Interactive Q&A: Joe Cross, President and CEO of Nanophase Technologies

This is the latest in the Seeking Alpha series of interviews with leading companies of interest to our readers. These are interviews with a twist: the executive has agreed to answer questions and respond to comments not from a single interviewer, but rather from our community of readers and contributors.

This interactive Q&A is with Joe Cross, President and CEO of Nanophase Technologies (NASDAQ: NANX). Nanophase has sponsored this interview, which works like this:

• Joe briefly introduces himself and the issues he's focused on below.
• Readers and contributors can immediately start to post questions and remarks using the comment box below (free SA registration required).
• Seeking Alpha editors will not filter or edit the questions and comments from readers, except to delete profane or hostile language.
• Joe will respond to the questions and remarks beginning Monday, March 3rd. Readers can track his answers and respond to them during that period, with the resulting dialogue remaining on the site.

Readers from external sites may join the Q&A by following this link.

Over to Joe:

Welcome to our interactive Q&A session and thank you for taking a few moments to learn more about Nanophase Technologies, a leading global nanomaterials innovator and commercial manufacturer with a unique, integrated family of nanomaterial technologies.

We produce a variety of engineered nanomaterial products for diverse market segments such as personal care products (sunscreens, lotions); coatings and plastic additives (floor coatings, clear coats), architectural coatings (interior and exterior paints, decking and fence treatments), antimicrobial products and polishing applications (semiconductors, optics). Additionally, new market segments and applications are targeted and continuously developed.

Unlike many nanotech companies still in development, Nanophase is an established publicly held company with a ten year operating and revenue history and established asset base. Nanophase’s business model is based on both strategic market partners, who typically occupy a specific market segment and sell Nanophase’s products globally, and direct sales to customers.

Market partners include BASF (BASFY.PK) in personal and sun care products; Rohm and Haas (ROH) Electronic Materials in chemical-mechanical polishing [CMP] for semiconductors; BYK Chemie for nanocomposite formulations in paints, coatings, inks, polymers, plastics and sealants. Nanophase has also achieved solid revenue growth selling directly to customers, for example, in architectural coatings, optics polishing, textiles, and biosensors.

In 2007, we reported revenue of $12.21 million, compared to $8.99 million in 2006, representing total year-over-year revenue growth of 36%. During 2007, gross margin on sales increased to 26% of revenue, versus 22% in 2006, due to increased volume. This was the third consecutive year Nanophase has reported 30% plus year-over-year revenue gains.

Our competitive position is strong. As of February 1, 2008, the company owns or licenses 18 US and 49 foreign patents and patent applications. We are one of the few companies able to produce discrete nanoparticles in commercial quality and quantity.

Surface chemistry is a highly critical factor in application performance for nanomaterials. We supply two unique surface-treated nanoparticles to address different cosmetic formulations in the US, Europe and Asia. We also supply highly stable nanoparticles in water or solvents for semiconductor CMP, optics polishing and polymer coatings markets to provide improved coating scratch resistance for “tougher” coatings.

Nanophase’s facilities and processes were recertified in 2007 to ISO9001:2000, the internationally recognized standard of manufacturing and quality excellence, and ISO14001:2004, the international environmental management standard. All processes are rigidly controlled under Lean Six-Sigma discipline.

As a responsible corporate citizen, Nanophase operates all manufacturing facilities in compliance with State and Federal hazardous waste [RCCA], air emissions, and wastewater permits, while meeting or exceeding applicable OSHA, TSCA, and hazardous materials requirements. Ending 2007, Nanophase employees reached a new safety record achieving 850,000 continuous working hours without a lost time accident.

Now I’d like to turn the session over to you. I’ll respond to your questions as quickly and as fully as possible. Thanks again for your interest in Nanophase Technologies.

Comments

[nano-nano]

In your recent conference call you gave some bleak forward looking guidence for 2008. What do you see on the horizon that would increase revenue expectation to at least 36% year over year growth for 2008 and will we see at least a couple of more quarters of cash-flow positive results.

