SECOND QUARTER 2011 CONFERENCE CALL
Jess Jankowski, President & CEO
Good morning everyone! We appreciate you joining us for our second quarter financial conference call. Communicating with our shareholders and members of the financial community is an important part of my job, and one that I enjoy.
As we’ve discussed with you in the past, our goal is to accelerate our rate of annual revenue growth. We do this with new product introductions (in Nanophase’s case, that usually means specific product formats, designed with our target customers and markets in mind). We do it with focused market and application expansion; and we do it by working closely with our existing customers. Our strategy is paying off, both in immediate results, with our growing revenue dropping down to the bottom line, as well as progress in product development work with our customers. We are also seeing a moderation to the cyclicality that has impacted our business over the years. While personal care products, along with outdoor paints and stains, generate a majority of our revenue, drastic seasonal revenue peaks are impossible to avoid.
As we begin to realize revenue from growth in our existing polishing business, along with new products in different markets, our sales should become less seasonal. We’ve seen this in the first half of 2011, to be sure, but, more importantly, our revenue streams are also becoming more diversified. As a consequence of this, we are starting to enjoy revenue growth and reduced cyclicality. Since we haven’t fully eliminated the seasonality of our revenue, we expect that the next two quarters will probably show a portion of the drop off from the second quarter we’ve seen in the past, but it will be more moderate. Further, we expect second half 2011 revenue to exceed second half 2010 revenue, just as first half 2011 revenue has exceeded first half 2010 revenue. The magnitude of the increase will depend on the usual mix of customer delivery schedules and how quickly certain projects reach commercialization, but we’re confident that this year’s revenue will grow beyond last year’s.
These positive factors help to level product demand, allow us to improve planning, manage inventory and labor better, and help to stabilize the company so that management can focus on new growth areas.
Now I’m going to hand off the mic to Frank for an overview of our second quarter financial results.
Frank Cesario, CFO
Good morning, this is Frank Cesario. Before I begin with an overview of our financial results for the second quarter, please note that all financial results are stated in approximate terms.
Revenue for the quarter was $2.9 million, slightly ahead of the $2.8 million reported in our first quarter. We shared during the previous call that we believed year to date revenue throughout 2011 would exceed that posted in 2010. While that has been true during the first half of 2011, we expect this favorable trend to accelerate as we enter the second half of 2011. Thus far, 2011 year to date revenue of $5.7 million is ahead of 2010’s comparable revenue of $5.3 million. 2010 included a seasonal spike in the second quarter that we didn’t see in 2011. With our expectation that the third and fourth quarters of 2011 will exceed related 2010 figures, we see an increasing gap between 2011 full year performance and 2010 full year performance from the 7% it stands today, into double digits for the 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 oxide is a common “rare earth” material 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 and continue through today. The cost of cerium oxide has exploded and availability is not guaranteed. Currently, we have been able to secure adequate supplies of cerium oxide, but at very 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 oxide, we may experience some decreased profit 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, our gross margin for the business has stayed strong during 2011, with a 33% gross margin exceeding the 32% gross margin posted for the first six months of 2010. Increased revenue is obviously a contributing factor, but incremental cost savings have helped resolve this raw material cost issue.
The net loss for the quarter was $0.5 million, or $0.02 per share, versus a net loss of $0.1 million, or $0.01 per share, for the comparable quarter. This is due to the 2010 revenue spike we discussed. On a year to date basis, net loss for 2011 was $1.1 million, or $0.05 per share, 15% better than the loss of $1.3 million, or $0.06 per share posted in 2010. Also significant, “non cash” depreciation expense in excess of replacement capital spending as well as equity compensation charges constitute the majority of the total net loss. Beyond working capital requirements, the business required approximately $0.4 million of cash to operate during the first half of 2011, an improvement from 2010, and a significant improvement from prior years.
With our current run rate, we could achieve cash flow break even with revenue below $14 million per year ($3.5 million per quarter).
Despite carrying substantially more working capital, our balance sheet remains strong, as we finished the quarter with $3.5 million in cash and cash equivalents. We reduced our cash position from the end of 2010 by $2.2 million, but $1.8 million of that $2.2 million went into working capital, and we don’t expect to have to make additional investments in working capital during 2011. We expect the cost of rare earth materials to come down eventually, at which point we would expect to reduce our investment in inventory. We are fortunate to have no debt.
