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<SEC-DOCUMENT>0000950137-06-008823.txt : 20060808
<SEC-HEADER>0000950137-06-008823.hdr.sgml : 20060808
<ACCEPTANCE-DATETIME>20060808104050
ACCESSION NUMBER:		0000950137-06-008823
CONFORMED SUBMISSION TYPE:	10-Q
PUBLIC DOCUMENT COUNT:		4
CONFORMED PERIOD OF REPORT:	20060630
FILED AS OF DATE:		20060808
DATE AS OF CHANGE:		20060808

FILER:

	COMPANY DATA:	
		COMPANY CONFORMED NAME:			NANOPHASE TECHNOLOGIES CORPORATION
		CENTRAL INDEX KEY:			0000883107
		STANDARD INDUSTRIAL CLASSIFICATION:	MISCELLANEOUS PRIMARY METAL PRODUCTS [3390]
		IRS NUMBER:				363687863
		STATE OF INCORPORATION:			IL
		FISCAL YEAR END:			1231

	FILING VALUES:
		FORM TYPE:		10-Q
		SEC ACT:		1934 Act
		SEC FILE NUMBER:	000-22333
		FILM NUMBER:		061011435

	BUSINESS ADDRESS:	
		STREET 1:		453 COMMERCE ST
		CITY:			BURR RIDGE
		STATE:			IL
		ZIP:			60521
		BUSINESS PHONE:		6303231200

	MAIL ADDRESS:	
		STREET 1:		453 COMMERCE STREET
		CITY:			BURR RIDGE
		STATE:			IL
		ZIP:			60521
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-Q
<SEQUENCE>1
<FILENAME>c07357e10vq.htm
<DESCRIPTION>QUARTERLY REPORT
<TEXT>
<HTML>
<HEAD>
<TITLE>e10vq</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
<!-- PAGEBREAK -->
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>
<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV style="width: 100%; border-bottom: 2pt solid black; font-size: 1pt">&nbsp;</DIV>
<DIV style="width: 100%; border-bottom: 1pt solid black; font-size: 1pt">&nbsp;</DIV>




<DIV align="center" style="font-size: 14pt; margin-top: 12pt"><B>SECURITIES AND EXCHANGE COMMISSION</B>
</DIV>

<DIV align="center" style="font-size: 12pt"><B>Washington, D.C. 20549</B>
</DIV>

<DIV align="center" style="font-size: 18pt; margin-top: 12pt"><B><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 26%; border-top: 1px solid #000000">&nbsp;</DIV></DIV></B>
</DIV>


<DIV align="center" style="font-size: 18pt; margin-top: 12pt"><B>Form&nbsp;10-Q</B>
</DIV>

<DIV align="center" style="font-size: 12pt; margin-top: 12pt"><B><FONT face="Wingdings">&#254;</FONT>QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF<BR>
THE SECURITIES EXCHANGE ACT OF 1934</B>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>For the Quarterly Period Ended: June&nbsp;30, 2006</B></DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 12pt"><B>Commission File Number: 0-22333</B></DIV>

<DIV align="center" style="font-size: 24pt; margin-top: 12pt"><B>Nanophase Technologies Corporation</B>
</DIV>

<DIV align="center" style="font-size: 10pt">(Exact name of registrant as specified in its charter)</DIV>


<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="47%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="47%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD align="center" valign="top"><B>Delaware</B><BR>
(State or other jurisdiction of<BR>
incorporation or organization)
</TD>
    <TD>&nbsp;</TD>
    <TD align="center" valign="top"><B>36-3687863</B><BR>
(I.R.S. Employer<BR>
Identification No.)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>1319 Marquette Drive, Romeoville, Illinois 60446</B><BR>
(Address of principal executive offices, and zip code)

</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt">Registrant&#146;s telephone number, including area code: <B>(630)&nbsp;771-6708</B>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant (1)&nbsp;has filed all reports required to be
filed by Section&nbsp;13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12&nbsp;months
(or for such shorter period that the registrant was required to file such reports), and (2)&nbsp;has
been subject to such filing requirements for the past 90&nbsp;days. Yes <FONT face="Wingdings">&#111;</FONT> No <FONT face="Wingdings">&#254;</FONT>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of &#147;accelerated filer and large
accelerated filer&#148; in Rule&nbsp;12B-2 of the Exchange Act. (Check one):
</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 0pt">Large accelerated filer <FONT face="Wingdings">&#111;</FONT>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Accelerated filer <FONT face="Wingdings">&#254;</FONT> &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Non-accelerated filer <FONT face="Wingdings">&#111;</FONT>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Indicate by check mark whether the registrant is a shell company (as defined in Rule&nbsp;12b-2 of
the Exchange Act). Yes <FONT face="Wingdings">&#111;</FONT> No <FONT face="Wingdings">&#254;</FONT>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of August&nbsp;1, 2006, there were 18,033,345 shares outstanding of common stock, par value
$.01, of the registrant.
</DIV>

<DIV style="width: 100%; border-bottom: 1pt solid black; margin-top: 10pt; font-size: 1pt">&nbsp;</DIV>
<DIV style="width: 100%; border-bottom: 2pt solid black; font-size: 1pt">&nbsp;</DIV>





<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">







<DIV align="left">
<!-- TOC -->
</DIV>
<DIV align="left">
<A name="tocpage"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>QUARTER ENDED JUNE 30, 2006</B>

</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>INDEX</B>

</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="88%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000"><B>Page</B></TD>

</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#101">PART I &#151; FINANCIAL INFORMATION</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#102">Item&nbsp;1. Financial Statements</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#103">Unaudited Balance Sheets as of June&nbsp;30, 2006 and December&nbsp;31, 2005</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#104">Unaudited Statements of Operations for the three months ended June&nbsp;30, 2006 and 2005 and the six months ended
June&nbsp;30, 2006 and 2005</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">4</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#105">Unaudited Statements of Cash Flows for the six months ended June&nbsp;30, 2006 and 2005</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">5</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px"><A href="#106">Notes to Unaudited Financial Statements</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">6</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#107">Item&nbsp;2. Management&#146;s Discussion and Analysis of Financial Condition and
Results of Operations</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">11</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#108">Item&nbsp;3. Quantitative and Qualitative Disclosures About Market Risk</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#109">Item&nbsp;4. Controls and Procedures</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#110">PART II &#151; OTHER INFORMATION</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#111">Item&nbsp;1. Legal Proceedings</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">16</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#112">Item&nbsp;4. Submissions of Matters to a Vote of Security Holders</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">25</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#113">Item&nbsp;5. Other Information</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">26</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">

<TD><DIV style="margin-left:30px; text-indent:-15px"><A href="#114">Item&nbsp;6. Exhibits and Reports on Form&nbsp;8-K</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">26</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><A href="#115">SIGNATURES</A></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">28</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="c07357exv31w1.htm">Certification</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="c07357exv31w2.htm">Certification</A></FONT></TD></TR>
<TR><TD colspan="9"><FONT size="2">&nbsp;<A HREF="c07357exv32.htm">Certification</A></FONT></TD></TR>
</TABLE>
</DIV>

<DIV align="left">
<!-- /TOC -->
</DIV>

<P align="center" style="font-size: 10pt">2
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left">
<A name="101"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>PART I &#151; FINANCIAL INFORMATION</B>
</DIV>

<DIV align="left">
<A name="102"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1. Financial Statements</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>

<DIV align="left">
<A name="103"></A>
</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>BALANCE SHEETS<BR>
(Unaudited)</B>

