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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
COMMISSION FILE NUMBER 0-22333
NANOPHASE TECHNOLOGIES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-3687863
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
453 COMMERCE STREET, BURR RIDGE, ILLINOIS 60521
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (630) 323-1200
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Class)
PREFERRED STOCK PURCHASE RIGHTS
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's voting stock held by
non-affiliates of the registrant, based upon the last reported sale price of the
registrant's Common Stock on March 22, 1999 was $24,781,416.
The number of shares outstanding of the registrant's Common Stock, par
value $.01, as of March 22, 1999 was 12,605,362.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Definitive Proxy Statement in connection with
the registrant's 1999 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Report on Form 10-K.
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PART I
ITEM 1. BUSINESS
Because Nanophase Technologies Corporation ("Nanophase" or the "Company")
wants to provide investors with more meaningful and useful information, this
Annual Report on Form 10-K (the "Form 10-K") contains, and incorporates by
reference, certain "forward-looking statements" (as such term is defined in
Section 21E of the Securities Exchange Act of 1934, as amended) that reflect the
Company's current expectations regarding its future results of operations,
performance and achievements. These forward-looking statements are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The Company has tried, wherever possible, to identify these
forward-looking statements by using words such as "anticipates," "believes,"
"estimates," "expects," "plans," "intends" and similar expressions. These
statements reflect the Company's current beliefs and are based on information
currently available to it. Accordingly, these statements are subject to certain
risks, uncertainties and contingencies which could cause the Company's actual
results, performance or achievements in 1999 and beyond to differ materially
from those expressed in, or implied by, such statements. These risks,
uncertainties and contingencies include, without limitation, demand for, and
acceptance of, the Company's nanocrystalline materials; changes in development
and distribution relationships; the impact of competitive products and
technologies; and the factors set forth under "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Risk Factors."
The Company undertakes no obligation to update or revise any such
forward-looking statements that may be made to reflect events or circumstances
after the date of this Form 10-K or to reflect the occurrence of unanticipated
events.
GENERAL
Nanophase develops and markets engineered solutions based on
nanocrystalline materials for a wide range of commercial applications. Many
companies, driven by market competition, are seeking to improve their products
or processes. Recognizing a need to provide enhanced performance and assist
customers with their product improvements, Nanophase targets markets in which a
practical solution may be found through the use of nanocrystalline materials.
The Company works closely with leaders in such target markets to identify their
material and performance requirements.
Nanocrystalline materials may be metallic, ceramic or semiconductor
materials. These materials generally consist of particles that are less than 100
nanometers (billionths of a meter) in diameter and contain thousands or tens of
thousands of atoms, rather than the millions or billions of atoms in
conventional particles of most materials. By creating materials in this size
range, the Company is able to design particles and, therefore, engineer their
properties to enhance their performance, as well as engineer new compounds and
formulations. Compared to conventional materials, the Company believes its
nanocrystalline particles, produced through its patented process, generally
exhibit superior chemical, mechanical, electronic, magnetic and optical
properties. Although these particles are sometimes the end product for various
customers, more often they are the required ingredient in formulations for a
customer's product or process. These particles can be further engineered by the
Company to meet its customers' specific performance requirements.
Traditional mechanical and chemical methods of producing nanocrystalline
materials have had difficulty consistently and economically producing commercial
quantities of high-quality nanocrystalline materials. Nanophase has developed
new technologies for the high-volume production of nanocrystalline materials
that it believes can satisfy the high-level performance requirements of, and
provide value-added solutions desired by, customers in its target markets.
NANOCRYSTALLINE MATERIALS
Solid materials are either crystalline or amorphous (non-crystalline).
Crystalline materials have an ordered atomic structure with given spacings
between the atoms. Crystalline particles that are less than 100 nanometers
(billionths of a meter) in diameter are called nanocrystals and contain only a
few thousand or tens of thousands of atoms. The physical, mechanical and
electrical properties of nanocrystalline materials depend upon several factors,
including the composition, size, shape and structure of the individual
particles. As the
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particles are made smaller, larger numbers of particles can occupy a given
space, resulting in a greater surface area. Thus, in the nanometer size range of
the materials' particles, there is an increased importance of the particles'
surface chemistry. Nanophase's process for producing nanocrystals creates
particles with controlled size and shape. These materials behave in ways
different from conventionally produced materials due to the novel physical,
chemical and surface properties that result from the Company's technologies.
THE COMPANY'S TECHNOLOGIES
Nanophase has developed and employs several related technologies for the
engineering and production of nanocrystalline materials and product
applications, including technologies for the synthesis, surface-treatment and
dispersion of nanocrystalline materials and the fabrication of structural
ceramic components. The Company also is engaged in ongoing research and
technology-licensing activities in order to further improve its core
technologies and add other complementary technologies. The Company believes this
will help it maintain a technical and commercial leadership position in the
field of nanocrystalline materials.
The following is a description of the Company's current technologies:
THE PHYSICAL-VAPOR-SYNTHESIS ("PVS") PROCESS
The Company uses its patented PVS process to produce nanocrystalline
powders. The PVS process is based on the formation of a physical vapor from
selected precursors that are fed through a plasma reactor and heated to a
temperature above its melting point. As the temperature rises, the atoms of this
material evaporate from its surface into a stream of flowing vapor. These
evaporated atoms are then mixed with selected gases that chemically react with
the atoms. Additional gases then cool the atoms sufficiently to condense the
vapor into solid, nearly spherical clusters of molecules. The flowing gas
transports the resulting clusters to a collection vessel. The rapid transport
and cooling of the nanometric particles prevent strong agglomeration.
The Company holds two United States patents relating to its PVS process
which expire in July 2013; one covers the process itself, while the other covers
the apparatus used in the process. A third United States patent, which will also
expire in July 2013, covers nanocrystalline materials formed by the PVS process.
The Company's plasma reactor embodies proprietary features that enable the
production of high-quality materials at high-volume and competitive cost.
Nanophase utilizes its PVS process to exploit the relative advantages of
physical versus chemical synthesis of nanocrystalline materials. These
advantages include the production of nanocrystalline materials with particles
that are extremely small, nearly spherical, essentially free of chemical
residue, relatively uniform in size and not strongly agglomerated.
The Company believes that the PVS process is a superior commercial process
because of the degree of control that can be exercised over particle size and
particle size distribution. By means of controlled and subtle modifications to
the PVS process (e.g., the evaporation rate, the type or pressure of the gas, or
how quickly the flow of gas carries the clusters to the collection vessel), the
Company can control the size of a material's particles, thereby altering such
material's properties. The Company is therefore able to engineer and produce a
wide range of materials and products without substantial process and product
re-engineering.
SURFACE TREATMENTS AND DISPERSIONS-THE DISCRETE PARTICLE ENCAPSULATION ("DPE")
PROCESS
Many of the applications that the Company is pursuing require further
engineering of the particles produced in the PVS process in order to meet
specific application requirements. To satisfy these requirements, the Company
has developed a variety of surface-treatment technologies to stabilize, alter or
enhance the performance of nanocrystalline particles, together with technologies
to enable the particles to be dispersed in fluids or polymers. At the core of
these surface-treatment and dispersion technologies, many of which are in the
early stage of development or are constantly being refined, is Nanophase's
proprietary DPE process which enables the Company to surround each
nanocrystalline particle with a durable coating. The Company has applied for a
patent for its DPE process.
The DPE process can coat the surface of each nanometer-sized particle
produced by the PVS process with a proprietary polymer that is not removed by
subsequent processing. Traditional coating technologies cannot completely cover
the surfaces of nanometric particles. The Company's DPE process encapsulates
each
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particle with a thin polymeric shell. This shell also can be engineered to
contain covalently bound spacer groups of controllable size that function to
prevent particles from sticking to each other. Alternatively, coated materials
can be formulated to attach various functional chemical groups to the shell for
specific properties and applications. The coatings also enable the particles to
be dispersed in a wide range of media, including water, cosmetic emollients,
plastics and polymers, thus enabling these materials to be used in applications
ranging from smooth colorants to dense opaque coatings.
CERAMIC SUPERPLASTIC FORMING
Ceramic superplastic forming exploits the ability of nanocrystalline
particles to physically slide past each other when a ceramic material is
subjected to mechanical pressure at high temperatures. The Company's development
of its ceramic superplastic deformation technology and its recent development of
new nanocrystalline powder compositions have enabled the Company to produce
materials for the fabrication of high-density ceramic parts with novel
properties. Thus, in selected applications, this forming technology offers
customers an attractive alternative to conventional ceramic processing. The
Company seeks to collaborate with other companies to further develop this
technology.
OTHER TECHNOLOGIES
The Company may also acquire, license, or develop other technologies
relating to nanocrystalline materials to augment its current core technologies.
Such activities are intended to enable the Company to develop new product
applications, satisfy the demanding performance requirements of its targeted
markets and offer more materials with enhanced capabilities.
ADVANTAGES OF THE COMPANY'S NANOCRYSTALLINE MATERIALS
Through the use of its patented PVS process, the Company produces
nanocrystalline materials with the following attributes:
SMALL PARTICLE SIZE provides a very high surface-to-volume ratio
compared to conventional materials. The ability to functionally tailor this
surface allows the Company to modify and control the resultant properties.
NEARLY SPHERICAL SHAPES enable particles to slide over each other,
allowing ceramic materials to become more ductile and more easily formed.
This enables the rapid molding of ceramic components without the costly and
time-consuming machining which is typically required for conventional
ceramics.
HIGH SURFACE PURITY enables particles to exhibit consistent surface
chemistry with little foreign contamination. This facilitates the Company's
ability to coat its materials for specific product applications.
NARROW SIZE DISTRIBUTION AND AGGREGATION CONTROL results in
nanocrystalline materials that are essentially free of large particles and
contain uniformly small and loosely agglomerated particles. These materials
can be further modified to enhance and tailor the performance of basic raw
materials for specific product applications. For example, the Company's
nanocrystalline materials can be readily and uniformly dispersed in a
variety of media.
MARKETS
The Company is pioneering advanced materials technology utilizing
nanocrystalline material formulations for process and product applications in
multiple markets. The Company believes that it has the technology to access
several markets in which its technologies address market demands or provide
competitive value. The Company evaluates several parameters, including
time-to-market, value of its solution, market drivers, revenue potential and
horizontal market opportunities, to select and prioritize its target markets.
The Company believes that it must understand market needs and be able to
deliver effective solutions utilizing its materials to successfully penetrate
its target markets. As part of its market penetration strategy,
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the Company seeks to partner with market leaders to co-develop solutions that
represent a viable revenue stream for the Company. Because most, if not all, of
these solutions are new and innovative and because its customers have specific
and demanding performance requirements, the Company's time-to-market for
commercial products utilizing its materials has historically been 18 months or
longer. The Company is attempting to reduce this period by organizing and
restructuring internal resources. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Limited History of Commercial Revenue; Uncertain Market Acceptance of
the Company's Nanocrystalline Materials" and -- "Reliance on Collaborative
Development Relationships."
The Company currently targets the following markets:
ELECTRONICS
Advanced Electronics
Increasing operating speeds, information storage requirements and market
driven miniaturization compel the electronics market to incorporate advanced
materials. For example, higher operating frequencies of cellular applications
require improved dielectric (insulating) properties of ceramic materials. The
Company believes that the consistent size, morphology, and particle size
distribution of its nanocrystalline powders, as well as its ceramic superplastic
forming technology, enable the production of materials which have the
combination of dielectric properties and low product variation critical to the
next generation of electronics component design.
Electromagnetic Radiation Protection
Cathode ray tubes ("CRTs") utilized in television and computer monitors
emit electromagnetic radiation due to the high voltages used to generate light.
In the past, little attention was paid to the potential harmful effects of this
radiation. Recent European Economic Community regulations scheduled to go into
effect over the next several years, however, place more stringent limits on the
quantity of radiation that can be emitted by television and computer monitors.
In response to such regulations, CRT manufacturers require transparent,
conductive coatings that meet the new electromagnetic radiation standards. The
Company believes that the materials currently used for conductive coating of
CRTs do not meet all of the new radiation requirements. Nanophase can produce a
proprietary metal oxide mixture, which has a narrower particle-size distribution
and cleaner particle surfaces than currently used materials. The Company's
nanocrystalline metal oxide mixture is highly conductive and easily dispersed
and, when applied as a coating to CRTs, is expected by the Company to meet the
increased radiation shielding regulatory requirements, while maintaining the
transparency required for quality video images.
Advanced Abrasives for Chemical Mechanical Polishing (CMP)
During the process of fabrication of an integrated circuit, many layers of
metal and dielectric (insulating) materials are deposited onto the surface of a
silicon wafer. This deposition results in an uneven surface. This uneven surface
causes problems in the subsequent deposition steps. Because many metal layers
are used to produce high density integrated circuits, some method must be used
to planarize, or flatten, the surface on the wafer prior to fabrication.
Chemical mechanical polishing (CMP) using an abrasive slurry has been adopted as
a viable process for planarization. The Company believes that the fine particle
size, narrow molecular weight distribution, and near-spherical morphology of its
nanocrystalline powders produces polishing slurries which allow for more
selective removal of materials and smoother surface finishes.
STRUCTURAL CERAMICS AND COMPOSITES
Advanced ceramics are used in a wide variety of industrial applications
that demand properties such as hardness, wear resistance and corrosion
resistance. The high fabrication cost associated with ceramic and composite
parts has limited the use of ceramic materials to critical applications in
environments largely unsuitable to conventional metallic materials. The
Company's recent developments in ceramic material compositions have produced
parts with a novel combination of properties, including exceptional wear
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resistance, hardness, toughness and strength. The parts incorporating
nanocrystalline materials could be a substitution for conventionally used
materials in several commercial product applications, including cutting tools,
armor plate, steel foundry components, grinding wheels and injector nozzles.
Nanophase is pursuing the development of new compositions with collaborative
partners that are seeking sustained competitive advantages through the use of
advanced material technology.
