Good day, ladies and gentlemen, and welcome to the Nanophase Third Quarter 2018 Financial Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions for the participants will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. Before we begin, I'd like to read the safe harbor statement. The words expect, anticipates, plan, 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 that 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 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. I'd now like to introduce your host for today's conference, Mr. Jess Jankowski, President and CEO. Sir, you may begin.

Thank you, Jamie, and good morning to those of you who have chosen to listen live. It's great to have you here along with those who've decided to listen to the taped version at their leisure. Again, your company has had another nice quarter, this time it's Q3. We expect more progress with the Solesence products in Q4 as well and we expect to post another record year for 2018 . Jaime Escobar, our Chief Financial Officer is joining me again today. During this call, I'll be giving an update on our progress in new business development within Solesence, along with updates on our advanced materials business and of course third quarter results. We've seen unprecedented market demand for our minerals-based UV absorbers within our advanced materials business. As I said last time, the markets continue to improve for the products we sell and we intend to take advantage of the strong position we're in. Our third quarter 2018 revenue was $4 million, a 44% improvement over the same quarter in 2017. We also showed a $136,000 net loss for Q3, which although much improved year-over-year fell below our expectations. One impact of the unexpected order flow we've seen through our largest active ingredient customer was the recognition of approximately 50% of the 2018 annual volume price discount in Q3. With this amount that have been spread ratably over the 4 quarters in 2018, the Q3 bottom line would have been at least $100,000 stronger. Our 9-month revenue numbers were just over $11 million, a 12% increase over the same period in 2017. As we discussed, the anomalous Q1 we believe we have this year with its $924,000 loss, it's had an outsized impact on our 9 months profit numbers. I'll return to share more about all of this and our forward strategic view in a few minutes. Now I'd like to introduce our CFO Jaime Escobar, who will give us a quick overview of the rest of our financial results. Jaime?

Thanks Jess, and good morning. Before I begin, please remember that all financial information is stated in approximate terms. Our third quarter revenue was $4 million in 2018 compared to $2.8 million in 2017. We had a decrease in our losses quarter-over-quarter. For this past quarter, we netted $136,000 loss or $0.00 per share compared to $642,000 of net loss or $0.02 per share for the same period last year. This loss was a function of many factors, which include lower margin revenue mix for the quarter, cost increases to raw materials used in production along with a reduction to our top line to account for certain contractual obligations. Jess described some of this in his openings statements. We ended the third quarter with a $1 million cash position and $500,000 drawn on our working capital line of credit. Jess?

