Nanophase Technologies' (NANX) CEO Jess Jankowski on Q2 2016 Results - Earnings Call Transcript

| About: Nanophase Technologies (NANX)

Nanophase Technologies Corporation (NASDAQ:NANX)

Q2 2016 Earnings Conference Call

August 5, 2016 11:00 AM ET

Executives

Jess Jankowski - President and Chief Executive Officer

Frank Cesario - Chief Financial Officer

Analysts

Rand Kay - RKA

Operator

Good day, ladies and gentlemen, and welcome to the Nanophase Technologies Corp Second Quarter 2016 Financial Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded.

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 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 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.

I would now like to introduce your host for today’s conference Mr. Jess Jankowski, President and CEO. Sir, you may begin.

Jess Jankowski

Thank you, Raneya, and good morning, everybody. I appreciate you all being here and I also appreciate your flexibility with the timing. Many of us attended Cosmoprof 2016 last week one of the biggest shows geared toward cosmetic professionals in North America. This was because of a typical gap between the press release and this call.

We’ll discuss this show further in a few minutes. But given this timing, I didn’t want to withhold our results an extra week to accommodate our travel schedules. We’re happy that you’re able to join us to discuss our second quarter 2016 financial results and business updates.

Frank Cesario, our CFO, has joined me again today. During this call we’ll be talking about some new products, an update on our strategic approach to new business development, our existing business and of course 2016 second quarter results. We had a strong Q2 driven to a great extent by growth in our existing personal care business and through sales within our diversified technologies customer base.

The second quarter of 2016 represented an exciting milestone in that Nanophase had more than $450,000 in GAAP profitability. We also had about $300,000 in positive adjusted EBITDA for the first six months of 2016 more than $500,000 improvement over the same period in 2015.

We’re still focused on new business development as our main metric, but by managing our business effectively. We’re working hard to apply our business development resources to maximize their impact while generating as many dollars of margin as we can as we focus on building new business.

One of our key strategic initiatives is to narrow our business development focus to two key markets. While continuing to deliver world-class materials and continuing to support our existing customers. Many of whom are unless strategic but nonetheless lucrative markets. The strategy can be very well supported by the gain sharing approach we discussed in greater detail last quarter. I plan on covering all the things in greater depth after Frank provides a short overview of our financial results.

With that, I’d like to introduce our CFO Frank Cesario.

Frank Cesario

Thanks Jess. Good morning. This is Frank Cesario. Before I begin today’s overview of our financial results for the second quarter of 2016 please remember that all financial results are stated in approximate terms.

Revenue for the second quarter of 2016 was $3.7 million versus $2.9 million in 2015. As we announced we posted our first net profit for the quarter at $0.5 million or $0.01 per share. The net loss for the comparable quarter in 2015 was $0.1 million or $0 per share. For the first six months of 2016 revenue was $5.9 million versus $5.2 million during 2015.

Our net loss for the six months period was $0.1 million in 2016 or $0 per share compared to $0.7 million or $0.02 per share in 2015. We ended the second quarter of 2016 with a $1.4 million cash position nothing drawn on our working capital credit line. Jess.

Jess Jankowski

Thanks Frank. So far so good for 2016 in the fiscalsense.We continue to expect this year to show overall growth in both revenue and margins. 2016 should exceed 2015 in revenue although second half 2016 volume will be lower than first half volume. The bulk of our markets particularly when dollar weighted are seasonal. Q3 will come in lower than Q2 did and Q4 will most likely be lower yet. We will have a much better handle on full-year 2016 revenue as we close Q3.

Regardless of the effect of cyclicality on our second half, I expect 2016 revenue and margins to exceed 2015. Due to our conservative approach to budgeting, we are seeing nice pickups in flow and earnings as volumes increase. Nanophase has recorded a series of record earnings quarters over the past year and we expect to see that trend continue.

As I mentioned earlier, we are focusing our business development resources on two main areas, personal care and solar control. For this call, I’ll focus mainly on our approach to new business development and personal care. Our personal care focus is now composed of three types of products Zinc Oxide and Titanium Dioxide or TiO2 powders. Zinc Oxide and TiO2 dispersion and for the future development of fully formulated skincare products to be sold on a white label basis.

