THIRD QUARTER 2001 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to our conference call for the third quarter of 2001. The Nanophase attendees for this session are: Dan Bilicki, VP Sales and Marketing; Dr. Don Freed, VP Business Development; Dr. Richard Brotzman, VP R&D; Jess Jankowski, CFO and Corporate Controller; and Bob Haines, VP of Operations.



• To begin, Jess Jankowski will review the financial results for the third quarter and the consolidated nine months of 2001. After which, I would like to comment on the company's progress during the quarter and highlight those actions that drive company growth and financial performance. Following my comments, Dan Bilicki will provide an update on the company's business development, sales, and marketing activities. After which, I will return to comment on activities and expectations for the fourth quarter. Jess…..

Jess Jankowski, CFO and Controller

• Good morning and thank you for attending.



• At this time I'd like to review third quarter financial results. Remember, all numbers are approximate.


For the third quarter of 2001, gross revenues before adjustment were $1,081,000, with net revenue being $680,000, versus net revenue of $1,049,000 for the second quarter of this year. This decrease in revenue was principally related to the reversal of a $400,000 sale that was originally recorded in the first quarter of this year. The sale was appropriately recorded. All terms of the sale were discussed with our auditors in advance, and recorded in accordance with generally accepted accounting principals for such transactions. Terms included transferring title to the product to the customer in Q1, however, Celox and its affiliates (the customer in the UK we previously referred to), never gave the company instructions for shipment or any other disposition of the product by July of 2001, as it was contractually obligated to do, ostensibly due to delays in the availability of their warehouse. Celox also failed to meet contractually required payment terms previously agreed upon. In the opinion of management, developments in Q3, and developments as late as an October 16th conversation with them where it became clear that the timing of payment was unsure, now have raised significant uncertainty as to whether Celox will ever pay for the product it bought. Accordingly, management decided, again, after discussions with our auditors, to reverse this revenue in the third quarter.

We are all living in difficult economic and turbulent social times. Although we recognize that this adjustment is disappointing, developments in the Celox transaction occurring during Q3, and during subsequent finalization of the results in mid-October, now make reversal of the previously reported revenue from the Celox sale appropriate.


• Cost of sales exceeded sales by $463,000 for the third quarter of this year. This was a result of several factors. First and foremost, the sale reversal resulted in a net hit to the gross margin of $212,000. Additionally, Nanophase used the month of July to make vital long-term improvements to the factory and the Company's patented PVS reactors. These improvements were targeted to improve output rates and product quality, as well as to further reduce manufacturing costs. As a result, Nanophase did not produce any material in July. Given that Nanophase had excess inventory remaining due to changes in customer demands, the Company also felt that not producing for a period was prudent. The downside of the depletion of inventory over the third quarter is that excess labor as well as unabsorbed fixed overhead costs had to be contended with. This is a function of our need to reduce inventory levels that were originally built to annual customer forecasts that, unfortunately, have since been reduced, as discussed earlier in the year. Fourth quarter gross margin is difficult to predict at this time, for reasons, including the fact that customer requirements schedules for the balance of calendar 2001 will not be fixed for several more weeks.



• On the bottom line, we lost 10 cents per share for the third quarter of this year versus 9 cents per share for the second quarter of this year, and 5 cents per share for the third quarter of 2000. Earlier in this presentation, I discussed comparative revenue between the current quarter and last quarter, versus the third quarter of 2000, the previous year. This was done to highlight the unusual events in Q3 of 2000. That quarter was anomalous in that revenue for that period reflected a bulge in orders for catalyst and sunscreen materials.



• For the nine months ended September 30, 2001, adjusted revenues were $2.8million, versus $3.1million for the same period in 2000. The majority of Company revenues continue to come from products.



• You may have noticed that SG&A expenses were up by about $500,000 for the nine months ended September 30, 2001 versus the same period last year. The bulk of this is due to costs relating to our new facility in Romeoville, rising expenses relating to business insurance, and our addition of a Vice President of Operations. These costs were partially offset by a reduction in bad debt expense.



• With respect to earnings per share, Nanophase lost 28 cents per share for the nine months ended September 30, 2001 versus 26 cents per share for the same period in 2000. The management of Nanophase is committed to driving down discretionary costs, and, in the last six months, has taken strides to do so. We anticipate that the results of these cost decreases will be reflected in the financials for fiscal 2002.