Thanks, Jaime. For any investors new to our call or those who are just getting re-engaged in the Nanophase and Solesence's story, I want to better explain the terms I've been using to define our commercial areas . You'll be hearing more and more about our advanced materials business and our Solesence business. They are significantly different from one another. The advanced materials business is composed of our personal care ingredients business and the materials businesses related to coatings, a diverse grouping of customers buying higher value specialties and the polishing business where we have partnered with M&S. The products we sell into these varied customers and markets are essentially enabling ingredients. And in the case of the personal care market, our largest advanced materials growth driver, they are considered active ingredients. We expect our advanced materials business to become more focused on skin and sun care ingredients over time. This is certainly where we're investing our business and product development energy in advanced materials. In the personal care, skincare and cosmetics markets, demand for more and better minerals-based products has become the biggest driver for growth within our advanced materials portfolio. The growing market focused on minerals-based products also comes at a great time for our Solesence business. Through Solesence, we're developing and manufacturing fully-formulated prestige beauty products for brands using what we refer to as our Active Stress Defense technology. All of our formulations are created using minerals based active ingredients as their backbone, which is where the demand is. Consumers and dermatologists generally prefer minerals, which are known to offer excellent health benefits, but adoption has been slowed by limitations of other technologies in the market, that's where Solesence comes in. Some of the key clinical benefits we've proven are comprehensive environmental protection, including protection against pollution, full spectrum UV protection and stopping the release of free radicals which contribute to signs of premature aging such as wrinkle formation and skin discoloration. These claims for Solesence products help the brands to provide evidence of being able to prevent the signs of premature aging, which continues to be one of the biggest drivers of consumer demand. We often refer to our Solesence clients as brands. That's because they'll be marketing these products with their names on them using their distribution channels enabled by our Solesence technology, our formulating expertise, marketing support and regulatory and production backbone. They're selling the products we create to consumers through a series of specialty channels. While Solesence is not selling products directly to consumers, we are helping brands to produce better products marketed as prestige products to capitalize on building demand. In Q3, we continued to fill demand related to our 3 successful Solesence product launches through our client, Colorescience. We are now working toward another launch with the new Solesence client in Q4. As exciting as Solesence has become, the largest story of Q3 is our personal care business in total. While Solesence is certainly a contributor and one that we expect to play on outsize role in our future growth, our minerals-based active ingredients volume is growing significantly as a result of the broad market demands for minerals-based sun care. Revenue from our largest customer tells a compelling story. It was up significantly year-over-year. When comparing third quarters, dollar volume was up more than [ 17% ] from 2017 to 2018. The big change was both a reflection of 2018 growth and a dampening of Q3 '17 revenue by a planned shutdown. However, for the 9-month periods, dollar volume was up by more than [ 28% ]. Our 9-month 2018 numbers have exceeded 2017 full year sales to them by more than 5% and we expect good volume in Q4. These dollar volumes also reflect lower price per unit in 2018 when compared to 2017. This means product volumes in terms of total tonnage sold will exceed those of 2017 by an even greater margin than reflected in the increased dollar volumes. We will effectively see more total margin dollars from this business than in past years, but at a lower margin percentage. In terms of operating expenses, we're still investing in new products and working towards building new and sustainable volume for 2019 and 2020 . Our main focus over the past 18 months or so has been to get our new finished products to market than to capitalize on some of the momentum we're seeing. We've also spent much of this year, pushing harder to meet the rapidly expanding demand from our largest customer for our minerals based actives. Going forward, we are expecting to see improvement in production efficiencies as we get more Solesence product launches under our belt and look to have more level-loaded demand within our advanced materials business. Your company is becoming more and more focused on skin care and cosmetic applications. Consumer demand, regulatory forces, and the success of our Solesence technology are things that are creating momentum; momentum that we expect to be sustained for the foreseeable future. As we mentioned in the press release, we're looking forward to breaking another revenue record in 2018 with more growth to come in 2019. We'll have more information to share both on the products and sales volumes over the next few quarters, but remember we are in the market and growing right now. Although the majority of our investors listen to the webcast or review the transcript after the live call, I'd like to invite those participating today in real-time to ask any questions you may have or share your comments. Jaime, would you please begin the Q&A session?

[Operator Instructions] Our first question comes from private investor, Ron Richards.

Hi Jess. I hope this question shows ignorance of accounting procedures, but here is where it is. Cash is way down, accounts receivables are way up, inventories are way up, accounts payable are way up. Does this mean Nanophase can't sell what it makes, isn't getting paid for what it sells and can't pay for what it has spent?

Good question. No, it doesn't mean that. What is really is a reflection of is a couple of things. The initial build-up for the Solesence materials required a certain quantity of inventory that we built. We also had sales that we were not able to ship at the very end of September, mostly Solesence related. So, our inventories were very high in that regard. Lastly, the -- this business puts a bigger strain on working capital in the sense that the timing to payment is stretched out a little bit more than we typically see. We're also seeing that with some of our other customers saying the terms that were typically in that 30-day range stretching out a little bit, so largely what you're seeing there is the working capital crunch, not an issue of either not getting enough margin on the sales we have or not selling in up or not able to sell what we have. That said, we expect that time to money as we refer to it to shorten, as we get further into this business and we also know that there were costs relative to the -- I mean some of the impact on the cash as well is certainly our net loss and we had costs relative to the ramp up and to the launches that every launch is going to cost a little bit more than steady state business. We will see savings there, as we go forward. So I'm not expecting that to be an issue.

