Letter To The Shareholders
A Periodic Update – September 21, 2011
I wanted to take an opportunity, between the regularly scheduled quarterly letters, to update you on some exciting new developments, as well as some of our upcoming plans.
In previous letters, I have covered our evolution from a company focused largely on, and completely dependent on, one technology (electron emission technology) to a much more diversified company focused more on materials for products rather than on the end products themselves. I have also discussed our efforts to expand our business model beyond the simple licensing model to a focus on commercialization and the development of more strategic relationships and alternative revenue sources.
Our transformation since 2007 has been remarkable and I cannot complement our technical staff of scientists and engineers highly enough on their outstanding achievements. The focus of our efforts is now in four main areas – nanoelectronics (solar and printed electronics inks), carbon nanotube (CNT) enhanced composites, thermal management materials, and sensors. Of course, we have an extensive electron emission patent portfolio that we intend to continue monetizing through licenses or selected patent sales, but it is no longer a focus of our research and development.
During the past few years we have successfully solidified our financial, technology and intellectual property (IP) position, and are now expanding our business development activities for a continued focus on revenue growth. As part of this expansion, we will be adding a direct sales team; initially focusing on our CNT enhanced composite materials and our thermal management materials. We believe these two areas, in particular, have reached the stage where our technologies can be implemented almost immediately by end-users. The focus of these efforts will be on product sales, although it may also lead to licenses or other relationships. While our new pilot facility in Austin is not a high volume manufacturing facility, it is sufficient to produce the materials needed to meet the needs of many applications. As higher volumes are required, we have already identified several potential outsourcing production partners that work with prime materials providers. We have no interest in establishing any separate manufacturing facilities on our own, although we may participate in joint ventures with existing manufacturers.
Our goal is to focus on a business model that maximizes the revenue potential for each product segment. This does not mean that we are abandoning our licensing model, but will focus our licensing efforts on products where we can generate royalties from the end product. For certain other products we will focus our efforts on direct sales of key materials or products in order to achieve healthier margins. In many cases, licensing may still be the best strategy, especially in cases where we can license for a specifically defined application, such as we did with our Yonex license. This expansion of our business model to include direct product sales gives us the opportunity for much larger revenues and gross profits than the 3-5% royalties we will be able to obtain with broad based licenses on a base material. I will expand on how I see each of our four divisions fitting in to our strategy.
CNT Composites
The cornerstone of our CNT composite work is our license with Yonex. We successfully developed a CNT enhanced resin that results in a lighter weight material that still retains the strength and other characteristics needed for the end product. Yonex has introduced golf clubs and badminton racquets using our technology, and they are working on tennis racquets. This year we started to record royalties from Yonex, based on product shipments, on a quarterly basis. From our initial project with Yonex, we have expanded into other similar resins, and other families of resins, gained extensive knowledge, and developed strong IP related to our results.
Business development in this area is not as simple as it might initially appear. There are hundreds of different resins and several families of resins. While there are similar characteristics within resin families, no two resins are exactly the same, so we can’t simply take a resin that we may be supplying one customer and provide it as a sample to another customer. We must work with the particular resins that the potential customer is using in their own products. However, over the past year, we have gained incredible amounts of additional knowledge about these resins and developed a process whereby we can quickly provide a sample so a potential customer can analyze the material with a specific product. This will enable us to reach a quick decision as to whether the customer is interested in the CNT enhanced resin as is, wants to pursue additional development work, or simply stick with their existing material. If the customer wants to use our technology, we will be able to provide the quantities of CNT enhanced resin needed for many applications. We have reached the point where it will be beneficial for us to hire a sales person to focus on enlarging our potential customer base that can use our technology without significant additional development work.
We can earn significantly higher margins on the actual sale of the enhanced material, as compared with the 3-5% royalty that we could get from licensing the process to a resin manufacturer. However, if a customer wants a license for a particular application, as Yonex did for golf clubs and racquets in Japan, we can license that particular narrow application, with a royalty based on the end product rather than the material, without restricting our ability to sell or license our product to others. In fact, we currently supply Yonex the enhanced resins that they use in their manufacturing process. Because the quantity of enhanced resin that is included in a golf shaft or badminton racquet is not huge, the revenue that we receive from these sales is not yet significant. However, it does demonstrate that we are capable of supplying material to be used in a production environment and that we are receiving revenue from both product sales and royalties.
