nanophase technologies corporation
DRIVING PRODUCT INNOVATION
>>> 2006 ANNUAL REPORT
letter to shareholders
in the news
products
officers
board of directors
10k
>>> anti-microbial
>>> architectural coatings
>>> industrial coatings
>>> personal care
>>> plastics
>>> semiconductor – cmp
nanophase technologies corporation
LETTER TO SHAREHOLDERS JOSEPH CROSS – President & CEO
2006 was another excellent year of growth and performance
for Nanophase. Continuing our focus on revenue growth,
margin expansion, operational and technical improvement,
and customer performance, the Company demonstrably
performed in each area.
Nanophase achieved double-digit year-over-year revenue
growth in each quarter of 2006 and, by the end of the year,
grew annual revenue 32% over 2005. Revenue growth
occurred primarily in sunscreens, personal care, and
architectural coatings, a relatively new and growing market
for the Company. In tandem, gross margin growth continued
and increased to approximately 22% of sales, growing over
50% from 2005 levels.
Again this year, we made significant
progress evolving our technologies
and manufacturing processes focused
on continuous improvement for
manufacturing cost, variable margin
expansion, and continually improving
product quality. Nanophase’s
facilities were also recer tified to
ISO 14001:2000, the international
environmental management standard,
as well as ISO 9001:2000, an
international standard of manu-
facturing and quality excellence.
For the fifth consecutive year, the
Company achieved essentially 100%
customer service levels with zero
customer complaints—a continuing
testament to our commitment to
our customers and world-class
performance.
As we enter 2007, we believe
that Nanophase is well positioned
for continuing revenue grow th
and financial performance. We
anticipate growth in all of our
market segments, especially
industrial coatings, architectural coatings,
and plastics, as well as addressing new
oppor tunities and markets. We continue
to be confident that Nanophase is and
remains at the leadership forefront in
nanomaterial solutions.
Joseph Cross
President & CEO
June 1, 2007
letter to shareholders
in the news
products
officers
board of directors
10k
I — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — I I
nanophase technologies corporation
IN THE NEWS
Nanophase Technologies is a nanotechnology company—
a technology that the US Government says is “likely to change
the way almost everything ... is designed and made.”
Founded in 1989, Nanophase has traded on the Nasdaq
Stock Exchange under the symbol NANX since 1997.
>>> Nanophase Technologies
Announces Architectural Coating
Order … Nanophase expects to begin
delivering its advanced nanoengineered
product during 2006. “We are pleased
with this series of orders and the
launch of this new consumer product
which we expect to grow into an
increased revenue stream as the
market rollout matures.”
NANOPHASE PRESS RELEASE
APRIL 10, 2006
>>> Nanophase announced a new
mutually exclusive supply agreement
with BASF to supply patent-pending
surface engineered nanoparticles for
current and future products for
BASF’s Z-COTE® MAX brand …
“We are honored to be designated
a strategic development partner
for BASF and proud of our mutual
collaboration on this new line of
BASF products.”
NANOPHASE PRESS RELEASE
March 16, 2005
>>> Nanophase Technologies
announced the Company was issued
a new patent entitled “Nanostructured
Compositions” … “We regard this
patent as seminal technology in the
coating field and it is significant for
the Company and our partnership
with ALTANA Chemie AG, one of
the world’s leading suppliers of paint
and plastic additives for coatings,
printing inks, and plastics. Substantially
transparent, abrasion and wear
resistant nanoparticle coatings have
numerous potential applications in many
commercial markets.”
NANOPHASE PRESS RELEASE
March 26, 2007
>>> Nanophase Technologies
announced that eleven new nanoparticle
products have been added to Alfa
Aesar’s distribution for research
quantities of Nanophase’s materials.
Alfa Aesar, the research chemicals unit
of Johnson Matthey, now distributes
33 Nanophase-branded products
as nanoparticles and nanoparticle
dispersions to a global customer base …
“Alfa’s powerful global marketing and
distribution capabilities, including a full
Internet ecommerce system, Internet
advertising, and print catalogues and
brochures, are a significant addition to
Nanophase’s marketing initiatives.”
NANOPHASE PRESS RELEASE
July 17, 2006
>>> Nanophase announces extended
exclusive partnership and $5 million
investment by Rohm and Haas
Electronic Materials. The par tnership
will collaborate in developing innovative
nanomaterials-based slurries for
current and future technology modes
in semiconductor fabrication.
NANOPHASE PRESS RELEASE
August 28, 2006
letter to shareholders
in the news
products
officers
board of directors
10k
I I I — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — I V
nanophase technologies corporation
PRODUCTS
Creating nanomaterials involves altering metal oxides and
other compounds at a molecular level, resulting in compounds
with enhanced or entirely new characteristics and capabilities.
Nanophase’s proprietary formulations are used in a variety
of applications including Anti-microbial, Architectural and
Industrial Coatings, Textiles, Personal Care, Plastics and
Semiconductor polishing.
>>> Anti-microbial
Products from Nanophase Technologies
can be useful in anti-microbial products
in applications including wood
preservation, marine antifouling systems,
various textile fibers, thermoplastics,
surface cleaners and permanent
coatings. The small particle size of our
products results in little influence on
the final formulation in terms of clarity,
rheology, surface texture, and gloss or
physical/mechanical properties.
>>> Architectural Coatings
The need for scratch, mar and abrasion
resistance is well established in various
markets, including paints, fingernail
polishes, flooring, plastic glazing,
headlamp covers and other automotive
parts, transportation windows and optical
lenses, where clear scratch-resistant
coatings are used. Our products can also
be surface treated through proprietary
technology to ensure compatibility with
a variety of coating systems.
>>> Industrial Coatings
Long term anti-microbial activity
can be imparted in many coating
formulations through the incorporation
of nanomaterials. The desire for
permanent coatings to impart long-term
antimicrobial or bacteria-stat properties
to coated products can be useful in
industrial applications such as healthcare,
industrial and institutional cleaning, food
processing and food service.
>>> Personal Care
The personal care industry is addressing
heightened concerns regarding protection
from ultra-violet light and providing anti-
microbial functionality, while maintaining
products that are mild and non-irritating.
Our products are produced according
to cGMP standards in an ISO 9001:2000
certified facility and are FDA approved
for use as active ingredients in personal
care products. Current personal care
applications where uv-attenuation, anti-
microbial activity, odor control, and/or
anti-irritating functionality are sought
include sunscreen formulations, foot
powder, shaving cream, oral care and
deodorants/antiperspirants.
>>> Plastics
Long-term antimicrobial needs in various
plastic, rubber and composite materials
have been increasing in recent years.
Nanomaterials can provide cost-effective
longevity of activity even in harsh
environments and after significant
thermal history, separating them from
the more unstable organic biocides.
Applications for antimicrobial plastic parts
include children’s toys, refrigerator liners
and other appliance parts, interior and
exterior wall coverings, adhesives, caulks
and sealants and food processing and
food service equipment.
>>> Semiconductor – CMP
As the semiconductor industry continues
to move forward to smaller chip
architecture, the need for advanced CMP
slurries becomes a requirement that
cannot be met by the slurries provided in
the past. Nanophase’s dispersions are on
the forefront of providing high planarity
surfaces and efficient removal rates.
These high purity dispersions feature
particles less than 100 nanometers
in size with uniform morphology for
critical electronic polishing applications.
The unique surface chemistry of these
nanomaterials allows formulation of
highly concentrated dispersions at a
variety of pH.
letter to shareholders
in the news
products
officers
board of directors
10k
V — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — V I
nanophase technologies corporation
OFFICERS
>>> JOSePH e. CROSS
President & Chief executive Officer
Mr. Cross joined Nanophase as
President and Chief Operating Officer
in November 1998. He was promoted
to Chief Executive Officer in December
1998. From 1993–1998, Mr. Cross
served as President and CEO of
APTECH, Inc., an original equipment
manufacturer of metering and control
devices for the utility industry, and
as President of Aegis Technologies,
an interactive telecommunications
company. He holds a B.S. in chemistry
and attended the M.B.A. program at
Southwest Missouri University. He brings
a background of successfully directing
several high-technology start-ups, rapid
growth and turnaround operations.
>>> keVIN J. weNTA
executive Vice President—
Sales & Marketing
Mr. Wenta joined the Company in
January 2007. He brings twenty years of
business development, sales, marketing,
finance and operations experience to
Nanophase. Prior to joining the Company,
Mr. Wenta was a Partner at Accenture,
a global consultancy. Previous to that
he was a General Manager at Eastman
Chemical Company, successfully leading
a turnaround of their $520 million resins,
monomers and textiles businesses. In
addition, he held the position of Director
of Corporate Strategy for the $5.5 billion
parent company. Previous experience
includes VP of Business Development
at ChemConnect (formerly CheMatch),
a global electronic chemical exchange,
financial positions at ARCO and he
began his career at Shell Chemical in
sales. Mr. Wenta holds a B.S. degree in
Chemical Engineering from the University
of Texas at Austin and a M.B.A. degree
from the University of Chicago.
>>> DR. RICHARD w. BROTzMAN
Vice President—Research
& Development
Dr. Brotzman joined Nanophase in
1994 as a Senior Scientist and was
promoted to his present position in
1996. He has more than 15 years
of experience in the research and
development of advanced materials
leading to new products—and is the
inventor of the Company’s coating
technology. From 1991–1994, Dr.
Brotzman served as Director of
Research at TPL, Inc., an advanced
materials company. He earned his B.S.
in chemical engineering from Lafayette
College, an M.S. in engineering and
applied science from the University
of California at Davis, and a Ph.D.
in chemistry from the University
of Washington.
>>> ROBeRT HAINeS
Vice President—Operations
Mr. Haines joined Nanophase
Technologies in January 2001 as
Vice President–Operations. Beginning
in 1996 and prior to joining Nanophase,
he served as Corporate Director of
Quality at Legrand North America.
Previous experience includes two years
as Vice President of Operations for Aegis
Technologies and eight years with Digital
Equipment Corporation. Mr. Haines has
a B.S. in Chemistry/Engineering Physics
from East Tennessee State University.
>>> JeSS A. JANkOwSkI,
Chief Financial Officer
Mr. Jankowski has served as Controller
of the Company since joining in 1995. He
was elected Secretary and Treasurer in
November 1999, Acting Chief Financial
Officer in January 2000, Vice President in
April 2002 and Vice President of Finance
and Chief Financial Officer in April 2004.
From 1990–1995 he served as Controller
for two building contractors in the
Chicago area, also serving in the business
development function. From 1986 to
1990 he worked for Kemper Financial
Services in their accounting control
corporate compliance unit, serving as
unit supervisor during his last two years.
He holds a B.S. in accountancy from
Northern Illinois University, an M.B.A.
from Loyola University of Chicago and
received his certified public accountant
certificate from the State of Illinois.
Mr. Jankowski has served on the advisory
board of WESTEC, an Illinois Technology
Enterprise Center focusing on the com-
mercialization of advanced manufacturing
technologies, since 2003. He was also
recently elected to the Romeoville
Economic Development Commission,
an organization focused on fostering new
business growth in Romeoville, Illinois
which resides in Will County, the twelfth
fastest growing county in the U.S.
letter to shareholders
in the news
products
officers
board of directors
10k
V I I — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — V I I I
nanophase technologies corporation
BOARD OF DIRECTORS
>>> DONALD S. PeRkINS
Chairman of the Board
Donald S. Perkins is the former Chairman
of Jewel Companies, Inc., a food and
drug store chain. Mr. Perkins graduated
from Yale University and the Harvard
Business School. He served in the U.S.
Merchant Marine in the mid 1940s
and the Air Force in the early 1950s.
Starting as a trainee with the then Jewel
Tea Company in 1953, he was elected
Vice President in 1960, Executive Vice
President three years later, President in
1965 and Chairman and Chief Executive
Officer in 1970.
He retired from Jewel Companies, Inc.
in 1983. Mr. Perkins currently serves as
a Director of Cantilever Technologies
LLC, LaSalle Hotel Properties, LaSalle
U.S. Realty Income and Growth Funds
I, II and III and Nanophase Technologies
Corporation, where he is Chairman.
For more than 30 years, he has served
on Corporate Boards including AT&T,
Aon, Corning, Cummins Engine, Eastman
Kodak, Firestone, Inland Steel Industries,
Kmart, Lucent Technologies, The Putnam
Funds, Springs Industries and Time Warner.
He is a Life Trustee and was Vice
Chairman of Northwestern University.
He co-chaired Campaign Northwestern,
Mr. McClung currently serves as
Corporate Director of Alticor (Amway),
Beaulieu of America Corporation,
NCCI Holdings, Turtle Wax and
Hu-Friedy. He was a founding member
of the U.S. Russia Business Council and
is active in other international business
organizations, such as the Japan
American Society, Chicago Council
of Foreign Relations and the Economic
Club of Chicago. He serves as a board
director at Thunderbird: The Garvin
School of International Management,
and the College of Wooster (Ohio).
Mr. McClung earned a Bachelor’s degree
from the College of Wooster, a
Master’s degree from the University
of Kansas, and a Doctorate from
Michigan State University.
a university-wide effort which has raised
more than $1.5 billion. He is Honorary
Chairman of The Illinois Coalition and
Protector of the Thyssen-Bornemisza
Continuity Trust. He has served as a
Trustee of The Ford Foundation and
The Brookings Institution and as a
member of The Business Council. He is
also a member of the Civic Committee
of The Commercial Club of Chicago,
a Director of Leadership for Quality
Education, and a member of the Advisory
Boards of RoundTable Heathcare
Partners L.P., Northwestern University’s
School of Communication and its
School of Education and Social Policy.
>>> JOSePH e. CROSS
(See biography under Officers)
>>> JAMeS A. HeNDeRSON
Director
Mr. Henderson has served as a director
of the Company since July 2001. He
retired as Chairman and Chief Executive
Officer of Cummins Engine Company
in December 1999, after joining the
company in 1964. Mr. Henderson
became President and Chief Operating
Officer of Cummins, Inc. in 1977, was
promoted to President and Chief
Executive Officer in 1994 and served as
Chairman and Chief Executive Officer
from 1995 until his retirement in 1999.
Mr. Henderson attended Culver Military
Academy, holds an A.B. in public and
international affairs from Princeton
University and an M.B.A. from Harvard
Business School. Mr. Henderson currently
serves as Chairman of the Board of The
Culver Education Foundation, member of
the Board of Directors of International
Paper, Ryerson Tull, Inc., SBC Comm-
unications, Inc., and is a member of the
Washington, D.C. Business Council.
>>> JAMeS A. McCLuNg
Mr. McClung has served as a director of
the Company since February 2000. He
is currently Vice Chairman of Charter
Consulting and former Senior Vice
President and executive officer for
FMC Corporation, a leading producer
of a diversified portfolio of chemicals
and machinery. He has over 30 years
of international business development
in over 75 countries, having managed
and developed new technologies and
production processes for diversified
global businesses, including specialized
chemicals and machinery, while living in
the United States, Europe and Africa.
letter to shareholders
in the news
products
officers
board of directors
10k
I X — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — X
nanophase technologies corporation
BOARD OF DIRECTORS
>>> JeRRy k. PeARLMAN
Mr. Pearlman has served as a director
of the Company since April 1999. Mr.
Pearlman retired as Chairman of Zenith
Electronics Corporation in November
1995. He joined Zenith as Controller
in 1971 and served as Chief Executive
Officer from 1983 through April 1995.
Mr. Pearlman is a director of Smurfit-
Stone Container Corporation and
Ryerson-Tull, Inc. He is a trustee of
Northwestern University and a director
and past Chairman of the Board of
Evanston Northwestern Healthcare.
Mr. Pearlman graduated from Princeton
with honors from the Woodrow Wilson
School and from Harvard Business
School with highest honors.
>>> DR. RICHARD w. SIegeL
Dr. Siegel is a co-founder of the Company
and has served as a director of the
Company since 1989. Dr. Siegel also
served as a consultant to the Company
from 1990 to 2002 with regard to the
application and commercialization of
nanocrystalline materials. Dr. Siegel is
an internationally recognized scientist
in the field of nanocrystalline materials.
During his tenure on the research staff at
Argonne National Laboratory from July
1974 to May 1995, he was the principal
scientist engaged in research with the
laboratory-scale synthesis process that
was the progenitor of the Company’s
physical-vapor-synthesis production system.
Dr. Siegel has been the Robert W. Hunt
Professor in Materials Science and
Engineering at Rensselaer Polytechnic
Institute since June 1995, and served as
Department Head from 1995 to 2000.
In April 2001, Dr. Siegel became the
founding Director of the newly created
Rensselaer Nanotechnology Center
at the Institute. During 1995–1998,
he was also a visiting professor at the
Max Planck Institute for Microstructure
Physics in Germany on an Alexander
von Humboldt Research Prize received
in 1994. During 2003–2004 he was a
visiting professor in Japan on a RIKEN
Eminent Scientist Award. He chaired the
World Technology Evaluation Center
worldwide study of nanostructure
science and technology for the U.S.
government, has served on the Council
of the Materials Research Society and as
Chairman of the International Committee
on Nanostructured Materials. He also
served on the Committee on Materials
with Sub-Micron Sized Microstructures
of the National Materials Advisory Board
and was the co-chairman of the Study
Panel on Clusters and Cluster-Assembled
Materials for the U.S. Department of
Energy. He currently serves on the
Nanotechnology Technical Advisory
Group to the U.S. President’s Council
of Advisors on Science and Technology.
Dr. Siegel holds an A.B. degree in physics
from Williams College and an M.S. degree
and Ph.D. from the University of Illinois
at Urbana-Champaign.
>>> JANeT wHITMORe
Ms. Whitmore joined the board in
November, 2003. She is currently a
director for Silverleaf Resorts, Inc.,
where she serves as Chairman of the
Compensation Committee and as a
member of the Audit and Finance
Committee. Ms. Whitmore is Founder of
Benton Consulting, LLC, which specializes
in business development and processes.
From 1976 through 1999, Ms. Whitmore
held numerous engineering and finance
positions at Mobil Corporation, including
Mobil’s Chief Financial Analyst and
Controller of Mobil’s Global Petrochemicals
Division. Ms. Whitmore holds a Bachelor
of Science degree in Chemical Engineering
from Purdue University and an M.B.A.
from Lewis University.
>>> Independent Auditors
MCgLADRey & PuLLeN LLP
20 North Martingale Rd., Suite 500
Schaumburg, Illinois 60173
>>> Transfer Agent
LASALLe NATIONAL ASSOCIATION
Corporate Trust Department
135 South LaSalle Street, Room 1960
Chicago, Illinois 60603
800-246-5761
>>> Stock Listing
Nanophase Technologies Corporation’s
common stock is traded on the Nasdaq
National Market under the symbol NANX.
>>> Annual Meeting
JuLy 30, 2007
at Nanophase Technologies Corporation
1319 Marquette Drive
Romeoville, Illinois 60446
>>> Form 10-k
Nanophase Technologies Corporation
will send a copy of its Form 10-K report
for fiscal 2006 as filed with the Securities
and Exchange Commission upon written
request to Investor Relations at the
corporate office.
letter to shareholders
in the news
products
officers
board of directors
10k
X I — N A N O P H A S E T E C H N O L O G I E S C O R P O R A T I O N
2 0 0 6 A N N U A L R E P O R T & F O R M 1 0 - K — X I I
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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, 2006 Commission File Number 0-22333
NANOPHASE TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction
of incorporation or organization)
36-3687863
(I.R.S. Employer Identification No.)
1319 Marquette Drive, Romeoville, Illinois 60446
(Address of principal executive offices) (zip code)
Registrant’s telephone number, including area code: (630) 771-6708
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
Preferred Stock Purchase Rights
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes (cid:134) No (cid:59)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes (cid:134) No (cid:59)
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 (cid:59) No (cid:134)
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. Yes (cid:59) No (cid:134)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12B-2 of the
Exchange Act. (Check one):
Large accelerated filer (cid:134) Accelerated filer (cid:59)
Non-accelerated filer (cid:134)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes (cid:134) No (cid:59)
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 June 30, 2006 was
$91,844,642 as of such date.
The number of shares outstanding of the registrant’s common stock, par value $.01, as of
March 12, 2007 was 19,001,509.
DOCUMENTS INCORPORATED BY REFERENCE
None.
2
PART I
Item 1. Business
General
Nanophase Technologies (“Nanophase” or the “Company”) is a nanomaterials developer and
commercial manufacturer and produces engineered nanomaterial products for diverse markets –
sunscreens, personal care, architectural coatings, industrial coating ingredients, plastic additives, water
filtration, DNA bio-sensors, semiconductor polishing, optics polishing and other markets. Additionally,
new markets and applications are constantly emerging and being developed on a global scale. Nanophase
markets its products globally – U.S, Europe and Asia. The Company was incorporated in Illinois on
November 25, 1989, and became a Delaware corporation on November 30, 1997. The Company’s
common stock trades on the NASDAQ Global Market under the symbol NANX.
Nanophase has created a leading commercial platform of integrated nanomaterials technologies
that are designed to deliver an optimal engineered nanomaterial ‘solution’ for a target market or specific
customer application. The Company has complete capability from application development and
laboratory samples through pilot production and, finally, commercial production in metric ton(s) capacity.
Nanophase has development and application laboratories and manufacturing capacity in two locations in
the Chicago area. The Company’s manufacturing is based on Lean Six Sigma discipline and is certified
to ISO 9001, American National Standard, Quality Management System Requirements; ISO 14001,
American National Standard, Environmental Management System Requirements; and is compliant with
cGMP for products under FDA regulation.
Most of the raw materials used in the Company’s various processes are commercially available.
In some cases, Nanophase relies on sole-source processors of materials who utilize an array of worldwide
sources for the materials that they process to the Company’s specifications.
Nanomaterials
Nanomaterials are generally comprised of particles (nanoparticles) that are less than 100
nanometers in diameter, which have a wide range of unique properties owing to their very small size. A
nanometer is one-billionth of a meter, or about 100,000 times smaller in size than the width of a human
hair. To give another perspective, a six-foot tall person is around two-billion nanometers in height.
Nanotechnology involves manipulating the properties of materials, made up of basic elements or
combinations thereof, at the 100-nanometer level or below. At this scale, the relatively small number of
constituent atoms, the large proportion of these atoms on surfaces, and their confined dimensions lead
materials to exhibit unique properties that can be used in many applications.
Nanomaterials are an important and enabling part of the diverse field of nanotechnology. The
properties of nanomaterials, and hence their ultimate application performance and value, depend on the
composition, size, shape, structure and surface chemistry of their constituent nanoparticles, as well as the
production process used in their fabrication and other key parameters. The Company’s technologies for
engineering and manufacturing nanomaterials control these critical parameters resulting in nanomaterials
that Nanophase believes demonstrably offer superior performance in many applications.
Nanomaterials have applications in diverse global markets where they are incorporated into a
process, such as semiconductor polishing, or a product, such as an industrial coating to prevent UV
degradation or significantly improve wear resistance. Multiple markets exist for Nanophase’s products
3
since nanomaterials offer advantages in many applications, such as improved performance, longer wear or
product life, lower overall product cost, or in the development of new products or processes.
The Company’s Technologies
Nanophase has created an integrated platform of commercial nanomaterial technologies that are
patented, patent-pending, or proprietary and designed to deliver a nanomaterial solution for a targeted
market or a specific customer application. The Company’s platform provides flexibility and capability to
engineer nanomaterials that meet a customer’s performance requirements and deliver its nanomaterial
solutions in a readily usable format. Nanophase’s technologies have been demonstrably scalable and
robust, having produced over 400 metric tons annually.
The Company’s nanomaterials platform begins with two distinct manufacturing processes (PVS
and NanoArc™ Synthesis) to make nanomaterials or nanoparticles. These technologies allow Nanophase
to control critical nanomaterial properties (composition, size, shape, structure, surface chemistry) and
engineer those to meet application performance. Compared to other major known global nanoparticle
processes, the Company believes that its plasma-produced particles have a unique set of bulk and surface
properties and are produced as nonporous, dense, discrete single crystals. Nanophase currently has the
capacity to produce over a million pounds of nanomaterials annually
Nanophase has developed patented and proprietary technology to coat or surface treat
nanoparticles to further engineer surface chemistry by two main processes. For performance in many
applications, such as sunscreens, this technology is vital to ensure formulation compatibility and, in some
cases, optimal application performance. The Company has the capacity to coat or surface treat
nanoparticles at a rate of about a ton every eight hours and delivers over 300 tons of surface engineered
nanoparticles to its customers annually. As an example, Nanophase sells coated nanomaterials that are
used by major global consumer products companies for sunscreens and personal care products.
Nanophase also has developed proprietary technology to disperse nanoparticles in both aqueous
and several organic solvent systems. Due to its technologies, the Company is able to achieve highly
stable dispersions at high weight loading (18-50% by weight), which are both market advantages.
Dispersed nanomaterials are desired by many customers for use in their processes or products due to the
ease of handling. As examples, dispersed nanomaterials are used in architectural coatings, industrial
coatings, plastic additives and semiconductor polishing.
As markets continue to develop and grow, the Company believes that customers’ preferred
delivery formats will likely be coated or dispersed nanomaterials. Nanophase believes it is well
positioned with its platform of integrated commercial nanomaterial technologies. The Company plans to
maintain and evolve its intellectual property and technologies to remain at the forefront of nanomaterials
development.
Nanophase has steadily expanded both its patented technologies in the U.S. and internationally,
and its ability to commercially utilize these technologies. Through large-scale manufacturing of
nanomaterials utilized in the manufacture of consumer sunscreen and personal care products, the
Company has developed production expertise that has allowed it to improve processes relating to those
nanomaterials, as well as processes relating to other nanomaterials. This experience has translated into
additional patents, pending patents and improvement of the Company’s technologies and manufacturing
processes to reduce variable manufacturing cost and improve gross margins.
4
Marketing
Nanophase sells its products to markets using a dual strategy of market partners and customers.
Markets are selected based on the Company’s assessment of the amount of market-pull and the product
value proposition for its nanomaterial products to avoid situations that are actually a technology-push
with an accompanying unacceptable probability of market success.
Nanophase’s market partners currently include BASF Corporation (“BASF”), a $50+billion
global chemical company; Rohm & Haas Electronic Materials CMP Technologies, part of an $8 billion
global chemical company; Altana Chemie, a $1+billion chemical company who is a leader in coating and
plastic additives; and Alfa Aesar, a division of Johnson Matthey. Each market partner is viewed as a
leader in its respective markets with recognized brands and global sales reach. Nanophase has long-term
exclusive relationships with each of its market partners. Market partners incorporate the Company’s
nanomaterial products into their own products and/or sell Nanophase’s nanomaterial products into
specific markets.
Market partners offer Nanophase several advantages. Nanophase is able to leverage its sales and
distribution capabilities by using those of its market partners to sell its products globally and reach
markets that would be difficult or unattainable for the Company alone. The Company is also able to
leverage its new nanomaterial product development capabilities by collaborating with market partners’
application development scientists and engineers. Nanophase has current products with each market
partner, in some cases multiple products, and has focused new nanomaterial product development based
on the market partners’ knowledge and expertise in each market and product application. Nanophase
anticipates that revenue generation from current products will continue growing while new revenues will
be generated in the future through focused new product development and market introduction through its
market partners. Nanophase also anticipates developing new markets with new market partners.
BASF markets and distributes Nanophase’s nanomaterials for sunscreens (beach wear and daily
wear products) and personal care under the Z-Cote brand to consumer products companies globally. The
Company’s revenues from these nanomaterial products grew 23% in 2005 and 13% in 2006 and
continuing growth is expected. Nanophase has manufactured and shipped over 1,500 metric tons of Z-
Cote products.
During 2005, Nanophase was designated a ‘BASF Strategic Development Partner’ for new
products. In the same year, BASF and Nanophase launched a second line of sunscreen and personal care
nanomaterials under the Z-Cote MAX brand specifically targeted for European and Asian markets.
During 2006, BASF and Nanophase launched a new product, T-Lite MAX, for the sunscreen market and
anticipates launching another new sunscreen product during 2007. Additional new product development
is also underway for potential personal care products.
During 2000, BASF loaned Nanophase $1.3 million to purchase and install production equipment
to produce nanomaterial products for the Z-Cote brand. As part of Nanophase’s business model, the
Company expects its market partners to fund equipment that is primarily dedicated to produce their
products. Nanophase typically repays such loans through a sales discount on product over time. The
BASF note was retired in 2006.
Rohm & Haas Electronic Materials CMP Inc. (“RHEM”) uses the Company’s nanomaterial
products to manufacture slurry to polish semiconductors for the STI, SOL, and ILD0 technology nodes.
RHEM’s slurry products are marketed and used globally by semiconductor manufacturers. In 2005,
RHEM awarded Nanophase its “Excellence in Partnership” award and during 2006 made a $5 million
equity investment in the Company for its exclusive use of nanomaterial products for semiconductor
slurries.
