FIRST QUARTER 2007 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to Nanophase’s conference call to review the first quarter of 2007. The Company had a strong first quarter on a number of fronts, including revenue, and it represents a solid start and foundation for 2007. Jess Jankowski, Nanophase’s CFO, and I will be hosting this session.
• To begin our discussion, Jess will summarize the financial highlights of the quarter. Jess....

Jess Jankowski, CFO

• Good afternoon and thank you for your continuing support of Nanophase. The first quarter results highlight an exciting milestone. We achieved another quarterly revenue record with $2.9M in Q1, a 45% improvement over Q1 of last year.
  
  Reviewing the financial performance, I intend to only address significant areas comparing Q1 of ’07 to Q1 of ‘06. As always, all numbers for today’s call will be in approximate terms for ease of discussion. For more details, please see the financials accompanying today’s press release. I will also continue to discuss a few new metrics that highlight some important positive shifts in our business.

  The growth from our architectural coatings customer, and from the expanding relationship with BYK Chemie, have been the main differentiators between this past quarter and Q1 of 2006.

  As we discussed in our year-end call, Nanophase has had one major customer, BASF, which had been responsible for the great majority of our sales over the preceding five years. In 2006, sales to BASF accounted for 56% of total revenue, while growing 13% from 2005 levels to hit $5M. We achieved both a revenue high water mark and we saw BASF’s growing revenue become a smaller percentage of our total revenue. BASF’s historical average had been 69% from 2001 to 2005. In keeping with the trend, for this past quarter, revenue from BASF amounted to 55% of total revenue and our other customers and partners are moving in.

  Continuing this trend, our architectural coatings customer and BYK Chemie accounted for 18% and 13% of our $2.9M in total Q107 revenue, respectively.

  The part of this revenue mix shift that merits further discussion, is that we’re starting to see meaningful growth in new markets, with new applications, from several customers, while BASF continues to grow in its existing markets. Joe will go in to more detail regarding expected new growth for BASF and what we expect to see from BYK-Chemie and our architectural coatings customer this year.

  To recap Q1 of 2007, and I say this mainly for the benefit of our analysts, BASF, our architectural coatings customer, and BYK Chemie accounted for 55%, 18% and 13% of our quarterly revenue, respectively.

  As we do have new analysts this quarter, as well as new investors, it’s worth explaining that, to us, there are certainly more than three companies that are driving 86% of our current quarter revenue. Particularly with BASF and BYK Chemie, many customers of those two companies create demand for Nanophase’s materials. BASF has multiple customers driving their demand for our materials, each having gone through product qualification cycles ranging from quick reviews to those lasting more than a year. BYK Chemie is selling our materials to an even larger number of downstream manufacturers and processors.

  I reiterate this because many people initially assume that Nanophase’s concentration of sales to several customers represents a liability. With BASF and BYK Chemie, we have effectively increased the breadth and reach of our market attack. Both BASF and BYK are supplying Nanophase materials to customers in the U.S., Europe and Asia.

  Fortunately, our strong relationships with these market partners allow us to gain direct knowledge of many of these users and their needs. This helps us to support BASF and BYK in developing new business with new downstream users as well as expanding upon existing business. We have tailored our solutions to multiple specific applications due to Nanophase having established applications development as a core competency. Our business model is now delivering.

  As an aside, in "Other revenue" we had $32K of recognized deferred revenue relating to the discount amortization and interest imputation issues around the $1.6M BYK Chemie loan from November of 2005. This accrued revenue will be a static quarterly amount recognized through Q2 of 2009 which cumulatively represents the recognition of the deferred revenue booked to offset the $350K imputed note discount. All this trouble was required because we negotiated favorable interest terms with a supportive partner. This simply proves again that no good deed goes unpunished!

  Gross margins for Q107 amounted to 25% of revenue, versus 17% for Q106. In dollars, we had $375K more in gross margin, or gross profit, on additional revenue of $876K. Looking closer, that shows we had an incremental gross margin in excess of 40% on the added volume. While we like the margin growth we’ve seen, some of it has been offset by increases in commodity metal prices that we have largely recovered, albeit not at the percentage margins of the pre-increase sales, and in overtime worked to react to demand that has been difficult to predict. In Q1, we have also added direct labor and hourly manufacturing support staff to support our revenue ramp.

  As the product mix matures and stabilizes, we expect margins to grow. Predicting a precise trend will be difficult for the balance of the year.

  Again, for our analysts, we had about $280K and $236K in depreciation expense in "Cost of revenue" for Q107 and Q106, respectively. Equity compensation, the relative impact of which I will discuss at length later, did not materially affect "Cost of revenue" for either period.

