Solesence Inc (SLSN) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the first quarter 2008 conference call. (OPERATOR INSTRUCTIONS.)

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 -- I'm sorry, 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 discussion of the customer -- I'm sorry, 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 like to now turn the conference over to Joseph Cross, President and CEO. Mr. Cross, you may begin your conference.

Thank you, Jennifer.

Welcome to Nanophase's conference call to review the first quarter of 2008. Especially given the current economic conditions, Nanophase had a solid quarter 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 comment on the first quarter financial reporting.

Good afternoon and thank you for your continuing support of Nanophase.

I'd like to start out with a recap of the first quarter and some forward-looking thoughts regarding 2008. As always, numbers will be discussed in approximate terms.

The first quarter was a pleasant surprise in terms of revenue volume for Nanophase. We grew 5% compared to the first quarter of 2007 and we maintained an excellent product mix. To qualify our comments here, because our outlook for all of 2008 still remains at 5% to 15% growth, and our visibility is not yet clear for the second half of the year. We thought that Q1 revenue would be lower than what we experienced and we now think that Q2 revenue will be roughly flat from Q1. At this point, we still need to get through the second quarter and into the third before we have a solid handle on annual revenue growth beyond what we have predicted.

As you may recall, in Q2 of 2007 we had two major customers building inventory that resulted in a record quarter of $4.1 million. Unfortunately, this was followed by a big drop in revenue, a drop of almost 40% to $2.6 million in Q3. We neither expect a repeat of 2007's $4 million in Q2, nor do we expect a repeat of the large revenue fallout between Q2 and Q3 of last year.

As frustrating as it may be for investors and analysts, Nanophase is still not established enough for quarterly trend and quarterly revenue estimates to track historical curves. Regardless, we are in strong applications with demonstrated value propositions for engineered nanomaterial solutions and these will grow over time. 2008 will be a good year and a critical setup year for 2009.

Roughly 90% of our revenue for Q1 '08 was from our four largest customers. BSF accounted for about 37% of our business; our large architectural coatings customer, 32%; BYK-Chemie, 10% of our business; and Rohm and Haas about 9% of our business.

The first three of these customers also accounted for about 90% of last year's first quarter, but with a decidedly different mix, with BSF accounting for more than 55% of last year's Q1 volume. While their Q1 '08 volume is lower than in 2007, based on BSF's current annual forecast we expect full-year 2008 shipments to exceed last year's.

Moving down, Nanophase achieved a 35% gross margin on sales for Q1 of 2008 compared to 25% for the same period in 2007. This was a function of both favorable product mix and manufacturing overhead reductions from last year flowing through the current P&L. While we're pleased with current margins, we expect them to normalize around 27% to 30% for 2008 given our product mix and volume expectations for this year.

Again, visibility is always an issue. Our margin expectations are tempered by the knowledge that we must maintain capacity, including some excess direct labor, while we continue to invest in the coatings business.

While we're still shipping a wide variety of products in relatively small lots, and as the demand within our coatings business grows, we'll see larger quantities of each type of coatings product being shipped. Efficiencies and margins will improve as a result.

This situation is typical with building new business with the characteristics we see with BYK-Chemie; namely, a larger than optimal catalog of products, a lot of sampling and engineering of initial parties from sample through pilot phase internally, and the building of product awareness in the marketplace.

To continue working my way down the P&L, R&D expenses were down 16% from Q1 of '07. Most of this reduction is due to a continued migration of the Company's R&D and advanced engineered groups to working mainly on applications development. We continue to focus on development that is market driven. We expect that total R&D expenses for 2008 might increase slightly from the first quarter's run rate, but will remain below historic levels.

SG&A expenses were up 20% from Q1 of '07 to Q1 of '08. Two discrete factors drove most of this increase. As we've indicated in the past, the U.S. Patent Office Rules and Practices have changed, and these changes have had a negative impact on small companies. And now, Nanophase has been lucky enough to experience this first hand.

In 2003 Nanophase was granted a broad patent covering plasma processing of nanomaterials. In 2004 the first of three re-exam requests were allowed. Nanophase prevailed in the first two re-exams but was unsuccessful in the third. Thus, in Q1 of '08 the claims in the broad patent were cancelled.

