THIRD QUARTER 2004 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to the Nanophase conference call for the third quarter of 2004. I will be hosting the call today and providing an overview of the Company’s progress during the third quarter in context of progress throughout 2004 and preparing to enter 2005. Jess Jankowski, Nanophase’s CFO is not available, so I will also be covering the relevant financial information in his place. Changing our normal agenda just a bit, I have asked Dr. Ed Ludwig, our VP of Business Development, to comment on the Company’s business development and market initiatives outside of our core market partners, which I will cover, relative to driving Nanophase’s revenue growth.

• To begin the discussion, let me cover the relevant financial aspects of the third quarter, as well as those financial topics that we think may be of interest to investors. Obviously, the financial details for the quarter were released on October 28, so I do not intend to dwell on or review all the details. All the numbers discussed today are approximations.
  • Revenues for the third quarter of 2004 were $1,377,000, up $138,000 or 11% compared to the third quarter of 2003.

  • Comparing the first nine months of 2004 versus 2003 and ignoring the sale of PVS reactor equipment to C.I. Kasei, our Japanese licensee, in 2003, which is an irregular event and not Nanophase’s main business, revenues are up 6%. Reviewing revenues, sales of sunscreen and personal care nanomaterials have been above expectations by 13% year-over-year, but sales into CMP via Rohm & Haas are down by $800,000 in product revenue compared to 2003. The reason is the inventory situation at Rohm & Haas due to the unexpected lengthy delay penetrating the CMP market. I intend to discuss this area in detail later in the call.

    Gross margin on product sales is modestly positive, somewhat resulting from our continued efforts to reduce manufacturing cost, but still impacted by the need for additional volume to absorb manufacturing overhead. Note that depreciation and amortization amounted to $0.06 per share of the Company’s $0.27 per share loss for the first nine months, or about 22%.

  • Relative to the balance sheet, Nanophase ended September with $13.9 million in cash and investments compared to about $5 million at the end of 2003. This increase is primarily due to the $10 million equity investment from Altana Chemie in March of 2004 and the $2 million warrant exercise by Grace Investments in September 2004. Grace, as you may know, is the Company’s largest institutional investor.

    Accounts receivable remains well under control with 97% due by our largest customers: BASF, Rohm & Haas Electronic Materials, C.I. Kasei, and Altana Chemie.

  • As announced, Nanophase withdrew the shelf registration statement that the Company had previously filed with the SEC. Based on market conditions, current cash and investment position, and the Company’s business models through 2006, we do not currently expect to need further equity to fund planned growth. Obviously, this is quite dependent on product mix and capital equipment needs, which may be different than current plans as we go forward.

  • Lastly, with respect to corporate governance, let me summarize the Company’s efforts regarding compliance with Section 404 of the Sarbanes-Oxley Act of 2002. To comply with the rather intricate and detailed requirements of this Act, we have engaged an outside consulting firm to review and augment, where necessary, our internal control systems and lean staff. Although management has always believed that Nanophase has solid internal controls in place, especially for a company our size, SOX-404 codifies specific internal control requirements that ALL companies must satisfy. This will amount to Nanophase having an internal control system that, in a pre-SOX-404 world, would be what one would expect in a much larger company.

    Internal controls to meet SOX-404 will increase the Company’s cost with increased audit and legal fees since the Act actually adds additional audit requirements each year.

• Moving forward to the rest of the business, I would like to cover four specific areas: first, the Company’s intellectual property growth; then, operational and engineering progress; followed by progress updates on our market partners (BASF, Altana Chemie, and Rohm & Haas Electronic Materials CMP Technologies); and, lastly, business development management, which will lead into Ed’s comments.

• Beginning with intellectual property, during the third quarter, Nanophase filed three new US patent applications:
  • The first is entitled “ Surface Treatment of Nanoparticles to Control Interfaces” and relates to our expanding nanoparticle coating and surface treatment technologies for applications ranging from sunscreens and personal care to polymer additives for tailored transport and mechanical properties. We believe that this is critical technology for the Company and will prove to be increasingly valuable in the future.

