In my area of the USA, we’re in the midst of our seemingly annual “false spring” once we get a stretch of climate in March or early April that’s unseasonably heat, solely to be adopted with extra freezing temperatures. I used to be at a highschool observe meet about 3 weeks in the past, throughout this 12 months’s false spring, sporting shorts and a tee-shirt, and will really feel myself beginning to get a light sunburn. Yesterday, then again, the meet I attended was held regardless of the wind, rain, and hail; I had on 4 layers of garments and was nonetheless chilly. However we cling to an anticipation that heat climate will ultimately arrive, and we’ll be breaking out the sunscreen as we spend extra time outside once more. Relying on the actual sunscreen we use, there’s a likelihood that the zinc oxide in it blocking these UV rays could possibly be within the nano particle type innovated by Nanophase Applied sciences (OTC:NANX). Nanophase Applied sciences is actually a nano cap sized firm (market cap of $45 million) that makes a speciality of nano particle formulations for functions starting from skincare and cosmetics to sprucing slurries used for home windows or high-end engineered optics merchandise, and different makes use of in-between.
Introduction and Abstract of 2022 Outcomes
Nanophase’s largest line of enterprise is its functions for skincare and cosmetics substances, which is marketed below its personal identify, Solésence. Some identified prospects of the Solésence substances embrace Colorescience, a subsidiary of AbbVie (ABBV) and Kendo, owned by luxurious conglomerate LVMH (OTCPK:LVMHF), in addition to some area of interest pure magnificence manufacturers like Credo Magnificence and Bloomefects. The opposite enterprise traces exterior of non-public care and Solésence account for roughly 10% of income, and I will not be trying to interrupt these out particularly.
This previous 12 months was a transitional 12 months for Nanophase. The corporate began leasing a a lot bigger facility, however for a time in This fall of 2022 was working a number of traces in several places, elevating bills in the course of the bodily transition time. In complete, the corporate ended 2022 with area at three amenities, all within the Chicago space. This rely features a new facility in Bolingbrook, which homes nearly all of the bodily footprint of the corporate, a 260,000 sq. ft area that Nanophase will not be but fully filling up. The method of transferring manufacturing to this huge new facility began within the 4th quarter of final 12 months, and the method of getting issues up and working there absolutely impacted fourth quarter outcomes. Particularly, administration famous that the time of transitioning between manufacturing amenities elevated labor prices significantly within the quarter, whereas they needed to run a number of manufacturing traces at totally different places, which can be a one-time issue. Extra price facilities which might be anticipated to say no into 2023 are unhealthy debt expense and consulting charges.
For full 12 months 2022, Nanophase had sturdy income progress, going from $29.5 million to $37.3 million, a really good 26.4% bump, and I feel a superb clue that total, their merchandise and improvements are in-demand, with a fair stronger hockey-stick progress going again to 2019.
Nonetheless, the bills grew sooner, leading to a internet lack of ($2.6 million) versus internet revenue of $2.3 million for 2021; this was a $0.10 swing in EPS, from $0.05 in 2021 to ($0.05) for 2022. The prices concerned in producing the upper gross sales have been particularly noticeable beginning with price of gross sales, which pushed gross margins from 29.4% in 2021 to simply 22.4% final 12 months, a bruising 700 foundation level drop off. Working bills weren’t contained any higher, as R & D shot up by 36%, whereas basic & administrative bills went up an eye-watering 95%, from $3.9 million to $7.6 million.
The silver lining on the G&A expense is simply how a lot of these ought to be both one-time or of restricted length. A couple of issues have been lumped into this that basically set it aside versus the prior 12 months, particularly: $1.3 million associated to gadgets like a cyberattack and consulting bills, with a further $0.4 million in authorized charges (see part beneath on pending litigation). There was a $0.3 million unhealthy debt expense, which the corporate is placing sources in direction of fixing going ahead. The purpose is, aside from the above-average authorized charges, administration fairly expects a cloth portion of the upper bills reported in 2022 to not recur on the similar elevated ranges in 2023.
