FIRST QUARTER 2004 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to the Nanophase conference call to review the first quarter for 2004. Jess Jankowski, chief financial officer, and I will be hosting this session.

• To begin the review, Jess will summarize the financial highlights. After which, I will return to discuss the first quarter and provide a brief overview of certain business and market development initiatives.

• Jess, would you please begin the financial review?

Jess Jankowski, Chief Financial Officer

• Good morning and thanks for your continuing interest in Nanophase.

• As I review the financial performance of the Company for the first quarter, I‘ll continue to do so at a strategic level. More details are included in the financials accompanying our press release of April 21st.

  All numbers will be in approximate terms for ease of discussion.

• Total revenues for the first quarter of 2004 were down $370K compared to the first quarter of 2003.

• For the periods presented, Other Revenue was down $90K. This decrease in Other Revenue, when compared to the first quarter of 2003, related to the sale last year of a PVS reactor to C.I. Kasei, our Japanese licensee, offset by the first quarterly payment of $150K in technology development funding from Rohm & Haas Electronic Materials. This funding from Rohm & Haas is part of its $600,000 commitment to support Nanophase’s efforts in jointly developing slurry products for current and future semiconductor technologies.

• For the periods presented, product Revenue was down $280K. Although sales of sunscreen and personal care materials were above expectations, and up relative to the fourth quarter, they were down $160K relative to the first quarter of 2003. It should be noted that the first quarter of 2003 accounted for 33% of total 2003 zinc oxide volume and exceeded sales of the next highest quarter by almost $300K. Also, sales of CMP materials were down by almost $160K quarter to quarter. This reduction, relating to CMP materials, was largely offset by the previously discussed technology development revenue in this quarter.

  These types of fluctuations underscore the limited visibility that management has relative to customers and markets.

• At current revenue levels, with the contribution from Other Revenue, we have generated a modest positive gross margin. Our margins have been impeded by not having enough revenue to absorb the manufacturing overhead that’s required to work with the customers we have and the new ones we expect to have. A large part of this infrastructure cost involves depreciation and our quality systems and people who support compliance with FDA and USP standards for sunscreen materials, as well as the exacting performance requirements of the electronic chemicals industry for CMP materials.

  Currently, the depreciation relating to the operations group, including manufacturing and quality, amounts to $250K per quarter, or about 20% of our cost of revenue. It’s important to note that Nanophase’s existing manufacturing infrastructure can support a multiple of 2003’s volume without significant augmentation. This means that we expect our variable margins to drive the expansion of our gross margin, and we believe this will occur as volume grows.

• R&D Expenses and SG&A Expenses were relatively flat quarter to quarter. Generally, health care expenses were up while legal fees were down and the D&O insurance premium decreases we discussed during the year-end call have begun to come through.

• In total, the Company lost $0.09/share this quarter versus $0.09/share for the same quarter last year. Note that depreciation amounted to about $0.02 cents per share or $350K of the Company’s loss for the first quarter of 2004.

• Moving to the balance sheet, Nanophase ended the first quarter with $14.8 million in cash and investments compared to about $5 million at the end of 2003. The increase in cash and investments was primarily related to two things:
  • First, former officers of the Company, in some cases to avoid looming expiration dates, exercised stock options resulting in proceeds to the Company of approximately $1.2 million, and;
  • The Company received a $10million investment from its new German partner, Altana Chemie, in return for common stock that will remain unregistered for a two-year period from the March 23rd closing date. Joe Cross will elaborate upon this later in the call.

• Looking at A/R, less than one percent of our $930K balance is past due. Ninety-eight percent of the total is made up of receivables from our three largest customers: BASF, Rohm and Haas Electronic Materials, and C.I. Kasei. These same customers accounted for 74%, 15% and 6% of our first quarter 2004 revenue, respectively.

• As you can see, inventory balances have increased by 5% to $717K. Approximately $125K of this total represents raw materials with the balance being finished goods.

  Given the Company’s Lean Manufacturing discipline, it’s a priority to keep inventory levels as low as possible while still maintaining the ability to respond to requests for material volumes beyond what has been planned. This balance may fluctuate based upon product revenue mix, materials lead times, and the overall economics of batch production of various materials. Management continues to minimize required working capital by holding inventory growth to a practical minimum.

• Equipment and leasehold improvements for the first quarter of 2004 amounted to only $14K, bringing the total balance, that’s net of accumulated depreciation, to $7.9 million. Most of the current equipment and leasehold improvements on the balance sheet were built during the period from the latter part of 2000 through mid - 2002.

  The Company expects that its known capital needs for 2004 will be somewhat greater than the $220K that was spent for all of ’03, but at this point unknown factors, including current and future customer demand, make an exact amount of anticipated capital need difficult to determine.

• On the liabilities side, adding the current and long-term debt and lease obligations together, the Company has about $1.1 million in total debt. Approximately 75% of this represents the note in favor of our largest customer for equipment to produce sunscreen nanomaterials, which, you may recall, we pay back on a per kilogram shipped basis. Most of the remaining balance relates to financed business insurance premiums.

