Nanophase Technologies Corporation (NASDAQ:NANX) Q1 2016 Earnings Conference Call April 28, 2016 11:00 AM ET
Jess Jankowski - President and Chief Executive Officer
Frank Cesario - Chief Financial Officer
James Liberman - Wells Fargo Securities
Rand Kay - RKA
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 conference 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 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.
I would now like to turn the call over to your host, Mr. Jess Jankowski, President and CEO.
Thank you Luke, Jess Jankowski here. Good morning folks and thanks for listening. We're glad you’re able to join us to discuss our first quarter 2016 financial results and business update. Frank Cesario, our CFO, has joined me again today. During this call we'll be talking about some new products an update on our existing business and of course 2016 first quarter results. We entered 2016 with a little bit of momentum and a continued focus on growing revenue. While Q1 was below my expectations in terms of revenue Q2 promises to be stronger. The Q1 flip was driven by order timing net of permanent reduction in demand.
In 2015 we had growth outside of our largest customer of about 1.1 million, our largest customer had a down year in 2015 and we expect more 2016 volume from them as well as some additional new revenue growth from the rest of the business.
We also generated cash based on a long time adjusted EBITDA metric during two of the four quarters of 2015 demonstrating success from our continued focus on improvement in operating results. I expect this improvement to continue in 2016. We've also seen new opportunity growth for our inorganics in the personal care market, I'll discuss that later in the call.
Lastly you may have noticed that we filed an 8-K regarding a new supply agreement for the first of our new personal care products based on our C3 coating technology. We don't pretend that this one supply agreement will drive significant 2016 revenue but it will be accretive and more importantly reflects the shape of anticipated future agreements in terms of our gain sharing approach. We'll talk a bit more about that too. As a matter of fact I'll discuss all of this in more depth after Frank provides a short overview of our financial results. With that I welcome Frank to begin his discussion.
Thanks Jess, good morning, this is Frank Cesario. Before I begin today's overview of our financial results for the first quarter of 2016 please remember that financial results are stated in approximate terms.
Revenue for the first quarter of 2016 was 2.2 million versus 2.3 million in 2015. The net loss for the quarter was 0.6 million or $0.02 per share for the first quarter of each year. We ended the first quarter of 2016 with a $1.5 million cash position and nothing drawn on our working capital credit line. Jess.
Thanks, Frank. That was brief. 2016 will be a good year for Nanophase. We're making good progress in several areas and we have market tailwinds in personal care to potentially accelerate our growth further. I expect 2016 to show better performance, top-line and bottom-line than 2015 did. In personal care which has been composed largely of our active ingredients for inorganic sunscreen we continue to sell a significant amount of zinc oxide into the market place and have recently expanded our product line to include titanium dioxide but in the form of two formulated dispersions which allow us to move up the value chain. Dispersions refer to products in a liquid format. Historically the bulk of our business and certainly all of our personal care business has involved sales of products in the dry powder format. These dispersions are the subject of our recently filed supply agreement. They were enabled by our new patented C3 technology. The dispersions were launched in Europe at the in-cosmetics show two weeks ago.
Before I go too far the answer is yes we anticipate more supply agreements for other products as we move forward. Our goal with the C3 enabled dispersion beginning with titanium dioxide was to create a dispersion that is chemically robust, stays well dispersed, leading to a high degree of transparency and limits the amount of free radicals generated as the skin is exposed both to the sun's rays and to other compounds included in the final sun or skin care product. It also has to have a really nice skin feel which comes about through building a good dispersion, keeping the minerals, titanium dioxide in this case from agglomerating or sticking together. This non-agglomeration leads to a much more pleasant tactile experience as well as helping to achieve the all important degree of transparency desired by the customer.
The initial feedback we received has been positive but the proof will be when the materials get included in commercial products. We expect the various downstream customers for these products to spend 12 to 24 months doing required testing and scale up. This means we should see sampling volumes possibly in the low six figure range late in 2016. If the scale up process is successful they will be test marketed by the end produced than produced at commercial scale. We expect more significant volumes to begin later in 2017 and related growth to continue through 2018. As I mentioned earlier the new contract that we filed is structured in a new way to allow both Nanophase and its partner to maximize sales. It requires that both parties be co-participants in the selling process. It's structured on a strategy that we've developed based upon gain sharing. While our typical contract involves a much higher degree of opacity between Nanophase and its customers, this contract allows us to approach the market, agree to what the market dictates and remain as transparent as possible with our customer. We're only implementing this strategy in cases when Nanophase is further down the value chain and thus further away from the end buyer. For areas where a strategic focus dictates that we're not doing much sales and applications development support.