The steadiness sheet as of 12/31/2022 is in honest situation, with present property sitting at a few 1:1 ratio to present liabilities, and the one debt being related-party debt totaling $8.3 million (with the present portion of it being $7.3 million). Money readily available was $2.2 million, and the e-book worth of shareholders’ fairness was sitting at $5.6 million, or $0.11 per share.
Outlook and Valuation
Administration is anticipating a return to profitability in Q1 of 2023 and growing all year long, with the excessive price of gross sales progress to proceed however executed with significantly better expense administration. When pressed a little bit on the earnings name, CEO Jess Jankowski, did point out that their gross margin goal is above 30% as a steady-state goal, and expects to be there within the first half of 2023.
Clearly getting that gross margin again as much as that 30% type of vary can provide the corporate some respiration room for getting money flows going, as capex investing trails off some and the brand new working set-up stabilizes. Mr. Jankowski indicated on the decision that worth will increase had gone into impact, and additional that:
Whole 2023 direct labor ought to are available nearer to 2021 direct labor than that of final 12 months , which might result in one other 5% to six% of enchancment in gross margin. [author’s transcription, in recording at the 9min 50sec mark; see link above]
For context, in 2021, Nanophase generated $2.3 million in money movement from operations and had $1.9 million in capex funding, leaving ~$400 thousand in free money movement; clearly not lots, however constructive. For 2022, money loss from operations was ($1.7 million), with a further funding in capex of $2.8 million, leaving detrimental free money movement of ($4.5 million). What’s the attainable path again to being free money movement constructive?
For those who start simply with 2022 gross sales as a baseline however see gross margin enhance to one thing like 26% (beneath the said purpose of 30% to be conservative), and strip out among the one-time prices in 2022, a clearer image comes into focus. On the topline foundation of $37.3 million and 26% gross margin, gross revenue would have come out to $9.7 million. Leaving R & D prices the identical at $3.0 million leaves $6.7 million. Setting apart $1.6 million in one-time prices however leaving within the elevated authorized bills and different G & A prices brings the full G & A right down to $6.0 million, for an working revenue of $0.7 million. Ignoring minimal taxes and making use of the identical changes to internet revenue from the money movement assertion brings a barely detrimental money movement from operations of ($0.2 million), or ($3.0 million) in free money movement when mixed with capex. I take that to be an inexpensive baseline chance, and units the bar for the place issues want to go to show issues constructive.
Primarily based on the 2022 historic baseline of precise money movement changes, the online revenue start line to completely breakeven on free money movement would have to be $1.850 million; when mixed with constructive $0.97 million in internet changes from working money and ($2.82 million) use of money for capex it might cancel out to $0. As a way to get to internet revenue of $1.850 million with assumed working bills of $9.75 million requires a gross revenue of $11.6 million. At 26% gross margins, complete income would have to be $44.6 million, or one other 20% increased than what Nanophase truly achieved in 2022. This means that even on a normalized foundation, there’s nonetheless a major wall to climb.
To start with, if the gross margin enchancment is the low-hanging fruit that administration believes, then the mixture of continued sturdy gross sales progress with higher gross revenue will go an incredible method in direction of producing constructive working money movement. Secondly, whereas R & D is essential for making developments on this enterprise, maintaining it dialed to sustainable ranges can be important (the corporate does have an total spectacular mental property portfolio of patents). Spending 30% of gross income on R&D as the corporate did in 2022 is just too excessive over the long term, but when it might keep pretty flat as gross revenue rises, then it might proceed at present ranges or develop as profitability permits. The actual problem can be tightening down the working prices inherent with progress, particularly in such an inflationary context. Having a extra strong readiness can be important, and administration has admitted as a lot, that the fast progress skilled has strained the flexibility to maintain up controls that may be normal in a bigger group. To that finish, the corporate has added some key further employees, notably a controller, Benjamin Babel, in August of 2022, in addition to some further provide chain personnel.
Nonetheless, the define of creating valuation can emerge from this narrative. Taking among the fundamental assumptions outlined above to return to one thing of a normalized price of income and working expense construction, we will see a basic path to constructive earnings. On a normalized foundation for 2022, EPS would have been $0.01, for a P/E of ~66.4x. This a number of is excessive, however not outlandish for a small progress firm.
