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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
COMMISSION FILE NUMBER 0-22333
NANOPHASE TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-3687863
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
453 COMMERCE STREET, BURR RIDGE, ILLINOIS 60521
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (630) 323-1200
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, based upon the last reported sale price of the
registrant's Common Stock on March 22, 2000 was $151,929,428.
The number of shares outstanding of the registrant's Common Stock, par
value $.01, as of March 22, 2000 was 13,449,253.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement in connection with
the registrant's 2000 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Report on Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
Nanotechnology, as practiced by Nanophase Technologies Corporation,
involves creating nanostructured materials by controlling matter at the
nanometer-size scale -- at the level of atoms and molecules. Because these
"nanostructures" are made with molecular building blocks, they can be designed
to exhibit novel and significantly improved physical, chemical and mechanical
properties.
When the structural features are sized between individual molecules and
bulk materials -- in the range of about 10 to 100 nanometers -- the objects
often display physical attributes substantially different from those found in
bulk materials. As a result, the properties of nanocrystalline materials often
cannot be predicted from those seen at larger sizes, and nanoparticles can
exhibit novel properties. For example, important changes in catalytic behavior
can occur because a significantly larger proportion of atoms are found at the
surface of a nanometer-sized particle than a normal-sized one. When it is
possible to control particle size and shape, it also is possible to enhance
material properties and devise functions beyond those normally found in a
material.
Nanophase's objective is to exploit its capabilities to efficiently
engineer and manufacture nanocrystalline materials. The Company does this by
providing value-enhanced solutions for commercial applications in multiple
global markets. Recognizing a need to offer enhanced performance and assist
customers with their product improvements, Nanophase targets markets in which a
practical solution may be found through using nanoengineered products. The
Company works closely with leaders in these target markets to identify their
material and performance requirements.
NANOCRYSTALLINE MATERIALS
Nanocrystalline materials generally are made of particles that are less
than 100 nanometers (billionths of a meter) in diameter. They contain only
1,000s or 10,000s of atoms, rather than the millions or billions of atoms found
in larger size particles. The properties of nanocrystalline materials depend
upon the composition, size, shape, structure, and surface of the individual
particles. Nanophase's methods for engineering and manufacturing nanocrystalline
materials result in particles with a controlled size and shape, and surface
characteristics that behave differently from conventionally produced larger
sized materials.
Although Nanophase's particles are sometimes the end product for various
customers, they more often are the required building blocks in a solution
engineered to meet a specific performance requirement for a customer's product
or process.
There have been problems with the traditional mechanical and chemical
methods of producing nanocrystalline materials. These methods have been unable
to consistently and economically produce commercial quantities of materials with
the unique properties found in the Company's products. The Company has developed
proprietary and patented technologies for the high-volume production of
nanocrystalline materials. Management believes this approach can satisfy the
high-level performance requirements of -- and provide the value-added solutions
desired by -- customers in its target markets.
THE COMPANY'S TECHNOLOGIES
Nanophase intends to maintain and grow a leading intellectual property
position in the rapidly emerging science of nanotechnology. The Company uses its
technologies to engineer and produce nanocrystalline materials designed for
specific product applications. These technologies include methods for the
synthesis, surface-treatment and dispersion of nanocrystals. Nanophase also is
engaged in ongoing research and technology-licensing activities that add to its
core technologies or provide complementary technologies. Management believes
that aggressively pursuing applications, inventions and patents will help it
maintain a technical and commercial leadership position. A description of
Nanophase's current technologies follows.
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THE PHYSICAL-VAPOR-SYNTHESIS ("PVS") PROCESS
The Company uses its patented PVS process to produce nanocrystalline
powders. This process begins by introducing a precursor material into a plasma
reactor, then heating it to a temperature above its melting point. As the
temperature rises, the atoms of this material evaporate from its surface into a
stream of flowing vapor. The evaporated atoms then are mixed with selected
gases, which chemically react with the atoms. Other gases then cool the atoms
sufficiently to condense the vapor into solid, nanometer-sized crystals. The
flowing gas transports these crystals to a collection vessel. The rapid
transport and cooling of the nanocrystalline particles prevent strong
agglomeration-clusters sticking to each other.
Nanophase holds three fundamental US patents on its PVS process, which do
not expire until July 2013. One covers the process itself, another includes the
apparatus used in the process, and a third protects the nanocrystalline
particles produced by the process. Corresponding patents have issued in Japan
and Australia, with additional applications pending in Europe and Japan. The
Company's plasma reactor has proprietary features that enable it to produce
nanocrystalline materials at commercial-volume and costs. Nanophase uses its PVS
process to exploit the relative advantages of physical versus chemical synthesis
of nanocrystalline materials. These advantages include the production of
nanocrystalline materials with particles that are extremely small, nonporous,
essentially free of chemical residue, relatively uniform in size, and not
strongly agglomerated.
Management believes its PVS process is superior to other methods because of
the degree of control it can exercise over particle size, particle surface
properties, and particle size distribution. By controlled and subtle
modifications -- the evaporation rate, the type or pressure of the gas, or how
quickly the flow of gas carries the clusters to the collection vessel, for
example -- Nanophase can control the particle size. This allows it to engineer
and produce high purity, nonporous particles with a narrow size distribution and
controllable size, without substantial process and product re-engineering.
SURFACE TREATMENTS AND DISPERSIONS: THE DISCRETE PARTICLE ENCAPSULATION
("DPE") PROCESS
Many of the applications Nanophase is pursuing can benefit if the Company
further engineers the particles produced by PVS. For example, some of
Nanophase's customers require the particles to uniformly disperse in a fluid. To
meet these needs, the Company developed a range of surface-treatment
technologies to achieve these objectives:
- Provide particle surfaces with reactive functional groups, enabling the
Company to create 3-D nanostructures.
- Modify the nanoparticle surface to allow particles to disperse in fluids
or polymers without agglomeration.
- Modify the chemical, physical, mechanical, electrical, and optical
properties of the particles.
At the core of these surface-treatment and dispersion technologies is
Nanophase's proprietary and patented DPE process. This enables the Company to
surround each nanocrystalline particle with a durable coating. Two fundamental
US patents protect the process, and additional applications are pending in
Europe and Japan.
The DPE process can encapsulate the surface of each nanometer-sized
particle (produced through PVS) with a robust shell that is not removed by
subsequent processing. This shell also can be engineered to contain bound spacer
groups of controllable size, which prevent particles from sticking to each
other. Alternatively, coated materials can be formulated to attach various
functional chemical groups to the shell, for specific properties and
applications. The coatings allow the particles to be dispersed in a wide range
of media, including water, cosmetic emollients, and polymers (plastics). As a
result, these materials can be used in applications from transparent
abrasion-resistant coatings to cosmetic sunscreens.
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EMERGING NANOTECHNOLOGIES
Nanophase owns or licenses 18 patents protecting its core technologies for
engineering nanoparticles and an additional 7 applications are pending. The
Company continually evaluates, acquires, licenses, or develops additional core
technologies relating to nanocrystalline materials, in an effort to augment its
current portfolio of technologies. This enables Nanophase to maintain and
enhance its leadership in intellectual property for nanoparticle creation, to
develop new product applications, to satisfy the demanding performance
requirements of its targeted markets, and to offer additional value-added
nanoengineered solutions.
ADVANTAGES OF THE COMPANY'S NANOCRYSTALLINE MATERIALS
Through its patented PVS process, the Company produces nanocrystalline
materials with these characteristics:
SMALL PARTICLE SIZE provides a high surface-to-volume ratio compared
with conventional materials. The ability to functionally tailor this
surface allows Nanophase to modify and control the material's properties.
CONTROLLED PARTICLE SIZE WITHIN SPECIFIC SIZE RANGES permits the
Company to create nanocrystalline materials for specific particle-size
critical applications. Additionally, it allows the Company to create
various functional coatings with a defined thickness.
NONPOROUS PARTICLES allow a large number of particles to be dispersed
in a fluid without undesirable thickening or absorbing of the fluid. This
means Nanophase can produce formulations with high weight loadings that are
relatively easy to apply to a variety of surfaces.
HIGH SURFACE PURITY enables particles to exhibit consistent surface
chemistry with little foreign contamination. This facilitates the Company's
ability produce materials for a variety of applications that are sensitive
to contaminants, such as products for health care or chemical catalysis.
NARROW SIZE DISTRIBUTION AND AGGREGATION CONTROL results in
nanocrystalline materials that are essentially free of large particles,
while containing uniformly small and loosely agglomerated ones. These
materials can be further modified to enhance and tailor the performance of
basic raw materials for specific product applications. For example,
Nanophase's nanocrystalline materials can be readily and uniformly
dispersed in a variety of media.
MARKETS
The Company focuses on advanced materials technology, using nanocrystalline
material formulations for process and product applications in a number of
markets. Management believes Nanophase is a pioneering leader in the "bottom up"
engineering and production of nanomaterials that add value to its customers'
products or processes. The Company evaluates several parameters--including
time-to-market, value of its solution, market drivers, revenue potential and
horizontal market opportunities--to select and prioritize its target markets.
Nanophase management believes it must understand market needs and be able
to deliver effective solutions that use its materials to successfully penetrate
its target markets. As part of its market penetration strategy, the Company
seeks to partner with market leaders to co-develop solutions that represent a
viable opportunity for both parties. Most if not all of these solutions are new
and innovative, and they must meet customers' specific and demanding performance
requirements. This combination meant the Company's time-to-market for commercial
products historically was 18 months or longer. Nanophase's new business model is
designed to provide nano-based solutions to lead customers in focused markets.
This model is based on driving product introduction acceptance, reducing
time-to-market, and gaining intellectual property in those markets. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors -- Limited History of Commercial Revenue; Uncertain
Market Acceptance of the Company's Nanocrystalline Materials", and "Reliance on
Collaborative Development Relationships".
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Nanotechnology is a rapidly emerging science. Nanophase management believes
many new markets for this approach will develop in the coming decades. The
Company's marketing strategy is to develop lead customers in attractive market
segments where the technical benefit of the Company's nanoengineered
products(TM) results in a profitable and long-term partnership. The following
section describes the nature of Nanophase's current market segments.
TRANSPARENT FUNCTIONAL COATINGS
Management believes that transparent functional coatings have a myriad of
applications, which makes this one of the most significant areas for growth.
CONDUCTIVE AND ANTISTATIC COATINGS The world market for indium/tin
oxide-based (ITO-based) conductive coatings is estimated at 20-30 metric tons,
with an estimated market size of $10-$20 million. These coatings are used
primarily for shielding electromagnetic radiation from computer monitors (in
response to increased regulatory requirements limiting these emissions).
Coatings typically are applied from solution via spin coating. Conventional
solutions suffer from poor in-use and shelf life problems, and usually are
shipped and stored in a frozen state. Management believes the primary advantages
of its ITO-based products lie in their ability to be stored and used at ambient
temperature, which provides a significant economic advantage to the end user.
Antimony/tin oxide (ATO) materials for transparent, antistatic coatings are
designed to replace more traditional raw materials, which are based on carbon
black and/or evaporated metals. ATO materials can be used in electronic
component packaging, prevention of static buildup on TV monitors and flat panel
displays, and colored toners for photocopying. The Company's key advantage here
is its ability to formulate transparent coatings from its nanometer-sized ATO.
These coatings, in contrast to those based on carbon or metal, enable an end
user to easily see the contents of a package, while maintaining anti-static
protection.
ABRASION-RESISTANT COATINGS Nanophase incorporates aluminum oxide into a
variety of coating products, which are aimed at creating transparent scratch-and
abrasion-resistant protective coatings. These coatings are used in applications
from coating vinyl flooring (which enhance scratch and scuff resistance while
retaining high gloss), to protective coatings (which decrease maintenance costs
of high-traffic area flooring). Additional applications include plastic
ophthalmic lenses, with a potential opportunity in temporary protective coatings
for automotive applications. The benefit offered by the Company's materials lies
in their ability to combine the two desirable functions of transparency and
scratch resistance.
CATALYSTS
Nanophase's materials have a large percentage of atoms lying on their
surfaces. This occurs because as particles become smaller, their surface area
becomes a larger percentage of the total bulk. When surface atoms comprise such
a large portion of the material, surface and interface effects strongly
influence the behavior of the material as a whole, such as catalytic activity.
Potential applications include cerium oxide-based environmental catalysts,
palladium on alumina hydrogenation catalysts, and iron oxide-based chemical
process catalysts
Much of the world's chemical manufacture is done through catalysts, which
is a global $7 billion industry. Environmental catalysts -- a significant
portion of the catalyst market -- are dominated by auto emissions control.
Ceria-based raw materials represent an important and widely used ingredient in
this market. Raw materials for palladium-based process catalysts and iron oxide
catalysts also hold high attractiveness for the Company. The available market
for Nanophase in these markets is estimated at $30-$60 million.
HEALTH CARE: SUNSCREENS AND OTHER TOPICAL HEALTH CARE PRODUCTS
The global market for health care products at the consumer level is
estimated at $50-60 billion. An important portion of this is attributable to
sunscreen products. Among the active ingredients in sunscreens, the market
opportunity for Nanophase lies in the inorganic segment: titanium dioxide and
zinc oxide. The demand for inorganic active ingredients is increasing along with
consumer awareness of the harmful effects of
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ultraviolet (UV) radiation. This has led to a rapid movement toward
incorporating UV protection in everyday skin care and cosmetic formulations. The
world market for inorganic sunscreen actives is predominantly titania-based.
However, zinc oxide is seeing rapid growth because it is hypoallergenic, can
provide broad coverage for protection from the entire solar spectrum, and has
better economics than titania.