  • The second is entitled “Cosmetic Formulations Comprising Zinc Oxide Nanoparticles and Method of Manufacture”, which we filed jointly with BASF. This relates to the second generation sunscreen nanomaterials that we have discussed and will update later in the call.

  • The third is entitled “Enhanced Scratch Resistance Of Articles Containing A Combination of Nanocrystalline Metal Oxide Particles, Polymeric Dispersing Agents, And Surface Active Materials”, which we filed jointly with BYK-Chemie, a company of Altana AG. This patent describes a new, and rather exciting, technology to increase wear and abrasion resistance, or improve mechanical properties, for coatings and sealants.

  • Additionally, during the quarter, the Company increased its foreign patents and patent application count by a total of eight (8).

  • As a result, Nanophase’s patent IP position now stands at 25 US patents and patent applications and 49 foreign patents and patent applications. The Company has now grown its US portfolio of core patents and patent applications over 150% since 2000.

• Turning now to operations and advanced engineering, we continue to constantly improve the Company’s manufacturing to reduce cost and grow variable margins. During the third quarter, we completed the bulk of manufacturing implementation that results in a 25% increase in reactor output, or production rates, for the Company’s highest volume products. Year-to-date, we have achieved a 21% reduction in variable manufacturing cost on high-volume nanomaterials, which we expect to become increasingly visible over time in our financials, especially as volume grows during 2005.

  In a parallel effort, Nanophase has a rather aggressive new nanomaterials development schedule based on market pull, not technical pull, from our current market partners and business development opportunities. We view this as a vital activity for the business to position new nanoproducts that are expected to drive future revenue growth. An example of this, the 20 nm alumina that we announced earlier in the year, is already in testing through BYK-Chemie for abrasion resistant coatings and is demonstrating early positive results. We expect to be announcing the initial availability of several new nanomaterials over the next 3-6 months.

• Moving to sales and revenue growth initiatives with our current market partners, continuing progress was made during the quarter.
  • Let me start with and describe Altana Chemie so our investors can understand the importance of this relationship to Nanophase. Altana Chemie is one of two major companies of Altana AG, which is a $3.5B pharmaceutical and specialty chemical company.

    Altana Chemie with sales of about $1B is a highly successful and fast-growing specialty chemical company organized into three divisions: Altana Additives and Instruments, Altana Coatings and Sealants, and Altana Electrical Insulation. Altana Chemie over the last ten years has grown sales at a rate of 18% annually while maintaining operating margins of 20% EBITDA. Let’s review each of their major divisions that are developing new products based on Nanophase’s nanomaterials.

    • Within Altana Additives and Instruments, BYK-Chemie is a world leader in additives for the coating and plastic markets. Typically, BYK additives for coatings and plastics formulations provide significant performance and quality improvements at low concentrations in the final product. BYK has eight regional labs and production plants throughout the world with sales and distribution capabilities in 100 countries.

    • Altana Coatings and Sealants has the most comprehensive product portfolio in packaging coatings and related products; it is considered number one for closure compounds and number 2 for can end sealants. They are also a leader in overprint varnishes and a major supplier for foil and coil coatings.

    • Altana Electrical Insulation includes wire enamels, impregnating resins and compounds for encapsulating electrical and electronic devices.

    • Pausing for a second at this point, as you consider the three divisions, contemplate the market reach this partnership offers Nanophase.

    • Each division of Altana Chemie is developing products for their respective markets based on Nanophase’s nanomaterials. Their new product performance needs are also driving our new nanomaterials development program. This is an added plus with Altana Chemie, and all of our partners for that matter, in that our new nanomaterials development efforts are being market-driven by defined market needs.

    • For instance BYK-Chemie, has now announced four products in their new NanoByk line of additive ingredients that incorporate our nanomaterials. Two for the coatings industry and two for the plastics industry. We believe that BYK has sent approximately 500 samples of these new products to potential customers for testing.

