do [co-development] materials, a claim few other nanomaterials suppliers can make."

We believe Nanophase is currently well-positioned on the global stage. As we strategically assess Nanophase entering 2008 relative to revenue-driven growth, we arrive at the following. The Company has done quite a remarkable job over the years developing nanomaterials technologies to address multiple horizontal and vertical markets, and we believe is a global leader.

Nanophase has created and evolved a relatively small but sophisticated manufacturing operation under Six Sigma discipline with rigorous environmental and EHMS practices that continually improves production processes and reduces manufacturing costs.

This has become a core Company competency and a distinct market advantage. Financially, the Company is well-positioned in 2008 with $16.7 million in cash and investments. We reduced our burn rate for operations by 50% during 2007 to %1.6 million and should improve upon that this year.

Simply do the math on your own. We clearly have adequate capital for the foreseeable future to fund the Company. We believe we currently have facilities and infrastructure to support $20 million to $25 million in annual revenue, with little or no material capital investment required for capacity. In short, without much doubt, the Company is well-funded to meet its obligations to grow plans over the planning horizon.

Especially over the past three to four years, Nanophase has gained appreciable knowledge in how to put nanomaterials into various customer products. Kitchen and bath paint, masonry paint, exterior stain and polyurethane floor finishes, and these products are currently in the consumer market. The same application knowledge that has multiple horizontal markets is continually augmented and expanded and should serve us well going forward.

So in summary, our technology is at the forefront. Product quality and quantity is likely the best available, as evidenced by the fact that Nanophase is the sole source for all of its market partners and customers. Application expertise is in all probability a globally leading position, and we are well capitalized to succeed.

What we have to address and improve is our revenue growth rate. Looking back and using 2004 as a base year, Nanophase grew revenue 31% in 2005, 32% in 2006, and 36% in 2007. While 30% compounded annual growth is generally considered solid, it will not meet our vision of reaching $50 million and then $100 million in annual sales in our desired timeframe. We believe that the Company needs to achieve a 50%-plus annual revenue growth rate to meet this vision.

To achieve this, we began reworking and honing our business development and sales strategy in the last half of 2006 and through 2007, and are seeing increased success. Steps we have taken include restructuring and reskilling the sales and business development team. During 2007 we hired Kevin Wenta as EVP of Sales and Marketing, and David Nelson as a Vice President of Sales, both with excellent experience in chemical sales.

This process continues. We are now searching and plan to add one to two additional sales directors. Moreover, Dr. Brotzman, who was focused solely on R&D, is now predominantly in a technology sales and marketing role for the Company, supporting customer business development and sales, where he's adding tremendous value.

We have also worked hard to hone our five-stage gate business development model and processes. If you're familiar with this model, stages zero to about two and a half are considered discovery stages, and about two and a half to five are develop and implement stages. We believe that the recent 50% annual revenue growth rates desired; we have to improve discovery stages.

We seem to do well in the develop and implement stages. To improve the discovery stages, we have taken several synergistic steps. First, we have increased our depth and level of understanding and target markets by consolidating and ranking about 44 market segments, but focusing on the top 20.

Market segments include energy, building and construction, current electronics, and automotive, so let's look at a few and provide a flavor of the effort. First with the top 20 and then the remainder, we are driving to the customer value proposition to understand the performance and costs required for specific applications.

Secondly, we have refocused our application scientists and engineers solely on these target markets, and our product development efforts are directed to demonstrating the value of nanomaterials in these specific markets.

For example, architectural coatings. We have installed equipment to test the benefit of nanomaterials in commercial formulations in a manner similar to architectural coating companies. We purchase commercially available architectural coating materials and use our developed applications knowledge to add our nano-engineered nanomaterials solutions.

We then apply the coatings to an appropriate substrate, test the samples to industry standards, and finally visually and quantitatively demonstrate the value of using Nanophase to leaders in the marketplace. This approach gets much better customer attention and mind share, demonstrates the value of nanomaterials in their particular products, and significantly reduces the time to market.

Thirdly, we're developing more opportunities in these targeted market segments. The sales team has been given goals to designed to increase directly touching the end customer on a weekly basis. We have increased customer touch two to three times.