• I would now like to spend a little time walking you through the major categories on the September 30, 2001 balance sheet:



• At September 30th, Nanophase had $8.9million in cash and investments.
• Accounts Receivable amounted to $961,000.
• Inventory has stayed relatively flat, at $2million, between the end of last quarter and September 30th.
• As discussed previously, much of this build-up was anticipated and controlled by management. 36% of the 9/30 inventory relates to product or materials for the Company's largest customer. We expect this amount to decrease as we complete required fourth quarter shipments.
• An equivalent amount of the 9/30 inventory relates to both raw and finished goods built in order to satisfy demand that Celox had represented to the Company for 2001 but which did not materialize. In the third quarter, we had an additional $290,000 of raw materials coming in to support this same business. The reason that Nanophase has accumulated as much of this material as it has is that the lead-time for the product Celox represented it planned to order, from start to finish, is between three and four months. We believe that this raw material is saleable and, given that demand does exist for it, will be eliminated from inventory, as sold, throughout 2002. We intend to reduce current inventory levels by 10-20% by the end of 2001. We continue to manage this situation closely.



• Changing to another key area of focus, I would like to discuss capital expenditures. Beginning in late 2000, the Company embarked on a specific capital plan to build capabilities that were absolutely vital to allow the Company to grow, and improve manufacturing costs. Capital expenditures have amounted to $5.4million dollars, according to plan, in the first nine months of this year. Again, according to that same plan, the Company anticipates spending an additional $1million in the balance of the year.



• Moving further down the Balance Sheet, Nanophase currently has $1.7million in long and short-term debt. $1.3million of this total represents long-term debt relating to the previously disclosed loan from a customer.



• Given the current outlook, we plan to exit this year with approximately $7.5million in cash and investments. Based upon the visibility that we now have, and the information currently available to Management, we expect that we have more than enough cash to fund our business plan through at least 2002.



• Thanks for your attention, now I'd like to turn things back to Joseph Cross, our President and CEO.

Joseph Cross, President and CEO

• Thank you, Jess.



• This past quarter, and indeed the first nine months of 2001, has been characterized by significant and considerable technical and operational successes, as well as technology growth throughout the company. Increasingly, we believe, the company has lengthened its lead in nanocrystalline technology, application development, and the commercial manufacturing of nanosolutions. In fact, we now believe that manufacturing and coating nanoparticles has become one of Nanophase's core competitive strengths and clearly differentiates this company from other nanocompanies. This view was definitely buttressed by the recent nano conference in Chicago and discussions with potential customers and competitors. Nanophase's technology and leadership continues to be the company's core strength, principal value, and foundation for future growth.



• Let me begin an overview of Nanophase with a discussion of business development and revenue growth, which is definitely the company's primary focus. We began to recognize by the end of the first quarter that the economy was declining rapidly, and we actually believed at the time that the severity and descent rate was even greater than was being reported and widely accepted. It seemed clear that the business development paradigm was changing quickly and becoming considerably more difficult. It seemed equally clear to management that the company would have to enlarge its scope of activities, increase the number of opportunities, and apply even greater effort and management in this area to drive the revenue growth necessary.


We began to reformulate our approach during the second quarter to enlarge and increase our efforts, on which Dan is going to elaborate a little later, and focused additional personnel in the business toward this effort, including much of my time. In short, we became highly proactive. Nanophase is now attacking business development and sales with a multifaceted effort that is both focused and opportunistic, and manages a time continuum from current to 18 months in the future. Our expanded approach encompasses strategic partnering, broad market initiatives in targeted vertical markets, business alliances, horizontal marketing, and guerilla marketing.

While we experienced uncontrollable periods of less activity then desired during the normal summer slow-down from mid-July through much of August, which was especially noticeable this year, and the period from September 11 to approximately the middle of October, we have seen considerable success from our efforts. We now have more opportunities, many of which are quite significant, than at any time since I have been with the company and a growing momentum in our efforts that we believe will uncover and bring about additional opportunities.