COSMETICS AND SKIN-CARE
Many cosmetic and skin-care products contain particulate materials as
pigments and active ingredients. Examples of product applications in the
cosmetics and skin-care market which the Company is developing include cosmetic
colorants and topical health-care applications. The nanometer-sized particles of
Nanophase's materials absorb light without significant visible scattering,
thereby providing color without opacity. In addition, the nearly spherical
particles of Nanophase's materials enable it to be discretely encapsulated and
readily dispersed to create smooth, free-flowing cosmetic foundations which
cosmetics formulators can blend to more closely match varying skin tones.
Furthermore, the uniformly small particles of the Company's materials contain a
large number of surface area atoms. Thus, a lower amount of the Company's
materials are needed to achieve the desired level of chemical activity in
topical health-care applications.
The Company is discontinuing its production of titanium dioxide ("titania")
for sunscreen applications because it believes the sunscreen market is limited
and characterized by intense competition which limits profitable growth. The
Company, however, will continue shipping titania dispersions to a Fortune 500
cosmetics company for use in a product with sunscreen protection through the
middle of 1999.
TECHNOLOGICALLY-SIMILAR APPLICATIONS
Although the Company currently focuses its efforts on product applications
in the above-mentioned markets, the Company believes there are a number of other
markets with technologically-similar product applications, the performances of
which could be substantially improved by utilizing the Company's materials and
technologies without extensive additional engineering. For example, abrasives
being developed by the Company for the electronics industry may have direct
applications in glass or optics polishing. As such, the Company may expand its
targeted markets to also pursue technologically-similar product applications.
MARKETING
The Company markets and sells its products through a combination of
business development and sales activities. Business development activities
assist in the qualification and quantification of markets and the development of
the business case strategy for successful market penetration. Once a market is
qualified, resources are positioned to form a technical/business development
team to effect the business case strategy. The development team partners with
selected market leaders to manage the development of solutions using the
Company's nanocrystalline materials and technologies. Once a solution is
established, management is transitioned to a sales team that is organized along
markets. The sales team is expected to grow revenue by selling such product and
process solutions and broadening the customer base.
The Company also seeks to market its materials through distributors in
certain application areas where the requirements for ongoing development and
technical support by Nanophase are not substantial, or where the distributor has
existing customer relationships, marketing or post-processing infrastructure, or
companion products or services that may enable Nanophase to enter the market
more quickly. For example, as part of its strategy to gain access to foreign
markets, Nanophase has entered into a license agreement with C.I. Kasei Co.,
Ltd. ("CIK"), a subsidiary of Itochu Corporation, formerly C. Itoh, which
enables CIK to use certain of the Company's patented technologies to exclusively
manufacture, use and sell Nanophase's nanocrystalline materials in broad-based
industrial markets throughout various Asian countries for all applications
except cosmetics, skin care and CMP. The agreement does not target specific
materials or applications; however, CIK is pursuing industrial applications in
electronics and industrial ceramics. This agreement expires in 2013 but may be
terminated (i) by the Company if CIK fails to achieve 20% of the minimum annual
sales obligations set forth in the agreement for a given year or (ii) by CIK
after March 31, 2000 upon 90 days' prior
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notice. Upon expiration of the agreement, CIK may elect to have the
non-exclusive right to still use the patented technologies licensed by the
Company to manufacture, use and sell Nanophase's nanocrystalline materials in
various Asian countries as long as CIK pays the Company a royalty based on the
net sales of such materials by CIK.
In February 1998, the Company and Whittaker, Clark & Daniels, Inc. ("WCD")
mutually agreed to end their distribution relationship with respect to the
cosmetics and skin-care market. The Company may discuss distribution
arrangements with other companies having access to the cosmetics and skin-care
market, but is currently selling directly to a small number of cosmetic and
skin-care customers.
The Company markets itself and its capabilities by attending and speaking
at advanced materials symposia, publishing articles in scientific journals, and
participating in industry trade shows for those markets it has selected to
penetrate. The Company also utilizes a web page on the Internet, advertises in
selected industry and trade journals, and provides specification sheets,
corporate journals, and other marketing materials. Additionally, the Company
routinely networks with Fortune 500 companies to display its technology and
uncover potential applications. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Limited Marketing Experience; Use of Distribution Agreements" and
"-- Revenue from International Sources."
RESEARCH AND DEVELOPMENT
The near-term objective of the Company's research and process-development
activities is to develop processes that consistently produce sufficient
commercial quantities of application-specific nanocrystalline materials to meet
the Company's requirements. A key component of the Company's long-term research
and development strategy is to identify and develop relationships with leading
industrial, university and government research programs across the United States
and internationally to leverage the Company's technological and scientific
capabilities. The Company believes that these research relationships may provide
accelerated introduction of new technologies into its product applications,
early indications of new technology developments that could enhance or compete
with the Company's nanocrystalline materials, and high-value improvements in its
current key technologies. The Company will also continue its efforts to attract
and retain top scientists and engineers, which management believes will enable
the Company to maintain a long-term leadership position in the nanocrystalline
materials field. The Company recently hired a vice president of technology and
engineering who will be overseeing all technology and research and development
functions.
The Company's total research and development expense during the years ended
December 31, 1998, 1997 and 1996 were $1,504,127, $990,331 and $677,284,
respectively. The future success of the Company will depend in large part upon
its ability to keep pace with evolving advanced materials technologies and
industry standards, and the Company may be unable to do so. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors -- Rapid Technological Change."
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The objective of Nanophase's intellectual property activities is to
implement ongoing strategies that maximize and protect the proprietary rights of
the Company. These strategies encompass (i) obtaining patents and trademarks
based on Nanophase inventions and products, and (ii) licensing third-party
patents to expand the Company's technology base and prevent Nanophase from being
blocked should future developments require use of technology covered by those
patents. Nanophase currently owns or licenses an aggregate of 17 United States
patents and patent applications: three issued patents owned directly by
Nanophase; three pending patent applications owned directly by Nanophase; and
eleven patents licensed from third parties.
Three United States patents have been issued to Nanophase: one covering its
PVS process for the synthesis of nanocrystalline materials, one covering the
related apparatus and one covering the materials produced by the PVS process.
All three patents expire in July 2013. Additional United States patent
applications filed by the Company include applications relating to
nanocrystalline materials, plasma sensors and the coating of metal oxides.
Foreign patent applications owned directly by Nanophase are pending in
Australia, Europe and Japan for the PVS process and apparatus. An international
patent application owned by
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the Company for the coating of ceramic powders is also pending under the Patent
Cooperation Treaty, with Australia, Canada, Europe and Japan designated for the
national phase of the application.
The Company holds the following licenses of United States patents: a fully
paid up exclusive worldwide license of two patents owned by ARCH Development
Corporation which embody a laboratory-scale method and apparatus for making
nanocrystalline materials; a non-exclusive license from the Japan Science and
Technology Corporation (formerly Research Development Corporation of Japan) of
four patents which embody early laboratory-scale work in the physical synthesis
of nanocrystalline materials; a non-exclusive license of two patents owned by
Hitachi, Ltd. which are related to the synthesis of nanocrystalline materials;
and a remainder-exclusive license of three patents held by Cornell University
relating to a laboratory-scale process for net-shaping of a limited range of
materials. Other than the license from the Japan Science and Technology
Corporation, which remains in force until May 2006 and is extendable upon
further agreement, each of the licenses lasts for the life of their respective
patents. Under each of the licenses, the Company is obligated to pay the
licensor royalties equal to a percentage of net sales of products, which embody
the licensed technology, and related taxes on any such royalty fees paid to
foreign licensors.
The Company requires its employees, consultants, outside scientific
collaborators and other advisors to execute confidentiality and proprietary
rights agreements upon the commencement of employment or consulting
relationships with the Company. These agreements generally provide that all
confidential information developed or made known to the individual during the
course of the individual's relationship with the Company will be kept
confidential and will not be disclosed to third parties except in specific
circumstances. In the case of research employees, the agreements also provide
that all inventions made by the individual shall be the exclusive property of
the Company. There can be no assurance, however, that these agreements will
provide meaningful protection for the Company's trade secrets, know-how or
patent rights or will provide the Company with adequate remedies in the event of
unauthorized use or disclosure of such information. In addition, because many of
the Company's employees have not entered into non-competition agreements with
the Company, they may become competitors of the Company upon termination of
employment. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors -- Dependence on Patents and
Protection of Proprietary Information."
COMPETITION
Within each of its targeted markets and product applications, Nanophase
faces current and potential competition from numerous chemical companies, as
well as the in-house capabilities of several of its current and potential
customers. For example, with regard to semiconductor wafer polishing, Cabot
Corporation, Rodel Incorporated and Fujimi Corporation (of Japan) all market
polishing slurries for CMP. In addition, Cabot Corporation, Baikowski
International Corporation and Norton Company (a unit of Compagnie De
Saint-Gobain) all manufacture their own ultrafine alumina. In the cosmetics and
skin-care market, various companies manufacture their own sub-micron iron oxide
(Sun Chemical Corporation, and Elementis, Inc.) and zinc oxide (Zinc Corporation
of America) by chemical or other means. In structural ceramics, the Company
competes against manufacturers of ceramic composites who machine such composites
for specific product applications. Although Nanophase believes that its
materials and technologies are superior to the competitive materials and
technologies that are utilized by these companies, such companies represent
significant competitive risks to Nanophase because they have substantially
greater financial and technical resources, larger research and development
staffs, and greater manufacturing and marketing capabilities than the Company.
The Company also faces potential competition from Vacuum Metallurgical Co.,
Ltd. of Japan ("Vacuum Metallurgical"), which manufactures nanocrystalline
materials and equipment. Currently, the Company does not compete with Vacuum
Metallurgical, but Vacuum Metallurgical may develop products or manufacturing
capabilities to compete with the Company in the future. Potential competitive
risks are also represented by numerous small development companies engaged in
the development of nanocrystalline materials, such as Advanced Powder Technology
Pty Ltd., Plasma Quench Technologies, Inc. and Nanopowder Enterprises, Inc. Most
of these companies are associated with university or national laboratories and
use chemical and physical methods to produce nanocrystalline materials.
Nanophase believes that most of such companies are
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engaged primarily in funded research, and is not aware of any such company with
commercial production capability. However, such companies may represent
significant competitive risks in the future. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Competition."
GOVERNMENTAL REGULATIONS
The Company's Chicago facility, which houses its coating operations, is a
"small quantity generator" of hazardous materials, including ethanol, under the
Federal Resource Conservation and Recovery Act and, as a result, is subject to
stringent federal, state and local regulations governing the handling, storage
and disposal of such materials. To date, the Company has not been required to
make substantial expenditures for preventive or remedial action with respect to
the hazardous materials it uses. The manufacture and use of certain of the
products that contain the Company's nanocrystalline materials are also subject
to governmental regulation. As a result, the Company is required to adhere to
the current Good Manufacturing Practices ("cGMP") requirements of the U.S. Food
and Drug Administration ("FDA") and similar regulations in other countries which
include testing, control and documentation requirements enforced by periodic
inspections.
In addition, the Company's facilities and all of its operations are subject
to the plant and laboratory safety requirements of various occupational safety
and health laws. To date, those regulations have not materially restricted or
impeded the Company's operations. See "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Risk
Factors -- Governmental Regulations."
EMPLOYEES
On March 22, 1999, the Company had a total of 43 full-time employees, 14 of
whom hold advanced degrees. Of the full-time employees, 10 are engaged in
research, development and engineering, 14 are engaged in manufacturing, 4 are
engaged in quality control, 6 are engaged in marketing and sales, and 9 are
engaged in general management, finance and administration. In the first quarter
of 1999, the Company hired (i) an experienced vice president of technology and
engineering to improve technology management, implement its solution approach
and further develop and expand the Company's core technologies and (ii) an
experienced vice president of sales and marketing to strengthen its capabilities
in the United States and internationally and implement its consultative
solution-based business development and sales approach. The Company also engages
scientists as consultants, one of whom is Dr. Richard W. Siegel, a co-founder
and director of the Company. In addition, prior to his appointment as Chairman
of the Company's Board of Directors, Donald S. Perkins was engaged by the
Company to provide additional services in connection with the Company's
organizational restructuring and refocusing. The Company is not subject to any
collective bargaining agreements and considers its relations with its employees
to be good.
ITEM 2. PROPERTIES
Nanophase operates a 20,000 square-foot production and research facility in
Burr Ridge, Illinois, a suburb of Chicago, which also serves as the Company's
administrative headquarters. The Company also operates a smaller facility in
Chicago, Illinois for coating nanocrystalline materials using its DPE process
and leases offsite warehouse space to store its materials. The Company believes
its Burr Ridge facility is the first in the world that is dedicated to the
commercial-scale development and production of physically synthesized
nanocrystalline materials. The Company's operations in Burr Ridge are registered
under ISO 9001 standards, and the Company believes its manufacturing operations
are in compliance with the cGMP requirements of the FDA.
The Company's preliminary manufacturing is accomplished with PVS plasma
reactors. The throughput of each reactor depends on many factors, including the
mix of products produced, the commencement, expiration or termination of
development programs, the status of tests and evaluations of samples and
prototypes and production yields. The Company expects to increase the throughput
per reactor as it increases the efficiency and yields of its PVS process and
decreases the amount of downtime for each reactor. Each PVS plasma reactor is
comprised of modular equipment, which is designed and assembled to the Company's
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proprietary specifications. These modular reactors provide flexibility in the
expansion of the Company's manufacturing capability. Also operational within the
Burr Ridge facility is a quality control laboratory designed for the dual
purpose of validating operations to cGMP and ISO standards, and production
process control. This laboratory is equipped to handle many routine analytical
and in-process techniques that are currently required by the Company. In
addition, capability for specialized analytical and physical measurements
currently are available through a number of outside laboratories, including
Argonne National Laboratory which is near the Burr Ridge facility, upon terms
which the Company believes are reasonable and adequate. The Company leases its
Burr Ridge facility pursuant to an agreement, which expires in September 1999.
The Company has options to extend the lease for up to five additional years. The
Company subleases its Chicago coating facility pursuant to a one year agreement,
which automatically renews unless terminated by either party upon proper notice.
