SECOND QUARTER 2009 CONFERENCE CALL
Jess Jankowski, President & CEO
Good afternoon and thank you for your ongoing support of Nanophase. We continue to move forward with our new business model and are beginning to see progress. Our expectations for Nanophase are well grounded and very high.
I understand that nothing speaks as loudly as additional revenue dollars, but given where we are at with our new approach, coupled with the 18-36 month time-to-market in most industries we sell to, I am looking for ways to mark progress toward future revenue so that you can share our optimism. The challenge that we grapple with is our ability to provide you with useful information about how your company is evolving, without alienating existing customers, or providing our competitors information. Disclosing too much can make it more difficult to expand into new markets and, especially pertinent here; this type of input can create confusion by packing too much material into a forum better suited to brevity. I am sure you will begin to sense our overriding theme as we continue to refine our message over the coming quarters.
Today, I will briefly cover the financial results for the second quarter, then spend the majority of time sharing the progress we are expecting as we continue to execute on our new business model. Focus remains the key here.
We are confident that it is not a matter of “if,” but “when” we are able to accelerate our growth. As many of you know, we are deeply tied to the consumer products and housing markets. Both have taken a beating during this recession. We managed our resources responsibly, by aligning our cost structure to what we saw happening in our targeted markets, while continuing to meet our customer commitments and focusing on developing markets for future growth. We have been successful and will share more of that after the financial presentation. Before moving on though, I would like to add that we are beginning to see a recovery in some of our key markets which I will also discuss later in more detail.
First, I would like to cover the financial results for the second quarter, which as always, are stated in approximate terms.
Revenue for the second quarter was $1.6 million, an improvement over the first quarter’s revenue of $1.4 million. We cautioned early on that revenue would trend down, as customers weathered the economy by squeezing their inventory levels and focusing on lower cost products. It now appears that much of the excess inventory has been taken out of the system and we, along with our customers, are starting to see signs of recovery. As a percentage of total revenue, gross margin was 11% for Q2 of ‘09, up from 6% for Q1. Gross margin is tied to sales volume and although we have reduced our fixed costs significantly, we need more volume to fully absorb our overhead.
We attribute the improvement to our margins in the second quarter to our February reorganization, which eliminated 25% of our staff; the majority in manufacturing. This move considerably reduced our fixed manufacturing costs. The second quarter net loss of $1.2 million, about 6 cents per share, was flat when compared to the first quarter’s $2.1 million loss, after backing out Q1 severance charges of $800,000.
Regarding operating expenses and cash flows…. we finished this past quarter with $4.3 million in cash and cash equivalents and an additional $5.3 million in longer-term investments. We have paid off more than a million dollars of our debt during the first half of 2009, with the final half million dollar payment made in July. We are pleased to add, that not only have we reduced our cash burn, but we now have a debt-free balance sheet, a statement not many companies can make and we should have more than enough resources to take us safely through 2010.
With all of the changes that have taken place at Nanophase, we have had an uncommon opportunity to analyze our operation and eliminate spending that doesn’t directly help to build the business. This exercise has allowed the company to perform as well, if not better, in meeting customer expectations than before. The February 2009 reorganization and last year’s changes in senior management reduced annualized operating expenses by approximately $2 million, or $500K per quarter. This reduction, along with additional cost reduction initiatives, was reflected in our current results, with a reduction of more than a million dollars year-over-year in SG&A expenses.
We remain confident that these staffing changes will not limit our ability to execute our business plan through 2010. We have seen our lean and flexible team deliver as well, or better, than before the cuts, demonstrating the significant benefit of a lean structure and a sharpened focus. As I have discussed, these changes reflect both the impact of the economic climate on Nanophase and our migration from a partner-driven, volume manufacturing model, to a customer-direct model.
Let’s break down the revenue composition for the current six-month period.
As discussed in April’s conference call, given the state of the semiconductor markets and inventory accumulation, our largest CMP customer did not purchase materials in the first half of 2009 and we expect minimal volume in the near term. This type of thing has been a clear driver of our focus on developing multiple customers in each of our group of targeted market segments. It is the only way to reduce the risk associated with any particular customer or market.
