Jess Jankowski - CEO Frank Cesario - CFO

James Liberman - Wells Fargo Advisors Bill Chapman - Morgan Stanley

Good day, ladies and gentlemen, and welcome to the Nanophase Technologies Corporation second-quarter 2015 financial results conference call. At this participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] Before we begin, I would like to remind you that 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 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 decision of the customer to cancel a purchase order or a 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. At this time I would like to turn the conference over to Mr. Jess Jankowski, President and CEO. Sir, you may begin.

Thanks, Ben. Good morning, everybody. We are glad you are able to join us to discuss our second-quarter 2015 financial results and business updates. Frank Cesario, our CFO, has joined me again today. During this call we'll be talking about the outlook for our growth initiatives as well as updating you on our existing business and 2015 second-quarter results. We talked about growing revenues as we entered 2015. And then we took a hit from our largest customer, announcing two months ago that it looked like that customer would be about $1.5 million below last year, and discussed how our other new revenue was filling a good bit of that shortfall as opposed to helping us expand our top line. Today, I'm happy to share that looks like we'll end up better than that, which means that we once again expect full-year revenue growth. Although sales to our largest customer were down a total of $1 million through six months, they look to be going strong in terms of purchase orders in hand for the second half on top of a newly expanded forecast. Make no mistake, this still represents a challenge for us to manage and a blow to our expectations. But the magnitude is less than we thought only two months ago. These sorts of ups and downs reinforce our need to develop new customers and new products, whether in current markets, adjacent markets, or in wholly new markets for Nanophase. After Frank provides a short overview of our financial results, I will talk about all of our key business development initiatives for 2015 and 2016. These are focused on growing our existing customer and applications base along with adding growth from personal care technologies, surface finishing technologies and energy technologies, including energy storage and solar control. With that, I'll hand things over to Frank.

Thanks Jess. Good morning. This is Frank Cesario. Before I began today's overview of our financial results for the second quarter and first six months of 2015, please remember that all financial results are stated in approximate terms. Revenue for the second quarter of both 2015 and 2014 was 2.9 million, with gross margins of 34% and 36%, respectively. Net loss for the quarter was 0.1 million or $0.00 per share for both 2015 and 2014. On the year-to-date basis, revenue was 5.2 million in 2015 versus 5.5 million in 2014, with margins of 30% and 32%, respectively. Net losses of 0.7 million or $0.02 per share and 0.5 million or $0.02 per share, respectively. I note that our business generated net cash during two the past five quarters, including the second quarter of 2015. We ended the second-quarter 2015 with a $1.2 million cash position and 250,000 drawn on our working capital credit line. Many of you are aware we have a $1 million cash covenant related to exclusive supply relationship with our largest customer that we disclose in more detail in our SEC filing. It remains our intention to focus on small-amount and short-period vehicles, such as this credit line facility, on an as-needed basis. During June we borrowed on this credit line strictly to meet contractual covenants, then repaid this borrowing in early July. Things could certainly change at any time. We may conclude it's best to seek a small amount of additional capital. But this is the way that our Company approached 2015 and remains so today. Again, should we seek additional capital, we do not expect that it would be a significant amount. Jess?