Let me break these three areas down for you. Most of you are probably quite familiar with our think Zinc Oxide powders business. We’ve been selling coated and uncoated Zinc Oxide as a mainstay of our business since shortly after we became a public company. As a matter of fact, our Zinc Oxide products are well known and appreciated throughout the industry.

We are currently testing the market to see if we can expand our reach to include Tio2 powders. Both of these materials are best classified as active ingredients to be sold to another manufacturer for incorporation into their final skincare and sunscreen products. Most of our growth in powders can be enabled by our new C3 coating technology, but it will always be limited to companies that have a high degree of minerals dispersion and formulation expertise.

Largely due to the relative newness of nano and non-nano minerals in near transparent products, we found that many companies in the personal care markets haven’t developed these formulating and processing capabilities over the preceding years. As many of you know, Nanophase has been working on industrial dispersion since the early 2000. Essentially dispersions refer to products, inorganic particles in our case in a liquid format designed to enable easier inclusion into finished products. It became apparent to us that the lack of high quality, easy formulating dispersions of mineral or inorganic sunscreen active ingredients for the personal care markets was limiting our growth.

Dispersions represents our second broad category of personal care products. For the past seven or eight years, we’ve been working on building more effective Zinc Oxide and TiO2 dispersions in order to address these formulating issues. It really wasn’t until the advent and then a more complete development of our new C3 coating technology over the past two years that we were able to see a clear path forward. Today, our dispersions are better than ever.

As we discussed last quarter, in April to our recently filed supply agreement, we officially launched two TiO2 based dispersions at the in-cosmetics show in Paris. Dispersions allow us to move further up the value chain, while increasing our understanding of our customers and the markets they serve beginning with TiO2 which will also ultimately expand to include Zinc Oxide. The goal of our line of dispersions is to enable the creation of finished products that are highly transparent, protect the user from UVB and UVA, protect the user and other beneficial ingredients in the products from free radicals and deliver an exceptional skin feel. I’ve mentioned before, that we’ve invested in our formulation capability at Nanophase related to this.

Initially, we are working on a series of what are referred to and the industry as model formulation. These are markups of finished products that allow our potential dispersion customers to see how well our materials can perform at the consumer level. We’ve also developed a stronger data and consumer claims support capability. Once these customers become interested in trying our dispersions, our formulators can then also help them to be more successful when incorporating our dispersions into their proprietary final products.

In the end, we expect these new capabilities to help our customers move more quickly toward adoption. This was a big step for Nanophase that represents a major shift in the way we approach personal care.

Now in addition to building our market knowledge in terms of consumer wants and needs. We are working more closely inside the finished products development cycle to better understand ways to improve them. As we connected to that, the development of a fully formulated white label finished products is a natural progression for Nanophase.

In building our formulations capabilities, building claims test data, and working to optimize performance in finished products in support of our dispersions line, we’ve created a roadmap for ourselves to develop our own finished products. Why not capitalized on it? By the way, when I say white label products, I’m referring to an approved finished product been incorporated the marketing companies desired claims and performance.

Nanophase will complete the entire development and production cycle, delivering a product in our customer’s final packaging. The customer will then be responsible for marketing, promoting, and the selling the product.

To their retail customers, it will look like it’s completely their own product design. This is a common practice in personal care and one with which we have a good deal of internal experience and at Nanophase. We are working in the early stages here, but development of white label products when completed not only brings us several steps up the value chain, but also enhance their degree of visibility and control over a business development.

I mentioned that several of us were traveling last week. We did a good bit of exploring, market testing, and even some sampling at cost of the profit 2016. Our target audience is there were generally skin care product marketing companies. Aside from those that we approached with our product concepts, we also spent several days verifying current market trends, spreading the word about our products more broadly, and exploring potential new personal care applications for Nanophase products.

Several of us also re-equated ourselves with prior industry contracts that operate more in the finished goods side of things than on the ingredient side where we had been spending the bulk of our business development time in the past. In terms of our growth outlook with respect to these three areas in personal care, the powder’s business will remain our largest business for some time.

Historically, this has been a $5 million to $7 million business and we expect modest growth here over the years. We expect that the dispersions business will grow the most rapidly in gross dollars over the next few years. We should see more sampling volumes in Q4 with more to follow in 2017. I no longer think that this will represent six figure sampling and ramp up revenue in Q4.

