October 14, 2009

case 1-428-883

Nanocerox
In March of 2003 Steve Swanson, the new CEO of Nanocerox, an Ann Arbor, Michigan based start up, pondered how to set a strategic direction for his company. As the Michigan town was digging out from the most recent winter snowstorm, he was busy preparing for a meeting with some professional angel investors. Nanocerox had recently witnessed an upsurge in the interest for its technology and products. Currently, there were at least five corporations that had approached Nanocerox about the possibility of forming a strategic alliance. The difficulty was that each alliance required a different application of Nanoceroxs technology and the company was facing strained financial assets. Further, while the company had made contacts with many experienced industry players, the management team was very small and needed additional people with business experience. See Exhibit 1 for further description on the management team. The question was which market application would allow Nanocerox to profitably commercialize its technology considering the companys limited resources. The funding environment was not optimum given the bursting of the internet bubble during 2000-2001. Investors had become ever more wary of early stage investment proposals. Nanocerox managements goal was to raise up to $1 million from angel investors. See Exhibit 2 for the pro-forma budgets for Nanocerox for 2003 and 2004. After an initial review of the company, these potential investors had requested that Nanocerox articulate a targeted strategy. Nanocerox needed to show the investors that the company was moving away from pure research and had created products with real market potential. Swanson needed a plan to move Nanocerox from what the investors had called a science project to a profitable company. The first decision that needed to be made was which of the numerous available market opportunities the firm should pursue.

Advanced Ceramics
Nanotechnology is named for the minute scale in which the field operates. A nanometer is one-billionth 1 of a meter, or 100,000 times narrower than the width of a human hair . By manipulating the properties of matter at this minute level, scientists believe nanotechnology will allow them to achieve such varied feats as creating materials 100 times stronger than steel at a fraction of the weight, or moving the storage of the entire Library of Congress collection onto a device the size of a sugar cube. See Exhibit 3 for a picture of the Nanotechnology landscape. One of the areas where nanotechnology is creating new possibilities is in advanced ceramics. Powders are the starting point for many of the materials we use every day, such as ceramic plates, cell phone covers,
Jitesh Tank, MBA 2003, and Laura S. Whitridge, MBA 2004 prepared this case under the supervision of Professor Thomas C. Kinnear, Executive Director of the Samuel Zell and Robert H. Lurie Institute for Entrepreneurial Studies at the Michigan Business School as a basis for class discussion. This case was developed from published sources, industry interviews, and internal documents and interviews provided by the management of Nanocerox.
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and the coating on drill bits to increase durability. Nanotechnology has provided scientists with the ability to make smaller powders, nanopowders, from increasingly pure elements through a more controlled engineering process. These smaller powders have the potential to create new products and new markets for advanced ceramics. Advanced ceramics is a mature technology with current uses as well as many potential applications from successful development of nanopowders. According to research from the Business Communications Company (BCC), advanced ceramics represents an enabling technology whose continued development is critical to advances in a host of new high-technology applications, ranging from modern microelectronics to superconductors and nanotechnology. In 2002, the total U.S. market for advanced ceramic powders, 2 including nano-sized powders, was estimated to be 918 million pounds, worth $1.6 billion . The portion of the advanced ceramic powders made up of nanopowders was small, but growing. See Exhibit 4 for BCC estimates of the advanced ceramic and nano-sized ceramic markets in 2002 and 2007.

History of Nanocerox
Professor Richard Laine founded Nanocerox in 1996 as a commercial spin-off from the Material Science and Engineering Department at the University of Michigans College of Engineering. He wanted Nanocerox to become a one-stop shop for providing nanopowder based research and development solutions for corporate customers. Until 2002, Nanocerox survived on small government grants for development of its basic scientific methods, revenues from sales of experimental powders, and a few small development contracts. During these years, Nanocerox personnel developed hundreds of recipes for making mixed-metal oxide nanopowder precursors. These precursors were basically patented recipes of different chemical compound mixtures that once fired in Nanoceroxs unique firing process, flame spray pyrolysis (FSP), created nanoparticles. Depending on the original chemical compound mixture, the fired particles had unique characteristics with different potential commercial applications. These formulas were vital trade secrets. However, with limited capital, Nanocerox had been unable to scale-up its powder production capability to a commercially viable level. One of the companys key strengths was the FSP (See Exhibit 5 for a picture of the FSP process) technology developed by Professor Laine. This technology was protected by U.S. patents and Nanocerox had an exclusive license from the University of Michigan to use this process. Professor Laines Liquid Feed-Flame Spray Pyrolysis (LF-FSP) technology solved three major problems associated with metal oxide nanomaterials production: The ability to easily produce exact composition mixed metal oxide nanopowders which allowed Nanocerox to meet precise specifications requested by potential partners. The potential to scale production to commercial quantities which many nano-solutions had not yet achieved. The reduction of pollution emissions which was a growing concern in the marketplace. After licensing the technology from the University of Michigan, Nanocerox had improved on the original LF-LSP and patented the improved process. This was called the CONCEPT (Controlled Oxide Nanopowders by Controlled Energetic Precursor Technology) process. See Exhibit 6 for a picture of the CONCEPT process. Nanoceroxs CONCEPT process involved combusting aerosols of single- and mixed-metal metalloorganic alcohol solutions (metal cocktails), with oxygen or air in a reaction chamber at temperatures of 1200-2000C. Rapid cooling then produced unagglomerated single particle nanopowders with the same composition as in the original precursor solutions. These materials could be made with unique optical, physical, and electrical properties.