• Moving down,

  R&D and SG&A Expenses, with some puts and takes, were relatively flat from first quarter 2006 to 2007.

  The "other items" line, below Q107 operations, was mainly composed of a write-down of fixed assets in the amount of $69K. This was a non-recurring event that was initiated due to a manufacturing process change which added flexibility to one of our lines. We hope to re-use this equipment at some point in the future, based upon future revenue mix.

  On a GAAP basis, as reported, Nanophase lost $0.06/share in Q1 of 2007 versus $0.09/share in Q1 of ’06.

  Analyzing the non-cash components of our Q107 loss, and the year over year comparisons, we have depreciation and amortization at about $350K and $315K company-wide, for Q107 and Q106, respectively. Depreciation and amortization, a regular component of our GAAP bottom line, amounted to $0.02/share of our Q107 loss.

  Equity compensation, also a non-cash expense, amounted to $205K and $195K for Q107 and Q106, respectively. Equity compensation expense contributed $0.01 per share to the Q107 loss.

  In total, depreciation, equity compensation expense, and the fixed asset write-down contributed to $0.03/share, or about half of the $0.06/share loss for Q107, and also $0.03 per share of the Q106 loss, including the $111K patent abandonment charge in 2006.

  For 2007, equity compensation expense comparisons to 2006 will have far less variability than they did last year, given that FAS 123R will have been in place for both reporting years. Annualizing Q107 expense, it would amount to $820K in equity comp. expense for all of 2007.

• Moving to the balance sheet highlights;

  Nanophase ended Q1 with $7.4 million in cash and investments.

  Q1 inventories are up to $1.4M, about 50% higher than at 12/31. This increase is all in material for which we have orders and solid forecasts. In this case, we made the choice to negatively impact working capital in order to allow for manufacturing flexibility. This all ties back to what I said about product mix predictability in the margin discussion along with the revenue ramp. Accounts payable have crept up also, directly in relation to the same issues.

  Equipment and leasehold improvements amounted to about $225K for the quarter. As 2007, and our view toward 2008 and beyond unfolds, we may need to add capital equipment and floor space to support future demand. Much of this is product mix dependent and, therefore, difficult to schedule. However, we view this as a good problem to have.

  On the liabilities side, the Company now has $1.8million in total debt. All but $105K of this relates to the BYK Chemie loan of $1.6M plus deferred revenue less related discounts. The debt discount, and offsetting deferred revenue referenced on the balance sheet, relate to the required accounting treatment under APB 21 of this loan and have no cash impact. Again, given that the terms are favorable to Nanophase, including interest-free periods and a low interest rate, we were required under GAAP to adopt this treatment.

  We also invite you to review our upcoming 10-Q which we expect to be filed by May 10^th.

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

Joseph Cross, President and CEO

• Thank you, Jess
• The first quarter of 2007 represents the ninth consecutive quarter of record annual quarter-over-quarter revenue growth stretching back to 2005. We believe that the revenue growth trend is being driven by several factors:
• An increasing global adoption rate for nanomaterials;
• Earlier adoption meaning that the adoption seems to be occurring in product development groups rather than thru R&D in large companies, which is a change over the past few years;
• Increasing recognition that nanomaterials provide applicational value in new or improved products; and, lastly,
• Nanophase’s business model relative to revenue growth through both market partners and customers is working...
• Moving forward during 2007, we anticipate a busy and productive year. Nanophase’s focus areas remain revenue growth, continued gross margin expansion, key technical objectives relative to process improvement and innovation, and increased new business development.
• Based on market partner forecasts and customer input, we anticipate revenue growth in 2007 from multiple markets and, based on initial planning, it is a trend that should continue through 2009. Volume and product growth will require Nanophase to continue evolving the Company’s technology and improving operations, while potentially adding capacity for nanoparticles, coated nanoparticles and dispersed nanoparticles. Management believes that the Company is on a solid growth trend and is highly focused on revenue growth. Let me summarize our current view of major market areas.
• As we have previously noted, the sunscreen and personal care market through our market partner, BASF, grew 24% in 2005 and 13% in 2006 and is forecast to grow by a double-digit percentage in 2007. BASF reaffirmed this forecast during the last quarter, so Nanophase is comfortable with the predicted growth. The growth is being driven by the increases in the original product, Z-Cote, as well as growing customer adoption of the two products in the Z-Cote MAX product line, which is targeted for Asian and European formulation chemistries.
• BYK Chemie, our market partner for coatings, plastics, and inks, continues to expand its customer base and, jointly with Nanophase, develop new applications for these markets. During the first quarter, revenue for BYK exceeded all of 2006 revenues. We continue to anticipate material revenue growth for 2007. Entering 2007, BYK Chemie is marketing approximately 20 NanoBYK nanomaterial-based products to potential customers throughout the world, but notably in the US, Asia, Europe, and India. Based on the amount of products in application development, we anticipate several additional new products should be released to the noted markets during 2007.