We developed this approach because the typical contract and the advanced materials, chemical or cosmetics industry does not allow for pricing flexibility based upon market condition. Historically this means Nanophase prices our products at a flat per kilogram rate maybe with volume discount. Under this system we price these products so that we can achieve strong margins on every sale based upon our indirect understanding of our customers' end customer. Our customer will then pay us our price go to market with the product and frequently ignore any business that falls below an arbitrary margin threshold, this is the way our entire business has been structured up until mid 2015. A common theme within our sales process through an intermediary has always been pushed back on pricing.
Under the typical agreement structure it could be difficult to determine whether to push back, is our customer looking for more margin themselves or whether sales volumes truly depend on more aggressive pricing. Yes, we've had some superior products but in case where we used another company's sales channels there often isn't enough profit to make it worth their while to pursue volume. Through gain sharing our goal is to empower whoever is selling the product to get and maintain all the business they can and for Nanophase to receive a portion of the dollar margin on each sale. This allows pricing to reflect market conditions. Effectively Nanophase now expects to be directly in profit sharing with some of its customers.
I also expect this strategy to allow us to pick up a greater total dollar volume of margin maximizing total profit dollars. Another nice feature of this approach is that in cases where our customers have multiple product lines in addition to ours, Nanophase products will become something that the customers' sales team will want to sell. There's more profit and more flexibility to be had for everybody under this model and we expect their efforts to reflect that reality. The gain sharing approach offers us the best of both worlds in certain types of applications. First we allow our selling partner to manage the interface which allows us to focus on other business development activities. Second we optimize market pricing which allows both parties to maximize our margins. Again we are only seeking to implement this strategy in cases when Nanophase is further down the value chain and thus further away from the end buyer or in cases where our strategic focus dictates that we not dedicate much sales and applications development support to certain market areas.
It's a true win-win. Regarding our markets more broadly in addition to the European launch of these new products at in-cosmetics in Paris, we also spent a good deal of time talking with our colleagues and attending seminars on market trends in sun care, the specific part of the personal care market we play in most. For the foreseeable future things look great for inorganics or minerals based industry. Generally consumers are taking a more holistic view of their skin care, tying together health, wellness, diet and lifestyles as they choose products. Things that are perceived as all natural or naturally derived as well as products with fewer and fewer ingredients are gaining traction and that's our sweet spot.
Several different key industry sources communicated that they see inorganics or minerals based sun care product becoming the dominant part of the market's growth over the coming years. All of this gives Nanophase a nice tailwind as we continue to raise awareness of our products and the advances they could bring to these markets. In terms of our energy business we've now developed and sold several solutions in the solar control area. This refers to applications which improve energy conservation, think of the window film used on vehicles and buildings. It may be easier for you to think of this business as using our technology to keep heat from the outside outside, keeping things cooler inside. We've sold small commercial quantities of a new material in this area that may be a market disruptor. We should know more about our potential for success here by the end of Q3.
We expect to continue to grow revenue during 2016 and at a greater rate than in 2015. I'm confident that we'll set some new financial performance milestones with revenue growth and cash generation being our top priority. The second quarter will be stronger than the first and we still have several new opportunities in the pipeline they expect to materialize this year. 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. Luke would you please begin the Q&A session.
Your first question comes from the line of James Liberman from Wells Fargo. Your line is open.
I can see the enthusiasm here for the patients. Regarding the second quarter, that’s historically been your strongest quarter. Are you seeing different mix that needs you to feel that this is a more robust and more likes to it?
We’re seeing that, I don’t know if the mix if different as much as the volume is going to be strong. We also saw that in Q1 there really was more of a timing issue than there was a volume issue. Overall, we’re seeing stronger demand this year than last year, at least at this stage in the year. We expect to have a better 2016, both on the top line and the bottom line that we did in 2015.
Are you allowed to discuss more it used to be the BASF was really your primary customer [indiscernible], is this new product you have the discussion in that going independent of BASF?
