FOURTH QUARTER 2011 CONFERENCE CALL


Jess Jankowski, President & CEO 

Good morning everyone! We appreciate your joining us for our fourth quarter and year-end 2011 financial conference call. With me today is our CFO Frank Cesario. Reflecting back on 2011, I believe, more strongly than ever, that the changes we’ve made in our business model have been the right ones. We’ve endured, and then flourished, while facing many challenges including a significant economic downturn. 

This last year, one of our raw materials, a rare earth from China called ceria, became temporarily scarce, and was subject to skyrocketing costs. Additionally, our largest customer negatively affected our revenue by reducing their inventory levels to deal with the sluggish economy. Last year we also quickly adapted to significant regulatory changes, again impacting our largest customer, in terms of their product disclosures and their marketing efforts. Along with the backdrop of continuing economic uncertainty, these abrupt changes naturally stalled their business development activities. 

Developing new marketing channels, and creating innovative product lines for growth markets is always difficult, and in a tough economy it can be almost impossible but I am pleased to say that we have been successful! In the past, these sorts of issues would have been enough to hurt our overall performance, but that didn’t happen in 2011. Despite all of those challenges, revenue increased and our bottom line improved. My thanks to our customers and the entire Nanophase team!

Heading into 2012, the raw material problem is easing as more suppliers move into the rare earth markets; but, the cost for these materials is still much higher than it was in 2010. We also expect the addition of new customers and markets to continue providing more revenue stability than we’ve experienced over the past few years. As we continue to refine our market-driven direct selling model, we’re experiencing solid improvement in our success rate. We believe this is due to the time spent working through customers,’ and prospective customers,’ product testing and development cycles. Taking their valuable input, and integrating it into our development process, has led us toward more efficient product development and targeted marketing activities. This input has also allowed us to more quickly identify products and markets where we foresee only limited potential for success, helping us to de-emphasize these, and apply our resources more effectively on others. The end result is a strong, targeted pipeline and increased sales. 

Frank, would you please take a few minutes and provide the financial update?


Frank Cesario, CFO

Thanks Jess. 

Good morning, this is Frank Cesario. Before I begin with an overview of our financial results for the fiscal year 2011 and the fourth quarter, please remember that all financial results are stated in approximate terms. 

Revenue for the fourth quarter was $1.7 million and we ended the year with revenue of $9.7 million, surpassing 2010’s revenue of $9.5 million. The raw material Jess mentioned is the cerium oxide we use in products for polishing applications. Cerium oxide, while abundant, can be difficult to extract. China has imposed severe export limitations on its rare earth metals for the past 18 months, which resulted in both cost and availability challenges. Fortunately, new sources of rare earth materials have been coming on line and are projected to increase the global supply. Also, as we head into 2012, China has not continued to tighten its export limitations. While the prices are still far higher than they were two years ago, they have stabilized. 

The high cost of cerium oxide raw material certainly hit our profit margins in 2011, but we were still able to maintain a strong 24% gross margin. Cost savings initiatives and working closely with our customers helped limit our exposure. As we move through 2012, we expect less of an impact on margins. 

The net loss for all of 2011 was $3.4 million, or $0.16 per share, which included $1 million in deprecation in excess of capital spending. This compares to a net loss of $4.1 million, or $0.19 per share, for 2010. Net losses on a quarterly basis were $1.3 million, or a loss of $0.06 per share, and $1.2 million, or a loss of $0.06 per share for the fourth quarters of 2011 and 2010, respectively. 

We spent $3.1 million of net cash during 2011. Approximately $1.1 million went into working capital, an area we expect to be positive in 2012. The remaining $2 million went to operate the business, including capital spending. We continue to become more efficient, even as we develop new sources of revenue. With our current run rate, we could achieve cash flow break even with revenue around $13 million per year ($3.25 million per quarter). 
Our balance sheet remains healthy, as we finished the year with $2.7 million in cash and cash equivalents and no debt. 

Now, I would like to turn the call back to Jess.