Okay, I was hoping that, that would be the answer. Is it possible that with an improvement in paying off accounts receivables in your next quarter will get a positive boost?

Well, relative to -- I mean from the accounting perspective that they won't really impact the bottom line. It's just a question of how much of our working capital is tied up with their customers versus the [multiple speakers]. It's possible that we'd be in a better cash position at the end of the year, in all likelihood we will. Volume usually dips a little bit in Q4, which in this case will probably due to our benefit in that regard only. But again, I'm not as focused on it as I am on the growth. And obviously, we're expecting margins to improve as we go into next year and some of this is just growing pains. We've got a lot of -- it's a good problem to have, but the company without throwing the exact number out there, the growth we've seen this year has been large -- fairly unprecedented for us and it's put a strain on a lot of things as we are catching up to being able to meet that demand. Had we not had the odd demand in Q1, which was kind of an anomalous thing and was back loaded, I think the entire year would be looking better because we've been scrambling to catch up with the market, whereas our overall capacity is fine. It's just our burst capacity, it’s not capable of putting up with this -- responding to bigger demand changes we've had. We're getting there though.

Are you looking at having to increase capacity soon?

We, I think relative to the base business, the advanced materials business, we don't have a need to do that soon. It's on the radar of course because hopefully the business will keep growing and growing. But we have more capacity than we need there with respect to the active ingredients business. We will probably make some investments in capacity for producing things for Solesence in the sense of lotions and other items. Some of that will be to have greater control over our supply chain, some of that will be just to enhance the margins. Because at the level we're at, the throughput on this equipment is pretty high, but the quantities that we're selling relative to big outside vendors isn't always the greatest. So I think there's opportunities there. I don't think we're going to need a lot of capital going forward for capital equipment to expand capacity, but certainly some.

And our next question comes from private investor, [ Jake Goldman ].

I want to ask you some questions about your patent portfolio and share anything coming off patent or any threats from generic manufacturers sniffing around sort of one question. And second question is, I didn't see the financials, but how much is being put into R&D into the company?

For your second question, our R&D is at a recent peak. We are putting a lot into developing new formulations, testing, building claims as well as securing new IP. So R&D is up and it's one of those things, it's really an investment in the future, because our goals to develop these [ solicit ] business particularly require that we continue to have new products and that we protect them as best we can. To your first question.

Wait, let me go to that Jess, can you give me a specific number, how much was R&D?

It's in the financials, I can -- let me [multiple speakers] I don't remember off the top of my head. We had $1.5 million through the 9 months versus $1.350 million through the 9 months last year. I expect that rate for this year to stay similar potentially going up a little bit over time. If you go back several years, it was lower than that.

Okay. And you just [indiscernible]. How many pure scientists do you have is – that a neophyte would look and say, “This guy is a scientist,” then nothing else so to speak. How many of those are in the company?

Very few. I would say none really. Probably our strongest pure scientist, our VP of R&D is absolutely world-class, but a lot of work. We have all of them doing is working toward building customer solutions, working toward getting applications developed versus just pure science. Now we do some pure science, but we don't have anybody who is just 100% geared on inventing new things. Our closest person is our VP of R&D, who is working on next generation things as we roll on.

Okay, thanks. And get to the first question please.

I think we're in a good shape relative to our intellectual property we have these Solesence patents, our new and newer, so we've got a nice horizon on that and we believe we have a very strong position. Additionally, we continue to patent around them. Picket Fences as they say, some of these things and develop new things. Our base material patents largely have expired the -- essentially there's a lot of trade secret in what we do and there's a lot of internal knowledge in terms of making these materials to surface. Surface chemistry of the particle is critical and how that interacts with anything it goes into and our process lends an advantage there. So we're never going to make zinc oxide for paint whitener because there are ways to make it much less expensively. However, the way we do make it and all other materials allows them to do certain things and accomplish certain things that others won't. Generally, we are not nearly as focused on materials, per se. As a company is we've been historically, we are focused on taking those materials, bringing them to an intermediate stage, and then relative to Solesence bringing them to a final product and getting all they have to work together, there's a lot of expertise and we think we've created some forms of barrier to entry there as well.