The Company believes that additional space may be required in the near term
and may use a portion of the net proceeds from its initial public offering (the
"Offering") of the Company's Common Stock, $.01 par value per share (the "Common
Stock"), for the relocation of, or acquisition of another site for, its
manufacturing and laboratory facilities, including the implementation of a pilot
manufacturing facility. See "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Risk Factors -- Limited
Manufacturing Capacity and Experience."
ITEM 3. LEGAL PROCEEDINGS
As previously disclosed in the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1998, five separate complaints were filed in the
United States District Court for the Northern District of Illinois, Eastern
Division, each of which alleged that the Company, certain of its officers and
directors, and the underwriters of the Company's Offering are liable under the
federal securities laws for making material misstatements of fact and omitting
and failing to state material facts necessary to make other statements of fact
not misleading in the Registration Statement and Prospectus relating to the
Offering. In an order entered by the Court, those cases were consolidated and a
consolidated complaint was filed on October 30, 1998. The consolidated complaint
alleges that the action should be maintained as (i) a plaintiff class action on
behalf of certain persons who purchased Common Stock from November 26, 1997
through January 8, 1998, excluding the defendants, members of their immediate
families, any entity in which a defendant has a controlling interest and certain
others related to or affiliated with the foregoing, and (ii) a defendant class
action against the underwriters who participated in the Offering. The
consolidated complaint seeks unquantified damages as provided for under the
federal securities laws, pre- and post-judgment interest, attorneys' fees,
expert witness fees, other costs and expenses and such other and further relief
as the Court may find proper. In addition, the consolidated complaint seeks
rescission and/or rescissory damages relating to purchases of the Common Stock,
as provided for under federal securities laws. All defendants have filed motions
to dismiss the consolidated complaint that are fully briefed and under
advisement by the Court.
On November 20, 1998, a separate complaint was filed in the Northern
District of Illinois, Eastern Division, which alleged that the Company, certain
of its officers and directors, and the underwriters of the Company's Offering
are liable under the federal securities laws for making material misstatements
of fact and omitting or failing to state material facts necessary to make other
statements of fact not misleading in connection with the solicitation of
consents to proceed with the Offering from certain of the Company's preferred
stockholders. The complaint alleges that the action should be maintained as a
plaintiff class action on behalf of those former preferred stockholders whose
shares of preferred stock of the Company were converted into Common Stock on or
about the date of the Offering, excluding the defendants, other officers and
directors of the Company, members of the immediate families of all individual
defendants, any entity in which a defendant has a controlling interest and
certain others related to, employed by or affiliated with the foregoing. The
complaint seeks unquantified damages as provided for under the federal
securities laws, pre-and post-judgment interest, attorneys' fees, expert witness
fees, other costs and expenses and such other and further relief as the Court
may find proper. On March 15, 1999, the preferred stockholders' complaint was
referred to the Court's Executive Committee for possible (i) reassignment to the
judge hearing the consolidated complaint described above and (ii) further
consolidation with that litigation.
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The Company, the defendant directors and the defendant officers have each
retained counsel with respect to both of the above-described litigations and
intend to defend against both complaints vigorously. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Legal Proceedings" and "Risk Factors -- Volatility of Common Stock Price and
Associated Litigation."
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 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol NANX. Such trading began on November 26, 1997 in connection with the
Offering. The following table sets forth, for the periods indicated, the range
of high and low sale prices for the Common Stock on the Nasdaq National Market:
HIGH LOW
---- ---
Fiscal year ending December 31, 1997:
Fourth Quarter (beginning November 26, 1997).............. $15.00 $7.00
Fiscal year ending December 31, 1998:
First Quarter............................................. 13.25 5.00
Second Quarter............................................ 9.38 4.25
Third Quarter............................................. 5.13 1.81
Fourth Quarter............................................ 3.69 1.50
On March 26, 1999, the last reported sale price of the Common Stock was
$2.125, and there were approximately 188 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 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 November 26, 1997 (the "Effective Date") the Company's Registration
Statement on Form S-1 (File No. 333-36937) relating to the Offering was declared
effective by the Securities and Exchange Commission. Since the Effective Date,
of its $28,837,936 of net proceeds from the Offering, the Company has used
$470,425 for capital expenditures primarily related to the further expansion of
the Company's existing manufacturing facility and the purchase of operating
equipment and $1,733,599 for working capital and other general corporate
purposes. The remainder of the net proceeds has been invested by the Company,
pending its use, in short-term, investment grade, interest-bearing obligations.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data is qualified by reference to, and
should be read in conjunction with, the financial statements and related notes
thereto appearing elsewhere in this Form 10-K and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations." The
selected
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financial data set forth below as of, and for, each of the years in the
five-year period ended December 31, 1998 have been derived from the audited
financial statements of the Company.
YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:
Product revenue................ $ -- $ -- $ 249,017 $ 924,763 $ 1,140,845
Other revenue.................. 31,144 93,591 236,019 2,798,729 162,944
Governmental research
contracts.................... 64,015 27,995 110,770 -- --
----------- ----------- ----------- ----------- -----------
Total revenue.................. 95,159 121,586 595,806 3,723,492 1,303,789
Cost of revenue................ 164,746 532,124 4,019,484 3,935,766 3,221,996
Research and development
expense...................... 456,162 485,059 677,284 990,331 1,504,127
Selling, general and
administrative expense....... 799,558 1,150,853 1,661,504 2,074,728 3,594,946
----------- ----------- ----------- ----------- -----------
Total operating expense........ 1,420,466 2,168,036 6,358,272 7,000,825 8,321,069
----------- ----------- ----------- ----------- -----------
Operating loss................. (1,325,307) (2,046,450) (5,762,466) (3,277,333) (7,017,280)
Interest income................ 37,535 86,576 184,778 204,863 1,539,400
Provision for income taxes..... -- -- -- -- (156,000)
----------- ----------- ----------- ----------- -----------
Net loss....................... $(1,287,772) $(1,959,874) $(5,577,688) $(3,072,470) $(5,633,880)
=========== =========== =========== =========== ===========
Net loss per share............. $ (0.45)
===========
Shares used in computing the
net loss per share........... 12,416,305
===========
AS OF DECEMBER 31,
-----------------------------------------------------------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Cash and cash equivalents...... $ 18,462 $ 261,902 $ 617,204 $ 3,988,368 $ 363,394
Working capital................ 2,226,184 2,451,627 3,070,789 32,038,915 26,535,018
Total assets................... 2,568,691 3,741,128 5,539,634 36,196,569 30,453,988
Total stockholders' equity..... 2,456,516 3,506,050 5,110,450 34,651,334 29,107,590
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Item 6. Selected Financial Data" and the financial statements and related notes
thereto appearing elsewhere in this Form 10-K. When used in the following
discussions, the words "anticipates," "believes," "estimates," "expects,"
"plans," "intends" and similar expressions are intended to identify
forward-looking statements. Such statements are subject to certain risks,
uncertainties and contingencies that could cause actual results, performance or
achievements to differ materially from those expressed in, or implied by, such
statements. See "-- Risk Factors."
OVERVIEW
From its inception in November 1989 through December 31, 1996, the Company
was in the development stage. During that period, the Company primarily focused
on the development of its manufacturing processes in order to transition from
laboratory-scale to commercial-scale production. As a result, the Company
developed an operating capacity to produce significant quantities of its
nanocrystalline materials for commercial sale. The Company was also engaged in
the development of commercial applications and formulations and the recruiting
of marketing, technical and administrative personnel. Since January 1, 1997, the
Company has been engaged in commercial production and sales of its
nanocrystalline materials, and the Company no longer considers itself in the
development stage. All of the Company's revenue since January 1, 1997 has been
generated through commercial sources. From inception through December 31, 1998,
the Company was primarily capitalized through the private offering of
approximately $19,558,069 of equity securities and its initial public offering
of $28,837,936 of Common Stock, each net of issuance costs. The Company has
incurred cumulative losses of $19,378,551 from inception through December 31,
1998.
RESULTS OF OPERATIONS
Years Ended December 31, 1998 and 1997
Revenue is recorded when the Company ships products, when specific
milestones are met regarding development arrangements or when the Company
licenses its technology and transfers proprietary information. Total revenue
decreased to $1,303,789 in 1998, compared to $3,723,492 in 1997. The decrease in
total revenue between 1998 and 1997 was primarily attributed to a $216,082
increase in product revenue offset by a $2,635,785 reduction in other revenue.
Product revenue increased to $1,140,845 in 1998, compared to $924,763 in 1997.
Other revenue decreased to $162,944 in 1998, compared to $2,798,729 in 1997. The
majority of the revenue generated in 1998 was from customers in the electronics
and structural ceramics and composites markets. Revenue from four customers
constituted 55.8% of the Company's 1998 revenue. In particular, revenue from (i)
EKC Technology, Inc., a manufacturer of semiconductor polishing slurries
("EKC"), (ii) CIK, (iii) a ceramics customer and (iv) an electronics customer
constituted approximately 11.5%, 14.0%, 16.9% and 13.4%, respectively, of the
Company's 1998 revenue. The Company does not currently anticipate future revenue
from either the ceramics customer or the electronics customer. See "-- Risk
Factors -- Dependence on a Limited Number of Key Customers."
Cost of revenue generally includes costs associated with commercial
production, customer development arrangements and licensing fees. Cost of
revenue decreased to $3,221,996 in 1998, compared to $3,935,766 in 1997. The
decrease in cost of revenue was generally attributed to the reduced cost of
development activities and efficiencies in the manufacture of the Company's
products, somewhat offset by inefficiencies in the Company's coating operations
and increased ceramic superplastic forming costs. Cost of revenue as a
percentage of total revenue increased in 1998, compared to the same period in
1997, due primarily to the decrease in total revenue.
Research and development expense primarily consists of costs associated
with the Company's development or acquisition of new product applications and
coating formulations and the cost of enhancing the Company's manufacturing
processes. Research and development expense increased to $1,504,127 in 1998,
compared to $990,331 in 1997. The increase in research and development expense
was primarily attributed to increased costs of $522,000 related to arrangements
with outside parties to further develop end-use products
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utilizing nanocrystalline materials, slightly offset by reductions in internal
costs regarding the development of new formulations and product applications.
The Company expects to further increase its research and development expense in
1999 in connection with its plans to continue to enhance and expand its product
lines, technologies and manufacturing processes.
Selling, general and administrative expense increased to $3,594,946 in
1998, compared to $2,074,728 in 1997. The selling, general and administrative
expense in 1997 included a one-time charge of $375,103 related to a public
offering withdrawn in May 1997. Excluding such one-time charge, selling, general
and administrative expense increased by $1,895,321 in 1998 over 1997. The net
increase was primarily attributed to increased costs associated with being a
public company, costs related to ongoing investor relation programs, additional
legal expenses, salaries of additional sales and administrative personnel and
increased recruiting and relocation costs. The Company expects to further
increase its selling, general and administrative expense during 1999 in
connection with its plans to further expand its sales force and administrative
staff.
Interest income increased to $1,539,400 in 1998, compared to $204,863 in
1997. This increase was primarily due to the investment of net proceeds from the
Company's sale of equity securities pending use of such proceeds. The Company
expects interest income to decrease in 1999 as such proceeds are utilized.
Income tax expense was $156,000, compared to $0 in 1997. The 1998 expense
was due to the foreign taxes withheld from license fees received from CIK. The
payment of such taxes creates a foreign tax credit which may be available to
offset federal income taxes when the Company generates taxable income.
Years Ended December 31, 1997 and 1996
Total revenue increased to $3,723,492 in 1997, compared to $595,806 in
1996. The increase in total revenue was due primarily to a one-time technology
transfer fee of $1,400,000 from CIK for a license to use certain patented
technology to exclusively manufacture, use and sell the Company's
nanocrystalline materials in Asia, a product development fee of $775,000 from
Moyco Technologies, Inc. ("Moyco"), a one-time fee of $160,000 from CIK for
training in the operation of a PVS reactor, and increased customer development
revenue and product shipments. Product revenue increased to $924,763 in 1997,
compared to $249,017 in 1996. Other revenue increased to $2,798,729 in 1997,
compared to $236,019 in 1996. Total revenue for the year ended December 31, 1997
was primarily generated from customers in the electronics and structural
ceramics and composites markets. In particular, revenue from Moyco and CIK
constituted approximately 42.2% and 43.1%, respectively, of the Company's
revenue in 1997. Revenue from governmental research contracts decreased to $0
for the year ended December 31, 1997, compared to $110,770 for the same period
in 1996, because the Company did not pursue any further U.S. government
contracts for the year. See "-- Risk Factors -- Dependence on a Limited Number
of Key Customers."
Cost of revenue decreased to $3,935,766 in 1997, compared to $4,019,484 in
1996. The decrease in cost of revenue was generally attributed to increased
efficiencies in the manufacture of the Company's products and the reduced cost
of product development activities. Cost of revenue as a percentage of total
revenue decreased significantly for the year ended December 31, 1997, compared
to the same period in 1996 because of the increased efficiencies in the
Company's manufacturing processes, minimal costs associated with the one-time
technology transfer fee from CIK and the product development fee from Moyco, and
increased production volumes.
Research and development expense increased to $990,331 in 1997, compared to
$677,284 in 1996. The increase in research and development expense is
attributable primarily to the acquisition of certain knowledge and technology
from Moyco for a one-time fee of $223,000, increased costs of developing new
coating formulations and product applications, and ongoing experimentation
expenses associated with technological enhancements and product improvements.
Selling, general and administrative expense increased to $2,074,728 for the
year ended December 31, 1997, compared to $1,661,504 for the same period in
1996. This increase is attributable primarily to the expending of certain
one-time costs aggregating $375,103 related to a proposed public offering
withdrawn in
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May 1997 and certain one-time costs associated with the Company's Asian
distribution agreement with CIK. These one-time costs were offset by decreases
in selling and general expenses.
Interest income increased to $204,863 in 1997, compared to $184,778 in
1996. This increase is primarily due to the investment of net proceeds from its
sale of equity securities pending use of such proceeds for operating activities
and expansion of its manufacturing facilities.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and investments amounted to
$26,633,912 at December 31, 1998, compared to $30,873,220 at December 31, 1997.
