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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, 1997
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
(Title of Class)
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 27, 1998 was $51,205,444.
The number of shares outstanding of the registrant's Common Stock, par
value $.01, as of March 27, 1998 was 12,277,467.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement in connection with
the registrant's 1998 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
Because Nanophase Technologies Corporation ("Nanophase" or the "Company")
wants to provide investors with more meaningful and useful information, this
Annual Report on Form 10-K (the "Form 10-K") contains, and incorporates by
reference, certain "forward-looking statements" (as such term is defined in
Section 21E of the Securities Exchange Act of 1934, as amended), that reflect
the Company's current expectations regarding the future results of operations,
performance and achievements of the Company. These forward-looking statements
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. The Company has tried, wherever possible, to
identify these forward-looking statements by using words such as "anticipates,"
"believes," "estimates," "expects," "plans," "intends" and similar expressions.
These statements reflect the Company's current beliefs and are based on
information currently available to it. Accordingly, these statements are subject
to certain risks, uncertainties and contingencies, which could cause the
Company's actual results, performance or achievements to differ materially from
those expressed in, or implied by, such statements. These risks, uncertainties
and contingencies include, without limitation, demand for, and acceptance of,
the Company's nanocrystalline materials; changes in development and distribution
relationships; the impact of competitive products and technologies; and the
factors 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 such forward-looking statements
that may be made to reflect events or circumstances after the date of this Form
10-K or to reflect the occurrence of unanticipated events.
GENERAL
Nanophase develops and markets nanocrystalline materials for use as
ingredients and components in a wide range of commercial applications. The
Company began manufacturing nanocrystalline materials in commercial quantities
in the fourth quarter of 1996. Nanocrystalline materials are metallic and
ceramic materials that generally consist of particles that are less than 100
nanometers (billionths of a meter) in diameter and contain only a few thousand
or tens of thousands of atoms, rather than the millions or billions of atoms in
particles of most conventional materials. By processing materials in this
near-atomic size range, the Company is able to engineer the structure of
particles and exploit the properties of their surface atoms to enhance the
performance of basic raw materials such as aluminum, iron, titanium and zinc, as
well as to molecularly engineer new composite materials. Compared to
conventional materials, the Company believes its nanocrystalline materials
generally exhibit superior chemical, mechanical, electronic, magnetic and
optical properties. The Company believes that through its extensive proprietary
research and development programs, combined with its proprietary and patented
production processes, it has established new standards for high-performance
commercially produced nanocrystalline materials.
The Company is in the advanced materials industry and has identified
initial commercial applications for its nanocrystalline materials in four
primary markets: electronics, structural ceramics and composites, cosmetics and
skin-care, and industrial catalysts. The Company believes each of these markets
provides numerous commercial applications in which its nanocrystalline materials
will have significant competitive advantages based on product performance.
Commercial applications which have been developed or are currently being
developed in these markets include the following:
- Electronics. Abrasives for chemical/mechanical polishing of semiconductor
wafers, anti-radiation coatings for cathode ray tubes and thin-film
materials for semiconductor manufacturing.
- Structural Ceramics and Composites. Ceramic mechanical seals, components
for continuous steel casting, abrasion-resistant polymers for oil
drilling sensors and ceramic armor.
- Cosmetics and Skin-Care. Topical health-care products, transparent
ultraviolet blockers and colorants for cosmetics.
- Industrial Catalysts. Chemical-process catalysts.
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In each of these markets, the Company's strategy is to establish
collaborative relationships with industry leaders in order to validate the
capabilities of its materials and coordinate the development and commercial
introduction of product applications. These relationships generally include
specific milestones and a development path that is intended to lead to
significant commercial product revenues. The Company is currently collaborating
with, among others, AG Industries ("Acutus Gladwin"), The Dow Chemical Company
("Dow"), E.I. Dupont & de Nemours & Co. ("DuPont"), Pacific Safety, Inc.
("Pacific Safety") and Philips Electronics N.V. ("Philips"). As a result of its
collaborative relationships, the Company entered into commercial supply
contracts with EKC Technology, Inc. ("EKC"), a subsidiary of ChemFirst
Corporation ("ChemFirst"), a manufacturer of semiconductor polishing slurries;
with Schering-Plough Corporation ("Schering-Plough") pursuant to which the
Company is supplying its nanocrystalline zinc oxide to Schering-Plough for use
in topical health-care products; and with LWT Instruments, Inc. ("LWT") for
anti-abrasive polymers used in oil drilling applications. To gain access to
foreign markets, Nanophase has entered into a license agreement which enables
C.I. Kasei Co., Ltd. ("CIK"), a subsidiary of Itochu Corporation ("Itochu"),
formerly C. Itoh, to manufacture, use and sell the Company's nanocrystalline
materials in broad-based industrial markets throughout various Asian countries.
The Company believes that its nanocrystalline materials have broad and
enabling potential beyond the product applications it is currently developing
with its customers. In 1995, the Battelle Memorial Institute, a leading contract
research organization, identified "molecularly engineered" materials (i.e.,
nanocrystalline materials) as "super materials" which represent one of the ten
most important technologies for the coming decade. Nanophase was organized in
1989 to commercialize technologies that are based on principles developed at
Argonne National Laboratories ("Argonne"), and believes that it is the only
company to successfully transition the production of high-performance
nanocrystalline materials from laboratory to commercial scale. In 1995, the
Company's patented physical-vapor-synthesis ("PVS") process for producing these
materials received the R&D 100 Award, given each year by R&D Magazine to
recognize the 100 most technologically significant new products and processes in
the world.
NANOCRYSTALLINE MATERIALS
All matter is composed of atoms, or molecules that are combinations of
atoms. Most solid materials, such as ceramics and metals, are polycrystalline in
nature, i.e., they consist of microscopic particles, or crystals, the atoms or
molecules of which are stacked in orderly patterns. The attributes of a
polycrystalline material, including strength, flexibility, color and electronic
conductivity, depend upon the composition, shape and size of the material's
individual crystals, the organization of atoms in the individual crystals, and
the relationships and interactions among the crystals. The particles of
conventional crystalline materials generally have irregular shapes and sizes.
The organization of a crystalline material's atoms or molecules, however, can be
manipulated to form particles that are much smaller and more uniform. Particles
that are less than 100 nanometers (billionths of a meter) in diameter are
generally called nanocrystals and contain only a few thousand or tens of
thousands of atoms, rather than the millions or billions of atoms in particles
of most conventional materials. Through molecular engineering, the shape and
size of such particles in nanocrystalline materials can be manipulated to
produce materials with superior properties. These nanocrystalline materials
behave in enhanced and novel ways because the properties of, and interactions
among, their ultra-small particles have been significantly altered.
The potential of nanocrystalline materials has been known for decades and
such materials have been produced by a variety of other processes. However,
these other processes are more limited in their ability to engineer the
materials for high-performance applications. Mechanical and chemical processes
are the two most common methods for producing nanocrystalline materials. In
mechanical processes, fine powders are commonly made from large particles
through the use of crushing techniques such as a high-speed ball mill. The
resulting fragmented powders contain particles of inconsistent shapes and sizes,
are relatively coarse, and are not adequate for many high-performance commercial
applications. Nanocrystalline materials can also be made through chemical
processes, which utilize chemicals to create a reaction that precipitates
particles of varying size and shape. Chemical processes, like mechanical
processes, often produce nanometric particles of inconsistent shapes and sizes
that are difficult to engineer for high-performance applications. Chemical
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processes also tend to leave chemical residues on the particle surfaces, making
it difficult to precisely engineer the mechanical, chemical and electronic
properties of the materials. Historically, high-quality nanocrystalline
materials have been difficult to consistently produce in other than
laboratory-scale quantities and have not been produced at commercially
affordable costs. The Company believes that these traditional methods of
producing nanocrystalline materials do not provide the means to realize the full
potential of such nanocrystalline materials.
ADVANTAGES OF THE COMPANY'S NANOCRYSTALLINE MATERIALS
The Company has developed new technologies for the engineering and
high-volume production of high-quality nanocrystalline materials that it
believes cannot be accomplished by the traditional methods described above. At
the core of the Company's technologies is its patented PVS process, whereby
metallic or ceramic materials are vaporized into atoms that are mixed with a gas
to form nanometric particles.
The following attributes of the particles produced by the Company's PVS
process enable it to produce significant quantities of nanocrystalline materials
which it believes to be superior, for a range of high-performance applications,
to both conventional materials and nanocrystalline materials produced by other
means:
SPHERICAL SHAPES AND SMALL SIZES enable particles to slide over each
other, which allows the Company's ceramic materials to become more ductile
and more easily formed. This enables the Company to rapidly mold variously
shaped ceramic components without the costly and time-consuming machining
which is typically used for conventional ceramics.
CLEAN SURFACES enable particles to exhibit consistent surface
chemistry, which facilitates the Company's ability to coat its
nanocrystalline materials. The Company's coatings enhance certain
commercial applications of its nanocrystalline materials, such as cosmetic
dispersions.
NARROW SIZE DISTRIBUTION of nanometric particles ensures that
nanocrystalline materials are virtually free of large particles, which
facilitates engineering of the chemical, mechanical, optical and electronic
properties of the material because these properties vary according to
particle size. For example, the Company produces titanium dioxide with
particles that are large enough to block ultraviolet rays but are
consistently smaller than the wave length of visible light, which enables
sunscreens formulated with these particles to provide high SPF protection
and transparency.
AGGREGATION CONTROL results in loosely agglomerated and uniformly
small particles that can be readily and uniformly dispersed in a variety of
media. For example, the Company produces ultra-fine abrasives for slurries
used to polish the surfaces of semiconductors, which results in
significantly smoother surfaces and faster and more selective removal of
material.
DIALABLE CONTROL OF PARTICLE SIZE enables precise engineering of
particles through subtle modifications of the Company's PVS process. By
controlling the evaporation rate of a material's atoms or the type or
pressure of gas used in the production process, the Company can alter,
enhance and tailor the performance of its basic raw materials for specific
product applications. For example, further decreasing the particle size of
a metal oxide increases its number of surface atoms, which enables the
Company to produce metal oxides with enhanced catalytic performance.
The Company has developed related technologies to further enhance the
materials produced by its PVS process. Because the PVS process produces
particles that, in contrast to particles of conventional materials, are (i)
nearly spherical, (ii) virtually free of chemical residues, (iii) uniformly
small, (iv) not strongly agglomerated, and (v) easily engineered, the Company
can apply its other proprietary technologies to further process these particles
to set new standards for a range of additional high-performance commercial
applications. For example, certain product applications require surface
treatments for nanocrystalline particles so they can be dispersed in a variety
of media. To enable the incorporation of its materials in dispersions, the
Company developed its proprietary discrete-particle-encapsulation ("DPE")
process that prevents particles from agglomerating by completely coating each
individual particle. The coating process also enables the Company to alter the
optical, chemical and electronic behavior of particles to meet the requirements
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particular applications. In addition, certain product applications require
nanocrystalline materials to be formed into structural ceramics of a precise
shape and tolerance. As part of its strategy to enter markets for structural
ceramics, the Company developed its net-shaping technology that enables the
rapid fabrication of dimensionally precise, high tolerance structural ceramic
components without costly machining.
CUSTOMERS AND APPLICATIONS
The Company is in the advanced materials industry and has identified four
primary markets -- electronics, structural ceramics and composites, cosmetics
and skin-care, and industrial catalysts -- each of which offers the Company
significant potential for revenue growth. In addition, the Company believes
these markets provide opportunities to achieve competitive advantages based on
product performance. The Company's strategy is to collaborate with industry
leaders in these markets in order to validate the capabilities of its materials
and coordinate the development and commercial introduction of product
applications. The collaborative relationships pursued by the Company include (i)
agreed-upon specifications for the proposed commercial application of the
Company's materials; (ii) confirmation by the customer that the proposed
application appears to be commercially viable and valuable; (iii) a significant
commitment of developmental resources; (iv) agreed-upon developmental
milestones, and (v) a development path that is intended to lead to significant
commercial revenues from the customer.
Following is a more detailed description of the Company's targeted markets
and its activities in certain material product applications.
ELECTRONICS
Electronics is one of the world's largest and fastest growing markets,
fueled in part by rising demand for increased computing power and information
storage requirements and the rapid growth of communications technologies. The
new levels of performance in electronics that are necessary to meet these
requirements depend, in large part, on advanced materials, especially advanced
ceramics, that enable higher performance and further miniaturization.