So is there any trepidation about something going off-patent or are you confident enough sort of in the internal processes that you think will create a barrier to entry to over companies?

I think the biggest impact if anything relative to a pattern was about 5 years ago, when the original patents that BSF had expired and what we've seen is the total volume continues to grow even though the specific market share relative to that patent protection has struck. And I think that's a testament to a few things. Most importantly, the demand for minerals-based products just continues to grow and everything is we've got a lot of tailwinds there. Secondly, when you have more people working with materials and doing more development, it just builds more demand. So I'm not concerned about any of that right now.

Okay. And lastly, one other question on non-proprietary basis, anybody sniffing around to buying the company, any larger company, forgetting whether you would entertain the offer?

There is something that I would share where it happening and that's not a regular conversation around here relative to those things. I'm focused on building the business as quickly as we can, taking advantage of the momentum and as I mentioned, we are kind of catching up and trying to make sure, we're doing things as efficiently as possible while still investing in growth.

I need to smile because that's a good diplomatic answer for your shareholders.

Sure, are you interested?

I'm surely I'm interested as a shareholder, where anybody sort of sniffing around. Forgetting the fact that you won’t sell or you’re not at the maturation point, but sort of just out of intellectual curiosity.

Shoot me an offer.

I haven't thought [indiscernible], probably not the right guy. All right, thank you Jess.

Okay, thanks Jake.

[Operator Instructions] Our next question comes from [ James Liberman with [ Vivar Securities ].

Greetings. I'm really impressed by this September quarter. It clearly demonstrates that you are getting some traction and momentum because compared to every other year and I was curious, it sounds like in your presentation that there are numerous other adoptees you see down the road. Can you give us some color to how you see that happening over the next couple of years?

HI Jim, are you talking about Solesence or something.

Yes, the Solesence. I'm sure, yes.

We are expecting to have a new launch with a new client next quarter and those quantities may not be great in the sense that anything like that is a wrap up to launch. We are awaiting to know what the order pattern is going to be for the existing launches next year, but we expect them to grow. We expect -- we have a pretty aggressive internal set of targets and growth without talking and speaking out of school, doubling that business next year is not a -- it's not something that wouldn't be unreasonable. And over time, there is a mixture of potential customers ranging from companies that will be 7-figure customers and companies that would be 6-figure customers ranging from the very low 6 figures to the mid. I think we can support a series of launches next year in addition to keeping care of the base customers though. And going out, I fully expect that the Solesence business in terms of top line will exceed the size of the advanced materials business and that could happen in several years. I don't think it's going to be 10 years until this business turns into a $15 million business, it may be several in other. In some cases, you're giving away a little bit of percentage margin for dollar margin. You get more access to more dollars as you integrate as we're effectively doing by having the -- doing the product development and everything but the selling. So, but I see life there and the indications are all very positive. It's just where we're rocking and rolling and trying to make it all happen. We've got a lot of excited people and lot of stress people too of course, but that's part of the gig.

It looks like your strategy is beginning to actually take hold, which is wonderful to see. And again looking at the inventories and receivables, for me, that was actually comforting to see that -- we see receivables out there when they come in and that's going to help your cash management and also with your inventory, so that actually make me feel a little better about your current cash position.

Yes.

And what do you think if [multiple speakers].

Yes, that's -- I'm not that concerned about it . I mean it's always an issue at our size because little ripples in the -- little things can cause big problems that a company our size, but I would say that generally, we haven't had these issues in the past to navigate and we're spending a lot more time and energy managing the working capital and those are just things that happened with growth and they happened with movement in new markets and as you know, we try to run pretty lean and I think that's one of those things we're dealing with effectively, but we are certainly challenged by now, but it's great. I mean this is the best year. We are -- I don't think that the company has been in a better position for [ months than we are ] right now.

No, no, it's not at all. And I have to say one other thing, this is an unpaid advertisement, but I've been using this unforgettable product total protection body shield, it's actually spectacular. Anyone who is ex-shareholder or anyone who knows anybody is the best product ever seen in the market for a moisturizer sunscreen ever? Thank you.