</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>June 30,</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2"><B>December 31,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2006</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD align="center"><DIV style="margin-left:75px; text-indent:-15px"><B>ASSETS</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Current assets:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Cash and cash equivalents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">542,962</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">340,860</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Investments</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">5,625,574</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">8,168,092</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Trade accounts receivable, less allowance for doubtful accounts of
$22,195 and $23,533 on June&nbsp;30, 2006 and December&nbsp;31, 2005,
respectively</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">957,260</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,180,117</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Inventories, net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">883,771</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">801,217</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Prepaid expenses and other current assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">344,692</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">414,363</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Total current assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">8,354,259</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">10,904,649</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Equipment and leasehold improvements, net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,570,040</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">6,587,787</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Other assets, net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">621,344</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">680,908</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,545,643</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">18,173,344</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD align="center"><DIV style="margin-left:60px; text-indent:-15px"><B>LIABILITIES AND STOCKHOLDERS&#146; EQUITY</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Current liabilities:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Current portion of long-term debt</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">200,254</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Current portion of deferred other revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">113,514</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">56,757</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Current portion of capital lease obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">31,527</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accounts payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">850,028</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">285,076</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accrued expenses</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,315,111</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,152,127</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Total current liabilities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,310,180</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,694,214</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Long-term debt, less current maturities and unamortized debt discount</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,323,001</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,265,875</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Long-term portion of capital lease obligations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">67,408</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Deferred other revenue, less current portion</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">236,486</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">293,243</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,626,895</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,559,118</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Contingent liabilities</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Stockholders&#146; equity:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Preferred stock, $.01 par value, 24,088 shares authorized and
no shares issued and outstanding</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Common stock, $.01 par value, 25,000,000 shares authorized;
18,009,348 and 17,976,592 shares issued and outstanding on
June&nbsp;30, 2006 and December&nbsp;31, 2005, respectively</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">180,093</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">179,766</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Additional paid-in capital</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">72,678,360</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">72,307,887</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Accumulated deficit</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(60,249,885</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(57,567,641</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Total stockholders&#146; equity</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">12,608,568</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">14,920,012</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">16,545,643</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">18,173,344</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><I>See Notes to Financial Statements.</I>

</DIV>

<P align="center" style="font-size: 10pt">3
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>

<DIV align="left">
<A name="104"></A>
</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>STATEMENTS OF OPERATIONS<BR>
(Unaudited)</B>

</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="52%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6" style="border-bottom: 0px solid #000000"><B>Three months ended June 30,</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6" style="border-bottom: 0px solid #000000"><B>Six months ended June 30,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2006</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2006</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Revenue:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Product revenue, net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">2,298,315</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">1,999,456</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">4,216,362</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">3,525,760</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Other revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">92,587</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">85,269</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">180,109</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">172,347</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Net revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,390,902</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,084,725</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">4,396,471</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,698,107</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Operating expense:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Cost of revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,846,678</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,594,264</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,514,429</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,038,764</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Research and development expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">487,133</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">476,241</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,034,279</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">970,680</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Selling, general and administrative
expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,241,403</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,194,192</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,628,857</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,337,336</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Total operating expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,575,214</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,264,697</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">7,177,565</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">6,346,780</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Loss from operations</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,184,312</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,179,972</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,781,094</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,648,673</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Interest income</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">74,769</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">71,370</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">157,482</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">136,417</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Interest expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(30,391</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(8,814</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(61,615</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(20,713</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Other, net</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">943</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">29,453</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,983</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">29,466</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Loss before provision for income
taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,138,991</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,087,963</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,682,244</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,503,503</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Provisions for income taxes</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(1,138,991</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(1,087,963</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(2,682,244</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(2,503,503</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net loss per share &#151; basic and
diluted</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.06</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.06</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.15</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(0.14</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Weighted average number of common
shares outstanding</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">18,009,155</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">17,913,818</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">18,001,238</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">17,910,459</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><I>See Notes to Financial Statements.</I>

</DIV>

<P align="center" style="font-size: 10pt">4
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>

<DIV align="left">
<A name="105"></A>
</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>STATEMENTS OF CASH FLOWS<BR>
(Unaudited)</B>

</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="6" style="border-bottom: 0px solid #000000"><B>Six months ended June 30,</B></TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2006</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>2005</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Operating activities:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(2,682,244</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">$</TD>
    <TD align="right">(2,503,503</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Adjustment to reconcile net loss to net cash (used in)
operating activities:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Depreciation and amortization</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">613,251</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">639,993</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Amortization of debt discount</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">57,125</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Stock compensation expense</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">325,646</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">28,034</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Allowance for excess inventory
quantities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(245,464</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,736</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Equipment write-off</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">6,128</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">13,163</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Patent write-off</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">111,162</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Changes in assets and liabilities related to operations:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Trade accounts receivable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">22,603</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(917,356</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Other receivable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">3,498</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Inventories</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">162,910</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">638</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Prepaid expenses and other assets</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">69,671</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(4,222</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Accounts payable</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">401,406</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">280,554</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:45px; text-indent:-15px">Accrued liabilities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">160,418</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">65,526</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net cash (used in) operating activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(997,388</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(2,395,411</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Investing activities:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Acquisition of equipment and leasehold
improvements</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(1,433,168</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(282,488</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Acquisition of Patents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(68,070</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(65,197</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Payment of accounts payable incurred for the purchase of
equipment and leasehold improvements</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">14,121</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Purchases of investments</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(39,626,957</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(109,769,600</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Sales of investments</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">42,169,475</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">112,413,572</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net cash provided by investing
activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,055,401</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">2,296,287</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Financing activities:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Principal payment on debt obligations, including capital
leases</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(3,665</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(10,321</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Proceeds from borrowings</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">102,600</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Proceeds from sale of common stock, net, and exercise of
stock options</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">45,154</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">36,784</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net cash provided by financing activities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">144,089</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">26,463</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Increase (decrease)&nbsp;in cash and cash
equivalents</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">202,102</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(72,661</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash and cash equivalents at beginning of
period</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">340,860</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">475,185</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Cash and cash equivalents at end of period</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">542,962</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">402,524</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Supplemental cash flow information:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Interest paid</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">4,490</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">20,713</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px"><B>Supplemental non-cash investing activities:</B></DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Accounts receivable paid through offset of long-term
debt</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">200,254</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">238,342</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Accounts payable incurred for the purchase of equipment
and leasehold improvements</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">149,425</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">76,217</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><I>See Notes to Financial Statements.</I>

</DIV>

<P align="center" style="font-size: 10pt">5
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>

<DIV align="left">
<A name="106"></A>
</DIV>

<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>NOTES TO FINANCIAL STATEMENTS<BR>
(Unaudited)</B>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(1)&nbsp;Basis of Presentation</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The accompanying unaudited interim financial statements of Nanophase Technologies Corporation
(the &#147;Company&#148;) reflect all adjustments (consisting of normal recurring adjustments) which, in the
opinion of management, are necessary for a fair presentation of the financial position and
operating results of the Company for the interim periods presented. Operating results for the
three and six month periods ended June&nbsp;30, 2006 are not necessarily indicative of the results that
may be expected for the year ended December&nbsp;31, 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;These financial statements should be read in conjunction with the Company&#146;s audited financial
statements and notes thereto for the year ended December&nbsp;31, 2005, included in the Company&#146;s Annual
Report on Form 10-K for the year ended December&nbsp;31, 2005, as filed with the Securities and Exchange
Commission.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(2)&nbsp;Description of Business</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company was incorporated on November&nbsp;30, 1989, for the purpose of developing
nanocrystalline materials for commercial production and sale in domestic and international markets.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Nanophase Technologies is a nanocrystalline materials developer and commercial manufacturer
with an integrated family of nanomaterial technologies. Nanophase produces engineered
nanomaterials for use in a variety of diverse existing and developing markets: personal care,
sunscreens, abrasion-resistant applications, antimicrobial products and a variety of polishing
applications, including semiconductors and optics. New markets and applications are also being
developed. The Company targets markets in which it feels practical solutions may be found using
nanoengineered products. The Company works with leaders in these target markets to identify and
supply their material and performance requirements.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company also recognizes regular other revenue from a technology license. This activity is
not expected to drive the long-term growth of the business. License revenue is recognized as &#147;other
revenue&#148; in the Company&#146;s Statement of Operations, as they do not represent revenue directly from
the Company&#146;s Nanocrystalline materials.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(3)&nbsp;Inventories</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Inventories consist of the following:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>June 30, 2006</B></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000"><B>December 31, 2005</B></TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Raw materials</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">227,669</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">498,144</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Finished goods</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,001,978</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">894,413</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,229,647</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,392,557</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Allowance for excess inventory quantities</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(345,876</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(591,340</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">883,771</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">801,217</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
        <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">6
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>NANOPHASE TECHNOLOGIES CORPORATION</B>
</DIV>