It is Jim. They’ve asked us not to disclose the specifics. The customer beyond the extent that we filed the 8-K there is an agreement there with products. I would say that our partner there is promoting the products aggressively. They’re outside of our relationship with BASF. They’re also -- both TiO2 and Zinc Oxide, are the two main inorganic and sunscreen and we haven’t had a TiO2 option in our portfolio, our material portfolio in quite some time in more than a decade probably. And I think this is a nice way to approach the market with an excellent partner expand the market also to expand the awareness of Nanophase as the player in the personal care, skincare, sun care market, because essentially over the last couple of years, several years, as we saw a lot more time out kinds of being the bushes and introducing ourselves to different companies, learning things, developing new products, as we mentioned earlier we hired a full time formulator internally. We’re also using some external formulators to help us develop or complete solutions. And essentially allow our customers to more quickly evaluate the materials and incorporate them into their products. So I think it's a great thing for Nanophase and I think it won’t be the first agreement that we have. Hopefully, not the first this year, but I expect to have a few more -- we have a few more in the pipeline. You can never determine when those things happen. But it's an approach I think that’ll be really good for us.
And just one other question if I may, and I can get back into the queue. Regarding the solar energy component, what other kinds of testing, like you said, you’ve already been pretty enthusiastic [indiscernible] so far and it's just confirming the data or is it more of different formulations that you’re working out?
No, we’ve actually had several different products that we’ve developed go into commercial products on a small scale. And these are items that relative to our technical capabilities, we really think we have a better handle on how to make that -- how to approach that market than many other companies do. The specific one that we mentioned in the press release is a new material we developed over the last two or three months. One of the things I like about the market Jim it's a blessing and a curse. There are some really big players in the market that take a long time to get in. There are some smaller players that could potentially buy volumes of materials from Nanophase that would be in the low to mid-6 figure range, maybe more with nice margins for everybody and about.
And in this market those smaller players go to market a lot quicker than say in cosmetics. Whereas in cosmetics, our partners started sampling materials really last summer and fall and then more aggressively now and those just take longer the nature of their product. So I don’t think there is a lot of testing as much as there is going to be reaching out to the market, getting samples produced, and in some cases in our case ramping up production, because some of these things as you know, as Frank of fond of saying, we try to do as much as we can on a shoestring and limit the amount of capital we invest prospectively. So we always have the issue of chicken and egg issue of how much do we scale before we get the volume and then the subsequent margin to cover it.
[Operator Instructions] Your next question comes from the line of Rand Kay from RKA. Your line is open.
Couple of questions here or three actually. First of all, how much did grandfathered from Q1 in revenue that you expected in Q1 into Q2, and has that all been collected.
Let me start with that, you know we typically don't go into a backlog metric, it hasn't been useful for this business. We usually we might get a full year forecast typically we don't give a lot of -- your order flow that goes for a tremendous amount of time as in more than two months, but when you put the year together you know we talk to our customers, we find out what their needs are, are we prepared to meet those needs and so we saw a little bit less than is typical in Q1, we then saw a significant quantity of orders coming through starting with Q2. So, I'll just say that you know we are stating publically that we expect the second quarter to be significantly stronger and to start that trajectory as we be 2015 on the top and bottom line.
The reason I brought it up was that Jess alluded to the fact that it was a timing issue and not necessarily an order flow issue, and so I just thought was it something that you have expected to come into Q1 and just you know float into Q2 or you know…
And I would say, Rand generally that answer is yes, there are customers who if they're taking something in large, they're taking in April or May and that you know true in a lot difference sites, so I won't point to any one thing, or any one customer or any one product, I'll just say that as you put the year together you have their expectations then it plays out which is the primary reason we don’t try to give quarter-by-quarter forecasting, you can talk about the whole year in aggregate because that gives us a much broader base from which to draw.
We do have, it's always one of those tough things because it's a lot of small number and we're painfully aware of -- you know a single purchase order typically can be 10% of our quarterly volume and so you kick one from March 20th to April 14th and all of a sudden you blow your quarter which essentially you didn't really blow anything there's a two week lag it's hard to determine even at this point what all of June volume is going to be and that's where Frank's better sense is be a little more specific because we just -- I would say the industry has changed to a degree where almost our entire customer base is being required to be much more reactive with their customers than they used to be and so they're waiting till the last minute, they're giving us indications of what they expect so that we're ready, but there's a lot of changing month-to-month as we saw last year we had a huge change in the first half and then a huge part of that came back in the second half and it was organizationally difficult to deal with them I'm sure from an investor's perspective, difficult to fathom.
Okay, with the change in the conversation, concentrating more on costs and bottom line and operating improvements, what kind of visibility do you guys now have on breakeven.
Let me kick off, I think breakeven is something we look at first on a quarterly basis and then on an annual basis as we add revenue streams to the existing revenue streams the ones that we had for quite some time, we've been developing for some time. So you look at last year and we announced we had two positive adjusted EBITDA quarters, okay that was progress. This year do we aspire to do better than that, absolutely we do, so you talk about your different expectations on a quarterly and then on an annual basis to tell you that that's what we've been flirting with and we look to break through.
