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| NANX > SEC Filings for NANX > Form 10-K/A on 27-Mar-2009 | All Recent SEC Filings |
27-Mar-2009
Annual Report
The following discussion and analysis should be read in conjunction with risks discussed in other filings made by the Company with the Securities and Exchange Commission, and the financial statements and related notes thereto appearing elsewhere in this Form 10-K. When used in the following discussions, the words "anticipates," "believes," "estimates," "expects," "plans," "intends" and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks, uncertainties and contingencies that could cause actual results, performance or achievements to differ materially from those expressed in, or implied by, such statements. See the "Forward Looking Statements" section in Part I., Item 1.
Overview
Nanophase is a nanomaterials and applications developer and commercial
manufacturer with an integrated family of nanomaterial technologies. Nanophase
produces engineered nanomaterials for use in a variety of diverse markets:
sunscreens, architectural coatings, industrial coatings, ingredients, personal
care, abrasion-resistant applications, antimicrobial products, plastics
additives, medical diagnostics and a variety of polishing applications,
including semiconductors and optics. The Company targets markets in which it
feels practical solutions may be found using nanoengineered products. The
Company works closely with current and potential customers in these target
markets to identify their material and performance requirements and market its
own materials to various end-use applications manufacturers. Newer developed
technologies have made certain new products possible and opened potential new
markets. Management expects growth in end-user (customers of Nanophase's
customers) adoption in 2009 and beyond and revenue growth in these areas to
follow thereafter. Management further expects that the Company will develop
additional customers to help it achieve growth in certain markets in 2009 and
beyond.
On July 2, 2007, the Company issued and sold 1,900,000 shares of common stock to certain institutional investors at a purchase price of $5.92 per share and received gross proceeds of $11.2 million.
On August 25, 2006, the Company sold, in a private placement to Rohm and Haas Electronic Materials CMP Holdings, Inc., 847,918 shares of common stock at $5.90 per share and received gross proceeds of $5.0 million.
From its inception in November 1989 through December 31, 1996, the Company was in the development stage. During that period, the Company primarily focused on the development of its manufacturing processes in order to transition from laboratory-scale to commercial-scale production. As a result, the Company developed an operating capacity to produce significant quantities of its nanomaterials for commercial sale. The Company was also engaged in the development of commercial applications and formulations and the recruiting of marketing, technical and administrative personnel. Since January 1, 1997, the Company has been engaged in commercial production and sales of its nanomaterials, and the Company no longer considers itself in the development stage. From inception, the Company was primarily capitalized through the private offerings of approximately $32.0 million of equity securities prior to its initial public offering, its initial public offering of $28.8 million of common stock in November of 1997, its private offering of $6.2 million of common stock in May of 2002, its private offering of $1.95 million of common stock in September of 2003, its receipt of a customer's equity investment of $9.3 million in March 2004 and its private offering of $1.95 million of common stock in September of 2004 (through the conversion of warrants that were attached to its September 2003 offering), its receipt of a customer's equity investment of $4.9 million in August 2006 and its offering of $10.5 million of common stock in July 2007 pursuant to a registration statement declared effective by the SEC on May 31, 2007, each net of issuance costs. The Company has incurred cumulative losses of $73.5 million from inception through December 31, 2008.
Critical Accounting Policies
Investments are classified by the Company at the time of purchase for appropriate designation and are reevaluated as of each balance sheet date. The Company's policy is to classify money market funds, certificates
The Company has also made investments in auction rate securities ("ARS") totaling $5.34 million as of March 3, 2009. These ARS holdings in the Company's investment portfolio have experienced "failed auctions" due to a lack of available buyers for them on their expected auction dates. An auction failure means that parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event there is a failed auction the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments. Despite these failed auctions, there have been no defaults on the underlying securities and investment income on these ARS holdings. They have been issued through the Federal Family Education Loan Program ("FFELPs Loans") and carry an AAA credit rating. These FFELPs Loans are guaranteed to 97% of their $6 million value by the Department of Education. However, these failed auctions have caused the Company to change the level of inputs to determine their fair values. The values of the Company's ARS's were estimated using a discounted cash flow model of analysis. Since these inputs were not observable, they are classified as level 3 inputs (see Note 3). As a result, for the period ending December 31, 2008, the Company recognized an other than temporary impairment loss on the ARS's in the amount of $660,000 which was reflected in the statement of operations. The Company's valuation models assume an average maturity of the ARS's in excess of one year; therefore, the Company has classified these securities as long-term on the December 31, 2008 balance sheet.