Jess Jankowski, President & CEO 

Thanks Frank! Before I get back to business, I’d like to address an administrative matter. As we mentioned in yesterday’s news release, our common stock will begin trading on the OTCQB marketplace March 20th. This is the world’s largest electronic marketplace, with over 160 broker/dealers, 10,000 securities listed, an aggressive growth strategy and a history that dates back to 1913. While the transition to the OTC marketplace does not change our obligations to continue periodic filings with the SEC, including our audited quarterly and year-end financial reports, our “public costs” will be reduced. An additional benefit of trading on the OTCQB is the ability of our investors to view Level II real-time stock quotes and market makers for Nanophase. Also, our stock symbol will remain “N-A-N-X.” 

Now, back to business. Looking back over the past two years, we’ve positioned ourselves well to build our new customer-direct business. We’ve maintained excellent business relationships with, and continue to receive revenue support from, our former exclusive partners, as these relationships have migrated from exclusive to non-exclusive. We find that after re-negotiating agreements with these partners, our relationships have actually improved, as we assumed the role of a more traditional vendor. Many of you may have seen a recent announcement between Nanophase and CIK NanoTek. CIK NanoTek is a Japanese company that originally purchased a technology license from Nanophase to make and market certain materials in certain Asian markets. That license arrangement is set to expire in April of 2013. In advance of that, we took a proactive stance, and all parties have already agreed to replace the exclusive relationship, with a non-exclusive one when the original license agreement expires. Armed with our recent experience, we expect to maintain a strong relationship with CIK NanoTek, providing us with a stronger position from which to launch our products into the Asian markets. As with our polishing business, and more recently our coatings additives business, we are transforming our CIK NanoTek relationship from one that is limiting to both parties, to one that allows us to better utilize our applications development strengths. In keeping with the positive spirit in which we started these negotiations, we believe this change will be another win for both of our companies! 

Since 2009, we have re-negotiated our three, most limiting, exclusive agreements to better position Nanophase to leverage its strengths. It has taken time, but these complex negotiations have allowed us to largely change the way we go to market. Where we were once almost completely dependent on others to market our products, we are now marketing and selling directly to the end-users. Most critically, where we were once dependent upon others to serve as the technical interface with the end-users of our products, we are now able to work directly with them, to ensure that our materials are both easy to work with, and effective in their applications. This has been a seminal change within Nanophase. We now have a solid pipeline of opportunities across several product lines and target markets where we expect to create and grow new revenue for 2012 and 2013.

While we don’t make annual revenue projections, we expect moderate amounts of new 2012 revenue from the following products:

In 2013, we also expect to enjoy revenue growth from:

This new business is very important for driving our YOY revenue growth, since we are also experiencing flat or declining revenue in some of our mature products, particularly with Ceria for CMP polishing. We expect our existing CMP polishing business to yield about half the volume in 2012 that it did in 2011, reflecting about a one million dollar reduction in revenue, as a direct result of raw materials pricing issues. Ceria supply, and pricing volatility, has driven many ceria users in the CMP market to find alternative technologies. Now, here’s the good news: Despite flat or declining revenues in our core business, we expect it to remain strong, and we expect to gain more than enough new business in 2012 to offset any losses in existing business. These markers are the ones that I focus on most. This is important to me because it signals that the direct selling model is beginning to deliver! We’re not out of the woods yet, but we’re moving in the right direction. Again, while we don’t share revenue growth projections, we expect there to be measurable top line progress in 2012, and we expect it to come from new customers.

Operationally, we’re now faster at evaluating opportunities and either converting them to commercial revenue, or halting development when we believe our resources could be better applied elsewhere. That’s the front end of our business model: we carefully evaluate potential applications, and then we review their progress against expectations. This makes us a very different Nanophase Technologies Corporation from the one we were before 2009. We’ve applied everything we’ve learned, we’ve built a higher quality pipeline, and we’re applying our hard-won knowledge in everything we do. I look forward to talking more about progress in our new application areas as we continue through 2012.

As always, we plan to keep you posted on our progress through news announcements and conference calls. I know most of our investors listen to the webcast, or review the transcript after the call, but for those on the line who would like to ask a question or share a comment directly, the floor is yours.

Shannon, would you please begin the Q&A session?

We are fully confident that we have the know-how, products, business strategy and potential to achieve our goals. We appreciate your continued support, and are always available for any follow-up questions you may have. Thanks for your participation and enjoy the rest of your day!