FOURTH QUARTER 2004 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to the Nanophase conference call to review 2004 and, more importantly, discuss Nanophase’s expectations for 2005. We are pleased that you are taking the time to visit with us today. Jess Jankowski, Nanophase’s chief financial officer, and I will be hosting this session.

• To begin the review, Jess will summarize the financial highlights. Jess….

Jess Jankowski, CFO and Controller

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

• As I review the financial performance of the Company, I intend to only address significant financial areas comparing 2004 to 2003. All numbers will be in approximate terms for ease of discussion. More details are included in the financials accompanying our press release of March 2nd.

• Although revenues for the fourth quarter were about a million dollars, versus 1.2 million last year, revenues for the first nine months were relatively flat year over year. As a result, for 2004, revenues were off by $240K, at $5.2 million.

• I said in the press release that Q4 revenue of this year reflected a bit of an anomaly. We expect first quarter revenue to be about 50% higher than in Q4.

• Given that, keep in mind that Nanophase and its revenue growth is not a quarterly story. Focusing on quarters assumes that the quarters will always link. With dependency on several large customers, a quarterly change in revenue doesn’t necessarily portend anything other than PO’s not coming in on a measured basis.

• For the year, 70% of our revenue came from BASF and 13% came from Rohm & Haas, the bulk of the Rohm & Haas revenue in the form of development funding. We expect Rohm & Haas’ 2005 revenue to be composed primarily of product. We also saw the beginnings of a revenue flow from Altana, our newest strategic partner. As our partnerships mature with Rohm & Haas and Altana, and product revenue volumes increase, we expect the revenue breakdown to reflect several large customers composing the majority of our revenue volume, leading to a more balanced distribution.

• This rebalancing should help to reduce quarter-to-quarter variations in demand, while enhancing management’s admittedly limited visibility.

• The Company posted a small positive gross margin for 2004. Our margins have suffered these past few years from not having enough revenue to absorb the manufacturing overhead that is required to work with the customers we have and the new ones who are coming on line.

It’s important to reiterate that Nanophase has an existing manufacturing infrastructure that can support a multiple of 2004’s volume without significant augmentation.

This structure has been dictated by our business model and is a key factor in making us an attractive partner to the large companies that we currently do business with and those that we expect to develop significant business with in the future.

Much of this infrastructure supports compliance with FDA and USP standards for sunscreen materials, as well as the exacting performance requirements of the electronic chemicals industry for CMP, and now the coatings industry.

The positive takeaway here is that as volume grows, we expect our strong variable margins, which we have improved four years running, and will continue to improve, to drive overall gross margin growth.

• Moving down, SG&A Expenses expanded by $270K year over year. The largest category increase was in audit and tax fees for GAAP accounting and, to a greater extent, costs relating to implementation and execution of the new internal control audit required by Section 404 of the Sarbanes-Oxley Act.

• In Other Expenses, the $300K+ increase you see was largely composed of $288K in costs related to the Company’s withdrawn “Shelf Offering.” Market conditions changed rapidly during the process and the offering was no longer an attractive alternative for the Company or its shareholders, by the time we could be ready to move forward. This is not typically a recurring expense.

• In total, the Company lost $0.37/share this year versus $0.38/share last year. Note that depreciation and amortization amounted to about $0.08/share or $1.4 million of the Company’s $6.4 million loss for the year.

• Moving to the balance sheet highlights;

• Nanophase ended the year with $11.6 million in cash and investments.

• In terms of accounts receivable, Ninety-two percent of this balance is made up of receivables from our four largest customers, BASF, Rohm and Haas, Altana, and the C.I. Kasei license fees. These same customers accounted for a cumulative total of approximately 92% of our 2004 revenue.

• Equipment and leasehold improvements amounted to $7.5 million in total, which included $530K for capital additions in 2004. 2005 capital requirements are projected to be a similar amount.

• Any larger capital expenditures would be market-driven, and no such large projects are currently required to achieve our targeted 2005 revenue.

• On the liabilities side, the Company has about $600K in total debt. Ninety-eight percent 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.

• Looking at Additional paid-in capital, you‘ll notice that it has increased by $12.7 million year over year. This is due to the March 2004 strategic investment by Altana, netting $9.2 million, the $2 million September 2004 warrant exercise by Grace Investments, and approximately $1.5 million received by Nanophase throughout 2004 relating to option exercises.

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

Joseph Cross, President and CEO

• Thank you, Jess.

• Since it is now March and we have covered most of Nanophase’s significant 2004 accomplishments during previous conference calls and in the earnings release, I would like to use the time this morning to first offer our assessment of where Nanophase views itself entering 2005 and, secondly, discuss the Company’s revenue growth strategy for 2005 and into 2006.

• As we benchmark the progress of the emerging nanomaterials industry and where Nanophase stands, we believe that we are still well in front of potential competitors as we qualitatively compare technologies, intellectual property, manufacturing capability, application technology readiness, and relationships with market partners, such as BASF, Altana Chemie, and Rohm & Haas. This was also Altana’s finding after it completed a comprehensive global survey beginning with about 300 companies and deciding that Nanophase was the best in class prior to their $10 million equity investment last year. Given the size of the investment, the endorsement is obvious.

