THIRD QUARTER 2006 CONFERENCE CALL

Joseph Cross, President and CEO

• Welcome to Nanophase's third quarter 2006 conference call to review both record third quarter revenue compared to previous years, as well as the largest revenue quarter in the Company's history. Jess Jankowski, Nanophase's CFO, and I will be hosting this session. Both from a revenue growth and margin expansion perspective, this past quarter reached new highs for Nanophase. In addition to record quarterly revenue, the Company achieved the highest quarterly gross margin in our history. Since we actively target both revenue growth and margin expansion, this quarter represents a validation of our efforts and our financial business modeling which predicts disproportionate gross margin growth with increasing volume based on our fixed cost business and manufacturing model. It was a very solid quarter for the Company and the team at Nanophase that made it happen.
• To begin our discussion, Jess will discuss financial highlights for the quarter and first nine months. Jess... ...

Jess Jankowski, CFO

• Good afternoon and thanks for your continuing support of Nanophase. As Joe mentioned, the third quarter set another revenue record for the Company.
  
  Given that the details are included in the financials accompanying today's press release, I intend only to present a brief overview of key points regarding the Company's three- and nine-month performance. Numbers are in approximate terms.
• Revenues for Q3 were 2.4 million dollars this year, versus 1.7 million last year. For the first nine months of this year revenues were $6.8million versus $5.4million for the same period in 2005. As a matter of fact, the nine months sales numbers for 2006 slightly exceeded our total revenue for all of last year.
  
  Gross margin also continues to grow. This is a sign of our business model delivering as promised. We experienced a 30% gross margin for Q3 of this year and a 23% margin for the nine month period, versus 12- and 16%, respectively, for the same periods in 2005. Recall that our fixed manufacturing cost structure, the minimum that's required to be in this business, does not need to grow materially until we achieve a multiple of 2005 revenue. This is a key component on our path to cash flow breakeven, then profitability.
  
  On a GAAP basis, as reported, we lost $0.05 per share for the quarter and $0.20, for the nine-months of 2006 versus $0.09 and $0.23 for the same periods last year.
  
  Much of this positive change has been obscured due to the implementation of FAS 123 (R) for calendar 2006. This change resulted in $400K more non-cash equity comp. expense being recognized in the first nine months of ‘06 than in the same period last year.
  
  To further illustrate, for the recent nine month period, Nanophase had $1.6million in non-cash expenses relating to depreciation and amortization, equity comp., and a one-time patent write-off. Of these, and I add this as a technical courtesy to our analysts, depreciation and amortization amounted to 59% and stock options and other equity comp. amounted to 28% of the total. For 2006, $712,000 of this non-cash expense was in cost of revenue, $691K of it being depreciation. The non-cash portion of cost of revenue was $719K in 2005, almost all of it being depreciation.
  
  In order to impart a better sense of the progress reflected in the comparative numbers, I'd like to highlight a new term, EBITDA-O, or EBITDAO. EBITDAO reflects earnings before interest income and expense, taxes, depreciation, amortization, and, now, equity comp. expense which primarily relates to options. For the nine-month period, EBITDAO amounted to a loss of $0.13 for 2006 versus $0.19 for the same period in 2005. This represents an improvement of more than $1M in EBITDAO on only $1.4M in incremental sales. As you can see, this is further evidence that our business model is working. We are reaping the financial benefits of additional sales volume that requires minimal additional fixed overhead costs to generate, given that the necessary supervision, quality, and other infrastructure is already in place.
  
  For 2006, as a result of this progress, we have experienced an average operating cash burn of approximately $500K per quarter. In other words, we have effectively cut our operating cash burn to about half of 2005 levels. We would expect cash burn to ratchet up a bit in Q4 as we build zinc oxide inventory to have a surplus entering Q1of 2007. We plan on building this inventory in order to prepare for increased potential Q1 and first half demand, from our new architectural coatings customer and BASF, without incurring significant overtime. Until the architectural coatings rollout is complete, we won't have a good gauge on where the peaks in quarterly demand will be. While we believe we have appropriate capacity to handle expected 2007 business within normal operations, that assumes a degree of level-loading and predictability. As we know well, and have the scars to prove it, visibility is less than perfect. Until these markets mature, we will continually assess the need for safety stocks and, in this instance, carry a bit more than we may require in order to avoid placing unnecessary, albeit temporary, strains on our manufacturing operations.
  