5
Altana Chemie, and its subsidiary BYK Chemie, uses Nanophase’s nanomaterial products as
ingredients and additives for paints, coatings, polymers, plastics, inks and sealants under its NanoBYK
brand. Entering 2007, there are approximately eighteen products being distributed globally to companies
in these markets with plans to introduce more new products during 2007. Altana Chemie made a $10
million equity investment in Nanophase during 2004 to exclusively obtain the Company’s nanomaterial
products for the noted markets, with limited exceptions. Altana Chemie also loaned Nanophase $1.6
million to purchase and install nanomaterials production equipment during 2006 to support capacity
requirements related to volume growth.
Alfa Aesar is a global distributor of Nanophase-branded nanomaterials and nanomaterial
dispersions to the research and development community. Through catalogs, websites, and a dedicated
nanomaterials brochure, Alfa Aesar markets approximately 33 Nanophase nanomaterial products to the
global development community. Nanophase anticipates that as new products or processes are developed
using the Company’s nanomaterial products, increasing demand may have a positive impact on revenue
growth.
In addition to the Company’s market partners, Nanophase utilizes market-focused business
development to drive new product applications and customers. Business development includes evaluation
and qualification of potential markets, identification of potential lead customers, and developing a
strategy for successful market penetration.
Nanophase collaborates with potential customers to develop a nanomaterials solution for their
specific application. This approach increases the probability of application success, allows the Company
to use its integrated platform of nanomaterial technologies to optimize a nanomaterial solution for the
product application, and reduces the time-to-market. Nanophase’s application scientists work along with
the business development and sales team and the customer’s new product developers to develop a
nanomaterial solution to meet performance demands.
In addition to the applications with market partners, Nanophase currently has customers using its
nanomaterial products for DNA Bio-Sensors, water filtration, textile coatings, architectural coatings,
optics polishing, LCD screen polishing and other applications.
Technology and Engineering
Consisting of research and development, process engineering and advanced engineering groups,
the Company’s focus is in three major areas: 1) application development for its nanomaterial products; 2)
creating or obtaining additional core nanomaterial technologies, or nanomaterials, that have the capability
to serve multiple markets; 3) continuing to improve the Company’s core technologies to improve
operations and reduce costs.
Most of the research and development at Nanophase is directly related to product development
for applications. The Company endeavors to either meet specific customer needs or to develop
applications solutions to unmet needs in a particular market where its materials may offer a distinct
performance advantage. The Company believes that aggressively pursuing applications, inventions and
patents will help Nanophase maintain its position as a technical and commercial innovator in
nanomaterials.
Nanophase’s total research and development expense, which includes all expenses relating to the
technology and advanced engineering groups, during the years ended December 31, 2006, 2005 and 2004
was $2,127,862, $1,934,528 and $1,929,348, respectively. This represents the Company’s share of these
expenses only and does not take into account amounts spent by our largest customers in support of our
partnerships. The Company’s future success will depend in large part upon its ability to keep pace with
evolving advanced materials technologies and industry standards. Through the five-year period ended
6
December 31, 2006, the Company has had cumulative research and development expenses of
approximately $9.5 million and cumulative expenditures on equipment and leasehold improvements of
approximately $4.7 million. These investments in technology and production capacity and capability
have helped to take Nanophase from a development stage company to full commercialization.
Manufacturing Operations
The Company has manufacturing capacity based in two locations in the Chicago area. At each of
these facilities, Nanophase is able to develop and supply nanomaterials in quantities ranging from grams
to metric tons. Nanophase’s facilities are certified to ISO 9001:2000 international standards and are
current Good Manufacturing Practices (cGMP) compliant for applicable bulk pharmaceutical
manufacturing. The Company’s facilities are also certified to the international standard for environmental
management, ISO 14001:2004.
All processes are controlled under Lean Six-Sigma discipline with the capability to manufacture
precisely to application requirements. Unlike traditional quality control systems, Lean Six Sigma
provides methods to re-engineer processes to eliminate non-value added steps and create a system that
minimizes errors and defects. The Company’s Director of Quality is a certified Six Sigma Master Black
Belt. Nanophase requires that its manufacturing supervisors, engineers and technicians are trained and
become, at minimum, certified Green Belts.
Nanophase’s operations employ a cellular, team-based manufacturing approach, where workers
operate in work “cells,” under a Lean Manufacturing environment to continuously advance and improve
production capabilities. The Company’s manufacturing approach and targeted engineering actions have
resulted in continuing process innovations and improvements that have reduced the variable
manufacturing cost significantly over the past four years. Using Lean Six Sigma discipline, Nanophase
has been able to achieve 99% customer service levels with no customer returns over the last four years.
Management is committed to a Lean Manufacturing approach, to the extent possible given a
certain measure of irregular demand, where the Company is able to reduce excess labor and manage the
lowest practical inventory and supply levels in order to minimize working capital demands. This
approach complements two of the Company’s major operational goals which are to increase
nanomaterials output without adding to existing equipment and to continually reduce production costs.
Intellectual Property and Proprietary Rights
Nanophase relies primarily on a combination of patent, trademark, copyright, trade secret and
other intellectual property law, nondisclosure agreements and other protective measures to protect its
intellectual property. In addition to obtaining patent and trademarks based on the Company’s inventions
and products, Nanophase also licenses certain third-party patents from time-to-time to expand its
technology base.
During 2006, the Company re-evaluated its intellectual property strategy in view of changes at
the USPTO and the increasing cost of obtaining and maintaining patents. Based on this analysis,
Nanophase elected to abandon some patents and forgo continuation of some patent applications since the
Company had already improved or surpassed the intellectual property described.
As of the date of this report, Nanophase owns or licenses 18 US patents and patent applications
consisting of 10 issued or allowed US patents, 7 pending US patent applications, and 1 licensed US
patent. The 10 owned US patents consist of 4 for its nanoparticle synthesis technologies, 2 for its surface
treatment technologies and 4 for its nanoparticle applications. The Company’s pending US patents
consist of 3 in nanoparticle synthesis, 1 in nanoparticle surface treatments, and 3 in nanoparticle
applications. Correspondingly, the Company owns 48 foreign patents and patent applications consisting
7
of 23 issued or allowed foreign patents and 25 pending foreign patents applications. All of the pending
and owned foreign patents are counterparts to domestic filings covering its platform of nanotechnologies.
The Company’s oldest issued patents will begin to expire in 2009.
Nanophase has licensed its PVS technology for certain specific markets and certain geographies
to C.I. Kasei, a division of Itochu Corporation (“CIK”). Under this agreement, the Company earns
royalties on net sales of manufactured products containing nanocrystalline materials. The agreement
provides for minimum royalty payments to maintain exclusivity. The agreement expires on March 31,
2013 unless earlier terminated as provided therein. Upon the expiration, the license will become non-
exclusive.
See “Item 1A. Risk Factors” for a discussion of risks related to our intellectual property and
proprietary rights.
Competition
Within each of its targeted markets and product applications, Nanophase faces potential
competition from advanced materials and chemical companies and suppliers of traditional materials. In
many markets, the Company’s potential competitors are larger and more diversified than the Company;
although management believes its materials and related technologies are superior to those of its
competitors in terms of Nanophase’s ability to produce highly engineered products to meet specific
performance requirements.
With respect to traditional suppliers, the Company may compete against lower priced traditional
materials for certain customer applications. In some product or process applications the benefits of using
nanomaterials do not always outweigh their typically higher costs.
With respect to larger producers of nanomaterials, while many of these producers do not currently
offer directly competitive products, these companies have greater financial and technical resources, larger
research and development staffs and greater manufacturing and marketing capabilities and could begin to
compete directly against Nanophase. In addition, the number of development-stage companies involved
in nanocrystalline materials continues to grow on a global basis, posing increasing competitive risks.
Many of these companies are associated with university or national laboratories and use chemical and
physical methods to produce nanocrystalline materials. Management believes that most of these
companies are engaged primarily in funded research and is not aware that any of them have commercial
production capabilities; however, they may represent competitive risks in the future. Some development
stage companies, especially in other countries, receive significant government assistance. Management
anticipates that foreign competition may play a greater role in the nanomaterials arena in the future.
Nanophase believes that its nanomaterial technology platform is currently at the forefront of
nanomaterials. Relative to potential competition, Nanophase believes it is well positioned with its
platform of integrated commercial nanomaterial technologies and its current plans for continual
technology improvement and evolution.
Governmental Regulations
The manufacture and use of certain of the products that contain the Company’s nanocrystalline
materials are subject to governmental regulations. 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 that include testing, control and documentation requirements enforced by
periodic inspections.
8
Nanophase is committed to environmental health and safety (“EH&S”). We comply with all
permissible exposure limits standards issued by OSHA. Because nanotechnology remains an emerging
and evolving science, there are no currently accepted standards, measurements or personal protective
equipment available that are specific to nanoparticle safety. Accordingly, Nanophase relies on nuisance
dust standards and general chemical safety to identify safe personal protective equipment and appropriate
handling protocols. The Company believes that it has taken a leadership position on EH&S in its
operations and fugitive emissions, and has internal and external review and monitoring of its practices.
In addition, the Company’s facilities and all of its operations are subject to the plant and
laboratory safety requirements of various environmental and occupational safety and health laws. We
believe we are in compliance with all such laws and regulations and to date, those regulations have not
materially restricted or impeded operations.
Nanophase has taken a responsible, proactive approach to Environmental Health and Safety by
implementing appropriate procedures and processes to have its facilities certified to ISO 14001, American
National Standard, Environmental Management System Requirements. The Company is also involved
with leading industry groups that are defining nanomaterial standards and protocols. These currently
include the ASTM International Committee on Nanotechnology, the National Pollution Prevention and
Toxics Advisory Committee – TSCA Voluntary Program, the American National Standards Institute
(ANSI), and participate in FDA reviews relative to cosmetic applications. The Company has a fulltime,
advanced degreed professional to manage government regulation compliance and EH&S.
Employees
On January 8, 2007, the Company hired Kevin J. Wenta as its Executive Vice President of Sales
and Marketing. He brings twenty years of business development, sales, marketing, finance and operations
experience to Nanophase. Prior to joining the company, Mr. Wenta was a Partner at Accenture, a global
consultancy. Previous to that he was a General Manager at Eastman Chemical Company and held the
position of Director of Corporate Strategy. Previous experience also includes positions at ChemConnect
(formerly CheMatch), ARCO and Shell Chemical. Mr. Wenta holds a B.S. degree in Chemical
Engineering from the University of Texas at Austin and a M.B.A. degree from the University of Chicago.
On December 31, 2006, the Company had a total of 60 full-time employees, 11 of who hold
advanced degrees. Nanophase has no collective bargaining agreements or relationships.
Backlog
Nanophase does not believe that a backlog as of any particular date is indicative of future results.
The Company’s sales are made primarily pursuant to purchase orders for delivery of nanomaterials.
Nanophase has some agreements that give customers the right to purchase a specific quantity of
nanomaterials during a specified time period. These agreements, however, often do not obligate the
customers either to purchase any particular quantity of such nanomaterials at all, or in the case where an
obligation exists, the risk to the customer for not purchasing nanomaterials is the loss of exclusivity. The
quantities actually purchased by the customer, as well as the shipment schedules, are frequently revised
during the agreement term to reflect changes in the customer’s needs. The Company does not believe that
such agreements are meaningful for determining backlog amounts.
9
Business Segment and Geographical Information
See Note 16 to the Financial Statements for additional information.
Key Customers
A limited number of key customers account for a substantial portion of the Company’s
commercial revenue. In particular, revenue from BASF, the Company’s new significant customer in
architectural coatings and RHEM constituted approximately 56.1%, 22.1% and 9.5%, respectively, of the
Company’s 2006 total revenue. The Company’s customers are significantly larger than the Company and
are able to exert a high degree of influence over the Company. While the Company’s agreements with
two customers are long-term agreements, they may be terminated by the customer with reasonable notice
and do not provide any guarantees that these customers will continue to buy the Company’s products.
The loss of one of these key customers or the failure to attract new customers could have a material
adverse effect on the Company’s business, results of operations and financial condition. See Item 1A.
Risk factors for additional discussion.
Forward-Looking Statements
Nanophase wants to provide investors with more meaningful and useful information. As a result,
this Annual Report on Form 10-K (the “Form 10-K”) contains and incorporates by reference certain
“forward-looking statements”, as defined in Section 21E of the Securities Exchange Act of 1934, as
amended. These statements reflect the Company’s current expectations of the future results of its
operations, performance and achievements. Forward-looking statements are covered under the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. The Company has tried, wherever
possible, to identify these statements by using words such as “anticipates”, “believes”, “estimates”,
“expects”, “plans”, “intends” and similar expressions. These statements reflect management’s current
beliefs and are based on information now available to it. Accordingly, these statements are subject to
certain risks, uncertainties and contingencies that could cause the Company’s actual results, performance
or achievements in 2007 and beyond to differ materially from those expressed in, or implied by, such
statements. These risks, uncertainties and factors include, without limitation: a decision by a customer to
cancel a purchase order or supply agreement in light of the Company’s dependence on a limited number
of key customers; uncertain demand for, and acceptance of, the Company’s nanocrystalline materials; the
Company’s manufacturing capacity and product mix flexibility in light of customer demand; the
Company’s limited marketing experience; changes in development and distribution relationships; the
impact of competitive products and technologies; the Company’s dependence on patents and protection of
proprietary information; the resolution of litigation in which the Company may become involved; and
other risks set forth under the caption “Risk Factors” below. Readers of this Annual Report on Form 10-K
should not place undue reliance on any forward-looking statements. Except as required by federal
securities laws, the Company undertakes no obligation to update or revise these forward-looking
statements to reflect new events or uncertainties.
Investor Information
The Company is subject to the informational requirements of the Securities Exchange Act of
1934 (the Exchange Act) and, accordingly, files periodic reports, proxy statements and other information
with the Securities and Exchange Commission (the SEC). Such reports, proxy statements and other
information may be obtained by visiting the Public Reference Room of the SEC at 450 Fifth Street, NW,
Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an
Internet site (http://www.sec.gov) that contains reports, proxy and information statements and other
information regarding issuers that file electronically.
10
Financial and other information may also be accessed at the Company’s web site. The address is
www.nanophase.com. The Company makes available, free of charge, copies of its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable
after filing such material electronically with, or otherwise furnishing it to, the SEC, and intends to make
all such reports and amendments to reports available free of charge on its web site.
Item 1A. Risk Factors
The following risks, uncertainties, and other factors could have a material adverse effect on our
business, financial condition, operating results and growth prospects.
We have a limited operating history and may not be able to address difficulties encountered by companies
in new and rapidly evolving markets.
We have only a limited operating history. We were formed in November 1989 and began our
commercial nanomaterials operations in January 1997. We have not yet generated a significant amount of
revenue from our nanomaterials operations. Because of our limited operating history and the early stage
of development of our rapidly evolving market, we have limited insight into trends that may emerge and
adversely affect our business and cannot be certain that our business strategy will be successful or that it
will successfully address these risks. In addition, our efforts to address any of these risks may distract
personnel or divert resources from other more important initiatives, such as attracting and retaining
customers and responding to competitive market conditions.
We have a history of losses that may continue in the future.
We have incurred net losses in each year since our inception with net losses of $6.45 million in
2004, $5.38 million in 2005 and $5.18 million in 2006. As of December 31, 2006, we had an accumulated
deficit of approximately $62.74 million and could expect to continue to incur losses on an annual basis
through at least the end of 2007. We believe that our business depends, among other things, on our ability
to significantly increase revenue. If revenue fails to grow at anticipated rates or if operating expenses
increase without a commensurate increase in revenue, or if we fail to adjust operating expense levels
accordingly, then the imbalance between revenue and operating expenses will negatively impact our cash
balances and our ability to achieve profitability in future periods.
We depend on a small number of customers for a high percentage of our sales, and the loss of orders
from a significant customer could cause a decline in revenue and/or increases in the level of losses
incurred.
Sales to our customers are executed pursuant to purchase orders and long-term supply contracts;
however, customers can cease doing business with us at any time with limited advance notice. We expect
a significant portion of our future sales to remain concentrated within a limited number of strategic
customers. We may not be able to retain our strategic customers, such customers may cancel or
reschedule orders, or in the event of canceled orders, such orders may not be replaced by other sales or by
sales that are on as favorable terms. In addition, sales to any particular customer may fluctuate
significantly from quarter to quarter, which could affect our ability to achieve anticipated revenues on a
quarterly basis.
Revenue from BASF Corporation, the Company’s new significant customer in architectural
coatings and Rohm and Haas Electronic Materials CMP Inc. (“RHEM”) (formerly known as “Rodel”),
accounted for approximately 88% of total revenue for the year ended December 31, 2006, and revenue
from the same three customers accounted for approximately 79% of total revenue in 2005. For the years
11
ended December 31, 2006 and 2005, BASF accounted for 56% and 66% of our total revenue,
respectively. If we were to lose, or receive significantly decreased orders from, any of these three
customers, then our results of operations would be materially harmed. While our agreements with our
largest customers are long-term agreements, they may be terminated by the customer with reasonable
notice and do not provide any guarantees that these customers will continue to buy our products. In
addition, while our agreements with BASF contain certain order requirements, the only repercussion
under the agreements for missing the order requirements is that we would be freed from the exclusivity
obligations under the BASF contracts.
We have been consistently expanding both our marketing and business development efforts and
our production efficiency in order to address the issues of our dependence upon a limited amount of
customers, enhancement of gross profit and operating cash flows, and the achievement of profitability.
We currently have customers that may grow to the point where they generate significant revenues and
margins as relationships expand. Given the special nature of our products, and the fact that markets for
them are not yet fully developed, it is difficult to accurately predict when additional large customers will
materialize. Going forward, the Company’s margins, as a percentage of revenue, will be dependent upon
revenue mix, revenue volume and the Company’s ability to continue to cut costs. The extent of the
growth in revenue volume and the related gross profit that this revenue generates, will be the main drivers
in generating positive operating cash flows and, ultimately, net income.
Any downturn in the markets served by us would harm our business.
A majority of our products are incorporated into products such as sunscreens, architectural
coatings, polishing slurries, personal care, and to a lesser extent, medical diagnostics, abrasion-resistant
coatings for flooring, and other products. These markets have from time to time experienced cyclical,
depressed business conditions, often in connection with, or in anticipation of, a decline in general
economic conditions. These industry downturns have resulted in reduced product demand and declining
average selling prices. Our business would be harmed by any future downturns in the markets that we
serve.
Our products often have long adoption cycles, which could make it difficult to achieve market acceptance
and makes it difficult to forecast revenues.
Due to their often novel characteristics and the unfamiliarity with them that exists in the
marketplace, our nanomaterials often require longer adoption cycles than existing materials technologies.
Our nanomaterials have to receive appropriate attention within any potential customer’s organization,
then they must be tested to prove a performance advantage over existing materials, typically on a
systems-cost basis. Once we have proven initial commercial viability, pilot scale production runs must be
completed by the customer, followed by further testing. Once production-level commercial viability is
established, then our nanomaterials can be introduced, often to a downstream marketplace that needs to be
familiarized with them. If we are unable to demonstrate to our potential customers the performance
advantages and economic value of our nanomaterials over existing and competing materials and
technologies, we will be unable to generate significant sales. Our long adoption cycle makes it difficult to
predict when sales will occur.
We frequently depend on collaborative development relationships with our customers and do not have a
substantial direct sales force or an established distribution network apart from the distribution networks
of our strategic partners. If we are unable to initiate or sustain such collaborative relationships or if the
terms of these relationships limit the distribution of our products or if our strategic partners are unable to
distribute our products efficiently, then we may be unable to independently develop, manufacture or
market our current and future nanomaterials or applications.
We have established, and will continue to pursue, strategic relationships with many of our
12
customers and do not have a substantial direct sales force or an established distribution network (other
than distribution arrangements for research samples). Through these relationships, we seek to develop
new applications for our nanomaterials and share development and manufacturing resources. We also
seek to coordinate the development, manufacture and marketing of our nanomaterials products. Future
success will depend, in part, on our continued relationships with these customers and our ability to enter
into similar strategic relationships with other customers. Our customers may not continue in these
collaborative development relationships, may not devote sufficient resources to the development or sale
of our materials or may enter into strategic development relationships with our competitors. These
customers may also require a share of control of these collaborative programs. Some of our agreements
with these customers limit our ability to license our technology to others and/or limit our ability to engage
in certain product development or marketing activities with others. These relationships generally can be
terminated unilaterally by customers.
Additionally, except for our research quantities distribution agreement with Alfa Aesar, these
customers generally require exclusive distribution arrangements within the field of application covered by
our agreement with these customers, and the very nature of these strategic relationships limits the
distribution of our products to the distribution networks available to our strategic relationship partners. In
addition, the development agreements with some of our larger customers contain provisions that require
us to license our intellectual property to these customers on disadvantaged terms and/or sell equipment to
these customers in the event that we materially breach these agreements or fail to satisfy certain financial
covenants. For example, see “Risk Factors—We may need to raise additional capital in the future.”
If we are unable to initiate or sustain such collaborative relationships or if the terms of these
relationships materially limit our access to distribution channels for our products, then we may be unable
to independently develop, manufacture or market our current and future nanomaterials or applications.
If commodity metal prices increased at such a rate that we are unable to recover lost margins on a timely
basis or that our products became uncompetitive in their current marketplaces, our financial and liquidity
position and results of operations would be substantially harmed.
Many of our significant raw materials come from commodity metal markets that may be subject
to rapid price increases. While we generally pass commodity price increases on to our customers, it is
possible that, given our limited customer base and the limited control we have over it, commodity metal
prices could increase at such a rate that could hinder our ability to recover lost margins from our
customers on a timely basis. It is also possible that such drastic cost increases could render some of our
materials uncompetitive in their current marketplaces when considered relative to other materials on a
cost benefit basis. If either of these potential results occurred, our financial and liquidity position and
results of operations would be substantially harmed.
If a catastrophe strikes either of our manufacturing facilities or if we were to lose our lease for either
facility due to non-renewal or other unforeseen events, we may be unable to manufacture our materials to
meet customers’ demands.
Our manufacturing facilities are located in Romeoville and Burr Ridge, Illinois. These facilities
and some of our manufacturing and testing equipment would be difficult to replace in a timely manner.
Therefore, any material disruption at one of our facilities due to a natural or man-made disaster or a loss
of lease due to non-renewal or other unforeseen events could have a material adverse effect on our ability
to manufacture products to meet customers’ demands. While we maintain customary property insurance,
this insurance may not adequately compensate us for all losses that we may incur and would not
compensate us for any interruption in our business.
If we are unable to expand our production capabilities to meet unexpected demand, we may be unable to
manage our growth and our business would suffer.
13
Our success will depend, in part, on our ability to manufacture nanomaterials in significant
quantities, with consistent quality and in an efficient and timely manner. We expect to continue to
expand our current facilities or obtain additional facilities in the future in order to respond to unexpected
demand for existing materials or for new materials that we do not currently make in quantity. Such
unplanned demand, if it resulted in rapid expansion, could create a situation where growth could become
difficult to manage, which could cause us to lose potential revenue.
Protection of our intellectual property is limited and uncertain
Our intellectual property is important to our business. We seek to protect our intellectual property
through patent, trademark, trade secret protection and confidentiality or license agreements with our
employees, customers, suppliers and others. Our means of protecting our intellectual property rights in the
United States or abroad may not be adequate and others, including our competitors, may use our
proprietary technology without our consent. We may not receive the necessary patent protection for any
applications pending with the U.S. Patent and Trademark Office (“USPTO”) and any of the patents that
we currently own or license may not be sufficient to keep competitors from using our materials or
processes. In addition, patents that we currently own or license may not be held valid if subsequently
challenged by others and others may claim rights in the patents and other proprietary technology that we
own or license. Additionally, others may have already developed or may subsequently develop similar
products or technologies without violating any of our proprietary rights. If we fail to obtain patent
protection or preserve our trade secrets, we may be unable to effectively compete against others offering
similar products and services. In addition, if we fail to operate without infringing the proprietary rights of
others or lose any license to technology that we currently have or will acquire in the future, we may be
unable to continue making the products that we currently make.
Moreover, at times, attempts may be made to challenge the prior issuance of our patents. For
example, the USPTO has granted a third-party request for re-examination with respect to one patent
relating to one of our nanoparticle manufacturing processes. On September 7, 2005, our representatives
conducted an interview with the Examiner assigned to the re-examination at the USPTO, resulting in the
Examiner preparing an interview summary indicating that rejections to issued claims may be formally
withdrawn. However, prior to the USPTO issuing a formal notice confirming patentability, the same
third party filed a second request for re-examination of the patent (which second request, the USPTO has
since denied). Nonetheless, a second interview was conducted, resulting in an amendment to all patent
claims. Thereafter, a third request for re-examination was filed and granted by the USPTO. We
subsequently conducted a third interview with the Examiner and responded to the third request. While we
will continue to vigorously defend our patent position, we may not be successful in maintaining the scope
of the claims of this patent during re-examination. While the Company intends to vigorously defend its
patent protection against such claims, it does not believe that these patent claims pose a risk of material
harm to the Company’s business prospects or competitive positions. If the scope of the Company’s claims
protected by the patent in question were ultimately reduced through the pending re-examination
proceedings before the USPTO, the Company would still continue to be able to conduct its business as
currently conducted, including the use of the technology that is the subject of the patented claims. A
reduction in the scope of the claims protected by the Company’s patent in question would limit the
Company’s ability to assert infringement claims and suits against other parties using the same or
sufficiently similar technology. The Company believes that while patent protection is a valuable asset, a
reduction in the scope of the claims protected by the Company’s patent in question would not materially
alter the competitive environment in which the Company operates or result in a material loss.
Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect our
trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of
resources and could harm our business, operating results and financial condition. In addition, if others
assert that our technology infringes their intellectual property rights, resolving the dispute could divert our
14
management team and financial resources.
In the future, we may license certain of our intellectual property, such as trademarks or
copyrighted material, to third parties. While we would attempt to ensure that any licensees maintain the
quality and value of our brand, these licenses might diminish this quality and value.
We may be subject to claims that one or more of the business methods used by us infringe upon
patents held by others. The defense of any claims of infringement made against us by third parties could
involve significant legal costs and require our management to divert time and other resources from our
business operations. Either of these consequences of an infringement claim could have a material adverse
effect on our operating results. If we are unsuccessful in defending any claims of infringement, we may
be forced to obtain licenses or pay royalties to continue to use our technology. We may not be able to
obtain any necessary licenses on commercially reasonable terms or at all. If we fail to obtain necessary
licenses or other rights, or if these licenses are costly, our operating results may suffer either from
reductions in revenue through our inability to serve clients or from increases in costs to license third-party
technology.
Our industry is experiencing rapid changes in technology. If we are unable to keep pace with these
changes, our business will not grow.
Rapid changes have occurred, and are likely to continue to occur, in the development of advanced
materials and processes. Our success will depend, in large part, upon our 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. We expect to commit substantial resources to develop our
technologies and product applications and, in the future, to expand our commercial manufacturing
capacity as volume grows. Our development efforts may be rendered obsolete by the research efforts and
technological advances of others and other advanced materials may prove more advantageous than those
we produce.
The markets we serve are highly competitive, and if we are unable to compete effectively, then our
business will not grow.
The advanced materials industry is new, rapidly evolving and intensely competitive, and we
expect competition to intensify in the future. The market for materials having the characteristics and
potential uses of our nanomaterials is the subject of intensive research and development efforts by both
governmental entities and private enterprises around the world. We believe that the level of competition
will increase further as more product applications with significant commercial potential are developed.
The nanomaterials product applications that we are developing will compete directly with products
incorporating both conventional and advanced materials and technologies. While we are not currently
aware of the existence of commercially available competitive products with the same attributes as those
we offer, other companies may develop and introduce new or competitive products. Our competitors may
succeed in developing or marketing materials, technologies and better or less expensive products than the
ones we offer. In addition, many of our potential competitors have substantially greater financial and
technical resources, and greater manufacturing and marketing capabilities than we do. If we fail to
improve our current and potential nanomaterials product applications at an acceptable price, or otherwise
compete with producers of conventional materials, we will lose market share and revenue to our
competitors.
We may need to raise additional capital in the future. If we are unable to obtain adequate funds, we may
be required to delay, scale-back or eliminate some of our manufacturing and marketing operations or we
may need to obtain funds through arrangements on less favorable terms or we may be required to sell
equipment to our largest customer.
15
We expect to expend significant resources on research, development and product testing, and in
expanding current capacity or capability for new business. In addition, we may incur significant costs in
preparing, filing, prosecuting, maintaining and enforcing our patents and other proprietary rights. If
necessary, we may seek funding through public or private financing and through contracts with
government or other companies. Additional financing may not be available on acceptable terms or at all.
If we are unable to obtain adequate funds, we may be required to delay, scale-back or eliminate some of
our manufacturing and marketing operations or we may need to obtain funds through arrangements on
less favorable terms. If we obtain funding on unfavorable terms, we may be required to relinquish rights
to some of our intellectual property.