During the four years we argued the broad patent, Nanophase's process technology has evolved and improved significantly. These new developments are well protected as trade secrets. While Nanophase continues to selectively prosecute patent applications which would protect specific plasma processes and products by these processes, our IP focus has shifted toward protecting the practical applications of our nanomaterial.

As a result of our continued innovation and development, the canceling of the claims in our broad process patent will have no impact on ongoing operations. However, there was some non-cash P&L impact. This treatment by the U.S. PTO, among other items, resulted in us expensing $168,000 of formerly capitalized patent and trademark work. The bulk of this charge was accumulated during the tortuous re-exam process and related to the disallowance of the claims in our original patent. As you may be able to intuit, I'm not a big fan of the re-exam process.

The second item contributing to this large quarter-over-quarter variances are approximately $120,000 in audit fees that were all recognized in Q1 of 2008. This is basically a timing difference. Given recent changes in SEC reporting requirements, we no longer accrue things like audit or annual report fees and expense them ratably throughout the year.

The bulk of the annual audit work is typically performed in Q1 and we are now expensing it as services that are rendered as newly required by the SEC. In 2007 we still had a remaining accrual that offset some of our 2006 audit fees, and this resulted in the delta between the two quarters being increased.

Aside from the patent charge, we expect cumulative SG&A expenses to remain roughly flat from 2007 to 2008, with the exception of some increases driven by the addition of more salespeople. Joe will elaborate further on this during his comments.

On a GAAP basis, as reported, Nanophase lost $0.04 per share in Q1 of '08 versus $0.06 per share in Q1 of '07. $270,000, or about $0.015 per share of this current Q1 loss, related to the two nonrecurring and timing items in SG&A that we just discussed.

Analyzing the non-cash components of the Q1 '08 loss we have depreciating and amortization of about $320,000. This expense, a regular component of our GAAP bottom line, amounted to about $0.015 of the $0.04 loss. Equity compensation, also a non-cash expense, amounted to $200,000 and contributed another penny per share to the loss.

In total, depreciating and equity comp expense amounted to about 55% of the 2008 loss, with the patent charge making up another 18% of the quarter's loss. You can see where this is heading. We're really closing in on cash flow breakeven.

Moving to the balance sheet highlights to dig in a little further, we ended Q1 with $16 million in cash and investments and remain in a strong financial position.

Equipment and leasehold improvements amounted to about $90,000 for the quarter, with $600,000 total expected for 2008. We don't anticipate material new capital expenditures this year beyond updating manufacturing, R&D and IT infrastructure as required. Furthermore, we believe that we currently have capacity in place to support a $20 million to $25 million revenue run rate depending on product mix.

On the liability side, the Company now has $1.8 million in total debt. All but $64,000 of this, representing capital leases on lab equipment, relates to the 2005 BYK-Chemie loan of $1.6 million that was used to expand both dispersion and powder production capability to support expected growth in the coatings business.

In terms of Q1 working capital impact, accounts receivable were up to almost $2 million at quarter end due to timing anomalies. Also, accounts payable were up significant from year-end 2007 to about $800,000. This was also related to the timing of payments for operational expenses and capital expenditures being very unfavorable at 12/31. Our quarterly average accounts payable balance for 2007 was about $700,000.

To summarize, cash burn from operations amounted to $575,000 for the first quarter, including some working capital drains related to timing. During 2007 our cash burn from operations was at $1.6 million for the year.

Depending upon how quarterly volume ramps and drives working capital, management expects to improve further on this number in 2008. We still believe that our cash flow breakeven point is in the range of $15 million to %16 million in revenue, with GAAP breakeven at 18 to 19.

Please see the financial statements accompanying today's press release for more details. We've added a supplementary schedule to breakout depreciation and equity comp expense in order not to bog down the call with details. Also, we invite you to review our upcoming 10-Q, which we expect to be filed by May 12th.

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

Thank you, Jess.

As you may recall, at the last conference call on February the 7th I discussed our assessment of Nanophase's competitive status entering 2008, noting that the Company was financially well-postured entering the year with $16.7 million in cash. And we believed that the combination of our technology product quality and application expertise placed Nanophase in the leading nanomaterials position globally.

I further noted that we're not satisfied with the 30% compounded annual revenue growth rate the Company has maintained from 2005 through 2007. And we are certainly not satisfied with our current growth rate estimates for 2008.

