Annual Reports

To Nanophase Shareholders:

Accompanying this letter is our Annual Report for the year ended December 31, 1997. The Annual Report includes management's discussion and analysis of the results for the year.

Since our inception eight years ago as a technology spin-off from Argonne National Laboratories, we have been pursuing the challenge of commercializing one of the world's most important new technologies: molecular engineering of advanced materials that offer the potential to set new standards for high performance in a wide range of high-value commercial applications.

In the early years, we ramped up our manufacturing technologies to commercial scale and established a viable manufacturing facility. More recently, we identified and entered four application areas that we believe offer substantial potential for future growth: electronics, structural ceramics and composites, cosmetics and skin-care, and industrial catalysts.

To penetrate these application areas quickly and effectively, our strategy has been to enter into collaborative relationships with industry leaders in order to validate the capabilities of our materials and to coordinate the development and introduction of commercial products. The major effort to establish these collaborative customer relationships began in 1996 and, at the end of that year, we had collaborative relationships in all of the targeted application areas and we had a total of 11 customers. However, our revenues for 1996 were still quite small (approximately $600,000).

Our goals in 1997 were to (1) increase the number of customers, (2) begin a rapid ramp-up of the revenues, and (3) begin the transition from developmental revenues to revenues from product sales. From an operating standpoint, the results for 1997 were quite gratifying. The number of customers increased fourfold to 44, revenues increased more than sixfold to $3.7 million, and a significant portion of those revenues (approximately 24%) were derived from the sale of products.

A substantial amount of revenues that had been expected in the fourth quarter were not realized for reasons which were mostly related to economic uncertainties in Asia. However, we continue to be optimistic about the long-term potential for the Asian markets, and about the long-term potential for each of the application areas that we have entered.

Our goals for the current year are to achieve further rapid growth in our customer base and revenues, and to make further progress toward long-term profitability. These goals, and our plans for the longer term, will be discussed in more detail at our meeting of shareholders on June 10. We hope that you will be able to attend.

Sincerely,

Robert W. Cross
President/CEO