  In terms of other capital uses, so far in 2006 Nanophase has incurred $2M in capital expenditures. Recall that over 80% of this was funded by the loan received from BYK Chemie, a division of Altana, last fall to speed market penetration and expansion.
  
  Relatively speaking, we're continuing to see progress where it matters, on our path to becoming cash flow positive. It is a satisfying indicator that, with sales volume, our actual results are in line with what we have been modeling. Sales growth is being followed by margin growth. This growth is proving to reduce cash burn and keep us moving quickly toward operational cash flow breakeven. The best is certainly yet to come.
• Thank you 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.
• To date, 2006 has been a very solid year for Nanophase in both revenue growth and operational performance. The latter is highly important as volume grows; Nanophase cannot afford to stumble on delivery or product quality. Management's first priority remains revenue growth and a close second is gross margin expansion. We are working very hard on both as we plan to enter 2007.
• Beginning with our longest-term Market Partner, BASF, sustained revenue growth, viewed from an annual perspective, continues to appear positive. In sunscreens and personnel care, the original Z-Cote product continues volume increases year-over-year. BASF is beginning to see market traction with the new Z-Cote MAX that was launched mid-2005 and recently introduced another new product, T-Lite MAX. That brings our sunscreen and personnel care product base to three distinct nanoengineered products, with a fourth anticipated in the first quarter of 2007. Nanophase has long-term exclusive supply agreements for each.
• BYK Chemie and Nanophase continue to make progress in nanoengineered product development and market penetration. There are now seven NANOBYK products in the market with 3-4 additional products planned for late Q4 '06 or early Q1 '07. We also have about 60 lab products being tested in various applications by different customers in several markets. We are beginning to see market traction in the US, Europe, and Asia on applications for UV resistance or attenuation, applications in UV curable coatings, and architectural coatings. BYK Chemie expects the momentum to increase and is forecasting appreciable growth for 2007. BYK Chemie's commitment and confidence in growth is evident in the $1.6 million dollar investment in Nanophase to implement production equipment to support increasing volume.
• Rohm & Haas has a long-term corporate, strategic commitment to the semiconductor CMP market and has demonstrated that commitment by their recent $5 million strategic investment in Nanophase. The new customers that I have previously discussed continue their adoption cycle and increasing use of nanoparticle-based slurries. We anticipate that their technology partners in Asia will start their adoption cycle in late Q4 or early Q1. It's a product that we expect to continue growing. Based on Rohm and Haas' success with this manufacturer and their technology partners, we believe that industry acceptance for the slurry may be accelerated going forward.
• Rohm and Haas and Nanophase are also working on a new slurry product that Rohm and Haas believes will be revolutionary in the CMP industry by providing a performance level previously unattainable. We are in the final stages of product development and we believe that Rohm & Haas plans to launch the new slurry in the near future.
• Moving from Market Partners to customers, and I only intend to cover significant situations, our leading architectural coating customer, Behr, continues to roll-out their new Premium Plus Ultra™ with NanoGuard^® exterior stain product through a large orange-roofed DIY retailer. Second quarter volume, representing less than 8% of retail locations, amounted to over $500,000 in revenue to Nanophase. During the third quarter, the roll-out was extended to about 33% of the retail locations and amounted to about 40% of Nanophase's revenue for the quarter. Behr has repeatedly forecast to us that the full roll-out will begin about January 2007 and has, in fact, provided the Company with a letter of understanding, which is non-binding, that forecasts volume for 2007. Based on forecast and expected volume, we have recently installed equipment to double the Company's dispersion capacity. We expect that this architectural coating application will be a material source of revenue growth during 2007.
• Again, as an approximate $40B global market, we believe architectural coatings may be a large market opportunity for nanomaterials and a market that we are pursuing vigorously with our market partner BYK Chemie.
• In summary to our prepared comments, prior to this call, I reviewed our first 2006 conference call which outlined some expectations for 2006. I am proud to say on behalf of the entire Nanophase team that we have essentially met, or exceeded, every expectation entering the year.
• We have consistently increased revenue each quarter through the first nine months. We set a Company revenue record in the second quarter only to exceed it in the third quarter. Through the first nine months of 2006, we have already exceeded 2005 revenues. Our market penetration through both focused business development and our market partners has been robust and continues to appear vital going forward. In the end, 2006 should be a strong year of Company and revenue growth, which, we believe based on customer forecasts and information, should continue through 2007.

That concludes our prepared comments; we are available for appropriate questions.