Increasingly, critical dimensions and performance criteria for high-speed
electronic pathways and dense platforms are measured in nanometers and angstroms
(tenths of nanometers). It is at this level of performance that Nanophase
believes its engineered nanocrystalline materials demonstrate advantages for
electronics applications.
Nanophase's primary focus in this market has been directed toward two
product applications: (i) semiconductor polishing and (ii) coatings for
electromagnetic radiation protection. The Company believes that the uniformly
small particle size, nearly spherical particle morphology and clean particle
surface of the Company's materials allow such materials to provide innovative,
value-added benefits for these and other product applications in the electronics
market.
Semiconductor Polishing
Increases in computing power require increased memory capacity, which is
achieved by fabricating smaller circuits on smoother semiconductor wafer
surfaces. These smoother surfaces are obtained by a technique called
chemical/mechanical polishing ("CMP"), in which an abrasive slurry is used to
polish semiconductor surfaces to a very fine finish.
Polishing slurries utilizing the Company's nanometer-sized aluminum oxide
("alumina") and cerium oxide ("ceria"), with their nearly spherical particle
shapes and uniformly small particle sizes, provide semiconductor polishing that
results in (i) significantly smoother surfaces, (ii) more selective removal of
material, and (iii) easier cleaning during the manufacturing process, compared
to slurries utilizing conventional materials. The Company believes that these
attributes will be an important element in the production of semiconductor
wafers with smaller geometries that will result in increased memory capacity,
faster processing speeds and lower production costs.
In December 1997, Nanophase entered into a seven-year supply agreement with
EKC, a subsidiary of ChemFirst, pursuant to which the Company will supply its
nanocrystalline alumina and ceria and provide
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related research and customer and technical support to EKC. This agreement
supersedes the Company's five-year requirements contract with Moyco
Technologies, Inc. ("Moyco") and was entered into after Moyco sold its CMP
intellectual property, technologies and certain other intangible assets to EKC
in December 1997. Sales to, and fees from, Moyco pursuant to such contract
constituted approximately 42% of the Company's revenue in 1997. The Company has
agreed to sell its nanocrystalline alumina and ceria to EKC for use in the
production and sale of slurries and other materials used in CMP on an exclusive
basis so long as EKC purchases certain annual minimum dollar amounts specified
in the agreement. If EKC fails to purchase such minimum dollar amounts, the
Company may terminate EKC's exclusivity. In addition, if EKC does not purchase
certain other minimum dollar amounts specified in the agreement, the Company may
terminate the entire agreement or its obligation to supply nanocrystalline
materials to future customers of EKC. The minimum dollar amounts specified in
the agreement which EKC must purchase over the term of the agreement to maintain
exclusivity, avoid termination of future supply obligations or avoid termination
of the agreement are approximately $50 million, $25 million or $5 million,
respectively, of the Company's nanocrystalline materials.
Electromagnetic Radiation Protection
Cathode ray tubes ("CRTs") utilized in television and computer monitors
emit electromagnetic radiation due to the high voltages used to generate light.
In the past, little attention was paid to the potential harmful effects of this
radiation. Recent European Economic Community regulations scheduled to go into
effect over the next several years, however, place more stringent limits on the
quantity of radiation that can be emitted by television and computer monitors.
In response to such regulations, CRT manufacturers require transparent,
conductive coatings that meet the new electromagnetic radiation standards.
The materials currently used for conductive coating of CRTs have not been
proven to meet all of the new radiation requirements. Nanophase can produce a
proprietary metal oxide mixture, which has a narrower particle-size distribution
and cleaner particle surfaces than currently used materials. The Company's
nanocrystalline metal oxide mixture is highly conductive and easily dispersed
and, when applied as a coating to CRTs, is expected by the Company to meet the
increased radiation shielding regulatory requirements, while maintaining the
transparency required for quality video images. The Company has developed a
coating for CRTs which meets the conductivity and transparency requirements of
Philips and is actively working with their manufacturing group to introduce this
product into production for CRTs manufactured by Philips.
Thin-Film Materials for Semiconductor Manufacturing
Nanophase has begun an early stage development program with a leading
electronic materials company for developing advanced materials for use in
semiconductor manufacturing. The objective is to develop advanced materials
which can be used to fabricate thin-films on the surfaces of semiconductors to
enable the production of semiconductor wafers with increased memory capacity,
faster processing speeds and lower production costs. Nanocrystalline materials
are used because the products require a uniform and fine-grained structure. This
product application is in an early stage of development and investigation.
STRUCTURAL CERAMICS AND COMPOSITES
Structural ceramics are advanced compounds that offer hardness, high
strength and inertness for a broad range of industrial applications involving
harsh chemical and thermal environments. The free-flowing nature and weak
agglomeration of the Company's nearly spherical nanocrystalline particles enable
the Company to rapidly fabricate high-tolerance, dimensionally precise
structural ceramic parts without costly machining. Because the conventional
methods for forming structural ceramics involve the use of high temperatures,
high pressures or lengthy machining operations, the high costs of fabrication
have limited the usage of dimensionally precise ceramics to only the most
critical applications. Through its net-shaping process, the Company can mold
nanocrystalline ceramic materials into fully dense ceramic parts with little or
no machining. This process makes it possible to fabricate a variety of
dimensionally precise structural ceramic components in a significantly shorter
period of time and at significantly lower temperatures and pressures than
conventional fabrication methods.
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Composites, like structural ceramics, are engineered structures that
consist of diverse elements and are geared toward high-stress product
applications that require durable, resistant materials. Composites combine the
advantageous qualities of their constituent materials. The properties of these
composites depend heavily on the nature and amount of the materials that are
incorporated into the composites. For example, incorporating a hard material
like alumina into a flexible and lightweight plastic can increase the plastic's
resistance to abrasion and wear. Such an increase is related to the number of
particles of the constituent alumina. Because there are more particles in one
pound of nanocrystalline materials than in one pound of more commonly used
micron-sized particles, properties such as abrasion resistance are enhanced by
substituting nanocrystalline materials for conventionally used materials.
Composite Polymer for Oil Drilling Machinery
Nanophase has entered into a contract with LWT, a supplier of
instrumentation to the oil drilling industry, for the supply of
abrasion-resistant composite polymers to protect down-hole data logging
equipment. In this application, instrumentation is lowered into a drilled shaft
in order to provide information to the drill operator on a continuous basis.
Because drilled shafts often pass through hard rock formations, or very abrasive
layers of sandstone, the data logging instruments must be protected from
potential wear. A protective housing, or collar, is used to protect the data
logging equipment. These collars are conventionally coated with a commercially
available ceramic-filled polymer. Conventional fabrication of these collars is
difficult because the polymer is thick and must be applied by hand. LWT requires
a polymer, which can be applied by automatic machinery, has a long service life
and is abrasion-resistant. Initial tests performed by LWT using the Company's
composite materials indicate that such materials can meet these requirements.
The Company is currently developing composite materials which meet LWT's
particular product specifications.
Ceramic Components for Continuous Steel Casting
The Company is collaborating with Acutus Gladwin, a leading supplier of
services and products in the steel industry, to produce a ceramic component for
use in continuous steel casting. Continuous steel casting is performed by
pouring molten steel from a ladle through a funnel-shaped nozzle into a mold,
which is several hundred feet long. Current nozzles are made of a porous
alumina/graphite material and require frequent replacement due to wear. During
replacement, steel-casting lines using these nozzles must be shut down for 15 to
45 minutes while new components are installed, resulting in down-time costs
which could approximate up to $25,000/hour and several tons of second-quality
steel which must be remelted or downgraded for use in lower-quality products.
Nanophase believes that its denser net-shaped ceramics in this application will
substantially increase wear resistance, resulting in significant cost savings
due to decreased downtime and less wasted or sub-standard steel. Under a
development agreement with Acutus Gladwin, the Company has successfully
completed laboratory testing of its material and prototypes are scheduled to be
field tested during the second quarter of 1998.
Ceramic Mechanical Seals
Nanophase has fabricated prototype ceramic mechanical seals which are
designed for use in harsh applications to prevent abrasive particles from
entering mechanical joints and to prevent oil from leaking from the joints.
Conventional seals used in these applications are commonly made of plastic
composite materials and either wear or corrode, requiring replacement after only
a few thousand hours of operation. Ceramic seals, because of their improved
abrasion and corrosion resistance, are believed by the Company to be more
reliable and durable than conventional seals. Customer-laboratory tests of
prototype seal designs have shown that Nanophase's ceramic seals can increase
the service life compared to currently-used seal materials, resulting in a
reduction of equipment downtime and associated costs. In addition, Nanophase's
net-shaping process reduces or eliminates the costly diamond grinding that
normally would be required to fabricate other ceramic seals. The Company
believes that reduced manufacturing costs make its ceramic seals cost-effective
for a number of high-volume mechanical-seal applications. The Company is
marketing its ceramic seals for potential commercial sales to various equipment
and machinery manufacturers.
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Ceramic Armor
The Company is currently fabricating net-shaped ceramic armor plates under
a development agreement with Pacific Safety, a leading Canadian armor producer.
Ceramic-based armor is highly desirable because of its strength and weight
advantage over steel. It can provide the same protection at a significantly
reduced weight. However, current ceramic armor materials, made from hot-pressed
alumina or boron carbide, are either not durable enough or very costly to
fabricate, and thus have limited markets. Based on preliminary studies, the
Company believes that it will be able to produce denser, fine-grained ceramic
armor tiles that will have greater durability and impact resistance than
hot-pressed alumina tiles and offer a significant economic advantage over boron
carbide.
COSMETICS AND SKIN-CARE
The cosmetics and skin-care market is a substantial consumer of particulate
materials as active ingredients and pigments. The Company has targeted three of
its nanocrystalline materials, titanium dioxide ("titania"), iron oxide and zinc
oxide, for applications in the cosmetics and skin-care market, including
sunscreens, cosmetic colorants and topical health-care applications. The Company
(i) is selling its titania to several cosmetics companies for use in sunscreens,
(ii) is shipping its iron oxide to a Fortune 500 cosmetics company for use as a
cosmetic colorant, (iii) is shipping titania dispersions to that same customer
for use in a product with SPF protection, which was introduced to the market in
the fourth quarter of 1997, and (iv) is shipping its nanocrystalline zinc oxide
pursuant to a commercial supply contract with Schering-Plough.
Topical Health-Care Applications
The Company recently entered into a four-year requirements contract with
Schering-Plough pursuant to which the Company will supply its nanocrystalline
zinc oxide to Schering-Plough for certain topical health-care products. For
example, the Company's nanocrystalline materials are being supplied for use in
new anti-fungal sprays and powders which were introduced to the market in the
fourth quarter of 1997. Several skin-care companies are currently evaluating
Nanophase's nanocrystalline zinc oxide for use in other topical health-care
products. The Company's zinc oxide contains uniformly small particles that
contain a large number of surface area atoms. Initial testing by the Company's
customers indicates that this attribute provides enhanced anti-fungal activity
compared to conventional materials because a lower amount of the Company's zinc
oxide is needed to achieve the desired level of activity. In addition, the
Company's zinc oxide, because of its weakly agglomerated particles, is better
suited than conventional materials for aerosol applicators.
Sunscreens
The market for titania-based sunscreens has rapidly expanded due to (i)
increasing consumer awareness of the harmful effects of ultraviolet ("UV") rays
and (ii) a desire to replace conventional chemical sun-block ingredients, which
can cause irritation, with "chemical-free" ingredients. Because the Company's
nanocrystalline titania is comprised of particles that are large enough to block
UV rays, but are consistently smaller than the wave length of visible light, it
enables "chemical-free" sunscreen products to provide high SPF protection and
transparency, which combination is superior to that achieved by conventional
titania. Nanophase's total-encapsulation coating, based on its DPE process, also
makes Nanophase's titania compatible with certain skin-product ingredients, like
self-tanning ingredients, with which competitive titania is not compatible. This
compatibility enables cosmetics formulators to develop self-tanning products
that offer chemical-free protection from excessive exposure to UV rays.
Cosmetic Colorants
Through its PVS and DPE processes, the Company has engineered
nanocrystalline iron oxide for use as a coloring agent in cosmetics. Because of
its visible transparency, this iron oxide can intensely color the skin without
the caking or streaking effects caused by conventional opaque coloring agents.