[nano-nano]

Who is your competition?

Where do you believe you stand in the pecking order of the nanomaterials that you produce, ahead of or behind the competition?

What other products do you plan to produce for what industries in the future?

[Joe Cross]

Since our most recent conference call, we have not seen anything that would increase our guidance at this time. The macroeconomic climate in the US, and most of the rest of the world, seems to have worsened; many believe that the US economy has already entered recession. From a qualitative viewpoint, we are concerned with an economic slowdown relative to the consumer and, thus, on products using our nanomaterials. We are continuing our cautiously optimistic view for 2008.

Having said that, we have several new market and customer initiatives that appear promising in the near-term (2008-2009) and are quite focused toward our internal goal of reaching 50% annual revenue growth going forward.

[Joe Cross]

As to your second question regarding competition, Nanophase's competition usually is an alternative technology that may provide the same benefit in an application at perhaps a better price point. We rarely encounter nanomaterial competition. Nanophase is clearly a global leader in nanomaterial technnologies and is generally perceived so by large multinational companies, such as BASF.

Relative to the future, we evaluate markets and opportunities based on the value proposition and time-to-market (TTM). We are evaluating about 40 markets at this moment and believe that we currently have the right mix of engineered nanomaterial products to address these markets. Going forward, should we encounter a market with a suitable value and TTM proposition that would require new nanomaterials, we will certainly consider that. Our technologies have the capability of producing a considerable number of nanomaterials.

[Phil G.]

Hi, thanks for this opportunity. I'm trying to understand your competitive landscape better. Would you describe to me a typical customer, the type of product you supply, and what barriers to entry you have against competitors who may offer a similar product to that customer?

Thanks, Phil

[Joe Cross]

Phil - at our stage of growth, it is difficult to "pick" a typical customer. We have several in highly divergent fields. Since BASF was our fist major customer, let me use them as an example. We supply nanozinc oxide, which is an excellent UVA and UVB absorber for sun and personal care products, both coated and uncoated for BASF. We manufacture these nanomaterial products using Nanophase's proprietary technologies, package them for BASF, and ship them to BASF for delivery to the customer. BASF is our market partner and globally sells and distributes the products.

Relative to competition, Nanophase has several advantages in the marketplace. This is demonstrated by the fact that virtually all of our customers are single sourced to the Company. From the uniqueness of our nanoparticles, relative to performance in applications, to Nanophase's manufacturing excellence, we are at the forefront of nanomaterials. You can get additional information on competitive advantages from our website and our 10K.

[Jonathan Liss, SA Editor]

I took a look at your last 6 income statements on Google Finance - annual revenue growth appears impressive as does gross profit growth. Still, operating expenses continue to rise, keeping your EPS in negative territory.

Are there any catalysts you can name that might push Nanophase into positive earnings? And when that happens, will your tax loss carry-forward make an impact?

[Joe Cross]

As we have annual growth revenues averaging 30+% each year in 2005-2007, the Company has also grown gross margin. As a percent of sales, gross margin grew tenfold in 2005 over 2004. Gross margin further increased about 50% in 2006 over 2005 and grew to 26% of sales in 2007. Gross margin, and growth therein, drives profitability. With increasing revenues and gross margins, Nanophase will reach profitability in the near future. With over $50 million in NOL carry forward, Nanophase does not expect to pay taxes for a considerable period of time.

[CrossProfit]

Good morning Mr. Cross.

As stated above, "Nanophase is an established publicly held company with a ten year operating and revenue history and established asset base."

Mr. Cross, we have some tough questions for you!

1) What is your revenue/sales break even point and when do you anticipate reaching this goal?

2) Would it be fair to state that since mid 1996 NANX's R&D department evolves around one scientist; Dr. Brotzman? Has any new 'scientific talent' been added and if so when?

3) What would it take to really get this company off the ground? Is it manufacturing capability/capacity or perhaps a larger sales force? In order to reach sales of $100M annually would you need additional new products or is there a market out there for existing products and price/performance is the sole obstacle?

