Jess Jankowski - President and CEO Frank Cesario - CFO

Rand Kay - RKA James Liverman - Wells Fargo Advisors

Good day, ladies and gentlemen, and welcome to the Nanophase First Quarter 2017 Financial Conference Call. At this time, all participants are in a listen-only mode and later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. The words expect, anticipate, plans, forecasts and similar expressions are intended to identify forward-looking statements. Statements contained in the 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 supply agreement, demand for or 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 activities 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. I would now like to introduce your host for today’s conference Mr. Jess Jankowski. Sir, you may begin.

Thanks for the introduction, Amanda and good morning everyone. I appreciate all of you here live and the larger group of you, who prefer to listen after the fact online. You are with us as we discuss our first quarter 2017 results and a few business updates. I'm Jess Jankowski, and our CFO, Frank Cesario, has joined me again today. Coming off a record year in 2016, we came out of the blocks in 2017 with a record quarter. We saw our base business expand, and we continue to make inroads in to our two strategic areas of focus, Personal Care and Solar Control. To start, I'd like to invite Frank to give you an overview of our first quarter results, then I'll tie things up, with a little more about where we're at, and where we expect to be by the end of this year. Frank?

Thanks Jess. Good morning, this is Frank Cesario. Before I begin today's overview of our financial results for the first quarter of 2017, please remember that all financial results are stated in approximate terms. Revenue for the first quarter of 2017 was $3.5 million versus $2.2 million in 2016. The net profit for the quarter was $47,000, or $0.00 per share, for the first quarter of 2017 versus net loss of $0.6 million, or $0.02 per share for 2016. We ended the first quarter of 2017 with a $1.5 million cash position and nothing drawn on our working capital credit line. Jess?

Thank you, Frank. As I mentioned in the press release, we had a few things swing our way in Q1 timing-wise, these basically piled on to what would have already been good results. That said, I believe our business has grown stronger and will continue to grow through 2017. Our base business enjoyed some growth, particularly in our Personal Care Ingredients business and through what we believe is the expansion of a new product launch by one of our coatings customers. Both of these businesses are a core part of our cash flow and have been expanding. As I've mentioned, Coatings, outside of the kind that are applied to human skin, is not where our Business Development efforts are focused. That said, we continue to bring performance advantages to some Industrial and Architectural Coatings applications. The reason that we've de-focused our Business & Product Development in these, and other areas, all of which we consider outside of Personal Care and Solar Control, is that these two key areas have advantages associated with them, that clearly make them the best choices for continued investment. Due to our alignment with market demand, we can see that the benefits that we can now bring to market are significant. We expect to see much better than incremental growth in both of these key areas. We also expect this rapid growth to yield strong margins as well. These variables are what drove our development in this direction in the first place. We are in a good spot. It's worth noting that we see both of these key areas as giving Nanophase, and its Solesence subsidiary, the opportunity to move much closer to the end-use customer and consequently, to a place further up the value chain than we've traditionally been. There are other factors that make these two key areas more attractive to us as well. Since I just gave an expansive overview of these areas last month in the year-end call, I've decided to wait until the Q2 call to spend a little more time describing the advantages that these areas offer in greater depth. I try to balance these discussions, so that newer investors can develop a better understanding of how we plan to win, while those of you who are regular call attendees don't get bogged down. As our results continue to indicate, we are persisting in effectively balancing the management of cash and expenses, against the need for ongoing investment in the development of our suite of fully formulated skin care products. To follow on in Personal Care, we are close to having externally validated our C-3 technology, the driver of many of the consumer benefits our White Label Personal Care products will enable. Our next investments will be more focused on developing clinical data, using our actual finished products, not just the discrete ingredients. The best way to think about this is that we're moving from validating our ingredient technology, to developing clinical data to support our consumer claims, within our specific White Label finished products. While these products are enabled by our technology, the sales cycle will move more swiftly when we can present specific product testing to our customers, essentially helping them sell the benefits of our products to the consumer. We're building a consumer claims set here. This is new for us and is in contrast to our ingredients businesses, where technical results tend to drive customer adoption. During the last half of this year, our goal is to have some White Label products scaling up for full 2018 launches. The volume for 2017 may be small, but, depending upon specific customers and products, the 2018 revenue should be in the six-figure plus range. It's still too early to pinpoint volumes. Regarding our Solar Control business, which we are marketing under the NanoShield trademark, there are fewer moving parts, so there is less to talk about today. We continue to make inroads and continue to work on commercializing additional materials from those we began with last year. I expect to have more to share later in the year, as it remains to be seen whether we see significant revenue from this area in 2017. We do expect this area to be a significant revenue driver over the next several years, but are currently awaiting further internal development, and further customer feedback. In terms of our revenue expectations for the business more broadly, at a high level, we expected 2016 revenue to exceed 2015's and it did, and we expect 2017 revenue to exceed 2016's. The extent of our 2017 year-over-year growth will become clearer as we get well in to Q3 and Q4. Given our experience and developed knowledge in various Personal Care markets, along with the historical success and broad acceptance of our ingredients in some of these markets, we can see our Personal Care business continuing to grow, but more rapidly, as we ramp to commercialization of our White Label products business later in the year. Currently, Personal Care is roughly a $7 million annual business for Nanophase. Based mainly upon our new product and business development focus, which is within our Solesence subsidiary, we see Personal Care having the potential to double of the next 3 to 4 years. In terms of our financial results, our added investment in building our skin care product line was the only thing that stood between us and positive adjusted EBITDA for all of 2016. As it was, we hit it for eleven of the twelve months last year. We use adjusted EBITDA as a near-proxy for positive operating cash flow. We have also just enjoyed another quarter of GAAP profitability in Q1 of this year. This follows GAAP profitability in Q2 of 2016. These quarters mark the first and second profitable quarters in the long history of Nanophase. Our annual results have been steadily improving and I expect this to continue through 2017. As you may have heard me mention in the past, revenue growth, cash generation and new business growth remain our top priorities. Although the largest group of our investors either listen to the webcast, or review the transcript, after the live call, I'd like to invite those participating in today's call to ask any questions you may have, or to share your comments. Amanda, would you please begin the Q&A session?

