Nanoco — Progress against stated objectives during FY21

FY21 revenue totalled £2.1m, slightly ahead of our £1.9m estimate. £1.6m was attributable to the major European customer. This was substantially lower than the £3.9m achieved in FY20, which benefited from £2.5m of revenues attributable to the final phase of the joint programme with the major US customer. Nevertheless, EBITDA losses were stable at £2.9m (slightly higher than our £2.6m estimate) because of the substantial cost savings resulting from a programme restructuring the business around its core competencies of R&D, scale up and production. For example, payroll costs were cut from £4.5m in FY20 to £3.3m in FY21.

Free cash outflow totalled £3.7m compared with £4.2m in FY20. The outflow was primarily attributable to operating losses and a £0.8m drop in payables as well as a £0.5m reduction in deferred revenue, both related to lower levels of activity. Management does not expect this adverse working capital movement to be repeated in FY22. Similarly to FY20, investment in tangible assets during FY21 was minimal, while investment in patents declined by £0.2m year-on-year to £0.4m as the group focused on protecting the IP most likely to generate a return in the short-to-medium term. The R&D tax credit of £0.9m was £0.2m less than the prior year, reflecting a more highly focused approach to R&D. The cash outflow was partly offset by the non-dilutive subscription for loan notes in July by major shareholders that raised £3.0m (net).

Since gross monthly cash costs have been cut to c £0.4m, and cash at the end of FY21 was £3.8m, management estimates that the loan notes have extended the cash runway for organic business activities into calendar H222, at which point there should be good visibility of potential production orders. The initial result of the PTAB and the verdict from the re-scheduled trial in the patent litigation against Samsung are both expected during calendar 2022, so the cash runway maintains both potential sources of value for shareholders. The cash runway would potentially be extended by each new business win. If none of the development programmes currently underway start to scale up during FY22, management has the option to remove the group’s R&D, production and scale-up capabilities, in effect becoming a shell company focused on pursuing the lawsuit against Samsung. The cash runway extends into mid-calendar 2023 in this scenario.

We adjust our FY22 estimates to reflect the recent guidance on gross monthly cash costs. Our revenue estimate has not been changed. It is supported by the recent announcement of a third package of work from a major European customer, who we have previously inferred is ST Microelectronics, to demonstrate how to scale-up production of a longer wavelength material for enhancing the sensitivity of silicon sensors. Our estimate also assumes that the first phase of the programme to develop a potential new nanomaterial for the Asian chemical company completes successfully in calendar Q421 and is followed by two further phases extending to the end of FY22.

Nanoco has progressed from the situation in FY18 where it was working on a single product for the major US customer to one where it has five customers, which include ST Microelectronics and the new major Asian chemical company announced in July 2021, and eight distinct materials (see Exhibit 2). Two of these customers have the scale to require sufficient output to take the group to break-even, which is achievable at c £6m annual revenues. The existing production capacity in Runcorn can output nanomaterials for sensing applications worth £100m per year. We note that whether any of these projects proceeds to commercialisation depends not only on Nanoco demonstrating it can make the nanomaterial in volume but also on whether the OEMs supplied by ST Microelectronics and the Asian chemical company decide to deploy QD-enhanced silicon sensors in their devices.

The most advanced of the customer programmes are the two with ST Microelectronics (Customer 1). If the ongoing programme to demonstrate how to scale-up production of the longer wavelength material is successful, this could lead to volume production in calendar 2023. The shorter wavelength material for ST Microelectronics was worked on as part of the earlier programme with the major US customer and could potentially transition to volume production fairly swiftly if required as the methodology for manufacturing this material in volume is already proven. The expanded range of market leading materials will support more stable revenue growth over the medium term. Our July update provides details of the range of applications which these sensing materials may be used for.

Nanoco continues to pursue opportunities for its cadmium-free QDs for displays, where it is working on some small-scale development programmes, life sciences and horticultural applications. Please refer to our July update and our thematic note on QDs for more information.

Nanoco made good progress in its legal action against Samsung for wilful infringement of its IP, with a positive outcome of the claim construction (Markman) hearing in March 2021. This established the court’s interpretation of five key words or terms used in the patents that Nanoco alleges Samsung has infringed. The judge rejected four of the five constructions proposed by Samsung and rejected one of the constructions proposed by Nanoco. In four of the five patents in the case, Nanoco's constructions were upheld and in the fifth patent Nanoco and Samsung each had one construction upheld.

The next stage, which management expects to complete by May 2022, is for the US PTAB to review the validity of the five patents under dispute in a formal inter partes review (IPR). The court trial, which will last for only one week, has been postponed until after the validity of the patents has been established, enabling Nanoco to focus on the issues of infringement and damages during the trial. Management expects that the trial will take place around October 2022. The company has a litigation funding agreement with a very large, undisclosed US litigation finance specialist with extensive experience in financing technology based IP patent litigation matters. This means that Nanoco is able to actively progress the lawsuit without adversely affecting its cash runway.

While the ongoing development and optimisation programmes confirm that there remains significant potential for generating revenues from the supply of nanomaterials for sensing applications, ahead of these definitely moving to commercial production, we believe that Nanoco’s value lies in a satisfactory resolution of the patent infringement dispute with Samsung. While the outcome of this litigation is by no means certain, we note that the large US litigation finance specialist funding the costs of the litigation undertook detailed due diligence before agreeing to provide finance. The lawyers, who working on the case on a discounted fee basis, also carried out due diligence.

Nanoco estimates that between April 2015 and the present Samsung has sold more than 14 million TVs deploying QDs based on Nanoco IP in the United States, which represents around one-third of its global sales. While Nanoco has not revealed its estimates of the potential payout if the litigation is successful, it has disclosed three possible damages models for calculating the value of the lost revenue to Nanoco. Top end: damages based on the premise that Samsung’s QD TV market in the US is wholly enabled by Nanoco’s QD technology, so the value of the lost revenue would be derived from the total value of that market. Mid: damages based on the premise that the QD-enabled display is a high proportion of the additional value of a QD-enhanced TV compared with a standard TV. Low end: damages based on the value only of the QD film in the displays. Further options exist.

Applying the low-end valuation model, we assume the QD enhanced TVs had an average sales price of US$2,200–2,500 compared with the average price of a top of the range TV without QDs of c US$1,000. Had the alleged patent infringement not taken place, we believe that the volumes of QDs Samsung required would have been higher than Nanoco could have produced in Runcorn, so it would have licensed its technology to partners, primarily Dow Chemical, and would have received significant royalties. If we assume that the cost of the QDs in each TV is equivalent to 10% of the uplift in price between QD and non-QD TV displays, and that Nanoco would have received a 12% royalty (as per our May 2017 initiation note) on these QDs, this represents US$14.4–18.0 in lost revenue per TV display or US$200–250m between April 2015 and the present in the United States alone.

Any damages awarded may also make an additional allowance for future sales of infringing TVs and a possible uplift of up to three times for wilfulness. While the ongoing litigation only covers the United States, we understand that Samsung would also be likely to seek a global negotiated settlement covering sales in other territories. Nanoco would retain 50–80% of the award, depending on its magnitude, and would have to pay UK corporation tax on the amount received, which could be offset against £36m losses.