4) Do you need additional capital and everything else is in place? If so, how much and what is the time frame?

5) The patent game is usually best played by companies with deep pockets. Last year NANX spent $1.7M on R&D and two new patents. Do you envision teaming up with a partner in 2008 in order to better exploit any of the homegrown patents? If so, is it likely to take on the form of joint manufacturing or in split mode where NANX manufactures and the partner markets the product? Perhaps sub-contracting is in the cards; can we have some color on this?

Thank you for this opportunity…

CrossProfit

[Joe Cross]

Yes, you do have have some good questions - a "multi-parter&quo... Let me attempt to answer your questions in order:

- As we have stated before, we believe that our break-even is around $16-18M in annual sales depending on product mix. We have not provided guidance as to when we expect to attain this. Beginning in 2008, we started providing revenue guidance and expectations; keep watching.

- I am not exactly sure how to answer this without offending Dr. Brotzman! While Dr. Brotzman is our lead scientist, and has recently been promoted to CTO, we have added to the scientific and engineering staff. In R&D, where the emphasis is 'D', we have an additonal PhD and three chemists to support customer application development. We have also assembled a highly competent engineering staff including, we believe, one of the world's leading plasma physical chemists, to advance our technologies and constantly improve our manufacturing prowess. Given our size, we have a highly competent group of engineering and scientific professionals.

- As we have stated on conference calls (see a total compilation on our website), we need revenue growth. We have restructured and reskilled sales and marketing during 2007 and are currently adding to this staff to increase sales initiatives. We believe that our current equipment should support $20-25M in sales depending on product mix. To reach $100M, we would have to add capital and probably reconfigure our Romeoville facility; exact capital numbers would depend on product mix. At this point, we believe that we should be able to handle the bulk of capital funding with cash currently available plus that generated as revenue grows.

- Let me be very clear on this; most of our R&D costs are 'D' to create new products for markets and applications, or improve current operations to improve yield or reduce cost. Beginning in 2006 and going forward, we have adopted a conservative patent strategy that recognizes the changes at the US PTO and the practical reality and costs of enforcing patents. It is preferable in many instances to keep IP as proprietary rather than patent. One cannot simply look at the Company's R&D expense and equate it to the cost of patents issued. As I explained, above, there are many other activities that are shown in R&D expenses.

[Lisa]

Joe,

Thanks for answering our questions. In your intro, you said "As of February 1, 2008, the company owns or licenses 18 US and 49 foreign patents and patent applications."

How should investors be thinking about how to value those patents?

Which of the patents do you think has most potential?

What do you think the aggregate value of the patents is?

[Joe Cross]

Lisa – this is a tough question. Valuing patents, in the sense of attempting to attach a dollar number, is a difficult, expensive process that we would not consider. So, I just do not know how to answer that part of the question. In general, the patents that encompass our basic technologies and those relating to applications would seem to us to be the most valuable. Going forward, given the changes at the US PTO and business reality, we expect to focus on application patents and keeping internal technology more in the proprietary information arena.

[Ralph F]

Thanks for taking questions, Joe.

My question is this:

Basic materials companies don't trade at very large multiples. Do you think investors should be viewing you as a basic materials stock or a technology stock? If the latter, can you elaborate and justify that in term of potential revenue growth and/or margins going forward?

[Joe Cross]

Ralph – if you consider the entire chemical industry, I think you will find a variety of companies with different multiples. Basic materials are at one end of the industry with multiples normally associated for that group. Specialty chemical companies, which are typically viewed as technology companies, command increasingly higher multiples generally due to higher gross margins. As Nanophase grows, we would expect to be considered at the upper level of specialty chemical companies and demonstrate the gross margins that would justify the much higher multiple.

[Ralph F]

A quick follow up question, if I may. On one of the message boards, someone posted the following comment:

"Nanosolar, a privately held company, is apparently the worlds lowest cost solar panal producer by far. See nanosolar.com. A key to its product's low cost is nanotechnology. Might it need some of NANX's intellectual property rights to produce its product? That would certainly produce a huge upside potential for NANX."