The various downstream customers for these products will spend 12 to 24 months doing required testing and scale up. Some are at various stages in the earlier part of this cycle. We do expect six figure revenues in 2017 with the potential for dispersions to grow to be a seven figure business. Over the next four to five years while we expect good growth, we don’t expect dispersions to grow to become a significant in revenue terms as our powder’s business.

Lastly, the white label finished products business is brand new to Nanophase and difficult to predict at this point. It will be composed to smaller customers and may offer us the greatest opportunities for growth as it develops. It submittedly embryonic stage, the earliest that I expect revenue from commercialized products is in Q2 to Q3 of 2017 with volumes not becoming significant until sometime after that.

Given our knowledge of various personal care markets along with the historical success and broad acceptance of our materials in some of those markets, we can see our personal care business in total having the potential to double over the next four to five years. There are still many things to be developed and perfected. But we feel good about our opportunities in personal care.

Regardless of our lack of clear visibility to growth for the foreseeable future, things look great for inorganic or minerals based sunscreen and skin care products. This is a great space for us to be in and we have a solid value proposition. In terms of our solar control business, things are still moving forward in a few different areas. By the end of Q3, we expect to know more about where we’ll be by year end and going into 2017 in terms of further potential commercialization.

We’ve sold small commercial quantities of a new material on this area and have done a good bit of sampling. I plan to cover this in greater depth in a future call. Outside of personal care and solar control, we still have other opportunities for profitable volume and growth that expect to materialize this year and next.

Please be clear that we are only limiting the focus of our new business development activities to the two key markets we’ve been discussing. We continue to serve other markets with high quality products that perform well and generate nice margins. In this respect, we are functioning much more like a typical seller of high end specialty products in these industries then we are as a product developer.

We remain in regular contact with all of these customers and we are taking advantage of our strong manufacturing capabilities to deliver. What we are not doing is devoting our internal new product development, new market development and new business development resources more broadly to markets outside of personal care and solar control.

By drawing this line within our business, we hope to accelerate our growth in our two most promising strategic areas by applying a higher degree of focus. I think of serving our existing volume businesses and markets as being critical, but more tactical in nature than I do personal care and solar control. We have more upside potential with these two markets and a clear vision of how they may unfold.

Going forward I’m confident that we’ll continue to set new financial performance milestones. Revenue growth, cash generation and new business growth are our top priorities. Although most of our investors either listen to the webcast or review the transcript after the live call, we’d like to invite those participating in today’s call to ask any questions you may have or to share your comments.

Raneya, would you please begin the Q&A session?

Question-and-Answer Session

Operator

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

Rand Kay

Hey, guys, how are you?

Jess Jankowski

Good. Sounds like you are busy.

Rand Kay

Yes. First of all, I want to say that very, very impressed with the new strategic focus on revenue generation and bottom line results, which I think has clearly borne fruit. My question is with these new markets that you are going into which is along your daily wake up of existing technologies and existing strengths.

Do you foresee continued positive cash generation or funding these developments from positive cash flow or do you think we’re still going to be dabbling back and forth between you know positive and negative cash flow for the next couple quarters or as you insinuated the next couple of years?

Frank Cesario

So I will take the first track of that Rand. This is Frank. We absolutely intend for the business to generate positive cash flows to keep growing our results, last year you saw for the first time back to back positive adjusted EBITDA quarters. This year you saw the first outright net profit.

So going forward is our intention to grow topline to grow bottom line to keep improving cash flow and to be investing that in this business group. It’ll depend on how well we do to see how quickly that does grow, but that is our plan, that is our intention. If we do need a small amount of cash to get over a hump or to deal with large order or to deal with capital equipment to service new market based on contract so albeit we will deal with those as they come.

Jess Jankowski

Then generally the last thing that I ever want to do is create more dilution and ideally as we generate cash from these businesses. Even if the Company as a whole is generating as much cash in the specific business within the company will be able to use that to finance any equipment we might need or growth we might need internally to support it. So I mean we’re very committed to that Rand.

Rand Kay

Okay. Last question as you guys talked about you know the incubation of some of these new initiatives and then the required testing that could go for as much as two years. Can you or do you expect any sequential minimal as it might be revenue growth during that time or is it going to be pretty flat in these new businesses. Especially this new liquid dispersion thing?