Now, I would like to turn the call back to Jess.
Jess Jankowski, President & CEO
With material revenue flows generated from several markets, Nanophase is becoming a more multi-dimensional company. Currently, 60% of our revenue is generated from the personal care market, 10% from coatings, 20% from polishing, and 10% from the sale of miscellaneous products, some of which we think may eventually develop in to larger markets for Nanophase. We expect that those percentages will continue to shift, with increased emphasis on scratch-resistant products for UV-curable coatings, polishing products and outdoor coatings.
Last November, we developed NanoArc® Aluminum Oxide dispersions to assist coatings formulators in meeting the rigorous scratch- and mar- resistance requirements for thin, highly transparent coatings. These products are designed for UV-cured coatings used on electronics, wood and in a variety of graphic arts applications, none of which are necessarily seasonal.
At the end of this past March, we combined an advertising campaign with the formal launch of our NanoArc Aluminum Oxides at the European Coatings Show in Nuremberg, Germany. Our sales team is currently working with a series of qualified prospects from the show. Judging by the demand for samples of these products, it looks like the market recognizes these products as innovative. In contrast to years past, Nanophase is working directly with the users of these materials; a critical factor which we think will dramatically increase the probability of success.
Separately, we attended the SemiCon West Show last month. We did this to continue to expand our knowledge in the various polishing markets where we’ve historically had partner-driven business and a series of smaller polishing customers. This is a broad area that we are spending more time on going forward to see if we can have an impact with our new customer direct approach.
While we don’t issue a lot of news releases, team Nanophase will be busy over the next six months, as we plan to attend and/or exhibit in several industry conferences—all targeting markets where we expect our products will have cutting edge performance advantages.
Additionally, there is important news from the personal care industry, which we believe will have a positive effect on our sales in that market. In June, the FDA released new sunscreen regulations that require products to pass certain effectiveness tests and adopt new labeling. The purpose of these regulations is to make it easier for consumers to understand exactly what protection a sunscreen can provide. The regulations require that all products labeled ‘broad spectrum,’ which you’re probably seeing more and more of in sunscreen marketing, pass tests for both UVB, which causes sunburn; and, importantly for us, UVA exposure, which has been linked to skin cancer. This is an important development for Nanophase, as we are one of the few providers of naturally occurring, metal oxide UV blockers, or so-called “physical sunscreen” products. The target customers for our products are formulators working to enhance SPF ratings on sunscreens, moisturizers and makeup. Our products provide protection from both UVB and UVA rays, so the new labeling requirements should be beneficial for ingredients like zinc oxide, which are inherently UVA blocking, and already approved for use by the FDA. Fewer of the synthetic organics are approved for use as UVA blockers in the US, which makes meeting the new labeling regulations challenging if formulators and manufacturers rely only on the organics.
Our business strategy, the benefits of which we are beginning to see, provides the freedom to launch new products that target the end user, such as our NanoArc Aluminum Oxides, while we maintain the flexibility to strengthen our customer relationships with both partners and manufacturers. Our strategy represents the best of both worlds, as it provides the advantage of working directly with excellent intermediary partners, and with world-class coatings manufacturers, who are ultimately our end users. We can now add our polishing customers to that club.
We are building momentum, and 2011 is an important year for Nanophase to establish itself as a stand-alone provider of products for the broad markets we serve and have targeted. In parallel with our strategy execution, we’re working hard to broaden general awareness of Nanophase among potential customers — domestic and international, in markets where we are active or planning to be active. Leveraging of our market expertise has resulted in a pipeline that’s full of solid opportunities.
Again, we had a solid quarter, we had a solid first half, and we’re building toward a solid year. As always, we plan to keep you all posted on our progress through news announcements and conference calls. I know several of our investors who regularly participate in the call are on vacation this week, but I’d see if we have any questions today on the live feed.
Kevin, would you please begin the Q&A session?
The August call is usually the call with the lightest attendance given vacations. Let me close by saying that, at the beginning of the year, we outlined the milestones necessary to achieve our goal, which is to build sustainable shareholder value. We’re now halfway through the year and fully confident that we have the know-how, products and business strategy to achieve our goal.
We appreciate your time today and are always available for any follow-up questions you may have. Enjoy your day and thanks for your participation.