The Company's investments are held by its investment bank who is a member of all major stock exchanges and the Securities Investor Protection Corporation (SIPC). Securities and cash held in custody by the Company's investment bank are afforded complete protection for the Company's investment positions through SIPC and a commercial insurer (commonly known as "Excess SIPC" coverage); however, it does not protect against losses from the rise and fall in market value of investments.
See Notes 2 and 3 to the financial statements, "Summary of Significant Accounting Policies" for a further discussion of liquidity issues.
The Company has decided to change our method of accounting for patent costs during the fourth quarter of 2008. The Company will now expense patent costs instead of capitalizing them.
The Company believes that it no longer has the ability to reasonably predict whether a patent will be granted, when it will be granted or whether all claims in a granted patent ultimately will be upheld. Therefore, management believes that it is preferable to expense all patent costs incurred as period costs. The expensing of patent costs as a period cost will more closely align these expenses with when the Company is recognizing the related revenue from the patented technology.
For more information regarding the impact of this accounting change, refer to Note 2 in the Notes to Financial Statements.
Results of Operations
Years Ended December 31, 2008 and 2007
Total revenue decreased to $10,213,817 in 2008, compared to $12,209,108 in 2007. A substantial majority of the Company's revenue for the year ended December 31, 2008 is from the Company's three largest customers. See Note 15 to the Financial Statements for additional information regarding the revenue the Company derived from these three customers for the year ended December 31, 2008. Product revenue decreased to $9,744,759 in 2008, compared to $11,766,565 in 2007. The decrease in product revenue was primarily attributed to decreased sales from the Company's largest customer, a portion of which management attributes to inventory issues and a
Other revenue increased to $469,058 in 2008, compared to $442,543 in 2007. This increase was primarily attributed to the Company recognizing revenue in connection with a research evaluation project.
The majority of the total revenue generated during the year ended December 31, 2008 was from BASF Corporation, the Company's largest customer, from the Company's second largest customer for applications in architectural coatings and from Rohm and Haas Electronic Materials.
Cost of revenue generally includes costs associated with commercial production and customer development arrangements. Cost of revenue decreased to $7,501,468 in 2008, compared to $9,032,187 in 2007. The decrease in cost of revenue was generally attributed to decreased revenue volume along with decreases in commodity metals pricing, reduction in manufacturing overhead and the Company's continued efficiencies in reducing its remaining variable manufacturing costs on nanomaterials. These decreases were partially offset by inefficiencies due to incomplete utilization of production assets. Nanophase expects to continue new nanomaterial development, primarily using its NanoArcŪ synthesis and dispersion technologies, for targeted applications and new markets through 2009 and beyond. At current revenue levels the Company has generated a positive gross margin. The Company's margins have been somewhat impeded by not having enough revenue to absorb the manufacturing overhead that is required to work with current customers and expected future customers. Management believes that the current fixed manufacturing cost structure is sufficient to support significantly higher levels of production, given current revenue mix and resultant product revenue. The extent to which the Company's margins continue to grow, as a percentage of total revenue, will be dependent upon revenue mix, revenue volume, the Company's ability to continue to cut costs and the Company's ability to pass commodity market-driven raw materials increases on to its customers. As product revenue volume increases, this will result in more of the Company's fixed manufacturing costs being absorbed, leading to increased margins. The Company expects to continue to focus on reducing its controllable variable product manufacturing costs through 2009 and beyond, with potential offsetting increases in the commodity metals markets, but may or may not continue to see absolute dollar gross margin growth through 2009 and beyond, dependent upon the factors discussed above.
Research and development expense, which includes all expenses relating to the technology and advanced engineering groups, primarily consists of costs associated with the Company's development or acquisition of new product applications and coating formulations and the cost of enhancing the Company's manufacturing processes. In another example, the Company has been and continues to be engaged in research to enhance its ability to disperse its material in a variety of organic and inorganic media for use as coatings and polishing materials. Much of this work has led to several new products and additional potential new products for use by BYK-Chemie and other customers of Nanophase.