  More recently, a large consumer products company, with whom we are now involved with several product development initiatives, has stated that it also surveyed approximately 300 companies and arrived at the same conclusion as Altana. While we believe that we continue to pioneer and lead in nanomaterials, we are encouraged to receive independent endorsements from sophisticated large companies.

• As we enter 2005 and peer into 2006, we believe that Nanophase is well positioned for material revenue growth. While it is the Company’s position to not provide guidance, and we are not, management believes that the Company is poised to increase revenue materially during 2005 and again in 2006, which we expect should achieve a cash-flow breakeven revenue run rate. Again, we are not providing guidance. Against this vision, we believe that Company is well prepared to succeed. Let me review at least part of our rationale:

• Platform Technologies. A recent overview of the nanotechnology industry by ThinkEquity Partners, entitled Thinking Big About the Small World, noted that “there will be “platform” companies going after multiple markets to capitalize on their unique technology position.” We believe that Nanophase is such a platform company based on the breadth of the nanomaterials technologies that we have developed and implemented over the past four years.

  We recognized in 1999 that simply making nanoparticles, especially through our 1999 technology, was not an adequate business model to succeed in the nanomaterials marketplace. Since that time we have added a new nanoparticle process, NanoArc Synthesis; sophisticated nanoparticle coating technologies; and, we believe, lead the industry in nanoparticle dispersion technology, in both water and solvent media. This is a platform of scaled, manufacturing nanomaterial technologies that we do not typically find outside of Nanophase. Nanophase’s entire nanomaterials platform is patented, patent-pending, or proprietary.

  Last year, we began extending this platform into distinct applications, most often with our market partners, and expect these adjunct technologies to also grow in importance. As nanomaterial applications are developed, Nanophase also typically files patent applications. It is this flexible nanomaterials platform of technologies that, we believe, is now positioned to support the revenue growth that the Company, and its stockholders, require.

• Market Reach. We believe that with the addition of Altana Chemie, along with BASF and Rohm & Haas, our market partners should drive sufficient organic growth in revenues and new product development for Nanophase to reach a break-even position. I am going to elaborate on this theme a little later in the discussion. We also believe that no other nanomaterials company has the global market reach offered by our current market partners. While managing our market partners development and growth, Nanophase is also continuing to develop new customers and potential partners for additional markets.

• Growing interest across multiple markets. As we have stated before, nanomaterials reach across multiple markets and applications. However, the readiness of the technology and the level of market interest have to be such that the situation is a market pull, not just a technology push. This is a lesson that we have learned repeatedly. We perceive growing, product related interest across several markets and we believe that the momentum is building. Nanomaterials appear to be beginning to leave the province of corporate R&D and entering product development groups, which are years closer to the market.

• Manufacturing prowess. Bluntly stated, few, if any, nanomaterial companies have the manufacturing prowess of Nanophase. In the investment and nanotechnology analyses we review, this crucial factor is generally poorly understood and consistently overlooked. However, a recent report by Stephens Inc. on Nanotechnology, which is essentially a general overview of the industry, dated September 1, 2004, noted that “….proprietary know-how is worth basically zero if it can’t be translated into a commercial product. The question now is who is capable of mass producing the various discoveries …”.

  Since 1999, Nanophase has consistently improved output and reduced cost while creating the nanomaterials platform I mentioned earlier. Few companies our size are ISO 9001: 2000 certified. Few companies can match Nanophase’s track record on quality and customer satisfaction measures over the past 3-4 years. Fewer still have the commercial metric ton shipment history and manufacturing capability. Manufacturing is something we do very well, it is a core competency of the Company, and a major reason large companies are increasingly interested in partnering with Nanophase.

• So, against this state of readiness entering a new fiscal year, let’s move the discussion to our perspective for 2005. We are quite optimistic about material revenue growth this year. We believe that potential revenue growth will be driven by our market partners and our internal business development initiatives that we expect to reach revenue fruition, especially during the latter part of 2005.

• Beginning with BASF, we believe, based on BASF’s plans, that revenue growth during 2005 and 2006 should be material.

  • Based on BASF information and orders to date, demand for the current sunscreen nanomaterial should grow about 25% during 2005, and BASF now anticipates further growth of around 15% for 2006, which would correlate to about 44% growth over 2004 levels for the two year period.

  • The next generation sun care coated nanomaterial that we have been discussing is essentially complete on our end. The Nanophase patent-pending coating formulation has been developed, testing is complete and positive, and we have produced the qualification lots to begin the planned market introduction sequence. We currently believe that revenues for this product will begin ramping perhaps in the last quarter of 2005, but more likely during the first quarter of 2006.

  • Additionally, we are jointly planning with BASF new personal care products some of which may begin introduction during 2005. New products potentially include another sun care formulation, two additional personal care products that we are not at liberty to identify, two new nanoparticle based products that we plan to develop and begin commercializing during 2005, and a personal care product based on Nanophase’s patent-pending nanoparticle dispersion technology. The exact timelines for the new products are in planning and should be further solidified later in 2005.

