Joseph Cross, President and CEO

• Welcome to our first quarter 2001 conference call. We appreciate your continuing interest and support. The Nanophase attendees for this session are: Dan Bilicki, VP Sales and Marketing; Dr. Don Freed, VP Business Development; Dr. Gina Kritchevsky, VP Technology and Engineering; Jess Jankowski, CFO and Corporate Controller; and Bob Haines, VP of Operations, who joined the company during the quarter.
  
  
• To review the quarter, Jess Jankowski will provide a financial summary of results …Jess……….

Jess Jankowski, CFO and Controller

• Good morning and thank you for attending.
  
  
• Beginning this quarter, in the interest of communicating better with our shareholders, we are going to review the Company's results and financial condition in more detail.
  
  
• For the first quarter of 2001, our revenues were approximately $1,072,000 versus approximately $619,000 for the same quarter in year 2000. The majority of our revenues continue to come from products. Please note that approximately $400,000 of first quarter 2001 product revenue related to the catalyst order that we discussed in our March 28th press release. We had had positive negotiations with that customer for some time prior to finalizing arrangements and were ready to fill the order immediately upon coming to terms. The timing of this revenue seems to have been a point of confusion to some of our shareholders.
  
  
• We had approximately $220,000 in gross margin for the first quarter of this year. This was achieved through a combination of favorable product mix and the fact that we are starting to see many of our manufacturing cost-saving measures coming through. We now feel that gross margins should remain positive through the balance of the year. The extent to which we remain positive, as a percentage of revenue, will be dependent upon revenue mix, revenue volume, and our ability to continue to cut costs. On the bottom line, we lost 8 cents per share for the first quarter of this year versus 11 cents per share for the first quarter of 2000.
  
  
• I would now like to spend a little time walking you through the major categories on the March 31, 2001 balance sheet:
  
  
• All numbers are approximate….

• At March 31st, we had $14.9million in cash and investments.
  
  
• Accounts Receivable amounted to $1.3million. 96% of our receivables were current. The reason that our receivables appear large in relation to sales are several:
  
  
  • First, we have an accrued receivable relating to a minimum royalty due us from a licensee, that amounts to $300,000/year and is accrued at a rate of $75,000 per quarter. Most of these monies are not due until the middle of this quarter. As the quarters go by, this builds our A/R and may lead people unfamiliar with this relationship to assume that we are not collecting on a timely basis. This receivable makes up 28% of our A/R balance.
    
    
  • Another reason is that receivables from BASF, currently our largest customer, amounted to 37% of our accounts receivable and have been historically shipped under 60-day terms. Through a series of negotiations, we have been able to reduce these terms to 30-days, beginning this month.
    
    
  • Another 30% of our A/R relates to the catalyst order that we filled at the end of the first quarter and discussed earlier. At this time we are not able to discuss customer specifics.

• What we can discuss however, is that Nanophase is confident that these customers, comprising approximately 95% of our receivables, are financially sound and will be paying us within proscribed terms.
  
  
• I'm sure that you have noticed that inventory has gone up by $500,000 between the end of 2000 and March 31st. This build-up was anticipated and strictly controlled by management. As a matter of fact, we originally planned to exit 2000 with more inventory than we actually did but were stymied by one of the nastiest winters in Chicago's history. On top of the December holiday schedule, we lost at least five shifts due to a combination of travel conditions and the weather's impact on utilities. In January, as many of you may be aware, BASF gave us an updated forecast that shifted much of our anticipated shipping schedule out, putting more weight on the 3rd and 4th quarters. In order to most efficiently manage resources, we will continue to build inventory in Q2 and through part of Q3 so as not to be placed in a "crunch" situation in the latter half of this year. 65% of our total inventory relates to this business. We continue to manage this situation closely.
  
  
• Nanophase, throughout our organization, remains focused on producing as efficiently as possible. When the time comes, we'll increase our capacity, via added manpower, to meet this customer's requirements….but, until then, we'd rather keep our overhead to a minimum. With the improvements made, our existing infrastructure can support this customer's current 2002 forecast.
  
  
• Switching gears to another key area of focus:
  
  
• Capital expenditures amounted to $1million dollars in the first quarter of this year. We anticipate spending an additional $6million in the balance of the year, depending on scheduling. These projects may take us into the first quarter of next year.
  
  
• Most of our spending is earmarked for three main categories:
  
  
  • The pilot manufacturing facility in Romeoville
  • The powder coating area in Romeoville (Includes upgrades to existing building utilities, like electrical power and related controls, and other things)
  • Planned capacity expansion to our Burr Ridge facility
    
    
• With respect to the powder coating area, our cash outflows are being offset by a $1.3million dollar loan from BASF upon which we have received roughly 50% and expect to receive the balance shortly.
  