<DIV align="Center" style="font-size: 10pt; margin-top: 6pt"><B>NOTES TO FINANCIAL STATEMENTS &#150; (Continued)<BR>
(Unaudited)</B>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(4)&nbsp;Share-Based Compensation</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Prior to January&nbsp;1, 2006, the Company accounted for its stock option plan under the
recognition and measurement provisions of APB Opinion No.&nbsp;25, Accounting for Stock Issued to
Employees and related Interpretations, as permitted by FASB Statement No.&nbsp;123, Accounting for
Stock-Based Compensation. No stock option-based employee compensation cost was recognized in the
Statement of Operations for the three or six months ended June&nbsp;30, 2005, as all options granted
under those plans had an exercise price equal to the market value of the underlying common stock on
date of grant. Effective January&nbsp;1, 2006, the Company adopted the fair value recognition provisions
of FASB Statement No.&nbsp;123(R), Shared-Based Payment, using the modified-prospective-transition
method. Under that transition method, compensation cost recognized for the three and six months
ended June&nbsp;30, 2006 includes: (a)&nbsp;compensation cost for all share-based payments granted prior to,
but not yet vested on January&nbsp;1, 2006, based on the grant date fair value estimated in accordance
with the original provisions of Statement 123, and (b)&nbsp;compensation cost for all share-based
payments granted subsequent to January&nbsp;1, 2006, based on the grant-date fair value estimated in
accordance with the provisions of Statement 123(R). Results for the prior period have not been
restated.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As a result of adopting Statement 123(R) on January&nbsp;1, 2006 the Company&#146;s loss before
provision for income taxes and net loss for the three and six months ended June&nbsp;30, 2006 were
$67,093 and $182,398 greater than if it had continued to account for share-based compensation under
Opinion 25. Basic and diluted earnings per share for the three and six months ended June&nbsp;30, 2006
would have been ($.06) and ($.14), if the Company had not adopted Statement 123(R), compared to
reported basic and diluted earnings per share of ($.06) and ($.15) respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Compensation expense is recognized only for share-based payments expected to vest. The Company
estimates forfeitures at the date of grant based on the Company&#146;s historical experience and future
expectations. Prior to the adoption of SFAS 123(R), the effect of forfeitures on the pro forma
expense was recognized based on estimated forfeitures.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of June&nbsp;30, 2006, there was approximately $376,000 of total unrecognized compensation cost
related to nonvested share-based compensation arrangements granted under the Company&#146;s stock option
plans. That cost is expected to be recognized over a weighted-average period of 8.78&nbsp;years.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following table illustrates the effect on net income and earning per share if the Company
had applied the fair value recognition provisions of SFAS No.&nbsp;123 to options granted under the
Company&#146;s stock option plan presented on June&nbsp;30, 2005. For purposes of this pro forma disclosure,
the value of the options is estimated using a Black-Scholes option-pricing formula and amortize to
expense over the option vesting periods.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Three months</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Six months</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">ended</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">ended</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">June 30, 2005</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">June 30, 2005</TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Net Loss:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">As reported</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">($</TD>
    <TD align="right">1,087,963</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">($</TD>
    <TD align="right">2,503,503</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Deduct total stock-based employee
compensation expense determined
under fair value based method for
all awards
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(116,112</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(234,005</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Pro forma net loss</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">($</TD>
    <TD align="right">1,204,075</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">($</TD>
    <TD align="right">2,737,508</TD>
    <TD nowrap>)</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 3px double #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<P align="center" style="font-size: 10pt">7
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="76%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Three months</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Six months</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">ended</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">ended</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">June 30, 2005</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">June 30, 2005</TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Loss per share:</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Basic &#151; As reported</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.06</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.14</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Basic &#150; Pro forma</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.07</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.15</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Diluted &#151; As reported</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.06</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.14</TD>
    <TD nowrap>)</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">Diluted &#150; Pro forma</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.07</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(0.15</TD>
    <TD nowrap>)</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Employees Stock Options and Stock Grants
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;During the six months ended June&nbsp;30, 2006, 21,386 shares of Common Stock were issued pursuant
to option exercises compared to 25,370 shares in the same period in 2005. No options were granted
to employees for the six months ended June&nbsp;30, 2006 and 2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following table summarizes the Company&#146;s option activity for Nanophase Technologies
Corporation employees and directors during the six months ended June&nbsp;30, 2006:
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="52%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Weighted</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Weighted</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Average</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Average</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Remaining</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Exercise</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Contractual</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Aggregate</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Price per</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Term</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2">Intrinsic</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">

<TD nowrap align="left" style="border-bottom: 1px solid #000000"><DIV style="margin-left:75px; text-indent:-15px">Options</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">Shares</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">Share</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">(years)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">Value</TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Outstanding on January&nbsp;1, 2006</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,744,232</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">5.92</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Granted</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Exercised</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(21,386</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">2.54</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Forfeited or expired</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">(4,080</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">5.25</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD nowrap colspan="2" align="right" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Outstanding on June&nbsp;30, 2006</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,718,766</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">5.96</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">4.70</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">3,049,260</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Exercisable on June&nbsp;30, 2006</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">1,548,268</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">5.98</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">4.25</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">2,807,571</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The aggregate intrinsic value in the table above is before income taxes, based on Nanophase&#146;s
closing stock price of $7.24 on the last business day for the period ended June&nbsp;30, 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;During the three and six months ended June&nbsp;30, 2006, the total intrinsic value of Nanophase
stock options exercised was $690 and $111,196, respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Restricted Stock
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On April&nbsp;3, 2006, the Company was to grant each outside director 814 shares of deferred
common stock totaling 4,884 shares under the Company&#146;s 2005 Non-Employee Director Restricted Stock
Plan. However, each outside director elected to defer receipt of the restricted stock until the
termination
</DIV>

