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Nanophase Model Bears Fruit

A little over a year ago, Nanophase Technologies (Nasdaq: NANX  ) , producers of a variety of nanomaterials, commenced a business model that centered on three distinct product niches with three separate partners. The company supplies nano oxides to BASF (NYSE: BF  ) as an ingredient in sunscreens and other personal care products; supplies Rohm & Hass (NYSE: ROH  ) nanomaterials for use in chemical-mechanical polishing (CMP); and supplies Altana Chemie (NYSE: AAA  ) nanomaterials for use in coatings and plastics.

Second-quarter results issued this week appear to validate that business model. Revenues were up 35% for the quarter and up more than 50% for the first half of 2005, compared with the first half of 2004. Even better news: Gross margins also increased, as production increases did not require much in increased costs, resulting in margins of more than 20%, compared with 7% for the same period last year.

Long-suffering Nanophase investors were rewarded for their patience with a 10% pop in the price immediately after the figures were released. So where do we go from here? Is this the start of a sustainable rise, leading to substantial growth for the company and our portfolios?

Even with record revenues, Nanophase still reported a loss of $0.06 per share, but this is a huge step forward from the same period last year, when it reported a $0.14 loss per share. This is primarily due to costs of revenue being dramatically reduced; Nanophase now appears to have hit a critical mass of production, where any increase in production requires a minimal increase in costs. Therefore, assuming other operating expenses remain relatively stable, any increase in revenues from here on out will impact the crucial bottom line far faster than has been the historic norm for Nanophase.

We should also note that in the quarterly release, trade receivables are up more than 80% -- indicating stock buildup for new product launches, notably BASF with its Z-Cote range of sunscreen products and Altana with additions to its Nanobyk scratch resistant coatings. Provided those launches go well, short-term growth is assured, and profitability -- that Holy Grail for new technology companies -- could be achieved by the end of 2005 or early in 2006.

This would indicate that now is a great entry point for new investors and a much-needed step forward for existing long-standing investors.

However (that fancy name for 'but''), we should caution that Nanophase's ability to reach profitability is entirely dependent on its partners' success, or lack thereof, with their products gaining market penetration. If those product launches stall or if existing products see a slowdown in sales, then we will be looking to Nanophase to seek longer-term developments in new products for existing partners or the identification of entirely new partners. In that case, investing in them now is yet another false dawn.

Interested in getting in on the ground floor of companies that haven't quite hit Wall Street's radar screen? The Motley Fool Rule Breakers research team seeks out tomorrow's ultimate growth stocks a day early. You can take a risk-free trial subscription by clicking here.

Carl Wherrett is one of Nanophase's "long suffering'' investors. John Yelovich is not. They own none of the other companies mentioned. The Motley Fool has adisclosure policy. Carl and John write for theRule Breaker service exclusively on the subject of nanotechnology.

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