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Nanocerox listed the following advantages of the companys capabilities in its business plan.
Nanocerox Capability CONCEPT Advantage

Patented technology for making oxide particles with control over

particle size, particle shape and crystal structure.

Precursor Chemistry Compositional Control Powder Treatment, Shaping, and Transformation into Macro-Scale Ceramic Products

Clean process (CO2 and H2O are the only by-products). Inexpensive relative to other processes for making nano-particles. Precursors are stable and have high ceramic yields. Nanocerox can meet a customers unique requirements quickly and
cost effectively.

Nanocerox has the intellectual property to transform its nanopowders

into high value-added ceramic products such as medical prosthetics and silica coatings.

Revenues for 2002 were approximately $154,000, which were primarily derived from: Outsourced R&D from corporate research departments of strategic customers such as McDermott International and PPG Industries Small / medium size companies providing end-use applications for their customers Royalties and licensing fees from using Nanoceroxs materials and technologies in customers products The development of nano-materials had only recently caught the attention of applied research and business communities. In 2003, Nanocerox managements goal was to increase sales growth and generate $650,000-$850,000 in sales, but so far only $45,000 of sales had been completed. Forecasted revenues 4 from current and potential customers are provided in the table below.
Market 2003 Revenue Forecast for Existing Customers $$100,000 $10,000 $8,000 $60,000 $145,000 $323,000 2003 Revenue Forecast for Prospect Pipeline $50,000 $$$$10,000 $80,000 $140,000 2004 Revenue Forecast for Existing Customers $10,000 $300,000 $20,000 $25,000 $140,000 $325,000 $820,000 2004 Revenue Forecast for Prospect Pipeline $160,000 $200,000 $1,000,000 $$150,000 $300,000 $1,810,000

Industrial Coatings Prosthetics Defense Equipment Security Inks Photonics Other Experimental Applications FORECASTED TOTALS

Up until this point, Nanocerox had opportunistically explored different markets rather than following an overall strategy. However, to achieve the revenue goals going forward Swanson wanted to serve specific markets where Nanocerox would have a distinct competitive advantage over other suppliers. Descriptions of the potential markets Nanocerox was considering are listed below.