Zinc oxide also is widely used for skin care applications, ranging from
topical antifungal ointments to odor and wetness absorbents for incontinence
products.
Nanophase's strengths lie in its ability to 1) manufacture USP (US
Pharmacopoeia) zinc oxide with a smaller particle size and a narrower size
distribution than competitive materials, and 2) to discretely encapsulate the
particles so they disperse in a wide range of media. Based on these attributes,
management estimates the potential available market for Nanophase zinc oxide in
this market is $20-$40 million.
ADVANCED CERAMICS
The Company's primary focus is in structural ceramics: the cutting tool
segment, with additional interests in ceramic bearings and related
wear-resistant products. The current worldwide market is estimated at over $1
billion.
Management believes Nanophase's strengths lie in its ability to formulate
alloys of nanoparticle-based ceramic oxides into dry, free-flowing powders,
which can be consolidated under heat and pressure to form dense parts. Initial
tests have shown that the wear resistance and impact strength of cutting tools
based on the Company's formulations are a significant improvement over
conventional materials.
CONTINUOUS DEVELOPMENT OF VERTICAL AND HORIZONTAL MARKET OPPORTUNITIES
Management believes Nanophase is viewed as a leader in nanotechnology, and
one of the very few companies that can deliver significant commercial quantities
of nanoproducts. The Company plans to continue developing new opportunities by
working with lead customers to co-develop products. This leads to a better
understanding of the customer's requirements and increased internal focus, while
reducing development risk and time-to-market. Nanophase continuously and
actively pursues both vertical and horizontal markets, where it can take
advantage of already developed products for new valued-added applications.
MARKETING
The Company markets and sells its products through a combination of
business development and sales activities in close collaborative relationships
with a lead customer in each market segment. Business development activities
evaluate and qualify potential markets, identify the lead customers within them,
and develop a business case strategy for successful market penetration. Once a
market is qualified, Nanophase forms a technical/marketing team to provide the
customer with an engineered solution to meet that company's specific
requirements. In many cases, products that satisfy a vertical market need can be
applied across similar or horizontal markets. For instance, materials used in
conductive coatings also can be used for antistatic coatings and conductive
strip carriers for color toners.
Nanophase tailors materials to provide specific solutions required by its
customers. Once a solution is established, application and customer management
is moved to a sales team that is organized along market lines. The sales team is
expected to increase revenue by selling product and process solutions and
broadening the customer base.
The Company leverages its resources through partnerships with organizations
and individuals focused on market-specific or geography-specific areas. This
enhances Nanophase's ability to quickly develop lead customers and applications
for its products. For example, to promote a more rapid penetration into Japanese
markets, the Company continues to maintain its relationship with C. I. Kasei, a
division of Itochu Corporation ("CIK"). CIK develops, engineers and manufactures
products under license from the Company for use in multiple industrial markets.
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Dr. Richard W. Siegel, an internationally recognized scientific leader in
the nanotechnology field, is a significant resource for the Company. Dr. Siegel
is a director of the Company. In addition, Nanophase has a consulting contract
with Dr. Siegel, who provides support for business development and marketing
activities. The Company also employs a number of marketing representatives and
third-party sales agents focused in specific application areas, including
conductive coatings, advanced ceramics and high intensity lighting.
Nanophase also markets itself and its capabilities by 1) sponsorship,
attendance and presentations at advanced materials symposia; 2) publishing
articles in scientific journals, and 3) participating in industry trade shows
for its target markets. The Company also uses its Website, advertises in
selected industry and trade journals, and provides specification sheets,
corporate journals, and other marketing materials. In addition, Nanophase
routinely networks with Fortune 500 companies to display its technology and
uncover potential applications. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Limited Marketing Experience; Use of Distribution Agreements" and
"-- Revenue from International Sources".
TECHNOLOGY AND ENGINEERING
The Company's Technology and Engineering Group includes the R&D and
engineering functions. The near-term objective of Nanophase's research and
process-development activities is to gather core technologies that have the
capability to serve multiple markets and provide the technical basis for
significant company growth. There are three legs to the Company's R&D strategy:
- Research and development to characterize novel or unique behavior and
characteristics of the nanocrystalline materials that it produces.
- Design of engineered solutions for customer-specific applications.
- To develop process engineering innovations that enable continuous
improvement in manufacturing yields, throughput and cost. This is
accomplished in a three ways: 1) by developing processes that
consistently produce sufficient commercial quantities of
application-specific nanocrystalline materials; 2) by developing
additional technologies to allow the PVS-produced particles to be
dispersed in a variety of matrices, and 3) by developing entirely new
methods for producing nanoparticles.
Nanophase's total Research and Development Expense, which includes all
expense relating to the technology and engineering group, during the years ended
December 31, 1999, 1998 and 1997 were $1,456,126, $1,504,127 and $990,331,
respectively. The Company's future success will depend in large part upon its
ability to keep pace with evolving advanced materials technologies and industry
standards, and the Company may be unable to do so. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Rapid Technological Change".
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The objective of Nanophase's intellectual property activities is to develop
a leadership position in the nanotechnology by implementing strategies that
maximize and protect its proprietary rights. These strategies include 1)
obtaining patents and trademarks based on Nanophase inventions and products, and
2) licensing third-party patents to expand the Company's technology base and
prevent Nanophase from being blocked if future developments require use of
technology covered by those patents. Nanophase currently owns or licenses an
aggregate of 25 United States and foreign patents and patent applications: seven
issued patents owned directly by Nanophase, seven pending patent applications
owned directly by Nanophase, and 11 patents licensed from third parties.
Five United States patents have been issued to Nanophase: one covering its
PVS process for synthesizing nanocrystalline materials, one covering the related
apparatus, one covering the materials produced by the PVS process and two
covering the DPE process for encapsulating nanoparticles. The three patents
relating to the PVS process expire in July 2013 and the two patents relating to
the DPE process expire in March 2017. PVS Patents also were issued in Japan and
Australia, and additional patent applications relating to both PVS and DPE
processes are pending in Europe and Japan for the PVS process and apparatus.
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The Company holds the following licenses of United States patents. The
first is a fully paid-up exclusive worldwide license of two patents owned by
ARCH Development Corporation, which involve a laboratory-scale method and
apparatus for making nanocrystalline materials. The second is a non-exclusive
license from the Japan Science and Technology Corporation (formerly Research
Development Corporation of Japan) of four patents, which embody early
laboratory-scale work in the physical synthesis of nanocrystalline materials.
The third is a non-exclusive license of two patents owned by Hitachi, Ltd.,
which relate to the synthesis of nanocrystalline materials. The fourth is a
remainder-exclusive license of three patents held by Cornell University,
relating to a laboratory-scale process for net-shaping a limited range of
materials. Other than the license from the Japan Science and Technology
Corporation, which remains in force until May 2006 and is extendable upon
further agreement, each of the licenses lasts for the life of their respective
patents. Under each of the licenses, Nanophase is obligated to pay the licensor
royalties equal to a percentage of net sales of products that use the licensed
technology, and related taxes on any royalties paid to foreign licensors.
The Company requires its employees, consultants, outside scientific
collaborators and other advisors to sign confidentiality and non-compete
agreements when their employment or consulting relationships begin. These
agreements generally provide that all confidential information developed or made
known to the individual during the course of that person's relationship with the
Company will be kept confidential, and not be disclosed to third parties except
in specific circumstances. In the case of research employees, the agreements
also provide that all inventions made by the individual shall be the exclusive
property of Nanophase. There can be no assurance, however, that these agreements
will provide meaningful protection for the Company's trade secrets, know-how or
patent rights, or will provide Nanophase with adequate remedies in the event of
unauthorized use or disclosure of such information. In addition, because many of
the Company's employees have not entered into non-compete agreements, they may
become competitors when their employment at Nanophase ends. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors -- Dependence on Patents and Protection of
Proprietary Information".
COMPETITION
Within each of its targeted markets and product applications, Nanophase
faces current and potential competition from many chemical companies, as well as
the in-house capabilities of several of its current and potential customers. In
the health care market, for example, several companies offer ultrafine zinc
oxide (Zinc Corporation of America, Elementis UK Limited, Millennium Chemical
and others) manufactured by chemical or other means. In structural ceramics, the
Company competes with manufacturers of ceramic composites who machine their
products for specific applications. Although management believes its materials
and technologies are superior to those used by its competitors, these companies
pose significant risks to Nanophase because they have substantially greater
financial and technical resources, larger research and development staffs, and
greater manufacturing and marketing capabilities.
The Company also faces potential competition from Vacuum Metallurgical Co.,
Ltd. of Japan ("Vacuum Metallurgical"), which manufactures nanocrystalline
materials and equipment. Nanophase does not currently compete with Vacuum
Metallurgical, but this company may develop products or manufacturing
capabilities to compete with Nanophase in the future. The number of
development-stage companies involved in nanocrystalline materials also represent
potential competitive risks. These include Advanced Powder Technology Pty. Ltd.;
Nanomaterials Research Corporation; Plasma Quench Technologies, Inc., and
Nanopowder Enterprises, Inc. Many of these companies are associated with
university or national laboratories, and use chemical and physical methods to
produce nanocrystalline materials. Management believes that most of these
companies are engaged primarily in funded research, and is not aware that any of
them have commercial production capability. However, they may represent
significant competitive risks in the future. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Competition".
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GOVERNMENTAL REGULATIONS
The manufacture and use of certain of the products that contain the
Company's nanocrystalline materials are subject to governmental regulation. As a
result, the Company is required to adhere to the current Good Manufacturing
Practices ("cGMP") requirements of the U.S. Food and Drug Administration ("FDA")
and similar regulations in other countries that include testing, control and
documentation requirements enforced by periodic inspections.
In addition, the Company's facilities and all of its operations are subject
to the plant and laboratory safety requirements of various occupational safety
and health laws. To date, those regulations have not materially restricted or
impeded operations. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors -- Governmental
Regulations".
EMPLOYEES
On December 31, 1999, the Company had a total of 42 full-time employees, 12
of whom hold advanced degrees. In the first quarter of 1999, the Company hired
1) an experienced vice president of technology and engineering to improve
technology management, implement its solution-provider approach, and further
enhance and expand the Company's core technologies, and 2) an experienced vice
president of sales and marketing, to strengthen its capabilities in the United
States and internationally. Nanophase is not subject to any collective
bargaining agreements, and management believes it has good relationships with
employees.
PROPERTIES
Nanophase operates a 20,000 square-foot production, research and
headquarters facility in Burr Ridge, Illinois, a Chicago suburb. The Company
also leases offsite warehouse space. Management believes the Burr Ridge facility
is the first in the world solely dedicated to the large-scale production of a
broad range of PVS nanocrystalline materials. The Company's operations in Burr
Ridge are registered under ISO 9001, and management believes that its
manufacturing operations are in compliance with the cGMP requirements of the
FDA.
The Company's primary means of nanoparticle manufacturing occurs in its PVS
plasma reactors. The throughput of each reactor depends on many factors,
including 1) the mix of products produced; 2) the commencement, expiration or
termination of development programs; 3) the status of tests and evaluations of
samples and prototypes, and 4) production yields. Management expects to increase
the throughput per reactor by increasing the efficiency and yields of its PVS
process, and decreasing the amount of downtime for each reactor. Each PVS plasma
reactor is made of modular equipment, which is designed and assembled to the
Company's proprietary specifications. These modular reactors provide the
flexibility to expand Nanophase's manufacturing capability. The Burr Ridge
facility has a quality control laboratory designed for the dual purposes of
validating operations to cGMP and ISO standards, and production process control.
This laboratory is equipped to handle many routine analytical and in-process
techniques the Company currently requires. Nanophase leases its Burr Ridge
facility under an agreement whose initial term expired in September 1999. The
Company has options to extend the lease for up to five additional one-year terms
and is currently in the first additional one-year term which expires in
September 2000.
Management believes that additional space will be required in the near
term. Nanophase intends to use a portion of the net proceeds from its initial
public offering (the "Offering") of its Common Stock, $.01 par value (the
"Common Stock") for the relocation to, or acquisition of another site for its
manufacturing and laboratory facilities. As of December 31, 1999, the Company
was in discussions with third parties concerning the potential occupancy of such
a site.
FORWARD-LOOKING STATEMENTS
Nanophase Technologies Corporation ("Nanophase" or the "Company") wants to
provide investors with more meaningful and useful information. As a result, this
Annual Report on Form 10-K (the "Form 10-K") contains and incorporates by
reference certain "forward-looking statements", as defined in Section 21E of the
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Securities Exchange Act of 1934, as amended. These statements reflect the
Company's current expectations on the future results of its operations,
performance and achievements. Forward-looking statements are covered under the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Nanophase has tried, wherever possible, to identify these statements by using
words such as "anticipates", "believes", "estimates", "expects", "plans",
"intends" and similar expressions. These statements reflect management's current
beliefs and are based on information now available to it. Accordingly, these
statements are subject to certain risks, uncertainties and contingencies that
could cause the Company's actual results, performance or achievements in 2000
and beyond to differ materially from those expressed in, or implied by, what
appears here. These risks, uncertainties and contingencies include, without
limitation, demand for and acceptance of the Company's nanocrystalline
materials; the Company's dependence on a limited number of key customers; the
Company's limited manufacturing capacity and experience; the Company's limited
marketing experience; changes in development and distribution relationships; the
impact of competitive products and technologies; the Company's dependence on
patents and protection of proprietary information; the resolution of litigation
in which the Company is involved; and other risks set forth under "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors". The Company undertakes no obligation to update or
revise any forward-looking statements to reflect events or circumstances after
the date of this Form 10-K, or to reflect the occurrence of unanticipated
events.