  
• Another thing I would like to address on the March 31st balance sheet is the Company's roughly $1million dollars in long and short-term debt. 65% of this, which is currently classified as long-term, reflects funds received against the previously discussed $1.3million loan. The balance reflects insurance premiums that management elected to finance. Given our current view, we plan to exit this year with between $9 and $10million. That number is a little difficult to determine at this point in our year. Keep in mind that we are currently involved with several business development opportunities whose ultimate magnitude and impact on cash are difficult to gauge. We will update you from time to time if there are significant changes.
  
  
• Lastly, we have also had some increases in our accounts payable. This is mainly a result of both our building inventory and our capital-spending plan.
  
  
• Thanks for your attention, now I'd like to turn things back over to Joseph Cross, our President and CEO.

Joseph Cross, President and CEO

• Thank you, Jess
  
  
• To summarize first quarter 2001, the management team believes that the quarter was quite successful and provides a sound beginning to the new fiscal year. Despite the unexpected delivery rescheduling for sunscreen materials that occurred during the end of January, Nanophase was still able to achieve a 73% increase in revenues and reduce its loss by approximately 30% compared to the same period last year. Perhaps more significantly, the company was able to demonstrate a positive gross margin on sales of 21%, representing a 50% increase compared to the same period last fiscal year and an approximate 28% improvement to the previous quarter.
  
  
• Gross margin growth is largely due to the company's rigorous efforts over the last 15 months to reduce manufacturing cost through engineering improvements to the process and implementing world-class manufacturing techniques. We have now been able to reduce cost on major products by approximately 50% and increase output per reactor by 30-100% depending on the product. As a secondary, but equally important contributor, we have also been able to obtain higher margin business, primarily in environmental catalysts, and believe that we have additional opportunities to increase sales margins on products in several of the potential business development opportunities currently in process.
  
  
• Addressing infrastructure, we made progress to our plans scaling-up Burr Ridge to have capacity in place for current annual supply agreements and customer forecasts during 2001, as well as into early 2002 as far as we have visibility. The Romeoville upfit remains on schedule as we completed two additional labs and continued readying manufacturing capability for our proprietary nanopowder coating area targeted for June and the pilot area to supply large-scale dispersions and formulations to customers, which should be ready during July.
  
  
• We also executed to our manufacturing plan of building inventory to manage and perform to the projected increased revenue and delivery schedule during the third and fourth quarters of this year. Or goal here is to perform to the customers needs without spending the capital to add peak capacity capability or incurring unnecessary cost in overtime or other variable manufacturing expenses.
  
  
• In business development, we continue to demonstrate progress with a new long-term supply agreement for abrasion-resistant material for vinyl flooring and a new environmental catalyst application. We made sound progress in application engineering developing nanosolutions with lead customers in target markets and toward readying Audrey for commercial production during the third quarter.
  
  
• To elaborate on this topic, I would like Dr. Don Freed, VP Business Development, to provide an update on the company's business development activity, Don.

Dr. Don Freed - Vice President, Business Development

• Good morning - and thanks for your interest. Despite the economic slowdown, interest in the Company's capabilities to develop unique nanoparticle solutions continues to be strong. During the 1st quarter we initiated new programs in several market areas including environmental catalysts - you've probably read our recent news release on that, as well as transparent functional coatings and electronics.
  
  
• Today, I'd like to focus on our activities in developing transparent, functional coatings, - we believe the programs that we are initiating now will contribute significantly to our revenue and profit targets for 2002 and 2003. But before I do this, I'd like to briefly remind you of just how the Company's business development activities are organized and how we select opportunities.
  
  
• We use two very important criteria to evaluate potential - time-to-market and value - value both to the customer and value to Nanophase. Our time-to-market criteria are 12 to 18 months from project inception to commercial production - and, because our materials are not commodities, but higher priced, uniquely engineered products, our value criteria require that customers gain significant performance advantages from using our nanomaterials.
  
  
• Now, getting back to transparent coatings, let's translate the value criteria to several programs. Nanophase has developed the capability to incorporate nanocrystalline aluminum oxide into a broad range of materials for application such as wear-resistant coatings - we've now taken the technology originally developed for wear-resistant flooring into several new products - We're working with a large manufacturer of specialty fabrics to increase the wear resistance of ballistic nylon and polypropylene - and gained a threefold improvement just by incorporating our nanoparticles into this particular customer's fabric coatings - we haven't changed that material substantially - in fact, because of the small size of our particles, the coating is practically invisible, but products made using this new material should have much better durability and we expect to be selling into this application later this year. We're also co-developing together, with one of the world's largest household appliance manufacturers, transparent wear-resistant protective coatings capable of withstanding elevated temperatures and with more than half a dozen additional companies in applications as diverse as scratchproof coil coatings to wear resistant floor polishes and we expect many of the above-identified opportunities to be realized during the next eighteen months.
  