<P align="center" style="font-size: 10pt">8
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">of their services to the Company. The deferral of restricted stock is being accounted
for under the Company&#146;s Non-Employee Director Deferred Compensation Plan. The fair value of the
awards granted was $36,000 for the restricted share rights and is included in stock-based
compensation expense for the three months ending June&nbsp;30, 2006 compared to $0 for the same period
in 2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In September&nbsp;2005 and October&nbsp;2004, the Company granted a total of 66,666 shares of restricted
stock at market value consisting of 33,332 restricted share rights and 33,334 performance share
rights, respectively. For the three and six months ended June&nbsp;30, 2006, the stock-based
compensation expense was $14,581 and $29,002 for the restricted share rights compared to $7,556 and
$15,029 for the same periods in 2005. For the three and six months ended June&nbsp;30, 2006, the
stock-based compensation expense was $12,742 and $42,246 for the performance share rights compared
to $5,290 and $13,005 for the same periods in 2005.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(5)&nbsp;Significant Customers and Contingencies</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenue from three customers constituted approximately 59%, 23% and 8% for the three months
ended June&nbsp;30, 2006, compared to 69%, 12% and 7% of the Company&#146;s total revenue for the six months
ended June&nbsp;30, 2006. Amounts included in accounts receivable at June&nbsp;30, 2006 relating to these
three customers were approximately $435,000, $161,000 and $180,000, respectively. Revenue from
these three customers constituted approximately 69%, 1% and 5% of the Company&#146;s total revenue for
the three months ended June&nbsp;30, 2005, compared to 77%, 2% and 3% for the six months ended June&nbsp;30,
2005. Amounts included in accounts receivable at June&nbsp;30, 2005 relating to these three customers
were approximately $848,000, $29,000 and $95,000, respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company currently has supply agreements with BASF Corporation (&#147;BASF&#148;), the Company&#146;s
largest customer, and Rohm and Haas Electronic Materials CMP, Inc. (&#147;RHEM&#148;), that have
contingencies outlined in them which could potentially result in the license of technology and/or
the sale of production equipment, providing capacity sufficient to meet the customer&#146;s production
needs, from the Company to the customer, if triggered by the Company&#146;s failure to meet certain
performance requirements and/or certain financial condition covenants. The financial condition
covenants in one of the Company&#146;s supply agreement with its largest customer, as amended, &#147;triggers&#148; a
technology transfer (license or, optionally, an equipment sale) in the event (a)&nbsp;that earnings of
the Company for a twelve month period ending with its most recently published quarterly financial
statements are less than zero and its cash, cash equivalents and investments are less than
$2,000,000, (b)&nbsp;of an acceleration of any debt maturity having a principal amount of more than
$10,000,000, or (c)&nbsp;of the Company&#146;s insolvency, as further defined within the agreement. In the
event of an equipment sale, upon incurring a triggering event, the equipment would be sold to the
customer at 115% of the equipment&#146;s net book value. Under another of the Company&#146;s supply
agreements with BASF, upon the Company&#146;s breach of its contractual obligations to BASF, the Company
would be required to sell BASF certain production equipment at the greater of 30% of the original
book value of such equipment, and any associated upgrades to it, or 115% of the equipment&#146;s net
book value.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company believes that it has sufficient cash and investment balances to avoid the first
triggering event through 2006. If a triggering event were to occur and BASF elected to proceed
with the license and related sale mentioned above, the Company would receive royalty payments from
this customer for products sold using the Company&#146;s technology; however, the Company would lose
both significant revenue and the ability to generate significant revenue to replace that which was
lost in the near term. Replacement of necessary equipment that could be purchased and removed by
the customer pursuant to this triggering event could take in excess of twelve months. Any
additional capital outlays required to rebuild capacity would probably be greater than the proceeds
from the purchase of the assets
</DIV>

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</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">as dictated by the Company&#146;s agreement with the customer. Such an
event would also result in the loss of many of the Company&#146;s key staff and line employees due to
economic realities. The Company believes that its employees are a critical component of its success
and could be difficult to replace and train quickly. Given the occurrence of such an event, the
Company might not be able to hire and retain skilled employees given the stigma relating to such an
event and its impact on the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(6)&nbsp;Business Segmentation and Geographical Distribution</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenue from international sources approximated $319,000 and $586,000 for the six months ended
June&nbsp;30, 2006 and 2005, respectively. As part of its revenue from international sources, the
Company recognized approximately $156,000 in product revenue from several German companies and
$150,000 in other revenue from a technology license fee from its Japanese licensee for the six
months ended June&nbsp;30, 2006 compared to $402,000 and $150,000 for the same period in 2005,
respectively.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company&#146;s operations comprise a single business segment and all of the Company&#146;s
long-lived assets are located within the United States.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(7)&nbsp;Administrative Actions</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In February&nbsp;2004, an unidentified party filed a Petition to Request a Reexamination of US
Patent No.&nbsp;6,669,823 B1 in the U.S. Patent and Trademark Office, or USPTO. US Patent No.&nbsp;6,669,823
B1 relates to certain parts of one of the Company&#146;s nanoparticle manufacturing processes, NanoArc
Synthesis. The Company subsequently received notice that the USPTO had granted the Request for
Reexamination. The reexamination process is provided for by law and requires the USPTO to consider
the scope and validity of the patent based on substantial new questions of patentability raised by
a third party or the USPTO. On September&nbsp;7, 2005, the Company&#146;s representatives conducted an
interview with the Examiner assigned to the Reexamination at the USPTO, resulting in the Examiner
preparing an interview summary indicating that the Examiner agreed all the issued claims were
patentable. A response, including further remarks about the interview and two new claims, was
submitted shortly thereafter. However, prior to the USPTO issuing a formal notice confirming
patentability, the same unidentified party referenced above filed a second Petition to Request
Reexamination of the patent. Although the second Petition was denied, an amendment to all patent
claims was made. The same unidentified party subsequently filed a third Request for Reexamination,
which the USPTO granted and to which the Company has responded. It is not feasible to predict
whether the Company ultimately will succeed in maintaining all the claims of this patent during
reexamination. If the patent claims in this patent ultimately are narrowed substantially by the
USPTO, the patent coverage afforded to certain parts of the Company&#146;s NanoArc Synthesis
nanoparticle manufacturing process could be impaired. While the Company intends to vigorously
defend its patent protection against such claims, it does not believe that these patent claims pose
a risk of material harm to he Company&#146;s business prospects or competitive positions. If the scope
of the Company&#146;s claims protected by the patent in question were ultimately reduced through the
pending re-examination proceedings before the USPTO, the Company would still continue to be able to
conduct its business as currently conducted, including the use of the technology that is the
subject of the patented claims. A reduction in the scope of the claims protected by the Company&#146;s
patent in question would limit the Company&#146;s ability to assert infringement claims and suits
against other parties using the same or sufficiently similar technology. The Company believes that
while patent protection is a valuable asset, a reduction in the scope of the claims protected by
the Company&#146;s patent in question would not materially alter the competitive environment in which
the Company operates or result in a material loss.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>(8)&nbsp;New Accounting Pronouncement</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In June&nbsp;2006, the FASB issued Interpretation No.&nbsp;48 (&#147;FIN 48&#148;), &#147;Accounting for Uncertainty in
Income Taxes &#150; an interpretation of SFAS 109, &#147;Accounting for Income Taxes.&#148; FIN 48 prescribes a
</DIV>