The net cash used in the Company's operating activities was $3,859,019,
$3,370,367 and $5,795,858 for the years ended December 31, 1998, 1997 and 1996,
respectively. The net cash used in operating activities for the year ended
December 31, 1998 was primarily for the further development of product
applications, the funding of research and development activities, the funding of
inventory levels and the payment of accounts payable, which was offset by the
collection of accounts receivable and an increase in accrued liabilities. Net
cash provided by or (used in) investing activities, including capital
expenditures and purchases of securities in which cash is invested pending its
use for operating activities and expansion of the Company's manufacturing
facilities offset by maturities of such securities, amounted to $143,909,
$(25,871,823) and $(951,806) for the years ended December 31, 1998, 1997 and
1996, respectively. Capital expenditures, primarily related to the further
expansion of the Company's existing manufacturing facilities and the purchase of
operating equipment, amounted to $470,425, $1,063,608 and $1,173,437 for the
years ended December 31, 1998, 1997 and 1996, respectively. Net cash provided by
financing activities, which related to the exercise of options and warrants for
291,224 shares of Common Stock, amounted to $90,136 for the year ended December
31, 1998, compared to $32,613,354 and $7,102,966 for the years ended December
31, 1997 and 1996, respectively, which related to the net proceeds from the
issuance of equity securities.
The Company believes that cash from operations and cash on hand, together
with the remaining net proceeds from the Offering and interest income thereon,
will be adequate to fund the Company's current operating plans. The Company's
actual future capital requirements will depend, however, on many factors,
including customer acceptance of the Company's current and potential
nanocrystalline materials and product applications, continued progress in the
Company's research and development activities and product testing programs, the
magnitude of these activities and programs, and the costs necessary to increase
and expand the Company's manufacturing capabilities and to market and sell the
Company's materials and product applications. Depending on future requirements,
the Company may seek additional funding through public or private financing,
collaborative relationships, government contracts or additional licensing
agreements. Additional financing may not be available on acceptable terms or at
all, and any such additional financing could be dilutive to the Company's
stockholders. See "-- Risk Factors -- Future Capital Needs."
At December 31, 1998, the Company had a net operating loss carryforward of
approximately $18.3 million for income tax purposes. Because the Company may
have experienced "ownership changes" within the meaning of the U.S. Internal
Revenue Code in connection with its various prior equity offerings, future
utilization of this carryforward may be subject to certain limitations as
defined by the Internal Revenue Code. If not utilized, the carryforward expires
at various dates between 2005 and 2013. As a result of the annual limitation, a
portion of this carryforward may expire before ultimately becoming available to
reduce income tax liabilities. At December 31, 1998, the Company also had a
foreign tax credit carryforward of $156,000, which could be used as an
offsetting tax credit to reduce U.S. income taxes. The foreign tax credit will
expire in 2013 if not utilized before that date.
IMPACT OF YEAR 2000
The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Computer programs
that have time-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations
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causing disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities.
The Company has identified the following areas as possibly being affected
by the Year 2000 Issue: (i) IT and non-IT systems, (ii) manufacturing
applications and (iii) third-party relationships. For each of these areas, the
Company is in the process of identifying and assessing specific software,
equipment and systems which are potentially susceptible to the Year 2000 Issue.
The Company expects to develop and implement corrective actions, if necessary,
to ensure that by September 30, 1999 its software, equipment and systems will
function properly with respect to dates in the year 2000 and thereafter. The
Company believes the total cost of such year 2000 compliance activities will not
be material. The Company believes that it has no material exposure to
contingencies related to the Year 2000 Issue for the products it has sold to
date.
The Company processes its transactions and applications utilizing personal
computers. In addition, the Company's telephone system, fax machines, payroll,
alarm systems and other miscellaneous systems utilize computer equipment and
software. The Company is identifying which software and equipment needs to be
upgraded. Based on its assessment to date, the Company does not believe that
significant modifications or replacements of its software or systems will be
required to be year 2000 compliant. As of January 1, 1998, the Company only
acquires software and invests in systems which are year 2000 compliant.
The Company's manufacturing activities rely on its PVS plasma reactors
comprised of modular equipment that contains embedded technology. The Company
also relies on a quality control laboratory for production process control. The
Company is identifying the particular hardware and software systems used in such
manufacturing applications to assess whether they are year 2000 compliant. The
Company believes such manufacturing applications are year 2000 compliant.
To date, the Company does not have any direct interface between its systems
and those of any significant supplier or customer. The Company, however, relies
on third party suppliers for raw materials, utilities, cash management services
and other key supplies and services. The Company, therefore, recognizes that it
is vulnerable to third party suppliers that fail to remediate their own Year
2000 Issues. The Company is corresponding with its significant suppliers to
determine their year 2000 compliance status. The Company is also dependent upon
its customers, product development partners and distributors for sales, cash
flow and product development. Although the Company has received some formal
information concerning the year 2000 compliance status of certain of its
customers, product development partners and distributors, this information is
limited and incomplete at this time. The Company has, however, received
indications that most of these entities are working on year 2000 compliance.
The Company's most reasonably likely worst case scenario with respect to
the Year 2000 Issue is that (i) its manufacturing systems may malfunction and
(ii) third party suppliers of ceramic and metallic materials, cash management
services and utilities, customers, product development partners and distributors
may be unable to remediate their own Year 2000 Issues. In such scenario, the
Company could experience manufacturing interruptions, difficulties in accessing
its cash and investments, delays in distribution of its products, delays in
development of new product applications and reduced shipments. This would have a
material adverse effect on the Company's operations. The Company currently has
no contingency plan in the event such most reasonably likely worst case scenario
occurs.
The Company currently believes that the Year 2000 Issue will not pose
significant operational problems for the Company. However, if all Year 2000
Issues are not properly identified or remediated on a timely basis, the
Company's results of operations or relationships with customers and suppliers
may be materially adversely affected. In addition, the systems of other
companies on which the Company relies may not be timely converted and any
failure by them to do so could have a material adverse effect on the Company's
operations.
LEGAL PROCEEDINGS
As disclosed in Note 16 to the Financial Statements and under "Item 3.
Legal Proceedings in Part I," five separate complaints were filed in the United
States District Court for the Northern District of Illinois, Eastern Division,
each of which alleged that the Company, certain of its officers and directors,
and the
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underwriters of the Company's Offering are liable under the federal securities
laws for making material misstatements of fact and omitting and failing to state
material facts necessary to make other statements of fact not misleading in the
Registration Statement and Prospectus relating to the Offering. In an order
entered by the Court, those cases were consolidated and a consolidated complaint
was filed on October 30, 1998. The consolidated complaint alleges that the
action should be maintained as (i) a plaintiff class action on behalf of certain
persons who purchased the Common Stock from November 26, 1997 through January 8,
1998, excluding the defendants, members of their immediate families, any entity
in which a defendant has a controlling interest and certain others related to or
affiliated with the foregoing, and (ii) a defendant class action against the
underwriters who participated in the Offering. The consolidated complaint seeks
unquantified damages as provided for under the federal securities laws, pre- and
post-judgment interest, attorneys' fees, expert witness fees, other costs and
expenses and such other and further relief as the Court may find proper. In
addition, the consolidated complaint seeks rescission and/or rescissory damages
relating to purchases of the Common Stock, as provided for under federal
securities laws. All defendants have filed motions to dismiss the consolidated
complaint that are fully briefed and under advisement by the Court.
On November 20, 1998, a separate complaint was filed in the Northern
District of Illinois, Eastern Division, which alleged that the Company, certain
of its officers and directors, and the underwriters of the Company's Offering
are liable under the federal securities laws for making material misstatements
of fact and omitting or failing to state material facts necessary to make other
statements of fact not misleading in connection with the solicitation of
consents to proceed with the Offering from certain of the Company's preferred
stockholders. The complaint alleges that the action should be maintained as a
plaintiff class action on behalf of those former preferred stockholders whose
shares of preferred stock of the Company were converted into Common Stock on or
about the date of the Offering, excluding the defendants, other officers and
directors of the Company, members of the immediate families of all individual
defendants, any entity in which a defendant has a controlling interest and
certain others related to, employed by or affiliated with the foregoing. The
complaint seeks unquantified damages as provided for under the federal
securities laws, pre-and post-judgment interest, attorneys' fees, expert witness
fees, other costs and expenses and such other and further relief as the Court
may find proper. On March 15, 1999, the preferred stockholders' complaint was
referred to the Court's Executive Committee for possible (i) reassignment to the
judge hearing the consolidated complaint described above and (ii) further
consolidation with that litigation.
The Company, the defendant directors and the defendant officers have each
retained counsel with respect to both of the above-described litigations and
intend to defend against both complaints vigorously. Although the Company
believes that the allegations of the complaints are without merit, it is unable
to predict at this time the outcome of either litigation or whether the
resolution of either litigation could have a material adverse effect on the
Company's results of operations, cash flows or financial condition.
RISK FACTORS
Investors should consider the following risks in connection with an
investment in the Company.
Limited History of Commercial Revenue; Uncertain Market Acceptance of the
Company's
Nanocrystalline Materials
The Company was founded in November 1989 and through December 31, 1996 was
engaged principally in research and development activities. While the Company
recently commenced marketing certain nanocrystalline materials, it is in the
early stage of commercialization and the potential product applications
utilizing the Company's nanocrystalline materials are in various stages of
development or under evaluation. As a result, the Company's nanocrystalline
materials have been sold only in limited quantities, often for testing and
evaluation purposes, and a significant market may not develop for such
materials. Because most, if not all, of the solutions utilizing the Company's
materials are new and innovative, the Company's time-to-market for commercial
products utilizing its materials has historically been at least 18 months and
may take several years. The Company is attempting to reduce this period by
organizing and restructuring internal resources. The Company may be unable to
decrease this time-to-market. The Company's current and potential commercial
customers establish demanding specifications for performance and reliability.
The Company's nanocrystalline
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materials may not meet future customer performance standards, or offer
sufficient price or performance advantages as required to achieve commercial
success. The Company's failure to develop, manufacture and commercialize
nanocrystalline materials on a timely and cost-effective basis or successfully
reduce the time-to-market of commercial products would have a material adverse
effect on the Company's business, results of operations and financial condition.
Because the Company's materials are used as ingredients in, or components of,
other companies' products, the inability of the Company's customers to achieve
market acceptance with respect to end-users of their products or to successfully
manufacture their products could also have a material adverse effect on the
Company's business, results of operations and financial condition.
Limited Operating History; History of Losses; Uncertainty of Future
Profitability
The Company began shipping significant amounts of its materials for
commercial use in January 1997. Accordingly, the Company has only a limited
operating history upon which an evaluation of the Company and its prospects can
be based. An investment in the Company must be considered in light of the risks,
expenses and difficulties frequently encountered by companies in the early
stages of development. The Company's nanocrystalline materials may not generate
significant revenues from commercial applications.
The Company has incurred net losses in each year since its inception, and
as of December 31, 1998, had an accumulated deficit of $19,378,551. The Company
may continue to incur operating losses and may be unable to achieve a profitable
level of operations. If the Company does achieve profitability, it may be unable
to sustain it. Commercial development of the Company's nanocrystalline materials
will require the commitment of substantial resources to continuing research and
development, establishment of additional commercial-scale and pilot-scale
manufacturing facilities, and further development of quality control, marketing,
sales, service and administrative capabilities. The Company's ability to achieve
profitability will depend on many factors, including the Company's ability to
enter into collaborative customer relationships and the Company's ability, alone
or with its customers, to develop, manufacture, introduce and market
commercially acceptable products based on the Company's nanocrystalline
materials and proprietary processes. The Company and its customers may not
successfully manufacture, introduce or market significant quantities of the
Company's nanocrystalline materials or their product applications.
Dependence on a Limited Number of Key Customers
A limited number of key customers have initially accounted for a
substantial portion of the Company's commercial revenue. For example, revenue
from EKC, CIK, a ceramics customer and an electronics customer constituted
approximately 11.5%, 14.0%, 16.9% and 13.4%, respectively, of the Company's 1998
revenue. The Company does not currently anticipate future revenue from either
the ceramics or electronics customer. The Company's customers are significantly
larger than, and are able to exert a high degree of influence over, the Company.
The loss of one or more of the Company's customers or failure to attract new
customers could have a material adverse effect on the Company's business,
results of operations and financial condition.
In December 1997, Nanophase entered into a seven-year supply agreement with
EKC, a subsidiary of ChemFirst, a manufacturer of semiconductor polishing
slurries, pursuant to which the Company has agreed to supply certain of its
nanocrystalline materials and provide related research and customer and
technical support to EKC. This agreement, as subsequently amended, supersedes
the Company's five-year requirements contract with Moyco and was entered into
after Moyco sold its chemical/mechanical polishing intellectual property,
technologies and certain other intangible assets to EKC in December 1997. If EKC
does not purchase certain separate minimum dollar amounts specified in the
agreement, the Company may terminate EKC's exclusivity, future supply obligation
or the entire agreement. Revenue from EKC is currently expected to constitute a
significant portion of the Company's revenues over the next several years. To
date, EKC's purchase of the Company's materials has been for a lesser dollar
amount and on a slower timetable as compared to that which the Company
previously expected from Moyco and this may continue.
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Reliance on Collaborative Development Relationships
The Company has established, and will continue to pursue, collaborative
relationships with a variety of corporate customers. Through such relationships,
the Company seeks to develop applications for the Company's nanocrystalline
materials, share development and manufacturing resources and coordinate the
development, manufacturing, commercialization and marketing of nanocrystalline
product applications. The Company's future success will depend, in part, on its
continued relationships with these customers, its ability to enter into similar
collaborative relationships, the commitment of the Company's customers to the
potential product applications under development and, eventually, the customers'
success in manufacturing and marketing, or willingness to purchase the Company's
nanocrystalline materials for, such product applications. The Company's
customers may decide to manufacture jointly developed products internally,
obtain them from alternative sources or no longer pursue their development.