Thanks, Frank. I'd like to key in now on our main business development initiatives. These areas are our top focus as we continue to build Nanophase to achieve the highest sustainable value possible. Again, these are personal care, surface finishing and energy technologies, which include energy storage or batteries and solar control, along with a focus on expanding business within our existing customer and application base. We expect revenue from these areas to make a meaningful difference this year. In personal care, which is composed largely of our active ingredients for inorganic sunscreens, we again hope to build on 2014's record year in terms of zinc oxide volume. Even with our recent challenges relating to forecast variability, we continue to believe there are positive indications that within a range of all-too-normal fluctuations, this is a sustainable-to-growing business for Nanophase. We believe our expansion here during recent years is a reflection of a growing consumer preference for full-spectrum inorganic sunscreen, specifically, zinc oxide and titanium dioxide which are also referred to as physical sun blockers in the industry, versus traditional organic sunscreens like avobenzone and the other perceived bad actors. As we have said in the past, dermatologists have long preferred zinc oxide, and to a lesser extent, titanium dioxide as full-spectrum UV blockers. And movement in consumer preferences has helped in this regard. In addition to existing demand, which is primarily based in the US, regulatory changes in the EU are in the pipeline which should present opportunities for growth in new applications there. We also expect to see consumer interest in Asia to further expand. We expect this market to continue to be a strong one for Nanophase. While personal care technologies is clearly the most mature of our current business development initiatives, we are adding new products to it and are consciously working to capitalize on the inherent strengths of nano and near-nano materials and, more importantly, our ability to coat them to enable their use in a wider range of personal care applications. Given its relative prominence in our technology portfolio, personal care has also caused the most difficulty earlier this year, as forecasts have changed, and total shipments through April were down significantly from prior years. This serves as a reminder of why we need to add new revenue streams to buffer any negative fluctuations in personal care, particularly with large customer volume. In that vein, we've also launched new solutions in personal care, the first two of which were displayed at a tradeshow in Asia for which we are currently filling sample requests. We believe that a relatively new patent-protected coating that we developed will be well received in the marketplace and look to get that coating marketed more broadly in a growing suite of products. In terms of the surest near-term growth, that's still in the surface finishing market. This area is very different from any other market that Nanophase is currently developing in terms of how we approach it and the customer and market profiles involved. It's a market that includes many medium-sized companies that may ultimately each buy low six-figure amounts of our polishing slurries. To reach these customers, we have to do more technical support. And we have to develop greater applications data to support the selling process than we do in our other markets. Our 2014 surface finishing revenue approached double the 2013 volume, in the mid-six-figure range. For 2015, we expect our surface finishing volume to well exceed 2014 levels, with some upside potential beyond that. While we expected much more growth here than we have seen thus far, we already have more shipments for 2015 than for all of 2014. Our two new energy technologies are in energy storage application, referring to batteries and then the solar control area, which refers to several applications involved with improving energy conservation. Think of the films used on vehicles and buildings. For the battery work, during 2014 we saw multiple large battery manufacturers duplicate the results we used to validate our value proposition, with entities further evaluating this proposition by actually incorporating our materials in the manufacture of their batteries on a small-scale production basis. We know that we can save customers money over more expensive existing materials and, in some cases, provide performance benefits at this lower cost. As this is a small piece of the overall cost in producing a battery, we now understand that the battery world won't stop to incorporate us immediately into their commercial line. But we believe one or more entities will incorporate us into new designs, and we are well positioned to benefit should the existing raw material increase in cost. Relative to our other energy area, solar control, despite previously telling you that this growth ramp was longer than with energy storage but offered potentially more upside, we now have two initial commercial shipments of the solar control product offering under our belt. We believe that our material is everything we thought it was, and it's well-positioned to participate in the market. We have several other initiatives in this area that are further away from revenue, but exciting nonetheless. We've also seen existing customers and applications expanded during the year, which reinforces our view that lead times may be far longer than we like, but that customers see value when formulating with our materials. This affirms that our technologies provide benefits that are not achievable through other means. We certainly support these efforts. We talk about making progress, which is both true and critical to the end result. And you know that I try to be cautious and avoid hype. Without abandoning my long-standing approach, I will share my belief that our growth initiatives will yield meaningful new business revenue during 2015 and 2016 and validate the strategy upon which the Company is based. I look forward to talking to you further as the story unfolds. Although most of our investors listen to the webcast or review the transcript after the live call, we would like to invite those participating in today's call to ask any questions you may have or to share your comments. Ben, would you please begin the Q&A session?

[Operator Instructions] And our first question comes from the line of James Liberman of Wells Fargo Advisors. Your line is open. Please go ahead.

I have to say that this was certainly the most positive conference call I've heard in a long time. The progress you are making on all segments, especially the coatings area -- I mean, the polishing area to me is very impressive. And I don't know enough about the other two products that you are bringing into the market, so I can't comment although it sounds like you're making progress on those areas as well, but can you comment even a little bit more about the polishing, since it really seems to have picked up dramatically from last year, how you see that technology broadening out over the next couple of years?

Sure. Well, we've got several applications in polishing. We have the CMP business, which we've had for some time. The growth expectations -- we also have another area in polishing that really hasn't resulted in any revenue that we are working toward and we expect may bring some benefits next year, which is certainly part of my thought process as we craft the strategy for the Company and make -- pivot when we have to and make course adjustments. The business that we banked on having the most growth this year and had the most growth last year has been in optics polishing. I made a comment in my prepared remarks that I was disappointed. We expected a much bigger year in that area than we have seen, and it has taken a little bit longer to get into the market. So that is typically polishing very high-end optics for things like laser lenses and other industrial applications that require a surface that in some cases is a sub-angstrom level of not just clarity but surface finish. And that is something that you really need a combination of nanos and then the ability to -- and some near-nanos and the ability to disperse them very well and understand the surface chemistry, not only on your particle, but also on the item being polished. That business is poised for some growth. I think just the optics component at some point could certainly be a seven-figure business. I do think that it's growing slower than I expected, and that has been a disappointment. And I think earlier we talked about the large-company revenue going down and being filled to a certain extent with growth revenue. We had a much higher expectation for revenue this year going in than merely exceeding last year's revenue. We are going to exceed last year's revenue, and -- by a little bit, or maybe more, depending on how the year, the next five months comes out. But we expected better than that. And part of that is that this polishing business, while growing, is not growing at what I expected it to do, which is probably a multiple of last year's volume.