Extra curiously, if the corporate can hit that 20% income progress with assumed gross margin beneath steerage and maintaining working bills in verify however nonetheless rising, EPS for 2023 might probably are available round $0.04, leading to a way more engaging P/E of 23.35x. Clearly this presumes success at attaining continued progress that’s higher managed, however the broader level is that the valuation will not be essentially as stretched as it would seem. Paying 23x earnings for a excessive progress firm that’s hitting GAAP earnings and in a position to create constructive free money movement is engaging.
Is it cheap? Administration is anticipating greater than 30% income progress within the Solésence enterprise line in 2023, and has said publicly that they intend to attempt to attain $100 million in gross sales inside a number of years’ time. On condition that Solésence accounted for roughly 60% of Nanophase’s enterprise in 2022, hitting 30% progress right here will certainly transfer the needle in the suitable route.
A big overhang for Nanophase is a lawsuit filed towards it by a serious consumer, BASF (OTCQX:BASFY), over an alleged breach of exclusivity. The Nanophase Applied sciences annual report summarizes as follows (edited for size):
On August 31, 2022, counsel for Nanophase Applied sciences Company (“Nanophase”) obtained a letter from legal professionals representing BASF Company (“BASF”) stating that BASF had filed a criticism towards Nanophase within the Superior Courtroom of New Jersey. . . The New Jersey Criticism claims that Nanophase breached the Zinc Oxide Provide Settlement . . . as amended via January 1, 2019. . . . [It] particularly alleges that Nanophase breached the exclusivity provision of the Settlement by promoting zinc oxide to entities apart from BASF, together with gross sales to Nanophase’s subsidiary Solésence, in markets designated as being within the area of use below the Settlement. . . Administration believes that the allegations of BASF’s New Jersey Criticism are with out benefit. . . on February 28, 2023, Nanophase answered BASF’s New Jersey Criticism . . . [requesting] a declaration that . . .the exclusivity provision of the Settlement doesn’t apply to all merchandise containing zinc oxide as an ingredient for makes use of designated below the Settlement nor does the exclusivity provision prohibit Nanophase’s gross sales of Solésence merchandise containing zinc oxide as an ingredient. . .Nanophase intends to proceed negotiating with BASF in good religion to resolve these points. Within the occasion that a suitable resolution will not be reached, and litigation proceeds, the last word decision can not now be decided with certainty.
Given the importance of BASF as the biggest single buyer for Nanophase and easily eager to get this case cleared up, there’s willingness to return to a good settlement, a basic sentiment additional expressed by administration on the investor relations name. Mr. Jankowski said on the decision that:
We really feel that our case is an efficient one, however we may even pursue a negotiated settlement with the purpose of resolving this difficulty as shortly as is sensible and useful to our firm (18min 21 sec mark of recording)
BASF will not be in search of to void the settlement, so I anticipate BASF is desirous about persevering with the connection. Nonetheless, the uncertainty of the influence round a remaining decision will not be useful and a reputable danger issue, though at the moment Nanophase has elected to not file a contingent legal responsibility associated to this case.
After a tough sell-off in latest days, Nanophase has fallen to new 52 week lows, and is now buying and selling just below $1 per share as of 4/27/23, and is off 50% from its latest excessive in March, however is down some 70% within the final 12 months.
Despite the authorized dangers and execution danger of rising too quick with too few controls in place, I consider Nanophase is on a gorgeous path from this entry level, with danger/reward extra skewed in favor of reward. My main warning is that this – simply as you do not wish to over expose your pores and skin to the solar’s rays, potential buyers in nano-cap shares have to be prudent in not over exposing their portfolio to the dangers concerned inherent in very small public firms. I price Nanophase Applied sciences a speculative purchase on sturdy progress prospects.
Editor’s Be aware: This text discusses a number of securities that don’t commerce on a serious U.S. trade. Please concentrate on the dangers related to these shares.