Jess Jankowski

We do expect sequential growth. Essentially, if you look at the three pieces in personal care we’ve got the powder’s business which we’ve been in for a long time and there could be growth there. There will be growth there in certain areas, the issue there is that we’ve got one big customer and occasionally there’s a demand that that kills us for a quarter and then it comes back typically because the market itself is prime.

So if you take that apart you’ve got dispersions and you’ve got with the white label products. Dispersions inherently take longer to bring to market because essentially these dispersions are being sampled all over the place we’ve got companies working on them. We are using an intermediary our partner that we disclosed with the agreement in April. So they sample the dispersions those companies do testing and dispersions do a lot of work our partner also supports that testing with data.

And then they make their own internal formulations, they take it a step further, take it into the marketing group that will do consumer testing and go forward that way. That’s why that takes longer. That being said, the last small numbers is good to us in this regard. We have good leverage. The sampling quantities and the ramp-up quantities will be six bigger quantities next year. So we’re going to see growth in that new business and we’ll talk about that discreetly as it come.

To think about the white label business that is attractive, but I’m being a little tentative just because we’re new into it is that we take those steps out of it, we come up with a formulation, we take it to somebody, they look at it, we’ve done some of the testing, a good deal of the testing and you’re talking about a quicker time to market once we do all that work.

So what that means is, the same amount of work has to get done, but essentially if Nanophase is doing that work, it’s our top priority to get it done, unlike we don’t - having an intermediary you really don’t know what the Company’s priority is, and the larger the Company, the greater the opportunity and slower the speed in some of these areas for white label products.

There are companies that you and I had never heard of before talking to them that could buy a few hundred thousand dollars’ worth of very profitable material from us in a relatively short period of time. I’m leery about saying that’s going to happen for sure next year, because in Q2 and Q3, just because some of these customers are smaller, some are bigger and we’re new at it, but I do see that ultimately to capitalize and everything we’ve built here, the expertise we have here.

We basically built barriers to entry for other people to get into some of these places. I think it just makes perfect sense that the usual we know how to do to take it down the line, we’ll have more control, ultimately worst case we’ll get a faster no, which is good. That’s not good enough, but it’s good, best case we’ll be able to have a handle on what’s happening and influence those customers.

And once you get in even if it’s a relatively small customer and they’re happy with the product then the typical route is that you expand it further into their line. And that’s one of those things that we look at and think as a nice opportunity for us.

As well as I mean the other business is that the solar control business, certainly had some good opportunities. We’re just not as far down the line and it’s just - it’s such a different business that we’re waiting for some milestones that are kind of fewer and bigger than the milestones in the personal care area.

Rand Kay

The reason I asked gentlemen is my concern has been historically - for example, if you take a look at the battery business, okay. There was from your perspective a clear opportunity for the battery manufacturers and you guys spent effort, time, resources to prove that to the battery manufacturers. At the end of the day, there seemed to be a miscalibration about the level of interest that they would put in the product to actually generate an order.

I know you know quite a bit more about the personal care business. I guess my question is that, is there any way to - if the value added proposition is going to be clearly beneficial to the customer wouldn’t it make sense to have the customer pick up part or as much of the tab as they possibly can even if it’s less from a time, from a time expediency issue a little bit slower just to say, hey, okay you’ve got skin in the game or is this something you feel you need to really push to get out into the marketplace and pay for the testing, pay for the verification, assume the cost of that just to get it to the market a little bit faster.

Jess Jankowski

So Rand, let me take a shot at that and I appreciate that you brought up the battery business. When we developed the battery solution, it was a cost savings vehicle largely when commodity prices were much, much higher. While folks were reviewing that cost benefit solution, commodity prices came down dramatically. That was not helpful to our cause. And so when you’re saving someone money and they are already saving money, doing the same thing, they are doing yesterday, it becomes a much harder sale.

In the case of what we’re talking about here - but it’s true in personal care and some of those folks on personal care. We are talking about the active ingredient and a formulation. In some cases the entire formulation that they’re then going to absorb and sell. And the way to fell into those businesses is to actually walk in with a tube you can put on your skin that you can feel it, you can touch it, you can look at it. That’s the way the selling process works in this industry. And the more that we match that, the more that we meet that standard expectation, we believe the faster this will go. And so we think that’s the best way to sell into this industry and in fact mutually exclusive.