• Payables were up from the end of the year mainly due to differing payout cycles. Accrued expenses were up $110K. Highlighting the largest categories of accrued expenses, 41% of the total relates to accrued compensation items and 21% relates to accrued professional fees.

• Looking at additional paid-in capital, you‘ll notice that it has increased by $10.4 million since the end of 2003. This is due to the previously discussed exercises of options by former officers and the March 2004 investment by Altana Chemie, net of offering costs.

• Thank you for your attention, now I'd like to turn things back over to Joe Cross, our CEO.

Joseph Cross, President and CEO

• Thank you, Jess. Since our last conference call was only one month ago, I intend to provide a concise summary of business and operational progress. Obviously, it has only been a brief time since our last discussion.

• As an overview, Nanophase had a solid first quarter both in performance and business development initiatives. The Company continues to make substantial progress in its technology development and evolution, building our intellectual property portfolio, and, we believe, increasing or maintaining our lead in nanomaterials technology. During the last quarter, actually during the last two quarters, we have also made considerable progress in business development that is focused on building revenues during 2004-2006.

  In regard to the latter, given the sensitivity of our business development partners and the prudence of maintaining confidentiality for specific application developments from potential competitors, we tend to avoid details of the breath and depth of business development. Suffice it to state that for the last eight months, business development activity has been robust and the Company has made significant progress on several fronts. We are both pleased and optimistic about our current level of initiatives and opportunities.

• On a more specific basis, relative to intellectual property, there have been two noteworthy events since our last call:
  • First, as permitted under applicable law, an unidentified person or company has requested that the US Patent Office re-examine our most recently granted patent that covers certain aspects of the NanoArc™ synthesis process. Understand that until some action is taken, the patent is issued and remains valid. At this time, the Patent Office has not agreed to reexamine the patent, but may at some time in the future. We view this as competitive posturing and believe that even should the Patent Office ultimately decide to re-examine the patent, most of our claims about the patented invention will survive largely intact. We do not view this as a serious challenge to the legal protection of our NanoArc synthesis technology nor the proprietary technology that surrounds this patent.

  • Additionally, we filed a provisional patent application that discloses technology where engineered nanoparticles are employed to control the properties of composite systems. The nanoparticles enable a wide range of composite properties to be application tailored including glass transition temperature, transport properties, and mechanical properties. The applications we envision include catalysts, personal care and sunscreen ingredients, polymer additives, coatings, and others. We believe that this technology is fundamentally important to broad targeted market applications and adds to Nanophase’s lead in nanomaterials technologies.

  • Lastly, the Company still has several pending patent applications, both US and foreign. We believe that these should begin issuing during 2004. In addition, we have approximately three additional patent applications that we currently plan to file during 2004.

• Reviewing operational progress, which includes manufacturing, and advanced and process engineering; we are implementing the process and manufacturing improvements that we discussed on the last conference call.

  • Based on the process innovation developed during last year, we are increasing PVS reactor output 20-30% for volume products without capital costs. Ignoring facility cost, Nanophase will add the capability equivalent to almost $1 million of current reactor capacity and output for little to no capital investment. Since we began focused process improvement in late 1999, we have increased PVS reactor output almost 8 times the initial rates.

  • We are also completing implementation of a work cell re-engineering scheme in Burr Ridge that reduces our reactor labor requirement by about 25%. To put this in perspective, since we began instituting state-of-the-art manufacturing practices in Nanophase in 1999, we have now reduced labor content and cost per reactor by a total of over 80%.

  • As we discussed on the last conference call, since 1999, Nanophase has reduced total variable manufacturing cost by about 2/3, or almost 70%, and improved equipment output with resultant growth in variable product gross margins.

  • We believe that there are significant points to the Company’s continuous improvements in technology and manufacturing that include the following:
    • First, these repeatedly demonstrate that the Company’s technology is robust and commercially scalable, with improvements continuing to increase or maintain Nanophase’s technology leadership and competitive position;
    • Secondly, these improvements facilitate future volume growth with significantly reduced capital investment;
    • Thirdly, they cumulatively position the Company for expected improved financial performance with increased revenue and product volume.

  • Relative to our NanoArc™ synthesis process, we are continuing to develop new materials on a prioritized schedule based on target market demand or market-driven development project agreements with our customer partners. We expect to be announcing new nanomaterial availability periodically through the end of the year.

• Turning to market and business development, our new marketing identity campaign entitled “Driving Product Innovation, TODAY” is showing positive results. Our improved web site has been further enhanced during the first quarter relative to identification capability by major search engines and we are seeing approximately double the site visits. This has increased contacts and potential application opportunities to Nanophase. In parallel, we have placed banner ads on Small Times, a leading nanotechnology internet site and magazine publisher, and our first identity print ad appeared in Chemical and Engineering News during the week of 4/19. Additional ads are planned for targeted publications throughout 2004, especially around nanotechnology publication features. Coupled with industry conference participation and attendance, we believe that the marketing effort is increasing Nanophase’s identity and recognition, and, in response, our business development activity.