This is due to the nanometer-sized particles of Nanophase's iron oxide that
absorb light without significant visible scattering, thereby providing color
without opacity. In addition, the nearly spherical particles of Nanophase's iron
oxide
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enable it to be discretely encapsulated and readily dispersed to create smooth,
free-flowing cosmetic foundations which cosmetics formulators can blend to more
closely match varying skin tones.
INDUSTRIAL CATALYSTS
Catalysts are materials that help convert, or accelerate the conversion of,
one chemical into another. The Company's PVS process allows for the fabrication
of two distinct types of solid catalysts: (i) a single pure material, such as
iron oxide, which is a widely used chemical-process catalyst for the synthesis
of hydrogen, ammonia and other bulk chemicals, and (ii) composite materials in
which a nanocrystalline metal, such as palladium, is deposited on a larger
substrate. This latter catalyst has a broad range of applications, including
polymer synthesis, hydrogen peroxide production and the conversion of petroleum
feedstock to higher value chemicals.
The activity of a catalyst (i.e., the amount of desired product that can be
produced per unit weight of catalytic material) is an important measure of its
efficacy, and is related to a number of physical properties of the catalyst,
including surface area, particle size and the reactivity of atoms on the surface
of the catalytic material. Nanocrystalline materials offer better performance as
catalysts because they have a higher proportion of catalytically active surface
atoms than conventional materials. In addition to enhanced reactivity, the
Company's materials can potentially reduce costs because less catalyst is needed
to achieve a desired level of activity.
Nanophase is developing a process to directly deposit nanocrystalline
metals on a substrate for use by DuPont as a catalyst in large-scale chemical
production. Early measurements have shown a two to fourfold increase in
catalytic activity over the current, chemically produced DuPont catalyst. The
Company is working with DuPont to meet specific performance requirements for
this catalyst. The Company has also begun an early-stage development program
with a Fortune 50 chemical company to produce catalysts comprised of
nanocrystalline metal oxides on larger substrates. Based on the Company's
discussions with potential customers, additional potential applications for
PVS-produced heterogeneous catalysts include wash coats for automotive catalysts
and surface-enhanced catalysts for the chemical-process industry.
TECHNOLOGICALLY-SIMILAR APPLICATIONS
Although the Company focuses its efforts on product applications in the
above-mentioned markets, the Company believes there is a broad range of
technologically similar applications, the performances of which could be
substantially improved by utilizing the Company's materials and technologies
without extensive additional engineering. Based on the Company's discussions,
both internally and with potential customers, these include applications for
fibers, textiles, plastics, paper, optical polymers, pigments and other
specialty products. These applications are primarily based on the coating or
dispersion of nanocrystalline materials produced by the PVS process. The Company
only pursues those specialty applications which fit into its business strategy
and which receive substantial support from a significant prospective customer.
THE COMPANY'S TECHNOLOGIES
Nanophase has developed and employs several related technologies for the
engineering and production of nanocrystalline materials and product
applications, including technologies for the synthesis, surface-treatment and
dispersion of nanocrystalline materials and the fabrication of structural
ceramic components. The Company also is engaged in ongoing research and
technology-licensing activities as part of its strategy to maintain a technical
and commercial leadership position in the field of nanocrystalline materials.
The PVS Process
The Company uses its patented PVS process to produce nanocrystalline
powders. The PVS process is based on the formation of a physical vapor from a
selected metallic or ceramic material that is fed through a plasma reactor and
heated 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. These evaporated atoms are then mixed with selected gases that chemically
react with the atoms. Additional gases then cool the atoms sufficiently to
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condense the vapor into solid, nearly spherical clusters of molecules. The
flowing gas transports the resulting clusters to a collection vessel. The rapid
transport and cooling of the nanometric particles produce a weakly agglomerated
powder.
The Company holds two patents relating to its PVS process which expire in
2013; one covers the process itself, while the other covers the apparatus used
in the process. The Company's plasma reactor embodies proprietary features that
enable the production of high-quality materials at high-volume and competitive
cost. Nanophase utilizes 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 nearly spherical, virtually free of chemical residue, uniformly small,
not strongly agglomerated, and easily engineered.
The Company believes that the PVS process is a superior commercial process
in the degree of control that can be exercised over particle size and particle
size distribution. By means of controlled and subtle modifications to the PVS
process (e.g., the evaporation rate, the type or pressure of the gas, or how
quickly the flow of gas carries the clusters to the collection vessel), the
Company can control the size of a material's particles, thereby altering the
traits of a substance. The Company is thus able to engineer and produce a wide
range of materials and products without substantial process and product
re-engineering.
Surface Treatments and Dispersions (The DPE Process)
Many of the applications that the Company is pursuing require further
engineering of the particles produced in the PVS process in order to meet
specific application requirements. To satisfy these requirements, the Company
has developed a variety of surface-treatment technologies to stabilize, alter or
enhance the performance of nanocrystalline particles, together with technologies
to enable the particles to be dispersed in fluids or polymers. At the core of
these surface-treatment and dispersion technologies, many of which are in the
early stage of development or are constantly being refined, is Nanophase's
proprietary DPE process, which enables Nanophase to completely surround each
nanocrystalline particle with a durable coating. The Company has applied for a
patent for its DPE process.
The DPE process can coat the surface of each nanometer-sized particle
produced by the PVS process with a proprietary polymer that is not removed by
subsequent processing. Traditional coating technologies employ strand-like
polymers that cannot completely cover the surfaces of nanometric particles. The
Company's DPE process uses polymers that are shaped like hands. When the
nanometer-sized particles are coated, the fingers of the hand collapse and
completely encapsulate each particle with a thin polymeric shell. This shell
also can be engineered to contain covalently bound spacer groups of controllable
size that function to prevent particles from sticking to each other. The
coatings enable the particles to be dispersed in a wide range of media,
including water, cosmetic emollients, plastics and polymers, thus enabling these
materials to be used in applications ranging from highly transparent sunscreens
to dense opaque coatings.
Net-Shaping
Nanophase has developed a proprietary process whereby it net-shapes its
nanocrystalline ceramic materials produced by the PVS process to rapidly
fabricate precise, high-tolerance industrial ceramic parts without costly
machining. This net-shaping technology was developed in collaboration with the
Company's subcontractors, Lockheed Missiles & Space Co., Inc. ("LMSC") and
Caterpillar, Inc., under an Advanced Technology Program ("ATP") contract funded
by the U.S. Department of Commerce.
The Nanophase technologies relevant to net-shaping involve (i) the
production of nanocrystalline ceramic materials in commercial quantities, (ii)
the consolidation of Nanophase's ceramic materials into dense nanocrystalline
preforms without exaggerated particle growth, and (iii) net-shape forming of
fully dense, precisely-shaped ceramic parts.
The conventional fabrication of structural ceramics involves machining that
uses diamond tools. This process is costly, time consuming and often produces
highly stressed ceramic parts and components with structural flaws. Nanophase's
process enables fabrication of ceramic parts and components using significantly
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lower temperatures and pressures than used by conventional fabrication methods
(e.g.,1300-1500-C and 2000-4000 psi, as compared to up to 1700-C and 100,000
psi). This technology enables the Company to fabricate dimensionally precise
ceramic components in a short period of time without costly machining. This
rapid deformation processing is made possible by the consistent ultrafine
particle size of the Company's nanocrystalline ceramic materials, the Company's
ability to control the consolidation of such particles into preforms of high and
uniform density, and the ability of the ultrafine particles to easily slide over
one another in the forming process. The Company's net-shaping technology
produces ceramic products with a variety of detailed shapes, high tolerances and
smooth surface finishes that can be tailored to a customer's needs.
Following the successful completion of the ATP program, the Company entered
into a research, development and prototyping agreement with LMSC whereby the
Company funds, on a month to month basis, LMSC to perform design, prototyping
and research and development tasks related to net-shaping using technology
developed during the ATP project. LMSC currently designs, engineers and
fabricates prototypes to the Company's specifications for the Company's
commercial projects. The Company and LMSC jointly own technology developed
during the ATP project. New technology developed under the current arrangement
between LMSC and the Company is wholly-owned by the Company and, under the terms
of the arrangement, LMSC can use the newly developed technology only for its
internal research. The Company has also recently entered into a collaborative
relationship with a parts fabricator which has agreed to develop the capability
to design, engineer and fabricate net-shaped ceramic parts and components for
the Company using the Company's net-shaping technology and nanocrystalline
materials.
Other Technologies
The Company constantly seeks to develop new technologies relating to
nanocrystalline-based materials through ongoing research and development
activities and collaborations with industrial, university and government
research programs. For example, the Company is developing a new generation of
metallic and ceramic precursors to be processed into nanocrystalline materials.
Such activities are intended to enable the Company to develop new product
applications and offer more materials with enhanced capabilities.
MARKETING
The members of the Company's marketing department, which the Company
intends to expand, have experience in each of the Company's targeted markets and
are often teamed with the Company's scientists and researchers to demonstrate
the advantages of the Company's materials and product applications to potential
customers. The Company's scientists, engineers and marketing personnel attend
and speak at advanced materials symposia, publish articles in scientific
journals and participate in selected industry trade shows. In addition, the
Company uses a web page on the Internet, advertisements in selected industry and
trade journals, and specification sheets and corporate brochures.
The Company also seeks to market its materials through distributors in
certain application areas where the requirements for ongoing development and
technical support by Nanophase are not substantial, or where the distributor has
existing customer relationships, marketing or post-processing infrastructure, or
companion products or services that may enable Nanophase to enter the market
more quickly. For example, as part of its strategy to gain access to foreign
markets, Nanophase has entered into a license agreement with CIK, a subsidiary
of Itochu, formerly C. Itoh, which enables CIK to use certain of the Company's
patented technologies to exclusively manufacture, use and sell Nanophase's
nanocrystalline materials in broad-based industrial markets throughout various
Asian countries for all applications except cosmetics, skin care and CMP. The
fees received from CIK constituted approximately 43% of the Company's revenue in
1997. The agreement will, as of April 1, 1998, supersede an existing
distribution agreement between the parties and is intended to enable Nanophase
to quickly establish foothold positions in Asian markets by utilizing the
technology and market-support capabilities of CIK. The agreement does not target
specific materials or applications; however, CIK is pursuing high-volume
industrial applications in electronics, industrial ceramics and catalysts. In
order to maintain exclusivity under this agreement, CIK is required to (i)
achieve 50% of the minimum annual sales obligations set forth in the agreement
for 1999 and thereafter, which would
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approximate $3 million in 1999 and $5 million in each year thereafter; or (ii)
pay the Company a minimum royalty of $300,000 for the applicable year. In the
event CIK manufactures nanocrystalline materials using certain of the Company's
patented technologies, CIK is required to pay the Company a royalty based on the
net sales of all such nanocrystalline materials manufactured by CIK. If after
1998 CIK elects to manufacture such nanocrystalline materials in order to
achieve the minimum annual sale obligations set forth in the agreement, it must
pay a minimum royalty of $300,000 to the Company in any twelve-month period
following such election. Any royalties received by the Company from CIK are
subject to certain foreign withholding taxes. This agreement expires in 2013 but
may be terminated (i) by the Company after 1998 if CIK fails to achieve 20% of
the minimum annual sales obligations set forth in the agreement for a given year
or (ii) by CIK after March 31, 2000 upon 90 days' prior notice. Upon expiration
of the agreement, CIK will have the non-exclusive right to still use the
patented technologies licensed by the Company to manufacture, use and sell
Nanophase's nanocrystalline materials in various Asian countries as long as CIK
pays the Company a royalty based on the net sales of such materials by CIK.
Initially, to gain worldwide access to the cosmetics and skin-care market,
the Company had entered into a global distribution agreement with Whittaker,
Clark & Daniels, Inc. ("WCD"), a leading distributor of cosmetic and skin-care
ingredients. In February 1998, the Company and WCD mutually agreed to end their
distribution relationship. The Company may discuss distribution arrangements
with other companies having access to the cosmetics and skin-care market or it
may elect to sell directly to potential cosmetic and skin-care customers.
Because virtually all of the product applications for the Company's
materials are new and innovative, in order for the Company to penetrate its
targeted markets, it must participate in a multi-step process that includes
initial discussions of the product application which highlight the advantages of
the Company's nanocrystalline materials, proof of concept, proof of feasibility
within the specific application, and evaluations of cost and manufacturability.
Completion of this evaluation process usually takes at least 18 months, and may
take several years.