[Operator Instructions] And our first question is from the line of Rand Kay from RKA. Your line is open.

Good morning. Good results. Couple of questions, this quarter of 3.5 was BASF revenues proportional to the 2.2 of the previous year or were they – I guess what I am saying was, the BASF do about the same amount of business and the real increase came from other avenues?

This is Frank, it came from everywhere. So dollar per dollar most of our areas were up and the largest customer for those who are - speak in the Nanophase story because that customer is up as well and you'll see that is our 10-Q filing but all of them were up.

Okay. Can you also talk a little bit about - I'm a bit confused on the NanoShield product. Are you funding the development of product yourself or are you looking for a strategic partner?

We are funding the product development ourselves, and it's really a – I’m glad you said product, it's a materials, it's more of a product, we have several - we started in the business with one, we have developed a few more and we are in the process of continuing that internally to optimize the products, as well as awaiting customer feedback. We've had - as you may know we've had a few products - few customers in the market last year, we expect to have more this year relative to volume is the question, it's the question of timing, it's a question of our internal development and as always it's a question of speed of adoption and feedback from those customers. But we are supporting all of this development internally.

Well I'm a bit confused because my understanding was on previous calls that you are going to concentrate your development in the skin care business and look for a strategic partner in the solar control area. Has that now changed?

Maybe I mischaracterized that or your understanding is incomplete. Essentially we are - the bulk of our resources are going into development in the Personal Care skin care products which are enabling ingredients typically dealing with UVA, UVB protection, free radical formation protection, lots of other great thing. In terms of seeking a partner, how I would cast that is we're not seeking a partner as much is there are fewer customers that are larger in that area. There is less as I said – earlier there are fewer moving parts it’s less work for us to do it’s more focused and it’s more technology focused which narrows the amount of work required. I wouldn’t say it’s a major investment but we are continuing that development.

Jess I would just highlight that we’ve talked about looking for partners for those areas that were not emphasizing our own development. And so that was never on the NanoShield line as it’s configured that was on other traditional product lines. We may be passing terms here in the sense that if we were to get a large solar control customer of course we will always discuss whether there can be some sort of exclusivity or some sort of relationship in that regard. But our goal is to retain as much of the IP as possible – as of course as much of the margin as possible given our relative strength to those customers we’re dealing with.

In three to five year timeframe gentlemen which market looks like better opportunity for us the NanoShield or the Celessence product?

I think the Celessence products are a broader opportunity probably a larger opportunity the exciting thing about the NanoShield products is that they’re also potentially a good sized opportunity and it’s a more concentrated market with a concentrate group of customers. So I had mentioned in the past and I at some point in the future I should walk through this again, but if we look at the white label business we will ultimately have customers that range from having a few products in the mid to maybe upper five figure range to the six figure range. And then expanding a product line able to bigger and smaller ones that allows us kind of a lot more opportunity to go after those things we have more levers to pull. On the NanoShield market, we bring some technical advantages due to the way we manufacture our material and the knowledge we’ve developed over the years in that space that we think are going to be enabling and we will be able to approach larger customers the thing with that is that it's less of we don't have the depth of experience we have in personal care. We know where personal care is going to go and it’s matter of risk the perfect strategy we want to follow leading us to where that goes. With NanoShield we have a strategy, we're going forward with it, but certainly may be they’ll develop this market adoption and where the products can go.