Thermal Management
Our thermal management material, CarbAl™ is a revolutionary patented material that fills the void between the existing low-end and high-end thermal management materials. Our issue since the original development of the material has been two-fold – working with potential customers to develop applications, while simultaneously trying to develop reliable supply sources. Furthermore, in the last 12 months we developed new additive materials and new processes that can be integrated with our CarbAl™ materials for considerable added value.
Over the past few months, we have devoted significant resources to analyzing and refining the production process and the integration of the additive materials with CarbAl™ substrates. We have substantially simplified these processes and secured reliable supply sources, capable of providing quantities sufficient for many applications.
Over the past two years, we have worked with many potential customers on application development and now have companies interested in adopting the technology in the very near future. In addition, we have developed many processes for the application of additive materials to CarbAl™ including coatings, laminates, etc., which will allow the printing of electronic circuits directly on the CarbAl™ substrates. This allowed us to extend the expertise we developed working with our inks and pastes, to the field of thermal management materials and processes. We have now patented these processes, making these patents much more valuable to us in protecting our interests than they would be in licensing to others.
We believe that by purchasing the base material from our source, providing value added services, and then selling it directly to the end user, we can earn margins that are much higher than a simple license agreement related to the sale of the base material. Once again, if a customer is interested in a license for a particular application, we can license the technology for that application, based on the sale of the end product. Now that we do not have any supply issues, we have a customer ready to use our thermal management material in its power LED lighting and we would expect to begin generating product sales in the not too distant future.
As with our CNT enhanced composites activity, our thermal management materials have reached the point where we can benefit from a stronger sales presence. We believe this division is poised for strong direct sales growth, although this may result in sacrificing license or research revenues in the short run. We believe the more powerful potential revenues and profits from the direct sale of the materials will more than offset this.
We will not be establishing a manufacturing facility for the base material on our own, or even high volume assembly or processing operations. We intend to purchase the material and, if necessary, outsource volumes in excess of our internal capabilities to a contract manufacturer.
Nanoelectronics
Our main focus in the nanoelectronics area has been metallic inks and pastes. We have licensed our copper ink and paste technology, focused on photosintering, exclusively to Ishihara Chemical Company. We have also licensed our solar ink and paste technology for silicon-based solar cells to YHCC limited to Asia, excluding Japan and Korea. We are currently working on opportunities in Japan, Korea and the rest of the world, areas not covered by the YHCC license. These opportunities may take the form of a license, joint venture or other strategic relationship.
On September 12, 2011, YHCC broke ground on the construction of its solar ink production facility. The first phase of this facility, which involves an investment of approximately $18 million and will result in an annual production capacity of 1,000 tons of solar inks and pastes, is expected to be operational in August 2012. At current exchange rates, YHCC expects to generate between $60 and $65 million in revenue from this first phase.
The developments related to our metallic inks, in particular copper inks, open other opportunities within the nanoelectronics field that we will continue to pursue. One example is our Exclucent™ product, a highly transparent copper metallic mesh film. Many industries, such as luminaires, flexible displays, flexible photovoltaic cells, smart windows, and touch input devices, etc., are looking for a replacement for transparent conductive substrates currently using expensive and problematic ITO (indium tin oxide). Exclucent™ may provide an excellent solution as an ITO replacement due to its excellent properties, availability in volume production and competitive cost. Furthermore, Exclucent™ is ideal for EMI shielding, which is used to protect electronic devices from the harmful effect of electromagnetic interference, as well as for smart windows and transparent heater applications. We may establish a stronger sales presence in this area as the markets develop and as conditions warrant.