To raise additional funds in the future, we would likely sell our equity or debt securities or enter
into loan agreements. To the extent that we issue debt securities or enter into loan agreements, we may
become subject to financial, operational and other covenants that we must observe. In the event that we
were to breach any of these covenants, then the amounts due under such loans or debt securities could
become immediately payable by us, which could significantly harm us. To the extent that we sell
additional shares of our equity securities, our stockholders may face economic dilution and dilution of
their percentage of ownership.
We currently have supply agreements with BASF and RHEM that contain provisions which could
potentially result in a mandatory license of technology and sale of production equipment to the customer
providing capacity sufficient to meet its production needs. Under our supply agreement with BASF, a
“triggering event” also would occur if:
•
•
our earnings for a twelve month period ending with our most recently
published quarterly financial statements are less than zero and our cash, cash
equivalents and investments are less than $2,000,000, or
the acceleration of any debt maturity having a principal amount of more than
$10,000,000, or we become insolvent as defined in the supply agreement.
In the event of a triggering event where we are required to sell to BASF production equipment
providing capacity sufficient to meet BASF’s production needs, the equipment would be sold at 115% of
the equipment’s net book value.
We believe that we have sufficient cash balances to avoid the first triggering event for the
foreseeable future. If a triggering event were to occur and BASF elected to proceed with the license and
related sale mentioned above, we would lose both significant revenue and the ability to generate
significant revenue to replace that which was lost in the near term. Replacement of necessary equipment
that would be purchased and removed by BASF pursuant to this triggering event could take six months to
a year. Any additional capital outlays required to rebuild capacity would probably be greater than the
proceeds from the purchase of the assets pursuant to our agreement with BASF. This shortfall might put
us in a position where it would be difficult to secure additional funding given what would then be an
already tenuous cash position. Such an event would also result in the loss of many of our key staff and
line employees due to economic realities. We believe that our employees are a critical component of our
success and would be difficult to quickly replace and train. Given the occurrence of such an event, we
might not be able to hire and retrain skilled employees given the stigma relating to such an event and its
impact on us. We might elect to effectively reduce our size and staffing to a point where we could remain
a going concern in the near term.
We depend on key personnel, and their unplanned departure could harm our business.
Our success will depend, in large part, upon our ability to attract and retain highly qualified
research and development, management, manufacturing, marketing and sales personnel on favorable
16
terms. Due to the specialized nature of our business, we may have difficulty locating, hiring and retaining
qualified personnel on favorable terms. If we were to lose the services of any of our key executive
officers or other key personnel, or if we are unable to attract and retain other skilled and experienced
personnel on acceptable terms in the future, or if we are unable to implement a succession plan to prepare
qualified individuals to assume key roles upon any loss of our key personnel, then our business, results of
operations and financial condition would be materially harmed. In addition, we do not currently have
“key-man” life insurance policies covering all of our executive officers or key employees, nor do we
presently have any plans to purchase such policies.
We face potential product liability risks which could result in significant costs that exceed our insurance
coverage, damage our reputation and harm our business.
We may be subject to product liability claims in the event that any of our nanomaterials product
applications are alleged to be defective or cause harmful effects to humans or physical environments.
Because our nanomaterials are used in other companies’ products, to the extent our customers become
subject to suits relating to their products, such as cosmetic, skin-care, architectural coatings and personal-
care products, these claims may also be asserted against us. We may incur significant costs including
payment of significant damages, in defending or settling product liability claims. We currently maintain
insurance coverage in the amount of $10 million for product liability claims, which may prove not to be
sufficient. Even if a suit is without merit and regardless of the outcome, claims can divert management
time and attention, injure our reputation and adversely affect demand for our nanomaterials.
We are subject to governmental regulations. The costs of compliance and liability for noncompliance with
governmental regulations could have a material adverse effect on our business, results of operations and
financial condition.
Current and future laws and regulations may require us to make substantial expenditures for
preventive or remedial action. Our operations, business or assets may be materially and adversely affected
by governmental interpretation and enforcement of current or future environmental, health and safety
laws and regulations. In addition, our coating and dispersion operations pose a risk of accidental
contamination or injury. The damages in the event of an accident or the costs to prevent or remediate a
related event could exceed both the amount of our liability insurance and our resources or otherwise have
a material adverse effect on our business, results of operations and financial condition.
In addition, both of our facilities and all of our operations are subject to the plant and laboratory
safety requirements of various occupational safety and health laws. We believe we have complied in all
material respects with governmental regulations applicable to us. However, we may have to incur
significant costs in defending or settling future claims of alleged violations of governmental regulations
and these regulations may materially restrict or impede our operations in the future. In addition, our
efforts to comply with or contest any regulatory actions may distract personnel or divert resources from
other important initiatives.
The manufacture and use of certain products that contain our nanomaterials are subject to
extensive governmental regulation, including regulations promulgated by the U.S. Food and Drug
Administration, the U.S. Environmental Protection Agency and the U.S. Occupational Safety and Health
Administration. As a result, we are required to adhere to the requirements of the regulations of
governmental authorities in the United States and other countries. These regulations could increase our
cost of doing business and may render some potential markets prohibitively expensive.
We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if an
acquisition could be beneficial to our stockholders.
In October 1998, we entered into a Rights Agreement, commonly referred to as a “poison pill.”
17
The provisions of this agreement and some of the provisions of our certificate of incorporation, our
bylaws and Delaware law could, together or separately:
•
•
•
discourage potential acquisition proposals;
delay or prevent a change in control; and
limit the price that investors might be willing to pay in the future for shares
of our common stock.
In particular, our board of directors is authorized to issue up to 24,088 shares of preferred stock
(less any outstanding shares of preferred stock) with rights and privileges that might be senior to our
common stock, without the consent of the holders of the common stock, including up to 2,500 shares of
Series A Junior Participating Preferred Stock issuable under the 1998 Rights Agreement.
In addition, Section 203 of the Delaware General Corporations Law relating to business
combinations with related stockholders and the terms of our stock option plans relating to changes of
control may discourage, delay or prevent a change in control of our company.
Future sales of our common stock by existing stockholders could negatively affect the market price of our
stock and make it more difficult for us to sell stock in the future.
Sales of our common stock in the public market, or the perception that such sales could occur,
could result in a decline in the market price of our common stock and make it more difficult for us to
complete future equity financings. A substantial number of shares of our common stock and shares of
common stock subject to outstanding warrants and options may be resold pursuant to currently effective
registration statements. As of March 1, 2007, there are:
•
•
•
•
•
15,991,308 shares of common stock that have been issued in registered
offerings, upon the exercise of options under our equity incentive plan or
in private placements and are freely tradable in the public markets,
1,481,290 shares of common stock that may be issued on the exercise of
stock options outstanding and exercisable under our equity incentive plan;
906,002 shares of common stock that were issued pursuant to our
September 8, 2003 private placement and the related warrant which was
exercised on September 2, 2004. The resale of these shares has been
registered pursuant to a Registration Statement on Form S-3 which was
declared effective by the Securities and Exchange Commission on August
13, 2004; and
1,256,281 shares of common stock that were issued pursuant to our March
23, 2004 private placement and may be registered for resale after March
23, 2006 pursuant to a Registration Statement on Form S-3 which was
filed with the Securities and Exchange Commission on February 5, 2007.
847,918 shares of common stock that were issued pursuant to our August
25, 2006 private placement and may be registered for resale after August
25, 2008 pursuant the terms of the Registration Rights Agreement
executed in connection with this private placement.
We cannot estimate the number of shares of common stock that may actually be resold in the
18
public market because this will depend on the market price for our common stock, the individual
circumstances of the sellers, and other factors. If stockholders sell large portions of their holdings in a
relatively short time, for liquidity or other reasons, the market price of our common stock could decline
significantly.
Bradford T. Whitmore has significant influence on all matters requiring stockholder approval because he
beneficially owns a large percentage of our common stock, and he may vote the common stock in ways
with which our other stockholders disagree.
As of March 1, 2007, Bradford T. Whitmore, together with his affiliates, Grace Brothers, Ltd. and
Grace Investments, Ltd., beneficially owned approximately 19% of the outstanding shares of our common
stock. As a result, he has significant influence on matters submitted to our stockholders for approval,
including proposals regarding:
•
•
•
any merger, consolidation or sale of all or substantially all of our assets;
the election of members of our board of directors; and
any amendment to our certificate of incorporation.
The ownership position of Mr. Whitmore could delay, deter or prevent a change of control or
adversely affect the price that investors might be willing to pay in the future for shares of our common
stock. Mr. Whitmore’s interests may be significantly different from the interests of our other
stockholders and he may vote the common stock he beneficially owns in ways with which our other
stockholders disagree. Investors in the Company should also note that R. Janet Whitmore, one of our
directors, is the sister of Mr. Whitmore.
We have been involved in litigation. If we are involved in similar litigation in the future, the expense of
defending such litigation and the potential costs of judgments against us and the costs of maintaining
insurance coverage could have a material adverse effect on our financial performance.
We have been involved in three securities class action lawsuits, one of which was a consolidation
of several related lawsuits. While all of these lawsuits have been settled and dismissed with all
settlements funded by our directors and officers liability insurance, we may be the target of additional
securities lawsuits in the future. If we are involved in similar litigation in the future, the expense of
defending such litigation, the potential costs of judgments against us, the costs of maintaining insurance
coverage and the diversion of management’s attention could have a material adverse effect on our
financial performance.
Our stock price is volatile.
The stock markets in general, and the stock prices of technology-based companies in particular,
have experienced extreme volatility that often has been unrelated to the operating performance of any
specific public company. The market price of our common stock has fluctuated in the past and is likely to
fluctuate in the future as well. Our future financial performance and stock price may be subject to
significant volatility, particularly on a quarterly basis. Shortfalls in our revenues in any given period
relative to the levels expected by investors could immediately, significantly and adversely affect the
trading price of our common stock.
Dilutive Effect of Private Placements
On September 8, 2003 we sold 453,001 shares of our common stock to Grace Brothers, Ltd. at a
purchase price of $4.415 per share together with a warrant to purchase a like number of shares of
19
common stock during the next twelve months also at a price of $4.415 per share. This warrant was
exercised on September 2, 2004 to acquire 453,001 newly issued shares of common stock. The share
price for the common stock was determined based on the fifteen-day market closing average for our stock
ending September 5, 2003. On September 8, 2003 and September 2, 2004 the closing sale price of our
common stock as reported on NASDAQ, was $5.50 and $5.49 respectively, per share. On March 23, 2004
we sold 1,256,281 shares of our common stock to Altana at a purchase price of $7.96 per share. The share
price for the common stock was determined based on the ten-day market closing average for our stock
ending March 18, 2004. On March 23, 2004 the closing sale price of our common stock, as reported on
NASDAQ, was $8.26 per share. On August 25, 2006 we sold 847,918 shares of our common stock to
Rohm and Haas Electronics Materials CMP Holdings, Inc. at a purchase price of $5.8968 per share. The
share price for the common stock was determined based on the twenty-five-day market closing average
for our stock ending August 21, 2006. On August 25, 2006 the closing price of our common stock, as
reported on NASDAQ, was $6.71 per share. Each of these averages was negotiated with the respective
investors in an effort to approximate a market price, given volatility. Each of these issuances of stock, at
their respective subsequent closing dates, represented below then-current market pricing (looking only at
that closing date for this measurement) and, in that context, had a dilutive effect on existing common
stockholders.
We have never paid dividends.
We currently intend to retain earnings, if any, to support our growth strategy. We do not
anticipate paying dividends on our stock in the foreseeable future.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Nanophase operates a 36,000 square-foot production, research and headquarters facility in
Romeoville, Illinois and a 20,000 square-foot production facility in Burr Ridge, Illinois. Both locations
are in Chicago suburbs. The Company also leases a 9,000 square-foot offsite warehouse in the same
vicinity.
The Company’s manufacturing operations in Burr Ridge are certified under ISO 9001:2000, and
the Company’s management believes that its manufacturing operations are within the current Good
Manufacturing Practices (cGMP) requirements of the FDA for products that require such compliance.
The Company’s facilities are also ISO 14001:2004 certified which is the international standard for
environmental management. The Burr Ridge facility has a quality control laboratory designed for the dual
purposes of validating operations to cGMP and ISO standards and production process control. This
laboratory is equipped to handle many routine analytical and in-process techniques the Company
currently requires.
facility houses
The Romeoville
the Company’s headquarters, advanced engineering,
manufacturing (nanoparticle coating, nanoparticle dispersion, and pilot-scale manufacturing) and three
research and development laboratories, and was used for additional commercial manufacturing space in
2005. All Romeoville manufacturing processes are certified to ISO 9001:2000 and ISO 14001:2004, and
the Company’s management believes that the nanoparticle coating used for sunscreens and personal care
is in compliance with the cGMP requirements of the FDA.
Nanophase leases both its Romeoville and Burr Ridge facilities. On October 18, 2005 Nanophase
entered into a Lease Amendment amending its current lease for its facilities in Romeoville, Illinois,
which, among other things, extended the term of such lease through December 31, 2015 (with the option
20
to extend the term for two additional five year periods) and granted Nanophase an option to purchase such
facility in certain instances. The Company renewed its Burr Ridge facility lease in September 2004. The
initial term of the lease expires in September 2007, but the Company has options to extend the lease for
up to three additional one-year terms.
Management believes that the Company’s leased facilities provide sufficient capacity to fulfill
current known customer demand as well as additional space to enable expansion of key production
processes. Management also believes that the Company’s capital expenditures made in 2006, and
budgeted for 2007, will support currently anticipated demand from existing customers. The Company’s
actual future capacity requirements will depend on many factors, including new and potential customer
acceptance of the Company’s current and potential nanomaterials and product applications, unknown and
currently unplanned growth from existing customers, continued progress in the Company’s research and
development activities and product testing programs and the magnitude of these activities and programs.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company’s security holders during the fourth quarter
of 2006.
21
PART II
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
The Company’s common stock is traded on the NASDAQ Global Market under the symbol
NANX. The following table sets forth, for the periods indicated, the range of high and low sale prices for
the common stock on the NASDAQ Global Market:
Fiscal year ended December 31, 2006:
First Quarter ..........................................................................
Second Quarter ......................................................................
Third Quarter.........................................................................
Fourth Quarter .......................................................................
Fiscal year ended December 31, 2005:
First Quarter ..........................................................................
Second Quarter ......................................................................
Third Quarter.........................................................................
Fourth Quarter .......................................................................
$
$
High
Low
8.31
8.42
7.15
7.35
9.20
7.07
7.65
6.96
$
$
5.46
5.10
5.50
5.90
5.32
4.75
5.50
5.05
On March 1, 2007, the last reported sale price of the common stock was $5.71 per share, and
there were approximately 156 holders of record of the common stock.
The Company has never declared or paid any cash dividends on its common stock and does not
currently anticipate paying any cash dividends or other distributions on its common stock in the
foreseeable future. The Company intends instead to retain any future earnings for reinvestment in its
business. Any future determination to pay cash dividends will be at the discretion of the Company’s
Board of Directors and will be dependent upon the Company’s financial condition, results of operations,
capital requirements and such other factors deemed relevant by the Board of Directors.
On August 25, 2006, the Company sold, in a private placement to Rohm and Haas Electronic
Materials CMP Holdings, Inc., 847,918 shares of common stock at $5.8968 per share and received gross
proceeds of $5.0 million. On March 23, 2004, the Company sold, in a private placement to Altana
Chemie AG (“Altana”), 1,256,281 shares of common stock at $7.96 per share and received gross
proceeds of $10.0 million. In accordance with the terms of such private placement, on February 5, 2007,
the Company filed a registration statement for such 1,256,281 shares of common stock. On January 22,
2004, the Company filed a universal shelf registration statement with the Securities and Exchange
Commission to allow Nanophase to offer up to $15.0 million of Nanophase securities, in the form of
common stock or various types of debt securities, in the future. In August 2004, the Company withdrew
its universal shelf offering due to unfavorable market conditions and the Company’s adequate cash
position to cover expected growth through 2006.
On September 8, 2003, the Company secured equity funding through a private placement offering
with Grace Brothers, Ltd., its largest investor. The Company issued 453,001 shares of additional common
stock at $4.415 per share and received gross proceeds of $2.0 million. Grace Brothers, Ltd. also had the
right to purchase an additional 453,001 shares for an additional $2.0 million pursuant to the terms of a
warrant issued in such private placement. In accordance with the terms of such private placement, on June
7, 2004, the Company filed a registration statement for such 453,001 shares and the additional 453,001
shares issuable upon exercise of the warrant which registration statement was declared effective on
August 13, 2004. On September 2, 2004, Grace Brothers, Ltd. exercised its warrant rights to acquire
453,001 newly issued shares of common stock and the Company received $2.0 million in gross proceeds.
22
Equity Compensation Plan Information
The following table gives information about our common stock that may be issued upon the
exercise of options, warrants, and rights under all of our existing compensation plans on December 31,
2006, including the 1992 Amended and Restated Stock Option Plan and the 2001 and the Amended 2004
Equity Compensation Plan and the 2005 Non-Employee Director Restricted Stock Plan.
(a) Number of Securities
to be Issued Upon
Exercise of Outstanding
Options, Warrants and
Rights
(b) Weighted Average
Exercise Price of
Outstanding Options,
Warrants, and Rights
(c) Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column
(a))
(d) Total of Securities
Reflected in Columns
(a) and (c)
1,784,183(1) $
None
$
6.14
-
1,126,476 (2)
2,910,659
None
-
Plan Category
Plans Approved by
Shareholders
Plans Not Approved
by Shareholders
(1) Consists of the 1992 Amended and Restated Stock Option Plan, the 2001 and the Amended 2004
Equity Compensation Plan, and shares of authorized but unissued Preferred Stock
(2) Consists of shares available for future issuance under the Amended 2004 Equity Compensation Plan
and the 2005 Non-Employee Director Restricted Stock Plan.
PERFORMANCE GRAPH
The following graph shows a comparison of cumulative total returns for the Company, the
NASDAQ Market Composite Index and an index of peer companies selected by the Company during the
period commencing on January 1, 2002 and ending on December 31, 2006. The comparison assumes
$100 was invested on January 1, 2002 in the Common Stock, the NASDAQ Market Composite Index and
the peer companies selected by the Company and assumes the reinvestment of all dividends, if any.
Comparison of Cumulative Total Returns
^IXIC
NANX
WSCI
LNDC
1/1/2002
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006
1,950.40
1,335.51
2,003.37
2,175.44
2,205.32
2,415.29
5.8900
2.8200
8.0900
8.8700
5.6500
5.9700
1.3200
1.1100
2.1800
2.3600
3.6600
3.1500
3.7500
2.0000
6.5900
6.8400
7.7500
10.7600
^IXIC
0.051
$ 100.00
$ 68.47
$ 102.72
$ 111.54
$ 113.07
$ 123.84
1/1/2002
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006
NANX
16.978
$ 100.00
$ 47.88
$ 137.35
$ 150.59
$ 95.93
$ 101.36
WSCI
LNDC
75.758
$ 100.00
$ 84.09
$ 165.15
$ 178.79
$ 277.27
$ 238.64
26.667
$ 100.00
$ 53.33
$ 175.73
$ 182.40
$ 206.67
$ 286.93
23
Peer Avg.
$ 100.00
$ 68.71
$ 170.44
$ 180.59
$ 241.97
$ 262.78
^IXIC
NANX
WSCI
LNDC
Avg.
1/1/2002
12/31/2002
12/31/2003
12/31/2004
12/31/2005
12/31/2006
100.00%
68.47%
102.72%
111.54%
113.07%
123.84%
100.00%
47.88%
137.35%
150.59%
95.93%
101.36%
100.00%
100.00%
84.09%
53.33%
165.15%
175.73%
178.79%
182.40%
277.27%
206.67%
238.64%
286.93%
100.00%
68.71%
170.44%
180.59%
241.97%
262.78%
Measurement Date
1/1/02
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
Nanophase Technologies
Corporation
NASDAQ
Peer Group
$100.00
$100.00
$100.00
47.88
68.47
68.71
137.35
102.72
170.44
150.59
111.54
180.59
95.93
113.07
241.97
101.36
123.84
262.78
The companies in the peer group, both of which are advanced materials or advanced technologies
companies, are Landec Corporation and WSI Industries, Inc. The Company believes these companies are
compatible to Nanophase with respect to their businesses, stages of development and market
capitalization.
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, 2006 have been derived from the audited financial statements of the
Company.
2006
Years Ended December 31,
2004
2005
2003
2002
$8,612,705
378,133
8,990,838
7,057,707
1,933,131
2,127,862
$6,444,444
357,463
6,801,907
5,827,719
974,188
1,934,528
Statement of Operations Data:
Product revenue ..........................................
Other revenue .............................................
Total revenue ..............................................
Cost of revenue...........................................
Gross profit
Research and development expense ...........
Selling, general and administrative
3,854,051
expense .......................................................
-
Lease accounting adjustment......................
(5,120,852)
Loss from operations ..................................
152,626
Interest income ...........................................
(125,181)
Interest expense ..........................................
6,844
Other, net ....................................................
(68,674)
Provision for income taxes .........................
Net loss ....................................................... $(5,177,830) $(5,383,611) $(6,446,955) $(5,827,650) $(5,155,237)
4,361,357
-
(6,207,987)
171,582
(74,277)
(306,273)
(30,000)
5,302,836
-
(5,497,567)
366,701
(52,469)
5,505
-
4,422,011
279,810
(5,662,161)
295,935
(50,273)
32,888
-
4,095,877
-
(5,761,072)
67,992
(109,889)
5,319
(30,000)
$5,002,986
398,229
5,401,215
5,095,019
306,196
1,572,997
$4,880,313
566,348
5,446,661
5,205,065
241,596
1,906,791
$4,253,478
954,456
5,207,934
5,125,216
82,718
1,929,348
24
Net loss per share-basic and diluted ........... $ (0.28) $ (0.30) $ (0.37) $ (0.38) $ (0.35)
Weighted average number of basic and
diluted common shares outstanding............
18,344,334
17,937,932
17,266,228
15,391,537
14,551,479
2006
2005
As of December 31,
2004
2003
2002
Balance Sheet Data:
Cash and cash equivalents ..........................
Investments……………………………….
Working capital ..........................................
Total assets .................................................
Long-term obligations ................................
Total stockholders’ equity ..........................
$ 132,387
8,434,793
9,201,677
19,743,745
1,434,259
15,825,447
$ 340,860
8,168,092
9,210,435
18,173,344
1,265,875
14,920,012
$ 475,185 $ 399,999
4,562,364
11,155,126
5,313,781
11,953,699
16,242,819
21,792,295
263,669
—
13,719,087
19,982,490
$ 445,684
7,062,808
7,380,051
20,012,970
364,563
16,832,965
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,” risks discussed in other filings made by the Company with the Securities and Exchange
Commission, and the financial statements and related notes thereto appearing elsewhere in this
Form 10-K. When used in the following discussions, the words “anticipates,” “believes,” “estimates,”
“expects,” “plans,” “intends” and similar expressions are intended to identify forward-looking
statements. Such statements are subject to certain risks, uncertainties and contingencies that could cause
actual results, performance or achievements to differ materially from those expressed in, or implied by,
such statements. See the “Forward Looking Statements” section in Part I., Item 1.
Overview
Nanophase Technologies is a nanomaterials developer and commercial manufacturer with an
integrated family of nanomaterial technologies. Nanophase produces engineered nanomaterials for use in
a variety of diverse markets: sunscreens, architectural coatings, industrial coatings, ingredients, personal
care, abrasion-resistant applications, antimicrobial products, plastics additives, water filtration, DNA
biosensors and a variety of polishing applications, including semiconductors and optics. The Company
targets markets in which it feels practical solutions may be found using nanoengineered products. The
Company works closely with leaders in these target markets to identify their material and performance
requirements. Newer developed technologies have made certain new products possible and opened
potential new markets. With the commercialization of the Company’s NanoArc™ synthesis and new
dispersion technologies in 2002, and the expansion of these capabilities in 2003 and 2004, Nanophase is
focusing on penetrating the chemical-mechanical-planarization (“CMP”) and fine polishing markets.
CMP is the process of polishing various types of integrated circuits or chips to be used in various
commercial electronics applications. Management believes that the Company’s inroads in the CMP and
fine polishing markets would have been very difficult without the Company being able to produce its
materials to exacting specifications verified by in-house and customer-based testing. Management
expects growth in end-user (customers of Nanophase’s customers) adoption in 2007 and revenue growth
to continue in both of these areas. Additionally, the Company feels that its exclusive relationship with
Altana Chemie (“Altana”), a global ingredients supplier to various coatings industries, will lead to growth
in several of its abrasion-resistant applications in the marketplace. Management expects this relationship
to continue to develop in 2007. In May of 2005, BASF announced the introduction of a new coated
sunscreen material. This material incorporated a new coating developed by Nanophase which,
management believes, should help to expand sales in the European and Asian markets with future revenue
growth expected. Management further expects that we will develop additional customers to help us
achieve growth in 2007 and beyond.
25
On August 25, 2006, the Company sold, in a private placement to Rohm and Haas Electronic
Materials CMP Holdings, Inc., 847,918 shares of common stock at $5.8968 per share and received gross
proceeds of $5.0 million.
On November 3, 2005, BYK-Chemie USA, a subsidiary of Altana and a customer of Nanophase,
lent $1,597,420 to Nanophase pursuant to the terms of a Promissory Note received effective October 27,
2005. This loan was for the purchase and installation of additional dispersion capacity and an additional
NanoArc™ synthesis reactor to allow both for quicker material and application development, which
should help to speed market penetration, and the ability to fulfill orders on a commercial scale for
additional materials in varying media. The equipment was commissioned on November 1, 2006.
From its inception in November 1989 through December 31, 1996, the Company was in the
development stage. During that period, the Company primarily focused on the development of its
manufacturing processes in order to transition from laboratory-scale to commercial-scale production. As
a result, the Company developed an operating capacity to produce significant quantities of its
nanomaterials for commercial sale. The Company was also engaged in the development of commercial
applications and formulations and the recruiting of marketing, technical and administrative personnel.
Since January 1, 1997, the Company has been engaged in commercial production and sales of its
nanomaterials, and the Company no longer considers itself in the development stage. From inception
through December 31, 2006, the Company was primarily capitalized through the private offering of
approximately $32.0 million of equity securities prior to its initial public offering, its initial public
offering of $28.8 million of common stock in November of 1997, its private offering of $6.2 million of
common stock in May of 2002, its private offering of $1.95 million of common stock in September of
2003, its equity investment of $9.3 million in March 2004 and its private offering of $1.95 million of
common stock in September of 2004 (through the conversion of warrants that were attached to its
September 2003 offering) and its equity investment of $4.9 million in August 2006, each net of issuance
costs. The Company has incurred cumulative losses of $62.7 million from inception through December
31, 2006.
Results of Operations
Years Ended December 31, 2006 and 2005
Total revenue increased to $8,990,838 in 2006, compared to $6,801,907 in 2005. A substantial
majority of the Company’s revenue for the year ended December 31, 2006 is from the Company’s three
largest customers. See Note 15 to the Financial Statements for additional information regarding the
revenue the Company derived from these three customers for the year ended December 31, 2006. Product
revenue increased to $8,612,705 in 2006, compared to $6,444,444 in 2005. The increase in product
revenue was primarily attributed to increased sales to a new significant customer in architectural coatings
as well as increased sales of sunscreen and personal care materials to BASF, the Company’s largest
customer. The Company and its largest customer currently have a technology agreement in place that has
led to the joint development of the second generation of sunscreen nanomaterials for other potential
personal care applications. Management anticipates the launch of one or more new sunscreen or personal
care applications in the near future, with related revenue subsequently to begin building.
Other revenue increased to $378,133 in 2006, compared to $357,463 in 2005. This increase was
primarily attributed to the Company recognizing deferred revenue in connection with its promissory note
to BYK Chemie and increases in shipping revenue partially offset by decreases in purchased supplies.
The majority of the total revenue generated during the year ended December 31, 2006 was from
the Company’s largest customers in the healthcare (sunscreens) and its new significant customer (2006’s
second largest customer) for application in architectural coatings as described above.