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Potential Target Markets

Industrial Coatings and Additives One of the markets Nanocerox was considering entering was the manufacturing and distribution of an industrial coating material, silica. Silica was used in the polishing of semiconductors, manufacturing of glass, and lubrication of powder transfer equipment in pharmaceutical production to name a few. Nanocerox currently had the capability to meet most of the requirements in this industry including chemical compositions, purity levels, particle shapes and the ability to use particles that would be useful in large scale industrial processes, but Nanocerox could not yet produce large quantities at a competitive cost. 5 Nanocerox estimated that Silica was a $500 million market opportunity . Multiple large suppliers catered to the silica market, including Degussa and Cabot, both of whom manufactured silica via the fumed silica process. (Further description of Degussa and Cabot can be found in the section titled Competitors or Potential Business Development Partners.) Manufacturing silica via the fumed silica process was the conventional method for producing smaller sized particles. The main advantage of silica produced by Nanoceroxs FSP process, nano-silica, was that it was environmentally friendly, producing only CO2 and H2O as by-products. Additionally, initial tests showed that nano-silica could reduce costs because it required less processing than the traditional fumed silica. The Nanocerox process was thought to be scaleable but had not yet exceeded 1 kilogram per hour of production capacity. A significant increase in production capacity would be necessary to supply commercial needs. Nanocerox managements current plan was to focus on specialty uses of silica in an attempt to penetrate a premium priced market instead of the generic silica market catered to by the large fumed silica manufacturers. Because Nanocerox had the ability to produce exact mixed-metal oxides, industries that were looking for an improvement in the currently available coating solutions in order to increase product effectiveness were a good target for Nanocerox. For example, Nanocerox had recently been approached by Ferro Corporation, a leading producer of ferro-magnetic devices. Ferro was looking for a new semi-conductor-polishing product. If a finer polisher was developed for silicon wafers, the surface could be made thinner enabling the further miniaturization of computer chips. If Nanocerox developed a finer polish, Nanocerox would be able to differentiate its product from the larger competitors, and charge a premium price. Penetrating this market would not be easy. Nanocerox did not currently have the resources or credibility to reach the large industrial coatings market. Additionally, Nanocerox only had the capability to create the powder for the coatings, a small part of the value chain. Nanocerox would either have to find partners to design and manufacture products that used Nanocerox coatings, or more likely, Nanocerox would need to license its technology to established companies who would then produce the powder, design and manufacture the products, and perform the sales and marketing as well as distribute the products. So far, Nanocerox had established one relationship in the industry with Silbond Corporation. Silbond was a privately held Michigan based corporation with whom Nanocerox was negotiating the first series of contracts to manufacture silica by its proprietary FSP process. Silbonds ethyl silicate derivatives had become widely accepted for use in a variety of manufacturing processes for high temperature ceramic and precision casting molds and non-conductive interlayer and inter-metal dielectric applications in computer chip manufacturing. If an agreement was reached, Nanocerox would license its CONCEPT technology to Silbond and would receive a royalty based on Silbonds gross revenue. Silbond was a large supplier to the silica market and entering into this alliance would provide access to the supply chain for Nanoceroxs products. Nanocerox was negotiating with Silbond to build a pilot plant facility for manufacturing high grade silica in tonnage quantities. While Silbond was the only currently established relationship, Swanson was hopeful that a successful association with Silbond would help convince other potential partners like Ferro who were looking for an improved coating solution to work with Nanocerox as a development partner in the future.