RESEARCH AND DEVELOPMENT
The near-term objective of the Company's research and process-development
activities is to develop and consistently produce sufficient commercial
quantities of application-specific nanocrystalline materials to meet the
Company's near-term requirements. Although the Company has de-emphasized the
pursuit of revenue from government research contracts, a key component of the
Company's long-term research and development strategy is to identify and develop
relationships with leading industrial, university and government research
programs across the United States and internationally to leverage the Company's
technological and scientific capabilities. The Company believes that these
research relationships may provide accelerated introduction of new technologies
into its product applications, early indications of new technology developments
that could enhance or compete with the Company's nanocrystalline materials, and
high-value improvements in its current key technologies. The Company will also
continue its efforts to attract and retain top scientists and engineers, which
management believes will enable the Company to maintain a long-term leadership
position in the nanocrystalline materials field.
The Company's total research and development expenses during the years
ended December 31, 1997, 1996 and 1995 were $990,331, $677,284 and $485,059,
respectively. The future success of the Company will depend in large part upon
its ability to keep pace with evolving advanced materials technologies and
industry standards, and there can be no assurance it will be able to do so. See
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations."
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The objective of Nanophase's intellectual property activities is to
implement ongoing strategies that maximize and protect the proprietary rights of
the Company. These strategies encompass (i) obtaining patents and trademarks
based on Nanophase inventions and products, and (ii) licensing third-party
patents to expand the Company's technology base and prevent Nanophase from being
blocked should future developments
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require use of technology covered by those patents. To date, the Company has not
been required to license technologies or design around other parties' patents in
order to avoid claims of patent infringement.
Nanophase currently owns or licenses an aggregate of 17 United States
patents and patent applications: two issued patents owned directly by Nanophase;
four pending patent applications owned directly by Nanophase; and eleven patents
licensed from third parties.
Two United States patents have been issued to Nanophase: one covering its
PVS process for the synthesis of nanocrystalline materials, and the other
covering the related apparatus. The patents expire in July 2013. Additional
United States patent applications filed by the Company include applications
relating to nanocrystalline materials, plasma sensors and the coating of metal
oxides. Foreign patent applications owned directly by Nanophase are pending in
Australia, Europe and Japan for the PVS process and apparatus. An international
patent application owned by the Company for the coating of ceramic powders is
also pending under the Patent Cooperation Treaty, with Australia, Canada, Europe
and Japan designated for the national phase of the application.
The Company holds the following licenses of United States patents: an
exclusive worldwide license of two patents owned by ARCH Development Corporation
which embody a laboratory-scale method and apparatus for making nanocrystalline
materials; 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; a non-exclusive license of two patents owned by
Hitachi, Ltd. which are related to the synthesis of nanocrystalline materials;
and a remainder-exclusive license of three patents held by Cornell University
relating to a laboratory-scale process for net-shaping of 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, the Company is obligated to pay the
licensor royalties equal to a percentage of net sales of products, which embody
the licensed technology, and related taxes on any such royalty fees paid to
foreign licensors.
The Company requires its employees, consultants, outside scientific
collaborators and other advisors to execute confidentiality and proprietary
rights agreements upon the commencement of employment or consulting
relationships with the Company. These agreements generally provide that all
confidential information developed or made known to the individual during the
course of the individual's relationship with the Company will be kept
confidential and will 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
the Company. 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 the Company with adequate remedies in the event of
unauthorized use or disclosure of such information. In addition, because none of
the Company's employees have entered into non-competition agreements with the
Company, they may become competitors of the Company upon termination of
employment.
COMPETITION
Within each of its targeted markets and product applications, Nanophase
faces current and potential competition from numerous chemical companies, as
well as the in-house capabilities of several of its current and potential
customers. For example, with regard to semiconductor wafer polishing, Cabot
Corporation, Rodel Incorporated, Fujimi Corporation (of Japan) and Solution
Technology Incorporated, all market polishing slurries for CMP. In addition,
Cabot Corporation, Baikowski International Corporation and Norton Company (a
unit of Compagnie De Saint-Gobain) all manufacture their own ultrafine alumina.
In the cosmetics and skin-care market, various companies manufacture their own
sub-micron titania (Tioxide Specialties Limited, Tayca Corporation (of Japan),
Ishihara Sangyo Kaisha, Ltd., Kemira Oy, Degussa AG and DuPont), iron oxide (Sun
Chemical Corporation, Harcros Pigments Incorporated) and zinc oxide (Zinc
Corporation of America) by chemical or other means. In structural ceramics, the
Company competes against manufacturers of ceramic composites who machine such
composites for specific product applications. In the catalysts market, the
Company faces competition from companies that chemically deposit metal oxides
onto
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substrates. Although Nanophase believes that its materials and technologies are
superior to the competitive materials and technologies that are utilized by
these companies, such companies represent significant competitive risks to
Nanophase because they have substantially greater financial and technical
resources, larger research and development staffs, and greater manufacturing and
marketing capabilities than the Company.
The Company also faces potential competition from Vacuum Metallurgical Co.,
Ltd. of Japan ("Vacuum Metallurgical"), which manufactures nanocrystalline
materials and equipment. Currently, the Company does not compete with Vacuum
Metallurgical, but there can be no assurance that Vacuum Metallurgical will not
develop products or manufacturing capabilities to compete with the Company in
the future. Potential competitive risks are also represented by numerous small
development companies engaged in the development of nanocrystalline materials,
such as Plasma Quench Technologies, Inc. and Nanopowder Enterprises, Inc. Most
of these companies are associated with university or national laboratories and
use chemical and physical methods to produce nanocrystalline materials.
Nanophase believes that most of such companies are engaged primarily in funded
research, and is not aware of any such company with commercial production
capability. However, there can be no assurance that such companies will not
represent significant competitive risks in the future.
GOVERNMENTAL REGULATIONS
The Company's Chicago facility, which houses its coating operations, is a
"small quantity generator" of hazardous materials, including ethanol, under 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. To date, the Company has not been required to
make substantial expenditures for preventive or remedial action with respect to
the hazardous materials it uses. The manufacture and use of certain of the
products that contain the Company's nanocrystalline materials are also 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 which
include testing, control and documentation requirements enforced by periodic
inspections.
In addition, both of 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 the Company's operations.
EMPLOYEES
On March 15, 1998, the Company had a total of 49 full-time employees, 12 of
whom hold advanced degrees. Of the full-time employees, 8 are engaged in
research, development and engineering, 22 are engaged in manufacturing, 4 are
engaged in quality control, 7 are engaged in marketing and sales, and 8 are
engaged in general management, finance and administration. The Company also
currently engages two scientists as consultants on a regular basis, one of whom
is Dr. Richard W. Siegel, a co-founder and director of the Company. The Company
is not subject to any collective bargaining agreements and considers its
relations with its employees to be good.
ITEM 2. PROPERTIES
Nanophase operates a 20,000 square-foot production and research facility in
Burr Ridge, Illinois, a suburb of Chicago, which also serves as the Company's
administrative headquarters. The Company also operates a smaller facility in
Chicago, Illinois, for coating nanocrystalline materials using its DPE process
and leases offsite warehouse space to store its materials. The Company believes
its Burr Ridge facility is the first in the world that is dedicated to the
commercial-scale development and production of physically synthesized
nanocrystalline materials. The Company's operations in Burr Ridge are registered
under ISO 9001 standards, and the Company believes its manufacturing operations
are in compliance with the cGMP requirements of the FDA.
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As of December 31, 1997, 19 PVS plasma reactors were operational and were
capable of producing various nanocrystalline materials at the Burr Ridge
facility. The throughput of each reactor depends on many factors, including the
mix of products produced, the commencement, expiration or termination of
development programs, the status of tests and evaluations of samples and
prototypes and production yields.
Each PVS plasma reactor is comprised of modular equipment, which is
designed and assembled to the Company's proprietary specifications. These
modular reactors provide flexibility in the expansion of the Company's
manufacturing capability. The Company is currently completing the build-out of
its Burr Ridge facility and expects to have 23 PVS reactors available for
production in the second quarter of 1998. In addition, the Company expects to
increase the throughput per reactor as it increases the efficiency and yields of
its PVS process and decreases the amount of downtime for each reactor. The
Company believes that additional manufacturing capacity will not be required
until 1999. Also operational within the Burr Ridge facility is a quality control
laboratory designed for the dual purpose of validating operations to cGMP and
ISO standards, and production process control. This laboratory is equipped to
handle all routine analytical and in-process techniques that are currently
required by the Company. In addition, capability for specialized analytical and
physical measurements currently is available at Argonne upon terms, which the
Company believes are reasonable and adequate. The Company leases its Burr Ridge
facility pursuant to an agreement, which expires in September 1999. The Company
has options to extend the lease for up to five additional years.
Based on the Company's current product mix, the Company's coating facility
has the capacity to coat those nanocrystalline materials which it desires to
coat. The Company believes that its coating capacity is adequate to support the
Company's anticipated 1998 production plans. The Company subleases its Chicago
facility pursuant to a one-year agreement, which automatically renews unless
terminated by either party upon proper notice.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any litigation and is not aware of any
pending or threatened litigation against the Company that could have a material
adverse effect on the Company's business, results of operations or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1997, the following matters were submitted to
a vote of security holders by written consent dated as of November 7, 1997.
a. The stockholders voted in favor of the Plan and Agreement of Merger
by and between the Company and its Illinois predecessor pursuant to which
the Company was reincorporated in Delaware. Of the 8,277,467 shares of
voting stock then outstanding (on a post-split basis, which split was
consummated immediately prior to the Offering), 5,733,058 shares voted for
the proposal. The remaining votes were not solicited.
b. The stockholders also voted in favor of the first amendment to the
Nanophase Technologies Corporation Amended and Restated 1992 Stock Option
Plan. Of the 8,277,467 shares of voting stock then outstanding (on a
post-split basis, which split was consummated immediately prior to the
Offering) 5,733,058 shares voted for the proposal. The remaining votes were
not solicited.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, $.01 par value per share (the "Common Stock"),
is traded on the Nasdaq National Market under the symbol NANX. Such trading
began on November 26, 1997 in connection with the Company's initial public
offering of Common Stock (the "Offering"). The following table sets forth for
the period indicated the range of high and low closing sale prices for the
Common Stock on the Nasdaq National Market:
HIGH LOW
---- ---
Fiscal year ending December 31, 1997:
Fourth Quarter (beginning November 26, 1997).............. $14.125 $7.50
On March 27, 1998, the last reported sale price of the Common Stock was
$5.5625, and there were approximately 247 holders of record of the Common Stock.
The Company has never declared or paid any cash dividends on its Common
Stock and does not anticipate paying any cash dividends or other distributions
on its Common Stock in the foreseeable future, but 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
operation, capital requirements and such other factors deemed relevant by the
Board of Directors.
In June 1997, the Company privately issued 421,992 shares of Series F
Convertible Preferred Stock (the "Series F Preferred") at $5.181 per share to 39
investors, which included various individuals, trusts, partnerships and
retirement plans, in exchange for cash in the aggregate amount of $2,186,487. In
August 1997, the Company privately issued 183,468 shares of Series F Preferred
at $5.181 per share to 10 investors, which included various individuals, trusts,
partnerships and retirement plans, in exchange for cash in the aggregate amount
of $950,613. In September 1997, the Company privately issued 142,629 shares of
Series F Preferred at $5.181 per share to 15 investors, which included employees
of Donaldson Lufkin & Jenrette Securities Corporation ("DLJ"), various other
individuals and a trust, in exchange for cash in the aggregate amount of
$739,008. Each share of Series F Preferred was automatically converted into one
share of Common Stock upon consummation of the Offering in December 1997.
The sales of shares of Series F Preferred were made in reliance on the
exemption from registration with the Securities and Exchange Commission (the
"Commission") pursuant to Section 4(2) of the Securities Act of 1933, as amended
(the "Securities Act"), and/or Regulation D promulgated thereunder as
transactions by an issuer not involving any public offering, in that the
transactions involved the issuance and sale by the Company of its securities to
financially sophisticated institutions or persons who represented that they were
aware of the Company's activities as well as its business and financial
condition, and who took such securities for investment purposes and understood
the ramifications of the same. Each security holder represented that they
acquired such securities for investment for their own account and not for
distribution. All certificates representing the Series F Preferred, as well as
the Common Stock issued upon conversion of the Series F Preferred, issued
pursuant to these transactions were legended.