ITEM 3. LEGAL PROCEEDINGS
As disclosed in Note 16 to the Financial Statements and as previously
disclosed in the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, five separate complaints were filed in the United States
District Court for the Northern District of Illinois, Eastern Division, each of
which alleged that the Company, certain of its officers and directors, and the
underwriters of the Offering are liable under the federal securities laws for
making supposedly negligent or reckless material misstatements of fact and
omitting to state material facts necessary to make other statements of fact not
misleading in the Registration Statement and Prospectus relating to the
Offering. Those cases were consolidated and a consolidated complaint was filed
in October 1998. The consolidated complaint alleges that the action should be
maintained as (i) a plaintiff class action on behalf of certain persons who
purchased the Common Stock from November 26, 1997 through January 8, 1998,
excluding the defendants, members of their immediate families, and any entity in
which a defendant has a controlling interest, and (ii) a defendant class action
against the underwriters who participated in the Offering. The consolidated
complaint seeks unquantified damages under the federal securities laws, pre- and
post-judgment interest, attorneys' fees, and expert witness fees. In addition,
the consolidated complaint seeks rescission and/or rescissory damages relating
to purchases of the Common Stock under federal securities laws. In October 1999,
the Court granted in part and denied in part motions to dismiss the consolidated
complaint that previously had been filed by each defendant. In its ruling, the
Court in part found that plaintiffs who did not purchase their Common Stock
during the Offering could not sue under Section 12(a)(2) of the Securities Act
of 1933. Each defendant's respective answer to the remaining claims in the
consolidated complaint was filed on November 15, 1999 and discovery began
thereafter.
In November 1998, a separate complaint was filed in the Northern District
of Illinois, Eastern Division, which alleged that the Company, certain of its
officers and directors, and the underwriters of the Company's Offering are
liable under the federal securities laws for making supposedly fraudulent
material misstatements of fact and omitting to state material facts necessary to
make other statements of fact not misleading in connection with the solicitation
of consents to proceed with the Offering from certain of the Company's preferred
stockholders. The complaint alleges that the action should be maintained as a
plaintiff class action on behalf of those former preferred stockholders whose
shares of preferred stock were converted into Common Stock on or about the date
of the Offering, excluding the defendants, other officers and directors of the
Company, members of the immediate families of all individual defendants, and any
entity in which a defendant has a controlling interest. The complaint seeks
unquantified damages as provided for under the federal securities laws, pre- and
post-judgment interest, attorneys' fees, and expert witness fees. In March 1999,
the preferred stockholders' complaint was reassigned to the judge hearing the
consolidated complaint described above. Thereafter, pretrial proceedings
involving the preferred stockholders' complaint were further consolidated with
that litigation. In October 1999, all defendants filed a joint motion to dismiss
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the preferred stockholders' complaint; briefing on that motion was completed in
February 2000. To date, the Court has not ruled on the motion to dismiss the
preferred stockholders' complaint nor has the Court indicated when it
anticipates ruling.
The Company, the defendant directors and the defendant officers each have
retained counsel for both of the above-described litigations and intend to
defend against both complaints vigorously. Although the Company believes that
the allegations of the complaints are without merit, it is not feasible for the
Company to predict at this time the outcome of either litigation or whether the
resolution of either litigation could have a material adverse effect on the
Company's results of operations, cash flows or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of 1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol NANX. Such trading began on November 26, 1997 in connection with the
Offering. The following table sets forth, for the periods indicated, the range
of high and low sale prices for the Common Stock on the Nasdaq National Market:
HIGH LOW
---- ---
Fiscal year ending December 31, 1998:
First Quarter............................................. $13.25 $5.00
Second Quarter............................................ 9.38 4.25
Third Quarter............................................. 5.13 1.81
Fourth Quarter............................................ 3.69 1.50
Fiscal year ending December 31, 1999:
First Quarter............................................. 3.00 2.03
Second Quarter............................................ 2.63 1.50
Third Quarter............................................. 2.72 1.50
Fourth Quarter............................................ 5.75 1.63
On March 22, 2000, the last reported sale price of the Common Stock was
$13.44, and there were approximately 134 holders of record of the Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock and does not currently anticipate paying any cash dividends or other
distributions on its Common Stock in the foreseeable future. The Company intends
instead to retain any future earnings for reinvestment in its business. Any
future determination to pay cash dividends will be at the discretion of the
Company's Board of Directors and will be dependent upon the Company's financial
condition, results of operations, capital requirements and such other factors
deemed relevant by the Board of Directors.
On August 25, 1999, the Company issued 24,500 shares of the Company's
Common Stock to Joseph Cross, the Company's Chief Executive Officer, as part of
the Company's compensation arrangement with Mr. Cross.
On November 26, 1997 (the "Effective Date") the Company's Registration
Statement on Form S-1 (File No. 333-36937) relating to the Offering was declared
effective by the Securities and Exchange Commission. Since the Effective Date,
of its $28,837,936 of net proceeds from the Offering, the Company has used
approximately $974,000 for capital expenditures primarily related to the further
expansion of the Company's existing manufacturing facility and the purchase of
operating equipment and $6,023,000 for working capital and other general
corporate purposes. The remainder of the net proceeds has been invested by the
Company, pending its use, in short-term, investment grade, interest-bearing
obligations.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified by reference to, and
should be read in conjunction with, the financial statements and related notes
thereto appearing elsewhere in this Form 10-K and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
selected
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financial data set forth below as of, and for, each of the years in the
five-year period ended December 31, 1999 have been derived from the audited
financial statements of the Company.
YEARS ENDED DECEMBER 31
----------------------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Product revenue................. $ -- $ 249,017 $ 924,763 $ 1,140,845 $1,128,861
Other revenue................... 93,591 236,019 2,798,729 162,944 295,986
Governmental research
contracts..................... 27,995 110,770 -- -- --
----------- ----------- ----------- ----------- ----------
Total revenue................... 121,586 595,806 3,723,492 1,303,789 1,424,847
Cost of revenue................. 532,124 4,019,484 3,935,766 3,221,996 2,610,667
Research and development
expense....................... 485,059 677,284 990,331 1,504,127 1,456,126
Selling, general and
administrative expense........ 1,150,853 1,661,504 2,074,728 3,594,946 3,641,736
----------- ----------- ----------- ----------- ----------
Total operating expense......... 2,168,036 6,358,272 7,000,825 8,321,069 7,708,529
----------- ----------- ----------- ----------- ----------
Operating loss.................. (2,046,450) (5,762,466) (3,277,333) (7,017,280) (6,283,682)
Interest income................. 86,576 184,778 204,863 1,539,400 1,166,615
Provision for income taxes...... -- -- -- (156,000) --
----------- ----------- ----------- ----------- ----------
Net loss........................ $(1,959,874) $(5,577,688) $(3,072,470) $(5,633,880) (5,117,067)
=========== =========== =========== =========== ==========
Net loss per share.............. $ (0.45) $ (0.40)
=========== ==========
Shares used in computing the net
loss per share................ 12,416,305 12,690,483
=========== ==========
AS OF DECEMBER 31
-----------------------------------------------------------------------
1995 1996 1997 1998 1999
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents...... $ 261,902 $ 617,204 $ 3,988,368 $ 363,394 $ 624,509
Working capital................ 2,451,627 3,070,789 32,038,915 26,535,018 21,831,264
Total assets................... 3,741,128 5,539,634 36,196,569 30,453,988 25,677,539
Total stockholders' equity..... 3,506,050 5,110,450 34,651,334 29,107,590 24,161,323
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Item 6. Selected Financial Data" 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 "-- Risk Factors."
OVERVIEW
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
nanocrystalline materials 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
nanocrystalline materials, and the Company no longer considers itself in the
development stage. All of the Company's revenue since January 1, 1997 has been
generated through commercial sources. From inception through December 31, 1999,
the Company was primarily capitalized through the private offering of
approximately $19,558,069 of equity securities and its initial public offering
of $28,837,936 of Common Stock, each net of issuance costs. The Company has
incurred cumulative losses of $24,495,618 from inception through December 31,
1999.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
Revenue is recorded when the Company ships products, when specific
milestones are met regarding development arrangements or when the Company
licenses its technology and transfers proprietary information. Total revenue
increased to $1,424,847 in 1999, compared to $1,303,789 in 1998. The increase in
total revenue between 1999 and 1998 was primarily attributed to a $133,042
increase in other revenue offset by a $11,984 reduction in product revenue.
Product revenue decreased to $1,128,861 in 1999, compared to $1,140,845 in 1998.
Other revenue increased to $295,986 in 1999, compared to $162,944 in 1998.
Revenue from three major customers constituted approximately 53.4% of the
Company's 1999 revenue. In particular, revenue from (1) CIK, (2) a cosmetics
customer and (3) a ceramics customer constituted approximately 33.8%, 9.9%, and
9.7%, respectively, of the Company's 1999 revenue. The Company does not
currently anticipate future revenue from either the cosmetics customer or the
ceramics customer. See "-- Risk Factors -- Dependence on a Limited Number of Key
Customers."
Cost of revenue generally includes costs associated with commercial
production, customer development arrangements, the transfer of technology, and
licensing fees. Cost of revenue decreased to $2,610,667 in 1999, compared to
$3,221,996 in 1998. The decrease in cost of revenue was generally attributed to
cost reduction activities and efficiencies in the manufacture of the Company's
products, decreased ceramic superplastic forming costs, and a smaller increase
in the allowance for excess quantities in inventory in 1999 than in 1998. Cost
of revenue as a percentage of total revenue decreased in 1999, compared to the
same period in 1998, due primarily to the factors discussed above.
Research and development expense 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. Research and development expense decreased to $1,456,126 in 1999,
compared to $1,504,127 in 1998. The decrease in research and development expense
was primarily attributed to the lack of costs relating to arrangements with
outside parties to further develop end-use products utilizing nanocrystalline
materials, versus $745,000 of such costs in 1998, offset by increases in
salaries, related recruiting and relocation, and payments to a former officer.
The Company expects to further increase its
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research and development expense in 2000 in connection with its plans to
continue to enhance and expand its product lines, technologies and manufacturing
processes.
Selling, general and administrative expense increased to $3,641,736 in
1999, compared to $3,594,946 in 1998. The net increase was primarily attributed
to costs associated with an organizational restructuring, including recording
amounts due to former officers and non-cash stock compensation charges relating
to the revision of vesting schedules for options previously granted to such
officers, associated legal and professional fees, and severance to other
employees. These increases were somewhat offset by an adjustment of estimated
amounts related to contingent liabilities, a reduction in recruiting and
relocation costs, and a reduction in bad debt expense.
Interest income decreased to $1,166,615 in 1999, compared to $1,539,400 in
1998. This decrease was primarily due to a reduction in funds available for
investment compounded by a reduction in investment yields.
There was no income tax expense in 1999, compared to $156,000 in 1998. The
1998 expense was due to the foreign taxes withheld from license fees received
from CIK. The payment of such taxes creates a foreign tax credit which may be
available to offset federal income taxes when the Company generates taxable
income.
YEARS ENDED DECEMBER 31, 1998 AND 1997
Total revenue decreased to $1,303,789 in 1998, compared to $3,723,492 in
1997. The decrease in total revenue between 1998 and 1997 was primarily
attributed to a $2,635,785 reduction in other revenue offset by a $216,082
increase in product revenue. Other revenue decreased to $162,944 in 1998,
compared to $2,798,729 in 1997. Product revenue increased to $1,140,845 in 1998,
compared to $924,763 in 1997. The majority of the revenue generated in 1998 was
from customers in the electronics and structural ceramics and composites
markets. Revenue from four customers constituted 55.8% of the Company's 1998
revenue. In particular, revenue from (1) EKC Technology, Inc., a manufacturer of
semiconductor polishing slurries ("EKC"), (2) CIK, (3) a ceramics customer and
(4) an electronics customer constituted approximately 11.5%, 14.0%, 16.9% and
13.4%, respectively, of the Company's 1998 revenue. See "-- Risk
Factors -- Dependence on a Limited Number of Key Customers."
Cost of revenue decreased to $3,221,996 in 1998, compared to $3,935,766 in
1997. The decrease in cost of revenue was generally attributed to the reduced
cost of development activities and efficiencies in the manufacture of the
Company's products, somewhat offset by inefficiencies in the Company's coating
operations and increased ceramic superplastic forming costs. Cost of revenue as
a percentage of total revenue increased in 1998, compared to the same period in
1997, due primarily to the decrease in total revenue.
Research and development expense increased to $1,504,127 in 1998, compared
to $990,331 in 1997. The increase in research and development expense was
primarily attributed to increased costs of $745,000 related to arrangements with
outside parties to further develop end-use products utilizing nanocrystalline
materials, slightly offset by reductions in internal costs regarding the
development of new formulations and product applications.
Selling, general and administrative expense increased to $3,594,946 in
1998, compared to $2,074,728 in 1997. The selling, general and administrative
expense in 1997 included a one-time charge of $375,103 related to a public
offering withdrawn in May 1997. Excluding such one-time charge, selling, general
and administrative expense increased by $1,895,321 in 1998 over 1997. The net
increase was primarily attributed to increased costs associated with being a
public company, costs related to ongoing investor relation programs, additional
legal expenses, salaries of additional sales and administrative personnel and
increased recruiting and relocation costs.
Interest income increased to $1,539,400 in 1998, compared to $204,863 in
1997. This increase was primarily due to the investment of net proceeds from the
Company's sale of equity securities pending use of such proceeds.