These customers may require the Company to share control of its development,
manufacturing and marketing programs, limit its ability to license its
technology to others, or restrict its ability to engage in certain product
development, manufacturing and marketing activities. These relationships may
also be subject to unilateral termination by the Company's customers. If the
Company is unable to initiate or sustain such collaborative relationships, the
Company may be unable to independently develop, manufacture, market or sell its
current and future nanocrystalline materials or their product applications. The
failure of the Company to initiate or sustain such collaborative relationships
would have a material adverse effect on the Company's business, results of
operations and financial condition.
Limited Manufacturing Capacity and Experience
The Company's success will depend, in part, on its ability to manufacture
its nanocrystalline materials in significant quantities, with consistent
quality, at acceptable cost, on a timely basis, and in a format needed by its
customers. The Company has limited experience in high-volume manufacturing and
may incur significant start-up costs and unforeseen expenses in connection with
attempts to manufacture substantial quantities.
The Company will need to improve manufacturing efficiency significantly,
implement additional manufacturing capability and expand its current facilities
and/or obtain other facilities in the near future in order to manufacture
adequate quantities of its products to meet expected market demands. The Company
may be unable to make the transition from pilot manufacturing to high-volume
manufacturing successfully on a timely basis. The Company may also be unable to
successfully develop its surface treatment and dispersion technologies so as to
be able to coat significant quantities of its nanocrystalline materials with
consistent quality, at acceptable cost and on a timely basis. The Company may
have to develop manufacturing capability that enables it to produce dispersions,
slurries, or formulations that contain its nanocrystalline materials in order to
provide solutions demanded by certain customers and/or markets. The Company's
primary operations, including research, engineering, manufacturing, marketing,
distribution and general administration, are housed in a single facility in Burr
Ridge, Illinois. Any material disruption in the Company's operations, whether
due to fire, natural disaster, power loss or otherwise, could have a material
adverse effect on the Company's business, results of operations and financial
condition. While the Company maintains property and business interruption
insurance, such insurance may not adequately compensate the Company for all
losses that it may incur.
Dependence on Patents and Protection of Proprietary Information
The Company's success will depend, in part, on its ability to obtain patent
protection for its nanocrystalline materials and processes, to preserve its
trade secrets, and to operate without infringing the patent or other proprietary
rights of others and without breaching or otherwise losing rights in the
technology licenses upon which any of the Company's products are based. The
Company has been granted three United States patents, all of which expire in
July 2013, has filed three applications for other United States patents and
licenses eleven patents held by others, which licenses generally last the life
of their respective patents. The patent applications filed by the Company may
not result in issued patents and the scope and breadth of any claims allowed in
any patents issued to the Company or its licensors may not exclude competitors
or provide competitive advantages to the Company. In addition, any patents
issued to the Company or its licensors may not be held valid if subsequently
challenged. Others may claim rights in the patents and other proprietary
technology owned or
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licensed by the Company. It is also possible that others have developed or will
develop similar products or technologies without violating any of the Company's
proprietary rights. The Company's inability to obtain patent protection,
preserve its trade secrets or operate without infringing the proprietary rights
of others, as well as the Company's loss of any license to technology that it
now has or acquires in the future, would have a material adverse effect on the
Company's business, results of operations and financial condition.
Patent applications in the United States are currently maintained in
secrecy until patents issue, and patent applications in foreign countries are
maintained in secrecy for a period of time after filing. Accordingly,
publication of discoveries in the scientific literature or of patents themselves
or laying open of patent applications in foreign countries tends to lag behind
actual discoveries and filings of related patent applications. Due to this
factor and the large number of patents and patent applications related to
nanocrystalline materials, comprehensive patent searches and analysis associated
with nanocrystalline materials are often impractical or not cost-effective.
Therefore, the Company's patent and publication searches may not have been
comprehensive, or materials or processes used by the Company for its planned
products may, now or in the future, infringe upon existing technology described
in United States patents or may infringe upon claims of patent applications of
others. Because of the volume of patents issued and patent applications filed
relating to nanocrystalline materials, there is a significant risk that current
and potential competitors and other third parties have filed or will file patent
applications for, or have obtained or will obtain patents or other proprietary
rights relating to, materials or processes used or proposed to be used by the
Company. In any such case, to avoid an infringement, the Company would have to
either license such technology or design around any such patents. The Company
may be unable either to successfully design around these third-party patents or
obtain licenses to such technology or if obtainable, such licenses may not be
available on terms acceptable to the Company.
Litigation, which could result in substantial cost to, and diversion of
effort by, the Company, may be necessary to enforce patents issued or licensed
to the Company, to defend the Company against infringement claims made by
others, or to determine the ownership, scope or validity of the proprietary
rights of the Company and others. An adverse outcome in any such litigation
could subject the Company to significant liabilities to third parties, require
the Company to seek licenses from third parties, and/or require the Company to
cease using certain technology, any of which could have a material adverse
effect on the Company's business, results of operations and financial condition.
The Company may also become involved in interference proceedings declared by the
United States Patent and Trademark Office ("PTO") in connection with one or more
of the Company's owned or licensed patents or patent applications to determine
priority of invention. Any such proceeding could result in substantial cost to
the Company, as well as a possible adverse decision as to priority of invention
of the patent or patent application involved. In addition, the Company may
become involved in reissue or reexamination proceedings in the PTO in connection
with the scope or validity of the Company's owned or licensed patents. Any such
proceeding could have a material adverse effect on the Company's business,
results of operations and financial condition, and an adverse outcome in such
proceeding could result in a reduction of the scope of the claims of any such
patents or such patents being declared invalid. In addition, from time to time,
to protect its competitive position, the Company may initiate reexamination
proceedings in the PTO with respect to patents owned by others. Such proceedings
could result in substantial cost to, and diversion of effort by, the Company,
and an adverse decision in such proceedings could have a material adverse effect
on the Company's business, results of operations and financial condition.
The Company also relies on trade secrets and proprietary know-how in the
conduct of its business and uses employee and third-party confidentiality and
non-disclosure agreements to protect such trade secrets and know-how. The
obligation to maintain the confidentiality of such trade secrets or proprietary
information may wrongfully be breached by employees, consultants, advisors or
others and the Company may not have adequate remedies for any breach. In
addition, the Company's trade secrets or proprietary know-how may otherwise
become known or be independently developed or discovered by third parties. In
addition, because the Company's employees have not entered into noncompetition
agreements with the Company, they may become competitors of the Company upon
termination of employment.
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Rapid Technological Change
Rapid changes have occurred, and are likely to continue to occur, in the
development of advanced materials and processes. The future success of the
Company will depend, in large part, upon its ability to keep pace with advanced
materials technologies, industry standards and market trends and to develop and
introduce new and improved products on a timely basis. The Company will require
substantial resources to expand its commercial manufacturing capacity, further
develop its technologies and develop and introduce innovative product
applications. The Company's development efforts may be rendered obsolete by the
research efforts and technological advances of others or other advanced
materials may prove more advantageous than those produced by the Company.
Limited Marketing Experience; Use of Distribution Agreements
The Company has limited experience marketing and selling its products. To
market its nanocrystalline materials directly, the Company must continue
developing a marketing and sales force that can effectively demonstrate the
advantages of its nanocrystalline product applications compared to competitive
products containing conventional or advanced materials. The Company currently
has arrangements for distribution of certain of its nanocrystalline materials
and expects to enter into additional distribution or other arrangements with
third parties regarding the commercialization or marketing of its materials. The
Company's future success will depend in part on its continued relationships with
distributors, its ability to enter into other distribution arrangements, the
continuing interest of the Company's distributors in current and potential
product applications and, eventually, the distributors' success in marketing, or
willingness to purchase, any of the Company's nanocrystalline materials. The
Company may be unsuccessful in its marketing efforts or may be unable to
establish adequate sales and distribution capabilities or to enter into or
maintain marketing and distribution arrangements with third parties on
financially acceptable terms. In addition, any third parties with whom it enters
into such arrangements may not be successful in marketing the Company's
products. In February 1998, the Company and WCD mutually agreed to end their
cosmetics and skin-care ingredients distribution relationship. While the Company
may discuss distribution arrangements with other companies having access to the
cosmetics and skin-care market and is currently selling directly to a small
number of cosmetic and skin-care customers, the Company may be unable to
maintain significant worldwide access to such market.
Revenue from International Sources
For the year ended December 31, 1998, 26.7% of the Company's total revenues
were derived from product shipments to, and development agreements with,
international customers, and the Company expects that it will continue to derive
a substantial percentage of revenues from international customers in the future.
The Company may be unable to successfully market, sell and deliver its
nanocrystalline materials in international markets. In addition, there are
certain risks inherent in conducting international business, including exposure
to currency fluctuations, longer payment cycles, greater difficulties in
accounts receivable collection, political instability, foreign withholding taxes
relating to royalties, difficulties in complying with a variety of foreign laws
and unexpected changes in regulatory requirements. One or more of such factors
could have a material adverse effect on the Company's business, results of
operations and financial condition. In particular, the Company has a license
agreement with CIK for the distribution of its materials throughout various
Asian countries. The recent economic uncertainties in Korea and other Asian
markets may continue and could have a material adverse effect on the Company's
ability to generate revenue from such markets.
Competition
The advanced materials industry is highly competitive. The market for
materials having the characteristics and potential uses of the Company's
nanocrystalline materials is the subject of intensive research and development
efforts by both governmental entities and private enterprises around the world.
The Company believes that the level of competition will increase further as more
product applications with significant commercial potential are developed. The
nanocrystalline product applications being developed by the Company will compete
directly with products incorporating conventional and advanced materials and
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technologies. While the Company is not currently aware of the existence of
commercially available competitive products with the same attributes as those
offered by the Company, such competitive products may be introduced by third
parties, or competing materials based on different or new technologies may
become commercially available. The Company's competitors may succeed in
developing or marketing materials, technologies and products that exhibit
superior performance, are more commercially desirable or are more cost effective
than those developed or marketed by the Company. In addition, many potential
competitors of the Company have substantially greater financial and technical
resources, larger research and development staffs, and greater manufacturing and
marketing capabilities than the Company. Failure of the Company's current and
potential nanocrystalline product applications to improve performance
sufficiently at an acceptable price, achieve commercial acceptance or otherwise
compete with conventional materials would have a material adverse effect on the
Company's business, results of operations and financial condition.
Volatility of Common Stock Price and Associated Litigation
During the first few months after the Offering, the market price of the
Company's Common Stock was volatile. Following such volatility in the market
price of the Company's Common Stock, securities class action litigation was
instituted against the Company. Such litigation initiated against the Company
may result in substantial costs and a diversion of management's attention and
resources, which could have a material adverse effect on the Company's business,
results of operations and financial condition. In addition, the stock market has
from time to time experienced significant price and volume fluctuations that may
be unrelated to the operating performance of any particular company. In
particular, there has been significant volatility in the market price of
securities of technology companies, particularly those that, like the Company,
are still primarily engaged in product development activities. Factors such as
announcements of technology innovations and new product applications,
collaborative development relationships or distribution relationships by the
Company or its competitors, disputes relating to patents and proprietary rights,
changes in financial estimates by securities analysts, failure to meet or exceed
earnings expectations of the market or of analysts, general market conditions
and actual or anticipated fluctuations in quarterly operating results may have a
significant impact on the future market price of the Common Stock.
Future Capital Needs
The Company believes that its future capital requirements will depend on
many factors, including continued progress in its research and development and
product testing programs, the magnitude of these programs, the costs necessary
to increase the Company's manufacturing capabilities and to market any resulting
materials and product applications, and customer acceptance of the Company's
current and potential materials and product applications. Additional factors
that may affect the Company's future capital requirements are the costs involved
in preparing, filing, prosecuting, maintaining and enforcing patents and other
proprietary rights or in obtaining licenses, the ability of the Company to
establish collaborative relationships, the costs related to the Company's
possible acquisition of complementary technologies or businesses, and the amount
and timing of future revenues. Depending on its requirements, the Company may
seek additional funding through public or private financing, collaborative
relationships, government contracts or licensing agreements. Such additional
financing may not be available on acceptable terms or at all. If adequate funds
are not available on acceptable terms, the Company may be required to delay,
scale-back or eliminate manufacturing and marketing of one or more of its
materials or product applications or research and development programs, or to
obtain funds through arrangements with customers or others that may require the
Company to relinquish rights to certain of its technologies or nanocrystalline
materials that the Company would not otherwise relinquish. Inadequate funding
also could impair the Company's ability to compete in the marketplace.
Dependence on Key Personnel
The Company's success will depend, in large part, upon its ability to
attract and retain highly qualified research and development, management,
manufacturing and marketing and sales personnel. Due to the specialized nature
of the Company's business, it may be difficult to locate and hire qualified
personnel, and to
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retain such personnel once hired. The loss of the services of any of the
Company's executive officers or other key personnel, or the failure of the
Company to attract and retain other skilled and experienced personnel on
acceptable terms, could have a material adverse effect on the Company's
business, results of operations and financial condition. The Company does not
have "key-man" life insurance policies covering any of its executive officers or
other key employees.
Product Liability Risks
The Company may be subject to product liability claims in the event that
any of its nanocrystalline product applications are alleged to be defective or
cause harmful effects. Because the Company's nanocrystalline materials are used
as ingredients in, or components of, other companies' products, to the extent
certain of the Company's customers become subject to claims, suits or complaints
relating to their products, such as cosmetic and skin-care products, such claims
may be asserted against the Company. The Company currently maintains separate
insurance coverage in the amount of $2 million for product liability claims. The
cost of defending or settling product liability claims may be substantial and
the Company may be unable to do so on acceptable terms or such claims, if
successful or settled, could have a material adverse effect on the Company's
business, results of operations and financial condition.