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</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. FIN 48 developed a
two-step process to evaluate a tax position and also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods, disclosure, and transition.
This interpretation is effective for fiscal years beginning after December&nbsp;15, 2006. Management
has not yet determined the impact that adoption will have on the Company&#146;s financial statements.
</DIV>
<DIV align="left">
<A name="107"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;2. Management&#146;s Discussion and Analysis of Financial Condition and Results of Operations</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><B>Overview</B>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Nanophase Technologies is a nanocrystalline materials developer and commercial manufacturer
with an integrated family of nanomaterial technologies. Nanophase produces engineered
nanomaterials for use in a variety of diverse markets: sunscreens, personal care,
abrasion-resistant applications, antimicrobial products and a variety of polishing applications,
including semiconductors and optics. The Company targets markets in which it feels practical
solutions may be found using nanoengineered products. The Company works closely with leaders in
these target markets to identify their material and performance requirements. Newer developed
technologies have made certain new products possible and opened potential new markets. With the
commercialization of the Company&#146;s NanoArc&#153; synthesis and new dispersion technologies in 2002, and
the expansion of these capabilities in 2003 and 2004, Nanophase is focusing on penetrating the
chemical-mechanical-planarization (&#147;CMP&#148;) and fine polishing markets. CMP is the process of
polishing various types of integrated circuits or chips to be used in various commercial
electronics applications. Management believes that the Company&#146;s inroads in the CMP and fine
polishing markets would have been very difficult without the Company being able to produce its
materials to exacting specifications verified by in-house and customer-based testing. Management
expects growth in end-user (customers of Nanophase&#146;s customers) adoption in 2006 and revenue growth
to continue in 2006 in both of these areas. Additionally, the Company feels that its exclusive
relationship with Altana Chemie (&#147;Altana&#148;), a global ingredients supplier to various coatings
industries, will lead to growth in several of its abrasion-resistant applications in the
marketplace. Management expects this relationship to continue to develop in 2006. In May of 2005,
BASF announced the introduction of a new coated sunscreen material. This material incorporated a
new coating developed by Nanophase which, management believes, should help to expand sales in the
European and Asian markets with revenues beginning in late 2006 and expected to expand in 2007.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On November&nbsp;3, 2005, BYK-Chemie USA, a subsidiary of Altana and a customer of Nanophase, lent
$1,597,420 to Nanophase pursuant to the terms of a Promissory Note received effective October&nbsp;27,
2005. This loan was for the purchase and installation of additional dispersion capacity and an
additional NanoArc&#153; synthesis reactor to allow both for quicker material and application
development, which should help to speed market penetration, and the ability to fulfill orders on a
commercial scale for additional materials in varying media.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;From its inception in November&nbsp;1989 through December&nbsp;1996, the Company was in the development
stage. During that period, the Company primarily focused on the development of its manufacturing
processes in order to transition from laboratory-scale to commercial-scale production. As a
result, the Company developed an operating capacity to produce significant quantities of its
nanocrystalline materials for commercial sale. The Company was also engaged in the development of
commercial applications and formulations and the recruiting of marketing, technical and
administrative personnel. Since January&nbsp;1997, the Company has been engaged in commercial
production and sales of its nanocrystalline materials, and the Company no longer considers itself
in the development stage. From inception through June&nbsp;30, 2006, the Company was primarily
capitalized through the private offering of approximately $32.0&nbsp;million of equity securities prior
to its initial public offering, its initial public offering of $28.8&nbsp;million of common stock in
November&nbsp;1997, its private offering of $6.2&nbsp;million of common stock in May of 2002, its private
offering of $1.95&nbsp;million of common stock in September of
</DIV>

<P align="center" style="font-size: 10pt">11
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">2003, its equity investment of $9.2
million in March&nbsp;2004 and its private offering of $1.95&nbsp;million of common stock in September of
2004 (through the conversion of warrants that were attached to its September&nbsp;2003 offering), each
net of issuance costs. The Company has incurred cumulative losses of $60.2&nbsp;million from inception
through June&nbsp;30, 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Results of Operations</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Total revenue increased to $2,390,902 and $4,396,471 for the three and six months ended June
30, 2006, compared to $2,084,725 and $3,698,107 for the same periods in 2005. A substantial
majority of the Company&#146;s revenue for the three and six month periods ended June&nbsp;30, 2006 is from
the Company&#146;s largest customer. See Note 5 to the Financial Statements for additional information
regarding the revenue
the Company derived from this customer for the three and six month periods ended June&nbsp;30,
2006. Product revenue increased to $2,298,315 and $4,216,362 for the three and six months ended
June&nbsp;30, 2006, compared to $1,999,456 and $3,525,760 for the same periods in 2005. The increase in
product revenue was primarily attributed to increased sales to a new significant customer in
architectural coatings, increased sales of CMP materials to Rohm and Haas Electronic Materials CMP,
Inc. (&#147;RHEM,&#148; formerly known as Rodel, Inc.) and increased sales of sunscreen and personal care
materials to BASF, the Company&#146;s largest customer. The Company and BASF currently have a technology
agreement in place that has led to the joint development of the second generation of sunscreen
nanomaterials for other potential personal care applications. Management anticipates the launch of
one or more new sunscreen or personal care applications this year, with related revenue to begin
building in late 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Other revenue increased to $92,587 and $180,109 for the three and six months ended June&nbsp;30,
2006, compared to $85,269 and $172,347 for the same periods in 2005. This increase was primarily
attributed to increased shipping revenue partially offset by decreases in purchased supplies.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The majority of the total revenue generated during the period ended June&nbsp;30, 2006 was from the
Company&#146;s largest customer in the healthcare (sunscreens)&nbsp;market and its new significant customer
(2006&#145;s second largest customer thus far) for application in architectural coatings as described
above.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Cost of revenue generally includes costs associated with commercial production and customer
development arrangements. Cost of revenue increased to $1,846,678 and $3,514,429 for the three and
six months ended June&nbsp;30, 2006, compared to $1,594,264 and $3,038,764 for the same periods in 2005.
The increase in cost of revenue was generally attributed to increased revenue volume and was
partially offset by the Company&#146;s continued efficiencies in reducing its variable manufacturing
costs on nanomaterials. Improvements to gross margins were primarily due to increased revenue
volume, favorable product mix and the completion of a series of process improvements that increased
PVS reactor output by 38% in conjunction with a re-engineering program that had reduced the
expected operational labor cost by 24% on high volume PVS-produced nanomaterials in 2005. These
gains were somewhat offset by increases in commodity metal prices, a major component of the
Company&#146;s raw material costs. Nanophase expects to maintain an aggressive schedule for new
nanomaterial development, primarily using its NanoArc&#153; synthesis and dispersion
technologies, for targeted applications and new markets throughout 2006. At current
revenue levels the Company has generated a modest positive gross margin. The Company&#146;s margins have
been impeded by not having enough revenue to absorb the manufacturing overhead that is required to
work with current customers and the new ones the Company expects to have. Management believes that
the current fixed manufacturing cost structure is sufficient to support significantly higher levels
of production and resultant product revenue. The extent to which the Company&#146;s margins remain
positive, as a percentage of total revenue, will be dependent upon revenue mix, revenue volume, the
Company&#146;s ability to continue to cut costs and the Company&#146;s ability to pass market raw materials
increases on to its customers (See Risk Factors Regarding Commodity Metal Prices). As product
revenue volume increases, this will result in more of the Company&#146;s fixed manufacturing costs being
absorbed, leading to increased margins. The Company expects to continue reducing its variable
product manufacturing costs in 2006 but may or may not continue to operate at a positive gross
margin in 2006,
</DIV>