Management views increasing the annual revenue growth rate as our first priority, coupled with the continued average gross margin expansion. We have a vision of reaching $50 million and then $100 million in annual revenue in a desired timeframe. To reach this level we need to establish and maintain the 50% revenue growth rate and have taken several initiatives to achieve this, as I discussed on the last conference call.

What has really been a brief time since the February 7th conference call, we have focused very hard on opportunities in our top 20 market segments, which include energy, building and construction, [pertinent] electronics and automotive, to list a few and provide a flavor of the effort.

We are intensely focused on the customer value proposition and understanding the performance and costs required for specific applicational success. We have experienced a very high level of customer activity during the first quarter, especially toward new opportunities and applications.

We have made considerable progress in R&D application development for nanomaterial-enabled industrial coatings, pertinent electronics, architectural coatings, increasing the service life of outdoor clear coatings, and animal hygiene.

We are continuing to rigorously advance customer and product opportunities through our stage-gate process, anticipate that some of our new opportunities should be accretive to revenue during 2008, and are optimistic about the result in revenue growth impact for 2009 from these efforts.

We have also further increased our sales team by adding [Chuck Arakis] as Director of Sales. Chuck brings 22 years of work experience in chemical sales with Ashland Chemical, where he sold to coatings, plastics, textiles, specialty materials, electronics, and building materials companies; industries that have direct correlation to many of our targeted markets. Chuck has a Masters in polymer chemistry and an MBA.

Relative to 2008, we continue to have limited visibility and concern about the macroeconomic condition, especially consumer spending and housing impacting current products in the market. We are maintaining our estimate of 5% to 15% revenue growth for 2008.

As Jess noticed, we expect the second quarter to be essentially flat compared to the first quarter. The surprise second quarter of 2007, in retrospect, we believe was due to inventory building by two of our major customers that will not recur during 2008.

We continue to anticipate increased year-over-year run rates during the second half of 2008, building towards 2009 based on current market partner forecasts and new opportunities that we believe should come online. As we see how the second quarter actually unfolds and have increased our understanding of new opportunity timing, we will reevaluate our 2008 outlook at the appropriate time.

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

Hello? Excuse me, Jennifer?

Yes, sir?

Yes. We're available for questions at this point.

Okay, sir. (OPERATOR INSTRUCTIONS.) Our first question comes from Avinash Kant. Your line is now open.

Good afternoon, Joe and Jess.

Good afternoon.

Hi, Avinash.

A quick question on margin first. You said, I believe, that for the full year calendar year '08 we should be thinking of gross margins in the 27% to 30%.

No.

No.

Is there--.

--No.

Is no?

No. For the next three quarters -- we had a very good revenue mix for the first quarter. I would say for the next three quarters would be in that 27% to 30%, would accrue to a higher level for the year. And we still are maintaining that, as we grow and we hit a level we're absorbing overhead, that we are looking to target 40% gross margins.

Okay. So that's for the next three quarters, right?

Yes.

Okay. And so basically in June, is by the flat revenues you would have lower margins then.

That's quite possible. And it really depends on product mix. If you look at -- I don't want to get into all the details on it, but if you look at the revenue mix for this quarter, we had a very nice revenue mix. And we probably won't have that same revenue mix over the next three quarters, without having any surprises based on what we expect for the year.

I see. And could you explain a little bit about the patent and -- you had three of them and two of them you passed and the third one you didn't. Could you elaborate on that a little bit?

Sure. We had -- we had a broad process patent that we filed in '03 that was granted in '03. And it was challenged. It was challenged once, we prevailed. It was challenged a second time, we prevailed. It was challenged a third time, we didn't prevail.

And internally we recognize we spent more than $100,000 in those challenge processes. We recognized that what we were protecting was essentially 2003 technology. We also have other patents that protect many of the aspects that were in the initial patent. And we've also advanced beyond that to such a level, and have trade secret protected what we actually need to operate the business, that it was fruitless to go a third time and incur more costs. And those costs were incurred roughly equally over '04 -- or over '05, '06 and '07.

And this has to do with the stance -- to a great extent of the U.S. PTO kind of changing and our understanding of it is different. Going forward we are not going to be capitalizing defense costs and things like that, not that we have this as an everyday issue, but that was something that was -- it was a lesson learned there. We don't believe though, in any way, this is going to stigmatize the business and not allow us to move forward with our business plan.