26
Cost of revenue generally includes costs associated with commercial production and customer
development arrangements. Cost of revenue increased to $7,057,707 in 2006, compared to $5,827,719 in
2005. The increase in cost of revenue was generally attributed to increased revenue volume and increases
in commodity metals pricing and was partially offset by the Company’s continued efficiencies in reducing
its remaining variable manufacturing costs on nanomaterials. Improvements to gross margins were
primarily due to increased revenue volume, favorable product mix and the completion of a series of
process improvements that increased PVS reactor output by 38% in conjunction with a re-engineering
program that had reduced the expected operational labor cost by 24% on high volume PVS-produced
nanomaterials in 2005. These gains were somewhat offset by increases in commodity metal prices, a
major component of the Company’s raw material costs. Nanophase expects to continue new nanomaterial
development, primarily using its NanoArc™ synthesis and dispersion technologies, for targeted
applications and new markets in 2007. At current revenue levels the Company has generated a positive
gross margin. The Company’s margins have been somewhat impeded by not having enough revenue to
absorb the manufacturing overhead that is required to work with current customers and the new ones the
Company expects to have. Management believes that the current fixed manufacturing cost structure is
sufficient to support significantly higher levels of production and resultant product revenue. The extent to
which the Company’s margins continue to grow, as a percentage of total revenue, will be dependent upon
revenue mix, revenue volume, the Company’s ability to continue to cut costs and the Company’s ability
to pass market raw materials increases on to its customers. As product revenue volume increases, this will
result in more of the Company’s fixed manufacturing costs being absorbed, leading to increased margins.
The Company expects to continue reducing its variable product manufacturing costs in 2007, with
potential offsetting increases in the commodity metals markets but may or may not continue to see gross
margin growth in 2007, dependent upon the factors discussed above.
Research and development expense, which includes all expenses relating to the technology and
advanced engineering groups, primarily consists of costs associated with the Company’s development or
acquisition of new product applications and coating formulations and the cost of enhancing the
Company’s manufacturing processes. The May 2005 development of BASF’s new sunscreen was an
example of this work. In another example, the Company has been and continues to be engaged in research
to enhance its ability to disperse its material in a variety of organic and inorganic media for use as
coatings and polishing materials. Much of this work has led to several new products and additional
potential new products for use by Altana. Now that the Company has demonstrated the capability to
produce pilot quantities of mixed-metal oxides in a single crystal phase, the Company does not expect
development of further variations on these materials to present material technological challenges. Many
of these materials exhibit performance characteristics that can enable them to serve in various catalytic
applications. This development has been driven largely by customer demand. Management is now
working on several related commercial applications. The Company expects that this technique should not
be difficult to scale to large quantity commercial volumes once application viability and firm demand are
established.
The Company also has an ongoing advanced engineering effort that is primarily focused on the
development of new nanomaterials as well as the refinement of existing nanomaterials. The Company is
not certain when or if any significant revenue will be generated from the production of the materials
described above.
Research and development expense increased to $2,127,862 in 2006, compared to $1,934,528 in
2005. The increase in research and development expense was largely attributed to stock compensation
expense (non-cash), the enhancement of existing processes and outside testing expenses. These increases
were partially offset by the capitalization of payroll related to the installation of dispersion equipment and
a NanoArc Synthesis Reactor supported by the previously discussed loan from BYK-Chemie USA and
decreases in materials and supplies expense. The Company does not expect research and development
expense to increase significantly in 2007.
27
Selling, general and administrative expense increased to $5,302,836 in 2006, compared to
$4,422,011 in 2005. The net increase was primarily attributed to increases in stock compensation expense
(non-cash), compensation expense, the abandonment of three United States patent applications and
professional fees. These increases were partially offset by decreases in directors and officers insurance
and audit fees.
A lease accounting adjustment of $279,810 was made in the third quarter of 2005. This charge
was due to the Company correcting an error in its prior accounting practices to conform the lease term
used in calculating straight-line rent expense with the useful lives used to amortize improvements on
leased property. See Note 19 to the Financial Statements for additional information.
Interest income increased to $366,701 in 2006, compared to $295,935 in 2005. These increases
were primarily due to increases in investment yields in 2006.
Years Ended December 31, 2005 and 2004
Total revenue increased to $6,801,907 in 2005, compared to $5,207,934 in 2004. A substantial
majority of the Company’s revenue for the year ended December 31, 2005 is from the Company’s three
largest customers. See Note 15 to the Financial Statements for additional information regarding the
revenue the Company derived from these three customers for the year ended December 31, 2005. Product
revenue increased to $6,444,444 in 2005, compared to $4,253,478 in 2004. The increase in product
revenue was primarily attributed to increased sales of sunscreen and personal care materials to BASF, the
Company’s largest customer, increased sales of CMP materials to Rohm and Haas Electronic Materials
CMP Inc. (“RHEM,” formerly known as Rodel, Inc.) and a new customer for application in medical
devices in the second quarter of 2005. The Company and its largest customer currently have a technology
agreement in place that led to the joint development of the second generation of sunscreen nanomaterials
for other potential personal care applications.
Other revenue decreased to $357,463 in 2005, compared to $954,456 in 2004. This decrease was
primarily attributed to no technology payments being received in 2005, compared to $600,000 in 2004
from RHEM. These payments from RHEM were part of its $600,000 commitment in 2004 as described
below which was amended for 2005.
In February of 2004, the Company amended its original agreement with RHEM. This amendment
allows RHEM to maintain exclusivity based upon it purchasing lower dollar amounts of nanomaterials,
while extending the agreement through 2009. This amendment did not require RHEM to purchase any
materials from the Company in 2004, but it did require an aggregate of $600,000 be paid to Nanophase in
four equal quarterly installments in 2004 to support on-going efforts in joint slurry product development
with RHEM during 2004. This $600,000 was fully earned in 2004. In October of 2004, the Company
amended its original agreement with RHEM a second time. This amendment reduced the minimum
purchase requirements necessary to maintain the Company’s exclusivity obligations to RHEM by
approximately 44% during 2005. The reduction reflected the parties’ recognition of the difficulty in
precisely estimating the timing of product development and sales in the semiconductor polishing market.
On August 25, 2006, the Company further amended and restated its original agreement with RHEM in
conjunction with Rohm and Haas Electronic Materials CMP Holdings, Inc.’s concurrent purchase of
847,918 shares of the Company's common stock for an aggregate gross consideration of $5,000,000. The
August 2006 amendment expanded the parties’ mutually exclusive relationship as to certain
nanomaterials for CMP applications and extended the relationship through 2019. This amendment
eliminated any specific minimum annual purchase requirements necessary for RHEM to maintain the
Company’s exclusivity obligations. However, the August 2006 amendment also provided that the
28
Company can end its exclusivity if RHEM does not purchase any nanomaterials for CMP applications for
two consecutive years.
The majority of the total revenue generated during the year ended December 31, 2005 was from
the Company’s largest customers in the healthcare (sunscreens) and CMP markets and its new customer
(second largest customer in the second quarter of 2005) for application in medical devices as described
above.
Cost of revenue generally includes costs associated with commercial production and customer
development arrangements. Cost of revenue increased to $5,827,719 in 2005, compared to $5,125,216 in
2004. The increase in cost of revenue was generally attributed to increased revenue volume somewhat
offset by decreases in depreciation and the Company’s continued efficiencies in reducing its variable
manufacturing costs on nanomaterials. Improvements to gross margins were primarily due to increased
revenue volume, favorable product mix and the completion of a series of process improvements that
increased PVS reactor output by 38% in conjunction with a re-engineering program that had reduced the
expected operational labor cost by 24% on high volume PVS-produced nanomaterials. Nanophase
maintained an aggressive schedule for new nanomaterial development, primarily using its NanoArc™
synthesis and dispersion technologies, for targeted applications and new markets throughout 2006. At
then-current revenue levels the Company generated a modest positive gross margin. The Company’s
margins were impeded by not having enough revenue to absorb the manufacturing overhead that is
required to work with current customers and the new ones the Company expects to have. Management
believes that the current fixed manufacturing cost structure is sufficient to support significantly higher
levels of production and resultant product revenue. The extent to which the Company’s margins remain
positive, as a percentage of total revenue, will be dependent upon revenue mix, revenue volume and the
Company’s ability to continue to cut costs. As product revenue volume increases, this will result in more
of the Company’s fixed manufacturing costs being absorbed, leading to increased margins.
Research and development expense, which includes all expenses relating to the technology and
advanced engineering groups, primarily consists of costs associated with the Company’s development or
acquisition of new product applications and coating formulations and the cost of enhancing the
Company’s manufacturing processes. The May 2005 roll-out of BASF’s new sunscreen was an example
of this work. In another example, the Company has been engaged in research to enhance its ability to
disperse its material in a variety of organic and inorganic media for use as coatings and polishing
materials. Much of this work led to new potential products for use by Altana. Now that the Company has
demonstrated the capability to produce pilot quantities of mixed-metal oxides in a single crystal phase, the
Company does not expect development of further variations on these materials to present material
technological challenges. Many of these materials exhibit performance characteristics that can enable
them to serve in various catalytic applications. This development has been driven largely by customer
demand. The Company expects that this technique should not be difficult to scale to large quantity
commercial volumes once application viability and firm demand are established. The Company also has
an ongoing advanced engineering effort that is primarily focused on the development of new
nanomaterials as well as the refinement of existing nanomaterials. The Company is not certain when or if
any significant revenue will be generated from the production of the materials described above. Research
and development expense increased to $1,934,528 in 2005, compared to $1,929,348 in 2004. This modest
increase in research and development expense was mainly attributed to salary expenses.
Selling, general and administrative expense increased to $4,422,011 in 2005, compared to
$4,361,357 in 2004. This modest net increase was primarily attributed to increases in compensation,
consulting expenses and audit fees. These increases were partially offset by decreases in directors and
officers and business insurance expenses and legal fees.
A lease accounting adjustment of $279,810 was made in the third quarter of 2005. This charge
was due to the Company correcting an error in its prior accounting practices to conform the lease term
29
used in calculating straight-line rent expense with the useful lives used to amortize improvements on
leased property. See Note 19 to the Financial Statements for additional information.
Interest income increased to $295,935 in 2005, compared to $171,582 in 2004. These increases
were primarily due to increased investment yields in 2005, along with an increase of funds available for
investment, largely composed of the March 23, 2004 equity investment from Altana, which resulted in net
proceeds of approximately $9.3 million.
Other income increased to $32,888 in 2005, compared to $306,273 of other expenses in 2004.
This net increase was primarily due to the Company taking a one-time charge in the amount of $279,000
for accounting and legal costs associated with the withdrawal of the Company’s universal shelf
registration in August 2004.
Liquidity and Capital Resources
investments amounted
The Company’s cash, cash equivalents and
to $8,567,180 on
December 31, 2006, compared to $8,508,952 on December 31, 2005. The net cash used in the
Company’s operating activities was $3,186,096, $4,408,535 and $4,866,797 for the years ended
December 31, 2006, 2005 and 2004, respectively. Net cash used in investing activities, which is due to
purchases of securities and capital expenditures and partially offset by sales of securities, amounted to
$2,445,690 for the year ended December 31, 2006 compared to $2,440,792 of net cash provided by and
$7,277,355 of net cash used in investing activities for the years ended December 31, 2005 and 2004,
respectively. Capital expenditures amounted to $2,013,810, $292,692 and $529,498 for the years ended
December 31, 2006, 2005 and 2004, respectively. The majority of the capital spending for the year ended
December 31, 2006 relates to the $1,597,420 loan from BYK-Chemie USA for the purchase and
installation of additional dispersion capacity and an additional NanoArc™ synthesis reactor. During the
second quarter in 2005 the Company completed implementation of a PVS process innovation started in
late 2003, within the current capital budget, that has increased PVS reactor output by approximately 38%
in conjunction with a re-engineering program that had reduced the expected operational labor cost by
24% on high volume PVS-produced nanomaterials. The Company expects that this innovation should
result in the need for less future capital as the Company’s PVS reactor-produced business grows.
Currently, all sunscreen and personal care nanomaterials are manufactured via the PVS process. Net cash
provided by financing activities is primarily due to the Company securing financing through an equity
investment in August 2006 and, to a lesser extent, by the issuance of shares of common stock pursuant to
the exercise of stock options and borrowings for equipment, partially offset by principal payments on debt
and capital lease obligations amounting, in total, to $5,423,313 for the years ended December 31, 2006.
Net cash provided by financing activities, is primarily due to a loan from BYK-Chemie (See discussion
below), the issuance of shares of common stock pursuant to the exercise of options, partially offset by
principal payments on debt and capital lease obligations, amounting, in total, to $1,833,418 for the year
ended December 31, 2005. Net cash provided by financing activities for the year ended December 31,
2004 was primarily due to the Company securing financing through an equity investment in March 2004
and, to a lesser extent, by the issuance of shares of common stock pursuant to the exercise of warrants and
options, partially offset by principal payments on debt and capital lease obligations, amounting, in total,
to $12,219,318.
On August 25, 2006, the Company sold, in a private placement to Rohm and Haas Electronic
Materials CMP Holdings, Inc., 847,918 shares of common stock at $5.8968 per share and received gross
proceeds of $5.0 million.
On November 3, 2005, BYK-Chemie USA, a customer of Nanophase, lent $1,597,420 to
Nanophase pursuant to the terms of a Promissory Note received effective October 27, 2005. The proceeds
of the Promissory Note were used to buy, install and commission certain equipment which now is being
30
used for fulfillment of orders by BYK-Chemie USA and other uses. The outstanding principal balance of
the Promissory Note is payable in three equal installments on January 30, 2009, April 30, 2009 and
December 31, 2009. Interest accrues and is payable on a quarterly basis one year after the equipment
referenced above is installed and commissioned at the rate of 100 basis points over the average daily
London Inter-Bank Offered Rate for the preceding quarter. See Note 7 to the Financial Statements for a
discussion on the computation of interest relating to this note.
On March 23, 2004, the Company sold, in a private placement to Altana Chemie AG (“Altana”),
1,256,281 shares of common stock at $7.96 per share and received gross proceeds of $10.0 million. In
accordance with the terms of such private placement, on February 5, 2007, the Company filed a
registration statement for such 1,256,281. Such registration statement has not yet been declared effective
by the SEC. While the Company has obligations to Altana with respect to the effectiveness of this
registration statement, Altana would not have the ability to settle such shares in cash if such registration
statement is not declared effective and, accordingly, the Company has treated the shares purchased by
Altana as permanent equity on its balance sheet (i.e., as additional paid-in capital). On September 8, 2003,
the Company secured equity funding through a private placement offering with Grace Brothers, Ltd., its
largest investor. The Company issued 453,001 shares of additional common stock at $4.415 per share and
received gross proceeds of $2.0 million. Grace Brothers, Ltd. also had the right to purchase an additional
453,001 shares for an additional $2.0 million pursuant to the terms of a warrant issued in such private
placement. In accordance with the terms of such private placement, on June 7, 2004, the Company filed a
registration statement for such 453,001 shares and the additional 453,001 shares issuable upon exercise of
the warrant which registration statement was declared effective on August 13, 2004. On September 2,
2004, Grace Brothers, Ltd. exercised its warrant rights to acquire 453,001 newly issued shares of common
stock and the Company received $2.0 million in gross proceeds. On May 29, 2002, the Company secured
equity funding through a private placement offering. The Company issued 1.37 million shares of
additional common stock at $5.00 per share and received gross proceeds of $6.85 million. Net proceeds
were approximately $6.2 million after commissions, legal, accounting and other costs. The Company used
the remaining proceeds from the foregoing offerings to fund expected growth in new markets as well as to
provide for expanded working capital needs expected to arise as sales volume grows and pay existing
debts.
The Company’s supply agreement with its largest customer contains several financial covenants
which could potentially impact the Company’s liquidity. The most restrictive financial covenants under
this agreement require the Company to maintain a minimum of $2.0 million in cash, cash equivalents and
investments and that the Company not have the acceleration of any debt maturity having a principal
amount of more than $10,000,000, in order to avoid triggering a transfer of technology and equipment to
the Company’s largest customer. The Company had approximately $8.6 million in cash, cash equivalents
and investments and debt net of unamortized debt discount of less than $1.5 million on December 31,
2006. This supply agreement and its covenants are more fully described in Note 15 to the Company’s
Financial Statements. See “Risk Factors—We may need to raise additional capital in the future”.
In November 2000, the Company executed a three-year promissory note, held by the Company’s
largest customer, in the amount of $1,293,895 for the construction of additional production capabilities at
the Company’s Romeoville, Illinois facility. This debt was fully paid in the second quarter in 2006.
The Company believes that cash from operations, the proceeds of $5 million equity investment
from RHEM and the $1,597,420 loan from BYK-Chemie USA (subject to the restrictions on the use of
such proceeds set forth in the Promissory Note evidencing such loan), and cash, cash equivalents and
investments on hand and interest income thereon, will be adequate to fund the Company’s operating plans
for the foreseeable future. The Company’s actual future capital requirements in 2007 and beyond will
depend, however, on many factors, including customer acceptance of the Company’s current and potential
nanomaterials and product applications, continued progress in the Company’s research and development
activities and product testing programs, the magnitude of these activities and programs, and the costs
31
necessary to increase and expand the Company’s manufacturing capabilities and to market and sell the
Company’s materials and product applications. Other important issues that will drive future capital
requirements will be the development of new markets and new customers as well as the potential for
significant unplanned growth with the Company’s existing customers. The Company expects that capital
spending relating to currently known capital needs for 2007 will be approximately $2,500,000, but could
be even greater due to the factors discussed above.
Should events arise that make it appropriate for the Company to seek additional financing, it
should be noted that additional financing may not be available on acceptable terms or at all, and any such
additional financing could be dilutive to the Company’s stockholders. Such a financing could be
necessitated by such things as the loss of existing customers; currently unknown capital requirements in
light of the factors described above; new regulatory requirements that are outside the Company’s control;
the need to meet previously discussed cash requirements to avoid a triggering event; or various other
circumstances coming to pass that are currently not anticipated by the Company.
On December 31, 2006, the Company had a net operating loss carryforward of approximately $70
million for income tax purposes. Because the Company may have experienced “ownership changes”
within the meaning of the U.S. Internal Revenue Code in connection with its various prior equity
offerings, future utilization of this carryforward may be subject to certain limitations as defined by the
Internal Revenue Code. If not utilized, the carryforward expires at various dates between 2007 and 2026.
As a result of the annual limitation and uncertainty as to the amount of future taxable income that will be
earned prior to the expiration of the carryforward, the Company has concluded that it is likely that some
portion of this carryforward will expire before ultimately becoming available to reduce income tax
liabilities. During the year ended December 31, 2006, the Company’s foreign tax credit carryforward of
$156,000 expired.
Contractual Obligations
The following table highlights the Company’s contractual obligations as of December 31, 2006:
Payments due by period
Total
Less than
1 Year
1-3 Years
3-5 Years
More than
5 Years
Long-term debt obligations
$1,597,420
$ -
$1,597,420
$ - $ -
Operating Leases
$7,124,079
398,344
1,021,600
986,400
4,717,735
Capital Leases
$ 83,525
32,973
50,552
-
-
Unfulfilled Purchase Orders $ 346,799
346,799
-
-
-
Totals
$9,151,823
$778,116
$2,669,572
$986,400 $4,717,735
Off−Balance Sheet Arrangements
The Company has not created, and is not party to, any special−purpose or off−balance sheet
entities for the purposes of raising capital, incurring debt or operating the Company’s business.
Nanophase does not have any off−balance sheet arrangements or relationships with entities that are not
consolidated into the Company’s financial statements that are reasonably likely to materially affect
Nanophase’s liquidity or the availability of capital resources.
32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The only financial instruments that the Company holds are investments of a short-term duration.
Management does not believe that the Company currently has material market risk relating to its
investments.
Item 8. Financial Statements and Supplementary Data
The financial statements and financial statement schedule, with the report of independent
auditors, listed in Item 15 are included in this Form 10-K.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure controls
An evaluation was conducted under the supervision and with the participation of the Company’s
management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the
effectiveness of the design and operation of the Company’s disclosure controls and procedures as of
December 31, 2006. Based on that evaluation, the CEO and CFO concluded that the Company’s
disclosure controls and procedures were effective as of such date to ensure that information required to be
disclosed in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in Securities and Exchange Commission rules
and forms and that the Company’s disclosure controls and procedures are effective to ensure that material
information required to be disclosed by the Company in reports that it files or submits under the
Exchange Act is made known to management and others, as appropriate, to allow timely decisions
regarding required disclosures.
Internal control over financial reporting
The Company’s management, including the CEO and CFO, confirm that there was no change in
the Company’s internal control over financial reporting during the quarter ended December 31, 2006 that
has materially affected, or is reasonably likely to materially affect, the Company’s internal control over
financial reporting.
Management’s report
Management’s report and the Report of independent registered public accounting firm on internal
control over financial reporting are set forth in Part IV, Item 15 of this Form 10-K.
Item 9B. Other Information
None.
33
PART III
Item 10. Directors, Executive Officers and Corporate Governance
DIRECTORS
Set forth below is certain information regarding the directors of the Company.
Name
Age
Position with
Company
Served as
Director Since
Term
Expires
Class
James A. Henderson
James A. McClung, Ph.D.
R. Janet Whitmore
Richard W. Siegel, Ph.D.
Joseph E. Cross
Donald S. Perkins
Jerry K. Pearlman
72
69
52
69
59
79
67
Director
Director
Director
Director
Director, President and
Chief Executive Officer
Chairman of the Board
of Directors
Director
2001
2000
2003
1989
1998
1998
1999
2007
2007
2007
2008
2008
2009
2009
I
I
I
II
II
III
III
Mr. Henderson has served as a director of the Company since July 2001. He retired as Chairman
and Chief Executive Officer of Cummins Engine Company in December 1999, after joining the company
in 1964. Mr. Henderson became President and Chief Operating Officer of Cummins in 1977, was
promoted to President and Chief Executive Officer in 1994 and served as Chairman and Chief Executive
Officer from 1995 until his retirement in 1999. Mr. Henderson attended Culver Military Academy, holds
an A.B. in public and international affairs from Princeton University and an M.B.A. from Harvard
Business School. Mr. Henderson currently serves as a member of the Board of Directors of ATT Inc. and
Ryerson Inc. He serves as Chairman of the Board of the Culver Education Foundation and is a past Chair
of the Executive Committee of the Princeton University Board of Trustees.
Mr. McClung has served as a director of the Company since February 2000. He retired as
Senior Vice President and executive officer for FMC Corporation, a leading producer of a diversified
portfolio of chemicals and machinery. He has over 30 years of international business development
experience in over 75 countries, having managed and developed new technologies and production
processes for diversified global businesses, including specialized chemicals and machinery, while living
in the United States, Europe and Africa. Mr. McClung currently serves as Corporate Board member of
Alticor (Amway), NCCI, Hu-Friedy and 7 M Group.. He was a founding member of the U.S.-Russia
Business Council and is active in other international business organizations, such as the Japan American
Society, Chicago Council of Foreign Relations and the Economic Club of Chicago. He serves as a board
director at Thunderbird School of Global Management and the College of Wooster (Ohio). Mr. McClung
earned a Bachelor’s degree from the College of Wooster, a Master’s degree from the University of
Kansas and a Doctorate from Michigan State University.
Ms. Whitmore joined the board in November 2003. She is currently a director of Silverleaf
Resorts, Inc., where she serves as Chairman of the Compensation Committee and as a member of the
Audit Committee. She is a former director of Epoch Biosciences, a supplier of proprietary products used
34
to accelerate genomic analysis. Ms. Whitmore is Founder of Benton Consulting, LLC, which specializes
in business development and processes. From 1976 through 1999, Ms. Whitmore held numerous
engineering and finance positions at Mobil Corporation, including Mobil’s Chief Financial Analyst and
Controller of Mobil’s Global Petrochemicals Division. Ms. Whitmore holds a Bachelor of Science degree
in Chemical Engineering from Purdue University and an M.B.A. from Lewis University.
Mr. Cross has served as Chief Executive Officer of the Company since December 1998 and
President and a director of the Company since joining the Company in November 1998. Prior to joining
the Company in November 1998, Mr. Cross served as President and Chief Executive Officer of Aptech, a
manufacturer of measurement, metering and control devices for the utility industry, from August 1996 to
October 1998. From December 1993 to July 1996, Mr. Cross served as President of Aegis Technologies,
an interactive telecommunications company. He holds a B.S. degree from Southwest Missouri University
and attended the M.B.A. program at Southwest Missouri University.
Dr. Siegel is a co-founder of the Company and has served as a director of the Company since
1989. Dr. Siegel served as a consultant to the Company from 1990 to 2002 with regard to the application
and commercialization of nanomaterials. Dr. Siegel is an internationally recognized scientist in the field
of nanomaterials. During his tenure on the research staff at Argonne National Laboratory from July 1974
to May 1995, he was the principal scientist engaged in research with the laboratory-scale synthesis
process that was the progenitor of the Company’s physical-vapor-synthesis production system. Dr. Siegel
has been the Robert W. Hunt Professor in Materials Science and Engineering at Rensselaer Polytechnic
Institute since June 1995, and served as Department Head from 1995 to 2000. In April 2001, Dr. Siegel
became the founding Director of the newly created Rensselaer Nanotechnology Center at the Institute.
During 1995-1998, he was also a visiting professor at the Max Planck Institute for Microstructure Physics
in Germany on an Alexander von Humboldt Research Prize received in 1994. During 2003-2004 he was
a visiting professor in Japan on a RIKEN Eminent Scientist Award. He chaired the World Technology
Evaluation Center worldwide study of nanostructure science and technology for the U.S. government, has
served on the Council of the Materials Research Society and as Chairman of the International Committee
on Nanostructured Materials. He also served on the Committee on Materials with Sub-Micron Sized
Microstructures of the National Materials Advisory Board and was the co-chairman of the Study Panel on
Clusters and Cluster-Assembled Materials for the U.S. Department of Energy. He currently serves on the
Nanotechnology Technical Advisory Group to the U.S. President’s Council of Advisors on Science and
Technology. Dr. Siegel holds an A.B. degree in physics from Williams College and an M.S. degree and
Ph.D. from the University of Illinois at Urbana-Champaign.
Mr. Perkins has served as a director of the Company since February 1998. Mr. Perkins retired
from Jewel Companies, Inc., the retail supermarket and drug chain, in 1983. He had been with Jewel
since 1953, serving as President from 1965 to 1970, as Chairman of the Board of Directors from 1970 to
1980, and as Chairman of the Executive Committee until his retirement. He has served on a number of
corporate boards and is currently a director of LaSalle Hotel Properties and La Salle U.S. Realty Income
and Growth Fund III. For more than 30 years, he has served on corporate boards including AT&T, Aon,
Corning, Cummins Engine, Eastman Kodak, Firestone, Inland Steel Industries, Kmart, Lucent
Technologies, The Putnam Funds, Springs Industries and Time-Warner, Inc. He is a Protector of the
Thyssen-Bornemisza Continuity Trust. He has served as a Trustee of The Ford Foundation and The
Brookings Institution and as a member of The Business Council. Mr. Perkins is a life trustee and was
Vice Chairman of
He co-chaired
Campaign/Northwestern, a university-wide effort which raised more than $1.5 billion. He is also a
member of the Civic Committee of The Commercial Club of Chicago, and Advisory Boards for Blue
Ridge Partners, Shields-Meneley, Syrus, RoundTable Healthcare Partners L.P., Northwestern
University’s School of Communication and its School of Education and Social Policy. Mr. Perkins holds
a B.A. degree from Yale University and an M.B.A. degree from the Harvard Graduate School of Business
Administration.
the Board of Trustees of
Northwestern University.
35
Mr. Pearlman has served as a director of the Company since April 1999. Mr. Pearlman retired
as Chairman of Zenith Electronics Corporation in November 1995. He joined Zenith as controller in
1971 and served as chief executive officer from 1983 through April 1995. Mr. Pearlman is a director of
Smurfit Stone Container Corporation and Ryerson Inc. He is a trustee of Northwestern University and a
life director and past chairman of the board of Evanston Northwestern Healthcare. Mr. Pearlman
graduated from Princeton with honors from the Woodrow Wilson School and from Harvard Business
School with highest honors.
Meetings of the Board and Committees -- During the year ended December 31, 2006, the
Board of Directors held six formal meetings. No director missed more than one board and committee
meeting held during 2006 (for all committees on which a particular director served).
Committees of the Board of Directors -- The Board of Directors has established an Audit and
Finance Committee, Compensation and Governance Committee and a Nominating Committee each
comprised entirely of independent directors who are not officers or employees of the Company. The
members of the Audit and Finance Committee are Mr. McClung (Chairman), Mr. Henderson,
Mr. Pearlman and Mr. Perkins. The members of the Compensation and Governance Committee are
Mr. Pearlman (Chairman), Mr. Henderson and Mr. Perkins. The members of the Nominating Committee
are Mr. Henderson (Chairman), Mr. McClung, Mr. Pearlman, Mr. Perkins and Dr. Siegel.
The Audit and Finance Committee generally has responsibility for retaining the Company’s
independent public auditors, reviewing the plan and scope of the accountants’ annual audit, reviewing the
Company’s internal control functions and financial management policies and reporting to the Board of
Directors regarding all of the foregoing. The Audit and Finance Committee held five formal meetings in
2006. The Board of Directors has determined that Mr. Pearlman, Mr. Perkins and Mr. Henderson, all of
whom serve on the Audit and Finance Committee, are “audit committee financial experts” as described in
applicable SEC rules. Each member of the Audit and Finance Committee is independent, as defined in
Rule 4200(a) (15) of the National Association of Securities Dealers’ listing standards and applicable SEC
rules.
