THIRD QUARTER 2011 CONFERENCE CALL
Jess Jankowski, President & CEO
Good morning everyone! We appreciate your joining us for our third quarter financial conference call.
All companies, Nanophase included, strive to accelerate annual revenue growth. Our strategy has been to change our business plan to address markets and customers directly, and, through the introduction of new products, address unmet industry needs, and expand our market reach. It’s beginning to pay off with significant progress in product development work with existing customers, continued revenue growth during a dreary economy, and an improved bottom line. We’re also experiencing moderation to the cyclicality that has greatly impacted how we’ve managed our business over the years, although we still continue to be too dependent for my liking on the personal care demand curve. The moderation we’ve seen thus far is a direct result of our market diversification, which includes product sales into non-seasonal industries such as electronics, as well as segments of the coatings industry. These positive factors help to balance product demand, improve our planning, better manage our inventory and labor, and help stabilize the company so that management can focus on new growth areas.
While we introduced you to one of these areas, scratch resistant additives, in Q1, I’d like to go over that in more depth after Frank provides an overview of our third quarter financial results. I’ll discuss why we’re giving this segment of the coatings industry a full court press, and why I’m enthusiastic about our future in it. I’ll also touch on some of the other market development we’re engaged in.
Frank, would you please provide the financial update?
Frank Cesario, CFO
Good morning, this is Frank Cesario. Before I begin with an overview of our financial results for the third quarter, please remember that all financial results are stated in approximate terms.
Revenue for the quarter increased 8 percent to $2.2 million. We are seeing some softening due to renewed economic concerns in the marketplace and will carefully monitor the market through the remainder of 2011 so that we can execute our 2012 strategy. 2011 year-to-date revenue of $8.0 million is ahead of 2010’s comparable revenue of $7.4 million.
As we have discussed in previous calls and press releases, we, along with our competitors, have a sensitive raw material issue. We use cerium oxide raw materials in products for polishing applications. Cerium oxide is a common “rare earth” material that, while abundant, can be difficult to extract. Please note this is only one area of our overall business.
China has continued imposing severe export limitations on its rare earth metals and the cost of cerium oxide has exploded with availability not guaranteed. We have been able to secure adequate supplies of cerium oxide, but at very high prices. This has affected our working capital and gross margin percentage, and requires us to work closely with our customers to jointly manage this challenge.
Until we can source less expensive cerium oxide, we will likely continue to experience profit margins that are tighter than we have experienced historically from the sale of our dispersions for polishing applications, which, to be clear, are a profitable business for Nanophase even in the existing climate. Despite this negative impact, our gross margin for the business stayed strong during the first nine months of 2011, with a 28 percent gross margin favorably comparing to the 29 percent gross margin posted for the first nine months of 2010. Increased revenue and incremental cost savings have helped offset the increasingly expensive cerium oxide raw material.
The net loss for the quarter was $1.0 million, or $0.05 per share, versus a net loss of $1.6 million, or $0.07 per share, for the comparable quarter. On a year-to-date basis, net loss for 2011 was $2.1 million or $0.10 per share, this favorably compares to a net loss of $2.9 million, or $0.13 per share posted in 2010. I would like to point out that 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 $1 million of cash to operate during the first nine months 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 healthy, as we finished the quarter with $3 million in cash and cash equivalents and no debt. We reduced our cash position from the end of 2010 by $2.5 million, but the majority of that went into working capital and we don’t expect to have to make additional investments in working capital through the remainder of the year. We expect the cost of rare earth materials to come down eventually, at which time we expect to reduce our investment in inventory. Our unencumbered balanced sheet continues to provide us a good deal of flexibility in handling challenges, such as this raw material issue.
Now, I would like to turn the call back to Jess.
Jess Jankowski, President & CEO
Last March we combined an advertising campaign with the formal launch of our NanoArc Aluminum Oxides at the European Coatings Show in Nuremberg, Germany. These materials address a market we broadly refer to as Scratch Resistance. This gave us our first opportunity to work directly with the end users of our products, which we think dramatically increases our probability of success from the testing and demonstration cycle directly to commercial order flow. This market has great potential for Nanophase, and if demand for product samples is an indication of interest in the commercialization of our technology, we expect to maintain our revenue momentum in 2012. Our sales team has a pipeline of potential customers in various stages of the sales cycle.