On November 26, 1997, the Company's Registration Statement on Form S-1
(File No. 333-36937) (the "Registration Statement") relating to the Offering was
declared effective by the Commission. The Registration Statement registered an
amount of Common Stock having an aggregate offering price of $46,000,000. The
Offering was consummated on December 2, 1997 and the Company issued 4,000,000
shares of Common Stock at $8.00 per share (for an aggregate offering amount of
$32,000,000). The managing underwriters of the Offering were DLJ, Furman Selz
LLC and CIBC Oppenheimer Corp. In connection with the Offering, the Company paid
underwriting discounts and commissions of $2,240,000 and $922,064 of other
expenses. Of such expenses, $100,000 was paid to Cross Technologies, Inc., of
which Robert W. Cross is chief executive officer and sole employee, as a
consulting bonus in connection with Mr. Cross' efforts in helping the Company
consummate the Offering. Mr. Cross is chief executive officer, president and a
director of the Company. Otherwise, none of such expenses were paid to
directors, officers, 10% stockholders or affiliates of the
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Company. After deducting such total expenses of $3,162,064, the Company's net
proceeds from the Offering were $28,837,936. Pending its use of the net
proceeds, the Company has invested the net proceeds 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 financial data set forth below as of, and for, each of the years in the
five-year period ended December 31, 1997 have been derived from the audited
financial statements of the Company.
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Commercial revenue............... $ 25,265 $ 31,144 $ 93,591 $ 485,036 $ 3,723,492
Government research contracts.... -- 64,015 27,995 110,770 --
--------- ----------- ----------- ----------- -----------
Total revenue.................... 25,265 95,159 121,586 595,806 3,723,492
Cost of revenue.................. 61,978 164,746 532,124 4,019,484 3,935,766
Research and development
expense........................ 143,362 456,162 485,059 677,284 990,331
Selling, general and
administrative expense......... 556,616 799,558 1,150,853 1,661,504 2,074,728
--------- ----------- ----------- ----------- -----------
Total operating expense.......... 761,956 1,420,466 2,168,036 6,358,272 7,000,825
--------- ----------- ----------- ----------- -----------
Operating expense in excess of
revenue........................ (736,691) (1,325,307) (2,046,450) (5,762,466) (3,277,333)
Other income, net................ 7,022 37,535 86,576 184,778 204,863
--------- ----------- ----------- ----------- -----------
Net loss......................... $(729,669) $(1,287,772) $(1,959,874) $(5,577,688) $(3,072,470)
========= =========== =========== =========== ===========
Pro forma net loss per
share(1)....................... $ (0.37)
===========
Shares used in computing the pro
forma net loss per share(1).... 8,208,306
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents....... $ 225,230 $ 18,462 $ 261,902 $ 617,204 $ 3,988,368
Working capital................. 225,988 2,226,184 2,451,627 3,070,789 32,038,915
Total assets.................... 406,238 2,568,691 3,741,128 5,539,634 36,196,569
Total stockholders' equity...... 348,434 2,456,516 3,506,050 5,110,450 34,651,334
- -------------------------
(1) Does not include as of December 31, 1997 the anti-dilutive effect of (i)
662,287 shares of Common Stock issuable upon the exercise of outstanding
warrants at an exercise price of $1.123 per share, (ii) 1,438,989 shares of
Common Stock issuable upon the exercise of outstanding options at a weighted
average exercise price of $2.471 per share and (iii) 1,275,618 shares of
Common Stock reserved for issuance upon the exercise of options that may be
granted in the future under the Stock Option Plan.
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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 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, Nanophase
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. From inception through
December 31, 1997, 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.
Through 1995, the majority of the Company's revenues resulted from
government contracts to perform research and development activities. During that
period, the Company also entered into cost-sharing agreements with the U.S.
government and offset amounts received against the related costs. During 1996,
the Company began emerging from the development stage and significantly
increased its commercial revenue. Commercial 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. Cost of revenue generally includes costs associated
with commercial production, customer development agreements and licensing
arrangements, and net costs of material production and development related to
government research contracts. In 1996, the Company also began to scale-up
operations in its Burr Ridge manufacturing facility. The Company incurred
substantial operating expenses as a result of certain one-time costs associated
with the scale-up of operations. In 1997, the Company incurred additional
one-time costs as it began the completion of its build-out of the Burr Ridge
facility.
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.
RESULTS OF OPERATIONS
Years Ended December 31, 1997 and 1996
Total revenue increased to $3,723,492 in 1997, compared to $595,806 in
1996. Commercial revenue increased to $3,723,492 in 1997, compared to $485,036
in 1996. This increase in commercial revenue was due primarily to a one-time
technology transfer fee of $1,400,000 from CIK for a license to use certain
patented technology to exclusively manufacture, use and sell the Company's
nanocrystalline materials in Asia, a product development fee of $775,000 from
Moyco, a one-time fee of $160,000 from CIK for training in the operation of a
PVS reactor, and increased customer development agreements and product sales.
Commercial revenue for the year ended December 31, 1997 was primarily generated
from sales of the Company's products to, product development agreements with,
and licensing fees paid by, customers in the electronics and structural ceramics
and composites markets. In particular, sales to, and fees from, Moyco and fees
from CIK constituted approximately 42% and 43%, respectively, of the Company's
revenue in 1997. Revenue from governmental research contracts decreased to zero
for the year ended December 31, 1997, compared to $110,770 for the same period
in 1996, because the Company did not pursue any further U.S. government
contracts for the year. See "Item 1. Business -- Customers and Applications --
Electronics -- Semiconductor Polishing" and "-- Marketing."
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Cost of revenue decreased to $3,935,766 in 1997, compared to $4,019,484 in
1996. This decrease in cost of revenue was generally attributed to increased
efficiencies in the manufacture of the Company's products and the reduced cost
of product development activities. Cost of revenue as a percentage of total
revenue decreased significantly for the year ended December 31, 1997, compared
to the same period in 1996 because of the increased efficiencies in the
Company's manufacturing processes, minimal costs associated with the one-time
technology transfer fee from CIK and the product development fee from Moyco, and
increased production volumes.
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 increased to $990,331 in 1997,
compared to $677,284 in 1996. The increase in research and development expense
is attributable primarily to the acquisition of certain knowledge and technology
from Moyco for a one-time fee of $223,000, increased costs of developing new
coating formulations and product applications, and ongoing experimentation
expenses associated with technological enhancements and product improvements.
The Company expects to increase its research and development expense in 1998 in
connection with its plans to continue to enhance and expand its product lines
and manufacturing processes.
Selling, general and administrative expense increased to $2,074,728 for the
year ended December 31, 1997, compared to $1,661,504 for the same period in
1996. This increase is attributable primarily to the expensing of certain
one-time costs aggregating $375,103 related to a proposed public offering
withdrawn in May 1997 and certain one-time costs associated with the Company's
Asian distribution agreement with CIK. These one-time costs were offset by
decreases in selling and general expenses. The Company expects its selling,
general and administrative expense to increase in 1998 due to the hiring of
additional marketing, sales and administrative personnel.
Interest income increased to $204,863 in 1997, compared to $184,778 in
1996. This increase is primarily due to the investment of net proceeds from its
sale of equity securities pending use of such proceeds for operations and
expansion.
Years Ended December 31, 1996 and 1995
Total revenue increased to $595,806 in 1996, compared to $121,586 in 1995.
Commercial revenue increased to $485,036 in 1996, compared to $93,591 in 1995.
This increase in commercial revenue was due primarily to increased commercial
acceptance and availability of the Company's products. Revenue from government
research contracts increased to $110,770 in 1996, compared to $27,995 in 1995,
as the Company completed certain development agreements with U.S. governmental
agencies.
Cost of revenue increased to $4,019,484 in 1996, compared to $532,124 in
1995. The increase in cost of revenue for 1996 was generally a result of the
scale-up of the Company's operations in anticipation of increased commercial
sales and development. Specifically, the Company increased expenditures relating
to product and process improvement activities. The Company also incurred
one-time costs in connection with the establishment of its Chicago coating
facility, extensive product development activities, the scale-up of
manufacturing operations, and the certification of its Burr Ridge facility under
ISO standards.
Research and development expense increased to $677,284 in 1996, compared to
$485,059 in 1995. The increase in research and development expense was
attributable primarily to the hiring of additional research and development
personnel, costs associated with the development and evaluation of new product
applications, and increased purchases and use of research supplies.
Selling, general and administrative expense increased to $1,661,504 in
1996, compared to $1,150,853 in 1995. This increase was attributable primarily
to the hiring of additional marketing and administrative personnel, an increase
in selling expenses, and the increase in costs associated with the establishment
of the Company's corporate headquarters.
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Interest income was $184,778 in 1996, compared to $86,576 in 1995. The
increase resulted from the Company's investment of net proceeds from its sales
of equity securities pending use of such proceeds for the Company's operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and investments were $30,873,220 at
December 31, 1997, compared to $2,614,992 at December 31, 1996 and $2,483,303 at
December 31, 1995. The Company's net cash used in operating activities was
$3,387,367, $5,795,858 and $1,860,353 for the years ended December 31, 1997,
1996 and 1995, respectively. The net cash used in operating activities for the
year ended December 31, 1997 was primarily for the further expansion of the
production infrastructure to support anticipated growth, the further development
of products, the funding of research and development activities, and the funding
of trade accounts receivable and inventory levels, which was offset by an
increase in accounts payable and accrued liabilities. Net cash used in investing
activities, including capital expenditures and purchases and sales of securities
in which cash is invested pending its use for the Company's operations, amounted
to $25,854,823, $951,806 and $905,615 for the years ended December 31, 1997,
1996 and 1995, respectively. Capital expenditures amounted to $1,063,608,
$1,173,437 and $937,956 for the years ended December 31, 1997, 1996 and 1995,
respectively, and were primarily for leasehold improvements and equipment
purchases. In December 1997, in connection with the Offering, the Company
received aggregate proceeds, net of issuance costs, of approximately
$28,837,936. In addition, proceeds provided by private placements of equity
securities, net of issuance costs, was $3,770,543 during the year ended December
31, 1997, compared to $7,182,088 and $3,009,408 during the years ended December
31, 1996 and 1995, respectively.
The Company believes that funds from operations and cash on hand, together
with the net proceeds of its initial public offering consummated in December
1997, will be adequate to fund the Company's current operating plans for the
foreseeable future. The Company expects capital expenditures of approximately
$20 million over the next two years, which expenditures will be funded in part
by the net proceeds from the Offering. The Company's actual future capital
requirements will depend, however, 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. In addition, the Company could potentially be required to fund a
rescission of shares of Series F Preferred. Depending on future requirements,
the Company may seek additional funding through public or private financing,
collaborative relationships, government contracts or licensing agreements. There
can be no assurance that such additional financing will be available on
acceptable terms or at all, and any such additional financing could be dilutive
to the Company's stockholders. See "-- Risk Factors -- Risk of Rescission of
Series F Offering."
At December 31, 1997, the Company had a net operating loss carryforward of
approximately $13.4 million for income tax purposes. Because the Company may
have experienced "ownership changes" within the meaning of the U.S. Internal
Revenue Code (the "Internal Revenue Code") related to the issuance of its
various 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 2012. As a result of
the annual limitation, a portion of this carryforward may expire before
ultimately becoming available to reduce income tax liabilities. As a result of
various agreements with companies located in foreign countries, the Company may
have generated foreign tax liabilities for which the Company would be entitled
to an offsetting tax credit that could be used to reduce U.S. income taxes.
IMPACT OF YEAR 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities.
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The Company processes its transactions and applications utilizing personal
computers. Based on a recent assessment, the Company determined that no
significant modifications or replacements of its software or systems will be
required to function properly with respect to dates in the year 2000 and
thereafter. As of January 1, 1998, the Company will only acquire software and
invest in systems which are compliant with the year 2000 conventions.
To date, the Company does not have any direct interface between its systems
and those of any significant supplier or customer. Although the Company
recognizes that it is vulnerable to third parties that fail to remediate their
own Year 2000 Issues, it does not believe that such failure would significantly
affect its operations. However, there can be no guarantee that the systems of
other companies on which the Company relies will be timely converted or that
their failure to do so would not have an adverse effect on the Company's
operations. The Company has determined it has no exposure to contingencies
related to the Year 2000 Issue for the products it has previously sold.
QUARTERLY INFORMATION
The following table presents selected unaudited quarterly results of the
Company for each quarter of 1997. The financial data is derived from the
unaudited quarterly financial statements of the Company which have been prepared
by the Company on a basis consistent with the Company's audited financial
statements included elsewhere in this Form 10-K and, in the opinion of
management, include all adjustments, including normal recurring adjustments,
that are necessary for a fair statement of the Company's results of operations
for such periods. These operating results are not necessarily indicative of
future performance.