<P align="center" style="font-size: 10pt">12
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">dependent upon the factors discussed above.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Research and development expense, which includes all expenses relating to the technology and
advanced engineering groups, primarily consists of costs associated with the Company&#146;s development
or acquisition of new product applications and coating formulations and the cost of enhancing the
Company&#146;s manufacturing processes. The May&nbsp;2005 development of BASF&#146;s new sunscreen was an example
of this work. In another example, the Company has been and continues to be engaged in research to
enhance its ability to disperse its material in a variety of organic and inorganic media for use as
coatings and polishing materials. Much of this work has led to new potential products for use by
Altana. Now that the Company has demonstrated the capability to produce pilot quantities of
mixed-metal oxides in a single crystal phase, the Company does not expect development of further
variations on these materials to present material technological challenges. Many of these
materials exhibit performance characteristics that can enable them to serve in various catalytic
applications. This development has been
driven largely by customer demand. Management is now working on several related commercial
applications. The Company expects that this technique should not be difficult to scale to large
quantity commercial volumes once application viability and firm demand are established. The Company
also has an ongoing advanced engineering effort that is primarily focused on the development of new
nanomaterials as well as the refinement of existing nanomaterials. The Company is not certain when
or if any significant revenue will be generated from the production of the materials described
above. Research and development expense increased to $487,133 and $1,034,279 for the three and six
months ended June&nbsp;30, 2006, compared to $476,421&#096; and $970,680 for the same period in 2005. The
increase in research and development expense was largely attributed to stock compensation expense
(non-cash), new materials development and outside testing expenses. These increases were partially
offset by decreased materials and supplies expense and the capitalization of payroll related to the
installation of dispersion equipment and a NanoArc Synthesis Reactor supported by the previously
discussed loan from BYK-Chemie USA. The Company does not expect research and development expense to
increase significantly in 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Selling, general and administrative expense increased to $1,241,403 and $2,628,857 for the
three and six months ended June&nbsp;30, 2006, compared to $1,194,192 and $2,337,336 for the same
periods in 2005. The net increase was primarily attributed to increases in stock compensation
expense (non-cash), professional fees and the abandonment of two United States patent applications.
These increases were partially offset by decreases in directors and officers insurance and audit
fees.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Interest income increased to $74,769 and $157,482 for the three and six month periods,
respectively, ended June&nbsp;30, 2006, compared to $71,370 and $136,417 for the same periods in 2005.
This increase was primarily due to increased investment yields.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Liquidity and Capital Resources</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company&#146;s cash, cash equivalents and investments amounted to $6,168,536 on June&nbsp;30, 2006,
compared to $8,508,952 on December&nbsp;31, 2005. The net cash used in the Company&#146;s operating
activities was $997,388 for the six months ended June&nbsp;30, 2006, compared to $2,395,411 for the same
period in 2005. Net cash provided by investing activities, which is due to sales of securities and
partially offset by purchases of securities and capital expenditures, amounted to $1,055,401 for
the six months ended June&nbsp;30, 2006 compared to $2,296,287 for the same period in 2005. Capital
expenditures amounted to $1,433,168 and $282,488 for the six months ended June&nbsp;30, 2006 and 2005,
respectively. During the second quarter in 2005 the Company completed implementation of a PVS
process innovation started in late 2003, within the current capital budget, that has increased PVS
reactor output by approximately 38% in conjunction with a re-engineering program that had reduced
the expected operational labor cost by 24% on high volume PVS-produced nanomaterials. The Company
expects that this innovation should result in the need for less future capital as the Company&#146;s PVS
reactor-produced business grows. Currently, all sunscreen and personal care nanomaterials are
manufactured via the PVS process. Net cash provided by financing activities is primarily due to the
issuance of shares of common stock pursuant to
</DIV>


<P align="center" style="font-size: 10pt">13
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">the exercise of options and borrowings for equipment, partially offset by principal payments
on debt and capital lease obligations, amounting, in total, to $144,089 for the six months ended
June&nbsp;30, 2006 compared to $26,463 for the same period in 2005.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On November&nbsp;3, 2005, BYK-Chemie USA, a customer of Nanophase, lent $1,597,420 to Nanophase
pursuant to the terms of a Promissory Note received effective October&nbsp;27, 2005. The proceeds of the
Promissory Note are to be used to buy, install and commission certain equipment which is then to be
used for fulfillment of orders by BYK-Chemie USA and other uses. The outstanding principal balance
of the Promissory Note is payable in three equal installments on January&nbsp;30, 2009, April&nbsp;30, 2009
and December&nbsp;31, 2009. Interest accrues and is payable on a quarterly basis one year after
installation and commissioning of the equipment referenced above has been completed at the rate of
100 basis points over the average daily London Inter-Bank Offered Rate for the preceding quarter.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On March&nbsp;23, 2004, the Company sold, in a private placement to Altana Chemie AG
(&#147;Altana&#148;), 1,256,281 shares of common stock at $7.96 per share and received gross proceeds of
$10.0&nbsp;million. On September&nbsp;8, 2003, the Company secured equity funding through a private
placement offering with Grace Brothers, Ltd., its largest investor. The Company issued 453,001
shares of additional common stock at $4.415 per share and received gross proceeds of $2.0&nbsp;million.
Grace Brothers, Ltd. also had the right to purchase an additional 453,001 shares for an additional
$2.0&nbsp;million pursuant to the terms of a warrant issued in such private placement. In accordance
with the terms of such private placement, on June&nbsp;7, 2004, the Company filed a registration
statement for such 453,001 shares and the additional 453,001 shares issuable upon exercise of the
warrant which registration statement was declared effective on August&nbsp;13, 2004. On September&nbsp;2,
2004, Grace Brothers, Ltd. exercised its warrant rights to acquire 453,001 newly issued shares of
common stock and the Company received $2.0&nbsp;million in gross proceeds. On May&nbsp;29, 2002, the Company
secured equity funding through a private placement offering. The Company issued 1.37&nbsp;million shares
of additional common stock at $5.00 per share and received gross proceeds of $6.85&nbsp;million. Net
proceeds were approximately $6.2&nbsp;million after commissions, legal, accounting and other costs. The
Company intends to use the remaining proceeds from the foregoing offerings to fund expected growth
in new markets as well as to provide for expanded working capital needs expected to arise as sales
volume grows and pay existing debts.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company&#146;s supply agreement with BASF contains several financial covenants which could
potentially impact the Company&#146;s liquidity. The most restrictive financial covenants under this
agreement require the Company to maintain a minimum of $2.0&nbsp;million in cash, cash equivalents and
investments and that the Company not have the acceleration of any debt maturity having a principal
amount of more than $10,000,000, in order to avoid triggering a transfer of technology and
equipment to the Company&#146;s largest customer. The Company had approximately $6.2&nbsp;million in cash,
cash equivalents and investments and debt net of unamortized debt discount of less than $1.5
million on June&nbsp;30, 2006. This supply agreement and its covenants are more fully described in Note
5 to the Company&#146;s Financial Statements. See &#147;Risk Factors&#151;We may need to raise additional capital
in the future&#148;.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In November&nbsp;2000, the Company executed a three-year promissory note, held by the Company&#146;s
largest customer, in the amount of $1,293,895 for the construction of additional production
capabilities at the Company&#146;s Romeoville, Illinois facility. This debt has been fully paid in the
second quarter in 2006.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company believes that cash from operations, the proceeds of the $1,597,420 loan from
BYK-Chemie USA (subject to the restrictions on the use of such proceeds set forth in the Promissory
Note evidencing such loan)<B>, </B>and cash, cash equivalents and investments on hand and interest income
thereon, will be adequate to fund the Company&#146;s operating plans through 2006. The Company&#146;s actual
future capital requirements in 2006 and beyond will depend, however, on many factors, including
customer acceptance of the Company&#146;s current and potential nanocrystalline materials and product
applications, continued progress in the Company&#146;s research and development activities and product
testing programs, the magnitude of these activities and programs, and the costs necessary to
increase and
</DIV>