      There are about twenty-two additional formulations in testing and we expect some of these to result in products. Additionally, there are other formulations in earlier development for a variety of potential applications, such as automotive clear coatings, which is currently a major development effort by BYK and Nanophase. BYK-Chemie is actively developing and marketing these products, as well as testing lab formulations in applications, throughout Europe, Asia, and the US. Developing NanoByk products and growing their market share is a major objective for BYK.

      Considering that our partnership was formalized in March of 2004, the progress and movement toward the markets has been surprisingly rapid. The new NanoByk products, products in lab testing, and those being developed, along with the patent application, have all happened in about six months. Product development and introduction will also obviously continue during 2005 and 2006.

      As announced, we spent last week supporting BYK-Chemie at the International Coating Exhibition, known as ICE 2004, which draws an international audience of potential customers and is the major event in the industry. BYK and Nanophase worked side-by-side introducing the new NanoByk products and discussing potential applications with several companies. Response, interest in nanomaterial enabled coating ingredients, and business development opportunities were excellent. We expect significant follow-up activity resulting from the exhibition.

      We continue to be quite optimistic about revenue growth via Altana Chemie for nanomaterials-based products in the additives, coatings, plastics, sealants, and electrical/electronic markets. These are large global markets and we are fortunate to be a partner with a known market and technical leader for demanding applications where nanomaterials bring value. We are also working closely with the other two divisions of Altana Chemie, Coatings and Sealants, and Electrical Insulation. We expect new nanomaterial-based product introductions in both of these in the near future.

      Initial Altana-Chemie revenues have started and we expect ramping to continue during 2005 and accelerate in 2006.

  • BASF continues to make progress. We held an executive level business review with BASF during this last quarter and believe that both parties are satisfied with the progress to-date and have formulated market and revenue expansion plans for the future.

    • Relative to the current sunscreen nanomaterials, volume is continuing to grow, as demonstrated by the 7% growth observed over the last 9-12 months, and we expect that trend to continue. BASF has stated that they intend to essentially relaunch the ZCote HP1 and market additional consumer attributes for the sunscreen and personal care market. Such a concentrated marketing action by BASF may increase the product growth rate over that currently planned.

    • The second generation sunscreen nanomaterial, which is based on Nanophase’s patent pending coating technology mentioned earlier, still remains on track to plan at this time and we are still expecting to ship initial market quantities during the last quarter of ‘04. BASF has established a detailed market launch program that culminates around May of ’05. We expect this new product to add to revenues during 2005.

    • BASF is also in the final stages of clinical testing for a new personal care product and currently expects to launch the product during early 2005. The potential for growth in this product is promising and we expect that the resulting demand for the Company’s nanomaterials will begin during 2005.

    • In summary, BASF continues to be the Company’s largest current customer and, we believe, between the three product areas just discussed, two of which are new, there is adequate reason to expect material revenue growth in 2005 and 2006.

  • Rohm & Haas Electronic Materials CMP Technologies (R&H) also continues to make progress penetrating the STI/SON semiconductor market node with slurries using our nanoparticles. R&H has made great strides improving their slurry chemistry from the initial Generation I originally introduced to the market in 2003. Generation II chemistry, which is now in market evaluation, is demonstrating positive results in continuing semiconductor testing. R&H currently has one customer that appears to have reached production adoption and is expected to be in actual production using the slurry during Q4 this year. Several other customers have advanced their testing stages and are getting closer to production adoption.

    Significantly, we believe, R&H has recently developed and tested Generation III slurry chemistry, which is demonstrating notable performance improvements over Gen II in reduced defect levels, improved planarity, and greatly improved dishing characteristics. R&H expects to begin introducing Gen III to the market focusing on key semiconductor targets during the fourth quarter. R&H is optimistic that Gen III chemistry will increase the adoption rate and reduce the time-to-market for potential customers going forward.