The Compensation and Governance Committee generally has responsibility for establishing
executive officer and key employee compensation, reviewing and establishing the Company’s executive
compensation and general corporate governance policies and reporting to the Board of Directors
regarding the foregoing. The Compensation and Governance Committee also has responsibility for
administering the Amended 2004 Equity Compensation Plan and the 2006 Stock Appreciation Rights
Plan, determining the number of options, if any, to be granted to the Company’s employees and
consultants pursuant to the Amended 2004 Equity Compensation Plan and reporting to the Board of
Directors regarding the foregoing. The Compensation and Governance Committee held four formal
meetings in 2006.
The Nominating Committee generally has responsibility for nominating candidates to serve on
the Board of Directors. All members of the Nominating Committee are independent. The Nominating
Committee was formed in 2004 and held one formal meeting in 2006.
EXECUTIVE OFFICERS
Set forth below is certain information regarding the executive officers of the Company who are
not identified above as directors.
Name
Jess Jankowski
Robert Haines
Daniel S. Bilicki
Age
41
56
63
Position
Chief Financial Officer, Vice President of Finance, Secretary and Treasurer
Vice President -- Operations
Vice President -- Sales and Marketing
36
Name
Richard W. Brotzman, Ph.D.
Age
53
Position
Vice President -- Research and Development
Mr. Jankowski has served as Controller of the Company since joining in 1995. He was elected
Secretary and Treasurer in November 1999, Acting Chief Financial Officer in January 2000, and Vice
President in April of 2002 and Vice President of Finance and Chief Financial Officer in April of 2004.
From 1990-1995 he served as Controller for two building contractors in the Chicago area. From 1986 to
1990 he worked for Kemper Financial Services in their accounting control corporate compliance unit,
serving as unit supervisor during his last two years. Mr. Jankowski holds a B.S. in accountancy from
Northern Illinois University, an M.B.A. from Loyola University, and received his certified public
accountant certificate from the State of Illinois. He has served on the advisory board of WESTEC, an
Illinois Technology Enterprise Center focusing on the commercialization of advanced manufacturing
technologies, since 2003. Mr. Jankowski was appointed to the Romeoville Economic Development
Commission in 2004.
Mr. Haines joined Nanophase Technologies in January 2001 as Vice President of Operations.
Beginning in 1996 and prior to joining Nanophase, he served as Corporate Director of Quality at Legrand
North America. Previous experience includes two years as Vice President of Operations for Aegis
Technologies and eight years with Digital Equipment Corporation. Mr. Haines has a B.S. in
Chemistry/Engineering Physics from East Tennessee State University.
Mr. Bilicki has served as Vice President -- Sales and Marketing of the Company since joining the
Company in March 1999. From January 1996 until March 1999, Mr. Bilicki served as President/Director
of PT Crosfield Indonesia in Jakarta, Indonesia, a subsidiary of Crosfield Company, which is a global
chemical company. From January 1994 to December 1995, Mr. Bilicki held the position of
President/Director North America of Crosfield Company. He holds a B.S. degree from Indiana Institute
of Technology and an M.B.A. degree from Winthrop University.
Dr. Brotzman joined the Company in July 1994 as a senior scientist and has served as Vice
President -- Research and Development of the Company since July 1996. He is the inventor of much of
the Company’s coating technology. Dr. Brotzman has more than 20 years experience in research and
development of advanced materials leading to new products. His technical areas of expertise include
interfacial adhesion and chemistry, self-assembled polymeric coatings, nanosized inorganic powders,
powder processing, reactive coupling agents, solgel derived protective coatings, non-destructive
evaluation of composites, neo-debye relaxation in green inorganic gels, asymmetric membranes and
plasma processing. From January 1991 to July 1994, Dr. Brotzman served as Director of Research at
TPL, Inc., an advanced materials company. He holds a B.S. degree in chemical engineering from
Lafayette College, an M.S. degree in engineering and applied science from the University of California,
Davis and a Ph.D. in chemistry from the University of Washington.
The Board of Directors elects executive officers annually and such executive officers, subject to
the terms of certain employment agreements, serve at the discretion of the Board of Directors.
Messrs. Cross, Jankowski, Bilicki, Haines and Dr. Brotzman each have employment agreements with the
Company. See Item 11 below. There are no family relationships among any of the directors or officers
of the Company.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), requires
the Company’s officers (as defined under Section 16), directors and persons who beneficially own greater
than 10% of a registered class of the Company’s equity securities to file reports of ownership and changes
in ownership with the Securities and Exchange Commission. Based solely on a review of the forms it has
received and on written representations from certain reporting persons that no such forms were required
37
for them, the Company believes that during 2006, all Section 16 filing requirements applicable to its
officers, directors and 10% beneficial owners were complied with by such persons.
CODE OF ETHICS
The Company has adopted a Code of Business Conduct and Ethics (“Code of Ethics”) that
applies to, among others, the Company’s principal executive officer, principal financial officer and
principal accounting officer or controller, or persons performing similar functions. The Code of Ethics is
posted on its Internet web site www.nanophase.com under the “Investor Relations” section. In the event
that the Company makes any amendment to, or grants any waiver from, a provision of the Code of Ethics
that requires disclosure under applicable SEC rules, the Company intends to disclose such amendment or
waiver on its web site.
38
Item 11. Executive Compensation
COMPENSATION DISCUSSION & ANALYSIS
This section discusses the material elements of compensation awarded to, earned by or paid to the
principal executive and principal financial officers of the Company, and the three other most highly
compensated executive officers of the Company (the “executive officers”).
The Board of Director’s Compensation and Governance Committee (the “Compensation
Committee”) generally has responsibility for establishing executive officer and key employee
compensation, reviewing and establishing the executive compensation and reporting to the Board of
Directors regarding the foregoing.
The Compensation Committee also has responsibility for
administering the Amended 2004 Equity Compensation Plan and the 2006 Stock Appreciation Rights
Plan, determining the number of options or stock appreciation rights, if any, to be granted under those
plans and reporting to the Board of Directors regarding the foregoing. None of the executive officers are
members of the Compensation Committee. The current Compensation Committee members are Jerry K.
Pearlman (Chairman), James A. Henderson and Donald S. Perkins.
Overview of Compensation Programs and Objectives
The objectives of the Compensation Committee in recommending the levels and components of
compensation for the executive officers are to:
1.
2.
3.
Attract, motivate and retain talented and dedicated executives;
Motivate performance to achieve our specific strategic and operating objectives; and
Provide both cash and equity incentives that align the interests of the executive officers
with the long-term interests of our stockholders.
The Compensation Committee reviews the achievement of corporate goals and individual
contributions to our success. The Compensation Committee relies on judgment and not upon rigid
guidelines or formulas in determining the amount or mix of compensation elements for each executive
officer. Factors affecting their judgment include performance compared to strategic goals, the nature of
the executive officer’s responsibilities and his effectiveness in leading our initiatives to achieve our goals.
Our Chief Executive Officer, Mr. Joseph E. Cross, as the manager of the members of the executive team,
assesses the executives’ individual contributions to their respective departmental goals and makes
recommendations to the Compensation Committee with respect to increases in base salary, discretionary
bonus and long-term incentive awards, for each member of the executive team, other than himself. The
Compensation Committee evaluates, discusses, modifies and approves these recommendations and
conducts a similar evaluation of Mr. Cross’ contributions and performance. Each member of the Board of
Directors is permitted to attend the Compensation Committee meetings and participate in the discussion.
However, approval of each executive officer’s compensation is made by the Compensation Committee.
As described in more detail below, the material components of the executive officers compensation
includes base salary, discretionary bonus, long-term incentive awards, severance protection and change-
in-control benefits. We believe that each element of our executive compensation program helps us to
achieve one or more of our compensation objectives.
Base salaries, severance protection and change-in-control benefits are all primarily intended to
attract and retain qualified executives. The value of these components in any given year is not dependent
on performance (unless determined by reference to base salary, which may increase depending on
performance). The Company believes it needs to provide executives with a level of predictable
compensation in order to attract and retain top-caliber executives and reward their continued services.
The Compensation Committee’s general philosophy is that discretionary bonuses and long-term incentive
compensation should fluctuate with the Company’s success in achieving financial and other goals, and
39
that the Company should continue to use long-term compensation such as stock options, restricted stock
and stock appreciation rights to align stockholder and executives’ interests. The Company also believes
that a mix of longer-term and short-term elements allows it to achieve the dual goals of attracting and
retaining executives while motivating their continued performance and aligning their financial interests
with that of our shareholders.
The Compensation Committee has found it difficult to benchmark the compensation levels of our
executive officers within a peer group of comparable companies due to the nature of our business and
technology. The Compensation Committee has evaluated the compensation practices of other high
technology companies, including other publicly-held advanced materials and advanced technologies
companies in determining an appropriate level and mix of compensation.
Current Material Elements
Base Salary. In determining the base salaries of the executive officers in 2006, the
Compensation Committee considered the performance of each executive during the prior year, the nature
of the executive’s responsibilities and the Company’s past compensation practice. Base salary is paid in
cash.
Each of the executive officers has employment agreements dictating a minimum level of base
salary. The executive officers annual base salaries were not increased for a period of approximately 18-
months ending on April 25, 2006. At that time, base salaries were increased by the following percentage
to the following levels: for Mr. Cross, 6.3% to $340,000, for Mr. Jankowski, 7.5% to $180,000, for Mr.
Haines, 8.9% to $220,000, for Mr. Bilicki, 4.0% to $220,500 and for Dr. Brotzman, 6.1% to $195,000.
The base salary that was paid to each executive officer in 2006 is the amount reported for such officer in
Column (c) of the Summary Compensation Table below. The executive officers’ base salaries are not
currently expected to change in 2007, however the Compensation Committee reserves the right to adjust
executive salaries at any time.
Discretionary Bonuses. Discretionary bonuses for executive officers, if any, are paid in cash
upon the achievement of our performance goals and are a function of the criteria which the Compensation
Committee believes appropriately takes into account the specific areas of responsibility of the particular
officer, performance and other factors such as our profitability, cash flow, revenue and customer
generation, market share and industry position. Discretionary bonuses, if any, are paid after consideration
of each executive officer’s performance and the input of Mr. Cross related to the individual performance
of the executive officers, other than himself. The Compensation Committee determines whether to pay a
discretionary bonus to Mr. Cross based on our performance, profitability, cash flow, revenue and
customer generations, market share and industry position.
Discretionary bonuses paid for performance in 2006 are shown in column (d) of the Summary
Compensation Table below.
Long-Term Incentive Compensation. Periodically, the Compensation Committee grants long-
term incentive compensation, in the form of stock options, restricted share rights, performance share
rights and stock appreciation rights in order to provide a long-term incentive which is directly tied to the
performance of our stock. These grants provide an incentive to maximize stockholder value by providing
the employees an equity interest which further aligns their interests with those of the stockholders. The
exercise price of these grants is the closing price (used to establish fair market value) of the underlying
Common Stock on the date of grant. In general, the options vest in equal annual installments over a
three-year period beginning one year after the date of grant, in certain instances the Board of Directors (or
the Compensation Committee) can adjust the vesting period for performance-based options. Restricted
share rights typically “cliff vest,” all at one time, at a date several years subsequent to their grant date.
Performance restricted share rights vest upon the achievement of milestones as defined by the
40
Compensation Committee. In 2006, the Company adopted the 2006 Stock Appreciation Rights Plan
which allows the Compensation Committee to award units that derive their value from the appreciation in
our stock without the issuance of additional shares. These awards are paid in cash. The Company
believes that the 2006 Stock Appreciation Rights Plan will allow it to continue to attract and retain key
employees while aligning the financial incentives of those individuals with the financial objectives of our
shareholders. One award has been issued under the 2006 Stock Appreciation Rights Plan to date.
Awards of stock appreciation rights are not currently intended to comprise a major part of our long-term
incentive compensation strategy. The Compensation Committee may elect, from time to time, to grant
these types of awards as particular situations arise. Vesting periods are used to retain key employees and
to emphasize the long-term aspect of contribution and performance. In making grants to executives in
2006, the Compensation Committee considered a number of factors, including the performance of such
persons, the Company’s performance, achievement of specific delineated goals, the responsibilities and
the relative position of such persons within the Company, the number of stock options each such person
currently possesses and the underlying value of the options held.
The Company traditionally awards long-term incentive compensation (including to the executive
officers) once per year. These awards have occurred in the latter half of the last several years. The
Compensation Committee may grant awards at any other time during the year in connection with the
hiring or promotion of employees or based upon other special circumstances or performance. The
aggregate amount as determined under FAS No. 123R recognized for purposes of our financial statements
for 2006 with respect to options granted to the executive officers is shown in the “Summary
Compensation Table” below. The grant date value of the options and restricted stock units awarded to the
executive officers in 2006 as determined under FAS No. 123R for purposes of the Company’s financial
statements is shown in the “Grants of Plan-Based Awards Table” below. The “Grants of Plan-Based
Awards” table and related narrative “Description of Plan-Based Awards” section below provide
additional detail regarding the options granted to the executive officers in 2006, including the vesting and
other terms that apply to the restricted stock units and options.
Severance Protection and Change-in-Control Benefits. The level of severance protection and
change-in-control benefits provided to each executive officer is based upon a review of the market and
consideration of the dedication and service provided by these executive officers to the Company. Please
see the “Potential Payments Upon Termination or Change in Control” section below for a description of
the potential payments that may be made to the executive officers in connection with their termination of
employment or a change in control.
Stock Ownership Guidelines
The Company currently does not require our directors or executive officers to own a particular
amount of our Common Stock. The Compensation Committee is satisfied that stock and option holdings
among our directors and executive officers are sufficient at this time to provide motivation and to align
this group’s interests with those of our stockholders.
Other Compensation and Benefits
Our executive officers participate in the same group insurance and employee benefit plans as our
other salaried employees.
Employment Agreements
The Company entered into an employment agreement with Mr. Cross dated November 9, 1999
(with an immaterial amendment thereafter to adjust language for changes in applicable governing
employment law) which provides for an annual base salary of not less than $220,000. In addition, Mr.
Cross received a lump sum payment of $50,000 on the first anniversary of the commencement of this
41
agreement. The Company also granted to Mr. Cross options to purchase up to 100,000 shares of
Common Stock at an exercise price of $2.9375 per share and options to purchase up to 50,000 shares of
Common Stock at an exercise price of $2.1875, with options for one-fifth of such shares becoming
exercisable on each of the first five anniversaries of the dates of grant. No term has been assigned to Mr.
Cross’ employment agreement. If Mr. Cross is terminated other than for “cause” (as such term is defined
in Mr. Cross’ employment agreement), Mr. Cross will receive severance benefits in an amount equal to
Mr. Cross’ base salary for 53 weeks.
Effective as of February 17, 2000, the Company entered into an employment agreement with Mr.
Jankowski (with an immaterial amendment thereafter to adjust language for changes in applicable
governing employment law) providing for an annual base salary of not less than $95,000. No term has
been assigned to Mr. Jankowski’s employment agreement. If Mr. Jankowski is terminated other than for
“cause” (as such term is defined in Mr. Jankowski’s employment agreement), Mr. Jankowski will receive
severance benefits in an amount equal to Mr. Jankowski’s base salary for 27 weeks.
Effective as of November 2, 2000, the Company also entered into an employment agreement with
Mr. Haines (with an immaterial amendment thereafter to adjust language for changes in applicable
governing employment law) providing for an annual base salary of not less than $160,000. The Company
also granted to Mr. Haines options to purchase up to 30,000 shares of Common Stock at an exercise price
of $10.1875. No term has been assigned to Mr. Haines employment agreement. If Mr. Haines is
terminated other than for “cause” (as such term is defined in Mr. Haines’s employment agreement), Mr.
Haines will receive severance benefits in an amount equal to Mr. Haines’s base salary for 53 weeks.
Effective as of February 17, 2000, the Company also entered into an employment agreement with
Mr. Bilicki (with an immaterial amendment thereafter to adjust language for changes in applicable
governing employment law) providing for an annual base salary of not less than $165,000. In addition,
Mr. Bilicki was granted options to purchase up to 50,000 shares of Common Stock at an exercise price of
$2.375. No term has been assigned to Mr. Bilicki’s employment agreement. If Mr. Bilicki is terminated
other than for “cause” (as such term is defined in Mr. Bilicki’s employment agreement), Mr. Bilicki will
receive severance benefits in an amount equal to Mr. Bilicki’s base salary for 53 weeks.
Effective as of September 26, 2001, the Company also entered into an employment agreement
with Dr. Brotzman (with an immaterial amendment thereafter to adjust language for changes in applicable
governing employment law) providing for an annual base salary of not less than $146,250. No term has
been assigned to Dr. Brotzman’s employment agreement. If Dr. Brotzman is terminated other than for
“cause” (as such term is defined in Dr. Brotzman’s employment agreement), Dr. Brotzman will receive
severance benefits in an amount equal to Dr. Brotzman’s base salary for 27 weeks.
Effective as of January 8, 2007, the Company also entered into an employment agreement with
Mr. Wenta providing for an annual base salary of not less than $270,000. In addition, Mr. Wenta was
granted options to purchase up to 75,000 shares of Common Stock at an exercise price of $5.72. No term
has been assigned to Mr. Wenta’s employment agreement. If Mr. Wenta is terminated other than for
“cause” (as such term is defined in Mr. Wenta employment agreement), Mr. Wenta will receive severance
benefits in an amount equal to Mr. Wenta’s base salary for 52 weeks.
42
Compliance with Section 162(m)
The Compensation Committee currently intends for all compensation paid to the executive
officers to be tax deductible to the Company pursuant to Section 162(m) of the Internal Revenue Code of
1986, as amended (“Section 162(m)”). Section 162(m) provides that compensation paid to the executive
officers in excess of $1,000,000 cannot be deducted by the Company for Federal income tax purposes
unless, in general, (1) such compensation is performance-based, established by a committee of outside
directors and objective, and (2) the plan or agreement providing for such performance-based
compensation has been approved in advance by stockholders. The Compensation Committee believes
that the requirements of Section 162(m) are uncertain at this time and may arbitrarily impact the
Company. In the future, the Compensation Committee may determine to adopt a compensation program
that does not satisfy the conditions of Section 162(m) if in its judgment, after considering the additional
costs of not satisfying Section 162(m), such program is appropriate.
COMPENSATION COMMITTEE REPORT
The Compensation Committee has reviewed and discussed with management the disclosures
contained in the Compensation Discussion and Analysis section of this Item 11. Based upon this review
and our discussions, the Compensation Committee recommended to its Board of Directors that the
Compensation Discussion and Analysis section be included in this Annual Report on Form 10-K.
Jerry K. Pearlman (Chairman)
James A. Henderson
Donald S. Perkins
COMPENSATION COMMITTEE’S INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee members whose names appear above were committee members
during all of 2006. Pursuant to a consulting agreement effective as of October 29, 1998, and prior to his
appointment as Chairman of the Board of Directors, Donald S. Perkins, who is a member of the
Compensation Committee, was engaged by the Company to provide additional services in connection
with the Company’s organizational restructuring and refocusing. In consideration for such services, Mr.
Perkins was granted options to purchase 25,000 shares of Common Stock at an exercise price of $3.50 per
share, of which 20,000 options remain vested but unexercised. Mr. Perkins’ consulting agreement was
terminated on June 1, 2000. No member of the Compensation Committee is or has been a former or
current executive officer of the Company. Mr. Cross serves as a director of the Company. None of the
Company’s executive officers served as a member of a compensation committee (or other committee
serving an equivalent function) of any other entity.
SUMMARY COMPENSATION TABLE
The following table sets forth all of the compensation awarded to, earned by, or paid to our
principal executive officer, principal financial officer and the three other highest paid executive officers
whose total compensation in fiscal year 2006 exceeded $100,000.
43
NAME AND PRINCIPAL
POSITION
(a)
YEAR
(b)
SALARY
($)
(c)
BONUS
($)(1)
(d)
OPTION
AWARDS
($)(2)
(f)
NON-EQUITY
INCENTIVE PLAN
COMPENSATION
($)(3)
(g)
2006
$340,000
$100,000
$89,946
2006
$180,000
$35,000
$67,460
2006
$220,500
$25,000
$53,968
-
-
-
ALL OTHER
COMPENSATION
($)(4)
(i)
TOTAL
($)
(j)
$27,999
$557,945
$22,040
$304,500
$19,539
$319,007
2006
$220,000
$40,000
-
$55,031
$23,408
$338,439
2006
$195,000
$20,000
$67,460
-
$22,608
$305,068
Joseph E. Cross
President and Chief Executive
Officer
Jess Jankowski
Chief Financial Officer
Daniel S. Bilicki
Vice President Sales and
Marketing
Robert Haines
Vice President Operations
Richard Brotzman, Ph.D.
Vice President Research and
Development
(1)
(2)
(3)
(4)
These amounts were earned in 2006 but paid in 2007.
The amounts in this column represent the dollar amount recognized for financial statement reporting
purposes with respect to the 2006 fiscal year in accordance with FAS 123(R). See Note 13 of the notes to
our financial statements contained elsewhere in this Annual Report for a discussion of all assumptions
made by us in determining the FAS 123(R) values.
The amount in this column is attributed to awards under the 2006 Stock Appreciation Rights Plan and
represents the dollar amount recognized for financial statement reporting purposes with respect to the 2006
fiscal year using the Black-Sholes model of valuation.
The amounts in this column represent 401(k) match, health and life insurance. Health insurance benefits are
the same for all employees. Life insurance is provided in the amount of one times the annual base salary
with a maximum of $150,000.
The Summary Compensation Table should be read in connection with the Compensation
Discussion and Analysis above and the tables and narrative descriptions that follow.
GRANTS OF PLAN BASED AWARDS
The following table sets forth each plan based award granted to our executive officers during
fiscal year 2006.
NAME
(a)
GRANT
DATE
(b)
NON-
EQUITY
INCENTIVE
PLAN UNIT
(#)
Joseph E. Cross
9/27/06
Jess Jankowski
9/27/06
Daniel S. Bilicki
9/27/06
ESTIMATED FUTURE PAYOUTS
UNDER NON-EQUITY
INCENTIVE PLAN AWARDS
ESTIMATED FUTURE PAYOUTS
UNDER EQUITY INCENTIVE
PLAN AWARDS
Threshold
(#)
(c)
Target
(#)
(d)
Maximum
(#
(e)
Threshold
(#)
(f)
20,000
Target
(#)
(g)
20,000
Maximum
(#
(h)
20,000
15,000
15,000
15,000
12,000
12,000
12,000
Robert Haines
9/27/06
15,000
15,000
15,000
15,000
EXERCISE OR
BASE PRICE OF
OPTION AWARDS
($/SH)
(k)
GRANT DATE
FAIR VALUE
OF AWARDS
(l)
$6.01
$6.01
$6.01
$6.01
$89,946
$67,460
$53,968
$55,031
Richard Brotzman,
Ph.D.
9/27/06
15,000
15,000
15,000
$6.01
$67,460
44
Description of Awards Granted in 2006
Each nonqualified stock option award described in the “Grants of Plan-Based Awards” table
above expires on the tenth anniversary of its associated grant date, vests in equal installments over the
course of three years, and is generally subject to accelerated vesting upon a change in control of the
Company or a termination of the executive without “cause.”
The amount of salary and bonus in proportion to total compensation for 2006 was:
NAME
Joseph E. Cross
Jess Jankowski
Daniel S. Bilicki
Robert Haines
Richard Brotzman, Ph.D.
PERCENTAGE
79%
71%
77%
77%
70%
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table sets forth information regarding each unexercised option held by each of our
executive officers as of December 31, 2006.
NAME
(a)
Joseph E. Cross
Jess Jankowski
Daniel S. Bilicki
OPTION AWARDS
NUMBER OF
SECURITIES
UNDERLYING
UNEXERCISED
EARNED
OPTIONS
(#)
EXERCISABLE
(b)
EQUITY INCENTIVE
PLAN AWARDS:
NUMBER OF SECURITIES
UNDERLYING
UNEXERCISED
UNEARNED OPTIONS
(#)
UNEXERCISABLE
(d)
-0-
-0-
-0-
-0-
-0-
-0-
-0-
5,000
10,000
20,000
-0-
-0-
-0-
-0-
-0-
-0-
-0-
3,666
6,666
15,000
100,000
50,000
100,000
50,000
50,000
55,000
50,000
10,000
5,000
-0-
6,960
5,334
21,775
13,000
13,000
20,000
18,000
7,334
3,334
-0-
10,000
50,000
30,000
30,000
30,000
STOCK AWARDS
EQUITY
INCENTIVE PLAN
AWARDS: NUMBER
OF SHARES OF
STOCK
THAT HAVE NOT
VESTED
(#)
(i)
EQUITY INCENTIVE
PLAN AWARDS: MARKET
VALUE
OF SHARES OF STOCK
THAT HAVE NOT
VESTED
($)
(j)
10,000
$59,700
OPTION
EXERCISE
PRICE
($)
(e)
OPTION
EXPIRATION
DATE
(f)
$2.937
$2.187
$7.687
$10.875
$7.062
$6.650
$3.660
$5.550
$6.030
$6.010
$3.812
$1.750
$7.687
$10.875
$7.062
$6.650
$3.660
$5.550
$6.030
$6.010
11/09/08
01/05/09
05/24/10
01/26/11
02/28/11
01/03/12
03/24/13
10/11/14
09/27/15
09/27/16
07/31/08
07/27/09
05/24/10
01/26/11
02/28/11
01/03/12
03/24/13
10/11/14
09/27/15
09/27/16
6,000
$35,820
-0-
-0-
-0-
-0-
-0-
$2.375
$7.687
$10.875
$7.062
$6.650
45
03/15/09
05/24/10
01/26/11
02/28/11
01/03/12
Robert Haines
Richard Brotzman,
Ph.D.
21,000
6,200
3,000
-0-
30,000
40,000
30,000
7,334
3,334
-0-
27,180
22,500
20,000
20,000
20,000
20,000
7,334
3,334
-0-
-0-
3,100
6,000
12,000
-0-
-0-
-0-
3,666
6,666
20,000
$3.660
$5.550
$6.030
$6.010
$10.187
$6.650
$3.660
$5.550
$6.030
$5.840
03/24/13
10/11/14
09/27/15
09/27/16
01/22/11
01/03/12
03/24/13
10/11/14
09/27/15
07/24/16
-0-
-0-
-0-
-0-
-0-
-0-
3,666
6,666
15,000
$3.812
$7.687
$10.875
$7.062
$6.650
$3.660
$5.550
$6.030
$6.010
07/31/08
05/24/10
01/26/11
02/28/11
01/03/12
03/24/13
10/11/14
09/27/15
09/27/16
6,000
$35,820
6,000
$35,820
6,000
$35,820
OPTION EXERCISE AND STOCK VESTED
The following table presents information regarding the exercise of stock options by Named
Officers during 2006.
OPTION AWARDS
STOCK AWARDS
NUMBER OF SHARES
ACQUIRED ON
EXERCISE
(#)
(b)
4,886
50,000
VALUE
REALIZED ON
EXERCISE
($)
(c)
$14,147
$162,722
OPTION AWARDS
NUMBER OF
SHARES
ACQUIRED ON
EXERCISE
(#)
(d)
-0-
-0-
VALUE
REALIZED ON
EXERCISE
($)
(e)
-0-
-0-
NAME
(a)
Jess Jankowski
Richard Brotzman, Ph.D.
POTENTIAL PAYMENT UPON TERMINATION OR CHANGE IN CONTROL
Severance Protection. Mr. Cross’s employment agreement provides that if Mr. Cross is
terminated other than for “cause” (as such term is defined in Mr. Cross’ employment agreement), Mr.
Cross will receive severance benefits in an amount equal to his base salary for 53 weeks. The
employment agreement with Mr. Jankowski provides that if Mr. Jankowski is terminated other than for
“cause” (as such term is defined in Mr. Jankowski’s employment agreement), Mr. Jankowski will receive
severance benefits in an amount equal to Mr. Jankowski’s base salary for 27 weeks. The employment
agreement with Mr. Haines provides that if Mr. Haines is terminated other than for “cause” (as such term
is defined in Mr. Haines’s employment agreement), Mr. Haines will receive severance benefits in an
amount equal to Mr. Haines’s base salary for 53 weeks. Mr. Bilicki’s employment agreement provides
that if Mr. Bilicki is terminated other than for “cause” (as such term is defined in Mr. Bilicki’s
employment agreement), Mr. Bilicki will receive severance benefits in an amount equal to Mr. Bilicki’s
base salary for 53 weeks. The employment agreement entered into with Dr. Brotzman provides that if Dr.