And who the challenger was? Could you please talk about that?

We don't know. They don't have to disclose that in the United States and that's where the patent was challenged. Interestingly, the same patent that was challenged has been granted and not challenged in Canada. And we have these floating through Europe and Japan and we haven't had any pushback at all. So, I'm sure it was a competitor of some sort, but we didn't view it as worthy of continuing down that line. And we also have additional patents that we believe protect everything here that's seminal.

It has to be a U.S.-based competitor? It could be a competitor from outside, too.

Could be anybody in the world.

Okay.

And there was no penalty for that company -- which is probably the same company -- for the first two failed challenges there's no downside for them. They write another letter and think of other things. So, this is just a tough system.

I see. And in terms of now new products and everything else, where do you see the most opportunity coming in? I know you are trying to drive your growth beyond close to 30% to 35% that you had been earlier. Where do you think that growth could come from next year?

Avinash, this is Joe. We think that a lot of the growth is going to happen in the industrial coating space, which would be typical industrial coatings. And also, we've done a lot of work and have a lot of interest in working with customers to prolong the life of clear coats for outdoors. That seems to be an area of very possible near growth.

Architectural coatings is an area we have a lot of activity in with several companies, so that's an area. Animal hygiene -- and I can't go into the details on animal hygiene, but animal hygiene has come on real strong for us. And pertinent electronics has come on strong. So there's four or five, I think, major areas that, say, throughout 2008 and 2009 -- that have the potential to favorably impact revenue.

Perfect. That's very good. Thank you so much.

Thank you.

Our next question comes from Nick Tishchenko. Your line is now open.

Good afternoon. Thank you very much. Joe and Jess, first I want to thank you for much more open form of presentation. You eliminated a lot of my questions. Two more questions still remain.

The first one is almost for the fourth quarter you are talking about inventories at your customers. What approach you are going to use to get a better handle of what is going on at your customers' inventories? How you can track it to accommodate in your business throughout the year?

And I have another question. I'll ask it after the answer.

Okay, Nick. Are you referring to our market partners or are you referring to the customers?

I'm talking about market partners and your customers.

Okay. So, relative to market partners, the communication with our market partners happens at least -- I mean, it happens every day and it happens every week. But from a face-to-face meeting standpoint, we're having pretty successful business meetings almost on a quarterly basis. And we're using the same stage-gate process with our market partners as we are with our customers.

So, we're pretty rigorously tracking progress to stage-gate. And with a focus on -- and asking -- and continuing to push on getting them to the revenue point. Getting into the market, getting into a productized position in the marketplace.

So, I think from a level of activity we're much more in the market partners' face and the customers' face than we have been in the past with the new team -- with the new sales team. And frankly, that's one of the reasons we're adding people is we need more people on the street. We need more people visiting customers. So, that's why we brought Chuck in.

I see. So, basically what you are telling us, that the situation when there was hidden accumulation of inventories in the second quarter of last year is not likely to repeat because you would be able to have a better handle on the situation in real time. Am I correct?

Well, I think so. But understand, the inventory building that we think now was going on in the second quarter of last year, we were strongly communicating with our customers at that standpoint, okay?

The one customer's an architectural coating customer. And they saw sales -- their projected sales, okay? So, this is a customer who gives us a sales forecast, Nick, plus or minus 50%. Okay? So, that's what we deal with. Okay? So, in that quarter they had forecasted a much higher level than they wound up getting, but that was a start of perhaps consumer cutback. And if you look -- if you go back and look at that quarter you'll see a lot of the do-it-yourself stores weren't in that quarter, I believe. So, I'm not sure how we could have predicted that to be really honest with you. We were talking to them every day. We had a sales forecast.

The other situation, which we could have probably have managed better, frankly, it was with a German customer. And we did not realize until the end of the quarter that the orders they were beating us about the head the shoulders for, a lot of it was for inventory. Okay? So, we're staying much closer on top of that with that particular customer. And -- because that's an easy thing to grapple with because the inventory's at one of their facilities. The architectural coating customer, the inventory primarily is not at their facility. They're -- it's at the retailer.

I understand. Thank you very much. It clears the situation for me.

