Business Context and Reporting Period
Company: Nanophase Technologies Corporation (Note: Metadata listed "SOLESENCE, INC." but filing text confirms Nanophase Technologies Corporation).
Filing Type: Form 10-Q (Quarterly Report).
Reporting Period: Quarter and nine months ended September 30, 2010.
Business Overview: Nanophase is a nanomaterials developer and commercial manufacturer producing engineered nanomaterials for markets including sunscreens, personal care, architectural coatings, industrial coatings, water filtration, and polishing applications (semiconductors, optics, windows). The company operates as a single business segment with all long-lived assets located in the United States.
Key Financial Metrics
| Metric | Three Months Ended Sep 30, 2010 | Nine Months Ended Sep 30, 2010 |
|---|---|---|
| Net Revenue | $2,076,214 | $7,416,186 |
| Gross Profit | $473,776 | $2,157,940 |
| Gross Margin | 22.8% | 29.1% |
| Net Loss | $(1,584,520) | $(2,856,600) |
| Loss Per Share (Basic/Diluted) | $(0.07) | $(0.13) |
| Cash and Cash Equivalents (Sep 30, 2010) | $6,754,127 | |
| Total Investments (Sep 30, 2010) | $30,000 | |
| Total Current Liabilities (Sep 30, 2010) | $1,926,943 | |
| Long-Term Debt | None (Capital lease obligations minimal) |
Cash Flow (Nine Months Ended Sep 30, 2010):
- Net cash used in operating activities: $(540,549)
- Net cash provided by investing activities: $3,401,562 (Primarily from sale of auction rate securities)
- Net cash used in financing activities: $(6,279)
Material Changes vs. Prior Period
- Revenue Growth: Net revenue increased 20.6% for the three months and 56.5% for the nine months compared to the same periods in 2009. This was driven primarily by increased sales to the company's two largest customers.
- Profitability: While gross profit increased, the company reported a net loss for both periods. The loss for the nine months ended September 30, 2010, was $2.86 million, an improvement from the $4.22 million loss in the prior year period.
- Unusual Items: The company incurred $700,000 in agreement termination charges in the third quarter of 2010 related to the settlement and termination of a Joint Development Agreement with Altana Chemie GmbH. This included a $350,000 cash payment and a $350,000 non-cash discount liability on future purchases.
- Investment Portfolio: The company sold its remaining auction rate securities (ARS) for $4 million in April 2010. Consequently, investments dropped from $3.59 million at year-end 2009 to $30,000 at September 30, 2010.
- Operating Expenses: Selling, general, and administrative (SG&A) expenses increased due to higher salary, legal, and marketing costs. Research and development (R&D) expenses decreased slightly due to reduced depreciation and legal fees.
Guidance, Outlook, Risks, and Contingencies
Outlook and Commentary:
- Management expects growth in end-user adoption for the remainder of 2010 and beyond.
- Gross margins are currently impeded by fixed manufacturing overhead not being fully absorbed by current revenue volumes. Margins are expected to improve as revenue volume increases.
- Capital spending for the remainder of 2010 is estimated at approximately $150,000.
Key Risks and Contingencies:
- Customer Concentration: Two customers accounted for approximately 63% and 9% of revenue for the three months ended September 30, 2010. The largest customer is BASF Corporation.
- BASF Supply Agreement Covenants: The agreement with BASF contains financial covenants. If the company fails to maintain earnings greater than zero AND cash/investments greater than $2 million, or if debt is accelerated, BASF may trigger a technology transfer and equipment sale. As of September 30, 2010, the company held approximately $6.8 million in cash and investments, well above the $2 million threshold, and had no significant debt.
- Supply Chain (Rare Earth Elements): The company relies on cerium oxide (a rare earth element) for polishing applications. Export limitations from China have created supply shortages and cost increases, creating uncertainty for the polishing business in 2011.
- Net Operating Losses: The company has a net operating loss carryforward of approximately $82 million. A portion of this carryforward expired in 2009, and the remainder will expire between 2010 and 2029 if not utilized.
Investor Verification Checklist
- Liquidity vs. Covenants: Verify that cash and investment balances remain above the $2 million threshold required by the BASF supply agreement to avoid triggering a technology/equipment transfer.
- Customer Concentration: Monitor the stability of revenue from the top two customers, which represent over 70% of total revenue.
- Rare Earth Supply Chain: Assess the impact of China's export restrictions on cerium oxide availability and pricing on the company's polishing product margins and fulfillment capabilities for 2011.
- Altana Settlement Impact: Confirm the utilization of the $350,000 discount liability on future purchases from Altana and the status of the new non-exclusive supply agreement.
- Margin Expansion: Track revenue volume growth to determine if fixed manufacturing costs are being absorbed efficiently to improve gross margins.