Business context and reporting period
Nanophase Technologies Corporation’s unaudited Form 10-Q for the quarter ended June 30, 2022 includes its wholly owned Solésence subsidiary. The company develops and manufactures materials, ingredients and finished products, with strategic emphasis on skin health and medical diagnostics. Figures below are in thousands of dollars unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Total revenue | $11,222 | $7,114 | $19,378 | $14,186 |
| Gross profit | $2,736 | $2,514 | $4,904 | $4,544 |
| Gross margin | 24.4% | 35.3% | 25.3% | 32.0% |
| Operating income | $123 | $960 | $228 | $1,457 |
| Net income | $50 | $41 | $112 | $1,351 |
| Operating cash flow | — | — | $(3,381) | $488 |
Q2 product revenue was $10,796, with other revenue of $426. For the first half, product revenue was $18,842 and other revenue was $536. Solésence sales rose to $7,099 in Q2 from $4,499, and to $12,659 for the half from $8,797. Personal Care Ingredients also grew; Advanced Materials revenue declined to $1,032 for the half from $2,213, reflecting sharply lower medical-diagnostics sales.
Gross margin contracted as higher material costs, manufacturing inefficiencies, overtime and labor constraints outweighed volume growth. R&D and selling, general and administrative expenses also increased. Six-month net income was substantially lower than in 2021, which included $952 of PPP loan-forgiveness income and $903 of debt-discount amortization expense; 2022 reported neither item.
At June 30, cash was $664, compared with $657 at year-end 2021. Current assets were $17,351 and current liabilities $13,534. Cash used in operations and investing was funded largely by $4,516 of net financing cash flow, including related-party revolving credit. Receivables increased to $6,537 and inventory to $8,949, contributing to operating cash use.
Related-party borrowings included $5,835 outstanding under revolving facilities and a $1,000 term loan. The A/R revolver has an $8,000 limit; the inventory facility permits up to $4,000 subject to eligible inventory. Facilities mature March 31, 2024, carry stated rates generally tied to prime plus 0.75%, and are secured by unencumbered company assets. Total liabilities also include $12,228 of operating lease obligations, net of imputed interest. Shareholders’ equity was $7,987.
Material changes, outlook and risks
- Revenue growth was driven by Solésence products and increased personal-care ingredient sales. Management reported little medical-diagnostics revenue in 2022 and noted that demand had decreased significantly.
- Management cited capacity constraints, difficulty hiring experienced workers, inflation in materials and wages, and delayed engineering projects. It expects capacity and efficiency improvements to support margins, but cautioned that margin percentage growth in 2022 may not be significant.
- Management estimated 2022 capital spending of $3 million to $6 million, dependent on project progress, demand and funding availability. It expects R&D spending to rise more slowly during the remainder of 2022; no formal revenue or earnings guidance was provided.
- Q2 SG&A included $104 of bad-debt expense and an approximately $180 one-time consulting accrual related to an Employee Retention Credit application. The company did not recognize the anticipated credit in earnings pending realization.
- Five customers represented 62% of Q2 revenue and 65% of first-half revenue. The largest customer accounted for 29% of both periods. BASF supply agreements include conditions that could require technology licensing and equipment transfer, potentially impairing production capacity and revenue.
- Borrowing is concentrated with related parties affiliated with a major shareholder. The company reported an unresolved material weakness in inventory controls dating from year-end 2021; remediation was in progress but incomplete. Management nevertheless concluded the financial statements fairly present the company’s position and results.
- The company reported no pending legal proceedings believed likely to have a material adverse effect. It stated it did not knowingly source materials directly from Russia or Ukraine and did not anticipate related supply disruptions.
Important facts for investors to verify
- Whether production capacity, hiring and engineering improvements ease inefficiencies and restore gross margins.
- Whether working-capital growth, capital spending and operating cash use remain financeable through available facilities and operating cash generation.
- Progress on inventory-control remediation and the accuracy of inventory valuation and reporting.
- Customer concentration, BASF agreement triggers, and the continued growth and demand outlook for Solésence and personal-care products.
- Status and amount ultimately realized, if any, from the Employee Retention Credit application.