Jess Jankowski, President & CEO

Good morning! Thanks for joining us today. We appreciate your participation in our first quarter financial call. We’re happy to see conference call attendance continue to increase, and we encourage you to stick around for questions during the Q&A session.

We’ve started the year with a great first quarter. Revenue increased 39 percent over the comparable quarter last year. During our year-end call, we talked about the importance of execution. 2010 was a pivotal year for the company, and I couldn’t be happier with the execution of our new direct-selling focused business plan. The company is positioned for a year of sound revenue growth and expansion into some exciting new markets. 

This year, we have a number of important milestones that will allow us to continue our revenue growth for the near-term, and provide new uses for our products that we think will allow Nanophase to enter some exciting new, high-growth markets. For continued growth, it’s important that we keep the company moving forward with cutting edge technology. The products for these target markets are a work in process, and we’ll keep you posted as we get closer to product validation.

We recently returned from the European Coatings Show, which is the largest annual event in the industry, where various additive suppliers showcase their products, and their know-how, before a global audience of end-users. At this show, we launched a new group of products for scratch-resistant coatings. We surprised not only our competitors, but also many in the coatings industry, as they’d been unaware that Nanophase has a family of products that can add significant benefits to a wide range of coatings. The importance of thin, durable and highly transparent coatings, with superior scratch and wear resistance, may be news to many investors, but if you’re in a grocery store, a furniture store, an electronics store, or a book store, almost all of the things you buy are coated to preserve the packaging, extend a product’s life, or aim for maintaining a like-new appearance. “Coatings” is a huge industry, and one that we can capitalize on. 

Before I go any further, I’d like to hand things over to our CFO, Frank Cesario, for an overview of our first quarter financial results.

Frank Cesario, CFO

Thanks, Jess. Good morning, this is Frank Cesario. Before I begin with an overview of our financial results for the first quarter, I’ll remind you that all financial results are stated in approximate terms. 

We were delighted with the 39 percent increase in revenue for the quarter. We reported revenue of $2.8 million, versus revenue of $2.0 million for the comparable 2010 quarter. For some perspective on a quarter-to-quarter basis, each quarter of 2010 reported more revenue than any quarter of 2009. The first quarter of 2011 reported more revenue than all but the second quarter of 2010. The first quarter results have positioned the company for another growth year. 

Currently, as we discussed in our year-end call and yesterday’s press release, we, along with our competitors, have a sensitive raw material issue. We use a cerium oxide in products for polishing applications. Cerium is a common “rare earth” metal that, while abundant, can be difficult to extract. 

Today, virtually all rare earth metals are exported from China, which began imposing severe export limitations during the second half of 2010. The cost of cerium has exploded and availability is not guaranteed. While other mines have announced their intention to provide cerium, it will take time for them to begin production. Currently, we can secure adequate supplies of cerium, but at high prices. This has affected our working capital and requires us to work closely with our customers to jointly manage this challenge. 

Until we can source less expensive cerium, we may experience some decreased profits margins from the sale of our dispersions for polishing applications, which are still a profitable business for Nanophase. Despite the negative impact in gross margin percentage due to the rare earth situation, the improvement in first quarter revenue covered more of our fixed expenses, and allowed us to report higher gross margin on a comparable quarter basis. Gross margin for the first quarter of 2011 was 33 percent, compared to a gross margin of 24 percent for the first quarter of 2010. Gross margin dollars were nearly double the 2010 figure. 

The net loss for the quarter was $0.6 million, or $0.03 per share, versus a net loss of $1.1 million, or $0.05 per share, for the comparable quarter. This is due to higher revenue and improved profitability. With our current run rate, we could break even with revenue of around $14 million per year, or $3.5 million per quarter.

Despite carrying more working capital, our balance sheet remains strong, as we finished the quarter with $4.1 million in cash and cash equivalents. We reduced our cash position by $1.7 million, but $1.5 million of the $1.7 million went into working capital. We expect the cost of rare earth materials to come down, eventually, and we will reduce our investment in inventory. And again, we are fortunate to have no debt.

Due to the improvement in our polishing business, the cyclicality we usually enjoy (peak revenues in the second quarter, falling off that summit on either side) should be more flat in 2011. We expect better first, third and fourth quarters in 2011 compared to the comparable quarters of 2010. As for the second quarter spike from 2010, our best guess is that we will be slightly less than that in the second quarter of 2011, but to be clear, we expect our Year To Date revenue numbers to be better throughout 2011 than 2010, and that spread to increase as we move through the second half of 2011. 