We have also increased our presence at application tradeshows such as coatings and electronics and similar target markets, to improve and extend our market knowledge and emphasize the advantage of nanomaterials in specific market applications for enhance performance.

Fourth, we are taking a much more rigorous approach to qualifying and quantifying opportunities, select those opportunities in the target market that most likely could succeed, provide the largest revenue opportunities, and appear to have the shortest time to market. Our improved process allows very close examination of each opportunity before it moves through a stage gate.

In summary, we've given a great deal of thought in market research to select market targets and increasingly focus our efforts and resources to optimize the potential for revenue growth. Again, our vision is to reach $50 million and then $100 million in sales. To do so, we have to increase annual revenue growth by 50%.

We have restructured, reskilled, and honed our business development and sales effort, and implemented and refined processes to achieve these goals. We are adding additional sales personnel to increase market and customer contacts.

As we've noted, while the revenue growth rate during 2008 may be below our internal goals for reasons we have stated and over many of which we have limited control, we're very positive about the future and confident that we can achieve the revenue growth goals the Company requires to reach the levels stated earlier. Our improved approach and increased understanding of market needs is rather quickly adding new opportunities to our pipeline.

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

(Operator instructions.)

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

Good afternoon, Joe and Jess.

Hey, Nick.

Hi, Nick.

You gave a very good algorithm of how you are going to grow your sales. My question is what specific applications you're targeting for 2008, and how long does it take for you from identifying the application to getting it to development stage with specific customers and producing first volume?

Okay. I will talk about a couple target markets, Nick. I'm not comfortable talking about any target markets, simply because we don't know who listens to this conversation.

We're focused really heavily in the coatings marketplace, including architectural coatings, specifically coatings that degrade in sunlight or coatings that require additional scratch resistance. We're seeing a lot of market pull for that. We've developed technology internally to address those markets; we're able to test those.

I think one of the key things we've learned is that we have to take our development much further than we ever imagined we were going to have two years ago. And beginning after we perfected our processes to make commercial nanomaterials, we used to send samples of powder out and customers couldn't work with them. If they tried to put them in dispersion, it would agglomerate the material and they just couldn't work with it.

So we developed dispersion technology, and we're very good at dispersing nanoparticles. And we can produce very stable nanoparticle dispersion, and we still find out customers can't work with them. And we've gotten this feedback from several different customers, especially over the past three or four months, even with large companies.

So it's clear to us we have to go even a step further and demonstrate the value of nanomaterials in the specific applications. So back to my architectural coating example I used during the prepared comments, we are actually putting nanoparticles in commercial products that are on the shelves at Home Depot and Lowe's and the typical places you go, and also those companies that have their own stores, and we're working with those formulations and adding nanoparticles.

And using our application knowledge to improve the life, the antimicrobial character of the coating, the adhesion of the coating, [tannin-blocking], and other things that are important to many manufacturers, and then we take those in.

Now relative to how long this takes, I think we all believe that it takes probably from the time of the initial conversation to revenue, 12 months would be fast, two years would be more typical, probably, okay? Does that answer your question, Nick?

All right, yes, though it's kind of limited answer competitive reasons. I understand.

Okay.

One of the things in that answer, Nick, that I think people get hung up on or get confused on is the degree of alteration required to the material from the one that won't work that gets shipped in a container to the one that will work is sometimes an hour conversation and a couple of tweaks, due to a lot of expertise here.

It's really more of being able to sell the customer, get the mind share, sell the customer on the fact that we have that expertise and we can do it. And that part is much quicker than a lot of people are led to believe.

Thank you. Before I yield to let others ask questions, I have a very small request. Is it possible to publish not just annual data but quarterly data for the fourth quarter? I'm talking about your press release.

We haven't done that in the past. We'll definitely consider that, Nick.

Thank you.

(Operator instructions.)

And gentlemen, I am showing no further questions from the audio lines at this time.

Okay, thank you for your attention today, and we'll look forward to talking to you next quarter. Thank you.

This concludes today's fourth quarter 2007 conference call. You may now disconnect.