Based on BYK Chemie forecasts, we believe that nanomaterial dispersions for these markets could be one of Nanophase’s strongest revenue growth areas during 2007-2009. In view of shipments and orders to date, not considering forecasts, we believe that 2007 revenue for these markets should increase about 5 times 2006 levels.

As you may recall, we develop nanomaterial products in a three stage process beginning with laboratory samples, then scaling to pilot plant quantities, and finally volume manufacturing. As we noted in the earnings release, during the first quarter, we scaled and delivered eight new commercial volume nanomaterial dispersion products and developed and produced nine new nanomaterial dispersion products at the pilot plant stage, primarily for the industrial coatings and plastic markets. We are beginning to see real customer traction for these nanomaterial-based products in several of these markets with recent new customer additions in the US, China, and Europe.

• Relative to semiconductor polishing through our market partner Rohm & Haas Electronic Materials CMP Technologies (RHEM), based on our recent meeting and market penetration review, we believe that they are getting increased market interest and making definitive progress. We continue to believe that CMP for semiconductors is a real potential growth area for nanomaterials and Nanophase’s unique nonmaterial dispersions. RHEM placed an annual order with Nanophase during this first quarter. While 2007 revenues will be flat due to tighter inventory controls, RHEM’s current forecast for 2008-2010 depicts appreciable growth. Again, we believe that chemical mechanical polishing for semiconductors is a growth area for Nanophase and we are excited about our long-term relationship with Rohm & Haas.
• Moving to significant customers let me provide a brief overview.
• We have received an annual order from our customer for DNA Biosensors, which increased 25% year-over-year. While this is not a large revenue item for the Company, it is nice to see continuing growth.
• Our primary customer for architectural coatings continues to rollout its product. This appears to be progressing to the plan and we still anticipate appreciable revenue growth during 2007. From a revenue standpoint, they were our second largest customer during Q1 and we anticipate that their order rate should be increasing. We continue to anticipate material revenue growth versus 2006 levels.
• I would like to spend a moment discussing the Company’s Sales and Business Development initiatives. As many of you are aware, I have been trying to directly manage this effort since early 2004. While we have made progress in growth revenue with nine consecutive quarters of record annual quarter-over-quarter revenue growth stretching back to 2005, it was increasingly apparent, that my time was stretched entirely too thin, we needed a full time marketing and sales professional to drive the effort, and we needed, perhaps, to modify our sales and marketing paradigm to effect the 40-50% annual revenue growth rate that the management team has targeted.

  During the first quarter, Kevin Wenta joined Nanophase as EVP Sales & Marketing. Kevin has a solid, 20 year background in sales and management leadership in the chemical industry and already taken control of the function. I believe that Kevin’s diverse business and sales experience will be a key asset to drive increasing market expansion and revenue growth.

  Recently, David Nelson joined Nanophase as vice president of sales. David has over 15 years of business development experience, most recently with Eastman Chemical where he delivered 100% growth annually, and has a solid past track record of success. We believe that David will play a key role in our revenue growth goals.

  We plan to continue strengthening our sales and marketing organization and initiatives. Management is dedicated to significant annual revenue growth going forward.

• Finally, I would like to spend a few minutes discussing gross margin since gross margin growth is a key management goal for 2007-2008. I am addressing this topic because it does not seem to be well understood as I talk to investors and potential investors.

  As we have explained before, Nanophase has a fixed cost manufacturing model. This means that we have a certain fixed costs that are necessary to be ISO and cGMP certified, have strong employee health safety practices, and have the required infrastructure to supply commercial quality and quantity products to world-class companies, such as BASF and Rohm & Haas, where typically we are the sole supplier.

  In our financial model, as volume grows, Nanophase generally only incurs additional variable manufacturing costs, think direct labor and materials, while overhead and fixed cost remain relatively stable. Since our variable margins are sound (remember we have decreased manufacturing cost over 80% in the last four years and continue to do so), increasingly, the variable manufacturing margin falls to the gross margin line. So, and this is just straight mathematics, gross margins grow as volume increases.
  In parallel, Nanophase is actively managing pricing in our markets. We have broadly raised prices where feasible entering 2007, which will become increasingly apparent as the year progresses, and will continue to monitor pricing based on applicational value as we go forward. In summary, we anticipate continuing gross margin growth as volume grows and as time passes.

• This concludes our planned remarks; we are available for questions at this time.