Nanosensors
We have developed several types of sensors; however our efforts are currently focused on our Differential Mobility Sensor (DMS). We have demonstrated the ability to detect gases in parts per trillion using this technology. We are currently still in the development stage for this sensor technology, but anticipate exploring licenses, joint ventures, and other strategic relationships over the next year. This technology has incredible future potential, and, while not as far down the commercialization continuum as some of our other technologies, we believe it is important to keep our pipeline of opportunities full and continue to develop future technologies.
We also have a fully developed hydrogen sensor technology that can be used for monitoring hydrogen levels in power transformers and other types of equipment. This sensor technology no longer fits with our strategic plan and we are currently working on monetizing this technology. We have retained ICAP Ocean Tomo to sell or auction this technology, with the goal of completing a transaction by the end of 2011.
Electron Emission Activities
We no longer perform any research or devote resources to our electron emission technology. We are, however, focused on monetizing this technology through licensing or patent sales. Our most significant group of patents in this area is the Raman family of patents. These patents were recently issued in Japan, which greatly strengthens the entire family of patents. We intend to license the Raman family of patents to others, however, at this point; we are completely dependent on others to introduce products requiring a license. This is a very powerful patent family, but if no products are introduced using this technology, there is little or no interest from others in licensing the patents. We intend to sell, or auction, the remaining patents related to our electron emission activities and have retained ICAP Ocean Tomo for this purpose.
Investor Relations Activities
Over the past year, we have focused our efforts on spreading awareness of our story, primarily with institutional investors, including hedge funds. Obviously the market fluctuations in our stock can be a source of frustration for everyone, so given the substantial progress we have made with our fundamental business activities over the past year, we are now ready to further expand our efforts and have hired the Redchip Companies to help tell our story in the retail markets.
Redchip has a long history of identifying and working with emerging companies and will be an excellent supplement to our existing investor relations activities. Redchip has represented hundreds of listed companies and was the first firm to issue an independent research report on Starbucks, back in 1992. Redchip’s services will include a research report distributed to the brokerage community, virtual conferences, and the Redchip small-cap investor conferences. We are excited to begin our relationship with Redchip. More information can be obtained at www.redchip.com. We expect their initial research report to be issued in approximately 45 days.
We are also beginning preparations to hold an investor day in Austin this fall. For those that can attend, it will be an opportunity to see our facilities and technologies first hand and also discuss with management our latest activities and progress. Once we have a date selected, we will announce it, but it will likely be in late October, or early November, after our next quarterly SEC filing.
Projections
We will continue to update our projections quarterly in connection with our SEC filings. Certainly we have done initial projections related to product sales, margins, and profits, but we want to continue to refine these projections, and consider input from the sales people that we hire. I know everyone is anxious for projected numbers, but I wanted to share the news as quickly as possible, rather than wait until we were in a position to provide complete data. We hope to complete our hiring in October and begin the process of generating increased product sales. As we continue with this process, we will be able to project future revenues for future years with more confidence. While we, of course, have internal projections of royalties by year for each of our various licensees, we are too far removed from their decision making and reporting process to be able to provide reliable projections until the products are in the market and we have a royalty history to rely on. As our direct sales model develops, investors can anticipate seeing forecasted revenue with much more accuracy than was possible with a pure license model.
Conclusion
I am excited about the progress that we have made and even more excited about the next step of our evolution. I think we are well positioned for strong revenue growth, and more importantly, laid the groundwork for profitability for years to come. Our revenue and profit growth, combined with improved visibility, and our increased investor relations activities designed to communicate our potential, should result in increased interest in our company.
Sincerely,
Doug Baker
Chief Executive Officer
Safe Harbor Statement
This letter contains forward-looking statements that involve risks and uncertainties concerning our business, products, and financial results. Actual results may differ materially from the results predicted. More information about potential risk factors that could affect our business, products, and financial results are included in our annual report on Form 10-K for the fiscal year ended December 31, 2010, and in reports subsequently filed by us with the Securities and Exchange Commission ("SEC"). All documents are available through the SEC's Electronic Data Gathering Analysis and Retrieval System (EDGAR) at www.sec.gov or from our website at www.appliednanotech.net. We hereby disclaim any obligation to publicly update the information provided above, including forward-looking statements, to reflect subsequent events or circumstances.