Annual Reports

Dear Fellow-Shareholder:

1998 was obviously a difficult year for the company. The strategy and actions that the company had been following have not produced the results that we as shareholders expect. Knowing that one definition of insanity is doing the same things repeatedly and hoping for different results, it was equally as obvious that a fundamental change in company strategy was crucial. For that reason, I will not dwell here on what has been, but rather what will be - the real potential and promise of Nanophase.

In the four months since my appointment as CEO, we have significantly changed our business model and attracted two seasoned executives to build the organization and implement the changes necessary to position the company for growth. We have also been fortunate to recruit Donald Perkins as the new Chairman of the board and to attract two new directors, Jerry Pearlman, retired Chairman of Zenith Electronics, and Edward Hagenlocker, retired Vice Chairman of Ford, and strengthen the company’s governance. This team is committed to grow the company and increase shareholder value.

Nanophase is being restructured to successfully penetrate the multiple vertical markets that are ripening for nano applications. In many cases, products developed to satisfy a vertical market need have significant applicability across similar or horizontal markets. For instance, materials used in conductive coatings also have applicability for antistatic coatings and conductive strip carriers for color toners. Within this spectrum, there is a variety of need drivers that compel potential customers to consider our technology. We are now focusing on, and will continue to emphasize, those markets where our science and materials represent a technology break-through and become enabling to the user - there is a clear need.

To drive acceptance in multiple targeted markets, Nanophase is required to become a ‘solution-provider’ to establish the empirical use and demonstrate the value of its technology. In most cases, there is a performance standard to be met or a processing condition to be achieved. It is not enough to have the base nanocrystalline materials; we must co-develop and co-implement nano-solutions for these needs in tandem with our customer. We must understand our customer’s markets and their specific requirements to successfully provide increased value. To do this, we will partner with market leaders to nano-engineer the specific formulation for the process or product, gain valuable market knowledge quickly, and reduce the time-to-market of our products.

To implement our market penetration strategy, Nanophase is forming skilled multidisciplinary teams that work actively with customers to fulfill specific needs. We are taking a more ‘hands-on’ approach to successfully introduce and embed our materials in customer applications. We strengthened our management team in Technology and Sales/Marketing early in 1999. We will increase our technical capability to nano-engineer direct customer applications, and expand our business development and sales staff to identify and quickly develop opportunities and increase our ability to manage our customers.

In parallel, we will actively seek to augment our own patented technology with new nano technologies that are being created on a global level. Nanophase is in the materials enhancement industry where it provides a molecular manufacturing service for customers to make their products or processes more effective in current applications, capable of performing innovative new functions, or less expensive in current applications. Customers do not really care how these material enhancements are performed as long as the resulting material(s) improves their products, strengthens their processes, or reduces their cost.

As a nanomaterials company, our interest is to gather core technologies that provide the capability to service multiple markets and the technical basis for significant company growth. Our interest is not to supply raw precursor materials that must be formulated for applications, but to move up the value chain and supply the fully-engineered material. Nanophase has situated itself as a pioneering leader in the top-down nanomaterials production market for material-enhancing formulations. I am committed to the ongoing development of technology to nano-engineer customer solutions and the drive to achieve the results that we as shareholders expect.

Although I believe that 1999 will provide a number of positive results in refocusing and restructuring the business, reducing time-to-market, and increasing revenue growth, I do not expect that the full impact of our efforts will be realized until 2000. My goals for 1999 include: creating a new and highly experienced management team; increasing the size and effectiveness of the sales and business development group; expanding and organizing our research and development capabilities to focus on target markets; refocusing and restructuring the organization to deliver solutions; and implementing the pilot production capabilities required for our customers. Through these efforts, I believe that we will have the necessary resources in place to execute and perform.

The events of this coming year will lay the groundwork to allow Nanophase to emerge as a leader in nanomaterials and truly fulfill its potential. Our new business model will provide internal focus and should allow the company to quickly move from the opportunity stage into manufacturing revenue realization. We believe that these efforts will be realized by a growing revenue ramp throughout late 1999 and, more specifically, into 2000. We will penetrate more market opportunities faster and with more success by focusing on the customer and nano-engineering a solution for their needs.

We intend to build this business on solid revenues that are based on proving the value of nanomaterials and recurring, long-term relationships. We fully expect that the company will have the necessary foundation for desired growth in the new millennium. We thank you for your continued support and wish to assure you that your allegiance and loyalty will be rewarded as we build shareholder value.