• In the business development arena, obviously the lead item is our recently announced partnership with Altana Chemie. We believe that this relationship is a key event for Nanophase and definitely provides global entrée to certain large potential markets that Nanophase previously has had difficulty penetrating. The strategic partnership plans to develop nanocomposite products for markets including: paints, coatings, inks, polymers, plastics, overprint varnishes, and electrical insulation. Each of these applications and markets, we believe, represent quite significant opportunities for revenue growth for both Nanophase and Altana. We also firmly believe that our partnership with Altana will reduce Nanophase’s time-to-market in the noted application areas and become a significant driver to the Company’s future revenue growth.

  Altana enjoys a pre-eminent presence in its markets and is one of the top chemical ingredient companies in Europe having grown their business by 18% per year while maintaining an operating margin of 20% EBITDA over the last 10 years. With this partnership, Altana’s strategic objective is to further accelerate growth by providing innovative products that utilize Nanophase’s nanomaterials. Altana’s commitment to this relationship is exemplified by its $10 million investment in Nanophase, which demonstrates Altana’s confidence in the Company’s technologies, manufacturing capabilities, and employees.

  At the current time, this partnership has products containing nanoparticles or nanoparticle dispersions in eight different end use applications with several of these products undergoing customer testing. We expect this already robust product development effort to enlarge over the coming quarters during joint market and technical planning meetings. We currently expect initial market introduction of nanocomposite products during the second half of 2004.

• Moving to our partner in the sunscreen and personal care business, BASF, there are now three aspects to the relationship: the continuing sunscreen business, a second generation sunscreen, and development of personal care products. In regard to the current sunscreen product, we are continuing to see progress in current sunscreen formulations and sales. During the first quarter, sunscreen sales were above expectations entering 2004 with some indications of a potentially continuing trend in the second quarter. It is too early to state the impact for the entire year, but the early trend, which is above the 2004 annual purchase order level, is encouraging.

  The development of the second generation sunscreen coated nanomaterial continues on track. The provisional patent application I mentioned earlier relates directly to this product. We continue to expect market introduction during the last quarter of 2004.

  Under a joint development agreement, BASF and Nanophase are collaborating on a personal care application, which may see initial market testing during the last part of 2004. However, in a development project, do understand that timing is always difficult to predict.

• Continuing in the personal care market, we have signed a new product development agreement with a $1B company to co-develop personal care products, apart from those we are collaborating on with BASF. The first development project is underway, while a second project is currently being defined and characterized. We view this relationship as a major market opportunity for Nanophase.

• In the fine polishing market, we continue to focus on CMP for semiconductors, hard disk drives, optics, and photomasks. Since we covered this area thoroughly about 30 days ago, I am only going to provide a brief summary. Our partner, Rohm & Haas Electronic Materials – CMP Technologies, formerly Rodel, continues to makes solid strides in penetrating two major wafer technologies within CMP – STI and SON technologies. RHEM has a dynamic market introduction effort in the US, Asia, and Europe with approximately 19 semiconductor fabs in various levels of testing and trials. RHEM is continuing to improve the performance of the slurry product and testing is showing extraordinarily low defectivity data relative to current industry product performance.

  We also continue to plan development of a second slurry product, which is underway, and believe that initial market testing should occur during late 2004. We have a market review meeting with our partner scheduled during May and I will be able to provide a better picture of market introduction activities during the next conference call.

• In hard disk substrates composed of glass and/or ceramic materials for the next generation of disk drives, we continue to make definitive progress in co-development with a market-leading manufacturer. We have advanced to a second round of development testing since our last conversation and expect this effort to continue in a positive manner. Again, I expect to be able to provide more color on this during the next call.

• Continuing in fine polishing, our foray into polishing fine optics continues to be positive. The manufacturer of polishing equipment that I mentioned on the last call has decided to standardize on our nanoparticle dispersion for all lines of equipment by summer and will be a routine customer for the Company. Additionally, a manufacturer of high quality lenses for an application that we are not at liberty to divulge, has also standardized on Nanophase’s nanoparticle dispersion for polishing and will now be a routine customer. Both of these represent new customers and new applications for the Company.

• Our other business development initiatives are robust, remain on track, and the Company is continuing at a high level of business development activity. In addition to those already discussed, we have several initiatives in multiple market areas that are progressing and we are continuing to experience increased new interest across several market areas. Based on our initiatives in progress, we expect the level to likely increase throughout 2004. We hope to be able to be somewhat more specific on some of the developing new opportunities by mid-summer or early fall.

• Considering business development and revenue growth going forward, let me just note that the Altana partnership, coupled with BASF in sunscreens and personal care, and Rohm & Haas in semiconductor CMP, offers global access to significant markets that we believe should provide a solid foundation for revenue growth and financial performance for Nanophase. These partnerships align the Company with a dominant partner in key markets, each of which has global presence and technical service, as well as a large, established customer base. We are pleased with our large market partners and optimistic about revenue growth in each area as we progress.

  We fully expect to add other opportunities and market partners to this foundation as we move forward. Several of these are in development, but their nature is confidential and we are unable to elaborate at this time.

• That concludes our prepared remarks. We are available for questions at this time.