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Income tax expense was $156,000, compared to $0 in 1997. The 1998 expense
was due to the foreign taxes withheld from license fees received from CIK. The
payment of such taxes creates a foreign tax credit which may be available to
offset federal income taxes when the Company generates taxable income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and investments amounted to
$21,840,677 at December 31, 1999, compared to $26,633,912 at December 31, 1998.
The net cash used in the Company's operating activities was $4,335,648,
$3,859,019, and $3,370,367 for the years ended December 31, 1999, 1998 and 1997,
respectively. The net cash used in operating activities for the year ended
December 31, 1999 was primarily for the further development of product
applications, the funding of research and development activities, and the
funding of receivables, which was offset by increases in accounts payable. Net
cash provided by or (used in) investing activities, including capital
expenditures and purchases of securities in which cash is invested pending its
use for operating activities and expansion of the Company's manufacturing
facilities offset by maturities of such securities, amounted to $4,550,288,
$143,909, and $(25,871,823) for the years ended December 31, 1999, 1998 and
1997, respectively. Capital expenditures, primarily related to the further
expansion of the Company's existing manufacturing facilities and the purchase of
operating equipment, amounted to $504,061, $470,425, and $1,063,608 for the
years ended December 31, 1999, 1998 and 1997, respectively. Net cash provided by
financing activities, which related to the exercise of options for 170,876
shares of Common Stock, amounted to $46,475 for the year ended December 31,
1999, compared to $90,136 for the year ended December 31, 1998, which related to
the exercise of options for 128,356 shares of common stock, and $32,613,354 for
the year ended December 31, 1997 which related mainly to the net proceeds from
the issuance of equity securities.
The Company believes that cash on hand, together with the remaining net
proceeds from the Offering and interest income thereon, will be adequate to fund
the Company's current operating plans. The Company's actual future capital
requirements will depend, however, on many factors, including customer
acceptance of the Company's current and potential nanocrystalline materials 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. Depending on future requirements, the
Company may seek additional funding through public or private financing,
collaborative relationships, government contracts or additional licensing
agreements. 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. See "-- Risk Factors -- Future Capital Needs."
At December 31, 1999, the Company had a net operating loss carryforward of
approximately $23.1 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. If not utilized, the carryforward expires
at various dates between 2005 and 2014. As a result of the annual limitation and
uncertainty as to the amount of future taxable income that will be incurred
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. At December 31, 1999, the
Company also had a foreign tax credit carryforward of $156,000, which could be
used as an offsetting tax credit to reduce U.S. income taxes. The foreign tax
credit will expire in 2013 if not utilized before that date.
YEAR 2000 SYSTEMS PREPAREDNESS
The Year 2000 issue focuses on the ability of information systems to
properly recognize and process date-sensitive information beyond December 31,
1999. To address this problem, the Company implemented a Year 2000 readiness
plan for information technology systems ("IT") and non-IT equipment, facilities
and systems. All material IT and non-IT equipment, processes and software were
compliant and resulted in no material
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Y2K issues as of the date of this report. While no material Y2K problems have
been encountered to date and none are expected, it is possible that such
problems could arise as the year progresses.
Total expenses on the project through December 31, 1999 were less than
$100,000 and were related to expenses for repair or replacement of software and
hardware, expenses associated with facilities, products and supplier reviews and
project management expenses.
RISK FACTORS
Investors should consider the following risks in connection with an
investment in the Company.
LIMITED HISTORY OF COMMERCIAL REVENUE; UNCERTAIN MARKET ACCEPTANCE OF THE
COMPANY'S NANOCRYSTALLINE MATERIALS
The Company was founded in November 1989 and through December 31, 1996 was
engaged principally in research and development activities. While the Company
recently commenced marketing certain nanocrystalline materials, it is in the
early stage of commercialization and the potential product applications
utilizing the Company's nanocrystalline materials are in various stages of
development or under evaluation. As a result, the Company's nanocrystalline
materials have been sold only in limited quantities, often for testing and
evaluation purposes, and a significant market may not develop for such
materials. Because most, if not all, of the solutions utilizing the Company's
materials are new and innovative, the Company's time-to-market for commercial
products utilizing its materials has historically been at least 18 months and
may take several years. The Company is attempting to reduce this period by
organizing and restructuring internal resources. The Company may be unable to
decrease this time-to-market. The Company's current and potential commercial
customers establish demanding specifications for performance and reliability.
The Company's nanocrystalline materials may not meet future customer performance
standards, or offer sufficient price or performance advantages as required to
achieve commercial success. The Company's failure to develop, manufacture and
commercialize nanocrystalline materials on a timely and cost-effective basis or
successfully reduce the time-to-market of commercial products would have a
material adverse effect on the Company's business, results of operations and
financial condition. Because the Company's materials are used as ingredients in,
or components of, other companies' products, the inability of the Company's
customers to achieve market acceptance with respect to end-users of their
products or to successfully manufacture their products could also have a
material adverse effect on the Company's business, results of operations and
financial condition.
LIMITED OPERATING HISTORY; HISTORY OF LOSSES; UNCERTAINTY OF FUTURE
PROFITABILITY
The Company began shipping significant amounts of its materials for
commercial use in January 1997. Accordingly, the Company has only a limited
operating history upon which an evaluation of the Company and its prospects can
be based. An investment in the Company must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in the early
stages of development. The Company's nanocrystalline materials may not generate
significant revenues from commercial applications.
The Company has incurred net losses in each year since its inception, and
as of December 31, 1999, had an accumulated deficit of $24,495,618. The Company
may continue to incur operating losses and may be unable to achieve a profitable
level of operations. If the Company does achieve profitability, it may be unable
to sustain it. Commercial development of the Company's nanocrystalline materials
will require the commitment of substantial resources to continuing research and
development, establishment of additional commercial-scale and pilot-scale
manufacturing facilities, and further development of quality control, marketing,
sales, service and administrative capabilities. The Company's ability to achieve
profitability will depend on many factors, including the Company's ability to
enter into collaborative customer relationships and the Company's ability, alone
or with its customers, to develop, manufacture, introduce and market
commercially acceptable products based on the Company's nanocrystalline
materials and proprietary processes. The Company and its customers may not
successfully manufacture, introduce or market significant quantities of the
Company's nanocrystalline materials or their product applications.
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DEPENDENCE ON A LIMITED NUMBER OF KEY CUSTOMERS
A limited number of key customers have initially accounted for a
substantial portion of the Company's commercial revenue. In particular, revenue
from (1) CIK, (2) a cosmetics customer and (3) a ceramics customer constituted
approximately 33.8%, 9.9%, and 9.7%, respectively, of the Company's 1999
revenue. The Company does not currently anticipate future revenue from either
the cosmetics customer or the ceramics customer. The Company's customers are
significantly larger than, and are able to exert a high degree of influence
over, the Company. The loss of one or more of the Company's customers or failure
to attract new customers could have a material adverse effect on the Company's
business, results of operations and financial condition.
RELIANCE ON COLLABORATIVE DEVELOPMENT RELATIONSHIPS
The Company has established, and will continue to pursue, collaborative
relationships with a variety of corporate customers. Through such relationships,
the Company seeks to develop applications for the Company's nanocrystalline
materials, share development and manufacturing resources and coordinate the
development, manufacturing, commercialization and marketing of nanocrystalline
product applications. The Company's future success will depend, in part, on its
continued relationships with these customers, its ability to enter into similar
collaborative relationships, the commitment of the Company's customers to the
potential product applications under development and, eventually, the customers'
success in manufacturing and marketing, or willingness to purchase the Company's
nanocrystalline materials for, such product applications. The Company's
customers may decide to manufacture jointly developed products internally,
obtain them from alternative sources or no longer pursue their development.
These customers may require the Company to share control of its development,
manufacturing and marketing programs, limit its ability to license its
technology to others, or restrict its ability to engage in certain product
development, manufacturing and marketing activities. These relationships may
also be subject to unilateral termination by the Company's customers. If the
Company is unable to initiate or sustain such collaborative relationships, the
Company may be limited in its ability to independently develop, manufacture,
market or sell its current and future nanocrystalline materials or their product
applications. The failure of the Company to initiate or sustain such
collaborative relationships would have a material adverse effect on the
Company's business, results of operations and financial condition.
LIMITED MANUFACTURING CAPACITY AND EXPERIENCE
The Company's success will depend, in part, on its ability to manufacture
its nanocrystalline materials in significant quantities, with consistent
quality, at acceptable cost, on a timely basis, and in a format needed by its
customers. The Company has limited experience in high-volume manufacturing and
may incur significant start-up costs and unforeseen expenses in connection with
attempts to manufacture substantial quantities.
The Company will need to improve manufacturing efficiency significantly,
implement additional manufacturing capability and expand its current facilities
and/or obtain other facilities in the near future in order to manufacture
adequate quantities of its products to meet expected market demands. The Company
may be unable to make the transition from pilot manufacturing to high-volume
manufacturing successfully on a timely basis. The Company may also be unable to
successfully develop its surface treatment and dispersion technologies so as to
be able to coat significant quantities of its nanocrystalline materials with
consistent quality, at acceptable cost and on a timely basis. The Company may
have to develop manufacturing capability that enables it to produce dispersions,
slurries, or formulations that contain its nanocrystalline materials in order to
provide solutions demanded by certain customers and/or markets. The Company's
primary operations, including research, engineering, manufacturing, marketing,
distribution and general administration, are currently housed in a facility in
Burr Ridge, Illinois. Any material disruption in the Company's operations,
whether due to fire, natural disaster, power loss or otherwise, could have a
material adverse effect on the Company's business, results of operations and
financial condition. While the Company maintains property and business
interruption insurance, such insurance may not adequately compensate the Company
for all losses that it may incur.
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DEPENDENCE ON PATENTS AND PROTECTION OF PROPRIETARY INFORMATION
The Company's success will depend, in part, on its ability to obtain
expanded patent protection for its nanocrystalline materials and processes, to
preserve its trade secrets, and to operate without infringing the patent or
other proprietary rights of others and without breaching or otherwise losing
rights in the technology licenses upon which any of the Company's products are
based. Patent applications filed by the Company may not result in issued patents
and the scope and breadth of any claims allowed in any patents issued to the
Company or its licensors may not exclude competitors or provide competitive
advantages to the Company. In addition, any patents issued to the Company or its
licensors may not be held valid if subsequently challenged. Others may claim
rights in the patents and other proprietary technology owned or licensed by the
Company. It is also possible that others have developed or will develop similar
products or technologies without violating any of the Company's proprietary
rights. The Company's inability to obtain patent protection, preserve its trade
secrets or operate without infringing the proprietary rights of others, as well
as the Company's loss of any license to technology that it now has or acquires
in the future, would have a material adverse effect on the Company's business,
results of operations and financial condition.
Patent applications in the United States are currently maintained in
secrecy until patents issue, and patent applications in foreign countries are
maintained in secrecy for a period of time after filing. Accordingly,
publication of discoveries in the scientific literature or of patents themselves
or laying open of patent applications in foreign countries tends to lag behind
actual discoveries and filings of related patent applications. Due to this
factor and the large number of patents and patent applications related to
nanocrystalline materials, comprehensive patent searches and analysis associated
with nanocrystalline materials are often impractical or not cost-effective.
Therefore, the Company's patent and publication searches may not have been
comprehensive, or materials or processes used by the Company for its planned
products may, now or in the future, infringe upon existing technology described
in United States patents or will not infringe upon claims of patent applications
of others. Because of the volume of patents issued and patent applications filed
relating to nanocrystalline materials, there is a significant risk that current
and potential competitors and other third parties have filed or will file patent
applications for, or have obtained or will obtain patents or other proprietary
rights relating to, materials or processes used or proposed to be used by the
Company. In any such case, to avoid an infringement, the Company would have to
either license such technology or design around any such patents. The Company
may be unable either to successfully design around these third-party patents or
obtain licenses to such technology or if obtainable, such licenses may not be
available on terms acceptable to the Company.
Litigation, which could result in substantial cost to, and diversion of
effort by, the Company, may be necessary to enforce patents issued or licensed
to the Company, to defend the Company against infringement claims made by
others, or to determine the ownership, scope or validity of the proprietary
rights of the Company and others. An adverse outcome in any such litigation
could subject the Company to significant liabilities to third parties, require
the Company to seek licenses from third parties, and/or require the Company to
cease using certain technology, any of which could have a material adverse
effect on the Company's business, results of operations and financial condition.
The Company may also become involved in interference proceedings declared by the
United States Patent and Trademark Office ("PTO") in connection with one or more
of the Company's owned or licensed patents or patent applications to determine
priority of invention. Any such proceeding could result in substantial cost to
the Company, as well as a possible adverse decision as to priority of invention
of the patent or patent application involved. In addition, the Company may
become involved in reissue or reexamination proceedings in the PTO in connection
with the scope or validity of the Company's owned or licensed patents. Any such
proceeding could have a material adverse effect on the Company's business,
results of operations and financial condition, and an adverse outcome in such
proceeding could result in a reduction of the scope of the claims of any such
patents or such patents being declared invalid. In addition, from time to time,
to protect its competitive position, the Company may initiate reexamination
proceedings in the PTO with respect to patents owned by others. Such proceedings
could result in substantial cost to, and diversion of effort by, the Company,
and an adverse decision in such proceedings could have a material adverse effect
on the Company's business, results of operations and financial condition.
19
20
The Company also relies on trade secrets and proprietary know-how in the
conduct of its business and uses employee and third-party confidentiality and
non-disclosure agreements to protect such trade secrets and know-how. The
obligation to maintain the confidentiality of such trade secrets or proprietary
information may wrongfully be breached by employees, consultants, advisors or
others and the Company may not have adequate remedies for any breach. In
addition, the Company's trade secrets or proprietary know-how may otherwise
become known or be independently developed or discovered by third parties. In
addition, because not all of the Company's employees have entered into
noncompetition agreements with the Company, they may become competitors of the
Company upon termination of employment.