    Recognizing both the reality of the market adoption rate as it is and the real market synergy of the R&H and Nanophase relationship for the CMP market going forward, we have recently mutually agreed to amend our Cooperation Agreement. The amended agreement retains the mutually exclusive relationship and requires minimum base R&H revenues to Nanophase to increase approximately 40% in 2005 compared to 2004, followed by a higher revenue growth rate for 2006. Despite the difficulty R&H has encountered in market penetration speed, we are seeing gathering momentum and continue to believe that CMP as a market offers a major revenue growth opportunity for Nanophase. We believe that it is important to take a longer term perspective for this market which offers increasing revenue growth opportunities over the next decade.

  • In summary, we believe that our three market partners, BASF, Altana Chemie, and R&H, provide a solid base of growing revenue opportunities towards the Company’s goal of reaching EBITDA break-even. I make this point simply to demonstrate the strength of our current partners, the breadth and size of the markets served collectively, and the revenue growth potential that management expects.

  • Moving to business development and new revenue growth opportunities for the Company, that are in addition to our market partners, let me address a couple of points before I turn this over to Ed.

    Since I assumed direct responsibility for Business Development and Sales late in 2003, we have made several changes to improve our tactics and methods. During 2004 we have been driving to improve the business development process, spend more time managing and understanding details, developing larger strategic relationships with our market partners, and identifying and increasing the number of “good” opportunities. We have also become significantly more active in the external environment and emerging nanotechnology industry, which has led to additional opportunities.

    Specifically, Ed and I, and the rest of the management team, have worked hard at qualifying and quantifying each business development opportunity. Part of the former for us is to understand whether an opportunity is a technical or market pull; we will only focus on market pull. We have been misled at times by a technical pull disguised as a market pull. We have also developed a methodology to quantify each opportunity relative to the probability of both technical development success and ultimate market success in terms of value expectations. This allows us to weed out those opportunities that do not meet reasonable criteria and focus on more optimal situations. In parallel, we have developed a process to measure development progress of each opportunity through a modified stage gate approach that helps us to manage the process better and focus management attention where it is needed.

  • So, at this point in 2004, we have been able to significantly expand the number of opportunities that we are addressing by almost a factor of three using the same resources by better management and focusing on synergistic opportunities. While business development opportunities may disappear as they progress through the normal cycle from development to commercialization, and this is normal and expected, the larger the number at the top of the funnel, the more that are expected to reach fruition and become revenue producers.

  • Without a doubt, we are seeing the most robust opportunities in both quality and quantity in the Company’s history and the list is growing.

• At this point, I will turn the business development discussion over to Ed.

Edward Ludwig, VP Business Development

• Thank you, Joe.

• Indeed this is an exciting time for Nanophase. Never before has the company had the level of business development activity that we are experiencing now. There are currently over 100 qualified opportunities that we are pursuing which are in various stages in the development process. These include initiatives with new partners and prospective customers, as well as new initiatives within existing partners and customers. Since the vast majority of our activities are pursued under nondisclosure agreements, we are not at liberty to discuss them in detail. Before I describe in general how we approach business development and certain key applications areas, let me first tell you about an addition we’ve made to our business development group.
  • In August of this year, Bo Kowalczyk joined our group as Market Development Manager reporting to me. Bo spent about a year with Nanophase as our Customer Services Manager to learn the business, prior to being promoted into his current position. With a master’s degree in chemistry and experience in the biotechnology industry, Bo’s background includes technical project management, market development and sales. We are very pleased with this solid addition to the business development team.