The timing is difficult to predict Rand exactly but it’s somewhere in the $11 million to $12 million range volume depending on how we run the business and it’s not, you mentioned the focus on operational. That really isn't our prime focus it's our necessary focus because we're running lean, our prime focus is really our business development and getting more revenue in the door and as such you couldn’t really take, you know last year we burned very little cash and mathematically there would be a very low breakeven, but essentially we are investing as we go into these areas to develop are we going to do formulator, making sure we have the resources we need and the thing we're not doing, the thing we're not doing relative to spending that is the toughest is investing in strictly CapEx, I mean that's something we've been trying to operate at a minimum we have partners that help us with that, and that's really -- that has a lot to do with cash. I think operating cash flow, we're in spitting distance from it, we saw it a couple of times last year, I expect to see it at least a couple of times this year or at least bigger than last year a couple of times if not more. We always have a bad, I mean seasonality wise, I'd love to have a whopper Q4 but generally that's not a great quarter for us. Once again, difficult to tell and then you've always got product mix. If the -- depending on what takes off in the portfolio you know a million dollars for the revenue in one product is very different from a million dollars worth of revenue in our other product, to the tune of potentially even a quarter million dollar delta on the cash side. So it really depends on how those things flow [indiscernible]?
Well, here is my concern. My concern is that with kind of the fussiness around breakeven and quote on quote the investment in the various product lines, my concern has been a great technology chasing a solution and marketing at this point has fluctuated vastly between emerging in new energy solutions as opposed to driving to the bottom line. And the reason I asked for color on specifically on the bottom line is I would like to hear some sort of disciplined approach to spending on ventures potential opportunities versus consideration on profitability. In other words I really like to see a verbal commitment from the company that they intent to drive to profitability and fund marketing opportunities from cash flow. And without some color as to breakeven, we keep getting an open ended result to when are we going to hit it?
So what we’re doing relative to as a proof point is that we are both keenly focused on two areas with our market development products from personal care and the energy space [indiscernible] some other things are going, those are largely be driven by the customer not by our internal product but [indiscernible]. So we are not nearly trying to save every nickel we can and that -- and then we do have a more rigorous plan on how [indiscernible] purchasing out. Part of it is there is a certain commitment that’s required to get there and we are doing that, we’re probably doing into the minimal amount that we can in order to do it.
I understand your concerns. It's certainly a concern all of our investors share, our board shares it, I share it, I think we’re doing the minimum prudent amount of business development we can to generate a nice return for our investors. I mean essentially we could be profitable tomorrow and just not have any growth potential based on the fact that we’re a technical organization. We have a lot of technical support here. I know that’s not where anybody wants to go and we’re trying to moderate between one and the other.
And I’ll only add to that Rand that we take that extremely seriously, we really do. And so we’re always performing that evaluation. Is this a good dollar of spend to get us where we’re on the go, or is the scenario where we should clamp that down a little bit, and take the benefit of it. And I can tell you, we track operating spending year-by-year and every year it gets smaller. And it gets smaller for a reason. But we still do that with investment in the upside of the Company. So each year is the best year, and I think we’ll all feel that as revenue catches up to with rest of the business has been doing.
And gentlemen, don’t get me wrong, I appreciate it. I just would like to see this burn of [indiscernible]. So I just want to make it clearer. I am concerned and just want to hear what your perspective on? Here is my last question, do you guys need, you were talking about strategic partners. Are you going to need a strategic partner for the solar business to launch that? Or are you able to develop the smaller businesses organically?
We think we’re going to be able to do all that organically, the business we have developed so far, it's been successful but our support internally and essentially if you look at something like personal care and you look at our -- as the Company that has global reach that can do things we can’t do that Nanophase is not at a point where we could invest in the sales support or that type of industry. There is too many people that has to be fast. It would also put too much strain on our infrastructure. Whereas, in the solar control area there is a handful of customers [indiscernible] versus there are literally thousands of customers at the personal care site.
I think as time goes on and we get more experienced in both markets, as far as we’ll be able to the turn area, like pinpoint areas where we’ll play directly to trying to maximize the profit that we get, because everybody wants to be at the very top of that value chain. But at this point, given our constraints that are just endemic to this kind of a company, we think that we’re using partners where it would just be too difficult for us to be able to support those markets internally and then we’re going ourselves after the things that we can support.
