Nanophase Technologies Corporation (including Solésence, LLC) — Q1 2022 Form 10-Q
Entity and period: The filer is Nanophase Technologies Corporation; Solésence, LLC is its wholly owned subsidiary and its results are consolidated. This unaudited report covers the three months ended March 31, 2022, compared with Q1 2021. Amounts below are in thousands of dollars except per-share data.
Financial results
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Total revenue | $8,156 | $7,072 |
| Gross profit | $2,168 | $2,030 |
| Gross margin | 26.6% | 28.7% |
| Operating income | $105 | $497 |
| Net income | $62 | $1,310 |
| Operating cash flow | $(1,775) | $(137) |
| Capital expenditures | $(378) | $(166) |
- Revenue rose 15.3%, led by Solésence sales ($5,560 versus $4,299) and Personal Care Ingredients ($2,382 versus $1,395). Advanced Materials revenue fell to $214 from $1,378, including a significant decline in medical diagnostics materials. Other revenue was $110 versus $22.
- Gross profit increased, but gross margin declined by about 2.1 percentage points. Higher volume and material-price inflation, manufacturing inefficiencies tied to Solésence launches, additional supply-chain staffing and temporary warehouse costs pressured costs.
- Operating expenses increased: R&D to $666 from $499 and selling, general and administrative expense to $1,397 from $1,034. Operating income fell to $105. Net income was $62, or $0.00 per basic and diluted share, versus $1,310, or $0.03 per share. The prior-year comparison included $952 of PPP loan-forgiveness income.
- Operating cash use increased as receivables and inventory grew. Cash at quarter-end was $897, up from $657 at year-end 2021, primarily supported by financing. The cash flow statement reports $2,393 of net cash provided by financing; the MD&A liquidity table displays this amount in parentheses, an apparent inconsistency.
- At March 31, current assets were $15,735 and current liabilities $11,431 (working capital of $4,304; current ratio about 1.38). Total liabilities were $24,709 and shareholders’ equity $7,748. Cash was limited relative to obligations, and operating lease liabilities totaled $12,279.
Debt, liquidity and financing
- Related-party borrowings included a $3,709 accounts-receivable revolver and a $1,000 term loan. The company drew $8,125 and repaid $5,767 on the related-party revolver during the quarter.
- In January 2022, the company amended its related-party financing: the A/R revolver limit increased to $8,000, and a new inventory facility provides up to $4,000 subject to a borrowing base; no inventory-facility funds had been drawn by quarter-end. The facilities mature March 31, 2024, at prime plus 0.75%. The $1,000 term loan was transferred to Strandler, LLC and has a stated 4.00% rate and the same maturity.
- The lenders are affiliates of a significant shareholder. The facilities are secured by unencumbered company assets and are subordinated to the bank’s credit facility. Management estimated 2022 capital spending of $3.5 million to $7 million, expected to be funded through operating profits, existing debt and lines, and possibly new debt.
Business developments, outlook and risks
- Management’s strategic focus is beauty science and life sciences, particularly skin health products and medical-diagnostics ingredients, while continuing to serve legacy advanced-materials markets. It cited continued demand in beauty and life sciences but said future COVID-19 testing demand is difficult to predict.
- Management is prioritizing manufacturing throughput and capacity to address demand that has exceeded production and shipping capability since late 2020. It expects higher volume could improve absorption of fixed manufacturing costs, but cautioned that gross-margin growth in 2022 is uncertain and depends on product mix, costs, pricing pass-throughs and scaling efficiency.
- Management expects R&D expense to increase more slowly over the remainder of 2022. It said supplier-price and wage inflation could materially affect results if cost increases cannot be passed to customers. It did not anticipate direct supply disruption from the Russia-Ukraine conflict because it did not knowingly source materials from either country.
- Revenue concentration remains substantial: four customers represented 69% of Q1 2022 revenue; the largest represented 29%. The filing describes exclusive BASF supply agreements that could, under specified triggers, permit technology licensing and equipment transfer, potentially causing significant revenue loss and capacity-replacement costs.
- Disclosure controls were deemed ineffective due to a material weakness in inventory controls identified at December 31, 2021. Remediation was ongoing. Management nevertheless concluded the quarter’s financial statements fairly presented the company’s financial position and results under U.S. GAAP.
- The company reported no pending legal proceedings believed likely to have a material adverse effect. Other risks cited include customer concentration, working-capital availability, raw-material sourcing and pricing, manufacturing capacity, product acceptance, competition, intellectual-property protection, regulation and business interruptions.
Important facts for investors to verify
- Whether inventory-control remediation is completed and whether inventory balances and related reporting controls remain reliable.
- Cash needs and borrowing availability under related-party facilities, including covenant or collateral terms and the implications of the lender relationships.
- Whether manufacturing capacity and product launches improve margins, and whether inflationary costs can be passed through to customers.
- How dependent revenue remains on the largest customers and the status and potential consequences of BASF’s supply-agreement provisions.
- Whether the planned $3.5 million–$7 million capital program is funded as expected and whether medical-diagnostics demand can be sustained.