1997
-------------------------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
STATEMENT OF OPERATIONS DATA:
Commercial revenue......................... $ 429,464 $ 603,003 $ 1,212,948 $1,478,077
Government research contracts.............. -- -- -- --
----------- ----------- ----------- ----------
Total revenue.............................. 429,464 603,003 1,212,948 1,478,077
Cost of revenue............................ (1,102,877) (1,059,204) (1,159,207) (614,478)
Research and development expense........... (161,198) (215,334) (194,678) (419,121)
Selling, general and administrative
expense.................................. (425,497) (765,995) (523,233) (360,003)
Interest income............................ 21,917 9,830 25,645 147,471
----------- ----------- ----------- ----------
Net (loss)/income.......................... $(1,238,191) $(1,427,700) $ (638,525) $ 231,946
=========== =========== =========== ==========
RISK FACTORS
Limited History of Commercial Sales; 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 its potential product applications are in
various stages of development or under evaluation. As a result, the Company's
nanocrystalline materials have been sold only in limited quantities, generally
for testing and evaluation purposes, and there can be no assurance that a
significant market will develop for such materials. Because virtually all of the
product applications for the Company's materials are new, in order to penetrate
its targeted markets, the Company must participate in a multi-step process that
includes initial discussions of the product application which highlight the
advantages of the Company's nanocrystalline materials, proof of concept, proof
of feasibility within the specific application, and evaluations of cost and
manufacturability. Completion of this evaluation process usually takes at least
18 months, and may take several years. The Company's current and potential
commercial customers establish demanding specifications for performance and
reliability. Although the products incorporating the Company's nanocrystalline
materials have passed certain product performance and
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reliability testing by certain current and potential customers, there can be no
assurance that the Company's nanocrystalline materials will continue to pass
such tests in the future, 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
complete its customers' multi-step evaluation processes 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 successfully to manufacture their products could also have a
material adverse effect on the Company's business, results of operations and
financial condition. See "Item 1. Business."
Limited Operating History; History of Losses; Uncertainty of Future
Profitability
Substantially all of the Company's revenues through December 31, 1996 were
derived from government research contracts, commercial development contracts and
sales of nanocrystalline products for customer evaluation. The Company has only
recently begun shipping significant amounts of its materials for commercial use
and there can be no assurance that the Company's nanocrystalline materials will
generate significant revenues from commercial applications. 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 has incurred net losses in each year since its inception, and
as of December 31, 1997, had an accumulated deficit of $13,744,671. The Company
may continue to incur operating losses and there can be no assurance that the
Company will become profitable. 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 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.
There can be no assurance that significant quantities of the Company's
nanocrystalline materials or their product applications will be manufactured,
introduced or marketed successfully, or that the Company will ever achieve a
profitable level of operations or, if profitability is achieved, that it can be
sustained. See "Item 1. Business" and "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations."
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. For example, sales to,
and fees from, Moyco and fees from CIK constituted approximately 42% and 43%,
respectively, of the Company's revenue in 1997. 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 would have a material adverse effect on the Company's
business, results of operations and financial condition. In December 1997,
Nanophase entered into a seven-year supply agreement with EKC, a subsidiary of
ChemFirst, a manufacturer of semiconductor polishing slurries, pursuant to which
the Company will supply certain of its nanocrystalline materials and provide
related research and customer and technical support to EKC. This agreement
supersedes the Company's five-year requirements contract with Moyco and was
entered into after Moyco sold its CMP intellectual property, technologies and
certain other intangible assets to EKC in December 1997. Sales to EKC are
currently expected to constitute a significant portion of the Company's revenues
over the next several years. There can be no assurance, however, that EKC's
purchase of the Company's materials will occur as expected or will not be for a
lesser dollar amount or on a slower timetable as compared to that which the
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Company previously expected from Moyco. See "Item 1. Business -- Customers and
Applications -- Electronics -- Semiconductor Polishing."
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 marketing, or willingness to purchase the Company's nanocrystalline
materials for, such product applications. There can be no assurance that the
Company's customers will not 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, there
can be no assurance that the Company will be able independently to 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. See "Item 1.
Business -- Customers and Applications."
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 and on a timely basis. 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 of nanocrystalline materials, and will need to increase
the efficiency of its manufacturing operations significantly to reach its
production goals. In addition, the Company will need to expand its current
facilities or obtain additional facilities in the near future in order to
manufacture substantial quantities of its products. No assurance can be given
that the Company will be able to make the transition to high-volume production
successfully. There can also be no assurance that the Company will be able 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's
primary operations, including research, engineering, manufacturing, marketing,
distribution and general administration, are housed in a single 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. See "Item 2. Properties."
While most of the Company's product applications involve the Company
producing materials which are to be used as ingredients in other companies'
products, the Company's net-shaping applications require the Company to produce
finished components. The Company currently is not capable of producing ceramic
finished components in commercial volume and therefore has recently established
an early-stage manufacturing arrangement with a third-party. The Company may
also develop an in-house capability to fabricate net-shaped components or
establish manufacturing arrangements with additional third parties. There can be
no assurance that the Company will be able to successfully collaborate with
others for the fabrication of net-shaped components or fabricate its net-shaped
components internally, or that it will be able to enter into additional
third-party arrangements on satisfactory terms. See "Item 1. Business -- The
Company's Technologies -- Net-Shaping."
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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 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. The
Company has been granted two United States patents which expire in July 2013,
has filed four applications for other United States patents and licenses eleven
patents held by others, which licenses generally last the life of their
respective patents. No assurance can be given that the patent applications filed
by the Company will result in issued patents or that the scope and breadth of
any claims allowed in any patents issued to the Company or its licensors will
exclude competitors or provide competitive advantages to the Company. In
addition, there can be no assurance that any patents issued to the Company or
its licensors will be held valid if subsequently challenged or that others will
not claim rights in the patents and other proprietary technology owned or
licensed by the Company, or that others have not developed or will not 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, there can be no assurance that the Company's patent and publication
searches have been comprehensive, or that materials or processes used by the
Company for its planned products do not or will not infringe upon existing
technology described in United States patents or will not infringe upon claims
of patent applications of others in the future. 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. There can be no assurance that the Company will
be able either to successfully design around these third-party patents or obtain
licenses to such technology or that, if obtainable, such licenses would 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
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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.
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. There can
be no assurance that the obligation to maintain the confidentiality of such
trade secrets or proprietary information will not wrongfully be breached by
employees, consultants, advisors or others, that the Company will have adequate
remedies for any breach, or that the Company's trade secrets or proprietary
know-how will not otherwise become known or be independently developed or
discovered by third parties. In addition, because the Company's employees have
not entered into noncompetition agreements with the Company, they may become
competitors of the Company upon termination of employment. See "Item 1.
Business -- Intellectual Property and Proprietary Rights."
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. There can be no assurance that the Company's development efforts
will not be rendered obsolete by the research efforts and technological advances
of others or that other advanced materials will not prove more advantageous than
those produced by the Company.
Limited Marketing Experience; Distribution Agreements
The Company has limited experience marketing and selling its products. To
market its nanocrystalline materials directly, the Company will be required to
develop 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 additional 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. There
can be no assurance that the Company will be successful in its marketing
efforts, that it will be able to establish adequate sales and distribution
capabilities, that it will be able to enter into or maintain marketing and
distribution arrangements with third parties on financially acceptable terms, or
that any third parties with whom it enters into such arrangements will be
successful in marketing the Company's products. In February 1998, the Company
and WCD mutually agreed to end their cosmetics and skin-care ingredients
distribution relationship. While the Company expects to either discuss
distribution arrangements with other companies having access to the cosmetics
and skin-care market or sell directly to potential cosmetic and skin-care
customers, there can be no assurance that the Company will be able to maintain
significant worldwide access to such market. See "Item 1. Business -- Customers
and Applications" and "--Marketing."
International Sales
For the year ended December 31, 1997, 46% of the Company's total revenues
were derived from product sales 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. There can be
no assurance that the Company will be able successfully to 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
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complying with a variety of foreign laws and unexpected changes in regulatory
requirements. There can be no assurance that one or more of such factors will
not 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. There can be no assurance that the recent economic
uncertainties in Korea and other Asian markets will not continue and have a
material adverse effect on the Company's sale of its materials in such markets.
See "Item 1. Business -- Marketing."
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, there can be no assurance that such competitive products
will not be introduced by third parties, or that competing materials based on
different or new technologies may not become commercially available. There can
be no assurance that the Company's competitors will not 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. See "Item 1.
Business -- Competition."
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, and the amount and timing of future
revenues. Depending on its requirements, the Company may seek additional funding
through public or private financing, collaborative relationships, government
contracts or licensing agreements. There can be no assurance that such
additional financing will 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. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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
26
27
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, there can
be no assurance that such claims will not be asserted against the Company. The
Company currently maintains separate insurance coverage in the amount of $1
million for product liability claims. The cost of defending or settling product
liability claims may be substantial and there can be no assurance that the
Company could do so on acceptable terms or that such claims, if successful or
settled, would not have a material adverse effect on the Company's business,
results of operations and financial condition.
Possible Volatility of Common Stock Price
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 by the Company or its competitors, disputes relating to patents and
proprietary rights, changes in financial estimates by securities analysts,
failure to meet earnings expectations of the market or of analysts, general
market conditions and fluctuations in quarterly operating results may have a
significant impact on the market price of the Common Stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been instituted against such a
company. Any such litigation initiated against the Company could 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.
Governmental Regulations
The Company's coating facility, which is located in Chicago, is a "small
quantity generator" of hazardous materials, including ethanol, under 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
preventive or remedial action, reduction of chemical exposure or waste treatment
or disposal. There can be no assurance that the Company's operations, business
or assets will not 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 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 exceed the Company's
resources or otherwise have a material adverse effect on the Company's business,
results of operations and financial condition.
In addition, both of 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
27
28
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.
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. See "Item 1. Business -- Governmental
Regulations."
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 and amount of expenses associated with expansion
of the Company's operations, 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,
and changes in the mix between pilot production of new nanocrystalline materials
and full-scale manufacturing of existing nanocrystalline materials. The Company
does not currently have any significant backlog of orders and the timing of
revenues will therefore depend upon the amount and timing of new orders received
for its nanocrystalline materials.
Anti-Takeover Provisions
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. The
rights of the holders of Common Stock will be subject to, and may be adversely
affected by, the rights of the holders of any preferred stock that may be issued
in the future. The issuance of preferred stock, while providing desirable
flexibility in connection with possible financings, acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire a majority of the outstanding voting stock of the
Company. The Company has no present plans to issue such shares of preferred
stock. Further, certain provisions of the Company's Certificate of Incorporation
and Bylaws and of Delaware law could delay or make more difficult a merger,
tender offer or proxy contest involving the Company.
Shares Eligible for Future Sale
The sale of a substantial number of shares of Common Stock, or the
perception that such sales could occur, could adversely affect prevailing market
prices for the Common Stock. Of the 12,277,467 shares of Common Stock
outstanding as of March 27, 1998, 8,277,467 shares of Common Stock are
"restricted securities" within the meaning of Rule 144 ("Rule 144") under the
Securities Act, (the "Restricted Shares") and all of such Restricted Shares are
subject to the lock-up provisions of a registration rights agreement or lock-up
agreements pursuant to which the holders of such Restricted Shares have agreed
that they will not, directly or indirectly, sell or otherwise dispose of any
shares of Common Stock prior to May 26, 1998 without the prior written consent
of DLJ. Upon expiration of the lock-up provisions of the registration rights
agreement or lock-up agreements (or earlier upon the consent of DLJ), 7,529,365
of the Restricted Shares will be eligible for sale under Rule 144, subject to,
in the case of the affiliates, the volume and other limitations of such rule. An
additional 662,287 Restricted Shares are issuable upon exercise of currently
exercisable warrants issued to certain of the Company's existing stockholders
and an additional 1,438,989 Restricted Shares are issuable at various dates upon
exercise of options heretofore granted to certain employees, consultants and
members of the advisory board of the Company pursuant to stock option
agreements. Such optionholders have also agreed not to sell, offer for sale or
otherwise dispose of any shares of Common Stock prior to May 26, 1998 without
the prior written consent of DLJ.
Subject to the lock-up provisions of the registration rights agreement and
lock-up agreements, the holders of all but 95,535 of the outstanding Restricted
Shares and all of the Restricted Shares issuable upon exercise
28
29
of the warrants have been accorded registration rights under the Securities Act.