• Within the past nine months, we have implemented a stage-gate business development process. The first stage is to draft and scrutinize what we call a preliminary value proposition, or PVP. We are hit with a variety of ideas each day, and we use the PVP to screen out which opportunities have the highest chance of success. Simplistically, the PVP first starts with a proposed market need and follows with a statement that indicates why a customer or partner would use our nanomaterials versus other commercial products or technologies. To receive a high priority, there would typically need to be a balance of properties that only nanomaterials could satisfy, such as a combination of scratch resistance, clarity, high gloss and formulation compatibility. Discipline is also applied to study the application and market sufficiently to ensure that the size of the opportunity justifies the effort needed for success.
  • As mentioned, we have over 100 identified opportunities. These run the gamut in terms of where they lie in our stage-gate process, but they all have reasonable PVP’s. The fact that we can readily produce a wide compositional palette of nanomaterials in commercial scale and in high quality, plus be able to offer the products not only as solid materials but also as coated products and/or fully stable dispersions in various media, gives very good support to the PVP. By being able to offer the products in a readily useable format, we can typically get into the evaluation stage more quickly and have a considerable competitive advantage. I should also point out that we have come to realize that Nanophase’s ability to prepare coated particles and stable dispersions of nanomaterials in such a broad compositional palette is unique in the industry.

• Our typical channel to market is through partnerships with companies that occupy the distribution channel and value chain for the application of interest. In addition, we look for partners with whom we can have a collaborative relationship, enhancing the chances of success. We like partners with an identified internal champion, sense of urgency and the ability to influence end-use decision makers.
  • We tend to stay clear of applications that involve a very long time to market or low technical feasibility. Likewise, we are hesitant to work with a partner who is not collaborative or does not have support within the organization at a level necessary to ensure that sufficient resources are applied to the development program.

  • Selecting the right partner is critical. To a large extent, we must rely on our development partner to conduct formulation and end-use testing. Because we cannot control our partner’s priorities, it is wise to have many different opportunities so that we can balance priorities based on various partners’ speed and level of commitment.

  • In a collaborative fashion, we work closely with our partner to fine tune nanoparticle formulations, coatings and dispersion characteristics to meet the application demands. This same collaborative approach is at the heart of our success with BASF and Altana, for example. It may take several iterations until the appropriate balance of properties is realized. As a result, timelines can often be extended from what was originally estimated. If we see that there is reasonable technical feasibility with good collaboration and a sound business opportunity, we continue to drive toward the goal. We are not timid about dropping opportunities when there is not a reasonable chance of success, allowing us to keep our valuable resources focused on the most promising activities.

• Now, let’s discuss some examples of opportunities that we expect to come to fruition in the near future, keeping in mind that I cannot disclose company names and, in some cases, products and applications.
  • I am very excited about a new opportunity that we expect to become a commercial reality within the near term. This is expected to result in revenue in 2005 of at least $1 million and has the potential to become a $3 – 5 million business annually. We have a signed non-binding letter of intent which discloses expected volumes over the next couple of years, and we currently have manufacturing capacity and all equipment in place to satisfy this opportunity. The customer has accomplished the necessary scale-up procedures and is awaiting approval from their end-user. We are now a registered vendor for this customer and once end-user approval is given, we expect to receive a PO for the first shipment. We have been assured that the question is when, not if, the business will proceed. While I cannot disclose the product, application or customer, I do want to point out that this development program was initiated less than one year ago. When there is a well characterized need and a strong market pull, depending on the application area, the timeline can be relatively short.

  • Powder metallurgy is a new and exciting area for Nanophase. We have a close collaborative relationship with a local company and have jointly developed a metal coating formulation that provides good lubricity and excellent corrosion resistance in one step. The automotive and heavy equipment industries represent key applications areas for this product and our partner has many of the necessary end-user relationships to move this forward. In this example, we envision that Nanophase will be a co-supplier of the final formulation, as opposed to a raw material supplier to a formulator. As such, we will participate in ensuring product quality and consistency, as well as being positioned higher in the value chain.

  • The area of industrial antimicrobial applications, I believe, offers a considerable growth opportunity for Nanophase. We have proven feasibility in antimicrobial fibers for carpet applications, but for now that application is not moving forward. However, we have newer opportunities in antimicrobial textiles, both woven and nonwovens, for a variety of specific applications that are under development. For certain types of products, these have proceeded to the clinical trial stage. While timing is difficult to predict, it appears that this area in general is well supported as a market pull.