Thank you. [Operator Instructions] Our next question comes from the line of Bill Chapman of Morgan Stanley. Your line is open. Please go ahead.

Jess, if I heard you right on the storage, now, we were doing a small-scale production where they were trying it out, and now it appears we're just going to be incorporated in new designs. But we were hoping they would just substitute our material for the material they are using on what they're producing right now. What happened on the test that would conclude them not to initiate swapping out with our material?

I think that essentially what I was trying to get at, and maybe I should have gone deeper into it -- we have a material that is a fraction of the cost of the material that is currently in many batteries in the marketplace. However, the amount of that material in those batteries is relatively low, and we misjudged the reception from the battery companies. I think our thought was, if you could save a fraction of an amount on each of 1 billion batteries, that it would be a good volume and for Nanophase and a good decision for the larger companies. And I think from their perspective, changing it out to a new material, because it's not the same -- it is not a smaller version of the identical material, it's a different material than they are using has a certain risk associated and R&D work required to do so. And I think they've decided, hey, I like these guys. I like the material. The value proposition is true with respect to the fact that it can replace this material. My incentive as a company to do that right now isn't all that high. Now, I think as we go and new platforms come out, I think we are going to be, if not included, certainly in the race to be included. And our goal, of course, is to be included in the new ones. That is a change from what we expected, say, six months ago. And part of this is that we've got these long lead times. And we are in -- you know, I mentioned that we are in -- we've got our existing markets; we've got adjacent markets; and then wholly new markets. So existing markets and adjacencies would be in something like personal care, where we are pretty deep. We understand well what goes into where our products go today in those markets. When it comes to something like batteries, we are getting up to speed quickly. And I think we got good feedback from these potentials. We processed it. We looked at it and thought, okay, this is something that is going to go. And there is just too much inertia to move it forward. I don't think this is anywhere near a done deal for Nanophase. I just think that in terms of something big happening quickly, I don't think that's going to be there. It's going to probably be next year before we see some revenue for that. But my visibility on it is not as good as I thought it was last time we talked about this in detail.

Okay. Well, that appears to be a material setback for us. Could you elaborate more on what the risk reward dynamics are for Nanophase on the solar control? Can you give us more detail on that, please?

Well, in that case, we've got some in the market now. And that market -- we’re expecting that customer to expand. We are also working on several longer term applications. Part of that is, you are going into an item that has to last for a period of time. It's not some kind of spray-on coating that would come on and off, and you just sell more and more every season. This is something that has to last a number of years. And so the testing is extended. So we did what we typically would do. What they would -- what you would do is go after a more aggressive, smaller producer who needs to get into the market quickly. And we've had success there. We are also trying to springboard on that success with the some producers at larger volumes. I think the reward is certainly high. What we bring to the table there is something that is not achievable with the existing materials, we believe. The risks, of course, are that we are dealing with very large players. Unlike, say, the optics polishing business, there are a few customers that make up the bulk of this market on the large-scale side. And with that you get combination of inertia and also, honestly, opacity, which is one of the things that makes it difficult because being outside -- you know, serving as somebody's -- doing product development for a company that you are not inside frequently makes it difficult to understand the nuances of what's happening. Now, I think our technology is very strong. Our performance has been validated. The customer that's out there in the marketplace has agreed, similar to the battery proposition, they have proven out our value. Additionally to that, they have it in the market. So we are waiting for further market feedback and, of course, to continue to move down the line and land some bigger customers.

[Operator Instructions] Thank you and with no further questions in queue, I would like to turn the conference back over to Mr. Jess Jankowski for any closing remarks.

Thank you, Ben. In terms of the direction of the Company, the quality of our pipeline, and the potential commercial value of our technology, I don't think there has been a better time to be a Nanophase investor. I'm glad that all of you are here, and I'm looking forward to achieving and enjoying great returns together. We should have more to talk about in Q3. I recognize this was a relatively short call. But in the case -- you know, I talk about what there is to talk about and when there's not, I don't think there's a point in going on too much longer. So I appreciate all of your time. Thanks again for joining us today.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and may all disconnect. Have a great rest of your day.