Brotzman is terminated other than for “cause” (as such term is defined in Dr. Brotzman’s employment
46
agreement), Dr. Brotzman will receive severance benefits in an amount equal to Dr. Brotzman’s base
salary for 27 weeks.
Change in Control. Upon a change in control, the Equity Compensation Plan (the predecessor to
the 2004 Equity Compensation Plan), the 2004 Equity Compensation Plan provides that: (1) vesting under
all outstanding stock options will automatically accelerate and each option will become fully exercisable;
(2) the restrictions and conditions on all outstanding restricted shares shall immediately lapse; and (3) the
holders of performance shares will receive a payment in settlement of the performance shares, in an
amount determined by the Compensation Committee, based on the target payment for the performance
period and the portion of the performance period that precedes the change in control. If the Company is
not the surviving entity, the successor is required to assume all unexercised options. Under the
Company’s 1992 Stock Option Plan, the vesting of options issued under it is accelerated upon a “sale or
merger” (as defined in the 1992 Stock Option Plan).
The following table quantifies the estimated payments that would be made in each covered
circumstance:
NAME
TERMINATION BY COMPANY
WITHOUT CAUSE (1)
CHANGE IN
CONTROL (2)
INVOLUNTARY TERMINATION IN
CONNECTION WITH OR FOLLOWING
A CHANGE IN CONTROL (3)
Joseph E. Cross
Jess Jankowski
Daniel S. Bilicki
Robert Haines
Richard Brotzman, Ph.D
$346,538
$93,461
$224,740
$224,230
$101,250
$61,800
$37,360
$37,122
$126,910
$37,360
$408,338
$130,821
$261,862
$351,140
$138,610
(1)
(2)
(3)
This amount represents the severance benefits that would be received under the executive officers
employment agreement as described had the executive officer been terminated by the company without
cause on December 31, 2006.
This amount represents an estimate of the value that would have been received under the equity
incentive plans had a change in control occurred as of December 31, 2006 and the executive officers
benefited from an acceleration of vesting in the equity-based plan awards as described above. For this
purpose, the share price as of December 31, 2006 was used. The amount represents the difference
between the exercise price of any unvested options and $5.97 plus the value of any restricted shares
that would have become vested as of this date.
This amount represents an estimate of the payments and value that would have been received by the
executive officers had the executive officers been terminated by the company without cause on
December 31, 2006 in connection with a change in control on this date. It is the sum of the first two
columns.
DIRECTOR COMPENSATION
Upon first being elected to the Board of Directors, each director of the Company who is not an
employee or consultant of the Company (an “Outside Director”) is granted stock options to purchase
10,000 shares of common stock at the closing price as of the date of issuance (the fair market value). This
initial option grant to an Outside Director vests over five years.
In January 2006, the Company paid $4,000 as quarterly compensation to its directors, which will
amount to an annual total of $16,000 per outside director for services performed in their capacity as
directors. In addition, each outside director will receive $6,000 each calendar quarter in deferred common
stock (the “Director Restricted Stock Plan” as described below) based on the closing price at the
beginning of each quarter. For the year ended December 31, 2006 each director received 3,754 shares
with the total value of the compensation of approximately $24,000 per year. In 2005, the Company paid
$6,250 quarterly, which amounted to an annual total of $25,000 per Outside Director, in cash
compensation for services performed in their capacity as directors. No stock based awards were issued to
47
Outside Directors in 2005. Beginning in 2004, Mr. McClung’s cash compensation is being paid to
Lismore International, Incorporated.
In 2005, the Company adopted, and the Shareholders’ approved, the 2005 Non-Employee
Director Restricted Stock Plan (the “Director Restricted Stock Plan”) which reserves 150,000 shares of
the Company’s common stock to be issued to Outside Directors in the form of restricted shares. In 2005,
no awards were made under the Director Restricted Stock Plan. In 2005, the Company also adopted the
Non-Employee Director Deferred Compensation Plan (the “Director Deferred Compensation Plan”)
which permits an Outside Director to defer the receipt of director fees until separation from service or the
Company undergoes a change in control. The Company amended the Director Restricted Stock Plan in
2005 to permit an Outside Director to defer receipt of restricted stock granted under it. The deferred
restricted shares are accounted for under the Director Deferred Compensation Plan and issued upon
separation from service or the Company’s change in control. Under the Director Deferred Compensation
Plan, the deferred fees that would have been paid in cash are deemed invested in 5 year U.S. Treasury
Bonds during the deferral period. The accumulated hypothetical earnings are paid following the Outside
Director’s separation from service or the Company’s change in control. The deferred fees that would
have been paid as restricted shares are deemed invested in common stock of the Company during the
deferral period. The Director Deferred Compensation Plan is an unfunded, nonqualified deferred
compensation arrangement. In 2006, all Outside Directors elected to defer receipts of all of the restricted
shares they became entitled to under the Director Restricted Stock Plan. No director’s fees paid in cash
were deferred under the Director Deferred Compensation Plan.
All Outside Directors are reimbursed for their reasonable out-of-pocket expenses incurred in
attending board and committee meetings.
2006 Director Compensation
Name
(a)
James A. Henderson
James A. McClung
Jerry K. Pearlman
Donald S. Perkins
Richard W. Siegel, Ph.D.
R. Janet Whitmore
Fees Earned or
Paid in Cash
($)
(b)
$16,000
$16,000
$16,000
$16,000
$16,000
$16,000
Stock Awards
($)
(d)
$24,000
$24,000
$24,000
$24,000
$24,000
$24,000
Total($)
(h)
$40,000
$40,000
$40,000
$40,000
$40,000
$40,000
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
SECURITY OWNERSHIP OF MANAGEMENT
AND PRINCIPAL STOCKHOLDERS
The following table sets forth, as of March 15, 2007 certain information with respect to the
beneficial ownership of the common stock by (1) each person known by the Company to own beneficially
more than 5% of the outstanding shares of common stock, (2) each Company director, (3) each of the
Named Officers and (4) all Company executive officers and directors as a group.
Name
Bradford T. Whitmore
Spurgeon Corporation
Number of Shares
Beneficially Owned (1)
3,558,007(2)
3,285,195(3)
Percent of Shares
Beneficially Owned
18.72%
17.29%
48
Grace Brothers, Ltd.
Grace Investments, Ltd.
Altana Chemie, AG
AMVESCAP PLC
Rohm and Haas Electronic Materials CMP, Inc.
Joseph E. Cross
James A. Henderson
Richard W. Siegel, Ph.D.
James McClung
Jerry Pearlman
Donald S. Perkins
R. Janet Whitmore
Daniel S. Bilicki
Jess Jankowski
Richard W. Brotzman, Ph.D.
Robert Haines
All executive officers and directors as a group
(11 persons)
2,985,195 (4)
300,000 (5)
1,256,281 (6)
980,716 (7)
847,918 (8)
476,500 (9)
22,410(10)
229,057 (11)
41,771 (12)
39,948 (13)
78,812 (14)
165,891 (15)
188,200 (16)
113,037 (17)
143,348 (18)
113,668(19)
15.71%
1.58 %
6.61%
5.16%
4.46%
2.45%
*
1.20%
*
*
*
*
*
*
*
*
1,612,642 (20)
8.01%
Unless otherwise indicated below, the persons address is the same as the address for the
Company.
*Denotes beneficial ownership of less than one percent.
(1)
(2)
(3)
(4)
(5)
Beneficial ownership is determined in accordance with the rules of the Securities and Exchange
Commission (the “Commission”). Unless otherwise indicated below, the persons in the above
table have sole voting and investment power with respect to all shares of common stock shown as
beneficially owned by them.
Includes 2,985,195 shares of common stock held by Grace Brothers, Ltd., 300,000 shares of
common stock held by Grace Investments, Ltd. and 272,812 shares held by Bradford T.
Whitmore. Mr. Whitmore is a general partner of Grace Brothers, Ltd. and is the sole owner of an
entity which is a general partner of Grace Investments, Ltd. In such capacities, Mr. Whitmore
shares voting and investment power with respect to the shares of common stock held by the Grace
entities. This information is based on information reported on Schedule 13D/A filed on
September 3, 2004 with the Commission by Mr. Whitmore. The address of the stockholder is
1560 Sherman Avenue, Suite 900, Evanston, Illinois 60201.
Includes 2,985,195 shares of common stock held by Grace Brothers, Ltd. and 3,200,000 shares of
common stock held by Grace Investments, Ltd. Spurgeon Corporation is a general partner of
both Grace entities and shares voting and investment power with respect to the shares of common
stock held by such Grace entities. This information is based on information reported on Schedule
13D/A filed on September 3, 2004 with the Commission by Spurgeon Corporation. The address
of the stockholder is 1560 Sherman Avenue, Suite 900, Evanston, Illinois 60201.
This information is based on information reported on Schedule 13D/A filed on September 3, 2004
with the Commission by Spurgeon Corporation and Bradford T. Whitmore. The address of the
stockholder is 1560 Sherman Avenue, Suite 900, Evanston, Illinois 60201.
This information is based on information reported on Schedule 13D/A filed on September 3, 2004
with the Commission by Spurgeon Corporation and Bradford T. Whitmore. The address of the
stockholder is 1560 Sherman Avenue, Suite 900, Evanston, Illinois 60201.
49
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
(16)
(17)
(18)
(19)
In accordance with the terms of the private placement of 1,256,281 shares of common stock to
Altana, the Company filed a registration statement for the shares on February 5, 2007. Such
registration statement has not yet been declared effective by the SEC.
This information is based on information reported on Schedule 13d-1(b) filed on February 14,
2007 with the Commission by AMVESCAP PLC. The address of the stockholder is 30 Finsbury
Square, London EC2A 1AG, England.
Consist of unregistered common stock, and therefore not freely saleable, until August 25, 2008.
Includes 470,000 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 14,000 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 19,600 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 18,000 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 18,000 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 36,668 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 10,000 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 180,200 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Includes 108,737 shares of common stock issuable upon exercise of options exercisable currently
or within 60 days of March 15, 2007.
Consists of 140,348 shares of common stock issuable upon exercise of options exercisable
currently or within 60 days of March 15, 2007.
Consists of 110,668 shares of common stock issuable upon exercise of options exercisable
currently or within 60 days of March 15, 2007.
(20)
Includes 1,126,221 shares of common stock issuable upon exercise of options exercisable
currently or within 60 days of March 15, 2007.
Item 13. Certain Relationships and Related Transactions, and Director Independence
See Item 12 above. In addition, on September 5, 2003, in anticipation of the September 8, 2003
private placement to Grace Brothers Ltd. discussed below, the Company amended its existing
Stockholder Rights Agreement to revise the beneficial ownership threshold at which a person or group of
persons becomes an “acquiring person” and triggers certain provisions under the Stockholder Rights
Agreement. As revised, a person or group would become an “acquiring person” if that person or group
becomes the beneficial owner of 35% or more of the outstanding shares of the Company’s stock. Prior to
50
such amendment, the beneficial ownership threshold was 25%. On September 8, 2003, the Company
issued 453,001 shares of its common stock to Grace Brothers Ltd. at a purchase price of $4.415 per share
together with a warrant to purchase a like number of shares of common stock during the next twelve
months also at a price of $4.415 per share. The share price for the common stock was determined based
on the fifteen-day market closing average for the Company’s stock ending September 5, 2003. On
September 2, 2004 the warrants were exercised to acquire 453,001 newly issued shares of common stock.
Grace Brothers, Ltd. and its affiliates beneficially own approximately 19% of the Company’s outstanding
common stock. Ms. R. Janet Whitmore is a sister of Bradford Whitmore who serves as the general partner
of Grace Brothers, Ltd.
On March 23, 2004, the Company entered into a joint development agreement with Altana
described in “Item 1. Business—Marketing.” In connection with this agreement the Company sold, in a
private placement to Altana, 1,256,281 shares of common stock at $7.96 per share and received gross
proceeds of $10 million. Altana beneficially owns approximately 7% of the Company’s outstanding
common stock.
On August 25, 2006, the Company sold, in a private placement to Rohm and Haas Electronic
Materials CMP Holdings, Inc., 847,918 shares of common stock at $5.8968 per share and received gross
proceeds of $5.0 million. Rohm and Haas Electronic Materials CMP Holdings, Inc. beneficially owns
approximately 4% of the Company’s outstanding common stock.
Item 14. Principal Accountant Fees and Services
Audit Fees. The aggregate amount billed by our principal accountant, McGladrey & Pullen, LLP,
for audit services performed for the fiscal years ended December 31, 2006 and 2005 was $223,000 and
$238,000, respectively. Audit services include the auditing of financial statements, internal control over
financial reporting and quarterly reviews.
Audit Related Fees. Total fees billed by McGladrey & Pullen, LLP were $12,000 for the year
ended December 31, 2006 include costs incurred for consultation on various accounting matters in
support of the Company’s financial statements and correspondence with the SEC related to comment
letters received during 2006. McGladrey & Pullen, LLP did not perform audit related services during the
fiscal years ended December 31, 2005.
Tax Fees. Total fees billed by RSM McGladrey, Inc. (an affiliate of McGladrey & Pullen, LLP)
for tax related services for the fiscal years ended December 31, 2006 and 2005 were $12,500 and $7,575,
respectively. These services include tax related research and general tax services in connection with
transactions and legislation.
All Other. Other than those fees described above, during the fiscal year ended December 31,
2006 and 2005 there were no other fees billed for services performed by McGladrey & Pullen, LLP or
RSM McGladrey, Inc.
All of the fees described above were approved by Nanophase’s audit committee.
Audit Committee Pre-Approval Policies and Procedures. Nanophase’s audit committee pre-
approves the audit and non-audit services performed by McGladrey & Pullen, LLP, our principal
accountants, and RSM McGladrey, Inc. (an affiliate of McGladrey & Pullen, LLP) in order to assure that
the provision of such services does not impair McGladrey & Pullen, LLP’s independence. Unless a type
of service to be provided by McGladrey & Pullen, LLP and RSM McGladrey, Inc. (an affiliate of
McGladrey & Pullen, LLP) has received general pre-approval, it will require specific pre-approval by the
audit committee. In addition, any proposed services exceeding pre-approval cost levels will require
specific pre-approval by the audit committee.
51
The term of any pre-approval is 12 months from the date of pre-approval, unless the audit
committee specifically provides for a different period. The audit committee will periodically revise the
list of pre-approved services, based on subsequent determinations, and has delegated pre-approval
authority to the Chairman of the audit committee. In the event the Chairman exercises such delegated
authority, he shall report such pre-approval decisions to the audit committee at its next scheduled
meeting. The audit committee does not delegate its responsibilities to pre-approve services performed by
the independent auditor to management.
PART IV
Item 15. 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
registered public accounting firm, are filed as part of this Form 10-K:
Management’s report
Report of McGladrey & Pullen, LLP, Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2006 and 2005
Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004
Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and
2004
Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
Notes to Financial Statements
2.
The following exhibits are filed with this Form 10-K or incorporated by reference as set
forth below.
Exhibit
Number
2
3(I).1
3(I).2
Plan and Agreement of Merger dated as of November 25, 1997 by and between the
Company and its Illinois predecessor, incorporated by reference to Exhibit 2 to the
Company’s Annual Report on Form 10-K for the year ended December 31, 1997 (the
“1997 10-K”).
Certificate of Incorporation of the Company, incorporated by reference to Exhibit 3.1
to the 1997 10-K.
First Amendment to the Certificate of Incorporation of Nanophase Technologies
Corporation dated July 27, 2006, incorporated by reference to Exhibit 99.3 to the
Company’s Current Report on Form 8-K filed July 27, 2006.
3(II).1
Bylaws of the Company, incorporated by reference to Exhibit 3.2 to the 1997 10-K.
4.1
Specimen stock certificate representing common stock, incorporated by reference to
Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (File No. 333-
36937) (the “IPO S-1”).
4.2
Form of Warrants, incorporated by reference to Exhibit 4.2 to the IPO S-1.
52
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
Rights Agreement dated as of October 28, 1998 by and between the Company and
LaSalle National Bank, incorporated by reference to Exhibit 1 to the Company’s
Registration Statement on Form 8-A, filed October 28, 1998.
Certificate of Designation of Series A Junior Participating Preferred Stock
incorporated by reference to Exhibit 4.4 to the Company’s Annual Report on
Form 10-K for the year ended December 31, 1998 (the “1998 10-K”).
Amendment to Rights Agreement dated August 1, 2001 between the Company and
LaSalle National Association, as Rights Agent, incorporated by reference to Exhibit
4.5 to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30,
2001.
2001 Nanophase Technologies Corporation Equity Compensation Plan, incorporated
by reference to Exhibit 4.3 to the Company’s Registration Statement on Form S-8
(File No. 333-74170).
Second Amendment to Rights Agreement dated May 24, 2002 between the Company
and LaSalle National Association, as Rights Agent, incorporated by reference to
Exhibit 4.3 to the Company’s Registration Statement on Form S-3 (File No. 333-
90326) filed June 12, 2003.
Third Amendment to Rights Agreement dated September 5, 2003 between the
Company and LaSalle National Association, as Rights Agent, incorporated by
reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed
September 10, 2003.
Subscription Agreement dated September 8, 2003 between the Company and Grace
Brothers, Ltd., incorporated by reference to Exhibit 99.2 to the Company’s Current
Report on Form 8-K filed September 10, 2003.
Stock Purchase Agreement dated March 23, 2004 between the Company and Altana
Chemie AG, incorporated by reference to Exhibit 4.10 to the Company’s Annual
Report on Form 10-K filed March 30, 2004.
Registration Rights Agreement dated March 23, 2004 between the Company and
Altana Chemie AG, incorporated by reference to Exhibit 4.11 to the Company’s
Annual Report on Form 10-K filed March 30, 2004.
2004 Nanophase Technologies Corporation 2004 Equity Compensation Plan,
(“2004 Equity Plan”) incorporated by reference to Exhibit 4 to the Company’s
Registration Statement on Form S-8 (File No. 333-119466).
Form of Stock Option Agreement under the 2004 Equity Plan, incorporated by
reference to Exhibit 4.13 to the Company’s Annual Report on Form 10-K filed
March 15, 2005.
Form of Restricted Share Grant Agreement under the 2004 Equity Plan, incorporated
by reference to Exhibit 4.14 to the Company’s Annual Report on Form 10-K filed
March 15, 2005.
Form of Performance Share Grant Agreement under the 2004 Equity Plan,
incorporated by reference to Exhibit 4.15 to the Company’s Annual Report on Form
10-K filed March 15, 2005.
53
4.16
4.17
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8*
10.9
10.10
10.11
10.12
2005 Nanophase Technologies Corporation Equity Compensation Plan, incorporated
by reference to Exhibit 4 to the Company’s Non-Employee Director Restricted Stock
Plan, incorporated by reference to Exhibit A to the Company’s Definitive Proxy
Statement on Form DEF14A filed May 17, 2005.
First Amendment to the Nanophase Technologies Corporation 2005 Non-Employee
Director Restricted Stock Plan, incorporated by reference to Exhibit 99.1 to the
Company’s Current Report on Form 8-K filed January 9, 2006.
The Nanophase Technologies Corporation Amended and Restated 1992 Stock Option
Plan, as amended (the “Stock Option Plan”), incorporated by reference to
Exhibit 10.1 to the IPO S-1.
Form of Indemnification Agreement between the Company and each of its directors
and executive officers, incorporated by reference to Exhibit 10.2 to the IPO S-1.
Amended and Restated Registration Rights Agreements dated as of March 16, 1994,
as amended, incorporated by reference to Exhibit 10.2 to the IPO S-1.
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.
License Agreement dated October 12, 1994 between the Company and Hitachi,
incorporated by reference to Exhibit 10.8 to the IPO S-1.
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.
License Agreement dated April 1, 1996 between the Company and Cornell Research
Foundation, incorporated by reference to Exhibit 10.10 to the IPO S-1.
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.
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.
Distribution Agreement between the Company and C.I. Kasei, Ltd., (a subsidiary of
Itochu Corporation) dated as of October 30, 1996, incorporated by reference to
Exhibit 10.15 to the IPO S-1.
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.
License Agreement between the Company and C.I. Kasei Co., Ltd. (a subsidiary of
Itochu Corporation) dated as of December 30, 1997, incorporated by reference to
Exhibit 10.17 to the 1997 10-K.
10.13*
Employment Agreement dated as of November 9, 1999 between the Company and
Joseph Cross, incorporated by reference to Exhibit 10.15 to the 1999 10-K.
54
10.14*
10.15*
10.16**
10.17*
Employment Agreement dated as of March 15, 1999 between the Company and
Daniel S. Bilicki, incorporated by reference to Exhibit 10.19 to the 1998 10-K.
Form of Options Agreement under the Stock Option Plan, incorporated by reference
to Exhibit 4.5 to the Company’s Registration Statement on Form S-8 (File No. 333-
53445).
Zinc Oxide Supply Agreement dated as of September 16, 1999 between the Company
and BASF Corporation, as assignee, incorporated by reference to Exhibit 10.22 to the
1999 10-K.
Employment Agreement dated as of November 2, 2000 between the Company and
Robert Haines, incorporated by reference to Exhibit 10.22 to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2000 (the “2000 10-K”).
10.18
Lease Agreement between Centerpointe Properties Trust and the Company, dated
June 15, 2000, incorporated by reference to Exhibit 10.23 to the 2000 10-K.
10.19** Amendment No. 1 to Zinc Oxide Supply Agreement dated as of January, 2001
between the Company and BASF Corporation, incorporated by reference to Exhibit
10.24 to the 2000 10-K.
10.20
Promissory Note dated as of September 14, 2000 between the Company and BASF
Corporation, incorporated by reference to Exhibit 10.25 to the 2000 10-K.
10.21**
Cooperation Agreement dated June 24, 2002 between the Company and Rodel, Inc.,
incorporated by reference to Exhibit 10.23 to the Company’s Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002.
10.22*
Consulting Agreement dated December 12, 2002 between the Company and Dr. Gina
Kritchevsky, incorporated by reference to Exhibit 10.24 to the Company’s Annual
Report on Form 10-K for the year ended December 31, 2002.
10.23
10.24
10.25*
10.26*
10.27*
First Amendment to Promissory Note dated as of March 11, 2003 between the
Company and BASF Corporation, incorporated by reference to Exhibit 10.25 to the
Company’s Annual Report on Form 10-K for the year ended December 31, 2002.
Amendment No. 2. to Zinc Oxide Supply Agreement dated as of March 17, 2003
between the Company and BASF Corporation, incorporated by reference to Exhibit
10.25 to the Company’s Annual Report on Form 10-K for the year ended December
31, 2002.
Employment Agreement dated March 24, 2003 between the Company and Mr.
Edward G. Ludwig, Jr., incorporated by reference to Exhibit 10.25 to the Company’s
Annual Report on Form 10-K for the year ended December 31, 2002.
Employment Agreement dated February 17, 2000 between the Company and Mr. Jess
Jankowski, incorporated by reference to Exhibit 10.26 to the Company’s Annual
Report on Form 10-K filed March 30, 2004.
Employment Agreement dated September 26, 2001 between the Company and Dr.
Richard W. Brotzman, incorporated by reference to Exhibit 10.27 to the Company’s
Annual Report on Form 10-K filed March 30, 2004.
55
10.28*** Amendment No. 1 to Cooperation Agreement dated February 25, 2004 between the
Company and Rohm and Haas Electronic Materials CMP Inc. (formerly known as
Rodel, Inc.), incorporated by reference to Exhibit 10.28 to the Company’s Annual
Report on Form 10-K filed March 30, 2004.
10.29
10.30
Joint Development Agreement dated March 23, 2004 between the Company and
Altana Chemie AG., incorporated by reference to Exhibit 10.29 to the Company’s
Quarterly Report on Form 10-Q filed August 13, 2004
Amendment No. 1 to License Agreement dated July 16, 2004 between the Company
and C.I. Kasei Co., Ltd., incorporated by reference to Exhibit 10.30 to the
Company’s Quarterly Report on Form 10-Q filed August 13, 2004.
10.31*** Letter Agreement Amending Cooperation Agreement dated October 15, 2004
between the Company and Rohm and Haas Electronic Materials CMP Inc.,
incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form
8-K filed October 22, 2004.
10.32
Building Lease dated September 15, 2004 between the Company and the Village of
Burr Ridge, incorporated by reference to Exhibit 10.32 to the Company’s Annual
Report on Form 10-K filed March 15, 2005.
10.33*** Second Amendment to Promissory Note dated as of May 1, 2005 between the
Company and BASF Corporation, incorporated by reference to Exhibit 10.33 to the
Company’s Quarterly Report on Form 10-Q filed May 9, 2005.
10.34
Lease Amendment effective October 1, 2005 between Nanophase Technologies
Corporation and Centerpoint Properties Trust, incorporated by reference to Exhibit
99.1 to the Company’s Current Report on Form 8-K filed October 20, 2005.
10.35
Promissory Note effective October 27, 2005 executed by BYK-Chemie USA in favor
of Nanophase Technologies Corporation, incorporated by reference to Exhibit 99.2 to
the Company’s Current Report on Form 8-K filed October 27, 2005.
10.36*** Distributor Agreement dated October 24, 2005 between Johnson Matthey Catalog
Company, Inc., d/b/a ALFA AESAR, and Nanophase Technologies Corporation,
incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form
8-K filed November 1, 2005.
10.37
10.38
First Amendment
to 2005 Non-Employee Director Restricted Stock Plan,
incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form
8-K filed January 9, 2006.
Nanophase Technologies Corporation Non-Employee Director Deferred
Compensation Plan, incorporated by reference to Exhibit 99.2 to the Company’s
Current Report on Form 8-K filed January 9, 2006.
10.39*** Supply Agreement dated March 3, 2006 between Roche Diagnostics GmbH and
Nanophase Technologies Corporation, incorporated by reference to Exhibit 99.1 to
the Company’s Current Report on Form 8-K filed March 9, 2006.
10.40
Z-COTE HP-2 Brand Supply Agreement dated May 15, 2006 between BASF
Corporation and Nanophase Technologies Corporation, incorporated by reference to
Exhibit 99.1 to the Company’s Current Report on Form 8-K filed June 20, 2006.
56
10.41
10.42
10.43
Amendment to 2004 Equity Compensation Plan, incorporated by reference to Exhibit
99.1 to the Company’s Current Report on Form 8-K filed July 27, 2006.
Stock Purchase Agreement dated August 25, 2006 between Rohm and Haas
Electronic Materials CMP Holdings, Inc. and Nanophase Technologies Corporation,
incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form
8-K filed August 28, 2006.
Registration Rights Agreement dated August 25, 2006 between Rohm and Haas
Electronic Materials CMP Holdings, Inc. and Nanophase Technologies Corporation,
incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form
8-K filed August 28, 2006.
10.44*** Amended and Restated Cooperation Agreement dated August 25, 2006 between
Rohm and Haas Electronic Materials CMP Inc. and Nanophase Technologies
Corporation, incorporated by reference to Exhibit 99.3 to the Company’s Current
Report on Form 8-K filed August 28, 2006.
10.45
10.46
23.1
31.1
31.2
32
2006 Stock Appreciation Rights Plan, incorporated by reference to Exhibit 99.1 to
the Company’s Current Report on Form 8-K filed October 3, 2006.
Form of Grant Agreement, incorporated by reference to Exhibit 99.2 to the
Company’s Current Report on Form 8-K filed October 3, 2006.
Consent of McGladrey & Pullen, LLP.
Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-
14(a) under the Exchange Act.
Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-
14(a) under the Exchange Act.
Certification of the Chief Executive Officer and the Chief Financial Officer pursuant
to 18 U.S.C. Section 1350
_______________________
* Management contract or compensatory plan or arrangement.
** Confidentiality previously granted for portions of this agreement.
*** Confidentially requested, confidential portions have been omitted and filed separately with
the Commission as required by Rule 24b-2.
(b)
Reports on Form 8-K:
On October 26, 2006, the Company furnished a Current Report on Form 8-K reporting
under Items 2.02 and 9.01 that on October 26, 2006 it issued a press release announcing third
quarter 2006 revenues.
On October 3, 2006, the Company furnished a Current Report on Form 8-K under Items
8.01 and 9.01 that on September 27, 2006, Nanophase established a stock appreciation rights
plan, the details of which are set forth in the Nanophase Technologies Corporation 2006 Stock
Appreciation Rights Plan (the “Plan”), and adopted a form of Grant Agreement under said Plan.
57
The purpose of the Plan is to encourage key employees to contribute materially to the growth of
the Company by aligning the financial incentives of such employees with those of shareholders.
The Plan accomplishes this by offering grants of stock appreciation rights to its employees, the
settlement of which will be at fair market value. The Plan will be administered by the
Compensation and Governance Committee of the Board of Directors which committee is
comprised exclusively of outside directors in accordance with its charter.