RAPID TECHNOLOGICAL CHANGE
Rapid changes have occurred, and are likely to continue to occur, in the
development of advanced materials and processes. The future success of the
Company will depend, in large part, upon its ability to keep pace with advanced
materials technologies, industry standards and market trends and to develop and
introduce new and improved products on a timely basis. The Company will require
substantial resources to expand its commercial manufacturing capacity, further
develop its technologies and develop and introduce innovative product
applications. The Company's development efforts may be rendered obsolete by the
research efforts and technological advances of others or other advanced
materials may prove more advantageous than those produced by the Company.
LIMITED MARKETING EXPERIENCE; USE OF DISTRIBUTION AGREEMENTS
The Company has limited experience marketing and selling its products. To
market its nanocrystalline materials directly, the Company must continue
developing a marketing and sales force that can effectively demonstrate the
advantages of its nanocrystalline product applications compared to competitive
products containing conventional or advanced materials. The Company currently
has arrangements for distribution of certain of its nanocrystalline materials
and expects to enter into additional distribution or other arrangements with
third parties regarding the commercialization or marketing of its materials. The
Company's future success will depend in part on its continued relationships with
distributors, its ability to enter into other distribution arrangements, the
continuing interest of the Company's distributors in current and potential
product applications and, eventually, the distributors' success in marketing, or
willingness to purchase, any of the Company's nanocrystalline materials. The
Company may be unsuccessful in its marketing efforts or may be unable to
establish adequate sales and distribution capabilities or to enter into or
maintain marketing and distribution arrangements with third parties on
financially acceptable terms. In addition, any third parties with whom it enters
into such arrangements may not be successful in marketing the Company's
products. While the Company may discuss distribution arrangements with companies
having access to the cosmetics and skin-care market and is currently selling
directly to a small number of cosmetic and skin-care customers, the Company may
be unable to maintain significant worldwide access to such market.
REVENUE FROM INTERNATIONAL SOURCES
For the year ended December 31, 1999, 40.2% of the Company's total revenues
were derived from product shipments to, and development agreements with,
international customers, and the Company expects that it will continue to derive
a substantial percentage of revenues from international customers in the future.
The Company may be unable to successfully market, sell and deliver its
nanocrystalline materials in international markets. In addition, there are
certain risks inherent in conducting international business, including exposure
to currency fluctuations, longer payment cycles, greater difficulties in
accounts receivable collection, political instability, foreign withholding taxes
relating to royalties, difficulties in complying with a variety of foreign laws
and unexpected changes in regulatory requirements. One or more of such factors
could have a material adverse effect on the Company's business, results of
operations and financial condition. In particular, the Company has a license
agreement with CIK for the distribution of its materials throughout various
Asian countries. The recent economic uncertainties in Korea and other Asian
markets may continue and could have a material adverse effect on the Company's
ability to generate revenue from such markets.
20
21
COMPETITION
The advanced materials industry is highly competitive. The market for
materials having the characteristics and potential uses of the Company's
nanocrystalline materials is the subject of intensive research and development
efforts by both governmental entities and private enterprises around the world.
The Company believes that the level of competition will increase further as more
product applications with significant commercial potential are developed. The
nanocrystalline product applications being developed by the Company will compete
directly with products incorporating conventional and advanced materials and
technologies. While the Company is not currently aware of the existence of
commercially available competitive products with the same attributes as those
offered by the Company, such competitive products may be introduced by third
parties, or competing materials based on different or new technologies may
become commercially available. The Company's competitors may succeed in
developing or marketing materials, technologies and products that exhibit
superior performance, are more commercially desirable or are more cost effective
than those developed or marketed by the Company. In addition, many potential
competitors of the Company have substantially greater financial and technical
resources, larger research and development staffs, and greater manufacturing and
marketing capabilities than the Company. Failure of the Company's current and
potential nanocrystalline product applications to improve performance
sufficiently at an acceptable price, achieve commercial acceptance or otherwise
compete with conventional materials would have a material adverse effect on the
Company's business, results of operations and financial condition.
VOLATILITY OF COMMON STOCK PRICE AND ASSOCIATED LITIGATION
During the first few months after the Offering, the market price of the
Company's Common Stock was volatile. Following such volatility in the market
price of the Company's Common Stock, class action lawsuits alleging violations
of federal securities laws were filed against the Company, certain of its
officers and directors and the underwriters of the Company's initial public
offering of its common stock. Such litigation initiated against the Company may
result in substantial costs and a diversion of management's attention and
resources, which could have a material adverse effect on the Company's business,
results of operations and financial condition. In addition, the stock market has
from time to time experienced significant price and volume fluctuations that may
be unrelated to the operating performance of any particular company. In
particular, there has been significant volatility in the market price of
securities of technology companies, particularly those that, like the Company,
are still primarily engaged in product development activities. Factors such as
announcements of technology innovations and new product applications,
collaborative development relationships or distribution relationships by the
Company or its competitors, disputes relating to patents and proprietary rights,
changes in financial estimates by securities analysts, failure to meet or exceed
earnings expectations of the market or of analysts, general market conditions
and actual or anticipated fluctuations in quarterly operating results may have a
significant impact on the future market price of the Common Stock.
In addition, the stock market, and specifically the stock prices of
advanced materials companies, has been very volatile. This volatility is often
not related to the operating performance of the companies. This broad market
volatility and industry volatility may reduce the price of our common stock,
without regard to our operating performance. Due to this volatility, the market
price of our common stock could significantly fluctuate.
FUTURE CAPITAL NEEDS
The Company believes that its future capital requirements will depend on
many factors, including continued progress in its research and development and
product testing programs, the magnitude of these programs, the costs necessary
to increase the Company's manufacturing capabilities and to market any resulting
materials and product applications, and customer acceptance of the Company's
current and potential materials and product applications. Additional factors
that may affect the Company's future capital requirements are the costs involved
in preparing, filing, prosecuting, maintaining and enforcing patents and other
proprietary rights or in obtaining licenses, the ability of the Company to
establish collaborative relationships, the costs related to the Company's
possible acquisition of complementary technologies or businesses, and the amount
and timing of future revenues. Depending on its requirements, the Company may
21
22
seek additional funding through public or private financing, collaborative
relationships, government contracts or licensing agreements. Such additional
financing may not be available on acceptable terms or at all. If adequate funds
are not available on acceptable terms, the Company may be required to delay,
scale-back or eliminate manufacturing and marketing of one or more of its
materials or product applications or research and development programs, or to
obtain funds through arrangements with customers or others that may require the
Company to relinquish rights to certain of its technologies or nanocrystalline
materials that the Company would not otherwise relinquish. Inadequate funding
also could impair the Company's ability to compete in the marketplace.
DEPENDENCE ON KEY PERSONNEL
The Company's success will depend, in large part, upon its ability to
attract and retain highly qualified research and development, management,
manufacturing and marketing and sales personnel. Due to the specialized nature
of the Company's business, it may be difficult to locate and hire qualified
personnel, and to retain such personnel once hired. The loss of the services of
any of the Company's executive officers or other key personnel, or the failure
of the Company to attract and retain other skilled and experienced personnel on
acceptable terms, could have a material adverse effect on the Company's
business, results of operations and financial condition. The Company does not
have "key-man" life insurance policies covering any of its executive officers or
other key employees.
PRODUCT LIABILITY RISKS
The Company may be subject to product liability claims in the event that
any of its nanocrystalline product applications are alleged to be defective or
cause harmful effects. Because the Company's nanocrystalline materials are used
as ingredients in, or components of, other companies' products, to the extent
certain of the Company's customers become subject to claims, suits or complaints
relating to their products, such as cosmetic and skin-care products, such claims
may be asserted against the Company. The cost of defending or settling product
liability claims may be substantial and the Company may be unable to do so on
acceptable terms or such claims, if successful or settled, could have a material
adverse effect on the Company's business, results of operations and financial
condition.
GOVERNMENTAL REGULATIONS
The Company is currently a producer of certain hazardous materials, such as
ethanol, governed by the Federal Resource Conservation and Recovery Act and, as
a result, is subject to stringent federal, state and local regulations governing
the handling, storage and disposal of such materials. It is possible that
current or future laws and regulations could require the Company to make
substantial expenditures for preventative or remedial action, reduction of
chemical exposure or waste treatment or disposal. The Company's operations,
business or assets could be materially and adversely affected by the
interpretation and enforcement of current or future environmental laws and
regulations. The Company believes it has complied in all material respects with
regard to environmental regulations applicable to it and does not anticipate
generating substantially increased amounts of such materials. In addition,
although management believes that its safety procedures for handling and
disposing of such materials comply with the standards prescribed by state and
federal regulations, the Company's coating operations do pose a risk of
accidental contamination or injury. To date, the Company has not needed, nor has
it been required to make substantial expenditures for preventive or remedial
action with respect to the hazardous materials it generates. The damages in the
event of an accident or the costs of such preventive or remedial actions could
have a material adverse effect on the Company's business, results of operations
and financial condition.
In addition, the Company's facilities and all of its operations are subject
to the plant and laboratory safety requirements of various occupational safety
and health laws. The Company believes it has complied in all material respects
with regard to governmental regulations applicable to it. There can be no
assurance, however, that the Company will continue to comply with applicable
government regulations or that such regulations will not materially restrict or
impede the Company's operations in the future.
22
23
The manufacture and use of certain products which contain the Company's
nanocrystalline materials are subject to governmental regulation. As a result,
the Company is required to adhere to the cGMP requirements of the FDA and
similar regulations in other countries which include testing, control and
documentation requirements enforced by periodic inspections. Such regulations
can increase the Company's cost of doing business and/or render certain
potential markets prohibitively expensive.
QUARTERLY FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced, and expects to continue to experience,
quarterly fluctuations in its results of operations as a result of a variety of
factors, including the timing of collaborative relationships with, and
performance of, customers, the timing of new product application offerings,
changes in the Company's revenue mix among its product application offerings,
the timing and amount of expenses associated with expansion of the Company's
operations, and changes in the mix between pilot production of new
nanocrystalline materials and full-scale manufacturing of existing
nanocrystalline materials. The Company did not have any significant backlog of
orders at December 31, 1999. The timing of revenues will therefore depend upon
the amount and timing of new orders received for the Company's nanocrystalline
materials.
ANTI-TAKEOVER PROVISIONS
In October 1998, the Company adopted a stockholders rights plan (the
"Rights Plan"). The Rights Plan may have the effect of delaying or preventing a
change of control of the Company, including acquisitions that may offer a
premium over market price to some or all of the Company's stockholders. Further,
certain provisions of the Company's Certificate of Incorporation and Bylaws and
Delaware law could delay or make more difficult a merger, tender offer or proxy
contest involving the Company. For example, the Company has a staggered Board of
Directors with three-year terms and the Company's Board of Directors has the
authority to issue up to 24,088 shares of undesignated preferred stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by the
Company's stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not have any material market risk sensitive instruments.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedules, with the report
of independent auditors listed in Item 14 are included in this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
23
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information in response to this item is incorporated by reference from
the "Proposal No. 1 -- Election of Directors," "Executive Officers" and "Section
16(a) Beneficial Ownership Compliance" sections of the Definitive Proxy
Statement to be filed with the Commission in connection with the Company's 2000
Annual Meeting of Stockholders (the "2000 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information in response to this item is incorporated by reference from
the section of the 2000 Proxy Statement captioned "Executive Compensation and
Certain Transactions."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in response to this item is incorporated by reference from
the section of the 2000 Proxy Statement captioned "Security Ownership of
Management and Principal Stockholders."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in response to this item is incorporated by reference from
the section of the 2000 Proxy Statement captioned "Executive Compensation and
Certain Transactions."
24
25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K:
1. The following financial statements of the Company, with the report of
independent auditors, are filed as part of this Form 10-K:
Report of Ernst & Young LLP, Independent Auditors
Balance Sheets as of December 31, 1998 and 1999
Statements of Operations for the Years Ended December 31, 1997, 1998
and 1999
Statements of Stockholders' Equity for the Years Ended December 31,
1997, 1998 and 1999
Statements of Cash Flows for the Years Ended December 31, 1997, 1998
and 1999
Notes to Financial Statements
2. The following financial statement schedules of the Company are filed
as part of this Form 10-K:
Schedule II -- Valuation and Qualifying Accounts
All other financial schedules are omitted because such schedules are
not required or the information required has been presented in the
aforementioned financial statements.
3. The following exhibits are filed with this Form 10-K or incorporated
by reference as set forth below.
EXHIBIT
NUMBER
-------
2 Plan and Agreement of Merger dated as of November 25, 1997
by and between the Company and its Illinois predecessor,
incorporated by reference to Exhibit 2 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1997 (the "1997 10-K").
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 to the 1997 10-K.
3.2 Bylaws of the Company, incorporated by reference to Exhibit
3.2 to the 1997 10-K.
4.1 Specimen stock certificate representing Common Stock,
incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-36937) (the
"IPO S-1").
4.2 Form of Warrants, incorporated by reference to Exhibit 4.2
to the IPO S-1.
4.3 Rights Agreement dated as of October 28, 1998 by and between
the Company and LaSalle National Bank, incorporated by
reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A, filed October 28, 1998.
4.4 Certificate of Designation of Series A Junior Participating
Preferred Stock incorporated by reference to Exhibit 4.4 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (the "1998 10-K").
10.1 The Nanophase Technologies Corporation Amended and Restated
1992 Stock Option Plan, as amended (the "Stock Option
Plan"), incorporated by reference to Exhibit 10.1 to the IPO
S-1.