No prediction can be made as to the effect, if any, that future sales of shares,
or the availability of shares for future sales, will have on the market price of
the Common Stock from time to time or the Company's ability to raise capital
through an offering of its equity securities.
Risk of Rescission of Series F Offering
In June, August and September 1997, the Company issued shares of Series F
Preferred for an aggregate of $3,876,108 to approximately 60 investors, all of
whom are "accredited investors" within the meaning of rules promulgated under
the Securities Act. The offering and sale of the Series F Preferred was not
registered under the Securities Act, but may not have qualified for an exemption
from the registration requirements of the Securities Act. If the sale of the
Series F Preferred was not consummated in accordance with a valid exemption
under the registration requirements of Section 5 of the Securities Act,
purchasers of Series F Preferred may have a right to rescind their purchases of
the Series F Preferred (which were converted into approximately 748,000 shares
of Common Stock upon consummation of the Offering in December 1997) pursuant to
Section 12(a)(1) of the Securities Act, and there may be a risk of enforcement
action by the Commission or state securities regulators. Under Section 13 of the
Securities Act, a rescission right, which is the effective equivalent of a put
right, can be maintained to enforce liability under Section 12(a)(1) of the
Securities Act at any time within one year after the violation on which it is
based, but in no event more than three years after the relevant securities were
bona fide offered to the public. A rescission right would entitle the holders of
the Series F Preferred to receive a return of the consideration paid for their
shares of Series F Preferred ($5.18 per share), together with interest from the
date of purchase. The Company does not currently intend to offer rescission to
the holders of the Series F Preferred. Even if the holders of Series F Preferred
are entitled to rescind their purchases, the Company does not believe that any
rescission would adversely affect its current financial condition.
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.
29
30
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 1998
Annual Meeting of Stockholders (the "1998 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information in response to this item is incorporated by reference from
the section of the 1998 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 1998 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 1998 Proxy Statement captioned "Executive Compensation and
Certain Transactions."
30
31
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, 1996 and 1997
Statements of Operations for the Years Ended December 31, 1995, 1996
and 1997
Statements of Stockholders' Equity for the Years Ended December 31,
1995, 1996 and 1997
Statements of Cash Flows for the Years Ended December 31, 1995, 1996,
and 1997
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.
3.1 Certificate of Incorporation of the Company.
3.2 Bylaws of the Company.
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.
10.1 The Nanophase Technologies Corporation Amended and Restated
1992 Stock Option Plan, as amended, 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 10.3 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 10.3 to the IPO S-1.
10.4* Employment Agreement dated February 3, 1994 between the
Company and Robert W. Cross, incorporated by reference to
Exhibit 10.4 to the IPO S-1.
10.5* 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.
10.6* Severance Benefits Agreement dated as of November 15, 1994
between the Company, Steven Lazarus and John C. Parker,
incorporated by reference to Exhibit 10.6 to the IPO S-1.
10.7 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.
10.8 License Agreement dated October 12, 1994 between the Company
and Hitachi, incorporated by reference to Exhibit 10.8 to
the IPO S-1.
31
32
EXHIBIT
NUMBER
-------
10.9 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.
10.10 License Agreement dated April 1, 1996 between the Company
and Cornell Research Foundation, incorporated by reference
to Exhibit 10.1 to the IPO S-1.
10.11* 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.
10.12 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.
10.13 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
of the IPO S-1.
10.14 Purchase Agreement between the Company and LWT Instruments,
Inc., dated February 1, 1997, incorporated by reference to
Exhibit 10.16 to the IPO S-1.
10.15 Letter of Understanding between the Company and LWT
Services, Inc. dated as of January 13, 1998.
10.16 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.
10.17 License Agreement between the Company and C.I. Kasei Co.,
Ltd. (a subsidiary of Itochu Corporation) dated as of
December 30, 1997.
10.18 Supply Agreement by and between the Company and EKC
Technology, Inc., dated as of December 31, 1997.
11 Statement regarding computation of per share earnings.
27.1 Financial Data Schedule.
27.2 Restated Financial Data Schedule.
---------------------------------
* Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-K.
(b) Reports on Form 8-K:
No reports on Form 8-K were filed by the Company for the quarter ended
December 31, 1997.
32
33
NANOPHASE TECHNOLOGIES CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... F-2
Balance Sheets as of December 31, 1996 and 1997............. F-3
Statements of Operations for the years ended December 31,
1995, 1996 and 1997....................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1995, 1996 and 1997.......................... F-5
Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997....................................... F-6
Notes to Financial Statements............................... F-7
F-1
34
The Board of Directors and Stockholders
Nanophase Technologies Corporation
We have audited the accompanying balance sheets of Nanophase Technologies
Corporation as of December 31, 1996 and 1997, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. Our audits also included the financial
statement schedule 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 generally accepted auditing
standards. 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, 1996 and 1997, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1997, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Ernst & Young LLP
Chicago, Illinois
January 23, 1998
F-2
35
NANOPHASE TECHNOLOGIES CORPORATION
BALANCE SHEETS
AS OF DECEMBER 31,
----------------------------
1996 1997
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 617,204 $ 3,988,368
Investments............................................... 1,997,788 26,884,852
Trade accounts receivable, less allowance for doubtful
accounts of $0 in 1996 and $19,276 in 1997............. 389,501 1,641,489
Inventories............................................... 445,205 957,303
Prepaid expenses and other current assets................. 50,275 112,138
------------ ------------
Total current assets................................... 3,499,973 33,584,150
Equipment and leasehold improvements, net................... 1,794,798 2,399,893
Other assets, net........................................... 244,863 212,526
------------ ------------
$ 5,539,634 $ 36,196,569
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 221,936 $ 930,397
Accrued expenses.......................................... 207,248 614,838
------------ ------------
Total current liabilities.............................. 429,184 1,545,235
STOCKHOLDERS' EQUITY:
Series A convertible preferred stock, no par value; 292,728
shares authorized, 169,490 shares issued and outstanding
at December 31, 1996; no shares authorized, issued, and
outstanding at December 31, 1997.......................... 600,000 --
Series B convertible preferred stock, no par value;
1,309,722 shares authorized, 758,358 shares issued and
outstanding at December 31, 1996; no shares authorized,
issued, and outstanding at December 31, 1997.............. 851,351 --
Series C convertible preferred stock, no par value;
1,143,846 shares authorized, 662,287 shares issued and
outstanding at December 31, 1996; no shares authorized,
issued, and outstanding at December 31, 1997.............. 743,500 --
Series D convertible preferred stock, no par value;
6,729,566 shares authorized, 3,896,419 shares issued and
outstanding at December 31, 1996; no shares authorized,
issued, and outstanding at December 31, 1997.............. 6,429,500 --
Series E convertible preferred stock, no par value;
3,500,000 shares authorized, 1,921,800 shares issued and
outstanding at December 31, 1996; no shares authorized,
issued, and outstanding at December 31, 1997.............. 7,157,850 --
Series F convertible preferred stock, no par value; no
shares authorized, issued, and outstanding at December 31,
1996 and December 31, 1997................................ -- --
Preferred stock, $.01 par value; no shares authorized,
issued, and outstanding at December 31, 1996; 24,088
shares authorized and no shares issued and outstanding at
December 31, 1997......................................... -- --
Common stock, no par value at December 31, 1996 and $.01 par
value at December 31, 1997; 10,316,158 shares authorized
at December 31, 1996 and 25,000,000 shares authorized at
December 31, 1997; 77,586 shares issued and outstanding at
December 31, 1996 and 12,277,467 shares issued and
outstanding at December 31, 1997.......................... 450 122,775
Additional paid-in capital.................................. -- 48,273,230
Accumulated deficit......................................... (10,672,201) (13,744,671)
------------ ------------
Total stockholders' equity................................ 5,110,450 34,651,334
------------ ------------
$ 5,539,634 $ 36,196,569
============ ============
See Notes to Financial Statements
F-3
36
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------
1995 1996 1997
---- ---- ----
REVENUE:
Commercial revenue.................................. $ 93,591 $ 485,036 $ 3,723,492
Governmental research contracts..................... 27,995 110,770 --
----------- ----------- -----------
Total revenue.................................. 121,586 595,806 3,723,492
OPERATING EXPENSE:
Cost of revenue..................................... 532,124 4,019,484 3,935,766
Research and development expense.................... 485,059 677,284 990,331
Selling, general and administrative expense......... 1,150,853 1,661,504 2,074,728
----------- ----------- -----------
Total operating expenses....................... 2,168,036 6,358,272 7,000,825
----------- ----------- -----------
Operating expenses in excess of revenue............... (2,046,450) (5,762,466) (3,277,333)
Interest income....................................... 86,576 184,778 204,863
----------- ----------- -----------
Net loss.............................................. $(1,959,874) $(5,577,688) $(3,072,470)
=========== =========== ===========
Pro forma net loss per share.......................... $ (0.48) $ (0.82) $ (0.37)
=========== =========== ===========
Pro forma weighted average number of common shares
outstanding......................................... 4,122,881 6,835,680 8,208,306
=========== =========== ===========
See Notes to Financial Statements
F-4
37
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, 1995... 3,730,073 $ 5,590,705 77,586 $ -- $ 450 $ (3,134,639) $ 2,456,516
Issuance of Series D shares... 1,742,447 3,009,408 -- -- -- -- 3,009,408
Net loss for the year ended
December 31, 1995........... -- -- -- -- -- (1,959,874) (1,959,874)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31,
1995.......................... 5,472,520 8,600,113 77,586 -- 450 (5,094,513) 3,506,050
Issuance of Series D shares... 14,034 24,238 -- -- -- -- 24,238
Issuance of Series E shares
net of offering costs....... 1,921,800 7,157,850 -- -- -- -- 7,157,850
Net loss for the year ended
December 31, 1996........... -- -- -- -- -- (5,577,688) (5,577,688)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31,
1996.......................... 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
========== ============ ========== ======== =========== ============ ===========
See Notes to Financial Statements
F-5
38
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
---- ---- ----
OPERATING ACTIVITIES:
Net Loss........................................... $(1,959,874) $ (5,577,688) $ (3,072,470)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................. 126,947 309,850 416,414
Loss on sale of equipment..................... -- -- 29,281
Write off of patents.......................... 19,857 -- --
Changes in assets and liabilities related to
operations:
Trade accounts receivable..................... (23,573) (318,656) (1,251,988)
Inventories................................... (65,280) (379,924) (512,098)
Prepaid expense and other assets.............. (50,261) 17,002 (164,365)
Patent costs.................................. (31,072) (40,548) (27,314)
Accounts payable.............................. 168,643 2,525 708,461
Accrued liabilities........................... (45,740) 191,581 486,712
----------- ------------ -------------
Net cash used in operating activities.............. (1,860,353) (5,795,858) (3,387,367)
INVESTING ACTIVITIES:
Acquisition of equipment and leasehold
improvements..................................... (937,956) (1,173,437) (1,063,608)
Purchases of held-to-maturity investments.......... (8,512,957) (15,486,131) (118,684,404)
Maturities of held-to-maturity investments......... 8,547,165 15,709,744 93,797,340
(Increase) decrease in asset held in trust......... (1,867) (1,982) 78,849
Proceeds from sale of equipment.................... -- -- 17,000
----------- ------------ -------------
Net cash used in investing activities.............. (905,615) (951,806) (25,854,823)
FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of offering
costs............................................ 3,009,408 7,182,088 32,613,354
Deferred offering costs............................ -- (79,122) --
----------- ------------ -------------
Net cash provided by financing activities.......... 3,009,408 7,102,966 32,613,354
----------- ------------ -------------
Increase in cash and cash equivalents.............. 243,440 355,302 3,371,164
Cash and cash equivalents at beginning of period... 18,462 261,902 617,204
----------- ------------ -------------
Cash and cash equivalents at end of period......... $ 261,902 $ 617,204 $ 3,988,368
=========== ============ =============
See Notes To Financial Statements
F-6
39
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 was in its development stage for the period from inception through
December 31, 1996. The Company began full-scale production in early 1997 at
which time it no longer was a development stage company. 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 sales approximated $51,400, $256,500, and $1,695,700 for the years
ended December 31, 1995, 1996, and 1997, 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.
Equipment and Leasehold Improvements
Equipment is stated at cost and is being depreciated over its estimated
useful life (5-7 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
40
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Commercial Revenue
Commercial revenue consists of sales of product and revenue from research
and development arrangements with non-governmental entities, and fees from the
transfer of technology. Sales of product are recorded as shipments are made by
the Company. 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.