  • Personal and health care applications continue to be important growth areas for Nanophase. Outside of BASF initiatives, we have several initiatives in place with very large companies where technical feasibility has been demonstrated. These represent global opportunities with companies that already have market presence and distribution channels in place. Two companies are moving programs into the product formulation stage in anticipation of beginning clinical trials followed by test marketing.

  • We have begun initial forays into medical appliances, again working with large companies active in this market. Our products can offer antimicrobial character, x-ray opacity and in some cases we believe that we can use our products to provide an ultrasound signature for certain types of products. Investigations in this market area are in an early stage but there appears to be opportunities.

  • We have also begun initial investigations into the use of our nanomaterials in electronics, for example, in embedded passive devices, screens and displays and similar applications. Once again, this initiative is in a very early stage.

• A second and exciting activity that we are employing within business development is what I refer to as publicity and networking. Recent escalation of activities such as trade show and technical meeting participation, cold calling at large companies and networking through our board of directors and others are encouraging.
  • Over the past 18 months, we have become much more active at trade shows, including sponsorships, exhibits, technical and business presentations and technical poster sessions. For example, last month we were gold sponsors of NanoCommerce 2004 in Chicago. This provided a high level of publicity, and Nanophase was also an exhibitor. At this conference, Joe presented an overview of Nanophase and chaired a panel discussion focused on nanomaterials in personal care products. In 2004, we actively participated in NanoTech 2004 in Boston, the NanoEconomic Congress in Washington, D.C., the NanoBusiness Alliance 2004 in New York City and others. In 2005, we plan to participate in at least eight nanomaterials conferences.

  • How does such tradeshow participation and associated publicity help Nanophase? Most major specialty chemical companies either have an active internal nanomaterials program and/or are actively seeking partnerships in various applications areas. For these reasons, large companies are heavily canvassing nanomaterials trade shows. Recently we have made extensive inroads into many Fortune 500 companies and in fact into several Fortune 50 companies. Our full-scale manufacturing capabilities and our ability to customize products, along with the key partnerships that have been publicly disclosed, puts Nanophase in high regard with companies looking to begin or augment nanomaterials programs.

  • Many of these large companies are eager to work with suppliers of nanomaterials that can be incorporated into their products, and they represent a solid channel to market.

  • A key outcome of this networking is that we will be able to participate in applications for our materials that we probably would not discover independently. Networking is a very important route for us to publicize the commercial capabilities of Nanophase to as wide an audience as possible.

  • As an example, we began a dialog with the nanotechnology initiative inside a Fortune 50 company in April, and we currently have three distinct programs underway, all of which are market-driven and are being pursued with very good collaboration.

• With our prowess at exploiting applications that are derived from market pull combined with the new introductions that we are achieving through publicity and networking, I believe that our overall level of opportunities will continue to grow and many will reach commercial fruition.

• That concludes my comments on business development activities and I will now turn the meeting back over to Joe.

Joseph Cross, President and CEO

• Thanks, Ed.

• Over the last 3 years or so, Nanophase has been focused on expanding its nanotechnologies to reach markets, improving its operations to reduce costs and provide consistent high-quality products to customers, and expanding the Company’s intellectual property. We have made quite significant progress in each of these areas over that time. During 2004, we have taken this same approach to improving our business development and sales processes. We believe that we have made significant progress in that regard during the year.

• More than at any time earlier in our history, we are optimistic about revenue growth, specifically for 2005 and 2006. Clearly, we have established a strong group of market partners, each of which is a direct channel to broad markets with strong opportunities for nanomaterials. We expect additions to this group on a selected basis. Also, perhaps more than at any other time, our business development is very robust: the opportunities in the business opportunity funnel are the best we have seen in both quantity and quality, and the opportunities continue to increase, both as a result of efforts by our market partners and our own business development initiatives. Management is keenly focused on sound revenue growth for the Company and reaching EBITDA break-even. Again, we are optimistic about revenue growth over the next 24 months.

• That concludes our formal discussion. We are ready for questions.