10.2 Form of Indemnification Agreement between the Company and
each of its directors and executive officers, incorporated
by reference to Exhibit 10.2 to the IPO S-1.
10.3 Amended and Restated Registration Rights Agreements dated as
of March 16, 1994, as amended, incorporated by reference to
Exhibit 10.2 to the IPO S-1.
10.4 License Agreement dated June 1, 1990 between the Company and
ARCH Development Corporation, as amended, incorporated by
reference to Exhibit 10.7 to the IPO S-1.
25
26
EXHIBIT
NUMBER
-------
10.5 License Agreement dated October 12, 1994 between the Company
and Hitachi, incorporated by reference to Exhibit 10.8 to
the IPO S-1.
10.6 License Agreement dated May 31, 1996 between the Company and
Research Development Corporation of Japan, incorporated by
reference to Exhibit 10.9 to the IPO S-1.
10.7 License Agreement dated April 1, 1996 between the Company
and Cornell Research Foundation, incorporated by reference
to Exhibit 10.10 to the IPO S-1.
10.8* Consulting and Stock Purchase Agreement between Richard W.
Siegel and the Company dated as of May 9, 1990, as amended
February 13, 1991, November 21, 1991 and January 1, 1992,
incorporated by reference to Exhibit 10.11 to the IPO S-1.
10.9 Lease Agreement between the Village of Burr Ridge and the
Company, dated September 15, 1994, incorporated by reference
to Exhibit 10.12 to the IPO S-1.
10.10 Distribution Agreement between the Company and C.I. Kasei,
Ltd., (a subsidiary of Itochu Corporation) dated as of
October 30, 1996, incorporated by reference to Exhibit 10.15
to the IPO S-1.
10.11 Supply Agreement between the Company and Schering-Plough
HealthCare Products, Inc. dated as of March 15, 1997,
incorporated by reference to Exhibit 10.17 to the IPO S-1.
10.12 License Agreement between the Company and C.I. Kasei Co.,
Ltd. (a subsidiary of Itochu Corporation) dated as of
December 30, 1997, incorporated by reference to Exhibit
10.17 to the 1997 10-K.
10.13* Employment Agreement dated as of September 3, 1996 between
the Company and Dennis J. Nowak, incorporated by reference
to Exhibit 10.5 to the IPO S-1.
10.14* Consulting Agreement dated as of June 25, 1999 between the
Company and Dennis J. Nowak.
10.15* Employment Agreement dated as of November 9, 1999 between
the Company and Joseph Cross.
10.16* Consulting Agreement effective as of October 29, 1998
between the Company and Donald S. Perkins, incorporated by
reference to Exhibit 10.17 to the 1998 10-K.
10.17* Employment Agreement dated as of February 15, 1999 between
the Company and Gina Kritchevsky, incorporated by reference
to Exhibit 10.18 to the 1998 10-K.
10.18* Employment Agreement dated as of March 15, 1999 between the
Company and Daniel S. Bilicki, incorporated by reference to
Exhibit 10.19 to the 1998 10-K.
10.19* Employment Agreement dated as of June 1, 1999 between the
Company and Donald Freed.
10.20* Form of Options Agreement under the Stock Option Plan,
incorporated by reference to Exhibit 4.5 to the Company's
Registration Statement on Form S-8 (File No. 333-53445).
10.21* Consulting and Severance Agreement dated October 28, 1998
between the Company and John C. Parker, incorporated by
reference to Exhibit 10.21 to the 1998 10-K.
10.22** Zinc Oxide Supply Agreement dated as of September 16, 1999
between the Company and an undisclosed customer of the
Company.
26
27
EXHIBIT
NUMBER
-------
11 Statement regarding computation of loss per share.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
- ---------------
* Management contract or compensatory plan or arrangement.
** Confidentiality Requested, confidential portions have been omitted
and filed separately with the Commission as required by Rule 24b-2.
(b) Reports on Form 8-K:
None
27
28
NANOPHASE TECHNOLOGIES CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... F-2
Balance Sheets as of December 31, 1998 and 1999............. F-3
Statements of Operations for the years ended December 31,
1997, 1998 and 1999....................................... F-4
Statements of Stockholders' Equity.......................... F-5
Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999....................................... F-6
Notes to the Financial Statements........................... F-7
F-1
29
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Nanophase Technologies Corporation
We have audited the accompanying balance sheets of Nanophase Technologies
Corporation as of December 31, 1998 and 1999, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1999. Our audit also included the financial
statement schedule for the three years in the period ended December 31, 1999,
listed in the index at Item 14(a). These financial statements and schedule are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Nanophase Technologies
Corporation at December 31, 1998 and 1999, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1999, in conformity with accounting principles generally accepted in the United
States. Also in our opinion, the related financial statement schedule for the
three years in the period ended December 31, 1999, when considered in relation
to the basic financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Ernst & Young LLP
Chicago, Illinois
February 8, 2000
F-2
30
NANOPHASE TECHNOLOGIES CORPORATION
BALANCE SHEETS
AS OF DECEMBER 31,
------------------------------
1998 1999
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 363,394 $ 624,509
Investments............................................... 26,270,518 21,216,168
Trade accounts receivable, less allowance for doubtful
accounts of $85,000 in 1998 and $120,000 in 1999....... 316,328 401,826
Other receivable, net..................................... -- 247,841
Inventories, net.......................................... 838,825 766,778
Prepaid expenses and other current assets................. 92,351 90,358
------------- -------------
Total current assets................................... 27,881,416 23,347,480
Equipment and leasehold improvements, net................... 2,383,091 2,152,413
Other assets, net........................................... 189,481 177,646
------------- -------------
$ 30,453,988 $ 25,677,539
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 413,378 $ 615,818
Accrued expenses.......................................... 933,020 900,398
------------- -------------
Total current liabilities.............................. 1,346,398 1,516,216
CONTINGENT LIABILITIES:..................................... -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 24,088 authorized and no
shares issued and outstanding............................. -- --
Common stock, $.01 par value; 25,000,000 shares authorized
and 12,568,691 shares issued and outstanding at December
31, 1998; 25,000,000 shares authorized and 12,764,058
shares issued and outstanding at December 31, 1999........ 125,687 127,641
Additional paid-in capital.................................. 48,360,454 48,529,300
Accumulated deficit......................................... (19,378,551) (24,495,618)
------------- -------------
Total stockholders' equity............................. 29,107,590 24,161,323
------------- -------------
$ 30,453,988 $ 25,677,539
============= =============
F-3
31
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1998 1999
---- ---- ----
REVENUE:
Product revenue..................................... $ 924,763 $ 1,140,845 $ 1,128,861
Other revenue....................................... 2,798,729 162,944 295,986
----------- ----------- -----------
Total revenue.................................. 3,723,492 1,303,789 1,424,847
OPERATING EXPENSE:
Cost of revenue..................................... 3,935,766 3,221,996 2,610,667
Research and development expense.................... 990,331 1,504,127 1,456,126
Selling, general and administrative expense......... 2,074,728 3,594,946 3,641,736
----------- ----------- -----------
Total operating expenses....................... 7,000,825 8,321,069 7,708,529
----------- ----------- -----------
Loss from operations................................ (3,277,333) (7,017,280) (6,283,682)
Interest income..................................... 204,863 1,539,400 1,166,615
----------- ----------- -----------
Loss before provision for income taxes.............. (3,072,470) (5,477,880) (5,117,067)
Provision for income taxes.......................... -- (156,000) --
----------- ----------- -----------
Net loss............................................ $(3,072,470) $(5,633,880) $(5,117,067)
=========== =========== ===========
Basic and diluted net loss net per share............ n/a $ (0.45) $ (0.40)
=========== =========== ===========
Weighted average number of common shares
outstanding...................................... n/a 12,416,305 12,690,483
=========== =========== ===========
Pro forma net loss per share........................ $ (0.37) n/a n/a
=========== =========== ===========
Pro forma weighted average number of common shares
outstanding...................................... 8,208,306 n/a n/a
=========== =========== ===========
F-4
32
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------- --------------------- PAID-IN ACCUMULATED
DESCRIPTION SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ------ ------ ------ ------ ---------- ----------- -----
Balance as of January 1, 1997...... 7,408,354 $ 15,782,201 77,586 $ -- $ 450 $(10,672,201) $ 5,110,450
Issuance of Series F shares, net
of offering costs.............. 748,089 3,770,543 -- -- -- -- 3,770,543
Exercise of stock options.......... -- -- 43,425 434 4,441 -- 4,875
Conversion of all outstanding
Preferred shares into Common
shares and all Common shares to
$0.01 par value................ (8,156,443) (19,552,744) 8,156,456 82,341 19,470,403 -- --
Issuance of Common shares, net of
offering costs................. -- -- 4,000,000 40,000 28,797,936 -- 28,837,936
Net loss for the year ended
December 31, 1997.............. -- -- -- -- -- (3,072,470) (3,072,470)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31, 1997.... -- -- 12,277,467 122,775 48,273,230 (13,744,671) 34,651,334
Exercise of stock options........ -- -- 128,356 1,283 88,853 -- 90,136
Exercise of warrants............. -- -- 162,868 1,629 (1,629) -- --
Net loss for the year ended
December 31, 1998.............. -- -- -- -- -- (5,633,880) (5,633,880)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31, 1998.... -- -- 12,568,691 125,687 48,360,454 (19,378,551) 29,107,590
Exercise of stock options........ -- -- 170,867 1,709 44,766 -- 46,475
Stock Compensation............... -- -- 24,500 245 124,080 -- 124,325
Net loss for the year ended
December 31, 1999.............. -- -- -- -- -- (5,117,067) (5,117,067)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31, 1999.... -- $ -- 12,764,058 $127,641 $48,529,300 $(24,495,618) $24,161,323
========== ============ ========== ======== =========== ============ ===========
F-5
33
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1998 1999
---- ---- ----
OPERATING ACTIVITIES:
Net loss...................................... $ (3,072,470) $ (5,633,880) $ (5,117,067)
Adjustments to reconcile net loss to cash
used in operating activities:
Depreciation and amortization............ 416,414 491,098 678,749
Stock compensation expense............... -- -- 124,325
Allowance for excess inventory
quantities............................. -- 190,633 69,581
Provision for asset write-down........... -- -- 61,011
Changes in assets and liabilities related to
operations:
Trade accounts receivable................ (1,251,988) 1,325,161 (85,498)
Other receivable......................... -- -- (247,841)
Inventories.............................. (512,098) (72,155) 2,466
Prepaid expenses and other assets........ (145,398) 38,961 8,807
Accounts payable......................... 708,461 (517,019) 202,440
Accrued liabilities...................... 486,712 318,182 (32,621)
------------- ------------- -------------
Net cash used in operating activities......... (3,370,367) (3,859,019) (4,335,648)
INVESTING ACTIVITIES:
Acquisition of equipment and leasehold
improvements................................ (1,063,608) (470,425) (504,061)
Purchases of held-to-maturity investments..... (118,684,404) (182,750,264) (126,819,265)
Maturities of held-to-maturity investments.... 93,797,340 183,364,598 131,873,614
Decrease in asset held in trust............... 78,849 -- --
------------- ------------- -------------
Net cash (used in) provided by investing
activities.................................. (25,871,823) 143,909 4,550,288
FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of
offering costs.............................. 32,608,479 -- --
Proceeds from option exercises................ 4,875 90,136 46,475
------------- ------------- -------------
Net cash provided by financing activities..... 32,613,354 90,136 46,475
------------- ------------- -------------
Increase (decrease) in cash and cash
equivalents................................. 3,371,164 (3,624,974) 261,115
Cash and cash equivalents at beginning of
period...................................... 617,204 3,988,368 363,394
------------- ------------- -------------
Cash and cash equivalents at end of period.... $ 3,988,368 $ 363,394 $ 624,509
============= ============= =============
F-6
34
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS
Nanophase Technologies Corporation (the "Company") was incorporated on
November 30, 1989, for the purpose of developing nanocrystalline materials for
commercial production and sale in domestic and international markets. The
Company issued common stock in its initial public offering consummated on
December 2, 1997.
In the course of its corporate development, the Company has experienced net
losses and negative cash flows from operations. Historically, the Company has
funded its operations primarily through the issuance of equity securities.
Export revenue approximated $1,695,700, $347,500, and $573,300 for the
years ended December 31, 1997, 1998, and 1999, respectively.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
Cash equivalents primarily consist of money market accounts which have a
maturity of three months or less from the date of purchase.
INVESTMENTS
Investments are classified by the Company at the time of purchase for
appropriate designation and such designation is reevaluated as of each balance
sheet date. Investments are classified as held-to maturity when the Company has
the positive intent and ability to hold the securities to maturity. Held-to
maturity securities are stated at amortized cost and are adjusted to maturity
for the amortization of premiums and accretion of discounts. Such adjustments
for amortization and accretion are included in interest income.
INVENTORY
Inventory is stated at the lower of cost, maintained on a first in, first
out basis, or market. The Company has recorded allowances to reduce inventory
relating to excess quantities of certain materials. Although materials subject
to this allowance remain in good condition, the quantities on hand exceed the
Company's short-term needs.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment is stated at cost and is being depreciated over its estimated
useful life (3-7 years) using the straight-line method. Leasehold improvements
are stated at cost and are being amortized using the straight-line method over
the shorter of the useful life of the asset or the term of the lease.
PATENT COSTS
Patent costs are included in other assets and are being amortized over the
life of the respective patent using the straight-line method.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the amounts reported in the Financial statements and
accompanying notes. Actual results could differ from those estimates.