I would like to now turn the call back to Jess.

Jess Jankowski, President & CEO

Thanks, Frank!

In late 2010, we announced our NanoArc® aluminum oxide dispersions for use in UV-cured, scratch-resistant coatings. At the end of March, we combined an advertising campaign with the launch of the products during the European Coatings Show in Nuremberg, Germany. This show was the perfect venue for Nanophase to introduce manufacturers and potential customers to our family of NanoArc® products. This launch gave us exposure to a critical mass of coatings manufacturers, who were pleased and surprised that we manufacture such versatile products for the industry. I attended the show, as did David Nelson, our VP of Sales and Marketing, Pat Murray, our VP of Research and Development, and several other members of our team. We typically wouldn’t send such a large group to an industry show, but it was important that we let the industry know that Nanophase was launching a product line, our NanoArc® alumina dispersions, and not simply announcing the availability of solutions in a new market. The interest level in our NanoArc® products was high, as evidenced by a busy booth, and our having to reprint additional brochures for handout during the show’s first day! We received a few hundred leads, which the sales and marketing team have already begun evaluating and making follow-up contact. We expect to generate a number of new customers from this activity. 

Our business strategy, and the modified contractual arrangements we announced last fall, have provided the freedom to make a product launch of this nature possible, while allowing us the flexibility, to maintain and strengthen our customer relationships, with both partners and manufacturers. It represents the best of both worlds, as it provides the advantage of working directly with excellent intermediary partners, and with world-class coating manufacturers, who are, ultimately, our end users. 

In yesterday’s news release, we briefly discussed product testing cycles and revenue leveling. When investing in a stock, we know you look at the company’s near- and long-term potential. So it’s important to understand the cycle of our newly launched NanoArc® alumina products.

1. The chemistries in the scratch-resistant marketplace are more straightforward, which we expect to lead to faster application development and product acceptance;
2. The pre-market testing cycle takes months, not years, as the bulk of the durability work we’ve done centers around scratch- and rub-testing. Unlike the timing limitations inherent with outdoor wood durability testing, where industry standards require several changes of seasons to fully determine the benefits of our UV-resistant dispersions, the pre-market testing of scratch-resistant coatings is relatively quick;
3. Additionally, in this market, we don’t expect to have the same revenue seasonality as we have with either skincare products, or exterior architectural coatings, where the bulk of our business builds in Q1 and Q2, then tapers off in Q3 and Q4.
4. This new scratch-resistant coatings market will provide a nice balance among our other markets in terms of time-to-market and seasonality.

While we highlight these applications today, scratch-resistant coatings are just one component of our product strategy. 

2011 will be an important year for Nanophase as a stand-alone provider of products for the broad coatings marketplace. 

To summarize our newer potential revenue streams:

 - We believe our exterior architectural coatings materials will generate new customer revenue this year, with a modest ramp-up in the second half of the year. 
 - We also expect our scratch-resistant additives to generate new customer revenue in 2011, while ramping up into 2012. 

Our goal is to launch more products soon, some that may generate revenue this year and ramp up in 2012. 
We’ll continue to focus on a variety of benefits that differentiate our products from the competition, while targeting unmet needs, in our four top markets:

 - Personal care 
 - Exterior architectural coatings, 
 - Scratch-resistant coatings, and 
 - Architectural windows, where we’re looking for consumer applications, which is where we think the volume will be.

It remains to be seen, but we think we’ll become a momentum company. We’re seeing the benefits from the launch of our direct selling strategy, even in a tough economy. In parallel with our strategy execution, we’re working hard to broaden brand awareness among the hundreds of potential customers, domestic and international. Our leverage is good and we have a pipeline that’s full of solid opportunities. Of course we plan to keep you all posted on our progress through news announcements and conference calls. 

Operator, would you please begin the Q&A session?

It’s a new year, but our strategy hasn’t changed. We’ve outlined the milestones necessary to achieve our goal: To build sustainable shareholder value. We move into the year with confidence, and an expanded family of nano-enabled solutions to enhance our customers’ products. Your management team expects to see continued growth throughout 2011.

I appreciate your time today. Frank and I are always available for any follow-up questions you may have. Enjoy your day and thanks for your participation.