Is there any basis to that speculation?

[Joe Cross]

Ralph – there is no basis to the speculation in the sense of us working with NanoSolar. We are familiar with the company and its technology. Relative to Nanophase, as solar applications evolve toward increased efficiency and performance, there may be an opportunity for nanomaterials. It is not a market that we envision developing in the very near future.

[Frank Li]

One of the smarter people following your stock left this comment after your latest conference call:

"My first thought was, there was only 1 question from the call-ins. Looks like analysts have lost interest in NANX. Second, I'm glad they are going to be hiring a couple more sales people because income has always been the missing element. The effort to grow the company from 30+% per year to 50+% per year is laudable, but I think they are going to have to go after more companies that may ultimately compete with each other using NANX products. An example would be if BEHR paints were competing with Benjamin Moore for example. Other wise, they weren't real specific about where they are going to be selling NANX products to hit those growth numbers. Lastly, they mentined as much as a two year window from finding a customer to providing usable product for that customer. Since the sales force 2 years ago was pretty much what we have now, it looks like 2010 before we'll notice an expansion of product line sales. Thoughts and comments anyone....."

Would love to hear your thoughts on the issues raised here, Joe. Also, it would be helpful if your conference call transcript was available like so many others on this site.

[Joe Cross]

Frank – first, the conference call (and all of our conference calls) are available on our site, nanophase.com under Investor Relations; please review at your convenience.

Relative to the call, it turns out that there were some technical problems with the company that handles this for Nanophase. Several questioners could not get noticed and therefore the questions were not asked as part of the call. The analysts did call us later and we were able to answer their questions.

Relative to revenue growth, understand that we expect revenues from our market partners (BASF, BYK Chemie, and Rohm & Haas CMP Technologies) to continue to grow going forward. We also expect revenue from current customers to continue to grow. So, there is a base of revenue growth in place for the future.

Additionally, we have to continue to add new markets and new customers. To accomplish this, we have been reworking and honing our business development and sales strategy during the last half of 2006 and through 2007, and seeing increased success. Steps we have taken include:
• Restructuring and reskilling the sales and business development team: during 2007 we hired Kevin Wenta, as EVP of Sales and Marketing, and David Nelson as Vice President of Sales – both with excellent experience in chemical sales. This process continues; we are now searching and plan to add 1-2 additional Sales Directors. Moreover, Dr. Brotzman, who was focused solely on R&D, is now predominately in a technical sales and marketing role for the Company, supporting customer business development and sales where he is adding tremendous value.
• We have also worked hard to hone our five stage gate business development model and processes. If you are familiar with this model, essentially Stages 0 to about 2.5 are considered the discovery Stages and about 2.5 to 5 are develop and implement stages. We believe that to reach the 50+% annual revenue growth rates desired, we have to improve the discovery Stages; we seem to do well in the develop and implement Stages.
• To improve the discovery stages, we have taken several synergistic steps:
o First, we have increased our depth and level of understanding in target markets by consolidating and ranking about 44 market segments, but focusing on the top 20. Market segments include energy, building & construction, printed electronics, and automotive to list a few and provide a flavor of the effort. First with the top 20, and then the remainder, we are driving to the customer value proposition to understand the performance and cost required for specific applications.
o Secondly, we have refocused our application scientists and engineers solely on these target markets and our product development efforts are directed to demonstrating the value of nanomaterials in these specific markets. For example architectural coatings – we have installed equipment to test the benefit of nanomaterials in commercial formulations in a manner similar to architectural coating companies. We purchase commercially available architectural coating materials and use our developed applications knowledge to add our engineered nanomaterial solutions. We then apply the coatings to the appropriate substrate, test the samples to industry standards, and, finally, visually and quantitatively demonstrate the value of using Nanophase to leaders in the marketplace. This approach gets much better customer attention and mindshare, demonstrates the value of nanomateirals in their particular products, and significantly reduces the TTM.
o Thirdly, we are developing more opportunities in these targeted market segments – the sales team has been given goals designed to increase directly touching the end customer on a weekly basis. We have increased customer touch 2-3X. We have also increased our presence at application trade shows such as coatings, electronics, and similar target markets to improve and extend our market knowledge and emphasize the advantage of nanomaterials in specific market applications for enhanced performance.
o Fourth, we are taking a much more rigorous approach to qualifying and quantifying opportunities to select those opportunities in the target market that are most likely to succeed, provide the largest revenue opportunities, and appear to have the shortest TTM. Our improved process allows very close examination of each opportunity before it moves through a stage gate.
In summary, we have given a great deal of thought and market research to select market targets and increasingly focus our efforts and resources to optimize the potential for revenue growth. Again, our vision is to reach $50M and then $100M in sales; to do so, we have to increase annual revenue growth to 50%. We have restructured, reskilled, and honed our business development and sales effort and implemented or refined processes to achieve these goals. We are adding additional sales personnel to increase market and customer contacts.