  
• By focusing our know-how in a concentrated area, we're increasing our chances of success - as we deliver more application solutions to customers, we gain more in-house knowledge (which we protect by filing for patents) and more experience which allows us to tackle more complex problems and most importantly, reduce our time-to-market. And, our available market also grows - to many times that just for the initial applications, which when we started we estimated at $25 - $30 million - we believe the current opportunity in wear-resistant coatings to be more than double that and growing rapidly - in fact, we believe that some day, nanoparticulate-based wear-resistant coatings will form the basis for a separate business unit within Nanophase.
  
  
• Bear in mind that we're not ignoring our other potential and on subsequent calls, we'll cover additional developing market areas so that before very long you'll have the total picture.
  
  
• Now, I'd like to turn it back to Joe Cross - Joe…

Joseph Cross, President and CEO

• Thanks, Don. Following in line with business development initiatives, Dan Bilicki, vice president of sales and marketing, will now summarize the company's progress during the first quarter. Dan…

Dan Bilicki, VP Sales & Marketing

• As reported, revenue from Q1 was $1,072 million with $980K or 91% being derived from sales of products. Compared to Q1 of 2000 this is an increase of 73% in revenue and a 101% increase in product sales.
  
  
• Nanophase consistently generates a majority of product sales from the 4 key market segments that include Personal Care, Transparent Functional Coatings, Catalysts, and Ceramics including Thermal Spray. For Q1 2001, of the $980K in product sales 96% were generated from these 4 key market segments.
  
  
• I would now like to provide an update on the progress of product sales by market segment for Q1 and an outlook for Q2.
  
  
• In the Personal Care market segment inventory adjustments and rescheduling off take of ZnO to personal care applications resulted in lower that expected sales volume for Q1. Sales volume of ZnO into the personal care market is expected to exceed last year by 37% resulting in strong demand in Q3 & Q4.
  
  
• Good progress has been made in on the installation of a material handling and proprietary surface treatment system that will allow Nanophase to end our dependence upon a third party and surface treat the ZnO in house. Surface treated ZnO from the Nanophase facility will be shipped to customers for their approval in Q3.
  
  
• As mentioned during last quarter conference call we have 2 other non-ZnO personal care initiatives underway. One of the programs is in the trial stage and is expected to move to the product sales stage in the fourth quarter of this year. The other program proposal is currently under review by senior management with approval expected in Q3.
  
  
• Nanophase has made progress in taking ZnO to horizontal markets outside of personal care; we expect to start selling ZnO into the electronics market in Q3.
  
  
• Transparent functional coating market segment has the highest level of product testing activities of all 4-market segments. As reported last quarter Nanophase has signed up 2 agreements with separate customers for flooring applications. The larger of these two customers has delayed their launch due to circumstances beyond their control. A meeting is scheduled in May to discuss rescheduling the new product launch. Sales revenue for this application has not been included in our current forecast for 2001.
  
  
• Sales to Catalysts applications continue to grow as the company has announced sales of $400,000 to a new environmental catalyst application in Q1. The nano crystalline material provided will be used for large-scale tests. Although this development effort is still in the early stage we expect that significant additional revenues will be generated in 2001 and beyond.
  
  
• In ceramics, Nanophase is currently working with lead customers and leading centers of thermal spray excellence to test and provide comparative analysis of the performance of our products in thermal spray applications. The development of nano chrome oxide for thermal spray applications is proceeding on schedule.
  
  
• In Summary: Q1 product sales were significantly ahead of Q1 last year. An initial sale of product into a new environmental catalyst application is a very encouraging development. Product sales for Q2 are expected to exceed Q1 by 50% as sales volume of ZnO into personal care applications returns to forecasted levels.
  
  
• And now back to Joe

Joseph Cross, President and CEO

• Thanks, Dan. Now, Dr. Gina Kritchevsky, vice president of Technology and Advanced Engineering, will summarize the company's quarterly technology achievements, Gina.

Dr. Gina Kritchevsky, VP of Technology and Engineering

• Good morning.
  