Now that the Company has demonstrated the capability to produce pilot quantities of mixed-metal oxides in a single crystal phase, the Company does not expect development of further variations on these materials to present material technological challenges. Many of these materials exhibit performance characteristics that can enable them to serve in various catalytic applications. Management is now working on several related commercial opportunities. The Company expects that this technique should not be difficult to scale to large quantity commercial volumes once application viability and firm demand are established. The Company also has an ongoing advanced engineering effort that is primarily focused on the development of new nanomaterials as well as the refinement of existing nanomaterials, as dictated by our customer-driven marketing strategy. The Company is not certain when or if any significant revenue will be generated from the production of the materials described above.
Selling, general and administrative expense decreased to $5,390,771 in 2008, compared to $5,560,960 in 2007. The net decrease was primarily attributed to decreases in salary expenses and consulting fees partially offset by increases in legal fees and recruiting and relocation expenses.
In the third quarter of 2008, the Company announced the resignations of Mr. Joseph E. Cross, its then-current President and Chief Executive Officer and Mr. Kevin J. Wenta, its then-current Executive Vice-President of Sales and Marketing along with Mr. Edward Ludwig its then-current Vice-President of Business Development. As a result of these resignations, the Company incurred a total of $1,578,859 of cash and non-cash severance charges. Included in these charges were salaries and benefits, accelerated vesting of stock options (non-cash) and other expenses. Of these charges, approximately $593,000, or 38%, were related to the accelerated vesting of stock options which have no cash impact and are expected to have a minimally dilutive effect if any. Mr. Joseph E. Cross was replaced by Mr. Jess Jankowski, initially as Acting Chief Executive Officer. Mr. Jankowski was then appointed President and Chief Executive Officer in February 2009. In addition to his new duties, Mr. Jankowski will continue to serve the Company as Vice President of Finance and Chief Financial Officer on a temporary basis. Also, in the third quarter of 2008, the Company appointed Ms. Nancy Baldwin to the position of Vice President, Human Resources and Investor Relations, Dr. Patrick Murray to the position of Vice President, Research and Development and Mr. David Nelson to the position of Vice President, Sales and Marketing.
Interest income decreased to $383,083 in 2008, compared to $661,512 in 2007. The decrease was primarily due to decreased investment yields partially offset by increases in funds available for investment, largely composed of the July 2, 2007 equity investment from certain institutional investors which resulted in net proceeds of approximately $10.5 million.
Inflation
Management believes inflation has not had a material effect on the Company's operations or on its financial position. However, supplier price increases and wage and benefit inflation, both of which represent a significant component of the Company's costs of operations, may have a material effect on the Company's operations and financial position in 2009 and beyond, if the Company is unable to pass through those increases under its present contracts or through to its markets in general.
Liquidity and Capital Resources
The Company's cash, cash equivalents and investments amounted to $12,971,957 on December 31, 2008, compared to $16,708,919 on December 31, 2007. The net cash used in the Company's operating activities was $2,560,783 and $1,808,886 for the years ended December 31, 2008 and 2007, respectively. Net cash provided by investing activities, which is due to maturities of securities and to a lesser extent capital expenditures offset partially by purchases of securities, amounted to $2,733,471 for the year ended December 31, 2008 compared to $8,987,887 of net cash used for the year ended December 31, 2007. Capital expenditures amounted to $499,967 and $1,226,736 for the years ended December 31, 2008 and 2007, respectively. Net cash used in financing activities is due to principal payments on capital lease obligations partially offset by the issuance of shares of common stock pursuant to the exercise of options, amounting, in total, to $12,694 for the year ended December 31, 2008 compared to $11,227,461 of net cash provided by financing activities, primarily due to the Company securing financing through an equity investment in July 2007, for the year ended December 31, 2007.
The Company's supply agreement with its largest customer contains several financial covenants which could potentially impact the Company's liquidity. The most restrictive financial covenants under this agreement require the Company to maintain a minimum of $2 million in cash, cash equivalents and investments and that the Company not have the acceleration of any debt maturity having a principal amount of more than $10 million, in order to avoid triggering a transfer of technology and equipment to the Company's largest customer. The Company had approximately $13 million in cash, cash equivalents and investments and debt net of unamortized debt discount of less than $1.6 million on December 31, 2008. This supply agreement and its covenants are more fully described in Note 14 to the Company's Financial Statements.