That's great to hear. That's great to hear. You [multiple speakers].

I recommend everybody to go out and buy some of this and give it as gifts to people. That's how good it this.

Yes, the market seems to like it. We're getting good feedback up and down the line and we've got a lot of products in development, lot of sampling we're doing. So it's good. We, Jaime just mentioned, we won the -- Colorescience won the Oprah award for new products and for their big product.

It doesn't surprise me. Everyone I've given this to has said it's amazing. Thank you.

Thank you.

And our next question comes from [ Randy Kay ] with [ RKA ].

I'm kind of curious where you are seeing -- if you're having any concerns, is it in margin -- is it margin value or is it in execution issues?

You're talking about relative to profitability on the products at the gross margin.

Right. Yes, I mean the numbers there -- the numbers are going up, which is outstanding, right. And I am just not fully getting my arms around why we keep running into unexpected shutdowns or unexpected issues regarding profitability launches more than we expected. Marketing is more than we expected. And I'm just wondering, are those execution issues or are they more issues and this is a new -- you guys are moving from specifically product from a product to a combination solutions product company. Are we just getting squeezed on margins here in order to get the volume.

I would say that, it's not a matter of getting squeezed from the customer side for the most product. That being said, you can always get -- try to get better pricing. With respect to our largest customer, we have a contract that has been existing for a long time that has some rigidity to it. And as the volume goes up, the price per unit goes down. That's what we were talking about relative to this specific quarter. That being said, we're dealing with a couple of things. We are making more material than we ever had for them. So the throughput is at an all-time high. We're running generally, 7 days a week for most of this year and that puts pressure on the organization and we're managing to it. And I think we're managing to it effectively. So you've got those issues, which are a matter of just bulking up to be able to manage that new volume with respect to the new types of products. So it's a finished product. So we're essentially formulating it, iterating on that testing, then we've got to make the bulk and then we send the bulk typically out to be packaged and there are a lot of moving parts there. As we get better at it doing it more often, I think we'll see more efficiencies there then we've had at both sides of the business. And as we go currently, there are some -- we do some outside processing even on the bulk side that requires a small amount of capital, but we haven't -- it takes time and money to do these things. So I think it's an execution, I guess, is a big part of it, if you define it broadly that way. We're getting it done. And our primary focus has been to make sure that we don't miss any launch dates and then we get the products out to satisfy the customers. So in the case of the Colorescience launch in Q2, we did everything we possibly could to get all that material out the door on a time that work for them to satisfy their base, which ended up responding very well. And those situations are inherently less efficient than head-to-head appeal for X amount of volume stretched over X amount of time.

Well, I guess I'm wondering -- while I'm very excited about the growth potential, I'm a bit concerned with a little bit of this trial by error, overhang that we seem to be facing. And we've been facing it now for a while and I'm just wondering what in the corporate mindset are you guys doing differently, so we avoid surprises? I mean launches -- I understand there is a certain amount of -- where do that come from factor in a launch. But I thought we were so far enough down the road here that I'm just wondering if there's any identification within the organization to say what -- we're trying to being surprised here, we need to figure out what's going on.

We do spend a lot of time working on that and we are tightening things up certainly around. To say that things are, I mean, to put it in context , the company really has never had a product before we had -- years ago, we had NanoUltra and we shipped very small quantities of material and little boxes that we can, we put it all together. This is a much bigger undertaking and I think that we haven't had the direct experience. We have internally people from that have background in it that have been helping us, but we also have a lot of people that are just getting up to speed on how to do it, I don't expect subsequent -- I don't expect subsequent volumes and launches to be nearly as difficult to do. With respect to the base business, we have not seen this kind of growth ever relative to the speed with which it came. I don't have the numbers in front of me. I actually didn't -- haven't -- I don't have them calculated. But the -- our volume for the year in terms of unit volume is going to be up with our largest customer significantly and more so than just the dollar volume. And that's something that we welcome it, but we haven't been there and we haven't seen a delta, year-over-year as big as this one ever. And that's one of those things that the whole company has been geared around making that material for a long time. So it impacts everybody when you go from X to one point something X rapidly and it kind of happened more so weighted toward the end of Q1 and Q2 then we had ever planned. So it's a good problem to have. I do think those things are difficult to respond to efficiently, and we are working on -- we're spending a lot of time doing 2019 planning and we are right now we have been and working through the process.