[BINVESTOR]

WILL YOU BE WORKING WITH IBM NOW THAT ROHM AND HAAS IS COLABORATING WITH THEM ON CMPS...THAT IS RATHER EXCITING.

ALSO IS YOUR RELATIONSHIP WITH ROHM AND HAAS LIMITED TO CMP/ELECTRONICS OR WOULD YOU BE TALKING TO THEM ABOUT APPLICATIONS RELATING TO WATER BASED PAINTS.

HOW FAR ALONG IS YOUR WATER BASED PAINT TECHNOLOGY, ARE YOU MAKING STABLE DISPERSIONS OR HOW FAR AWAY WOULD YOU SAY STABLE DISPERSIONS IN IN WATER ARE AWAY; AS THAT IS A HUGE MARKET.

[Joe Cross]

Thank you for the questions; let me try to answer these in the same relative order.

First, we have an exclusive global relationship with Rohm & Haas for nanomaterials in semiconductor polishing. As you may know, R & H is also a significant stockholder in Nanophase. Within this umbrella, there are several activities underway. For obvious reasons, we are unable to comment on specific customers or activities.

With Rohm & Haas, we believe that we have an excellent corporate relationship. We have initiatives and discussions in a variety of areas where there may be synergism between nanomaterials and their products. Again, we are unable to comment on specifics.

Our water-based technology is ready now and is being sold commercially in large volume specifically to the architectural coating and polishing industries. Our dispersions are typically stable for at least 2 years. We believe that dispersions are likely the delivery vehicle of choice for nanomaterials and Nanophase is rather uniquely well positioned to deliver.

[Gary G.]

I was wondering if the additional sales people have come on board yet? Also, how will they be deployed? Will they be looking for more customers in existing markets served by your present products or will they be looking for customers in new markets requiring new product development?

[Joe Cross]

At this moment, we have candidates in the interview process and anticipate completing the selection process in the near-term. As I noted above, we have qualified and quantified over 40 markets and down selected about 20. New sales personnel will be targeting potential new customers in these markets.

[stoppmann]

In order for you to sell your technology in the consumer market place, you are relying on your customers to market products and brands that contain your nanocrystalline technology. Your customers are not doing that. Why aren't they? I don't believe that the typical consumer is familiar with brands or products that contain your nanoparticles and why there is a value-added benefit in purchasing products that contain your technology. For example, I purchase sunscreen products but I don't know what sunscreen brands contain your nanoparticles.

Here is another example. I wanted to see how Behr marketed their Ultra Premium paint that contains your Nanoguard product. I went to Home Depot and found the paint on the shelf. The paint was about $10/gallon more than other Behr paint. However, there was no advertisement, marketing information, or display at Home Depot that show cased the paint or explained why the paint was more expensive and the value-added benefit of a paint with nanoparticles. The marketing of the value of Ultra Premium product is also lacking on Behr's website.

How can you educate the end-user? Should that be your role?. Why aren't the companies that use your technology in their products doing a better job of educating and marketing nanotech products to the consumer. If they are, I'm not seeing it and I am looking for it.