• A vital part of business development for Nanophase is success in application science, or applying nanomaterial technology to solve market or customer needs. The company continues to make significant strides in its application science technology. During the quarter, Nanophase applied for a patent on unique chemistry to disperse nanocrystalline materials in organic resins and solvents to achieve highly stable dispersions that are applicable to a variety of applications. In combination with this technology, which is somewhat of a break-through and coincidentally was the topic of several papers at the recent nanoconference in Chicago, the company's new, improved materials, resulting from multiple improvements in PVS reactor technology, allow Nanophase to offer the availability of three types of transparent, functional coatings. These coatings are designed to protect against ultraviolet and infrared radiation, provide significantly increased wear resistant coatings, and allow conductive or anti-static coatings on a variety of substrates. In each case, the company has been able to achieve improved functionality with increased and significantly improved coating clarity. Dan will give some examples of industry reaction to this later in the discussion.



• A second area of concentration for the company is continual reduction in manufacturing cost, which also directly relates to growth in product margins, or provides increased ability to penetrate additional markets. As I stated during the last conference call, we have been able to achieve our stated manufacturing cost reduction goals for 2001 in the first half of the year. During the third quarter, July to be specific, we essentially shutdown the Burr Ridge nanoparticle facility to install improvements in infrastructure, material handling systems, and the PVS reactors to significantly increase reactor output rates for several different products, improve product quality, and reduce variable manufacturing cost. Results from all of these improvements are a dramatic reduction in operational or manufacturing costs. Specifically,



• Through the new control systems, reactor improvements, and new automatic material handling systems, the company was able to reduce its manufacturing workforce by 25% without any loss of output or capability. This was a true 25% labor reduction;



• Reactor output for NanoTek® Antimony Tin Oxide was increased by 2.3 times and variable manufacturing cost reduced by 40%;



• Reactor output was increased by 2.5 times for NanoTek® Aluminum Oxide HP and variable manufacturing cost reduced by 38%;



• The culmination of all improvements in 2001 has allowed the company to reach a five-sigma control limit in its manufacturing process in its continued drive for six-sigma. This is a highly significant achievement and is, quite frankly, dramatic progress from the point we began this journey in 1999.



• These changes have provided significant product quality improvements in particle size control as well as increasing the purity and quality of our materials. Product improvements have already demonstrated increased opportunities in transparent functional coatings, as I described earlier, and allowed the company to announce a line of higher performance products based on these same improvements targeted for the electronics, polishing, lighting, thermal spray, and catalysis markets. We are currently pursuing opportunities in each area.



• Another large area of focus and effort for the company has been to implement the infrastructure and the capability that is required for substantial market penetration and revenue growth. During the third quarter, we completed the construction of the production coating facility, primarily for our largest sunscreen customer, and a pilot manufacturing facility to be able to deliver nanocrystalline materials in dispersions and formulations to our target markets and customers. The coating facility produced initial qualification lots for customer acceptance during the third quarter and is expected to begin scaling production during the balance of the year as we reduce and then cease our reliance on a third party manufacturer for this vital aspect of our business.


The pilot line facility, which is scaled to produce moderate commercial quantities, is in the final stages of construction and is beginning operations by the end of this month. We expect to begin producing initial volumes during the fourth quarter.


• The last significant area of innovation has been in commercializing our new nanocrystalline manufacturing process, Audrey, which we view as complementary to our core PVS process. During the first and into the second quarter, we successfully established the process capability to produce multiple materials, including mixed metal oxides, at highly competitive cost and production rates. We believe that we have demonstrated that the palate of materials in Audrey's capability is approximately 5 times greater than PVS plus offering the capability to manufacture mixed materials.


During the third quarter, we shipped initial production quantities of material. We expect to continue scaling Audrey for an eventual three shift manufacturing capability during the fourth quarter. Again, we do not expect Audrey to significantly impact revenue until early 2002.


• That concludes my comments. Dan Bilicki will now provide an update on the company's business development and sales activities, and more details on the expanded effort.

Dan Bilicki, VP Sales & Marketing

• Good morning and thank you for your interest in Nanophase.



• Although significant progress has been made on both the technical and manufacturing fronts throughout the year, fiscal 2001 has been very disappointing in revenue generation. As you are aware Nanophase can only grow sales when we prove that our products provide value in potential customer's application. The interest and capability of these potential customers to run tests, trials, and evaluations in a timely fashion has been significantly reduced for a whole host of reasons, which include a global decline in business activity, significant layoffs, a serious decline in manufacturing, and business shifting to playing defense rather than offence.



• The key issues I would like to address are: 1. What are we doing differently to get revenue generation back on track? 2. And, What has been the progress to date?