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Prosthetics/ Orthopedics Advanced ceramics were becoming increasingly useful in the medical world. Surgeons were using bioceramic materials for repair and replacement of human hips, knees, shoulders, elbows, fingers and wrists. Ceramics were also being used to replace diseased heart valves. When used in the human body as implants or even as coatings to metal replacements, ceramic material was believed to stimulate bone growth and promote tissue formation. Additionally, ceramics was one of the few materials that were durable and stable enough to withstand the corrosive effect of bodily fluids making ceramics a strong candidate not only for artificial replacements, but also for injury fixation devices such as screws and pins The aging population, in the United States and abroad, along with the introduction of new products, was expected to help this market grow at 7-9% during 20032010. The global orthopedics industry generated 6 sales of $7 billion in 2002, of which 63% were U.S. sales . Joint replacements, internal and external fixation, 7 spinal hardware, and arthroscopy products accounted for about 75% of the global orthopedic market . The materials used for the fabrication of prosthetic components included metals, plastics and ceramics . Ytrria doped zirconia (YSZ) had come to replace alumina, a component of the original ceramic prostheses 9 owing to its excellent degree of bio-stability, bio-compatibility, and superior tribiological properties . YSZ manufactured by Nanocerox had a superior profile on all these aspects. Unlike its competitors, Nanoceroxs technology was thought to help create more robust/durable prosthetic devices due to the close packing nature of its fine particles. Additionally, if Nanocerox was successful in producing transparent or even translucent material, this material was projected to capture a substantial market share given the increased ability to detect defects. At this point, however, Nanocerox had only created a better process to manufacture YSZ. No novel materials resulting from unique chemical compound mixtures had been produced or patented. The supply chain for this market was very rigid with very few suppliers to the prosthetic device manufacturers. Historically, European manufacturers dominated the prosthetic component market. Nanocerox needed to partner with a manufacturer who was currently a supplier to this market. The fundamental building material for prosthetic devices would be manufactured by Nanocerox whereas the final prosthetic device manufacturing would have to be performed by the manufacturer. Additionally, the sales and the marketing function would also be the responsibility of the manufacturer, given the established industry relationships. Another method under consideration for penetrating this market was, again, to license Nanoceroxs technology to the component suppliers and let these companies perform the entire manufacturing process. One recent event in this space was the recall of an orthopedic implant made by Sulzer Orthopedics, the largest manufacturer of joint prostheses in Europe. A component of approximately seventeen thousand artificial hip implants amounting to a total of $250 million in total recall charges was estimated. This negative publicity had dampened the champions of ceramic components in artificial implants. Nanocerox management felt that if the implant could be made transparent or even translucent and could be visually checked or laser tested for defects prior to implantation, this would reduce the instances of in-situ damage and alleviate market concern. There was disagreement in the company about how long it would take before Nanocerox could deliver a translucent material. Adequate funding for research would be crucial to the actual length of the development period. Nanocerox had just started Phase I of a development project with Signal Medical Corporation, a Michigan based provider of prosthetic products. Signal Medical had contracted with Nanocerox to develop ceramic bars out of YSZ as an initial test with the ultimate goal of developing a ceramic knee replacement. With 250,000 annual surgical operations, at a cost of $2,0006,000 per prosthetic component, and a projected a growth rate of 4 to 7% over the next 10 years, this relationship could represent a significant opportunity for
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Nanocerox. While Signal had never commercialized a new joint replacement product, the company did have established distribution channels and familiarity with the prosthetics market. Signal could help establish Nanocerox in the industry and allow Nanocerox to partner with other large medical suppliers. Defense Equipment Ceramics were gaining increased attention for possible military applications because they had the 10 potential to be lighter, cheaper and easier to replace than traditional metal armor . The U.S. Department of Defense had supported nanotechnology research for more than two decades and expected to spend about $243 million in 2003. For the same period, the total federal budget for nanotechnology research and development was $774 million. A soldier normally carried 9 or 10 pounds of metal armor on both his front and back. This could be cut down to 8 or 9 pounds by using ceramic material. Lighter armor would confer a distinct advantage during urban fighting owing to greater mobility. Also, tanks weighed 70 tons due to the numerous sheets of metal armor bolted to them and took weeks to get to battle scenes because they had to be brought on ships. Lighter vehicles would be able to move in and out of danger zones much more quickly and could be transported on cargo aircraft rather than on massive ships. Additionally, if Nanocerox could develop a mixed-metal oxide that created transparent armor, soldiers could wear face shields and tanks could have windshields that were bulletproof. Another potential defense usage was in the Patriot missile-defense system, where ceramic cones could allow for greater velocities while protecting the onboard electronics 11 from microwave energy, a common means to deflect missiles . Ceramic armor was still being developed and had several limitations to overcome. While a piece of fine china, traditional ceramics had flexural strength or the ability to survive pressure, of 5,000 to 15,000 pounds per square inch, the specially designed ceramics armor currently available could potentially withstand 140,000 pounds per square inch; stronger than a bullet. This was fine for armor for soldiers, but for use on tanks, the strength of ceramic armor would need to be significantly improved. Additionally, when ceramic armor was hit by a projectile, the ceramic component turned back to powder. Thus, when a ceramic plate was hit, it shattered and had to be completely replaced. With metal armor, another piece of metal could simply be attached on top of the damaged portion. Finally, the cost for ceramics was currently higher than its metal equivalents. There were many small companies focused on entering this lucrative defense market. Nanocerox was aware of at least one venture-funded competitor. Additionally, government contracts were difficult to obtain. Nanocerox would first need to prove its technology through commercial companies and would most likely need to partner with a larger company to compete for the defense contracts. Nanocerox had received strong interest in its research from several large, important companies that worked in this area, but no specific partnerships had been completed. For the defense market, Nanocerox was working on creating novel material and was still in the research phase. To support this research Nanocerox needed to sell its research services to large companies that had an interest in producing ceramic armor. The sales cycle for selling into large companies such as DuPont or Dow began with contacting the VP of Business Development or VP of Research and Development. A majority of the first attempts to contact these leads never resulted in a return call of interest. However, a few of them returned with a proposal for developing research quantities of material. The process for licensing the technology or material was lengthy and cumbersome with numerous non-disclosure agreements (NDAs). These NDAs could prevent Nanocerox from leveraging its successes with its current customers to attract new customers. Additionally, it often took several months before a purchase order from the large company was formulated and Nanocerox could begin work. Then, the customer would experiment with the material for a period of up to one year before deciding to pursue manufacturing of the material in large quantities. Worse, sometimes, the material was never experimented with.