  • In summary, current products with BASF are demonstrating solid organic market growth and there are continuing plans to introduce several new products. We believe that revenue growth with BASF in the personal care market should continue to be a driver for Nanophase over the next three years.

• Moving to Altana Chemie, and specifically coating ingredients through BYK Chemie, our relationship continues to grow, product development plans continue to be honed, and the global market approach continues to be better focused and organized. Let me review our current market and application efforts, which we expect to broaden as we gain market experience. Understand that as we attempt to quantify markets and nanoproduct opportunities in this discussion, we are discussing the total identified opportunity. We do not presently have estimates or expectations of potential or predicted market share.

  • Wood coatings represent about a $200 million global market of which $60 million is estimated as the total opportunity applicable for nanomaterial products for scratch or abrasion resistance, UV formula stabilization in interior and exterior wood coatings, and antimicrobial nanoparticles for exterior wood coatings. There are two released products in this market and several in various stages of development both at BYK and Nanophase.

  • The global automotive coatings market is estimated at $200 million for refinish and OEM, specifically for scratch or abrasion resistant clear coats, where the total nanomaterial product opportunity is estimated to be $40-60 million. Both BYK and Nanophase have an intensive development schedule for this market, which includes new nanoparticle development and manufacturing, which Nanophase plans to accomplish during the first half of this year.

  • Coil Coatings, a market where BYK has been typically strong, is estimated as a $40 million global market with approximately $8-12 million as a total opportunity for nanomaterial products for scratch resistance, antimicrobial and UV protection.

  • General Industrial Coatings represent greater than a $200 million global market with about $20-60 million relevant as a total opportunity for nanomaterial products, primarily for scratch or abrasion resistance.

  • Other market areas that BYK and Nanophase are jointly pursuing include powder coatings, printing inks, thermoplastics, PVC, polyurethanes foams, and cold cure materials. Plans for each market are being formulated and product development has started.

  • As a summary for Altana Chemie, we have made definitive progress since the agreement was signed a year ago this month. Relationships with Altana Chemie through top management are excellent. During January, we provided a training session on nanoproducts to the BYK US sales force and are scheduled to do the same for Europe and Asia during April. We believe that our market relationship with Altana Chemie will be a material revenue driver for Nanophase over the next three years and the foreseeable future.

• Last but certainly not least, let me review Rohm & Haas Electronic Materials for CMP technologies, which appears to be gaining market traction with both their generation 2 and 3 chemistry. During the fourth quarter of ’04, R&H secured its first customer and has about four additional fabs well down the path that R&H expects should lead to adoption. In total, R&H is involved with about 20 engagements and is optimistic about success during 2005 and even more growth during 2006. For 2005, R&H has committed to nanomaterials from Nanophase at a revenue rate about 25% higher than last year.

  In parallel, we are involved in mutual development for new slurry products to address both the Copper and Tungsten technology nodes and expect that these efforts will advance toward maturity.

• Moving to Nanophase business development, during 2004 our development efforts essentially evolved into five distinct areas:

  • Personal Care initiatives that are mutually synergistic with our market partner BASF and focus on many of the top tier personal care companies;

  • Business development that is synergistic with Altana Chemie, especially in the US, for coatings and sealants;

  • Mutual business development with Rohm & Haas for CMP;

  • A new initiative with a company that we are not at liberty to divulge for bioactive and dental nanoglass;

  • And, Nanophase-driven business development, for example: personal care applications outside of BASF, cross-linking catalysts, antimicrobial, optics polishing, and adhesives. A significant part of our efforts here are also directed to obtain new market partners.

  • You may recall that we mentioned during the last conference call that we anticipated securing a major new customer and revenue stream stemming from our internal business development. That situation continues to advance toward a new product roll-out. We shipped the initial manufacturing scale-up quantity to the customer early in Q1 of 2005 and continue to expect initial orders during the second quarter. Based on statements from this potential customer, we currently believe that this new effort may add approximately $1 million to annual revenues in 2005 and grow close to $2 million during 2006.

  • Additionally, there are two other situations that we currently anticipate closing during the first half that should materially add to revenues during 2005. As soon as these are finalized, we will communicate appropriately.

  • Our other business development initiatives continue to progress. The business development pipeline is robust and growing, and, we believe, should support our aggressive revenue growth plans for 2005-2006. A critical part of new business expansion and growth, both with our market partners, especially BASF and Altana Chemie, and for Nanophase’s business development opportunities, is innovation of new nanoparticles for specific applications and markets. Nanophase has accordingly planned aggressive new nanoparticle and coating development throughout 2005, but especially in the first half. I want to make it clear that these are market-pull development initiatives, which we believe is a definite positive for Nanophase.

  • In summary, management enters 2005 quite optimistic that the Company has developed excellent market partners and global opportunities across a significant market breadth. Current market relationships and Nanophase’s vigorous business development initiatives should allow Nanophase to achieve material revenue growth in 2005 and 2006. This concludes our prepared remarks; we are now open to questions.