[Joe Cross]

Friend, I understand the frustration. Through our market partners and with our customers, we have encouraged marketing the ‘nano’ advantages. In the sunscreen market, major brands simply recognize that consumers tend to purchase on price versus performance as long as the consumer thinks the “SPF Rating” is acceptable. While that is naïve on the part of the consumer, that seems to be the way it is. Secondly, NGO’s like to attack nanotechnology, and anything else that may be new it seems to me, and major consumer brands simply do not want to do battle with these groups, who use innuendo fluently and get sympathetic media coverage. In sunscreens, it may surprise you, our nanoproducts seem to be endorsed and encouraged by some dermatologists and medical personnel who recognize the broad spectrum benefits of nano zinc oxide, in this case, versus the perhaps harmful effects of alternative organic materials.

Relative to architectural coatings, the NanoGuard trademark promotes the nanotechnology enabled performance of the coating. There have been marketing materials at most retail locations we have checked, so I am surprised at your experience. Check out the company website - it has a video showing advantages of the material.

[Steve D]

Hello Joe,

First, I think this public Q&A is a great way to gain some exposure with the investing public, kudos to you.

It's good to see R&H CMP Polishing moving forward. But in that regard, it has been in the news that there is abit of oversupply of memory chip products in the face of consumer slowness. I'm hoping R&H is in the rampup/rollout phase and wont be actually affected with stagnant growth as their market develops for advanced polishing regarding memory chips. Can you speak to this concern, how confident is R&H in the market pull for their & nanx's product?

Thanks.

[Joe Cross]

Steve – it is our impression that the market opportunity is currently large enough and still growing due to the introduction of new semiconductor technology nodes, that a general industry slow-down should not have a material impact. Based on our last business meeting with R&H and the continuing joint technical effort in polishing slurry development, we believe there is growth opportunity. To the best of our knowledge, the market pull for the nanomaterial-based slurry with R&H is significant and appears to have opportunity to be used in other technology nodes.

[Bruce B.]

I thought that the polishing application would be a big revenue source for Nanophase, but to date, that hasn't seemed to happen. What kind of ramp up do you see for this market segment looking forward? Also, what application do you see that has the most potential for rapid growth?

[Joe Cross]

Bruce – obviously, we are highly dependent on our market partner, Rohm & Haas, to develop this market and expand sales. This is not a market we could even consider entering without a market partner like R&H. Based on the latest information from R&H, we anticipate this market will continue to grow over the next 3-5 years in a material manner to Nanophase assuming the slurry development evolution occurs as currently planned.

Applications where we anticipate the most growth in the next 12-36 months, from the perspective of new business or customers, would likely be in applications for industrial coatings, architectural coatings, and, perhaps, CMP. We are pursuing several other applications, many of which are exciting, so this list could well change in the next six months.

[Blake S.]

Mr. Cross:
Thank you for taking the time to answer some questions. It has been a very informative exchange of information and I hope that this forum will continue in the future. My question refers to the current economic slow down in the U.S. and global market. Can you provide general estimates as to percentage of revenue generated through U.S. sales vs. Global sales and speak to what products are most sensitive to these current conditions?

[Joe Cross]

Blake – we don’t really track US versus European sales; we tend to track by market/customer. Most of our overseas sales (Europe/Asia) are through our market partners – BASF, BYK Chemie, and Rohm & Haas CMP Technologies.

Considering the recessionary pressure in the US, we are currently watching architectural coatings and consumer cosmetic products closely.

[stoppmann]

Will you be pursuing relationships with paint manufacturers other than Behr?

[Joe Cross]

Nanophase is pursuing relationships with architectural coating companies for a variety of products; this is a Focus Market for us.

[SMnano]

Hi Mr Cross,
Thanks for this opportunity.
If you don't mind, I would like to ask an estimate of Nanophase's selling price per MT for nano ZnO (30nm).
You might know that the biggest users of ZnO are rubber manufacturers and the use of nano ZnO in rubber has been a hot research area. Do you think that nano ZnO prices will go below USD30 per MT in the coming years?