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Nanocerox did have another option. To sustain research in this area, Nanocerox could apply for the Small Business Innovation Research (SBIR) program and receive grants from the government. This would alleviate the need for funding, but Nanocerox would lose much of the input into the desired product qualities from potential customers. SBIR grants also entailed detailed expense tracking and reporting paperwork which could distract Nanocerox management from other goals. Security Inks Annual revenue losses from counterfeiting were estimated to be more than $200 billion in the U.S. and 12 $350 billion globally . Check fraud had become widespread, with an average of more than one bad check per second and more than 500 million forged checks per year. Up-converting phosphors are the only form of taggant (chemicals that could act as active tags), that worked by converting low energy infrared light into higher energy visible light. Combining phosphors of different wavelengths and intensities generated an infinite number of unique taggant codes for each customer or application. While there were several solutions currently on the market, Nanoceroxs technology offered the following advantages: High security: Up-converting phosphors were invisible under normal conditions making them difficult for counterfeiters to detect. Duplication was practically (and financially) impossible due to limited availability of up-converting phosphors and the challenge of reproducing the exact wavelength and intensity combination used in a specific customers code. Ease of authentication: Official detection devices offered a simple, quick and accurate determination of authenticity. There was virtually no background noise to limit sensitivity. Value pricing: Nanoceroxs patented FSP process was the lowest cost method for producing upconverting phosphor nanopowders. Flexibility: The small size of the particles produced by the FSP process and its inert nature allowed the taggants to be suspended in a wide variety of inks. Different ink formulations could be developed to support any conventional printing process, which would also sustain high temperatures (up to 2000 degrees C) and long detection life since there was no performance degradation over time. Because Nanocerox did not currently have ink making or printing capabilities, Nanoceroxs place in the value chain for security inks would again be as an input supplier or technology licensor. Nanocerox was cooperating with a company called Flint Ink to develop the appropriate combination of mixed-metal oxides for security inks. Flint Ink, a privately held corporation since 1920, had 2002 revenues that totaled $1.4 billion. Based in Ann Arbor, Michigan, it served printing needs in the following areas: cold and heatset, web offset, flexographic, gravure and inkjet inks and coatings for commercial printing applications. The new trend in security inks had captured the attention of Flint Ink and it was interested in conducting a joint product development with Nanocerox. It was unclear whether the market would adopt an improved security ink, in order for the new ink to be effective new systems would need to be developed for reading the ink. A large ink manufacturer such as Flint Ink would not only need to help Nanocerox with the product development process but would also need to lead the marketing and sales effort required to switch the traditional security printers and commercial printers to Nanoceroxs security system. A three-way partnership was being considered which would also include the device manufacturer who would develop systems capable of reading the invisible up converting phosphors used in the new security inks. Photonics / Optical Application Two components of high-power lasers were made from mixed-metal oxides, both of which offered significant market opportunities for Nanocerox. Lasing crystals, the part that produced the laser light, were made from an yttria alumina garnet crystal (YAG) doped with neodymium. Currently, the best material available for these crystals was produced by the Choralsky method. In this procedure, yttria and alumina

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were melted together with a small amount of neodymium and were allowed to grow into a crystal, referred to as a single crystal because the atoms throughout the lattice were oriented in the same direction. Because growth of single YAG crystals occurred at the rate of only two millimeters per hour, it could take weeks or even months to make this material in practical quantities. In addition to the constraints of high cost and low yield, single crystal YAG could contain no more than 1% neodymium, the element that gave the crystal its lasing property. If more neodymium could be added, more powerful lasers would be possible. To overcome the limitations of single crystal YAG, researchers in Japan had been working to develop lasing crystals out of polycrystalline YAG, so-called because it was made of small grains of crystalline YAG with each grain oriented in a random direction. This approach began with YAG nanopowder of five-nines purity. The nanopowder was dispersed in a binder to make a smooth paste, then formed into a slab, fired in a high-tech kiln, and polished to a smooth finish. The Japanese company Konoshima was currently the leader in polycrystalline YAG production. In the laboratory setting, a design using Konoshimas YAG neodymium held the current power record for polycrystalline lasers. A U.S. company called Baikowski, the leading manufacturer of ultra pure alumina powders, marketed Konoshimas YAG products in the U.S., but the supply was erratic and the cost was very high. Laser manufacturers were actively looking for new YAG sources. In response to the growing demand for better laser materials, Nanocerox was investing development dollars to meet the needs of the industry. So far Nanocerox had not yet been able to develop a product that met all of the requirements. For example, a 99.99% purity level was needed and Nanocerox had only reached 99.95%. Additionally, Nanocerox had produced promising results on the transparency level, but had not yet been able to create reproducible results of laser quality material. Even if the results were obtained, Nanocerox still faced the uphill battle of breaking into the laser market as a supplier. Customers were looking for a reliable supplier with a track record of developing laserquality materials. While Nanoceroxs work showed promise, the largest potential customers of YAG needed more evidence before undertaking an expensive laser development effort. On the other hand, if Nanocerox could produce the needed evidence, large companies like Raytheon or Northrop Grumman had indicated that they would be willing to try to obtain government funding to develop higher power lasers with Nanocerox as a development partner. Nanocerox also had potential for commercial success in the laser field from its work on the second mixed-metal oxide component of high power lasers: the Faraday rotator (FR). FRs were critical mechanisms that rotated polarized laser light, preventing the high-energy beams from scattering back into the working parts of the laser. Currently, FRs were made out of terbium gallium garnet (TGG), but the inherent limitations of TGG have become a barrier to further progress by the laser industry. In order to produce higher-power lasers, the industry needed a new FR material with improved ability to rotate polarized light and greater heat resistance. In this area, Nanocerox was working with Electro-Optics Technology (EOT) of Traverse City, MI. Founded by physicists from Livermore Laboratories, EOT was the worlds leading producer of Faraday rotators. EOTs CEO had entered into a $150,000 development deal with Nanocerox to produce laser-quality terbium aluminum garnet (TAG). The project has been divided into fifteen $10,000 phases. After two phases of work, Nanocerox had made a TAG ceramic with islands of transparency, but had not yet achieved total transparency. On the positive side, optical testing results performed by EOT confirm that TAG performed 40% better than TGG.