The second question probably to Jess. Jess, there was a meaningful pick up in account receivables and inventories. You mentioned something but I didn't get it. Would you please elaborate a little bit on this?

Sure. I mean, it's really straightforward. On the inventory side it really didn't pick up that much and we're doing a nice job. We did have a higher rate at the end of the year.

Just to be able to smooth out demand occasionally we'll pick up inventory. We have nothing in inventory that is not -- we don't convert things, first of all, prior to having orders for them. And we have nothing sitting in inventory that's at risk.

The bigger change this particular quarter in A/R, accounts receivable, was a fluke. We have a customer who routinely pays very well who just simply didn't get an invoice and it was the last minute and we got paid after 3/31. So, that was one of those where we ship them once or twice a quarter a big amount and, for whatever reason, they didn't have an invoice handle on it.

I would say to further elaborate, of that $1.9 million, 0.14% of it is over 60 days. I mean, we have very good experience with all of our customers and market partners and this was just -- there was a flukish part to that. It should have been more in the neighborhood of what it typically is, one-point-something, 900 to 1.4 or 1.5 million.

So, if you would be reporting your quarter today this situation would be very different.

It would be.

Thank you very much.

Sure. You're welcome.

Our next question comes from Jim Liberman. Your line is now open.

Hey, Jim, are you there?

Maybe he dropped.

Mr. Liberman, your line is now open.

Okay. Are you able to hear us now, Mr. Liberman?

I can hear you. Can you hear me?

Yes, we can, sir.

Okay. There's somewhat -- can you hear me, Jess?

Yes, we can.

We're here.

Okay. Okay, I'll start again. Thank you. It sounds like you're making a great deal of progress on a number of different fronts. Did I hear you correctly that one of the areas of products under development was in the energy field?

Yes.

And are you able to describe in any general terms what the applications may be?

We're in the midst of negotiating a development agreement on that, Jim, and I'd really rather not talk about it right yet.

Okay.

We've done a lot of development and now it's time to formalize an arrangement.

Okay. I did have another follow on question. I--.

--Sure--.

--I respect the confidentiality on all regards.

Are you making -- do you feel you're making good progress in bringing along other coatings customers so that you won't have such a reliance on the current customers you have right now?

Yes, I do. I think that it takes time. Coatings customers study things a long time. I mean, in the coatings industry, especially architectural coatings, there are test methods to artificially age and artificially advance time. Okay?

Yes.

But those are used to screen techniques. There's still finite time involved once you perfect the formulation and go through the final test before it's taken to market. So, there is just a time lag involved in that.

But I would say that in the last several months we've seen a real increase in interest in nanomaterials used for industrial coatings. And I noted the clear outdoor coatings. We have several people we're working with on that.

So, I feel like it's going well. I feel like it's a real interest as compared to the -- some of our past, where it was a scientific interest but it wasn't necessarily business or product-driven interest. You know what I'm saying?

Yes, I do. Do you think that--.

--And this is people trying to get new products to the marketplace.

Right. And do you think that some of your existing customers will be more inclined to flag or advertise some of the new features so that the rest of the general public will be aware of it? Because it seems like very exciting coatings technology that you have, but not enough people know about it.

I don't know, Jim. That's hard for me to answer.

Right.

It's just hard for me to answer at this stage. I don't know how they're going to be. I think -- some of them are trying to put together some kind of slogan, some kind of names that might say something about Nano. Now, whether they're gonna talk about us, I highly doubt.

Yes.

I mean, people just don't.

So, your best approach here is to get -- is get a broader array of customers so that you can get more presence in the field.

Sure. Sure.

Okay.

And frankly, that's what we're working on, especially in architectural coatings.

And if I were -- wanted to buy some of the clear coating for outdoor applications, would I be able to find them if I looked hard enough these days?

They're not quite on the market yet.

Okay.

They're not quite on the market yet. But you'll be able to find them at -- hopefully at do-it-yourself stores shortly.

Okay. Excellent.

Okay.

Thank you very much.

Thank you.

(OPERATOR INSTRUCTIONS.) There are no further questions in queue.

Thank you for your time today. I hope you found the information a little bit more appointed towards some of the questions we've been asked in the past and we covered it the first time. And we'll talk to you again next quarter. Thank you.

Thank you.

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