Six-month revenue from our largest architectural coatings customer was about $600K, down significantly from 2008. This is partially due to the down turn in the housing and home improvement markets in general, but is also due to lower volumes being purchased by this customer. They are a very innovative company and a very important customer for Nanophase. We continue to proactively provide them with new ideas to drive future growth, but it is our view that revenue from this customer for existing products will continue to be lower than it originally had been, going forward. We are confident, however, that our Exterior Coatings Market will remain a strong growth driver over time.
It has been our experience in Exterior Coatings that UV protection in transparent architectural and industrial coatings represents one of the biggest growth opportunities for Nanophase. This has been and will continue to be an area of focus, because this is where we see the greatest opportunity for building sustainable value.
Revenue from our largest customer, BASF, amounted to more than 50% of our sales for the first six months. At $1.8 million they were down by approximately 25% year-over-year.
On the upside, we are seeing the climate for personal care products improve, as there continues to be a strong need for inorganic, full-spectrum UV absorbers. Industry trends are also favorable, including UVA-disclosure regulations, increased demand for higher SPF values and growing demand for all-natural products. Our materials provide the best, non-organic chemical UVA absorbers currently available. These outstanding material qualities are marketable not only in Personal Care and Exterior Coatings, but also in many other potential markets.
Long-term, the sunscreen and personal care markets should continue to grow at a sustainable single digit pace and continue to be a solid base of revenue for Nanophase.
Throughout 2009, the personal care and housing markets will clearly have an impact on our top line. Fortunately, the personal care market appears robust and may provide a near-term bright spot for Nanophase. I will have a better feel for it next quarter. As frustrating as it is, this remains a highly variable situation.
We are focused on actively positioning Nanophase for the rebound of these and other markets and we are aggressively pursuing multiple market opportunities.
Under our new model, we have reached a level of applications development and market expertise in one broad market; Exterior Coatings (which includes paints, stains and industrial coatings) that, in many cases, has given us a knowledge level exceeding that of our customers.
Let me give you a recent and telling example of why our new approach is critical: We were fortunate enough to get some indirect feedback from a product development manager at a company that we thought had never been interested in working with Nanophase in the past. He told our source that he would eventually get around to working with the samples we sent him, but because we didn’t provide him lab test data, comparing his existing product to his product with our material incorporated into it, compared against his competitor’s product, he moved our material to the back burner, saying he would get to it in six months or so. He pointed out that, if we could give him this sort of data package on the front end, he would fast-track our materials and start working with them right away. In other words, without us shouldering more of the load, the amount of risk and effort required for him to move our products through to a commercial roll-out is too high, unless we take some of the early stage risk away. His request is exactly what we are currently able to support in many of our exterior architectural coatings applications. Typically, this efficacy work takes us six months to do, but once it is done, we can apply it to many other customers across an entire market. It is an excellent investment!
Our challenge is to focus on a few key markets with unmet needs we can address, prove that our materials make sense, then identify the specific customers we can engage to evaluate our materials in their applications. It is more time-consuming than difficult and we don’t have the resources to do this in a dozen markets, but we can go after a targeted group very effectively. This investment will pay off, but it is front-loaded.
When we can walk in with proof that our materials work, we make our customers’ decision making process much easier and we can ensure we have the highest likelihood of success from day one. This is why we continue to refine this focus to our best advantage.
In this critical year, we have developed a new management team that is well aligned and now complete, with the recent addition of Frank Cesario, our new CFO, a new sales strategy that is starting to bear fruit, a new ready-to-go product approach, new strategic markets, new applications and a solid balance sheet, debt-free as of July 2009.
The level of enthusiasm and commitment to the future at Nanophase is very strong. All of us are aligned with our strategic vision, the goal of which is to build the value of Nanophase.
The economy is tough, but our technology, our products and most significantly, our people bring resources and options to the table for our customers and prospective customers, that will better help them gain a competitive advantage in their marketplaces.
Unlike many companies, we didn’t just cut costs; we challenged our model to be more efficient, while maintaining extremely high quality. For those who don’t know, our customer returns are virtually zero and in Q2 we hit our millionth hour of production without a lost-time accident. That speaks to a company that is focused on getting the process right. We are good at what we do and have been developing new ways to demonstrate those skills to the marketplace. This is how we will grow.
If it is not clear by now, I am optimistic about our future, as is our entire team.
I appreciate your time today and I am available for any questions that you may have.