In addition to what we don’t talk about as much as we have, there are projects going on that are really customer driven that we’re not as involved with. We refer to that as diversified revenue. Internally, there are projects going on that company A is investing in it or not, they’re pretty okay about what they’re telling us. I expect some of those things to come to fruition as well, similarly to what we had last year in the coatings business with some things that have been perking along for a number of years finally started to create revenue.
You didn’t mention anything about the polishing business. I wonder if you had any color on that.
Polishing business is moving forward and I would be -- I’d like to see our business grow year-over-year some of that is dependent. We’ve got a series of what I would call mezzanine customers, the good customers, they’ve got some volume and then we’ve got one bigger customer in our -- the legacy business with [indiscernible], and last year they had a really good year. So I am not sure exactly where that’s all going to go. So I am cautiously optimistic we have a couple of new products that are out there, that we are supporting to a degree that we expect to have some growth but similar to the rest of the business we’ve got a bigger volume customer that we have less control over the demand. And so it's hard to know where it's going to go. I like that business I think it's a good business for us. I think we just -- at this point, we’re not investing in development per se we’re still doing some selling.
Your next question comes from the line of James Liberman from Wells Fargo. Your line is open.
Regarding the inorganic dispersion, I am assuming that the initial interest or the orders are coming from smaller players. But regarding the larger cosmetic companies that might be interested, because there the inorganics are very good safety profile, do you see the acceptance level process being shorter than other evaluations and acceptance process that we have?
Not necessarily I think first of all just to say that, the partner we’re working with there is not -- the volume isn’t going to be small customers, it's going to be sampling volume that makes it not big volume this year. They’re going to go after every customer they can and have good experience going after much larger customers. I think we’ve got a couple of issues relative to inorganics. What we’re bringing to the table with our technology in concert with their product as well is included in the technology, is a way to use inorganics in a manner that typically they don’t function. So you’re asking people to say historically a lot of people don’t like something like TiO2 they came back at our Zinc Oxide because it's whitening create something they refer to as ghosting doesn’t feel as good on my skin. I know it's safer but this is an issue.
So, we are having to do that kind of they are and we are doing that selling where you’re trying to explain to some of these that there is kind of a paradigm shift here, you could use a material historically that hasn’t been used for the higher transparency applications. And you’ll get good skin field. So I don’t expect it to take any less time. They’re still required in the United States and in most of the world it's registered as -- these materials are registered as an active ingredient or an over the counter drug. So there is still a series of testing that everybody has to do, and that’s really the reason that takes as long as it does on the front end and that people are doing all kinds of testing to make sure that they have new product that complies with regulations, it's inherently safe.
Lastly, you also have the -- there are people that don’t like the idea of particulars because of some places where nano-materials are not as much of an issue. We make both, nano and non-nano. We don’t believe there is a safety issue. Asia generally doesn’t believe there is a safety issue. It depends on the individual market and the way that the seller, downstream seller markets the technology.
And just to expand on that slightly, we’ve spoke in the past about Europe slowly be more receptive to the mineral solutions and we’re seeing that continue. So, we don’t expect an individual customer to become very quick to go through that qualification process I mean it's significant. So the qualification process will take time. What we like about selling dispersions Jim is that they can be more targeted to different pieces of an expanding market. And so now as an entity I think we’re getting a better coverage because the entirety of the market is growing. There’re more elements to the marketplace and they’re growing at different speeds. And so now we can participate more directly in different facest of that market.
And when these organic dispersions get better and are available in the marketplace. So, can you let us know where we can get them? Will it be obvious to us what the products we might be able to find, so we could use them ourselves?
Well, we’ll have to see. I mean I know with respect to our powder materials that there’re lot of PND products and if you go a CVS or Walgreens and see materials with what they often refer to as sheer zinc oxide a lot of that is ours -- used to be all of it was ours, the patent scenario has changed over the last several years, but a lot of it is ours and the volume is still robust for that. So we’ll see what we can do Jim in terms of sharing that. Some of that would also be up to our -- it may not be obvious from the label is the question. If it is obvious in the label you’ll certainly -- we’ll certainly point at that, if it's not, we’ll have to see if the partners wish to share that or no.
So we’ll have to look at that for a potential future dividend.
I am showing no further questions at this time. I would now like to turn the call back to Mr. Jess Jankowski.
Thank you, Luke. We look forward to talking to all of you again in a few months. Nanophase is making good progress, and as I said I expect 2016 results to reflect that going forward. Thank you for joining in on today’s call.
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