Okay. Now it nice - it’s actually heartening to hear that you not only feel you have a product in the solar shield business but you have a competitive advantage to execute manufacture the product. So getting locked out of that or moved out or displaced sounds like it's going to be a tough option for a competitor which is nice to hear. Last question is I know in the past you guys counted the polishing business and had actually committed some resources to setting up a lab to you know to pursue that business and had expected revenues which apparently thus far have not materialized. Does that mean that you throttling back on the polishing business are you still putting as much effort into the development that polishing business so it's costing you more than you expected to see returns in the polishing business I mean just some general color on that area would be helpful?

Sure a couple of things I mean the earlier comment I never believe we have such a massive advantage in any market that we shove people out, but I do believe we have strong advantages with the NanoShield product and Celessence. When we get to polishing we were looking at incremental growth, we were looking at a large investment to get there to continue to get there so over a period of time we had good products there's some growth there for us, but the investment requirement ended up being too high I overestimated the growth we’d be able to enjoy there. We’re still seeing good margins, good growth that would be an area where we may very well work with somebody in some sort of a partnership or some sort of tribulationship to have them do more the development. We are not currently putting any resources other than technical support towards that market just because – again not because we can't grow the business that way but because we see the others as greater opportunities and we have to live in a world of prioritization are relatively small treasury right now.

But on a standalone basis that product is not burning capital it's making it either breakeven or making money?

And we have a series of products there at different levels back to our original product that we started out are very small series of products. We started out with what was then Rodel that became Rohm & Haas now is Dow other small products as well as the larger Nano products and some products in the optics polishing business which really was the area we expected to see greater expansion than we now believe is possible in terms of repetitivity of growth. So that's really ultimately if I had a peg what made me and made us beside we were going to focus elsewhere it was a combination of particularly coming across and realizing how many advantages we had with Celessence how strong this technology is relative to passed technologies. On the one hand now on the other side saying hey I can keep funding this other business and as we’re a mature business and throwing of cash may be we would. Because and looking for some related growth – finding real difficult I don’t think we’re going to find growth difficult with either Celessence or NanoShield I think Celessence has more avenues I think the likelihood of success is very high and we know more about that market. So I’m very comfortable with the decisions we’ve made there.

I like breakeven guys short of making money I really like breakeven so I feel like we’re on the right path and I like your minds of basically driving opportunities organically So I’m pleased with the direction you’re going. That’s it from me thank you?

[Operator Instructions] Our next question is from the line of James Liverman of Wells Fargo Advisors. Your line is open.

Thank you. This was really from my perspective it was blow about quarter and especially not being in June quarter the quality of the business the non of the business and I am assuming that it actually generated a fair amount of cash but you’re are putting a lot do some significant investment some product development at this time now is that a fair assumption?

That’s a fair assumption last year our financial results would have been much better had we not spend and this year will be the same putting investing more money in a product development for the Celessence line the contra point to that is were we not doing that. Our growth prospects wouldn’t look nearly as good. And so I’m trying to we’re all trying to balance how much can we invest while not having to worry about capital in the near-term and when things start rolling everything will get a lot easier.

And we talked about adjusted EBITDA earlier in the press release and one can see its about $200,000 for the quarter and that's approximately for cash flow from operations so it's a generating quarter and that certainly a good thing.

That’s great. Now regarding Celessence if I go online am I able to now identify products that I could order for myself and my family or is it still is that still an evolving process if miss something?

There is two pieces it is evolving but you really - Celessence is a technology we have a website for our subsidiary and what we're doing is Celessence is the brand of our technology that will be included in product you can buy for your wife or your family through other marketers. So the goal is we will design the product we've got our basic products we’ll go to a marketing company. We will say you know this is the product, this is our testing this is it compared to what’s in the marketplace they will say okay either we love it or we love it but could you change the tense or add a fragrance or whatever it would be than that company will market that product but the goal is we have these Celessence logo on the side of the product and basically if you go on to the Celessence’s website it’s really designed for formulators and people that are marketing products versus consumer suite we don't sell directly to consumers because the goal at this point is to is to create white label products that enable companies with a much faster marketing reach to grow their business to differentiation. That being said, we also by moving further up the value chain white label products we retain more margin per unit for Nanophase and essentially and Jim I know you’ve been around a long time. But the goal is always been is you know we make something special here we bring something to the table a lot of people don't have we have a lot of knowledge internal and that we brought in and that we’ve learned I always would prefer to sell fewer quantities of product at greater margins than volume. An essentially that’s where white label kind of moves us toward we expect that relative to NanoShield in our existing market particularly if look at something like the coatings business for architectural coatings or the ingredients business for substrate. We are selling 100 of tons of material and the life I think what we bring is important enough and special enough that we can sell 10 of tons of material and make a lot of money and create a lot of volume and that's really the direction we’re headed.