As Joe mentioned, we have been driving an expanded business development and sales effort throughout the company. This is a multifaceted attack plan that recognizes the difficulty of the economic environment and provides a multi-tiered, increased effort and personnel dedicated to the task. The major elements of this plan are:


• Enlist the involvement of the entire Nanophase organization, including our Board of Directors, to extend our contacts at existing customers as well as open doors at new potential customers. This initiative has proved valuable at a major potential customer that we expect to start shipping next year. It has also helped in identifying those companies where there is a Research & Development push rather than a business pull allowing Nanophase to do a better job of prioritizing application opportunities.



• We have increased our involvement in publishing papers and putting on presentations at Nano related conferences. For example, a paper in the October issue of Paint & Coatings Industry magazine on nanomaterials for abrasion resistant coatings has already generated at least 18 new leads for the company. Nanophase hosted the Fine, Ultra Fine, and Nanoparticle Conference last week. Even though 30 participating organizations, mostly Asian & European, cancelled at the last minute due the FBI warning on imminent terrorist activities, out of the 90 that did attend, several potential customers expressed serious interest in analyzing our products and organizing follow up technical meetings. We are in the process of addressing these opportunities now.



• The third initiative to build revenues involves developing additional partnerships and strategic alliances, as well as look for joint venture opportunities. This effort includes discussions with companies that are interested in becoming involved with nanotechnology for strategic and tactical long-term business reasons. To date, we have are involved with at least 4 discussions with interested parties.



• We have redoubled our efforts with those potential customers who we expected to be purchasing product by now, but are still in the testing and development stage, to move these projects into product sales. Two major companies are moving forward and, if we continue to be successful, these opportunities would provide Nanophase with critical mass that, along with our current personal care business, results in a solid platform for growth. In addition to the two large potentials mentioned above Nanophase have 19 on going development projects with potential customers. The break down of these development projects is as follows: 6 of the fall into the category of $1 million per year plus revenue once the testing and ramp up has been completed. 3 of the projects are in the $500 to $1 million range, and the remaining 10 projects have the potential of delivering between $100 and $500 per year of new revenue. We are currently in the process of qualifying an additional 12 opportunities to determine time to market, commitment of the potential customer, and technical complexity. At this juncture we are unable to predict the how many of these projects will result in additional revenue or the timing of this revenue



• In the personal care area, our major customer's demand has matched their revised plans. Nanophase will, before the end of this year, be producing and shipping surface treated zinc oxide from its new facility in Romeoville, IL. Indications are that next years business will increase as new customers begin to formulate zinc oxide into their personal care products. We are working out the details of a joint development agreement to begin focused efforts on the next generation of surface treated products for personal care applications.



• At this time, I will turn the agenda back over to Joe to discuss the fourth quarter.

Joseph Cross, President and CEO

• Thank you, Dan.



• At this time, I would like to address our expectations for the fourth quarter. First, I would like to emphasize that Nanophase is being impacted by the rather severe, sudden, and steep global macro economic slow-down, as are most companies in most industries. This is obviously the most acute in the manufacturing, or product-based, sector that represents our primary customer base. The US manufacturing sector is reported to be at an 18 year low with almost 12 consecutive months of decreasing industrial production. In September, leading indicators for the U.S. economy posted its largest decline since 1996, apparently foreboding continued economic softness into next year.



• The direct effects on Nanophase continue to be the difficulty gaining mind share and significant interest with potential customers who are focused solely on their own business issues; secondly, potential customers are moving much slower into new applications; and sales to existing customers are sliding varying lengths depending on the degree that segment has softened. While each of these are being addressed with our expanded effort, we have seen a definite lengthening of the business development cycle due solely to the various market situations and increasing restrictions customers are experiencing. This is impacting the timing of product revenue and is undeniably impacting our visibility on the timing of future revenue.



• Having said that, we continue to experience significantly increased activity and interest with current and potential customers. Our reinvigorated and expanded business development and sales approach is beginning to show demonstrable results. Again, we have a very high and increasing customer activity level.



• During the fourth quarter, we will concentrate in three main areas: continued robust activity in business development and sales; continued improvement in technology and application science; and careful management of cost and expenses.