F-7
35
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PRODUCT REVENUE
Product revenue consists of sales of product which are recorded as
shipments are made by the Company.
OTHER REVENUE
Other revenue consists of revenue from research and development
arrangements with non-governmental entities, fees from the transfer of
technology and related royalties. Research and development arrangements include
both cost-plus and fixed fee agreements and such revenue is recognized when
specific milestones are met under the arrangements. Fees related to the transfer
of technology are recognized when the transfer of technology to the acquiring
party is completed and the Company has no further significant obligation.
Royalties are recognized when earned pursuant to the contractual arrangement.
RESEARCH AND DEVELOPMENT EXPENSES
Expenditures for research and development activities are charged to
operations as incurred by the Company. During 1998, the Company incurred
$745,000 in third party development expenses that were charged to research and
development expense. During 1997, the Company acquired certain research and
development from a customer for $223,000 and charged this acquisition to
research and development expense.
INCOME TAXES
The Company accounts for income taxes using the liability method. As such,
deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax assets and
liabilities are calculated using the enacted tax rates and laws that are
expected to be in effect when the anticipated reversal of these differences is
scheduled to occur.
EMPLOYEE STOCK OPTIONS
As permitted by Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" (FASB 123), the Company accounts for
stock options granted to employees in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB No. 25). As long as the exercise
price of the options granted equals the estimated fair value of the underlying
stock on the measurement date, no compensation expense is recognized by the
Company for these options. FASB 123, established an alternative fair value
method of accounting for stock-based compensation plans. As required by FASB 123
for companies using APB No. 25 for financial reporting purposes, the Company
makes pro forma disclosures regarding the impact on net loss of using the fair
value method of FASB Statement No. 123.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include investments, accounts
receivable, accounts payable and accrued liabilities. The fair values of all
financial instruments were not materially different from their carrying values.
NET LOSS AND PRO FORMA NET LOSS PER SHARE
Pro forma net loss per common share and historical net loss per common
share are computed based upon the weighted average number of common shares
outstanding. Common equivalent shares of 1,041,300 for 1997, 643,484 for 1998,
and 252,349 for 1999 are not included in the pro forma and historical per share
calculations because the effect of their inclusion would be anti-dilutive. For
the pro forma calculation, all convertible preferred stock is treated as if
converted into common shares for all periods shown.
F-8
36
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Net loss per common share computed on a historical basis is as follows:
$2.39, $.45, and $.40 for the years ended December 31, 1997, 1998, and 1999
respectively. The weighted average number of common shares outstanding used to
calculate these net loss per common share amounts are 1,283,359 for 1997,
12,416,305 for 1998, and 12,690,483 for 1999.
(3) INVESTMENTS
Investments consist of government bonds and commercial paper with an
estimated fair value of $26,251,000 and $21,113,000 at December 31, 1998 and
1999, respectively. All investments have been classified as held-to-maturity and
mature in subsequent year.
(4) INVENTORIES
Inventories consist of the following:
AS OF DECEMBER 31,
------------------------
1998 1999
---- ----
Raw Materials......................................... $ 284,162 $ 257,485
Finished Goods........................................ 745,296 769,507
---------- ----------
1,029,458 1,026,992
Allowance for Excess Quantities....................... (190,633) (260,214)
---------- ----------
$ 838,825 $ 766,778
========== ==========
(5) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
AS OF DECEMBER 31,
--------------------------
1998 1999
---- ----
Machinery and equipment............................. $ 2,842,258 $ 3,072,978
Office equipment.................................... 194,258 226,760
Office furniture.................................... 49,864 43,580
Leasehold improvements.............................. 664,143 729,505
----------- -----------
3,750,523 4,072,823
Less: Accumulated depreciation and amortization..... (1,367,432) (1,920,409)
----------- -----------
$ 2,383,091 $ 2,152,414
=========== ===========
Depreciation expense was $412,233, $486,444, and $673,728 for the years
ended December 31, 1997, 1998, and 1999, respectively.
(6) LEASE COMMITMENTS
The Company leases manufacturing and office space under an agreement that
will expire in September 2000. Monthly minimum lease payments amount to $8,600
for this facility. The Company also leases off site warehouse space under an
agreement expiring in September 2000. Monthly minimum lease payments amount to
$2,900 for this facility.
Net rent expense under these leases amounted to $168,781, $191,995, and
$190,832 for the years ended December 31, 1997, 1998, and 1999, respectively.
F-9
37
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
AS OF DECEMBER 31,
--------------------
1998 1999
---- ----
Accrued payroll and related expenses..................... $211,283 $364,911
Accrued professional services............................ 288,000 133,923
Other.................................................... 201,353 174,143
Accrued payments to former officers...................... -- 181,065
Accrued costs for goods received but not invoiced........ 232,384 46,356
-------- --------
$933,020 $900,398
======== ========
(8) RESEARCH AND DEVELOPMENT AGREEMENTS
The Company is party to a number of research and development arrangements
with commercial entities. These arrangements are generally short-term in nature
and provided $1,445,705, $160,984, and $197,500 of revenues for the years ended
December 31, 1997, 1998, and 1999, respectively.
(9) LICENSE AGREEMENTS
The Company was granted an exclusive license by a third party to make, have
made, use and sell products of the type claimed in a U.S. patent. In
consideration for this license, the Company agreed to pay royalties of 1/2% of
net sales of licensed products, as defined. As of December 31, 1999, no royalty
payments were due under this agreement.
The Company was granted a non-exclusive license by a third party to make,
use, and sell products of the type claimed in two U.S. patents. In consideration
for this license, the Company agreed to pay royalties of 1% of net sales, as
defined, and made an advance royalty payment of $17,500. Royalties under this
agreement amounted to approximately $8,400, $9,900, and $12,900 for the years
ended December 31, 1997, 1998, and 1999, respectively.
The Company was granted a non-exclusive license by a third party to produce
and sell ultrafine powders of metal and ceramics claimed in four U.S. patents.
In consideration for this license, the Company agreed to pay $14,000 as an
initial payment, and pay royalties of 3% of net proceeds of sales of the
product, as defined. Royalties under this agreement amounted to approximately
$11,900, $12,100, and $37,900 for the years ended December 31, 1997, 1998, and
1999, respectively. The Company was also granted a remainder-exclusive license
by a third party to make, have made, use, import, sell or have sold products of
the type claimed in three U.S. patents. In consideration for this license, the
Company agreed to pay $5,000 as an initial payment, $5,000 upon reaching the
earlier of either defined profitability or the second anniversary of the
agreement, and royalties at the rate of 4% of the defined net sales of the
related products. The agreement also provides for minimum royalty payments
beginning in 1999, the fourth license year. As of December 31, 1999, aggregate
royalties under this agreement amounted to $20,000.
In December 1997, the Company entered into a license agreement whereby the
Company granted a royalty-bearing exclusive right and license, as defined, to
purchase, make, use and sell nanocrystalline materials to a third party. As
consideration for the right and license thereby granted, the Company recognized
a non-refundable technology transfer fee of $1,400,000, which was earned upon
execution of the agreement. As defined, the Company also will earn royalties on
net sales of manufactured products containing nanocrystalline materials. The
agreement also provided for minimum sales targets and minimum royalty
F-10
38
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
payments to maintain exclusivity. The agreement expires on March 31, 2013 unless
earlier terminated as provided therein. In 1998 and 1999, the Company recorded
revenue of $1,690 and $4,417, respectively.
(10) INCOME TAXES
The Company has net operating loss carryforwards for tax purposes of
approximately $23,100,000 at December 31, 1999, which expire between 2005 and
2014. The Company has not paid income taxes since inception.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred income taxes consist of the following:
AS OF DECEMBER 31,
-------------------------
1998 1999
---- ----
DEFERRED TAX ASSETS:
Net operating loss carryforwards.................. $ 7,137,000 $ 8,932,000
Foreign tax credit carryforward................... 156,000 156,000
Start-up cost capitalized for income tax
purposes....................................... 81,000 41,000
Inventory and other allowances.................... 143,000 148,000
Excess book depreciation.......................... -- 113,000
Other accrued costs............................... 146,000 203,000
----------- -----------
Total deferred tax assets...................... 7,663,000 9,593,000
Less: Valuation allowance......................... (7,663,000) (9,593,000)
----------- -----------
Deferred income taxes............................... $ -- $ --
=========== ===========
The valuation allowance increased $1,930,000 for the year ended December
31, 1999 due principally to the increase in the net operating loss carryforward
and uncertainty as to whether future taxable income will be generated prior to
the expiration of the carryforward period. Under the Internal Revenue Code,
certain ownership changes, including the prior issuance of preferred stock and
the Company's public offering of common stock, may subject the Company to annual
limitations on the utilization of its net operating loss carryforward.
As a result of certain transactions with third parties operating in foreign
countries, the Company may be subject to the withholding and payment of foreign
income taxes as transactions are completed. Under the Internal Revenue Code,
foreign tax payments may be used to offset federal income tax liabilities when
incurred, subject to certain limitations. At December 31, 1999, the Company has
a foreign tax credit carryforward of $156,000.
(11) CAPITAL STOCK
In 1997, a total of 748,089 shares of Series F convertible preferred stock
were issued for cash amounting to $3,770,543 which is net of financing costs of
$105,565.
In November 1997, a total of 4,000,000 shares of common stock was issued in
conjunction with the Company's initial public offering at an offering price of
$8 per share. The Company received proceeds of $28,837,936, which is net of
offering costs of $3,162,064. All Series A, B, C, D, E and F convertible
preferred stock was automatically converted to common stock in conjunction with
the initial public offering.
In October 1998, the Company declared a dividend of one Preferred Stock
Purchase Right (a "Right") for each outstanding share of Company common stock on
November 10, 1998. The Rights are not presently
F-11
39
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
exercisable. Each Right entitles the holder, upon the occurrence of certain
specified events, to purchase from the Company one ten-thousandth of a share of
the Company's Series A Junior Participating Preferred Stock at a purchase price
of $25 per one-ten thousandth of a share (the "Purchase Price"). The Rights
further provide that each Right will entitle the holder, upon the occurrence of
certain specified events, to purchase from the Company, common stock having a
value of twice the Purchase Price and, upon the occurrence of certain other
specified events, to purchase from another entity into which the Company is
merged or which acquires 50% or more of the Company's assets or earnings power,
common stock of such other entity having a value of twice the Purchase Price. In
general, the Rights may be redeemed by the Company at a price of $0.01 per
Right. The Rights expire on October 28, 2008.
At December 31, 1999, 2,500 shares of authorized but unissued Preferred
Stock have been reserved for future issuance regarding the Rights. In addition,
authorized but unissued shares of common stock have been reserved for future
issuance as follows:
Warrants.................................................... 429,796
Options..................................................... 2,415,384
---------
2,845,180
=========
(12) STOCK OPTIONS AND WARRANTS
The Company has entered into stock option agreements with certain officers,
employees, directors (two of whom are also service providers) and three Advisory
Board members. At December 31, 1999, the Company had outstanding options to
purchase 1,853,244 shares of common stock. The stock options generally expire
ten years from the date of grant. Of the total number of options granted 987,184
of the outstanding options vest over a five-year period and 257,619 vest over a
three-year period from their respective grant dates. Of the remaining 608,441
outstanding options, 103,822 vest on the eighth anniversary following their
grant date, and the remaining 504,619 were accelerated to vest over a five-year
period due to specific performance targets being met. For the year ended
December 31, 1999, the Company recognized $124,325 in stock compensation expense
related to the grant of 24,500 shares of stock to an officer and to the
extension of stock option vesting periods for three former officers.
F-12
40
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Exercise prices are determined by the Board of Directors and equal the
estimated fair values of the Company's common stock at the grant date. The table
below summarizes all option activity through December 31, 1999:
WEIGHTED
NUMBER OF EXERCISE AVERAGE EXERCISE
OPTIONS PRICE PRICE
--------- -------------- ----------------
Outstanding at January 1, 1997.................. 1,615,526 $.112 - 3.886 $2.499
Options granted during 1997..................... 17,370 5.181 5.181
Options exercised during 1997................... (43,425) .112 .112
Options canceled during 1997.................... (150,482) .112 - 3.886 3.760
---------
Outstanding at December 31, 1997................ 1,438,989 .112 - 5.181 2.471
Options granted during 1998..................... 521,400 2.938 - 5.750 3.694
Options exercised during 1998................... (128,356) .112 - 3.886 .702
Options canceled during 1998.................... (50,648) 3.813 - 3.886 3.874
---------
Outstanding at December 31, 1998................ 1,781,385 .112 - 5.750 2.916
Options granted during 1999..................... 417,000 1.750 - 5.000 2.115
Options exercised during 1999................... (170,867) .112 - 1.727 .272
Options canceled during 1999.................... (174,274) .432 - 5.250 3.641
---------
Outstanding at December 31, 1999................ 1,853,244 .112 - 5.750 2.911
=========
At December 31, 1999, options for 17,371, 83,484, 137,222, 20,000, 5,000,
61,090, 326,131, 11,619, 1,332, and 3,333 shares of common stock were
exercisable at $.112, $.432, $1.727, $2.938, $3.500, $3.813, $3.886, $5.181,
$5.25, and $5.750 per share, respectively. At December 31, 1998, options for
547,940 shares of common stock were exercisable at a weighted average exercise
price of $2.072. At December 31, 1997, options for 336,384 shares of common
stock were exercisable at a weighted average exercise price of $0.686. To date,
342,648 options have been exercised and none have expired. The weighted average
remaining contractual life of the outstanding options at December 31, 1999 was
eight years.