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Nanocerox management felt that a successful partnership with EOT would establish Nanocerox as an input supplier of laser quality materials. There was a lot of excitement around this market because the advancement of the laser industry was being curtailed by the inability of current materials to meet needed specifications. If Nanocerox was able to develop the needed solution, Swanson felt there would be a large market for Nanoceroxs technology. Competitors or Potential Business Development Partners There were multiple companies, large and small, working in advanced ceramics. These companies had products with potential applications in many of the same target markets Nanocerox was considering. Most of the large companies with in-house R & D departments could be competitors, but they could also be potential customers or partners for Nanocerox. Some of these companies are described below. Cabot: Cabot Corporation, based in Boston, Massachusetts, was a global specialty chemicals company with $1.8 billion in 2002 revenues founded in 1882. Its most popular products were not household names, but were commonly used for household and industrial applications. Carbon black, one of Cabots products was a key ingredient in rubber for tires and automotive part as well as the main ingredient in coatings and plastic masterbatch. Cabot also manufactured fumed metal oxide, often found in cosmetics, pharmaceuticals, and composites. Another product, tantalum formed a key component of cell phones, pagers and computers. Cabot also recently introduced solutions, like inkjet colorants, cesium formate brines and aerogels, all of which were a critical link in the performance of the final products where they were incorporated. Degussa: Based in Dsseldorf, Germany with revenues of almost $12 billion in 2002, Degussa products ranged from fine and industrial chemicals to high performance materials. Degussa was also a large producer of fumed silica. Additionally, Degussa had established an Advanced Nano division called AdNano. With its deep industry knowledge, Degussa and AdNano knew which markets would need nanopowders in large quantities at low prices, and would be able to scale production to deliver the product at low cost. Dow Chemicals: Based in Midland, Michigan, Dow Chemicals was a leading science and technology company that provided innovative chemical, plastic and agricultural products and services to many essential consumer markets. With annual sales of $28 billion, Dow served customers in a wide range of markets including food, transportation, health and medicine, personal and home care, and building and construction, 13 among others . DuPont: DuPont Corporation, based in Wilmington, Delaware was one of the oldest chemical companies around. Founded in 1802, it currently manufactured and marketed some of the most respected brands in the chemical industry. These included DuPont Teflon resins, DuPont Lycra brand spandex fiber, DuPont Stainmaster stain-resistant carpet, DuPont Dacron polyester fiber, DuPont Kevlar brand fiber, DuPont Nomex fire-retardant material, DuPont Tyvek brand protective material, and DuPont Coolmax and DuPont Cordura textile fibers. Also, DuPont had developed and used the general flame spray pyrolysis method, devoid of any solution or liquid precursors. Its process was being used by other manufacturers including Degussa to produce a variety of nanosized chemicals. General Electric: GE was a diversified technology and services company dedicated to creating products that made life better. GE had $132 billion in total annual revenues. Two divisions of GE were focused on areas similar to the potential markets being considered by Nanocerox management, GE Medical Systems and GE Plastics. With 2002 annual revenues of $9 billion, GE Medical Systems was the fastest growing division within GE and a global leader in diagnostic and interventional medical imaging, information and services technology. Its products included X-ray, CT, MRI, nuclear/PET, functional imaging, bone Mineral densitometry and ultrasound. Recently GE had announced its entry into the orthopedics business by forming a dedicated solutions team to serve that community. Additionally, GE Plastics was a leading