58
NANOPHASE TECHNOLOGIES CORPORATION
INDEX TO FINANCIAL STATEMENTS
Management’s Report
Report of McGladrey and Pullen, LLP, Independent Registered Public Accounting Firm
Balance Sheets as of December 31, 2006 and 2005
Statements of Operations for the years ended December 31, 2006, 2005 and 2004
Statements of Stockholders’ Equity for the years ended December 31, 2006, 2005 and 2004
Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004
Notes to the Financial Statements
Page
F-2
F-3
F-5
F-6
F-7
F-8
F-9
F-1
Management’s Report
Management is responsible for the preparation, integrity and fair presentation of the financial statements
and Notes to the financial statements. The financial statements were prepared in accordance with the
accounting principles generally accepted in the U.S. and include certain amounts based on management’s
judgment and best estimates. Other financial information presented is consistent with the financial
statements.
Management is also responsible for establishing and maintaining adequate internal control over financial
reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The
Company’s internal control over financial reporting is designed under the supervision of the Company’s
principal executive and financial officers in order to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. The Company’s internal control over financial reporting
includes those policies and procedures that:
(i) Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of assets of the Company;
(ii) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting principles, and that receipts
and expenditures of the Company are being made only in accordance with authorizations of
management and directors of the Company; and
(iii) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition,
use or disposition of the Company’s assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of
December 31, 2006. In making this assessment, management used the criteria established in Internal
Control–Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
Based on our assessment and those criteria, management believes that the Company maintained effective
internal control over financial reporting as of December 31, 2006.
The Company’s independent registered public accounting firm, McGladrey & Pullen, LLP, has issued an
attestation report on management’s assessment of the Company’s internal control over financial reporting.
That report appears on a subsequent page of this Report and expresses unqualified opinions on
management’s assessment and on the effectiveness of the Company’s internal control over financial
reporting.
NANOPHASE TECHNOLOGIES CORPORATION
March 14, 2007
F-2
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Nanophase Technologies Corporation
Romeoville, Illinois
We have audited the accompanying balance sheets of Nanophase Technologies Corporation as of
December 31, 2006 and 2005, and the related statements of operations, stockholders’ equity, and cash
flows for each of the years in the three-year period ended December 31, 2006. We also have audited
management's assessment, included in the accompanying Annual Report on the Form 10-K, that
Nanophase Technologies Corporation maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Control— Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Nanophase
Technologies Corporation’s management is responsible for these financial statements, for maintaining
effective internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on these financial statements,
an opinion on management’s assessment, and an opinion on the effectiveness of the company's internal
control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material respects. Our audit of financial
statements included examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting,
evaluating management’s assessment, testing and evaluating the design and operating effectiveness of
internal control, and performing such other procedures as we considered necessary in the circumstances.
We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the
risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of Nanophase Technologies Corporation as of December 31, 2006 and 2005, and the
F-3
results of its operations and its cash flows for each of the years in the three-year period ended December
31, 2006 in conformity with accounting principles generally accepted in the United States of America.
Also in our opinion, management’s assessment that Nanophase Technologies Corporation maintained
effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material
respects, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our
opinion, Nanophase Technologies Corporation maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2006, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
As described in Note 13 to the financial statements, on January 1, 2006, the Company changed its method
of accounting for share-based payments to adopt Statement of Financial Accounting Standard No.123(R).
/s/ McGladrey & Pullen, LLP
Schaumburg, Illinois
March 14, 2007
F-4
NANOPHASE TECHNOLOGIES CORPORATION
BALANCE SHEETS
Current assets:
ASSETS
Cash and cash equivalents
Investments
Trade accounts receivable, less allowance for doubtful accounts
of $22,000 and $24,000 on December 31, 2006 and 2005,
respectively
Inventories, net
Prepaid expenses and other current assets
Total current assets
Equipment and leasehold improvements, net
Other assets, net
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt
Current portion of capital lease obligations
Current portion of deferred other revenue
Accounts payable
Accrued expenses
Total current liabilities
Long-term debt, less current maturities and unamortized debt
discount
Long-term portion of capital lease obligations
Deferred other revenue, less current portion
As of December 31,
2006
2005
$ 132,387 $ 340,860
8,168,092
8,434,793
1,459,391
923,223
534,407
11,484,201
1,180,117
801,217
414,363
10,904,649
6,587,787
7,608,326
651,218
680,908
$ 19,743,745 $ 18,173,344
$ - $ 200,254
-
56,757
285,076
1,152,127
1,694,214
32,972
127,273
478,694
1,643,585
2,282,524
1,383,707
50,552
201,515
1,635,774
1,265,875
-
293,243
1,559,118
Commitments and contingencies
-
-
Stockholders’ equity:
Preferred stock, $.01 par value; 24,088 authorized and no shares
issued and outstanding
-
-
Common stock, $.01 par value; 30,000,000 shares authorized;
18,995,581 and 17,976,592 shares issued and outstanding on
December 31, 2006 and December 31, 2005, respectively
Additional paid-in capital
Accumulated deficit
Total stockholders’ equity
179,766
189,956
72,307,887
78,380,962
(62,745,471)
(57,567,641)
15,825,447
14,920,012
$ 19,743,745 $ 18,173,344
(See accompanying Notes to Financial Statements)
F-5
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF OPERATIONS
Revenue:
Product revenue
Other revenue
Total revenue
Operating expense:
Cost of revenue
Gross Profit
Research and development expense
Selling, general and administrative expense
Lease accounting adjustment
Loss from operations
Interest income
Interest expense
Other, net
Loss before provision for income taxes
Provision for income taxes
Net loss
2006
Years ended December 31,
2005
2004
$ 8,612,705
378,133
8,990,838
$ 6,444,444
357,463
6,801,907
$ 4,253,478
954,456
5,207,934
7,057,707
1,933,131
5,827,719
974,188
5,125,216
82,718
1,934,528
2,127,862
4,422,011
5,302,836
-
279,810
(5,662,161)
(5,497,567)
295,935
366,701
(50,273)
(52,469)
32,888
5,505
(5,383,611)
(5,177,830)
-
-
$ (5,177,830) $ (5,383,611)
1,929,348
4,361,357
-
(6,207,987)
171,582
(74,277)
(306,273)
(6,416,955)
(30,000)
$ (6,446,955)
Net loss net per share-basic and diluted
$ (0.28) $ (0.30)
$ (0.37)
Weighted average number of basic and diluted
common shares outstanding
18,344,334
17,937,932
17,266,228
(See accompanying Notes to Financial Statements)
F-6
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF STOCKHOLDERS’ EQUITY
Preferred Stock
Common Stock
Description
Shares Amount
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Total
Balance on January 1, 2004
Exercise of stock options
Exercise of warrants
Common stock issuance
Stock-based compensation
Net loss for the year ended
December 31, 2004
Balance on December 31, 2004
Exercise of stock options
Stock-based compensation
Net loss for the year ended
December 31, 2005
—
—
—
—
—
—
—
—
—
$ —
—
—
—
—
—
—
—
—
15,902,674 $ 159,027
2,835
4,530
12,563
—
283,526
453,001
1,256,281
—
$59,297,135
1,466,552
1,956,634
9,249,769
17,475
$(45,737,075)
—
—
—
—
$13,719,087
1,469,387
1,961,164
9,262,332
17,475
—
—
—
(6,446,955)
(6,446,955)
17,895,482
178,955
71,987,565
(52,184,030)
19,982,490
81,110
—
811
—
247,013
73,309
—
—
247,824
73,309
—
—
—
—
—
(5,383,611)
(5,383,611)
Balance on December 31, 2005
—
—
17,976,592
179,766
$ 72,307,887
$(57,567,641)
$14,920,012
Exercise of stock options
Common stock issuances, net of
transaction cost of $72,850
Stock-based compensation
Net loss for the year ended
December 31, 2006
—
—
148,547
1,486
513,754
—
—
870,442
—
8,704
—
5,062,445
496,876
—
—
—
515,240
5,071,149
496,876
—
—
—
—
— (5,177,830)
(5,177,830)
Balance on December 31, 2006
—
$ —
18,995,581 $ 189,956
$ 78,380,962
$(62,745,471)
$15,825,447
(See accompanying Notes to Financial Statements)
F-7
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF CASH FLOWS
Operating activities:
Net loss
Adjustments to reconcile net loss to cash used in
operating activities:
Depreciation and amortization
Amortization of debt discount
Amortization of deferred revenue
Interest added to equipment
Stock compensation expense
Allowance for excess inventory quantities
(Gain) Loss on disposal of equipment
Abandonment of pending patents
Changes in assets and liabilities related to operations:
Trade accounts receivable
Other receivable
Inventories
Prepaid expenses and other assets
Accounts payable
Accrued liabilities
Net cash used in operating activities
Investing activities:
Acquisition of patents
Acquisition of equipment and leasehold improvements
Proceeds from disposal of equipment
Payment of accounts payable incurred for the
purchase of equipment and leasehold improvements
Purchases of investments
Sales of investments
Net cash (used in) provided by investing activities
Financing activities:
Principal payment on debt obligations, including
capital leases
Proceeds from borrowings
Proceeds from sale of common stock and exercise of
stock options and warrants
Net cash provided by financing activities
(Decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental cash flow information:
Interest paid
Income taxes paid
Supplemental non-cash investing and financing
activities:
Accounts receivable paid through offset of long-
2006
Years ended December 31,
2005
2004
$ (5,177,830) $ (5,383,611)
$ (6,446,955)
1,269,719
117,832
(21,212)
(74,109)
645,210
(247,986)
(2,697)
149,811
1,228,515
18,455
—
—
73,309
(14,205)
69,710
—
1,392,122
—
—
—
17,475
(5,636)
55,265
—
(479,528)
—
125,980
(120,044)
146,839
481,919
(3,186,096)
(766,674)
3,498
50,324
85,334
(25,288)
252,098
(4,408,535)
175,034
20,716
(148,701)
160,081
(225,189)
138,991
(4,866,797)
(156,158)
(142,180)
(166,075)
(2,013,810)
5,100
(292,692)
—
(529,498)
11,000
(14,121)
(84,983,188)
84,716,487
(2,445,690)
(111,370)
(164,935,218)
167,922,252
2,440,792
—
(279,852,900)
273,260,138
(7,277,335)
(19,076)
—
(11,826)
1,597,420
(473,565)
—
5,442,389
247,824
12,692,883
1,833,418
5,423,313
(134,325)
(208,473)
340,860
475,185
$ 132,387 $ 340,860
12,219,318
75,186
399,999
$ 475,185
$ 8,747
$ 31,818
$ — $ —
$ 74,277
$ 30,000
term debt
$ 200,254
$ 379,219
$ 276,794
Accounts payable incurred for the purchase of
equipment and leasehold improvements
Debt discount offset by deferred other revenue
Capital lease obligations incurred in the purchase of
equipment
$ 60,900 $ 14,121
$ — $ 350,000
$ 111,370
$ —
$ 102,600 $ —
$ —
(See accompanying Notes to Financial Statements)
F-8
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1)
Description of Business
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.
Nanophase Technologies is a nanomaterials developer and commercial manufacturer with an
integrated family of nanomaterial technologies. Nanophase produces engineered nanomaterials for use in
a variety of diverse existing and developing markets: personal care, sunscreens, architectural coatings,
industrial coating ingredients, abrasion-resistant applications, plastics additives, water filtration, DNA
biosensors, antimicrobial products and a variety of polishing applications, including semiconductors and
optics. New markets and applications also are being developed. The Company targets markets in which it
feels practical solutions may be found using nanoengineered products. The Company works with leaders
in these target markets to identify and supply their material and performance requirements.
The Company also recognizes regular other revenue from a technology license as well as
$600,000 in revenue earned for 2004 (only) as discussed in Note 15. None of these activities are expected
to drive the long-term growth of the business. All of these types of items are recognized as “other
revenue” in the Company’s Statement of Operations, as they do not represent revenue directly from the
Company’s nanomaterials.
(2)
Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements 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.
Cash and Cash Equivalents
Cash and cash equivalents primarily consist of demand deposits. The Company has employed
corporate “sweep” accounts, when cost-effective in order to maximize interest income earned with its
operating funds. From time to time, the Company’s cash accounts may exceed federally insured limits.
Investments
Investments are classified by the Company at the time of purchase for appropriate designation
and are reevaluated as of each balance sheet date. The Company’s policy is to classify money market
funds and certificates of deposit as investments. These 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.
The Company has also made investments in variable rate demand notes. The investments have been
classified as available for sale securities. Investments classified as available for sale securities are
recorded at market value using the specific identification method; unrealized gains and losses (excluding
other-than-temporary impairments) are reflected in other comprehensive income (“OCI”). Due to the
nature of the Company’s investments being short-term, the fair value of these investments approximates
their cost, accordingly, no unrealized gains or losses have been reflected in OCI.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-
temporary. The Company employs a systematic methodology that considers available evidence in
F-9
evaluating potential impairment of its investments on a quarterly basis. If the cost of an investment
exceeds its fair value, the Company evaluates, among other factors, general market conditions, the
duration and extent to which the fair value is less than cost, as well as the Company’s intent and ability to
hold the investment. The Company also considers specific adverse conditions related to the financial
health of and business outlook for the investee, including industry and sector performance, changes in
technology, operational and financing cash flow factors and rating agency actions. Once a decline in fair
value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in
the investment is established.
The Company’s investments are held by its investment bank who is a member of all major stock
exchanges and the Securities Investor Protection Corporation (SIPC). Securities and cash held in custody
by the Company’s investment bank are afforded complete protection for the Company’s investment
positions through SIPC and a commercial insurer (commonly known as “Excess SIPC” coverage),
however, it does not protect against losses from the rise and fall in market value of investments.
Trade Accounts Receivable
Trade accounts receivable are carried at original invoice amount less an estimate made for
doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management
determines the allowance for doubtful accounts by identifying troubled accounts and by using historical
experience applied to an aging of accounts. Trade accounts receivable are written off when deemed
uncollectible. Recoveries of trade accounts receivable previously written off are recorded when received.
The Company’s typical credit terms are thirty days from shipment and invoicing.
The activity in the Allowance for Doubtful Accounts is as follows:
Balance, Beginning of year
Charge offs
Recoveries
Provision
2006
$ 23,533
2005
$ 24,271
(1,403)
-
-
(738)
-
-
Balance, End of year
$ 22,130
$ 23,533
Inventories
Inventories are stated at the lower of cost, maintained on a first in, first out basis, or market. The
Company has recorded allowances to reduce inventory relating to excess quantities of certain materials.
Write-downs of inventories establish a new cost basis, which is not increased for future increases in
market value of inventories or changes in estimated excess quantities.
Equipment and Leasehold Improvements
Equipment is stated at cost and is being depreciated over its estimated useful life (3-20 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 (3-16 years).
Depreciation expense for leased assets is included with depreciation expense for owned assets. From time
to time the company has self-constructed assets. These assets are stated at cost plus the capitalization of
labor and have an estimated useful life (7-10 years) using the straight-line method.
F-10
Intangible Assets
Intangible assets are included in other assets and are being amortized over the estimated useful
life (17 or 20 years) of the respective patents and trademarks using the straight-line method. From time to
time, the Company abandons patents, when either; due to advances in Company technology they are no
longer of value, or when they have served mainly as a defensive measure to preclude others from a given
technological space and the costs of continuing to pursue their award outweighs their relative benefit.
Long Lived Assets
The Company follows the provisions of SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” Reviews are performed whenever events or changes in circumstances
indicate that the carrying amount of assets may not be recoverable or that the useful life is shorter than
originally estimated. The Company assesses the recoverability of its assets by comparing the projected
undiscounted net cash flows associated with the related asset or group of assets over their remaining lives
against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying
amount over the fair value of those assets. If assets are determined to be recoverable, but the useful lives
are shorter than originally estimated, the net book value of the assets is depreciated over the newly
determined remaining useful lives.
Deferred Other Revenue
In connection with its promissory note to BYK Chemie (see Note 7), the Company recorded
$350,000 of deferred other revenue. The note requires that the Company give BYK Chemie first
preference in use of the new equipment commissioned on November 1, 2006 and accordingly, has begun
to recognize deferred revenue under this note and the Company has also agreed to provide experimental
product made using this equipment. As a result of a lack of further specificity with regards to the
equipment use obligations, the Company intends to recognize the deferred revenue ratably, on a straight-
line basis over a period beginning with the commissioned date on November 1, 2006 and ending on July
30, 2009, the expected date of the Company’s final payment under the note. As of December 31, 2006 the
Company has recognized $21,212 of deferred other revenue.
Asset Retirement Obligations
In connection with its leased facilities, the Company is required to remove certain leasehold
improvements upon termination of its occupancy. Effective January 1, 2003, the Company follows the
provisions of SFAS 143, “Accounting for Asset Retirement Obligations”, under which the Company
recognizes a liability for the fair value of its asset retirement obligations. The fair value of that liability is
measured based on an expected cash flow approach and accretion expense is recognized each period to
recognize increases to the fair value of the liability due to the passage of time. Increases to the fair value
of the liability, except for accretion, are added to the carrying value of the long-lived asset. Those
increases are then reported in amortization expense over the estimated useful life of the long-lived asset.
Activity in the asset retirement obligation account for the years ended December 31, is as follows:
Balance, beginning
Accretion due to passage of time
Balance, ending
2006
2005
$ 109,256 $ 105,417
3,839
3,037
$ 112,293
$ 109,256
F-11
The effect of the implementation of this standard resulted in an increase in net loss of $5,877,
$7,114 and $40,912 (no effect on per common share calculation) for 2006, 2005 and 2004, respectively.
The added expenses were comprised of $3,037, $3,839 and $11,260 in accretion expense and $2,840,
$3,272 and $29,109 in amortization expense for 2006, 2005 and 2004, respectively.
Fair Value of Financial Instruments
The Company’s financial instruments include investments, accounts receivable, accounts payable,
accrued liabilities and long-term debt. The fair values of all financial instruments were not materially
different from their carrying values.
Product Revenue
Product revenue consists of sales of product that are recognized when realized and earned. This
occurs when persuasive evidence of an arrangement exists, title transfers via shipment of products or
when delivery has occurred, the price is fixed or determinable and collectibility is reasonably assured.
Other Revenue
Other revenue consists of revenue from technology development (see RHEM discussion in Note
15), fees from a technology license and deferred other revenue in connection with the Company’s
promissory note to BYK Chemie. Technology license fees are recognized when earned pursuant to the
agreed upon contractual arrangement, when performance obligations are satisfied, the amount is fixed or
determinable, and collectibility is reasonably assured. The Company intends to recognize the deferred
revenue ratably, on a straight-line basis over a period beginning with the commissioned date on
November 1, 2006 and ending on July 30, 2009, the expected date of the Company’s final payment under
the note.
Shipping and handling costs are included in other revenue when products are shipped and
invoiced to the customer. The Company includes the related cost of shipping and handling in cost of
goods sold.
Advertising Expenses
The Company does not capitalize advertising expenses, they are either expensed when incurred or
when related advertisements are first published. The Company recognized $1,130, $6,889 and $21,248 in
advertising expenses for the years 2006, 2005 and 2004, respectively.
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. Deferred tax assets are reduced
by a valuation allowance when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.
F-12
Earnings per share
Net loss per common share is computed based upon the weighted average number of common
shares outstanding. Common equivalent shares of 317,875 for 2006, 357,796 for 2005 and 514,337 for
2004 are not included in the per share calculations because the effect of their inclusion would be anti-
dilutive. Included in common equivalent shares are In-The-Money stock options and the issuance of
restricted stock grants.
Net loss
Weighted average common shares outstanding
Net loss per common share-basic and diluted
Recently Issued Accounting Standards
2006
Years ended December 31,
2005
$ (5,177,830) $ (5,383,611) $(6,446,955)
18,344,334
17,266,228
17,937,932
$ (0.28) $ (0.30) $ (0.37)
2004
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and
Financial Liabilities. SFAS 159 permits entities to choose to measure many financial instruments and
certain other items at fair value at specified election dates. Under SFAS 159, a business entity shall report
unrealized gains and losses on items for which the fair value option has been elected in earnings (or
another performance indicator if the business entity does not report earnings) at each subsequent reporting
date. SFAS 159 also establishes presentation and disclosure requirements designed to facilitate
comparisons between entities that choose different measurement attributes for similar types of assets and
liabilities. This Statement is effective for fiscal years beginning after November 15, 2007. The
Company does not believe that adoption of SFAS 159 will have a material effect on its financial
statements.
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157 defines
fair value, establishes a framework for measuring fair value and expands disclosures about fair value
measurements. The requirements of SFAS 157 are effective for financial statements issued for fiscal
years beginning after November 15, 2007. The Company does not believe that adoption of SFAS 157
will have a material effect on its financial statements.
In June 2006, the FASB issued FIN 48, (Accounting for Uncertainty in Income Taxes – an
interpretation of SFAS 109, “Accounting for Income Taxes”). FIN 48 prescribes a recognition threshold
and measurement attribute for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 developed a two-step process to evaluate a tax position and
also provides guidance on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. This interpretation is effective for fiscal years beginning after
December 15, 2006. Management has determined the adoption of FIN 48 will not have a material impact
on the Company’s financial statements.
In September 2006, the U.S. Securities and Exchange Commission staff issued Staff Accounting
Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements
in Current Year Financial Statements” (“SAB 108”). The intent of SAB 108 is to reduce diversity in
practice for the method companies use to quantify financial statement misstatements, including the effect
of prior year uncorrected errors. SAB108 establishes an approach that requires quantification of financial
statement errors using both an income statement and a cumulative balance sheet approach. SAB 108 is
effective for the fiscal year ending after November 15, 2006. The adoption of SAB 108 did not have an
impact on our Consolidated Financial Statements.
(3)
Investments
Investments at December 31, 2006 and 2005 were comprised of variable rate demand notes,
certificates of deposit and a money market fund. Included in investments is $30,000 on December 31,
F-13
2006 and 2005, respectively, in the form of certificates of deposit which are pledged as collateral,
primarily for the Company’s rent in 2006 and 2005, and is restricted as to withdrawal or usage.
Investments held in short-term variable rate demand notes and certificates of deposit have maturity days
of less than 30 days. The Company’s investments on December 31, 2006 and 2005 were as follows:
As of December 31,
2006
$ 6,750,000
1,640,819
30,000
13,974
$ 8,434,793
2005
$ 7,250,000
874,801
30,000
13,291
$ 8,168,092
As of December 31,
2006
2005
$ 173,750 $ 498,144
1,092,827
894,413
1,392,557
1,266,577
(343,354)
(591,340)
$ 923,223 $ 801,217
Variable rate demand notes ............................................................
Money market fund ........................................................................
Certificates of deposit.....................................................................
Accrued interest..............................................................................
(4)
Inventories
Inventories consist of the following:
Raw materials .................................................................................
Finished goods................................................................................
Allowance for excess quantities .....................................................
The activity in the Allowance for Excess Inventory Quantities as
follows:
Balance, Beginning of year
Deductions(1)
Costs and
Expenses
2006
$ 591,340
(247,986)
2005
$ 605,545
(14,205)
- -
Balance, End of year
$ 343,354
$ 591,340
(1) Reduction in inventory allowance as a result of the disposal or sale of
inventories for which an allowance had previously been provided.
(5)
Equipment and Leasehold Improvements
Equipment and leasehold improvements consist of the following:
Machinery and equipment ..............................................................
Office equipment ............................................................................
Office furniture ...............................................................................
Leasehold improvements ................................................................
Construction in progress.................................................................
Less: Accumulated depreciation and amortization ........................
As of December 31,
2006
2005
$ 11,426,106 $ 9,345,563
405,000
75,871
4,468,079
245,575
14,540,088
453,582
75,871
4,532,825
274,280
16,762,664
(9,154,338)
$ 7,608,326 $ 6,587,787
(7,952,301)
Depreciation expense was $1,228,180, $1,190,208 and $1,297,912, for the years ended
December 31, 2006, 2005 and 2004, respectively.
F-14
(6) Intangible Assets
The following is a summary of intangible assets on December 31, 2006 and 2005:
Subject to Amortization:
Trademarks
Patents
2006
2005
Gross Carrying
Amount
Accumulated
Amortization
Gross Carrying
Amount
Accumulated
Amortization
$ 44,429
469,660
$ 514,089
$ 10,358
159,183
$ 169,541
$ 44,429
370,881
$ 415,310
$ 7,979
126,198
$ 134,177
Amortization expense recognized on all amortizable intangibles totaled $35,364, $31,196 and $41,919 for the
years ended December 31, 2006, 2005 and 2004, respectively.
Estimated aggregate amortization expenses for each of the next five years is as follows:
Year ending December 31:
2007
2008
2009
2010
2011
Thereafter
$ 39,807
39,904
39,807
38,762
33,853
152,415
$344,548
On December 31, 2006 and 2005 patents pending were $293,949 and $386,384, respectively.
Patents pending are not amortized.
(7)
Pledged Assets and Long-Term Debt
In November 2000, the Company executed a three-year promissory note, held by the Company’s
largest customer, in the amount of $1,293,895 for the construction of additional production capabilities at
the Company’s Romeoville, Illinois facility. Nanophase repaid this loan through a sales discount on
product over time. The BASF note was retired in the second quarter in 2006.
In November 2005, the Company executed a promissory note, held by BYK Chemie (a U.S.
subsidiary of Altana Chemie AG which owns approximately 7% of the Company’s outstanding common
stock) in the amount of $1,597,420 for the purchase and installation of additional dispersion capacity and
an additional NanoArc™ synthesis reactor at the Company’s Romeoville, Illinois facility. The note
requires that the Company give BYK Chemie first preference in use of the new equipment commissioned
on November 1, 2006 under this note, and that the Company agrees to provide experimental product made
using this equipment. In addition, the Company also capitalized approximately $74,000 in interest related
to this note. The rate of interest in the note will float at 1% over LIBOR, measured on a quarterly average.
Interest will not begin to accrue until one year after the commissioning of the specified equipment and
principal will be repaid in three equal payments during the first three quarters of 2009. Management has
determined that the required interest payments, including a flexible interest free period of more than a
year, are substantially lower than the Company would be required to pay in a more traditionally
underwritten equipment note. As such, management’s imputation of interest, in accordance with the
provisions of APB No. 21, “Interest on Receivables and Payables”, at 9% over the entire life of the note,
it’s determination of a market interest rate, resulted in the Company recording a debt discount of
F-15
$350,000, having an unamortized balance of $213,713 on December 31, 2006. Management further
determined that the debt discount of $350,000 recorded at the inception of the loan was attributable to
deferred other revenue relating to the issuance of right of first preference on the new equipment being
commissioned and the Company’s commitment to provide experimental product.
(8)
Lease Commitments
The Company leases its operating facilities under operating leases. On October 18, 2005
Nanophase entered into a Lease Amendment amending its current lease for its facilities in Romeoville,
Illinois, which, among other things, extended the term of such lease through December 31, 2015 (with the
option to extend the term for two additional five year periods) and granted Nanophase an option to
purchase such facility in certain instances. The current monthly rent on this lease amounts to $0 for the
first five months in 2006 and $25,000 for the remainder of the year. Nanophase leases its Burr Ridge
facility under an agreement whose initial term expired in September 1999. The Company exercised its
option to extend the lease for five additional one-year terms, the last of which expired in September 2004.
The Company executed a new lease for its Burr Ridge facility in September 2004. The initial term of the
new lease expires in September 2007, but the Company has options to extend the lease for up to three
additional one-year terms. The current monthly rent on this lease amounts to $10,643.
The following is a schedule of future minimum lease payments as required under the above
operating leases:
Year ending December 31:
2007
2008
2009
2010
2011
Thereafter
Total minimum payments required:
$ 398,344
350,800
318,000
325,200
331,200
5,400,535
$ 7,124,079
Rent expense, including real estate taxes, under these leases amounted to $601,364, $546,815 and
$521,264, for the years ended December 31, 2006, 2005 and 2004, respectively.
On December 31, 2006 and 2005, equipment under capital leases had a cost of $311,067 and
$205,314, respectively, with accumulated depreciation of $205,341 and $169,476, respectively. On
December 31, 2006 the Company has one capital lease.
(9)
Accrued Expenses
Accrued expenses consist of the following:
Accrued payroll and related expenses
Accrued professional services
Accrued rent
Other
As of December 31,
2005
2006
$ 584,485 $ 356,537
246,391
314,265
234,934
321,435
490,216
247,449
$ 1,643,585 $ 1,152,127
F-16
(10)
License Agreements
The Company was granted a non-exclusive license by a third party to make, use, and sell products
of the type claimed in two U.S. patents. In consideration for this license, the Company agreed to pay
royalties of 1% of net sales, as defined, and made an advance royalty payment of $17,500. Royalties
under this agreement amounted to approximately $49,252, $37,166 and $29,200 for the years ended
December 31, 2006, 2005 and 2004, respectively
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 in designated parts of Asia to C. I. Kasei, a division of Itochu Corporation (“CIK”). Under this
agreement, the Company also will earn royalties on net sales of manufactured products containing
nanocrystalline materials. The agreement also provided for minimum sales targets and minimum royalty
payments to maintain exclusivity. The agreement expires on March 31, 2013 unless earlier terminated as
provided therein. The Company recorded royalty revenues, classified as “Other Revenue” on the
Statements of Operations, under this agreement of $300,000 for the years ended December 31, 2006,
2005 and 2004, respectively.