So if I go online my now or shortly in the future be able to go online or see a variety of products, your products that you are involved in because then choose between or you’re going to have they’re like somehow go to the store – just figure this out some other way on my own?

Well right now you can go online and you could see the types of products we are offering for formulators.

Okay.

To examine and develop you could see some test results you’ll be able to see more at some point we keep beefing up that offering on the website and then eventually when these products ramp and launch we expect to be able to point on our website saying hey Lieberman Pharmaceuticals just launched $1 billion brand.

Right.

Enabled by Celessence and then you'll be able to see it.

Okay. This really still very early stage is what you're saying in terms of adoption?

Certainly, in terms of adoption in terms of, we've been working on it for a number of years we've gotten a lot of data what I love about this Jim in some ways in addition to us to having deep market experience I mean the products we’re selling that we’ve been selling particularly through our largest customer have been considered the class of the market and degree in space. We know a lot of other things about the market and as we get further into it we are developing, we are getting validated externally. These are Nanophase R&D people tests that are telling us that we’re outperforming the competition. We're going to external last we’re doing in vitro, vivo testing to say yes we can deliver these things in a mineral sunscreen which is a popular want in the marketplace. The typical issue with mineral sunscreens as some of you are aware is that it tends to be a little bit more of a white cast on the case some even a blue cast on the skin and that relates directly to the formulation to the sizes of the particles to the way they are dispersed a lot of that is right in our sweet spot. So the testing for the technology development largely is done. We have a little bit more but the product side we need to be able to bring a suite of results that are based on actual clinical tests and life human beings skin that tell that prospective customer hey they've done the homework and I can sell this I can go to the market, I could deliver on things that they want and if you ask your dermatologist or anybody in that industry everybody would prefer mineral-based sunscreens it’s a question of getting them in formulation that look good, feel good, smell good you know and have efficacy and that's the direction we’re headed.

And can you see as it look too early, but you said there is a good first half and generally your June quarter has been your strongest quarter. Do you this quarter took a lot from your June quarter or you think you'll still see some reasonable strength give a guidance about June and then beyond that do you see yourself transforming into a company that has more legs throughout the whole year so less cyclical.

Well that's a deep question that take me into the mire in terms of trying the ability.

Right.

I anticipate that.

Down the road type of thing.

So, I do think Q2 will be strong probably not and I know it will be strong as Q1 generally I think we're going to remain a cyclical business to a degree because the bulk of our businesses is in North America and there is a cyclicality driven by the markets and when they put new materials or launch new materials into the skin care space. We use to talk a lot about beachwear that’s not where our business is, that’s really not where the SF business is either it’s in daily sun care so would think it would be a year round issue. But it's not roughly sometimes between the beginning to middle of the third quarter and early in the fourth quarter people decide what they’re going to do for next year. And so we’re always going to have that degree of cyclicality it will certainly get blunted a little bit as we get more volume. The NanoShield business will probably also be cyclical to a degree because it’s trying to limit the effects of the sun I mean effectively becoming an environmental protection company if you look at it that way, but I think they'll be better. For the second half, I think the key focus is on new business growth particularly towards the end of the year I'm not as concerned about the volumes as I am concerned about the ramp. I want to see new customers and new products coming online that are going to lead to a much bigger 2018 volume I don’t where that’s going to be and as I said it’s difficult to tell just based on the fact that it's a little bit opaque when it comes to what's going outside on the customer side, but I can see progress and I do see us – I definitely see us moving forward.

Can I ask one more question, but you probably can't answer have I missed you have you given any greater detail on the solar control technology and what it is and how it present itself in the marketplace?

We haven’t given a lot greater detail I mean essentially its easiest to think of trying to keep what’s outside relative to the initial volume is in the automobile world on glass typically a coating on glass can ultimately be impregnated in a layer in glass. Early adopters have been a lot of the automotive aftermarket businesses and that can provide very fast I mean volume to us all by itself. We believe there’ll be an architectural glass market ultimately there is somewhat of one now but it's growing a lot of these things – will potentially get bigger and stronger as solutions come into the market that are more economical and easier for people to apply and also robust and I think we have some of that growing in our portfolio.

Well it's a very exciting to see the progress you made in the way which you’ve been able to manage the company and to get here thank you very much.

Thank you. And at this time I’m showing no further questions. I’d like to turn the call back over to Jess Jankowski for closing remarks.

Thank you, Amanda. I'd also like to thank all of you who have taken the time to listen live, and on the web, for your interest in Nanophase. I expect 2017 to be a year of stronger growth, accompanied by stronger results. Frank and I are looking forward to our next opportunity to discuss our business with you. Let's all make it a great day.

Ladies and gentlemen thank you for your participation in today's conference. This does conclude the program, you may now disconnect. Everybody have a great day.