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global manufacturer and distributor of plastics resins and plastics shapes that were used in the automotive, computers, and telecommunications industries to name a few. GE Plastics was familiar with government defense contracts and had experience creating materials that could be applicable to defense applications. Nanophase Technologies Corporation: On the smaller side, with $5.4 million in 2002 revenues, Romeoville, Illinois, based Nanophase was by far the leader in manufacturing nanomaterials through its 14 patented and proprietary nanocrystalline technology . Nanophase used a Physical Vapor Synthesis process (PVS) to produce materials with unique characteristics, including sizes measured in nanometers, narrow size distribution, and non-porous nearly spherical shapes. When coupled with proprietary surface treatment chemistry, these PVS-produced nanocrystalline particles could be dispersed in a wide range of formats. This allowed Nanophase to tailor its particles to meet a variety of customer applications right from product development through to high volume manufacturing. One-third of its staff had a masters or doctorate degree in materials-related fields, including chemistry, engineering, physics, ceramics and metallurgy. In many cases, products that satisfied a vertical market need could also be applied across similar or horizontal markets. For instance, materials used in conductive coatings also could be used for anti-static coatings and conductive strip carriers for color toners. Nanophase worked with its customers to ensure the solutions it provided would continue to provide benefits and meet the highest quality standards. For example, nanopowdered zinc oxide produced by Nanophase was the primary ingredient in Dr. Scholls foot spray because of its unique properties that avoided nozzle clogging. Another product was nano titanium oxide which was used to toughen coatings manufactured by BASF. Nanophases expertise was in single metals not manufactured mixed-metal oxides, but Nanophase was a good example of the type of company Nanocerox would like to resemble in the new world of nanomaterials.

The Decision
Swanson was very excited about Nanoceroxs future and the possibility of Nanocerox developing advanced ceramic products in one or more of the markets under consideration. The feedback from potential angel investors was clear. In order to raise funds, the company needed to have a specific plan for commercializing its technology to reduce the investors concerns that the company was just a research project without potential for profitability. Swanson was just not sure what criteria to use in selecting the potential target markets for Nanocerox to pursue. He wondered, even with its limited resources, if it was necessary for Nanocerox to prioritize the exploration of the potential target markets at this point, or if the company could continue to pursue multiple paths. Additionally, Swanson struggled with the type of partnerships that would be best for the company in the long term. He wondered if Nanocerox should be a supplier or if Nanocerox should license the new processes and materials that it developed. Swanson stepped away from the glass window overlooking the snow outside and began the investor presentation.

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Exhibit 1

Nanocerox Management Team

15

Tony Sutorik, Lab Director. Dr. Sutorik is the inventor of many of the precursors used to make nanopowders by Nanoceroxs CONCEPT process. After receiving his Ph.D. in Chemistry from Michigan State University, he did post-doctoral work at Penn State and the University of Michigan. With Nanocerox since its formation in 1997, Dr. Sutorik has developed precursors for over 200 mixed-metal oxides. Dr. Sutorik currently oversees four scientists in the Nanocerox lab. Richard M. Laine, Founder, Dr. Laine is a Professor at the University of Michigan in the Material Science and Engineering Department. Professor Laine is credited with developing the patented Flame Spray Pyrolysis production process that is Nanoceroxs core competency. His research team (the Laine group) focuses on the development of nanopowders and their processing, and Professor Laine has published many articles on the subject. He has previous experience running R & D groups at SRI International as an Associate Director of Inorganic and Organometallic Chemistry Programs and at the University of Michigans Material Science and Engineering Department. Steve Swanson, Chairman and CEO Mr. Swanson is Managing Director of Arbor Partners, an Ann Arbor, Michigan-based venture capital firm committed to helping entrepreneurs build lasting, growth companies. Mr. Swanson coordinates Arbors fundraising and cash management functions. He is also the firms primary liaison with other venture capital firms and financial institutions. In 1973, Mr. Swanson founded Swanson Capital Management, an investment advisory firm located in Ann Arbor, Michigan. By 1998, when Mr. Swanson sold his interest in Swanson Capital and retired as Chairman of the Board, the firm was managing assets approaching $200 million and had clients in 20 states. Beginning in 1989, Mr. Swanson instituted a process of reviewing private, early to mid-stage companies and led a group of private investors in making equity investments. That effort resulted in the investment of more than $5 million in seven companies, six of which were technology-related businesses. Several of these investments have experienced successful exits. In particular, an investment in Network Express resulted in a return of almost 12 times invested capital when Cabletron, Inc. acquired the company in 1996. Mr. Swanson served on the Board of Directors of Network Express from 1992 to 1996. Mr. Swanson received a BS in business administration from Indiana University in 1967. In 1968, he attended the University of Texas to take the Securities Institute course, and in 1981 he completed the Wharton School of Business Securities Institute Course. Peter Gray, President and COO Mr. Gray is Technology Partner of Arbor Partners, an Ann Arbor, Michigan-based venture capital firm committed to helping entrepreneurs build lasting, growth companies. He is responsible for providing product development and product management assistance to Arbor Partners portfolio companies. Since July 1, 2003 Mr. Gray has been full-time at Nanocerox. Arbor Partners has granted him a leave of absence with full pay in return for warrants in Nanocerox. Mr. Gray joined Arbor Partners in 1997 after 19 years at Comshare. As Vice President of Product Development from 1987 to 1997, he was responsible for Comshares market-leading software products. From 1978 to 1987, he was responsible for Comshares time-sharing operations in the U.S. and Canada. He serves