When we create a new product, or suite of products in the case of scratch-resistant additives, we start by looking for large addressable markets. By attacking some of the largest markets in the coatings industry, we expect to quickly get in front of the leading manufacturers with these materials. Scratch Resistance represents a significant addressable market for Nanophase. We’ve launched a line of products designed to make coatings more resistant to scratches and abrasions, while maintaining optical clarity. This allows features like product colors and design elements to be clearly seen through the coating. Optical clarity is an extremely important benefit to the coatings industry, and a benefit that is inherent in nanomaterial dispersions that are well engineered for specific applications. We’re aggressively pursuing this market because we know we can add tremendous value, and that such a large varied market means that acquiring just a small percentage should yield several million dollars in annual revenue to Nanophase, and make us a leading provider to segments of this industry. Remember, almost every product manufactured, including our iPhones, Golf Digest magazine, or the burl wood trim in a Lexus, has a protective coating.
We also continue to look for new applications where our products could provide innovation opportunities. We’ve completed a good deal of internal development work, and have established a program within the energy industry to explore select segments of those markets, where our nano-based products can address some of the many unmet needs. This is a growing industry that has invested, and continues to invest, millions into research and development. At this point, no specific company has built the perfect product or achieved a leadership position in many technical areas where nano-solutions are being sought.
These are typical of the markets we are pursuing, of which there are several more at various stages in the development cycle. Working directly with the product manufacturers and end users allows us to better understand their needs and tailor our products to not only meet, but to exceed, their expectations. More on this in a minute...
Shifting to personal care, while we may have touched on this during our second quarter conference call, it really bears repeating. The FDA released new regulations earlier this year that require sunscreen products to pass certain effectiveness tests, and require manufacturers of these products to adopt new labeling. The purpose of these regulations is to make it easier for consumers to understand exactly what protection their sunscreens provide. The regulations require that all products labeled ‘broad spectrum,’ a term which you’re probably seeing often in the marketing of sunscreen, pass tests for both UVB, which causes sunburn; and, especially relevant to Nanophase, UVA exposure, which has been linked to skin cancer. This is an important development for our business, 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 and other ratings in sunscreens, moisturizers and makeup. Fewer of the synthetic organics are approved for use as UVA blockers in the U.S., which makes meeting the new labeling regulations challenging if formulators and manufacturers rely only on the organics. Our inorganic zinc oxide products provide protection from both UVB and UVA rays, so the new labeling requirements should be beneficial for suppliers of ingredients like zinc oxide, which, in addition to being excellent UVB blockers, are inherently UVA blocking, and are already approved for this use by the FDA. This should give Nanophase a nice “leg up.”
While these regulatory changes have caused manufacturers to initially evaluate their labeling and formulations, we don’t expect these changes to have a positive effect on revenue until early next year. We do expect to see an upward trend during 2012 as manufacturers become compliant with the FDA regulations. We like where we’re positioned today. Our “all-natural” effective UV blockers are ready today to meet this new demand.
Although we’ve focused on the Scratch Resistant launch and Personal Care today, we have been working for some time on expanding our polishing business, exploring several applications in energy and other areas, along with a fair number of single-customer-specific projects. I recognize that the lack of commercial feedback, i.e. “Revenue Growth,” from new business is frustrating to you, as it is to me! We are contending with the ups and downs of a tough economy as a company that is almost completely dependent on new product development. We also have to live within the realities of the advanced materials business development cycle, which is much longer than such cycles for commodity materials, software, or other items which compete with like items for advantage. We are frequently developing new applications for materials where few existed before our entry in to the market.
I have no doubt that we would have more new business in a stronger economy. New product development is an area that receives less focus in times such as these. I also have no doubt that we have competitive products! We routinely outperform existing technologies in our various markets, at least incrementally. While that tells me we know what we’re doing generally, that we understand the applications and we’re in markets that make sense, that’s not enough today to move product managers. These are the frogs we have to kiss as we develop these markets! That’s why we continue to work to find and focus on applications where we offer a significant advantage over existing technology, and we are making progress in these, although the cycle has extended beyond what I originally expected. We’ll do a more complete review of what we’re doing during the next call, but be sure that there is a lot going on here!
All of us here at Nanophase will be busy over the next several months. First and foremost continuing to meet with customers directly, this includes potential customers in all the markets we’re working in. Every aspect of business development I discussed today involves regular external customer feedback.
We are also planning for and attending and/or exhibiting in several industry conferences—all targeting markets where we expect our products to have cutting edge performance advantages. We’re 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’re active or are planning product introductions. Leveraging our market expertise has resulted in a pipeline that’s full of solid opportunities.
As always, we plan to keep you posted on our progress through news announcements and conference calls. I know most of our investors listen to the webcast or review the transcript after the call, but for those on the line who have questions or comments immediately, the floor is yours.
Devin, would you please begin the Q&A session?
We are fully confident that we have the know-how, products, business strategy and potential 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.