• We currently expect to:



• Continue scaling production in the nanomaterials coating area, primarily for personal care materials;



• Continue scaling production and materials in the Audrey process;



• Further implement the company's Lean Manufacturing discipline in the Burr Ridge nanoparticles facility that is targeted to further reduce reactor downtime and increase capacity per reactor



• Develop and introduce an additional Zinc Oxide product in the 20-25 nanometer particle size range targeted specifically for electronics applications. This will be the third zinc oxide product line for the company.



• Submission of 3-4 new patent applications covering additional unique product applications for the company's nanomaterials and technology. As soon as this technology is protected, we will address and accelerate business development for appropriate applications.



• At the current point in time, we now expect fourth quarter revenue to be a minimum of $1.2 million. We are unable to clarify the number to any greater detail given the economic environment, turbulence in the global situation and the economy, and the unpredictability of future events, especially during the fourth quarter.



• 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 Monday, October 28. We will respond to any questions you may have at this time.




THIRD QUARTER CONFERENCE CALL 10-25-01
QUESTIONS & ANSWERS

• Do any of Nanophase several patents generate revenue for the company?



• Nanophase's patents generate current and future revenue in two regards:



1. Patents protect the company's intellectual property, including its processes and applications, which helps sustain and strengthen the company's position in the industry. This, in turn, enhances the company's opportunities with current and potential customers.
2. The company does license its patents when it makes prudent business sense. Currently, the company licenses its PVS technology to CIK, based in Japan, along with the right to sell nanomaterials made by the company's technology to specific markets. Revenue generated by Nanophase through licensing is typically shown in the company's financial statements under 'other revenue'.



• Does Nanophase have any military contracts?



• Not at the current time. Nanophase has previously sold certain of its materials to companies who are either prime or sub-contractors to the U.S. Navy. Future contracts cannot be predicted with any degree of certainty.



• Is Nanophase currently seeking, or does it intend to seek, additional financing to meet its operational needs beyond 2002?



• The company continuously evaluates its capital needs based on perceived market growth, customer demand, and the company's growth plans. At this time, the company anticipates that it has adequate capital to fund operations through 2002.



• What guidance can Nanophase provide on future revenue and profitability?



• As the company stated during the conference call and in other public communications, the company does not have adequate insight into revenue for 2002 to warrant providing a forecast at this time.



• What other categories of product sales does the company expect in 2002 and in what approximate amounts?



• As stated by management during the conference call, the company is not in a position to provide guidance for the total year revenue, much less by category and estimated amounts.



• Would it be possible to estimate the company's sales into the sunscreen market next year?



• Nanophase currently expects materials and revenue in the personal care market, which includes sunscreens, to increase between 3 - 15% for 2002 based on current customer forecasts. However, these are preliminary numbers. The company anticipates that more precise estimates will be made available around the end of January 2002.



• Some investors have expressed concern about stock purchases and the lack of stock ownership by officers of the company. Could the company comment on the status of any stock acquisitions by officers?



• First, officers and corporate directors currently have stock and vested stock options that are beneficially owned amounting to approximately 6% of the outstanding shares as of 9-30-01. Secondly, considering total stock options, exercisable and unvested, and stock that is personally owned, officers and directors currently have approximately 13% of the outstanding shares as of 9-30-01. The company believes that at the levels noted, officer and director's interests are very much aligned with stockholders and the investment community.


On future purchases by company officers, the company believes that its stock is currently undervalued in the market. From time to time, officers and directors may add to their current positions.



• During the call you spoke about many different initiatives the company is working on. However, there were very few details given. Could you be a little more specific in describing some of these initiatives?



• The company has several application initiatives underway at the current time, including: automotive coatings, abrasion resistance for textile fibers, various electronic devices, photo printing, chemical/mechanical polishing for semiconductors and optics, solar control, static dissipation, environmental catalysis, abrasion resistant coatings, personal care products, and others.

The words "expect", "anticipates, "plans", "forecasts" and similar expressions are intended to identify forward looking statements. Statements contained in this news release that are not historical facts are forward looking statements that are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements reflect the Company's current beliefs, and a number of important factors could cause actual results for future periods to differ materially from those expressed in this news release. These important factors include, without limitation: a decision of the customer to cancel a purchase order or supply agreement; demand for, and acceptance of, the Company's nanocrystalline materials; changes in development and distribution relationships; the impact of competitive products and technologies; possible disruption in commercial activities occasioned by terrorist activity and armed conflict; and other risks indicated in the Company's filings with the Securities and Exchange Commission. Nanophase undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.