So to the extent that someone wants to engage with this more quickly, they have more fine tuning that they would like to do, we have the flexibility to do that and to the extent that folks look at what we give them and say this is great, we want to use it. We are ready to supply it. So in going after the market our way, driving the bus ourselves, we have the ability to go after those different areas of the market the way they need to be touched and dealt with.

Frank Cesario

I’d add to that. Part of it its sounds more complicated than it is, there are a lot of moving parts, but it’s not as expensive as this sounds and it’s not as deep as it sounds, so if you compare the dispersion business to the white label business. On the dispersion side, we’re going to have a series at some point I mean ideally I don’t know five or six dispersion that testing gets done, we take that the large companies relying on them to do the testing just close everything down, but also - first of all, we’ve done a lot of the testing already.

And it’s something that isn’t as deepen wide it sounds. When you get into the white label side, it’s proportionately less expensive just because you’ve got smaller - you’re looking at a smaller world.

However, it also gives you a higher degree of control and I look at it in both senses that we’ve been doing quite a bit of this all year. So when you look at our financials and you look at - I mean our product development, business development numbers are a mixture between R&D and SG&A, selling Kevin’s time, that group, we have an outside consultant that some other people had support it as well as the R&D group.

We’ve skinned everything else down in order to focus on these two things. When I talk about being clear on what we are and are not doing, essentially 90% of our R&D group is focused on the two areas and our engineers that actually do the scale up work are focused on these two areas. So if you’re looking at the financials today, Jankowski just said, we’re going to do all this new great stuff, that’s going to cost something, how are they going to offset those cost. First of all, we already have by changing the focus.

And then secondly it’s a lesser issue, but it’s still there. My preference going forward in some of these markets in solar control as well is to do as much as we can before we invest in any sort of equipment which could include having somebody else do some of the processing that’s capital intensive, making a smaller margin on the front end, building a business. And all of a sudden now if I could point at a business that is a [x100,000 dollar] business that generates x% profit and if I took it internally I would make more. It’s much easier to justify either internally financing that capital or getting it externally.

And I think we’re very much focused on running as lean as we possibly can. And I’m sure that a lot of our investors are tired of hearing about it, but we all are very, very vested in the equity of this Company and the reason we’re here is to build the value of Nanophase for all of us, yourself and all of our investors, our board, and our employees. And I think that the best way to do that is trying to balance to lean this with what we do best, where do we get the most traction and that’s what we’re doing.

Rand Kay

Well, I first of all want to let you know that I certainly appreciate the strategy that you guys indicated as of the last quarter with this new focus or a quarter and a half already borne fruit. I appreciate it, the market appreciates it. It is absolutely clear that the reapportionment of resources is bearing fruit for you guys.

And the fact that you have plugged a one drain is terrific. I just want to understand by plugging one drain, if this new - well I don’t want to open up another. So the market appreciates what you do and the street appreciates it and I appreciate it. So I think the focus is terrific. I just would like to see you continue down that road. And as long as you guys are continuing to manage bottom line, that’s terrific to me.

Frank Cesario

As I said, that’s right. The equity value which is critical to us and also in terms of the way that our Board evaluates performance, it’s very much directed toward the combination of revenue growth, bottom line management and new business development. So we’re very aligned internally in the same direction.

Rank Kay

Thank you, guys. Good call.

Jess Jankowski

Thank you.

Frank Cesario

Thanks, Rand.

Operator

And I’m not showing any further questions. I would now like to turn the call back to Mr. Jess Jankowski for any further remarks.

Jess Jankowski

Thank you, Raneya. And thanks everybody for participating. We had a few people contact us earlier and say they weren’t going to be able to be on the call and naturally those were some of the people that asked the most questions, but Rand always asked good questions and I appreciate the dialogue there. And hopefully that fills out some of the points.

Putting together these scripts every quarter is difficult for me at some point to understand what our investors do and don’t understand and I know I’m speaking to the choir here essentially the people that are actually on the call live, but we have a multiple of this number that listen to the call online and read the transcript. So it’s great to flush those things out. I’m looking forward to talking to all of you again in a few months. Nanophase is making good progress and I’m really excited about our outlook. Thank you for joining us today for today’s call.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program and you may all disconnect. Everyone have a wonderful day.

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