The Company believes that cash from operations, the net proceeds of $10.5 million from its July 2, 2007 Offering, and cash, cash equivalents and investments on hand and interest income thereon, will be adequate to fund the Company's operating plans for the foreseeable future. The Company's actual future capital requirements in 2009 and beyond will depend, however, on many factors, including customer acceptance of the Company's current and potential nanomaterials and product applications, continued progress in the Company's research and development activities and product testing programs, the magnitude of these activities and programs, and the costs necessary to increase and expand the Company's manufacturing capabilities and to market and sell the Company's materials and product applications. Other important issues that will drive future capital requirements will be the development of new markets and new customers as well as the potential for significant unplanned growth with the Company's existing customers. The Company expects that capital spending relating to currently known capital needs for 2009 will be approximately $700,000, but could be even greater due to the factors discussed above.
As of March 20, 2009, the Company's investments in auction rate securities totaled $5.34 million. These three auction rate securities ("ARS") in the Company's investment portfolio have experienced "failed auctions" due to a lack of available buyers for them on their expected auction dates. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar short-term instruments. Despite these failed auctions, there have been no defaults on the underlying securities and investment income on these ARS holdings. They have been issued through the Federal Family Education Loan Program ("FFELPs Loans") and carry an AAA credit rating. These FFELPs Loans are guaranteed to 97% of their $6 million value by the Department of Education. Although a liquidity short-fall may exist from auction to auction, the Company is not aware of any changes to ratings or other indicators of a permanent decline in value. However, these failed auctions have caused the Company to change the level of inputs to determine their fair values. Should current market conditions for ARS persist, the Company may be forced to sell some portion or all of its holdings at a discount to face value of between 6% and 50% in order to avoid a potential liquidity crisis in 2010. Management has undertaken aggressive measures to reduce cash used in operations in hopes of avoiding a discounted sale of any of these ARS's prior to the market for them stabilizes. The values of the Company's ARS's were estimated using a discounted cash flow model of analysis. Since these inputs were not observable they are classified as level 3 inputs (see Note 3). As a result, for the period ending December 31, 2008, the Company recognized an other than temporary impairment loss on the ARS's in the amount of $660,000 which was reflected in the statement of operations. The Company's valuation models assume an average maturity of the ARS's in excess of one year; therefore, the Company has classified these securities as long-term on the December 31, 2008 balance sheet.
Should events arise that make it appropriate for the Company to seek additional financing, it should be noted that additional financing may not be available on acceptable terms or at all, and any such additional financing could be dilutive to the Company's stockholders. Such a financing could be necessitated by such things
On December 31, 2008, the Company had a net operating loss carryforward of approximately $77.3 million for income tax purposes. Because the Company may have experienced "ownership changes" within the meaning of the U.S. Internal Revenue Code in connection with its various prior equity offerings, future utilization of this carryforward may be subject to certain limitations as defined by the Internal Revenue Code. A layer of the Company's carryforward expired in 2008. If not utilized, the remaining carryforward expires at various dates between 2009 and 2027. As a result of the annual limitation and uncertainty as to the amount of future taxable income that will be earned prior to the expiration of the carryforward, the Company has concluded that it is likely that some portion of this carryforward will expire before ultimately becoming available to reduce income tax liabilities.
Off-Balance Sheet Arrangements
The Company has not created, and is not party to, any special-purpose or off-balance sheet entities for the purposes of raising capital, incurring debt or operating the Company's business. Nanophase does not have any off-balance sheet arrangements or relationships with entities that are not consolidated into the Company's financial statements that are reasonably likely to materially affect Nanophase's liquidity or the availability of capital resources.
Credit Environment
The credit markets continue to be volatile and have experienced a shortage in overall liquidity due to the sub-prime lending industry. The Company neither engages in any business activities in the mortgage industry, nor does it hold mortgage-backed securities in its investment portfolio. Overall the liquidity shortage in the marketplace includes Auction Rate Securities. The Company believes it has sufficient liquidity from its cash and investment accounts to satisfy 2009 operational needs. See Notes 2 and 3 to the financial statements, "Summary of Significant Accounting Policies" for a further discussion of liquidity issues.
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