<P align="center" style="font-size: 10pt">14
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">expand the Company&#146;s manufacturing capabilities and to market and sell the Company&#146;s materials and
product applications. Other important issues that will drive future capital requirements will be
the development of new markets and new customers as well as the potential for significant unplanned
growth with the Company&#146;s existing customers. The Company expects that capital spending relating to
currently known capital needs in 2006 will be approximately $2,000,000, but could be even greater
due to the factors discussed above.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Should events arise that make it appropriate for the Company to seek additional financing, it
should be noted that additional financing may not be available on acceptable terms or at all, and
any such additional financing could be dilutive to the Company&#146;s stockholders. Such a financing
could be necessitated by such things as the loss of existing customers; currently unknown capital
requirements in light of the factors described above; new regulatory requirements that are outside
the Company&#146;s control; the need to meet previously discussed cash requirements to avoid a
triggering event; or various other circumstances coming to pass that are currently not anticipated
by the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On June&nbsp;30, 2006, the Company had a net operating loss carryforward of approximately $60.2
million for income tax purposes. Because the Company may have experienced &#147;ownership changes&#148;
within the meaning of the U.S. Internal Revenue Code in connection with its various prior equity
offerings, future utilization of this carryforward may be subject to certain limitations as defined
by the Internal Revenue Code. If not utilized, the carryforward expires at various dates between
2006 and 2025. As a result of the annual limitation and uncertainty as to the amount of future
taxable income that will be earned prior to the expiration of the carryforward, the Company has
concluded that it is likely that some portion of this carryforward will expire before ultimately
becoming available to reduce income tax liabilities. On June&nbsp;30, 2006, the Company also had a
foreign tax credit carryforward of $156,000, which could be used as an offsetting tax credit to
reduce U.S. income taxes. The foreign tax credit will expire in 2014, if not utilized before that
date.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Safe Harbor Provision</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Nanophase Technologies Corporation wants to provide investors with more meaningful and useful
information. As a result, this Quarterly Report on Form 10-Q (the &#147;Form&nbsp;10-Q&#148;) contains and
incorporates by reference certain &#147;forward-looking statements&#148;, as defined in Section&nbsp;21E of the
Securities Exchange Act of 1934, as amended. These statements reflect the Company&#146;s current
expectations of the future results of its operations, performance and achievements. Forward-looking
statements are covered under the safe harbor provisions of the Private Securities Litigation Reform
Act of 1995. The Company has tried, wherever possible, to identify these statements by using words
such as &#147;anticipates&#148;, &#147;believes&#148;, &#147;estimates&#148;, &#147;expects&#148;, &#147;plans&#148;, &#147;intends&#148; and similar
expressions. These statements reflect management&#146;s current beliefs and are based on information now
available to it. Accordingly, these statements are subject to certain risks, uncertainties and
contingencies that could cause the Company&#146;s actual results, performance or achievements in 2006
and beyond to differ materially from those expressed in, or implied by, such statements. These
risks, uncertainties and factors include, without limitation: a decision by a customer to cancel a
purchase order or supply agreement in light of the Company&#146;s dependence on a limited number of key
customers; uncertain demand for, and acceptance of, the Company&#146;s nanocrystalline materials; the
Company&#146;s limited manufacturing capacity and product mix flexibility in light of customer demand;
the Company&#146;s limited marketing experience; changes in development and distribution relationships;
the impact of competitive products and technologies; the Company&#146;s dependence on patents and
protection of proprietary information; the resolution of litigation in which the Company may become
involved; and other risks set forth under the caption &#147;Risk Factors&#148; above. Readers of this
Quarterly Report on Form 10-Q should not place undue reliance on any forward-looking statements.
Except as required by federal securities laws, the Company undertakes no obligation to update or
revise these forward-looking statements to reflect new events or uncertainties.
</DIV>

<P align="center" style="font-size: 10pt">15
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="left">
<A name="108"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;3. Quantitative and Qualitative Disclosures About Market Risk</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The only financial instruments that the Company holds are investments of a short-term
duration. Management does not believe that the Company currently has material market risk relating
to its investments.
</DIV>
<DIV align="left">
<A name="109"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;4. Controls and Procedures</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of the end of the period covered by this report, the Company conducted an evaluation,
under the supervision and with the participation of the principal executive officer and principal
financial officer, of the Company&#146;s disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the &#147;Exchange Act&#148;). Based on
this evaluation, the principal executive officer and principal financial officer concluded that the
Company&#146;s disclosure controls and procedures are effective to ensure that information required to
be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in Securities and Exchange
Commission rules and forms and that the Company&#146;s disclosure controls and procedures are effective
to ensure that material information required to be disclosed by the Company in reports that it
files or submits under the Exchange Act is made known to management and others, as appropriate, to
allow timely decisions regarding required disclosures. There was no change in the Company&#146;s
internal control over financial reporting during the Company&#146;s most recently completed fiscal
quarter that has materially affected, or is reasonably likely to materially affect, the Company&#146;s
internal control over financial reporting.
</DIV>
<DIV align="left">
<A name="110"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>PART II &#150; OTHER INFORMATION</B>
</DIV>

<DIV align="left">
<A name="111"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1. Legal Proceedings</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;None.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;1A. Risk Factors</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The following risks, uncertainties, and other factors could have a material adverse
affect on our business, financial condition, operating results and growth prospects.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We have a limited operating history and may not be able to address difficulties encountered
by early stage companies in new and rapidly evolving markets.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have only a limited operating history. We were formed in November&nbsp;1989 and began our
commercial nanocrystalline materials operations in January&nbsp;1997. We have not yet generated a
significant amount of revenue from our nanocrystalline materials operations. Because of our
limited operating history and the early stage of development of our rapidly evolving market,
we have limited insight into trends that may emerge and adversely affect our business and
cannot be certain that our business strategy will be successful or that it will successfully
address these risks. In addition, our efforts to address any of these risks may distract
personnel or divert resources from other more important initiatives, such as attracting and
retaining customers and responding to competitive market conditions.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><I>We have a history of losses that may continue in the future.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have incurred net losses in each year since our inception with net losses of $5.83
million
</DIV>

<P align="center" style="font-size: 10pt">16
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">in 2003, $6.45&nbsp;million in 2004 and $5.38&nbsp;million in 2005. As of June&nbsp;30, 2006, we had an
accumulated deficit of approximately $60.2&nbsp;million and presently expect to continue to incur
losses on an annual basis through at least the end of 2006. We believe that our business
depends, among other things, on our ability to significantly increase revenue. If revenue
fails to grow at anticipated rates or if operating expenses increase without a commensurate
increase in revenue, or if we fail to adjust operating expense levels accordingly, then the
imbalance between revenue and operating expenses will negatively impact our cash balances and
our ability to achieve profitability in future periods.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We depend on a small number of customers for a high percentage of our sales, and the loss of
orders from a significant customer could cause a decline in revenue and/or increases in the
level of losses incurred.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Sales to our customers are executed pursuant to purchase orders and annual supply
contracts; however, customers can cease doing business with us at any time with limited
advance notice. We expect a significant portion of our future sales to remain concentrated
within a limited number of strategic customers. We may not be able to retain our strategic
customers, such customers may cancel or reschedule orders, or in the event of canceled orders,
such orders may not be replaced by other sales or by sales that are on as favorable terms. In
addition, sales to any particular customer may fluctuate significantly from quarter to
quarter, which could affect our ability to achieve anticipated revenues on a quarterly basis.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Revenue from BASF Corporation, Rohm and Haas Electronic Materials CMP, Inc. (formerly known as
&#147;Rodel&#148;) and C.I. Kasei, a division of Itochu Corporation, accounted for approximately 83% of total
revenue for the year ended December&nbsp;31, 2005, and revenue to the same three customers accounted for
approximately 89% of total revenue in 2004. For the years ended December&nbsp;31, 2005 and 2004, BASF
accounted for 66% and 70% of our total revenue, respectively. BASF and Rohm and Haas Electronic
Materials CMP, Inc. represented a significant majority of total revenue for the six months ended
June&nbsp;30, 2006, as described in Note 5 to the Financial Statements. If we were to lose, or receive
significantly decreased orders from, any of these two customers, then our results of operations
would be materially harmed. While our agreements with our two significant customers are long-term
agreements, they may be terminated by the customer with reasonable notice and do not provide any
guarantees that these customers will continue to buy our products. In addition, while our
agreements with our two significant customers contain minimum order requirements, the only
repercussion under the agreements for missing the minimum order requirement is that we would be
freed from the exclusivity obligations under these contracts.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have been consistently expanding both our marketing and business development efforts and
our production efficiency in order to address the issues of our dependence upon a limited amount of
customers, enhancement of gross profit and operating cash flows, and the achievement of
profitability. We currently have customers that may grow to the point where they generate
significant revenues and margins as relationships expand. Given the special nature of our products,
and the fact that markets for them are not yet fully developed, it is difficult to accurately
predict when additional large customers will materialize. Going forward, the Company&#146;s margins, as
a percentage of revenue, will be dependent upon revenue mix, revenue volume and the Company&#146;s
ability to continue to cut costs. The extent of the growth in revenue volume and the related gross
profit that this revenue generates, will be the main drivers in generating positive operating cash
flows and, ultimately, net income.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Any downturn in the markets served by us would harm our business.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;A majority of our products are incorporated into products such as sunscreens, polishing
slurries, personal care, and to a lesser extent, medical diagnostics, abrasion-resistant coatings
for flooring, and other products. These markets have from time to time experienced cyclical,
depressed business
</DIV>