Okay. I just -- I would like to leave you with one but please don't get me wrong. I know this is a difficult process. I worked with companies that have been in the start-up phase and I understand the issue. The equation that I am concerned about going down further here is that a little bit higher than expected execution costs and at the same time diminishing margin percentages -- I mean I'd rather see okay execution issues, but increased margins or pricing power. But the two -- the other two all of concern. If we continue to grow, are we growing in a way that we absolutely know it's going to be profitable? Are we putting in too many resources into an area where we will -- the ROI is always going to be a questionable or concern -- questionable concern?

Sure. I understand your concern and we've -- and we have a 2 and we've been dealing with it, I think well. I think the picture looks a little less -- a little more negative in that context than it actually is part of it. We have an outsized customer as we all know that has a very rigid pricing structure. So that one, we don't have a lot of flexibility on, so it's incumbent on us to make that production as efficient as possible then try to recover some of that. We also had increases in zinc metal pricing this year that were higher than our average, which was a contributor specific to that situation relative to pricing power on the Solesence side, I think we have pretty good pricing power. And I think as the acceptance grows, we're going to see that for a while and be able to trade on that. So I hear what you're saying and I think what I can do more so in our next call is kind of breakout the 2 businesses. Once I know what the -- this Q4 is going to be an important quarter both for the base business and the active ingredients business and the Solesence business. I think when I can talk about all of that in a direct way of talking about where we came from 2016 to '17 to '18, I think that I can probably weigh some of your concerns.

And we have a follow-up question from Ron Richards, private investor.

Jess, a moment back you mentioned that there was going to be a launch next quarter. What are you referring to, Q4 or Q1 next year?

We are expecting to have a launch in Q4. We actually are also expecting to have a launch in Q1. And it's just a little further down the line and I prefer to know that these things are going to happen before I share a lot of detail with our investor base just because of the lack of predictability and some of the predictability comes from the customer side as well. They have their own issues to contend with, but we are planning -- we are expecting to have a new client launching a new product in Q4 for Solesence.

Okay and I missed out on that unpaid advertisement a while back. What products should I buy for my Christmas presents and where should I buy it?

You should get -- so the product -- the company name is Colorescience and they have a line of products. They call the Sunforgettable line. They have a Sunforgettable Body Shield, which is what Jim was talking about. That is our product with them. They have a Sunforgettable Face Shield. Those are the 2 lotion products and then they have a product called Sunforgettable Age Defense Mineral Shield, which has our materials in that as well, although we didn't build that from the bottom up. But those 3 products, they're all great products. The face shield was the award winner this year, but all of them are really nice products and they're doing a great job, marketing, and they've been a great partner for us. You can get them online. You can get them at dermatologist offices. These are higher-end products typically, but if you just Google Sunforgettable or Colorescience, it will give you some sources there. Certainly appreciate any volume you can add.

And I am showing no further questions in the queue at this time. I'd like to turn the call back over to CEO Mr. Jess Jankowski for any closing remarks.

Okay. Thank you, Jimmy. Thanks all of you for taking the time to listen to engage in the support Nanophase and Solesence. Our fourth quarter coming looks good and we're expecting to be able to discuss another Solesence launch next time. We're working harder on securing more Solesence product launches for the coming spring. So you know I'm going look forward to the opportunity to discuss the business with all of you again soon. I really like where we're at. Remember, enjoy the sun, we need the sun, but be sure to protect yourself from its effects on your skin because rain or shine, you get skin damage without proper care and I know just the stuff you should use and I think so do Ron and Jim. So have a great day everybody. Certainly appreciates you're calling in.

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