(11)
Income Taxes
The Company’s provision for income taxes, as presented on its Statements of Operations for the
periods presented, is attributable to foreign income taxes paid as a result of certain transactions with
customers in foreign countries for the year ended December 31, 2004. In 2006 and 2005, no foreign
income taxes were paid. The Company has no income tax provision, current or deferred, relating to U.S.
federal, state or local income taxes.
A reconciliation of income tax expense to the amount computed by applying the Federal income
tax rate to loss before provision for income taxes as of December 31, 2006, 2005 and 2004, is as follows:
Income tax credit at statutory rates
Nondeductible expenses
Tax benefit of exercise of non-qualified
stock options
State income tax, net of federal benefits
Foreign income taxes
Other
Benefit of net operating loss and foreign
tax credits not recognized,
Increase in valuation allowance
2006
$ (1,760,462)
8,213
2005
$ (1,830,428)
8,094
2004
$ (2,181,765)
9,084
-
(258,892)
-
(42,859)
(120,766)
(269,180)
-
19,280
(683,900)
(320,848)
30,000
24,429
2,054,000
$ 0
3,153,000
2,193,000
$ 0 $ 30,000
F-17
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,
2006
2005
Deferred tax assets:
Net operating loss carryforwards ..............................................
$ 27,282,000 $ 25,730,000
Foreign tax credit carryforward.................................................
-
156,000
Inventory and other allowances.................................................
Excess (tax) book depreciation..................................................
Excess (tax) book amortization
Other accrued costs ...................................................................
Total deferred tax assets.....................................................
151,000
(113,000)
41,000
275,000
27,636,000
250,000
(127,000)
3,000
131,000
26,143,000
Less: Valuation allowance
Deferred income taxes
(27,636,000)
(26,143,000)
$ — $ —
The valuation allowance increased $2,054,000 for the year ended December 31, 2006 (including
$561,000 for expiring net operating loss carryforwards and expiring foreign tax credit carryforwards) due
principally to the increase in the net operating loss carryforward and uncertainty as to whether future
taxable income will be generated prior to the expiration of the carryforward period. Under the Internal
Revenue Code, certain ownership changes, including the prior issuance of preferred stock and the
Company’s public offering of common stock, may subject the Company to annual limitations on the
utilization of its net operating loss carryforward. As of December 31, 2006, the amounts subject to
limitations has not yet been determined.
The Company has net operating loss carryforwards for tax purposes of approximately
$70,000,000 on December 31, 2006, which expire between 2007 and 2026.
As a result of certain transactions with third parties operating in foreign countries, the Company
may be subject to the withholding and payment of foreign income taxes as transactions are completed.
Under the Internal Revenue Code, foreign tax payments may be used to offset federal income tax
liabilities when incurred, subject to certain limitations. During the year ended December 31, 2006, the
Company’s foreign tax credit carryforward of $156,000 expired.
(12) Capital Stock
In October 1998, pursuant to a Stockholder Rights Agreement between Nanophase and LaSalle
National Association, as Rights Agent, the Company declared a dividend of one Preferred Stock Purchase
Right (a “Right”) for each outstanding share of Company common stock on November 10, 1998 and each
share of common stock issued by the Company after such date. The Rights are not presently exercisable.
Each Right entitles the holder, upon the occurrence of certain specified events, to purchase from the
Company one ten-thousandth of a share of the Company's Series A Junior Participating Preferred Stock at
a purchase price of $25 per one-ten thousandth of a share (the “Purchase Price”). The Rights further
provide that each Right will entitle the holder, upon the occurrence of certain specified events, to
purchase from the Company, common stock having a value of twice the Purchase Price and, upon the
occurrence of certain other specified events, to purchase from another entity into which the Company is
merged or which acquires 50% or more of the Company’s assets or earnings power, common stock of
such other entity having a value of twice the Purchase Price. In general, the Rights may be redeemed by
the Company at a price of $0.01 per Right. The Rights expire on October 28, 2008. On September 5,
2003, in anticipation of the September 8, 2003 private placement to Grace Brothers Ltd., the Company
amended its existing Stockholder Rights Agreement to revise the beneficial ownership threshold at which
a person or group of persons becomes an “acquiring person” and triggers certain provisions under the
F-18
Stockholder Rights Agreement. As revised, a person or group would become an “acquiring person” if that
person or group becomes the beneficial owner of 35% or more of the outstanding shares of the
Company’s stock. Prior to this amendment, the beneficial ownership threshold was 25%.
On March 23, 2004, the Company sold, in a private placement to Altana, 1,256,281 shares of
common stock at $7.96 per share and received gross proceeds of $10.0 million. In accordance with the
terms of such private placement, on February 5, 2007, the Company filed a registration statement for the
1,256,281 shares. Such registration statement has not yet been declared effective by the SEC. While the
Company has obligations to Altana with respect to the effectiveness of this registration statement, Altana
would not have the ability to settle such shares in cash if such registration statement is not declared
effective and, accordingly, the Company has treated the shares purchased by Altana as permanent equity
on its balance sheet (i.e., as additional paid-in capital).
On August 25, 2006, the Company sold, in a private place to RHEM, 847,918 shares of
unregistered common stock at $5.8968 per share and received gross proceeds of $5.0 million. The
Company is obligated to prepare a registration statement within five business days of the second
anniversary of this transaction to be filed with the SEC. While the Company has obligations to RHEM
with respect to the effectiveness of this registration statement, RHEM would not have the ability to settle
such shares in cash if such registration statement is not declared effective and, accordingly, the Company
has treated the shares purchased by RHEM as permanent equity on its balance sheet (i.e., as additional
paid-in capital).
On July 27, 2006, the Company amended its Certificate of Incorporation to increase its authorized
shares of common stock to 30,000,000.
As of December 31, 2006 and 2005, the Company has 24,088 authorized shares of preferred
stock, of which 2,500 shares have been designated as Series A Junior Participating Preferred Stock and
reserved for issuance in connection with the Rights described above. Shares of Series A Junior
Participating Preferred Stock are nonredeemable and subordinate to any other series of the Company’s
preferred stock, unless otherwise provided for in the terms of the preferred stock; has a preferential
dividend in an amount equal to 10,000 times any dividend declared on each share of common stock; has
10,000 votes per share, voting together with the Company’s common stock; and in the event of
liquidation, entitles its holder to receive a preferred liquidation payment equal to 10,000 times the
payment made per share of common stock. In addition, as of December 31, 2006, 2,783,183 authorized
but unissued shares of common stock have been reserved for future issuance upon exercise of stock
options.
(13) Stock Options, Warrants and Stock Grants
The Company has entered into stock option agreements with certain officers, employees,
directors and three members of the Company’s former Advisory Board. On December 31, 2006, the
Company had outstanding options to purchase 1,740,347 shares of common stock. The stock options
generally expire ten years from the date of grant. Of the total number of exercisable options, 421,603 of
the outstanding options vested over a five-year period, 1,047,168 vested over a three-year period from
their respective grant dates and 17,011 vested on the eighth anniversary following their grant date.
Exercise prices are determined by the Compensation and Governance Committee of the Board of
Directors and equal the estimated fair values of the Company’s common stock at the grant date. The table
below summarizes option activity through December 31, 2005:
Number of Options
Exercise Price
Weighted Average
Exercise Price
Options outstanding on January 1, 2004
Options granted during 2004
1,928,619
100,000
.112-11.625
5.550
5.705
5.550
F-19
Options exercised during 2004
Options canceled during 2004
Outstanding on December 31, 2004
(283,526)
(4,001)
1,741,092
.112-10.875
.112-3.660
.432-11.625
Options granted during 2005
Options exercised during 2005
Options canceled during 2005
Outstanding on December 31, 2005
100,000
(81,110)
(15,750)
1,744,232
6.030
.432-3.886
3.660-10.875
1.727-11.625
5.183
3.659
5.786
6.030
3.055
6.623
5.918
F-20
Share-Based Compensation
Prior to January 1, 2006, the Company accounted for its stock option plan under the recognition
and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees and
related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based
Compensation. No stock option-based employee compensation cost was recognized in the Statement of
Operations for year ended December 31, 2005, as all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on date of grant. Effective January 1,
2006, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-
Based Payment, using the modified-prospective-transition method. Under that transition method,
compensation cost recognized for the year ended December 31, 2006 includes: (a) compensation cost for
all share-based payments granted prior to, but not yet vested on January 1, 2006, based on the grant date
fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation
cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair
value estimated in accordance with the provisions of Statement 123(R). Results for the prior period have
not been restated.
As a result of adopting Statement 123(R) on January 1, 2006 the Company’s loss from operations,
loss before provision for income taxes and net loss for the year ended December 31, 2006 was $382,791
greater than if it had continued to account for share-based compensation under Opinion 25. Basic and
diluted earnings per share for the year ended December 31, 2006 would have been ($.26), if the Company
had not adopted Statement 123(R), compared to reported basic and diluted earnings per share of ($.28).
Compensation expense is recognized only for share-based payments expected to vest. The
Company estimates forfeitures at the date of grant based on the Company’s historical experience and future
expectations. Prior to the adoption of SFAS 123(R), the effect of forfeitures on the pro forma expense was
recognized based on estimated forfeitures.
As of December 31, 2006, there was approximately $997,000 of total unrecognized compensation
cost related to nonvested share-based compensation arrangements granted under the Company’s stock
option plans. That cost is expected to be recognized over a weighted-average period of 6.71 years.
The following table illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123 to options granted under the Company’s stock
option plan presented on December 31, 2005 and 2004. For purposes of this pro forma disclosure, the value
of the options is estimated using a Black-Scholes option-pricing formula and amortize to expense over the
option vesting periods.
Net Loss:
As reported
Deduct total stock-based employee compensation
expense determined under fair value based method for all
awards
Pro forma net loss
Loss per share:
Basic and diluted - As reported
Basic and diluted – Pro forma
Years Ended December 31,
2005
2004
$(5,383,611)
$(6,446,955)
(491,690) (835,394)
$(5,875,301) $(7,282,349)
(0.30)
(0.37)
(0.33)
(0.42)
F-21
Fair Value and Assumptions Used to Calculate Fair Value under SFAS 123 (R) and SFAS 123
The following table illustrates the various assumptions used to calculate
the Black-Scholes option pricing model for all years presented:
Years Ended December 31,
2006
2005
2004
Weighted-average risk-free
interest rates:
4.76%
4.68%
Dividend yield:
0.00%
0.00%
3.93%
0.00%
Weighted-average expected life of
the option:
Weighted-average expected stock
price volatility:
Weighted-average fair value of
the options granted:
7 years
7 years
7 years
62.07%
78.79%
79.10%
$3.67
$4.50
$4.12
Under SFAS No. 123(R), the Company will continue to use the Black−Scholes option pricing
model to determine the fair value of stock based compensation. The Black−Scholes model requires the
Company to make several assumptions, including the estimated length of time employees will retain their
vested stock options before exercising them (“expected term”), the estimated volatility of the Company’s
common stock price over the expected term and estimated forfeitures. Expected price volatility of the
fiscal 2006 grants is based on the daily market rate changes of the Company’s stock going back to
January 1, 1998. The shares granted in fiscal 2006 had a vesting period of three years and a contractual
life of 10 years. Forfeitures were estimated based on the Company’s historical experience. The
Black−Scholes model also requires a risk free interest rate, which is based on the U.S. Treasury yield
curve in effect at the time of the grant, and the dividend yield on the Company’s common stock, which is
assumed to be zero since the Company does not pay dividends and has no current plans to do so in the
future. Changes in these assumptions can materially affect the estimate of fair value of stock based
compensation and consequently, the related expense recognized on the condensed consolidated statement
of operations. The Company recognizes stock based compensation expense on a straight-line basis.
Employees Stock Options and Stock Grants
For the year ended December 31, 2006, 148,547 shares of Common Stock were issued pursuant to
option exercises compared to 81,110 and 283,526 shares of Common Stock for the same period in 2005 and
2004, respectively. For the year ended December 31, 2006, 201,000 shares of stock options were granted
compared to 100,000 shares granted for the same period in 2005 and 2004, respectively. For the year
ended December 31, 2006, 22,524 shares were issued in the form of restricted stock grant to the Company’s
outside directors compared to none in 2005 and 2004.
F-22
The following table summarizes the Company’s option activity for Nanophase Technologies
Corporation employees and directors during the year ended December 31, 2006:
Weighted
Average
Remaining
Contractual
Term
(years)
Aggregate
Intrinsic
Value
Weighted
Average
Exercise
Price per
Share
$5.92
$5.99
$3.47
$4.33
Shares
1,744,232
201,000
(148,547)
(12,502)
1,784,183
$6.14
5.11 $1,455,494
1,481,290
$6.18
4.27 $1,429,806
Options
Outstanding on January 1, 2006
Granted
Exercised
Forfeited or expired
Outstanding on December 31,
2006
Exercisable on December 31,
2006
The aggregate intrinsic value in the table above is before income taxes, based on Nanophase’s
closing stock price of $5.97 on the last business day for the period ended December 31, 2006.
During the year ended December 31, 2006, the total intrinsic value of Nanophase stock options
exercised was $490,762. Cash received for option exercises was $515,240 during the year ended
December 31, 2006. Based on the Company’s election of the “with and without” approach, no realized
tax benefit from stock options was recognized for the year ended December 31, 2006.
Restricted Stock
For the year ended December 31, 2006, the Company was to grant each outside director 3,754
shares of deferred common stock totaling 22,524 shares under the Company’s 2005 Non-Employee
Director Restricted Stock Plan. However, each outside director elected to defer receipt of the restricted
stock until the termination of their services to the Company. The deferral of restricted stock is being
accounted for under the Company’s Non-Employee Director Deferred Compensation Plan. The fair value
of the awards granted was $144,000 for the restricted share rights and is included in stock-based
compensation expense for the year ending December 31, 2006 compared to $0 for the same period in
2005 and 2004.
In September 2005 and October 2004, the Company granted a total of 66,666 (33,333 each year)
shares of restricted stock at market value consisting of 33,332 restricted share rights and 33,334
performance share rights, respectively. Grant date fair value was $5.55 for the September 2005 grant and
$6.03 for the October grant, respectively. The Company uses an estimated forfeiture rate of 5.5% for both
the restricted and performance shares. A summary of the status of the Company’s nonvested restricted
shares as of December 31, 2006 is presented below:
# of Restricted Shares
Weighted Average Remaining
Life on Unvested Shares
Unrecognized Compensation
Cost
33,332
1.29
F-23
$70,746
For the years ended December 31, 2006, 2005 and 2004, the stock-based compensation expense
was $58,328, $39,025 and $6,725 for the restricted share rights. A summary of the status of the
Company’s nonvested performance share rights as of December 31, 2006 is presented below:
# of Performance Shares
Weighted Average Remaining
Life on Unvested Shares
Unrecognized Compensation
Cost
33,334
1.46
$87,268
For the years ended December 31, 2006, 2005 and 2004 the stock-based compensation expense
was $55,757, $34,284 and $10,750 for the performance share rights. Compensation expense for
performance share rights is based upon management’s estimate of the number of share rights that will
eventually vest.
In connection with the issuance of Series C convertible preferred stock in 1993, the Company
issued common stock purchase warrants for 662,287 shares at no additional cost to the Series C
convertible preferred stockholders. At the Company’s initial public offering on November 26, 1997, all
preferred stock shares were converted to common stock shares. These warrants had an exercise price of
$1.123 per share and expired upon the tenth anniversary of issuance. For the year ended December 31,
2002, 28,950 warrants were converted into 28,950 shares of common stock and were exercised for
$32,511. On December 31, 2003 there were 453,001 warrants issued, outstanding, and exercisable. All
of these outstanding warrants were issued pursuant to the Company’s September 8, 2003 private equity
offering at a rate of one per common share purchased. Their exercise price was $4.415 per share and the
expiration was September 8, 2004. No warrants were exercised in 2003. On September 2, 2004, 453,001
warrants were exercised relating to the Company’s September 2003 private equity offering of $4.415 per
share. For the year ended December 31, 2005 and 2006 there were no warrants outstanding.
(14)
401(k) Profit-Sharing Plan
The Company has a 401(k) profit-sharing plan covering substantially all employees who meet
defined service requirements. In 2004, the Company amended its 401(k) plan providing for deferred
salary contributions by the plan participants and maximum contributions by the Company of 100% of the
first 3% and 50% of the next 2% of the participant’s salary. The Company contributions under this plan
were $166,781, $131,137 and $120,335 for the years ended December 31, 2006, 2005 and 2004,
respectively.
(15)
Significant Customers and Contingencies
Revenue from three customers constituted approximately 56.1%, 22.1% and 9.5%, respectively,
of the Company’s 2006 revenue. Amounts included in accounts receivable on December 31, 2006 relating
to these three customers were approximately $619,000, $289,000 and $309,000, respectively. Revenue
from these three customers constituted approximately 65.8%, 1.0% and 12.4%, respectively, of the
Company’s 2005 revenue. Amounts included in accounts receivable on December 31, 2005 relating to
these three customers were approximately $374,000, $0 and $373,000, respectively. Revenue from these
three same customers constituted approximately 69.7%, 0% and 12.9%, respectively, of the Company’s
2004 revenue.
The Company currently has supply agreements with BASF Corporation (“BASF”), the
Company’s largest customer, and Rohm and Haas Electronic Materials CMP Inc. (“RHEM”), that have
contingencies outlined in them which could potentially result in the license of technology and/or the sale
of production equipment, providing capacity sufficient to meet the customer’s production needs, from the
Company to the customer, if triggered by the Company’s failure to meet certain performance
requirements and/or certain financial condition covenants. The financial condition covenants in the
F-24
Company’s supply agreement with its largest customer, as amended, “triggers” a technology transfer
(license or, optionally, an equipment sale) in the event (a) that earnings of the Company for a twelve
month period ending with its most recently published quarterly financial statements are less than zero and
its cash, cash equivalents and investments are less than $2,000,000, (b) of an acceleration of any debt
maturity having a principal amount of more than $10,000,000, or (c) of the Company’s insolvency, as
further defined within the agreement. In the event of an equipment sale, upon incurring a triggering
event, the equipment would be sold to the customer at 115% of the equipment’s net book value.
The Company believes that it has sufficient cash and investment balances to avoid the first
triggering event for the foreseeable future. If a triggering event were to occur and BASF elected to
proceed with the license and related sale mentioned above, the Company would receive royalty payments
from this customer for products sold using the Company’s technology; however, the Company would lose
both significant revenue and the ability to generate significant revenue to replace that which was lost in
the near term. Replacement of necessary equipment that could be purchased and removed by the customer
pursuant to this triggering event could take in excess of twelve months. Any additional capital outlays
required to rebuild capacity would probably be greater than the proceeds from the purchase of the assets
as dictated by the Company’s agreement with the customer. Such an event would also result in the loss of
many of the Company’s key staff and line employees due to economic realities. The Company believes
that its employees are a critical component of its success and could be difficult to replace and train
quickly. Given the occurrence of such an event, the Company might not be able to hire and retain skilled
employees given the stigma relating to such an event and its impact on the Company.
In February of 2004, the Company amended its original agreement with Rohm and Haas
Electronic Materials CMP, Inc. (“RHEM,” formerly known as Rodel, Inc). This amendment allows for
RHEM to maintain exclusivity based upon it purchasing lower dollar amounts of nanocrystalline
materials, while extending the agreement through 2009. This amendment did not require RHEM to
purchase any materials from the Company in 2004, but, in lieu of materials purchased it did require an
aggregate of $600,000 be paid to Nanophase in four equal quarterly installments in 2004 to support on
going efforts in joint slurry product development during 2004. This $600,000 was fully earned in 2004.
RHEM resumed purchases from the Company in 2005. Sales to RHEM in 2005 and 2006 are included in
the revenue concentration disclosed in a preceding paragraph.
(16)
Business Segmentation and Geographical Distribution
Revenue from international sources approximated $664,500, $1,094,200 and $673,900 for the
years ended December 31, 2006, 2005 and 2004, respectively. As part of its revenue from international
sources, the Company recognized approximately $249,800 and $59,515 in product revenue from several
German and Taiwan companies respectively, and $300,000 in other revenue from a technology license fee
from its Japanese licensee for the year ended December 31, 2006. Revenue from these same international
sources approximated $479,400, $220,200 and $306,800 for the year ended December 31, 2005, compared
to $299,200, $1,900 and $322,500 for the same period in 2004, respectively. The $300,000 technology
license fee typically received every twelve months from our Japanese licensee is included in each of the
three years presented.
The Company’s operations comprise a single business segment and all of the Company’s long-
lived assets are located within the United States.
F-25
(17) Quarterly Financial Data (Unaudited)
2006
Total revenue
Gross Profits
Loss from operations
Net loss
Basic and diluted loss per share
2005
Total revenue
Gross Profits
Loss from operations
Net loss
Basic and diluted loss per share
2004
Total revenue
Gross Profits
Loss from operations
Net loss
Basic and diluted loss per share
(18) Administrative Actions
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
$2,005,568
337,817
(1,596,783)
(1,543,254)
(0.09)
$2,390,902
544,224
(1,184,312)
(1,138,991)
(0.06)
$2,425,790
720,065
(973,673)
(915,713)
(0.05)
$2,168,578
331,025
(1,742,799)
(1,579,872)
(0.08)
$1,613,382
168,882
(1,468,701)
(1,415,540)
(0.08)
$2,084,725
490,461
(1,179,972)
(1,087,963)
(0.06)
$1,674,614
207,824
(1,602,239)
(1,534,707)
(0.09)
$1,429,186
107,021
(1,411,249)
(1,345,401)
(0.07)
$1,293,359
80,249
(1,453,580)
(1,470,564)
(0.09)
$1,542,068
113,893
(1,467,153)
(1,452,248)
(0.08)
$1,377,118
65,496
(1,397,026)
(1,658,272)
(0.09)
$995,389
(176,920)
(1,890,228)
(1,865,871)
(0.11)
On February 23, 2004, an unidentified party filed a Petition to Request a Reexamination of US
Patent No. 6,669,823 B1 in the U.S. Patent and Trademark Office, or USPTO. US Patent No. 6,669,823
B1 relates to certain parts of one of the Company’s nanoparticle manufacturing processes, NanoArc
Synthesis. The Company subsequently received notice that the USPTO had granted the Request for
Reexamination. The reexamination process is provided for by law and requires the USPTO to consider
the scope and validity of the patent based on substantial new questions of patentability raised by a third
party or the USPTO. On September 7, 2005, the Company’s representatives conducted an interview with
the Examiner assigned to the Reexamination at the USPTO, resulting in the Examiner preparing an
interview summary indicating that rejections to issued claims may be formally withdrawn. A response,
including further remarks about the interview and two new claims, was submitted shortly thereafter.
However, prior to the USPTO issuing a formal notice confirming patentability, the same unidentified
party referenced above filed a second Petition to Request Reexamination of the patent. A second
interview was conducted, resulting in an amendment to all patent claims. Thereafter, a third request for
re-examination was filed and granted by the USPTO. We subsequently conducted a third interview with
the Examiner and responded to the third request. It is not feasible to predict whether the Company
ultimately will succeed in maintaining all the claims of this patent during reexamination. If the patent
claims in this patent ultimately are narrowed substantially by the USPTO, the patent coverage afforded to
certain parts of the Company’s NanoArc Synthesis nanoparticle manufacturing process could be
impaired, which could impede the extent of Nanophase’s legal protection of the invention that is subject
to this patent and potentially harm its business and operating results, but the Company believes that the
likelihood of a material loss arising from this matter is remote.
F-26
(19) Lease Accounting Adjustment
Along with many other companies with leased properties in 2005, Nanophase has reviewed its
policies with respect to leasing transactions. Following this review, the Company corrected an error in its
prior accounting practices to conform the lease term used in calculating straight-line rent expense with the
useful lives used to amortize improvements on leased property. The result of this correction was
primarily to accelerate the recognition of rent expense under its lease for the Romeoville headquarters that
included fixed rent escalations by revising the computation of straight-line rent expense to include those
escalations for certain option periods. As the correction related solely to accounting treatment, it had no
effect on Nanophase’s historical or future cash flows or the timing of payments under the related lease.
Had the Company, from the inception of the lease in June 2000, correctly calculated its straight-line rent
expense, the effect would have been an increase in rent of approximately $13,220 per quarter. This
quarterly effect, and the annualized effect, of this adjustment are immaterial to the Company’s prior
year’s earnings per share or shareholders’ equity. The total amount of this expense was $279,810 and
was expensed in the third quarter of 2005.
F-27
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 14th day of March, 2007.
NANOPHASE TECHNOLOGIES CORPORATION
By:
/s/ Joseph Cross
Joseph Cross
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed
below by the following persons on behalf of the registrant and in the capacities indicated on the 14th day
of March, 2007.
Signature
/s/ Joseph Cross
Joseph Cross
/s/ Jess Jankowski
Jess Jankowski
/s/ Donald S. Perkins
Donald S. Perkins
/s/ James A. Henderson
James A. Henderson
/s/ James A. McClung
James A. McClung
/s/ Jerry Pearlman
Jerry Pearlman
/s/ Richard W. Siegel
Richard W. Siegel
/s/ R. Janet Whitmore
R. Janet Whitmore
Title
President, Chief Executive Officer (Principal
Executive Officer) and a Director
Chief Financial Officer, Treasurer and
Secretary (Principal Financial and Accounting
Officer)
Chairman of the Board and Director
Director
Director
Director
Director
Director
23.1 Consent of McGladrey & Pullen, LLP.
EXHIBIT INDEX
31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) under
the Exchange Act.
31.2 Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a)
under the Exchange Act.
32
Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350.
_______________________
*
Confidentially requested, confidential portions have been omitted and filed separately
with the Commission as required by Rule 24b-2.
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have issued our report, dated March 14, 2007, on the financial statements and internal
controls over financial reporting of Nanophase Technologies Corporation as of December 31, 2006. We
hereby consent to the use of our report in the Registration Statements on Form S-8 (No. 333-53445 and
No. 333-74170) and the Registration Statements on Form S-3 (No. 333-90326 and No. 333-140461) of
Nanophase Technologies Corporation. We also consent to the reference to our Firm under the caption
“Experts” in the Prospectus.
/s/ McGladrey & Pullen LLP
Schaumburg, Illinois
March 14, 2007
Certification of the Chief Executive Officer
Pursuant to
Rules 13a-14(a) and 15d-14(a) under the Exchange Act
Exhibit 31.1
I, Joseph Cross, certify that:
1.
I have reviewed this annual report on Form 10-K of Nanophase Technologies
Corporation;
2.
Based on my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-
15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15(d)-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal
control over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures
and presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over
financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee
of registrant’s board of directors (or persons performing the equivalent function):
(a)
All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal control over financial reporting.
Date: March 14, 2007
JOSEPH E. CROSS
/s/
Joseph E. Cross
Chief Executive Officer
Certification of the Chief Financial Officer
Pursuant to
Rules 13a-14(a) and 15d-14(a) under the Exchange Act
Exhibit 31.2
I, Jess Jankowski, certify that:
1.
I have reviewed this annual report on Form 10-K of Nanophase Technologies
Corporation;
2.
Based on my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information
included in this report, fairly present in all material respects the financial condition, results of operations
and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-
15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15(d)-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal
control over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures
and presented in this report our conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over
financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s
fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably
likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee
of registrant’s board of directors (or persons performing the equivalent function):
(a)
All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant’s internal control over financial reporting.
Date: March 14, 2007
/s/
JESS A. JANKOWSKI
Jess A. Jankowski
Chief Financial Officer
Exhibit 32
Certification Pursuant to 18 U.S.C. Section 1350
(as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002)
In connection with this annual report of Nanophase Technologies Corporation (the “Company”)
on Form 10-K for the year ending December 31, 2006 as filed with the Securities and Exchange
Commission on the date hereof (the “Report”), we, Joseph E. Cross, Chief Executive Officer of the
Company, and Jess A. Jankowski, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C.
§ 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to our knowledge:
1.
The Report fully complies with the requirements of section 13(a) or 15(d) of the
Securities Exchange Act of 1934; and
2.
The information contained in the Report fairly presents, in all material respects, the
financial condition and result of operations of the Company.
Date: March 14, 2007
/s/
JOSEPH E. CROSS
Joseph E. Cross
Chief Executive Officer
/s/
JESS A. JANKOWSKI
Jess A. Jankowski
Chief Financial Officer
nanophase technologies corporation
DRIVING PRODUCT INNOVATION
>>> www.nanophase.com
1319 Marquette Drive Romeoville, Illinois 60446 phone: 630.771.6700 fax: 630.771.0825 investor relations: 630.771.6708