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as a Director of: Bulbs.com, an Arbor Partners portfolio company in Worcester, MA; Xplane, a marketing services company in St. Louis, MO; ADG Software, enterprise software, Pittsburgh, PA; GoKnow, educational software, Ann Arbor; and Nanocerox. Mr. Gray received his Bachelors and Masters degrees in Mathematics from the University of Michigan.

Exhibit 2

Financial Plan for Nanocerox for 2003 and 2004

Tal Materials Summary Pro-forma Budget (cash-based) For Year 2003
In Thousands Revenue Expenses Operating Income

16

Q1
$45 $176 $(131)

Q2
$50 $190 $(140)

Q3
$129 $220 $(91)

Q4
$176 $250 $(74)

Total
$400 $836 $(436)

Tal Materials Summary Pro-forma Budget (cash-based) For Year 2004

In Thousands Revenue Expenses Operating Income

Q1
$220 $280 $(60)

Q2
$450 $310 $140

Q3
$390 $340 $50

Q4
$520 $370 $150

Total
$1,580 $1,300 $280

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Exhibit 3

The Nanotechnology Landscape

17

Exhibit 4

U.S. Market Size for Advanced Ceramic and Nanosized Ceramic Powders

18

U.S. Market for Advanced Ceramic and Nano-sized Ceramic Powders, 2002 and 2007 (Millions) 2002 2007 lbs $$ lbs $$ Advanced ceramic Nano-sized ceramic Total 895 23 918 $1,451 $155 $1,605 1129 49 1178 $2,054 $241 $2,286

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Exhibit 5

FSP Process

19

Exhibit 6

CONCEPT Process

20

Liquid

Vapor

Ceramic

Oxygen

~2000C

Growth Coalescence Nucleation Flocculation

By Products H2O & CO2

Atomized

Energetic Combustion

Particle Formation

Rapid Quench

Collection

Nanopowder Precursor

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Endnotes
1

Diameter of human hair ranges from 17 to 181 microns (millionths of a meter, 10-6meter). 1 meter = 1000 millimeters, 1 millimeter = 1000 microns, 1 micron = 1000 nanometers Source: BCC Research, April 2003 Nanocerox Business Plan Nanocerox Investor Presentation Board of Advisors and Nanocerox Management, Data from Silica Manufacturers Stimson, R., Global Orthopedic Markets: Bridging the Divide. Datamonitor, 2003. Gold, R, Healthcare: Products and Supplies, Standard & Poors Industry Surveys, March 2003 Wright, T.M. and Goodman, S.B. Implant Wear: The Future of Total Joint Replacement, American Academy of Orthopedic Surgeons Conference, Rosemont, IL, 1996. Piconi, C. and Maccauro G. Zirconia as a Ceramic Biomaterial, Biomaterials, 20, 1-25, 1999. Squeo, A. M, 21st Century Armor. Marketplace, Wall Street Journal, February 2003. Anonymous, Nanotechnology to Revolutionize War, International Herald Tribune, April 2003 Flint Ink Corporate Research and Government Estimates. www.dow.com. www.nanophase.com. Investor Relations, Financial Statements 2002 Nanocerox Business Plan Nanocerox Investor Presentation BCC, Inc. BCC, Inc. www.nanocerox.com Nanocerox Investor Presentation

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