Business context and reporting period
Nanophase Technologies Corporation’s Form 10-Q covers the quarter ended March 31, 2017, compared with the quarter ended March 31, 2016. The company develops and manufactures engineered nano- and sub-micron materials for markets including personal care, coatings, energy management and polishing. Its wholly owned Solésence LLC subsidiary sells formulated skin-care products. The filing is by Nanophase Technologies Corporation, not a separate Solésence, Inc. registrant.
Financial performance and position
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Total revenue | $3.485 million | $2.211 million; up 58% |
| Product revenue | $3.466 million | $2.189 million |
| Gross profit / margin | $1.204 million / 34.5% | $456,000 / 20.6% |
| Operating income (loss) | $56,000 | $(606,000) |
| Net income (loss) | $46,000; $0.00 per share | $(610,000); $(0.02) per share |
| Operating cash flow | $(158,000) | $(698,000) |
| Cash and cash equivalents | $1.527 million at March 31, 2017 | $1.779 million at December 31, 2016 |
Cost of revenue was $2.281 million, research and development expense $384,000, selling, general and administrative expense $764,000, and interest expense $10,000. Gross margin improved as revenue grew and manufacturing processes became more efficient. R&D expense increased from $301,000; SG&A was nearly unchanged from $761,000.
At March 31, 2017, current assets were $3.944 million and current liabilities $1.608 million. Total liabilities were $2.509 million, including $322,000 of capital lease obligations; stockholders’ equity was $2.887 million. No borrowings were outstanding on the revolving line of credit. The line provides up to $300,000 subject to eligible receivables and other conditions and was extended to March 2018.
Material changes and cash flows
- Revenue growth was attributed primarily to increased orders from several larger customers, including the largest customer in personal care and sunscreen applications.
- Cash declined by $252,000 during the quarter. Operating activities used $158,000, investing activities used $25,000, and financing activities used $69,000. The operating cash outflow included an $836,000 increase in trade receivables.
- Capital expenditures were $55,000. The company entered into a $175,000 financing lease and made $71,000 of capital lease principal payments.
- Q1 2016 financing cash flow included $988,000 from a common-stock issuance to the largest stockholder; there was no comparable issuance in Q1 2017.
Outlook, risks and contingencies
Management expected quarterly R&D and SG&A expenses to remain near Q1 levels for the rest of 2017. It anticipated $500,000–$700,000 of capital spending for the remainder of 2017, potentially financed through leases; actual spending could be outside that range depending on project outcomes and financing availability. Management believed cash, operating cash flow and available credit would fund operating plans through 2017, but noted that future capital needs depend on customer adoption, development programs and manufacturing requirements.
- Customer concentration is substantial: three customers represented approximately 69%, 7% and 5% of Q1 2017 revenue. The largest customer, BASF, is covered by exclusive supply agreements.
- BASF agreements can permit technology licensing and equipment transfers in specified circumstances, including certain financial covenant triggers. One trigger includes trailing 12-month earnings below zero and cash, cash equivalents and specified investments below $1 million. The filing reported approximately $1.5 million in cash and cash equivalents at quarter-end.
- Management warned that loss of a major customer, inability to pass through raw-material or labor cost increases, financing constraints, or triggering BASF remedies could materially harm operations and liquidity. Additional financing, if needed, might be unavailable or dilutive.
- The company reported an approximately $82 million tax-loss carryforward, subject to potential ownership-change limitations and expiration dates from 2018 through 2035.
- No material changes to previously disclosed risk factors were reported; the company reported no pending legal proceedings believed likely to have a material adverse effect.
Important facts for investors to verify
- Whether the Q1 revenue growth and gross-margin improvement continue, particularly given dependence on a small number of customers.
- Receivables collection and working-capital trends, given the quarter’s significant receivables increase and operating cash outflow.
- Cash levels and compliance with BASF agreement covenants, including the $1 million threshold and any other contractual triggers.
- Timing, financing and returns associated with planned 2017 capital spending and Solésence and energy-management product opportunities.
- Potential impact of customer concentration, commodity input costs, and the availability and terms of future financing.