Governmental Regulations
The Company's coating facility, which is located in Chicago, is a "small
quantity generator" of hazardous materials, including ethanol, under the Federal
Resource Conservation and Recovery Act and, as a result, is subject to stringent
federal, state and local regulations governing the handling, storage and
disposal of such materials. It is possible that current or future laws and
regulations could require the Company to make substantial expenditures for
preventive or remedial action, reduction of chemical exposure or waste treatment
or disposal. The Company's operations, business or assets could be materially
and adversely affected by the interpretation and enforcement of current or
future environmental laws and regulations. The Company believes it has complied
in all material respects with regard to environmental regulations applicable to
it and does not anticipate generating substantially increased amounts of such
materials. In addition, although management believes that its safety procedures
for handling and disposing of such materials comply with the standards
prescribed by state and federal regulations, the Company's coating operations do
pose a risk of accidental contamination or injury. To date, the Company has not
been required to make substantial expenditures for preventive or remedial action
with respect to the hazardous materials it generates. The damages in the event
of an accident or the costs of such preventive or remedial actions could exceed
the Company's resources or otherwise have a material adverse effect on the
Company's business, results of operations and financial condition.
In addition, the Company's facilities and all of its operations are subject
to the plant and laboratory safety requirements of various occupational safety
and health laws. The Company believes it has complied in all material respects
with regard to governmental regulations applicable to it. There can be no
assurance, however, that the Company will continue to comply with applicable
government regulations or that such regulations will not materially restrict or
impede the Company's operations in the future.
The manufacture and use of certain products which contain the Company's
nanocrystalline materials are subject to governmental regulation. As a result,
the Company is required to adhere to the cGMP requirements of the FDA and
similar regulations in other countries which include testing, control and
documentation requirements enforced by periodic inspections. Such regulations
can increase the Company's cost of doing business and/or render certain
potential markets prohibitively expensive.
Quarterly Fluctuations in Operating Results
The Company has experienced, and expects to continue to experience,
quarterly fluctuations in its results of operations as a result of a variety of
factors, including the timing of collaborative relationships with, and
performance of, customers, the timing of new product application offerings,
changes in the Company's revenue mix among its product application offerings,
the timing and amount of expenses associated with expansion of
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the Company's operations, and changes in the mix between pilot production of new
nanocrystalline materials and full-scale manufacturing of existing
nanocrystalline materials. The Company does not currently have any significant
backlog of orders and the timing of revenues will therefore depend upon the
amount and timing of new orders received for its nanocrystalline materials.
Anti-Takeover Provisions
In October 1998, the Company adopted a stockholders rights plan (the
"Rights Plan"). The Rights Plan may have the effect of delaying or preventing a
change of control of the Company, including acquisitions that may offer a
premium over market price to some or all of the Company's stockholders. Further,
certain provisions of the Company's Certificate of Incorporation and Bylaws and
Delaware law could delay or make more difficult a merger, tender offer or proxy
contest involving the Company. For example, the Company has a staggered Board of
Directors with three-year terms and the Company's Board of Directors has the
authority to issue up to 24,088 shares of undesignated preferred stock and to
determine the price, rights, preferences, privileges and restrictions, including
voting rights, of those shares without any further vote or action by the
Company's stockholders.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to interest rate risk on its investment portfolio. A
1% fluctuation in interest rate would result in a change in the portfolio
earnings of approximately $260,000 per year.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and financial statement schedules, with the report
of independent auditors, listed in Item 14 are included in this Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information in response to this item is incorporated by reference from
the "Proposal No. 1 -- Election of Directors," "Executive Officers" and "Section
16(a) Beneficial Ownership Compliance" sections of the Definitive Proxy
Statement to be filed with the Commission in connection with the Company's 1999
Annual Meeting of Stockholders (the "1999 Proxy Statement").
ITEM 11. EXECUTIVE COMPENSATION
The information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Executive Compensation and
Certain Transactions."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Security Ownership of
Management and Principal Stockholders."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in response to this item is incorporated by reference from
the section of the 1999 Proxy Statement captioned "Executive Compensation and
Certain Transactions."
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K:
1. The following financial statements of the Company, with the report of
independent auditors, are filed as part of this Form 10-K:
Report of Ernst & Young LLP, Independent Auditors
Balance Sheets as of December 31, 1997 and 1998
Statements of Operations for the Years Ended December 31, 1996, 1997
and 1998
Statements of Stockholders' Equity for the Years Ended December 31,
1996, 1997 and 1998
Statements of Cash Flows for the Years Ended December 31, 1996, 1997
and 1998
Notes to Financial Statements
2. The following financial statement schedules of the Company are filed
as part of this Form 10-K:
Schedule II -- Valuation and Qualifying Accounts
All other financial schedules are omitted because such schedules are
not required or the information required has been presented in the
aforementioned financial statements.
3. The following exhibits are filed with this Form 10-K or incorporated
by reference as set forth below.
EXHIBIT
NUMBER
-------
2 Plan and Agreement of Merger dated as of November 25, 1997
by and between the Company and its Illinois predecessor,
incorporated by reference to Exhibit 2 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1997 (the "1997 10-K").
3.1 Certificate of Incorporation of the Company, incorporated by
reference to Exhibit 3.1 to the 1997 10-K.
3.2 Bylaws of the Company, incorporated by reference to Exhibit
3.2 to the 1997 10-K.
4.1 Specimen stock certificate representing Common Stock,
incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-1 (File No. 333-36937) (the
"IPO S-1").
4.2 Form of Warrants, incorporated by reference to Exhibit 4.2
to the IPO S-1.
4.3 Rights Agreement dated as of October 28, 1998 by and between
the Company and LaSalle National Bank, incorporated by
reference to Exhibit 1 to the Company's Registration
Statement on Form 8-A, filed October 28, 1998.
4.4 Certificate of Designation of Series A Junior Participating
Preferred Stock.
10.1 The Nanophase Technologies Corporation Amended and Restated
1992 Stock Option Plan, as amended (the "Stock Option
Plan"), incorporated by reference to Exhibit 10.1 to the IPO
S-1.
10.2* Form of Indemnification Agreement between the Company and
each of its directors and executive officers, incorporated
by reference to Exhibit 10.2 to the IPO S-1.
10.3 Amended and Restated Registration Rights Agreements dated as
of March 16, 1994, as amended, incorporated by reference to
Exhibit 10.3 to the IPO S-1.
10.4* Employment Agreement dated as of September 3, 1996 between
the Company and Dennis J. Nowak, incorporated by reference
to Exhibit 10.5 to the IPO S-1.
10.5 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.
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EXHIBIT
NUMBER
-------
10.6 License Agreement dated October 12, 1994 between the Company
and Hitachi, incorporated by reference to Exhibit 10.8 to
the IPO S-1.
10.7 License Agreement dated May 31, 1996 between the Company and
Research Development Corporation of Japan, incorporated by
reference to Exhibit 10.9 to the IPO S-1.
10.8 License Agreement dated April 1, 1996 between the Company
and Cornell Research Foundation, incorporated by reference
to Exhibit 10.10 to the IPO S-1.
10.9* Consulting and Stock Purchase Agreement between Richard W.
Siegel and the Company dated as of May 9, 1990, as amended
February 13, 1991, November 21, 1991 and January 1, 1992,
incorporated by reference to Exhibit 10.11 to the IPO S-1.
10.10 Lease Agreement between the Village of Burr Ridge and the
Company, dated September 15, 1994, incorporated by reference
to Exhibit 10.12 to the IPO S-1.
10.11 Distribution Agreement between the Company and C.I. Kasei,
Ltd., (a subsidiary of Itochu Corporation) dated as of
October 30, 1996, incorporated by reference to Exhibit 10.15
to the IPO S-1.
10.12 Supply Agreement between the Company and Schering-Plough
HealthCare Products, Inc. dated as of March 15, 1997,
incorporated by reference to Exhibit 10.17 to the IPO S-1.
10.13 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.
10.14 Supply Agreement by and between the Company and EKC
Technology, Inc. ("EKC"), dated as of December 31, 1997 (the
"Supply Agreement"), incorporated by reference to Exhibit
10.18 to the 1997 10-K.
10.15 Amendment to the Supply Agreement dated as of October 15,
1998 between the Company and EKC.
10.16* Employment Agreement dated as of November 9, 1998 between
the Company and Joseph Cross.
10.17* Consulting Agreement effective as of October 29, 1998
between the Company and Donald S. Perkins.
10.18* Employment Agreement dated as of February 15, 1999 between
the Company and Gina Kritchevsky.
10.19* Employment Agreement dated as of March 15, 1999 between the
Company and Daniel S. Bilicki.
10.20* Form of Options Agreement under the Stock Option Plan,
incorporated by reference to Exhibit 4.5 to the Company's
Registration Statement on Form S-8 (File No. 333-53445).
10.21* Consulting and Severance Agreement dated October 28, 1998
between the Company and John C. Parker.
11 Statement regarding computation of loss per share.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
- ---------------
* Management contract or compensatory plan or arrangement required to
be filed as an exhibit to this Form 10-K.
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(b) Reports on Form 8-K:
The only Current Report on Form 8-K filed by the Company for the quarter
ended December 31, 1998 was dated October 27, 1998 and, pursuant to Items 5
and 7, reported the Company's adoption of the Rights Plan.
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NANOPHASE TECHNOLOGIES CORPORATION
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... F-2
Balance Sheets as of December 31, 1997 and 1998............. F-3
Statements of Operations for the years ended December 31,
1996, 1997 and 1998....................................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1996, 1997 and 1998.......................... F-5
Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998....................................... F-6
Notes to Financial Statements............................... F-7
F-1
30
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Nanophase Technologies Corporation
We have audited the accompanying balance sheets of Nanophase Technologies
Corporation as of December 31, 1997 and 1998, and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule for the years ended December 31, 1996, 1997 and 1998 listed
in the index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Nanophase Technologies
Corporation at December 31, 1997 and 1998, and the results of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule for the years ended December
31, 1996, 1997 and 1998, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ ERNST & YOUNG LLP
Ernst & Young LLP
Chicago, Illinois
February 23, 1999
F-2
31
NANOPHASE TECHNOLOGIES CORPORATION
BALANCE SHEETS
AS OF DECEMBER 31,
------------------------------
1997 1998
------------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 3,988,368 $ 363,394
Investments............................................... 26,884,852 26,270,518
Trade accounts receivable, less allowance for doubtful
accounts of $19,276 in 1997 and $85,000 in 1998........ 1,641,489 316,328
Inventories, net.......................................... 957,303 838,825
Prepaid expenses and other current assets................. 112,138 92,351
------------- -------------
Total current assets................................... 33,584,150 27,881,416
Equipment and leasehold improvements, net................... 2,399,893 2,383,091
Other assets, net........................................... 212,526 189,481
------------- -------------
$ 36,196,569 $ 30,453,988
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable.......................................... $ 930,397 $ 413,378
Accrued expenses.......................................... 614,838 933,020
------------- -------------
Total current liabilities.............................. 1,545,235 1,346,398
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 24,088 shares authorized
and no shares issued and outstanding...................... -- --
Common stock, $.01 par value; 25,000,000 shares authorized
and 12,277,467 shares issued and outstanding at December
31, 1997; 24,930,377 shares authorized and 12,568,691
shares issued and outstanding at December 31, 1998........ 122,775 125,687
Additional paid-in capital.................................. 48,273,230 48,360,454
Accumulated deficit......................................... (13,744,671) (19,378,551)
------------- -------------
Total stockholders' equity................................ 34,651,334 29,107,590
------------- -------------
$ 36,196,569 $ 30,453,988
============= =============
See Notes to Financial Statements
F-3
32
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
---- ---- ----
REVENUE:
Product revenue..................................... $ 249,017 $ 924,763 $ 1,140,845
Other revenue....................................... 236,019 2,798,729 162,944
Governmental research contracts..................... 110,770 -- --
----------- ----------- -----------
Total revenue.................................. 595,806 3,723,492 1,303,789
OPERATING EXPENSE:
Cost of revenue..................................... 4,019,484 3,935,766 3,221,996
Research and development expense.................... 677,284 990,331 1,504,127
Selling, general and administrative expense......... 1,661,504 2,074,728 3,594,946
----------- ----------- -----------
Total operating expenses....................... 6,358,272 7,000,825 8,321,069
----------- ----------- -----------
Loss from operations.................................. (5,762,466) (3,277,333) (7,017,280)
Interest income....................................... 184,778 204,863 1,539,400
----------- ----------- -----------
Loss before provision for income taxes................ (5,577,688) (3,072,470) (5,477,880)
Provision for income taxes............................ -- -- (156,000)
----------- ----------- -----------
Net loss.............................................. $(5,577,688) $(3,072,470) $(5,633,880)
=========== =========== ===========
Net loss per share (see Note 2)....................... $ (0.45)
===========
Weighted average number of common shares outstanding
(see Note 2)........................................ 12,416,305
===========
Pro forma net loss per share (see Note 2)............. $ (0.82) $ (0.37)
=========== ===========
Pro forma weighted average number of common shares
outstanding (see Note 2)............................ 6,835,680 8,208,306
=========== ===========
See Notes to Financial Statements
F-4
33
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
PREFERRED STOCK COMMON STOCK ADDITIONAL
------------------------- --------------------- PAID-IN ACCUMULATED
DESCRIPTION SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ------ ------ ------ ------ ---------- ----------- -----
Balance as of January 1, 1996... 5,472,520 $ 8,600,113 77,586 $ -- $ 450 $ (5,094,513) $ 3,506,050
Issuance of Series D shares... 14,034 24,238 -- -- -- -- 24,238
Issuance of Series E shares,
net of offering costs....... 1,921,800 7,157,850 -- -- -- -- 7,157,850
Net loss for the year ended
December 31, 1996........... -- -- -- -- -- (5,577,688) (5,577,688)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31,
1996.......................... 7,408,354 15,782,201 77,586 -- 450 (10,672,201) 5,110,450
Issuance of Series F shares,
net of offering costs....... 748,089 3,770,543 -- -- -- -- 3,770,543
Exercise of stock options..... -- -- 43,425 434 4,441 -- 4,875
Conversion of all outstanding
Preferred shares into Common
shares and all Common shares
to $0.01 par value.......... (8,156,443) (19,552,744) 8,156,456 82,341 19,470,403 -- --
Issuance of Common shares, net
of offering costs........... -- -- 4,000,000 40,000 28,797,936 -- 28,837,936
Net loss for the year ended
December 31, 1997........... -- -- -- -- -- (3,072,470) (3,072,470)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31,
1997.......................... -- -- 12,277,467 122,775 48,273,230 (13,744,671) 34,651,334
Exercise of stock options..... -- -- 128,356 1,283 88,853 -- 90,136
Exercise of warrants.......... -- -- 162,868 1,629 (1,629) -- --
Net loss for the year ended
December 31, 1998........... -- -- -- -- -- (5,633,880) (5,633,880)
---------- ------------ ---------- -------- ----------- ------------ -----------
Balance as of December 31,
1998.......................... -- $ -- 12,568,691 $125,687 $48,360,454 $(19,378,551) $29,107,590
========== ============ ========== ======== =========== ============ ===========
See Notes to Financial Statements
F-5
34
NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------------------
1996 1997 1998
---- ---- ----
OPERATING ACTIVITIES:
Net Loss........................................... $(5,577,688) $ (3,072,470) $ (5,633,880)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................. 309,850 416,414 491,098
Allowance for excess inventory quantities..... -- -- 190,633
Changes in assets and liabilities related to
operations:
Trade accounts receivable..................... (318,656) (1,251,988) 1,325,161
Inventories................................... (379,924) (512,098) (72,155)
Prepaid expense and other assets.............. (23,546) (145,398) 38,961
Accounts payable.............................. 2,525 708,461 (517,019)
Accrued liabilities........................... 191,581 486,712 318,182
----------- ------------ -------------
Net cash used in operating activities.............. (5,795,858) (3,370,367) (3,859,019)
INVESTING ACTIVITIES:
Acquisition of equipment and leasehold
improvements..................................... (1,173,437) (1,063,608) (470,425)
Purchases of held-to-maturity investments.......... (15,486,131) (118,684,404) (182,750,264)
Maturities of held-to-maturity investments......... 15,709,744 93,797,340 183,364,598
(Increase) decrease in asset held in trust......... (1,982) 78,849 --
----------- ------------ -------------
Net cash (used in) provided by investing
activities....................................... (951,806) (25,871,823) 143,909
FINANCING ACTIVITIES:
Proceeds from issuance of stock, net of offering
costs............................................ 7,182,088 32,613,354 90,136
Deferred offering costs............................ (79,122) -- --
----------- ------------ -------------
Net cash provided by financing activities.......... 7,102,966 32,613,354 90,136
----------- ------------ -------------
Increase (decrease) in cash and cash equivalents... 355,302 3,371,164 (3,624,974)
Cash and cash equivalents at beginning of period... 261,902 617,204 3,988,368
----------- ------------ -------------
Cash and cash equivalents at end of period......... $ 617,204 $ 3,988,368 $ 363,394
=========== ============ =============
See Notes To Financial Statements
F-6
35
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS
Nanophase Technologies Corporation (the "Company") was incorporated on
November 30, 1989, for the purpose of developing nanocrystalline materials for
commercial production and sale in domestic and international markets. The
Company was in its development stage for the period from inception through
December 31, 1996. The Company began full-scale production in early 1997 at
which time it no longer was a development stage company. The Company issued
common stock in an initial public offering consummated on December 2, 1997.