In connection with the issuance of Series C convertible preferred stock in
1993, the Company issued common stock purchase warrants for 662,287 shares at no
additional cost to the Series C convertible preferred stockholders. At the
Company's initial public offering on November 26, 1997, all preferred stock
shares were converted to common stock shares. These warrants have an exercise
price of $1.123 per share and expire upon the tenth anniversary of issuance. In
July of 1998, 232,491 warrants were converted, via a cashless exchange, into
162,868 shares of common stock. At December 31, 1999, 429,796 warrants remain
outstanding.
The Company has elected to follow APB No. 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB No. 123 requires use
of option valuation models that were not developed for the use in valuing
employee stock options. Pro forma information regarding net income is required
by FASB No. 123, which also requires that the information be determined as if
the Company had accounted for the employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following assumptions for the years ended December
31, 1997, 1998, and 1999: U.S. government zero coupon 7-year bond interest rates
ranging from 4.6% to 6.9%, depending upon the specific grant date of the
options; a dividend yield of zero percent; and a weighted-average expected life
of the option of 7 years. The volatility factor was assumed to be zero as the
Company was privately held and no market existed for its stock during the period
during which options were granted in 1997. For 1998 and 1999, the volatility
factor used was 25%. The weighted average fair value of the net options granted
during 1997, 1998, and 1999 was $1.753, $1.505, and $.885 per share,
respectively.
F-13
41
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Black-Scholes option valuation model was developed for the use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's option, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period of the respective
option. Because FASB No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma impact will not be fully reflected until 2002.
The Company's pro forma net loss would be $3,275,177, $5,922,570, and $5,456,516
and the pro forma net loss per share would be $0.40, $0.48, and $0.43 for the
years ended December 31, 1997, 1998, and 1999, respectively.
(13) 401(K) PROFIT-SHARING PLAN
The Company has a 401(k) profit-sharing plan covering substantially all
employees who meet defined service requirements. The plan provides for deferred
salary contributions by the plan participants and a Company contribution.
Company contributions, if any, are at the discretion of the Board of Directors
and are not to exceed the amount deductible under applicable income tax laws. No
Company contributions have been made since inception of the plan.
(14) RELATED PARTY TRANSACTIONS
The Company has an ongoing consulting agreement with a director/stockholder
that is renewable on an annual basis. Payments under this agreement amount to
$2,500 per month. The Company is guarantor of a note payable of an officer
totaling $65,000 at December 31, 1999.
(15) SIGNIFICANT CUSTOMERS
Revenue from two customers constituted approximately 43.1% and 42.2%,
respectively, of the Company's 1997 revenue. Revenue from four customers
constituted approximately 16.9%, 14%, 13.4% and 11.5%, respectively, of the
Company's 1998 revenue. Revenues from three customers constituted approximately
33.8%, 9.9%, and 9.7%, respectively, of the Company's 1999 revenue.
(16) CONTINGENT LIABILITIES
Five separate complaints were filed in the United States District Court for
the Northern District of Illinois, Eastern Division, each of which alleged that
the Company, certain of its officers and directors, and the underwriters of the
Offering are liable under the federal securities laws for making supposedly
negligent or reckless material misstatements of fact and omitting to state
material facts necessary to make other statements of fact not misleading in the
Registration Statement and Prospectus relating to the Offering. Those cases were
consolidated and a consolidated complaint was filed in October 1998. The
consolidated complaint alleges that the action should be maintained as (i) a
plaintiff class action on behalf of certain persons who purchased the Common
Stock from November 26, 1997 through January 8, 1998, excluding the defendants,
members of their immediate families, and any entity in which a defendant has a
controlling interest, and (ii) a defendant class action against the underwriters
who participated in the Offering. The consolidated complaint seeks unquantified
damages under the federal securities laws, pre- and post-judgment interest,
attorneys' fees, and expert witness fees. In addition, the consolidated
complaint seeks rescission and/or rescissory damages relating to purchases of
the Common Stock under federal securities laws. In October 1999, the Court
granted in part and denied in part motions to dismiss the consolidated complaint
that previously had been filed by each defendant. In its ruling, the Court in
part found that plaintiffs who did not purchase their Common Stock
F-14
42
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
during the Offering could not sue under Section 12(a)(2) of the Securities Act
of 1933. Each defendant's respective answer to the remaining claims in the
consolidated complaint was filed on November 15, 1999 and discovery began
thereafter. In August 1998, the Company received a request for indemnification
from the underwriters of the Offering pursuant to the underwriting agreement for
the Offering. In response to such request, the Company has agreed to be
responsible for the underwriters' attorneys' fees with respect to the
litigation.
In November 1998, a separate complaint was filed in the Northern District
of Illinois, Eastern Division, which alleged that the Company, certain of its
officers and directors, and the underwriters of the Company's Offering are
liable under the federal securities laws for making supposedly fraudulent
material misstatements of fact and omitting to state material facts necessary to
make other statements of fact not misleading in connection with the solicitation
of consents to proceed with the Offering from certain of the Company's preferred
stockholders. The complaint alleges that the action should be maintained as a
plaintiff class action on behalf of those former preferred stockholders whose
shares of preferred stock were converted into Common Stock on or about the date
of the Offering, excluding the defendants, other officers and directors of the
Company, members of the immediate families of all individual defendants, and any
entity in which a defendant has a controlling interest. The complaint seeks
unquantified damages as provided for under the federal securities laws, pre- and
post-judgment interest, attorneys' fees, and expert witness fees. In March 1999,
the preferred stockholders' complaint was reassigned to the judge hearing the
consolidated complaint described above. Thereafter, pretrial proceedings
involving the preferred stockholders' complaint were further consolidated with
that litigation. In October 1999, all defendants filed a joint motion to dismiss
the preferred stockholders' complaint; briefing on that motion was completed in
February 2000. To date, the Court has not ruled on the motion to dismiss the
preferred stockholders' complaint nor has the Court indicated when it
anticipates ruling.
The Company, the defendant directors and the defendant officers each have
retained counsel for both of the above-described litigations and intend to
defend against both complaints vigorously. Although the Company believes that
the allegations of the complaints are without merit, it is not feasible for the
Company to predict at this time the outcome of either litigation or whether the
resolution of either litigation could have a material adverse effect on the
Company's results of operations, cash flows or financial condition.
F-15
43
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
-------------------------------------------------------------------
BALANCE
BEGINNING COSTS AND OTHER BALANCE AT
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS END OF PERIOD
----------- --------- --------- -------- ---------- -------------
Year ended December 31, 1997:
Allowance for doubtful accounts....... $ -- $ 46,976 $ -- $27,700 $ 19,276
========== ========== ====== ======= ==========
Deferred tax asset valuation
account............................. $4,350,000 $1,010,000 $ -- $ -- $5,360,000
========== ========== ====== ======= ==========
Year ended December 31, 1998:
Allowance for doubtful accounts....... $ 19,276 $ 125,623 $5,005 $64,904 $ 85,000
========== ========== ====== ======= ==========
Allowance for excess inventory
quantities accounts................. $ -- $ 190,633 $ -- $ -- $ 190,633
========== ========== ====== ======= ==========
Deferred tax asset valuation
account............................. $5,360,000 $2,303,000 $ -- $ -- $7,663,000
========== ========== ====== ======= ==========
Year ended December 31, 1999:
Allowance for doubtful accounts....... $ 85,000 $ 54,068 $ -- $19,068 $ 120,000
========== ========== ====== ======= ==========
Allowance for excess inventory
quantities accounts................. $ 190,633 $ 69,581 $ -- $ -- $ 260,214
========== ========== ====== ======= ==========
Deferred tax asset valuation
account............................. $7,663,000 $1,930,000 $ -- $ -- $9,593,000
========== ========== ====== ======= ==========
S-1
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 30th day of
March, 2000.
NANOPHASE TECHNOLOGIES CORPORATION
By: /s/ JOSEPH CROSS
------------------------------------
Joseph Cross
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 30th day of March, 2000.
SIGNATURE TITLE
--------- -----
/s/ JOSEPH CROSS President, Chief Executive Officer (Principal
- ------------------------------------------------ Executive Officer) and a Director
Joseph Cross
/s/ JESS JANKOWSKI Acting Chief Financial Officer, Corporate
- ------------------------------------------------ Controller, Treasurer and Secretary (Principal
Jess Jankowski Financial and Accounting Officer)
/s/ DONALD S. PERKINS Chairman of the Board and Director
- ------------------------------------------------
Donald S. Perkins
/s/ EDWARD E. HAGENLOCKER Director
- ------------------------------------------------
Edward E. Hagenlocker
/s/ JAMES A. MCCLUNG Director
- ------------------------------------------------
James A. McClung
/s/ JERRY PEARLMAN Director
- ------------------------------------------------
Jerry Pearlman
/s/ RICHARD W. SIEGEL Director
- ------------------------------------------------
Richard W. Siegel
45
EXHIBIT INDEX
EXHIBIT
NUMBER
- -------
2 Plan and Agreement of Merger dated as of November 25, 1997
by and between the Company and its Illinois predecessor,
incorporated by reference to Exhibit 2 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1997 (the "1997 10-K")
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 to the 1997 10-K
3.2 Bylaws of the Company, incorporated by reference to Exhibit
3.2 to the 1997 10-K
4.1 Specimen stock certificate representing Common Stock,
incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-36937) (the
"IPO S-1")
4.2 Form of Warrants, incorporated by reference to Exhibit 4.2
to the IPO S-1.
4.3 Rights Agreement dated as of October 28, 1998 by and between
the Company and LaSalle National Bank, incorporated by
reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A, filed October 28, 1998.
4.4 Certificate of Designation of Series A Junior Participating
Preferred Stock incorporated by reference to Exhibit 4.4 to
the Company's Annual Report on Form 10-K for the year ended
December 31, 1998 (the "1998 10-K")
10.1 The Nanophase Technologies Corporation Amended and Restated
1992 Stock Option Plan, as amended (the "Stock Option
Plan"), incorporated by reference to Exhibit 10.1 to the IPO
S-1.
10.2 Form of Indemnification Agreement between the Company and
each of its directors and executive officers, incorporated
by reference to Exhibit 10.2 to the IPO S-1.
10.3 Amended and Restated Registration Rights Agreements dated as
of March 16, 1994, as amended, incorporated by reference to
Exhibit 10.2 to the IPO S-1.
10.4 License Agreement dated June 1, 1990 between the Company and
ARCH Development Corporation, as amended, incorporated by
reference to Exhibit 10.7 to the IPO S-1.
10.5 License Agreement dated October 12, 1994 between the Company
and Hitachi, incorporated by reference to Exhibit 10.8 to
the IPO S-1.
10.6 License Agreement dated May 31, 1996 between the Company and
Research Development Corporation of Japan, incorporated by
reference to Exhibit 10.9 to the IPO S-1.
10.7 License Agreement dated April 1, 1996 between the Company
and Cornell Research Foundation, incorporated by reference
to Exhibit 10.10 to the IPO S-1.
10.8* Consulting and Stock Purchase Agreement between Richard W.
Siegel and the Company dated as of May 9, 1990, as amended
February 13, 1991, November 21, 1991 and January 1, 1992,
incorporated by reference to Exhibit 10.11 to the IPO S-1.
10.9 Lease Agreement between the Village of Burr Ridge and the
Company, dated September 15, 1994, incorporated by reference
to Exhibit 10.12 to the IPO S-1.
10.10 Distribution Agreement between the Company and C.I. Kasei,
Ltd., (a subsidiary of Itochu Corporation) dated as of
October 30, 1996, incorporated by reference to Exhibit 10.15
to the IPO S-1.
10.11 Supply Agreement between the Company and Schering-Plough
HealthCare Products, Inc. dated as of March 15, 1997,
incorporated by reference to Exhibit 10.17 to the IPO S-1.
10.12 License Agreement between the Company and C.I. Kasei Co.,
Ltd. (a subsidiary of Itochu Corporation) dated as of
December 30, 1997, incorporated by reference to Exhibit
10.17 to the 1997 10-K
10.13* Employment Agreement dated as of September 3, 1996 between
the Company and Dennis J. Nowak, incorporated by reference
to Exhibit 10.5 to the IPO S-1.
46
EXHIBIT
NUMBER
- -------
10.14* Consulting Agreement dated as of June 25, 1999 between the
Company and Dennis J. Nowak
10.15* Employment Agreement dated as of November 9, 1999 between
the Company and Joseph Cross
10.16* Consulting Agreement effective as of October 29, 1998
between the Company and Donald S. Perkins, incorporated by
reference to Exhibit 10.17 to the 1998 10-K
10.17* Employment Agreement dated as of February 15, 1999 between
the Company and Gina Kritchevsky, incorporated by reference
to Exhibit 10.18 to the 1998 10-K
10.18* Employment Agreement dated as of March 15, 1999 between the
Company and Daniel S. Bilicki, incorporated by reference to
Exhibit 10.19 to the 1998 10-K
10.19* Employment Agreement dated as of June 1, 1999 between the
Company and Donald Freed
10.20* Form of Options Agreement under the Stock Option Plan,
incorporated by reference to Exhibit 4.5 to the Company's
Registration Statement on Form S-8 (File No. 333-53445)
10.21* Consulting and Severance Agreement dated October 28, 1998
between the Company and John C. Parker, incorporated by
reference to Exhibit 10.21 to the 1998 10-K
10.22** Zinc Oxide Supply Agreement dated as of September 16, 1999
between the Company and an undisclosed customer of the
Company
11 Statement regarding computation of loss per share.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule
- ---------------
* Management contract or compensatory plan or arrangement.
** Confidentiality Requested, confidential portions have been omitted and filed
separately with the Commission as required by Rule 24b-2.