Government Research Contracts
The Company accounts for contracts with governmental entities to complete
research and development activities using the percentage of completion method
measured by the relationship of costs incurred to total estimated costs. Amounts
paid to the Company under its cooperative cost-sharing agreement with the U.S.
government are accounted for as offsets against cost of revenues. See Note 8.
All payments to the Company for work performed on contracts and agreements with
agencies of the U.S. government are subject to adjustment upon audit by agencies
of the U.S. government. The Company believes that such audits, if any, will not
have significant effect on the financial position or results of operation of the
Company.
Research and Development Expense
Expenditures for research and development activities are charged to
operations as incurred by the Company. 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
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). The exercise price of the options granted equals the estimated fair value
of the underlying stock on the date of grant. As such, no compensation expense
has been recognized by the Company for these options. In October 1995, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" (FASB No. 123).
FASB No. 123, which was adopted by the Company in 1996, establishes an
alternative method of accounting for stock-based compensation plans. In 1996,
the Company adopted the disclosure alternative for stock-based compensation
(Note 12) which provides for the use of APB No. 25 for financial statement
purposes with pro forma disclosure of the impact of FASB 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.
F-8
41
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Net Loss and Pro Forma Net Loss Per Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (FASB No. 128).
FASB No. 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is generally
consistent with the previously reported fully diluted earnings per share. All
earnings per share amounts for all periods have been presented and, where
appropriate, restated to conform to the FASB No. 128 requirements.
Pro forma net loss per share and historical net loss per common share are
computed based upon the weighted average number of common shares outstanding.
Common equivalent shares are not included in the pro forma and historical per
share calculations since the effect of their inclusion would be anti-dilutive.
In addition, for the pro forma calculation, all convertible preferred stock is
treated as if converted into common shares for all periods shown.
Net loss per common share computed on a historical basis is as follows:
$25.26, $71.89 and $2.39 for the years ended December 31, 1995, 1996 and 1997,
respectively. The weighted average number of common shares outstanding used to
calculate these net loss per common share amounts are 77,586, for 1995 and 1996,
and 1,283,359 for 1997.
(3) INVESTMENTS
Investments consist of U.S. Treasury bills, government bonds, and
commercial paper with an estimated fair value of $1,998,000 and $26,885,000 at
December 31, 1996 and 1997, respectively. All investments have been classified
as held-to-maturity and mature in the subsequent year.
(4) INVENTORIES
Inventories consist of the following:
AS OF DECEMBER 31,
--------------------
1996 1997
---- ----
Raw Materials............................................ $332,167 $379,505
Finished Goods........................................... 113,038 577,798
-------- --------
$445,205 $957,303
======== ========
(5) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
AS OF DECEMBER 31,
------------------------
1996 1997
---- ----
Machinery and equipment............................... $1,662,721 $1,835,964
Office equipment...................................... 113,959 116,307
Office furniture...................................... 49,864 49,864
Leasehold improvements................................ 447,465 610,932
---------- ----------
2,274,009 2,613,067
Less: Accumulated depreciation and amortization....... (479,211) (881,323)
---------- ----------
1,794,798 1,731,744
Construction in progress.............................. -- 668,149
---------- ----------
$1,794,798 $2,399,893
========== ==========
F-9
42
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(6) LEASE COMMITMENTS
The Company leases manufacturing and office space under an agreement that
will expire in September 1999. Monthly minimum lease payments amount to $8,100
for this facility. The Company also leases a smaller pilot manufacturing space
as well as offsite warehouse space, both under renewable annual agreements.
Monthly minimum lease payments amount to $5,000 and $2,100, respectively, for
these facilities.
Net rent expense under these leases amounted to $122,422, $175,538, and
$168,781, for the years ended December 31, 1995, 1996, and 1997, respectively.
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
AS OF DECEMBER 31,
--------------------
1996 1997
---- ----
Accrued subcontract costs................................ $ 40,000 $161,791
Accrued payroll and related expenses..................... 87,124 138,798
Accrued costs for goods received but not invoiced........ 24,332 98,802
Other.................................................... 55,792 215,447
-------- --------
$207,248 $614,838
======== ========
(8) RESEARCH AND DEVELOPMENT AGREEMENTS
In July 1992, the Company entered into a cooperative cost-sharing agreement
with the U.S. Government under the Department of Commerce Advanced Technology
Program. The three-year agreement ended in 1995. Under the terms of the
agreement, the U.S. Government agreed to share costs of the Company's research
efforts up to an aggregate of $944,259, including subcontractor costs. The net
costs associated with the total effort amounted to $2,992,130. The difference
between these amounts represented indirect costs of $2,047,871 which were
absorbed as operating expenses by the Company. For the year ended December 31,
1995, the Company offset $154,710 received from the U.S. government against cost
of revenues in the statement of operations.
The Company is party to a number of other research and development
arrangements with both governmental and commercial entities. These arrangements
are generally short-term in nature and provided $54,680, $236,019, and
$1,445,705 of revenues for the years ended December 31, 1995, 1996, and 1997,
respectively.
(9) LICENSE AGREEMENTS
In 1991, 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, 1997, no royalty
payments were due under this agreement.
In 1994, 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. As of
December 31, 1997, royalties under this agreement amounting to $10,688 have been
offset against the royalty advance.
In 1996, 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
F-10
43
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
defined. As of December 31, 1997, royalties under this agreement approximated
$13,000. 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. As
of December 31, 1997, no royalty payments were due to this party under this
agreement.
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 provides for minimum sales targets and minimum royalty payments
to maintain exclusivity. The agreement expires on March 31, 2013 unless earlier
terminated as provided therein. As of December 31, 1997, no royalty payments
were earned by the Company under this agreement.
(10) INCOME TAXES
The Company has net operating loss carryforwards for tax purposes of
approximately $13,400,000 at December 31, 1997, which expire between 2005 and
2012. 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,
-------------------------
1996 1997
---- ----
DEFERRED TAX ASSETS:
Net operating loss carryforward................... $ 4,212,000 $ 5,226,000
Start-up cost capitalized for income tax
purposes....................................... 162,000 122,000
Other accrued costs............................... 29,000 74,000
----------- -----------
Total deferred tax assets...................... 4,403,000 5,422,000
DEFERRED TAX LIABILITY:
Accelerated tax depreciation...................... (53,000) (62,000)
----------- -----------
Net deferred tax asset.............................. 4,350,000 5,360,000
Less: Valuation allowance......................... (4,350,000) (5,360,000)
----------- -----------
Deferred income taxes............................... $ -- $ --
=========== ===========
The valuation allowance increased $1,010,000 for the year ended December
31, 1997 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 initial 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
F-11
44
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
incurred, subject to certain limitations. At December 31, 1997, the Company had
not recognized any foreign tax liability or foreign tax credit regarding these
transactions.
(11) CAPITAL STOCK
In November 1997, the Company's Board of Directors approved a migratory
merger of the Company from Illinois to Delaware, authorized a reverse stock
split and restated the par value of the Company's common stock. All share and
per share amounts in the financial statements and notes to financial statements
have been restated to reflect a .579-for-1 reverse stock split and restatement
of the par value to $0.01 for all common stock.
In 1997, a total of 748,089 shares of Series F convertible preferred stock
was 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. Pursuant to the Company's prior Illinois articles
of incorporation, 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.
At December 31, 1997, authorized but unissued shares of common stock have
been reserved for future issuance as follows:
Warrants.................................................... 662,287
Options..................................................... 2,714,607
---------
3,376,894
=========
(12) STOCK OPTIONS AND WARRANTS
The Company has entered into stock option agreements with certain officers,
employees, directors (one of whom is also a service provider) and three Advisory
Board members. At December 31, 1997, the Company had granted options to purchase
1,438,989 shares of common stock. The stock options generally expire ten years
from the date of grant. Of the total number of options granted, 673,377 of the
outstanding options vest on the eighth anniversary following their grant date,
subject to an earlier five-year vesting period if specified performance targets
are met. Of the remaining 765,612 outstanding options, 748,242 vest over a
five-year period and 17,370 vest over a three-year period from their respective
grant dates.
F-12
45
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, 1997:
WEIGHTED
NUMBER EXERCISE AVERAGE EXERCISE
OF OPTIONS PRICE PRICE
---------- -------- ----------------
Outstanding at December 31, 1994...................... 255,339 $ .112 $ .112
Options granted during 1995........................... 186,728 .432 .432
Options canceled during 1995.......................... (6,948) .112-.432 .180
---------
Outstanding at December 31, 1995...................... 435,119 .112-.432 .249
Options granted during 1996........................... 1,192,508 1.727-3.886 3.309
Options canceled during 1996.......................... (12,101) .112-1.727 1.549
---------
Outstanding at December 31, 1996...................... 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
=========
At December 31, 1997, options for 180,378, 75,270, 62,903 and 17,833 shares
of common stock were exercisable at $.112, $.432, $1.727 and $3.886 per share,
respectively. To date, 43,425 options have been exercised and none have expired.
The weighted average remaining contractual life of the outstanding options at
December 31, 1997 was eight years.
In connection with the issuance of Series C convertible preferred stock,
the Company issued common stock purchase warrants for 662,287 shares at no
additional cost to the Series C convertible preferred stockholders. These
warrants have an exercise price of $1.123 per share and expire upon the tenth
anniversary of issuance. All warrants were outstanding at December 31, 1997.
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, 1995, 1996, and 1997: U.S. government zero coupon 7-year bond interest rates
ranging from 6.0% to 7.2%, 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 in 1995, 1996, or
during the period during which options were granted in 1997. The weighted
average fair value of the net options granted during 1995, 1996 and 1997 was
$.170, $1.124 and $1.753 per share, respectively.
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 opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
F-13
46
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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 $1,965,649, $5,621,482, $3,275,177 and
the pro forma net loss per share would be $0.48, $0.82, and $0.40 for the years
ended December 31, 1995, 1996, and 1997, 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. The agreement is on a month-to-month basis. Payments under
this agreement amount to $2,500 per month.
(15) SIGNIFICANT CUSTOMERS
Revenue from two customers was approximately 43% and 42%, respectively, of
total revenue for the year ended December 31, 1997. The amount due from one of
these companies comprised 85% of the Company's trade accounts receivable at
December 31, 1997.
F-14
47
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, 1995:
Deferred tax asset valuation
account........................... $1,254,000 $1,015,000 $ -- $ -- $2,269,000
========== ========== ==== ======= ==========
Year ended December 31, 1996:
Deferred tax asset valuation
account........................... $2,269,000 $2,081,000 $ -- $ -- $4,350,000
========== ========== ==== ======= ==========
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
========== ========== ==== ======= ==========
S-1
48
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, 1998.
NANOPHASE TECHNOLOGIES CORPORATION
By: /s/ ROBERT W. CROSS
------------------------------------
Robert W. 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, 1998.
SIGNATURE TITLE
--------- -----
/s/ ROBERT W. CROSS President, Chief Executive Officer (Principal
- ------------------------------------------------ Executive Officer) and a Director
Robert W. Cross
/s/ DENNIS J. NOWAK Vice President -- Finance and Administration, Chief
- ------------------------------------------------ Financial Officer, Treasurer and Secretary
Dennis J. Nowak (Principal Financial and Accounting Officer)
/s/ LEONARD A. BATTERSON Chairman of the Board and Director
- ------------------------------------------------
Leonard A. Batterson
/s/ STEVEN LAZARUS Director
- ------------------------------------------------
Steven Lazarus
/s/ DONALD PERKINS Director
- ------------------------------------------------
Donald Perkins
/s/ RICHARD W. SIEGEL Director
- ------------------------------------------------
Richard W. Siegel
/s/ ROBERT W. SHAW, JR. Director
- ------------------------------------------------
Robert W. Shaw, Jr.
49
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.
3.1 Certificate of Incorporation of the Company.
3.2 Bylaws of the Company.
10.15 Letter of Understanding between the Company and LWT
Services, Inc. dated as of January 13, 1998.
10.17 License Agreement between the Company and C.I. Kasei Co.,
Ltd. (a subsidiary of Itochu Corporation) dated as of
December 30, 1997.
10.18 Supply Agreement by and between the Company and EKC
Technology, Inc., dated as of December 31, 1997.
11 Statement regarding computation of per share earnings.
27.1 Financial Data Schedule.
27.2 Restated Financial Data Schedule.