  
• During the first quarter of 2001 we have continued to focus much of our advanced engineering efforts on Audrey. For any newcomers to our conference call, Audrey is a new nanoparticle production technology that we have been developing over the past nine months. The goal is to enable us to broaden the range of nanomaterials that we offer in the marketplace and to produce these materials at significantly higher rates than PVS with a wider range of feed materials. During the quarter we have screened over a dozen candidate materials. We continue to be extremely encouraged by both the results and the progress to date. Depending upon the feedstock and the product, rates have varied from two to 10 times the rates for the same material produced by the PVS process. In many instances, the cost of the raw feed material has also been substantially less expensive than the wire and rod feed used in PVS. In several cases, the feed materials have been half or less than half the cost of the feed for PVS.
  
  
• The experience gained in the course of the screening experiments has provided additional insight into the Audrey process. In the second quarter we will implement the equipment and process design improvements derived from our experiences during the initial trials, and will begin to commercialize Audrey processes for several selected materials.
  
  
• Nanophase currently relies on two major complementary core technologies. The first is nanoparticle production and we constantly work to broaden both the range of nanomaterials we produce and the processes that we are able to use to manufacture these particles. Our second core technology involves tailoring the chemistry of the particle surface and the interfacial region between the particles and the material that the particles are imbedded into. This also includes controlling the interactions between particles and the dispersion of the particles into a formulation liquid.
  
  
• Several breakthroughs in our Application Engineering labs during the quarter will enable us to make better particle dispersions and coatings in addition to providing some novel particle chemistries. We expect these breakthroughs to develop into new products during the year. We have also been active during the first quarter in protecting the intellectual property that we have developed in both these core technologies and for applications of our products.

Joseph Cross, President and CEO

• Thanks, Gina. Now, I would like to introduce Bob Haines, our new vice president of operations, who will give an update on our manufacturing team and the achievements in the first quarter.

Bob Haines, VP of Operations

• Nanophase is the industry leader in making industrial quantities of nanomaterials, with current manufacturing capabilities of producing at an annualized rate of over 400,000 kilograms. At this level, we have certainly demonstrated that Nanophase has robust manufacturing processes capable of delivering high volumes of quality nano powders.
  
  
• Nanophase had a very strong quarter in terms of our ability to manufacture and deliver high volume, high quality nano powders. Using a lean manufacturing approach focused on continuous improvement, our manufacturing and process engineering team made significant progress in terms of process optimization, reducing manufacturing costs and a notable increase in the productivity of existing manufacturing processes.
  
  
• During the first quarter of this year, our customer service rate was greater than 98.5%. This is a measurement of our actual delivery performance versus commitment as viewed from the customer's perspective. The overall variable manufacturing cost per kilogram of high volume product was reduced by 21% as compared to the last quarter of 2000. In addition, process output in terms of kilograms per hour produced was improved by over 50% without adding additional reactors. With these output improvements, we are able to ramp up zinc oxide production to meet increased third and fourth quarter customer requirements without significant additional capital.
  
  
• Early in January, we introduced a Manufacturing Score Card that focused our operations on real time management of five critical manufacturing performance metrics,

  • Quality / Customer Satisfaction
  • Safety
  • Cost
  • Capital Utilization
  • Productivity

• We know every shift, every day where we are in terms of these critical performance measurements and where we should be focusing our attention and resources. Our objective is to set the right aggressive goals, frequently measure and communicate our performance against the goals, and continuously improve our manufacturing operations in those areas that actually create value as perceived by our customers.
  
  
• During the first quarter, our Burr Ridge plant was recertified as an ISO9001 manufacturing facility and maintained cGMP status for Zinc Oxide products for the health care industry. Going forward, we will obtain a similar status for the Romeoville coating facility once it is commissioned and producing production quantities of coated zinc oxide.
  
  
• Over this year, we will be bringing on-line additional production capacity for environmental catalysts and precursors for abrasion resistant coatings. We will continue to develop our lean manufacturing approach with a focus on agility to meet our developing customer requirements; having the right manufacturing capacity at the right time with unquestionable quality.
  
  
• Going forward, we will continue to reduce manufacturing costs, improve process yields, and productivity and delight our customers.

Joseph Cross, President and CEO

• Thanks, Bob.
  
  
• Looking forward into the second quarter, we expect that revenue will increase by at least 50% from first quarter 2001 while variable manufacturing cost and variable expenses will continue to decrease due to continuing aggressive management efforts in those areas. We also expect to close some of our existing business development opportunities during the second quarter, which we believe will contribute to revenue in 2001 and 2002.
  
  
• For this fiscal year, we remain comfortable with our current revenue forecast of approximately $10 million, which would be about 2.4 times 2000 revenue, or an increase of 140%.
  
  
• This concludes our prepared comments. Let me remind you that our comments will be available on our web site, www.nanophase.com, on or about Friday, April 27. We are available for any questions you may have.

FIRST QUARTER CONFERENCE CALL 04-26-01 QUESTIONS & ANSWERS