In the course of its corporate development, the Company has experienced net
losses and negative cash flows from operations. Historically, the Company has
funded its operations primarily through the issuance of equity securities.
Revenue from international sources approximated $256,500, $1,695,700, and
$347,500 for the years ended December 31, 1996, 1997, and 1998, respectively.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents
Cash equivalents primarily consist of money market accounts which have a
maturity of three months or less from the date of purchase.
Investments
Investments are classified by the Company at the time of purchase and such
classification is reevaluated as of each balance sheet date. Investments are
classified as held-to-maturity when the Company has the positive intent and
ability to hold the securities to maturity. Held-to-maturity securities are
stated at amortized cost and are adjusted to maturity for the amortization of
premiums and accretion of discounts. Such adjustments for amortization and
accretion are included in interest income.
Inventory
Inventory is stated at the lower of cost, determined on a first in, first
out basis, or market. In 1998, the Company recorded an allowance to provide for
estimated excess quantities of certain materials currently in inventory.
Equipment and Leasehold Improvements
Equipment is stated at cost and is being depreciated over its estimated
useful life (5-7 years) using the straight-line method. Leasehold improvements
are stated at cost and are being amortized using the straight-line method over
the shorter of the useful life of the asset or the term of the lease.
Patent Costs
Patent costs are included in other assets and are being amortized over the
life of the respective patent using the straight-line method.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires the Company to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
F-7
36
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Product Revenue
Product revenue consists of revenue generated from product shipments made
by the Company.
Other Revenue
Other revenue consists of revenue from research and development
arrangements with non-governmental entities, fees from the transfer of
technology and royalties. Research and development arrangements include both
cost-plus and fixed fee agreements and such revenue is recognized when specific
milestones are met under the arrangements. Fees related to the transfer of
technology are recognized when the transfer of technology to the acquiring party
is completed and the Company has no further significant obligation. Royalties
are recognized when received.
Governmental Research Contracts
The Company accounts for contracts with governmental entities to complete
research and development activities using the percentage of completion method
measured by the relationship of costs incurred to total estimated costs.
All payments to the Company for work performed on contracts and agreements
with agencies of the U.S. government are subject to adjustment upon audit by
agencies of the U.S. government. The Company believes that such audits, if any,
will not have significant effect on the financial position or results of
operation of the Company.
Research and Development Expense
Expenditures for research and development activities are charged to
operations as incurred by the Company. During 1998, the Company recorded
$745,000 in charges from unrelated entities for development that was charged to
research and development expense. During 1997, the Company acquired certain
research and development from a customer for $223,000 and charged this
acquisition to research and development expense.
Income Taxes
The Company accounts for income taxes using the liability method. As such,
deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Deferred tax assets and
liabilities are calculated using the enacted tax rates and laws that are
expected to be in effect when the anticipated reversal of these differences is
scheduled to occur.
Employee Stock Options
In 1996, the Company adopted Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123). As permitted
by SFAS No. 123, the Company accounts for stock options granted to employees
using Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued
to Employees" (APB No. 25). Under APB No. 25, no compensation expense is
recorded if the number of shares is fixed and the exercise price equals the
market price on the date of grant. SFAS No. 123 requires companies using APB No.
25 to disclose pro forma net earnings and earnings per share using the fair
value method alternative prescribed by SFAS No. 123. Such disclosures are
included in Note 12.
F-8
37
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value of Financial Instruments
The Company's financial instruments include investments, accounts
receivable, accounts payable and accrued liabilities. The fair values of all
financial instruments were not materially different from their carrying values.
Net Loss and Pro Forma Net Loss Per Share
Pro forma net loss per common share and historical net loss per common
share are computed based upon the weighted average number of common shares
outstanding. Common equivalent shares are not included in the pro forma and
historical per share calculations because the effect of their inclusion would be
anti-dilutive. In addition, for the pro forma calculation, all convertible
preferred stock is treated as if converted into common shares for all periods
shown.
Net loss per common share computed on a historical basis is $71.89 and
$2.39 for the years ended December 31, 1996 and 1997, respectively. The weighted
average number of common shares outstanding used to calculate these net loss per
common share amounts are 77,586 for 1996 and 1,283,359 for 1997.
(3) INVESTMENTS
Investments generally consist of certificates of deposit, commercial paper
and corporate notes and have an estimated fair value of $26,885,000 and
$26,251,000 at December 31, 1997 and 1998, respectively. All investments have
been classified as held-to-maturity and mature in the subsequent year.
(4) INVENTORIES
Inventories consist of the following:
AS OF DECEMBER 31,
----------------------
1997 1998
-------- ----------
Raw Materials........................................ $379,505 $ 284,162
Finished Goods....................................... 577,798 745,296
-------- ----------
957,303 1,029,458
Allowance for Excess Inventory Quantities............ -- (190,633)
-------- ----------
$957,303 $ 838,825
======== ==========
F-9
38
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(5) EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements consist of the following:
AS OF DECEMBER 31,
------------------------
1997 1998
---------- ----------
Machinery and equipment............................. $1,835,964 $2,842,258
Office equipment.................................... 116,307 194,258
Office furniture.................................... 49,864 49,864
Leasehold improvements.............................. 610,932 664,143
---------- ----------
2,613,067 3,750,523
Less: Accumulated depreciation and amortization..... (881,323) (1,367,432)
---------- ----------
1,731,744 2,383,091
Construction in progress............................ 668,149 --
---------- ----------
$2,399,893 $2,383,091
========== ==========
(6) LEASE COMMITMENTS
The Company leases manufacturing and office space under an agreement that
will expire in September 1999. Monthly minimum lease payments amount to $8,300
for this facility. The Company also leases smaller pilot manufacturing space as
well as offsite warehouse space, both under renewable annual agreements. Monthly
minimum lease payments amount to $5,000 and $2,900, respectively, for these
facilities.
Net rent expense under these leases amounted to $175,538, $168,781, and
$191,995 for the years ended December 31, 1996, 1997, and 1998, respectively.
(7) ACCRUED EXPENSES
Accrued expenses consist of the following:
AS OF DECEMBER 31,
--------------------
1997 1998
-------- --------
Accrued professional services.......................... $ 29,943 $288,000
Accrued costs for goods received but not invoiced...... 98,802 232,384
Accrued payroll and related expenses................... 138,798 211,283
Accrued subcontract costs.............................. 161,791 30,000
Other.................................................. 185,504 171,353
-------- --------
$614,838 $933,020
======== ========
(8) RESEARCH AND DEVELOPMENT AGREEMENTS
The Company is party to a number of research and development arrangements
with both governmental and commercial entities. These arrangements are generally
short-term in nature and provided $236,019, $1,445,705, and $160,984 of revenue
for the years ended December 31, 1996, 1997, and 1998, respectively.
(9) LICENSE AGREEMENTS
In 1991, the Company was granted an exclusive license by a third party to
make, have made, use and sell products of the type claimed in a U.S. patent. In
consideration for this license, the Company agreed to pay
F-10
39
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
royalties of 1/2% of net sales of licensed products, as defined. As of December
31, 1998, no royalty payments were due under this agreement.
In 1994, the Company was granted a non-exclusive license by a third party
to make, use, and sell products of the type claimed in two U.S. patents. In
consideration for this license, the Company agreed to pay royalties of 1% of net
sales, as defined, and made an advance royalty payment of $17,500. As of
December 31, 1998, royalties in addition to the $17,500 amounted to $3,088.
In 1996, the Company was granted a non-exclusive license by a third party
to produce and sell ultrafine powders of metal and ceramics claimed in four U.S.
patents. In consideration for this license, the Company agreed to pay $14,000 as
an initial payment, and pay royalties of 3% of net proceeds of sales of the
product, as defined. As of December 31, 1998, aggregate royalties under this
agreement approximated $25,000. The Company was also granted a
remainder-exclusive license by a third party to make, have made, use, import,
sell or have sold products of the type claimed in three U.S. patents. In
consideration for this license, the Company agreed to pay $5,000 as an initial
payment, $5,000 upon reaching the earlier of either defined profitability or the
second anniversary of the agreement, and royalties at the rate of 4% of the
defined net sales of the related products. The agreement also provides for
minimum royalty payments beginning in 1999, the fourth license year. As of
December 31, 1998, aggregate royalties under this agreement amounted to $10,000.
In December 1997, the Company entered into a license agreement whereby the
Company granted a royalty-bearing exclusive right and license, as defined, to
purchase, make, use and sell nanocrystalline materials to a third party. As
consideration for the right and license thereby granted, the Company recognized
a non-refundable technology transfer fee of $1,400,000, which was earned upon
execution of the agreement. As defined, the Company also will earn royalties on
net sales of manufactured products containing nanocrystalline materials. The
agreement also provided for minimum sales targets and minimum royalty payments
to maintain exclusivity. The agreement expires on March 31, 2013 unless earlier
terminated as provided therein. In 1998, the first year which royalties were
earned under this agreement, the Company recorded revenue of $1,960.
(10) INCOME TAXES
The Company has net operating loss carryforwards for tax purposes of
approximately $18,300,000 at December 31, 1998, which expire between 2005 and
2013. The Company has not paid income taxes since inception. The Company also
has a foreign tax credit carryforward of approximately $156,000 which could be
used as an offsetting tax credit to reduce U.S. income taxes. This foreign tax
credit will expire in 2013 if not utilized before that date.
F-11
40
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
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,
-------------------------
1997 1998
---- ----
DEFERRED TAX ASSETS:
Net operating loss carryforward................... $ 5,226,000 $ 7,137,000
Start-up cost capitalized for income tax
purposes....................................... 122,000 81,000
Inventory and other allowances.................... -- 143,000
Other accrued costs............................... 74,000 146,000
----------- -----------
Total deferred tax assets...................... 5,422,000 7,507,000
DEFERRED TAX LIABILITY:
Accelerated tax depreciation...................... (62,000) --
----------- -----------
Net deferred tax asset.............................. 5,360,000 7,507,000
Less: Valuation allowance......................... (5,360,000) (7,507,000)
----------- -----------
Deferred income taxes............................... $ -- $ --
=========== ===========
The valuation allowance increased $2,147,000 for the year ended December
31, 1998 due principally to the increase in the net operating loss carryforward
and uncertainty as to whether future taxable income will be generated prior to
the expiration of the carryforward period. Under the Internal Revenue Code,
certain ownership changes, including the prior issuance of preferred stock and
the Company's public offering of common stock, may subject the Company to annual
limitations on the utilization of its net operating loss carryforward.
As a result of certain transactions with third parties operating in foreign
countries, the Company may be subject to the withholding and payment of foreign
income taxes as transactions are completed. Under the Internal Revenue Code,
foreign tax payments may be used to offset federal income tax liabilities when
incurred, subject to certain limitations. In 1998, the Company recorded $156,000
in foreign tax expense due to withholding by foreign tax authorities on amounts
due from foreign customers.
(11) CAPITAL STOCK
In November 1997, the Company's Board of Directors approved a migratory
merger of the Company from Illinois to Delaware, authorized a reverse stock
split and restated the par value of the Company's common stock. All share and
per share amounts in the financial statements and notes to financial statements
have been restated to reflect a .579-for-1 reverse stock split and restatement
of the par value to $0.01 for all common stock.
In 1997, a total of 748,089 shares of Series F convertible preferred stock
were issued for cash amounting to $3,770,543 which is net of financing costs of
$105,565.
In November 1997, a total of 4,000,000 shares of common stock was issued in
conjunction with the Company's initial public offering at an offering price of
$8 per share. The Company received proceeds of $28,837,936, which is net of
offering costs of $3,162,064. Pursuant to the Company's prior Illinois articles
of incorporation, all Series A, B, C, D, E and F convertible preferred stock was
automatically converted to common stock in conjunction with the initial public
offering.
In October 1998, the Company declared a dividend of one Preferred Stock
Purchase Right (a "Right") for each outstanding share of Company common stock on
November 10, 1998. The Rights are not presently exercisable. Each Right entitles
the holder, upon the occurrence of certain specified events, to purchase from
F-12
41
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
the Company one ten-thousandth of a share of the Company's Series A Junior
Participating Preferred Stock at a purchase price of $25 per one-ten thousandth
of a share (the "Purchase Price"). The Rights further provide that each Right
will entitle the holder, upon the occurrence of certain specified events, to
purchase from the Company, common stock having a value of twice the Purchase
Price and, upon the occurrence of certain other specified events, to purchase
from another entity into which the Company is merged or which acquires 50% or
more of the Company's assets or earnings power, common stock of such other
entity having a value of twice the Purchase Price. In general, the Rights may be
redeemed by the Company at a price of $0.01 per Right. The Rights expire on
October 28, 2008.
At December 31, 1998, 2,500 shares of authorized but unissued Preferred
Stock have been reserved for future issuance regarding the Rights. In addition,
authorized but unissued shares of common stock have been reserved for future
issuance as follows:
Warrants.................................................... 429,796
Options..................................................... 2,586,251
---------
3,016,047
=========
(12) STOCK OPTIONS AND WARRANTS
The Company has entered into stock option agreements with certain officers,
employees, directors (two of whom are also service providers) and three Advisory
Board members. At December 31, 1998, the Company had granted options to purchase
1,781,385 shares of common stock. The stock options generally expire ten years
from the date of grant. Of the total number of options granted, 1,117,690 of the
outstanding options vest over a five-year period and 37,370 vest over a
three-year period from their respective grant dates. Of the remaining 626,325
outstanding options, 121,818 vest on the eighth anniversary following their
grant date, and the remaining 504,507 were accelerated to vest over a five-year
period due to specific performance targets being met.
Exercise prices are determined by the Board of Directors and equal the
estimated fair values of the Company's common stock at the grant date. The table
below summarizes option activity from January 1, 1996 through December 31, 1998:
WEIGHTED
NUMBER OF EXERCISE AVERAGE EXERCISE
OPTIONS PRICE PRICE
--------- -------------- ----------------
Outstanding at January 1, 1996.................... 435,119 $.112 - .432 $ .249
Options granted during 1996....................... 1,192,508 1.727 - 3.886 3.309
Options canceled during 1996...................... (12,101) .112 - 1.727 1.549
---------
Outstanding at December 31, 1996.................. 1,615,526 .112 - 3.886 2.499
Options granted during 1997....................... 17,370 5.181 5.181
Options exercised during 1997..................... (43,425) .112 .112
Options canceled during 1997...................... (150,482) .112 - 3.886 3.760
---------
Outstanding at December 31, 1997.................. 1,438,989 .112 - 5.181 2.471
Options granted during 1998....................... 521,400 2.938 - 5.750 3.694
Options exercised during 1998..................... (128,356) .112 - 3.886 .702
Options canceled during 1998...................... (50,648) 3.813 - 3.886 3.874
---------
Outstanding at December 31, 1998.................. 1,781,385 .112 - 5.750 2.916
=========
At December 31, 1998, options for 153,435, 65,113, 91,422, 232,063, and
5,907 shares of common stock were exercisable at $.112, $.432, $1.727, $3.886
and $5.181 per share, respectively. At December 31, 1997,
F-13
42
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
options for 180,378, 75,270, 62,903, and 17,833 shares of common stock were
exercisable at $.112, $.432, $1.727, and $3.886 per share, respectively. At
December 31, 1996, options for 187,675, 38,793, and 2,606 shares of common stock
were exercisable at $.112, $.432, and $1.727 per share, respectively. To date,
171,781 options have been exercised and none have expired. The weighted average
remaining contractual life of the outstanding options at December 31, 1998 was
eight years.
In connection with the issuance of Series C convertible preferred stock in
1993, the Company issued common stock purchase warrants for 662,287 shares at no
additional cost to the Series C convertible preferred stockholders. At the
Company's initial public offering on November 26, 1997, all preferred shares
were converted into shares of common stock. These warrants have an exercise
price of $1.123 per share and expire upon the tenth anniversary of issuance. In
July 1998, 232,491 warrants were exercised in a cashless transaction whereby the
Company issued 162,868 common shares. The balance of 69,623 shares was retired
by the Company in exchange for the exercise price for such warrants. At December
31, 1998, 429,796 warrants remained outstanding.
The Company has elected to follow APB No. 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB No. 123 requires use
of option valuation models that were not developed for the use in valuing
employee stock options. Pro forma information regarding net income is required
by FASB No. 123, which also requires that the information be determined as if
the Company had accounted for the employee stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following assumptions for the years ended December
31, 1996, 1997, and 1998: U.S. government zero coupon 7-year bond interest rates
ranging from 4.6% to 6.9%, depending upon the specific grant date of the
options; a dividend yield of zero percent; and a weighted-average expected life
of the option of 7 years. The volatility factor was assumed to be zero as the
Company was privately held and no market existed for its stock in 1996, or for
the period during which options were granted in 1997. For 1998, the volatility
factor used was 25%. The weighted average fair value of the net options granted
during 1996, 1997, and 1998 was $1.124, $1.753, and $1.505 per share,
respectively.
The Black-Scholes option valuation model was developed for the use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's option, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period of the respective
option. Because FASB No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma impact will not be fully reflected until 2002.
The Company's pro forma net loss would be $5,621,482, $3,275,177, and $5,922,570
and the pro forma net loss per share would be $0.82, $0.40, and $0.48 for the
years ended December 31, 1996, 1997, and 1998, respectively.
(13) 401(K) PROFIT-SHARING PLAN
Company has a 401(k) profit-sharing plan covering substantially all
employees who meet defined service requirements. The plan provides for deferred
salary contributions by the plan participants and a Company contribution.
Company contributions, if any, are at the discretion of the Board of Directors
and are not to exceed the amount deductible under applicable income tax laws. No
Company contributions have been made since inception of the plan.
F-14
43
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(14) RELATED PARTY TRANSACTIONS
The Company has an ongoing consulting agreement with a
director/stockholder. The agreement is on a month-to-month basis. Payments under
this agreement amount to $2,500 per month.
In October 1998, the Company entered into a consulting agreement with
another director/stockholder. The consulting agreement may be terminated at any
time by either party. In consideration for the services provided as a
consultant, the Board granted the individual options to acquire 25,000 shares of
Company common stock at an exercise price of $3.50 per share. The options vest
equally over a 5-year period from the date of grant.
(15) SIGNIFICANT CUSTOMERS
Revenue from four customers constituted approximately 64.3% of the
Company's 1996 revenue. In particular, revenue from each such customer
constituted approximately 22.5%, 16.9%, 14.2% and 10.8%, respectively, of the
Company's 1996 revenue. Revenue from two customers constituted approximately
85.3% of the Company's 1997 revenue. In particular, revenue from each such
customer constituted approximately 43.1% and 42.2%, respectively, of the
Company's 1997 revenue. Revenue from four customers constituted approximately
55.8% of the Company's 1998 revenue. In particular, revenue from each such
customer constituted approximately 16.9%, 14.0%, 13.4% and 11.5%, respectively,
of the Company's 1998 revenue.
(16) CONTINGENT LIABILITIES
Five separate complaints were filed in the United States District Court for
the Northern District of Illinois, Eastern Division, each of which alleged that
the Company, certain of its officers and directors, and the underwriters of the
Company's Offering are liable under the federal securities laws for making
material misstatements of fact and omitting and failing to state material facts
necessary to make other statements of fact not misleading in the Registration
Statement and Prospectus relating to the Offering. In an order entered by the
Court, those cases were consolidated and a consolidated complaint was filed on
October 30, 1998. The consolidated complaint alleges that the action should be
maintained as (i) a plaintiff class action on behalf of certain persons who
purchased the Common Stock from November 26, 1997 through January 8, 1998,
excluding the defendants, members of their immediate families, any entity in
which a defendant has a controlling interest and certain others related to or
affiliated with the foregoing, and (ii) a defendant class action against the
underwriters who participated in the Offering. The consolidated complaint seeks
unquantified damages as provided for under the federal securities laws, pre- and
post-judgment interest, attorneys' fees, expert witness fees, other costs and
expenses and such other and further relief as the Court may find proper. In
addition, the consolidated complaint seeks rescission and/or rescissory damages
relating to purchases of the Common Stock, as provided for under federal
securities laws. All defendants have filed motions to dismiss the consolidated
complaint that are fully briefed and under advisement by the Court. In August
1998, the Company received a request for indemnification from the underwriters
of the Offering pursuant to the underwriting agreement for the Offering. In
response to such request, the Company has agreed to be responsible for the
underwriters' attorneys' fees with respect to the litigation.
On November 20, 1998, a separate complaint was filed in the Northern
District of Illinois, Eastern Division, which alleged that the Company, certain
of its officers and directors, and the underwriters of the Company's Offering
are liable under the federal securities laws for making material misstatements
of fact and omitting or failing to state material facts necessary to make other
statements of fact not misleading in connection with the solicitation of
consents to proceed with the Offering from certain of the Company's preferred
stockholders. The complaint alleges that the action should be maintained as a
plaintiff class action on behalf of those former preferred stockholders whose
shares of preferred stock of the Company were converted into Common Stock on or
about the date of the Offering, excluding the defendants, other officers and
directors of the Company, members of the immediate families of all individual
defendants, any entity in
F-15
44
NANOPHASE TECHNOLOGIES CORPORATION
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
which a defendant has a controlling interest and certain others related to,
employed by or affiliated with the foregoing. The complaint seeks unquantified
damages as provided for under the federal securities laws, pre-and post-judgment
interest, attorneys' fees, expert witness fees, other costs and expenses and
such other and further relief as the Court may find proper. On March 15, 1999,
the preferred stockholders' complaint was referred to the Court's Executive
Committee for possible (i) reassignment to the judge hearing the consolidated
complaint described above and (ii) further consolidation with that litigation.
The Company, the defendant directors and the defendant officers have each
retained counsel with respect to both of the above-described litigations and
intend to defend against both complaints vigorously. Although the Company
believes that the allegations of the complaints are without merit, it is unable
to predict at this time the outcome of either litigation or whether the
resolution of either litigation could have a material adverse effect on the
Company's results of operations, cash flows or financial condition.
F-16
45
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
----------------------------------------------------------------------
BALANCE BEGINNING COSTS AND OTHER BALANCE AT
DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS END OF PERIOD
----------- ----------------- --------- -------- ---------- -------------
Year ended December 31, 1996:
Deferred tax asset valuation
account........................... $2,269,000 $2,081,000 $ -- $ -- $4,350,000
========== ========== ==== ======= ==========
Year ended December 31, 1997:
Allowance for doubtful accounts..... $ -- $ 46,976 $ -- $27,700 $ 19,276
========== ========== ==== ======= ==========
Deferred tax asset valuation
account........................... $4,350,000 $1,010,000 $ -- $ -- $5,360,000
========== ========== ==== ======= ==========
Year ended December 31, 1998:
Allowance for doubtful accounts..... $ 19,276 $ 125,623 $ -- $59,899 $ 85,000
========== ========== ==== ======= ==========
Allowance for excess inventory
quantities
account........................... $ -- $ 190,633 $ -- $ -- $ 190,633
========== ========== ==== ======= ==========
Deferred tax asset valuation
account........................... $5,360,000 $2,147,000 $ -- $ -- $7,507,000
========== ========== ==== ======= ==========
S-1
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on the 30th day of
March, 1999.
NANOPHASE TECHNOLOGIES CORPORATION
By: /s/ JOSEPH CROSS
------------------------------------
Joseph Cross
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 30th day of March, 1999.
SIGNATURE TITLE
--------- -----
/s/ JOSEPH CROSS President, Chief Executive Officer (Principal
- ------------------------------------------------ Executive Officer) and a Director
Joseph Cross
/s/ DENNIS J. NOWAK Vice President -- Finance and Administration, Chief
- ------------------------------------------------ Financial Officer, Treasurer and Secretary
Dennis J. Nowak (Principal Financial and Accounting Officer)
/s/ DONALD S. PERKINS Chairman of the Board and Director
- ------------------------------------------------
Donald S. Perkins
/s/ STEVEN LAZARUS Director
- ------------------------------------------------
Steven Lazarus
/s/ RICHARD W. SIEGEL Director
- ------------------------------------------------
Richard W. Siegel
/s/ ROBERT W. SHAW, JR Director
- ------------------------------------------------
Robert W. Shaw, Jr
47
EXHIBIT INDEX
EXHIBIT
NUMBER
- -------
4.4 Certificate of Designation of Series A Junior Participating
Preferred Stock.
10.15 Amendment to the Supply Agreement dated as of October 15,
1998 between the Company and EKC.
10.16 Employment Agreement dated as of November 9, 1998 between
the Company and Joseph Cross.
10.17 Consulting Agreement effective as of October 29, 1998
between the Company and Donald S. Perkins.
10.18 Employment Agreement dated as of February 15, 1999 between
the Company and Gina Kritchevsky.
10.19 Employment Agreement dated as of March 15, 1999 between the
Company and Daniel S. Bilicki.
10.21 Consulting and Severance Agreement dated October 28, 1998
between the Company and
John C. Parker.
11 Statement regarding computation of loss per share.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.