<P align="center" style="font-size: 10pt">17
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">conditions, often in connection with, or in anticipation of, a decline in general economic
conditions. These industry downturns have resulted in reduced product demand and declining average
selling prices. Our business would be harmed by any future downturns in the markets that we serve.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our products often have long adoption cycles, which could make it difficult to achieve market
acceptance and makes it difficult to forecast revenues.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Due to their often novel characteristics and the unfamiliarity with them that exists in the
marketplace, our nanocrystalline materials often require longer adoption cycles than existing
materials technologies. Our nanomaterials have to receive appropriate attention within any
potential customer&#146;s organization, then they must be tested to prove a performance advantage over
existing materials, typically on a systems-cost basis. Once we have proven initial commercial
viability, pilot scale production runs must be completed by the customer, followed by further
testing. Once production-level commercial viability is established, then our nanomaterials can be
introduced, often to a downstream marketplace that needs to be familiarized with them. If we are
unable to convince our potential customers of the performance advantages and economic value of our
nanocrystalline materials over existing and competing materials and technologies, we will be unable
to generate significant sales. Our long adoption cycle makes it difficult to predict when sales
will occur.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We depend on collaborative development relationships with our customers and do not have a
substantial direct sales force or an established distribution network apart from the distribution
networks of our strategic partners. If we are unable to initiate or sustain such collaborative
relationships or if the terms of these relationships limit the distribution of our products or if
our strategic partners are unable to distribute our products efficiently, then we may be unable to
independently develop, manufacture or market our current and future nanocrystalline materials or
applications.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have established, and will continue to pursue, strategic relationships with many of our
customers and do not have a substantial direct sales force or an established distribution network
(other than distribution arrangements for research samples). Through these relationships, we seek
to develop new applications for our nanocrystalline materials and share development and
manufacturing resources. We also seek to coordinate the development, manufacture and marketing of
our nanocrystalline products. Future success will depend, in part, on our continued relationships
with these customers and our ability to enter into similar strategic relationships with other
customers. Our customers may not continue in these collaborative development relationships, may not
devote sufficient resources to the development or sale of our materials or may enter into strategic
development relationships with our competitors. These customers may also require a share of control
of these collaborative programs. Some of our agreements with these customers limit our ability to
license our technology to others and/or limit our ability to engage in certain product development
or marketing activities. These relationships generally can be terminated unilaterally by
customers.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Additionally and except for our research quantities distribution agreement with Alfa Aesar,
these customers generally require exclusive distribution arrangements within the field of
application covered by our agreement with these customers, and the very nature of these strategic
relationships limits the distribution of our products to the distribution networks available to our
strategic relationship partners. In addition, the development agreements with some of our larger
customers contain provisions that require us to license our intellectual property to these
customers on disadvantaged terms and/or transfer equipment to these customers in the event that we
materially breach these agreements or fail to satisfy certain financial covenants. For example,
see &#147;Risk Factors&#151;We may need to raise additional capital in the future.&#148;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;If we are unable to initiate or sustain such collaborative relationships or if the terms of
these relationships materially limit our access to distribution channels for our products, then we
may be unable to independently develop, manufacture or market our current and future
nanocrystalline materials or
</DIV>

<P align="center" style="font-size: 10pt">18
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">applications.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>If commodity metal prices increased at such a rate that we are unable to recover lost margins on a
timely basis or that our products became uncompetitive in their current marketplaces, our financial
and liquidity position and results of operations would be substantially harmed.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Many of our significant raw materials come from commodity metal markets that may be subject to
rapid price increases. While we generally pass commodity price increases on to our customers, it
is possible that, given our limited customer base and the limited control we have over it,
commodity metal prices could increase at such a rate that could hinder our ability to recover lost
margins from our customers on a timely basis. It is also possible that such drastic cost increases
could render some of our materials uncompetitive in their current marketplaces when considered
relative to other materials on a cost benefit basis. If either of these potential results
occurred, our financial and liquidity position and results of operations would be substantially
harmed.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>If a catastrophe strikes either of our manufacturing facilities or if we were to lose our lease for
either facility due to non-renewal or other unforeseen events, we may be unable to manufacture our
materials to meet customers&#146; demands.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our manufacturing facilities are located in Romeoville and Burr Ridge, Illinois. These
facilities and some of our manufacturing and testing equipment would be difficult to replace in a
timely manner. Therefore, any material disruption at one of our facilities due to a natural or
man-made disaster or a loss of lease due to non-renewal or other unforeseen events could have a
material adverse effect on our ability to manufacture products to meet customers&#146; demands. While we
maintain customary property insurance, this insurance may not adequately compensate us for all
losses that we may incur and would not compensate us for any interruption in our business.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>If we are unable to expand our production capabilities to meet unexpected demand, we may be unable
to manage our growth and our business would suffer.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our success will depend, in part, on our ability to manufacture nanocrystalline materials in
significant quantities, with consistent quality and in an efficient and timely manner. We expect
to continue to expand our current facilities or obtain additional facilities in the future in order
to respond to unexpected demand for existing materials or for new materials that we do not
currently make in quantity. Such unplanned demand, if it resulted in rapid expansion, could create
a situation where growth could become difficult to manage, which could cause us to lose potential
revenue.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Protection of our intellectual property is limited and uncertain.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our intellectual property is important to our business. We seek to protect our intellectual
property through patent, trademark, trade secret protection and confidentiality or license
agreements with our employees, customers, suppliers and others. Our means of protecting our
intellectual property rights in the United States or abroad may not be adequate and others,
including our competitors, may use our proprietary technology without our consent. We may not
receive the necessary patent protection for any applications pending with the U.S. Patent and
Trademark Office (&#147;USPTO&#148;) and any of the patents that we currently own or license may not be
sufficient to keep competitors from using our materials or processes. In addition, patents that we
currently own or license may not be held valid if subsequently challenged by others and others may
claim rights in the patents and other proprietary technology that we own or license. Additionally,
others may have already developed or may subsequently develop similar products or technologies
without violating any of our proprietary rights. If we fail to obtain patent protection or preserve
our trade secrets, we may be unable to effectively compete against others offering similar products
and services. In addition, if we fail to operate without infringing the proprietary rights of
others or lose any license to technology that we currently have or will acquire in the future, we
may be
</DIV>

<P align="center" style="font-size: 10pt">19
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">unable to continue making the products that we currently make.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Moreover, at times, attempts may be made to challenge the prior issuance of our patents. For
example, the USPTO has granted a third-party request for re-examination with respect to one patent
relating to one of our nanoparticle manufacturing processes. On September&nbsp;7, 2005, our
representatives conducted an interview with the Examiner assigned to the re-examination at the
USPTO, resulting in the Examiner preparing an interview summary indicating that the Examiner agreed
that all the issued claims were patentable. However, prior to the USPTO issuing a formal notice
confirming patentability, the same third party filed a second request for re-examination of the
patent (which second request, the USPTO has since denied). Nonetheless, a second interview was
conducted, resulting in an amendment to all patent claims. Thereafter, a third request for
re-examination was filed and granted by the USPTO. We subsequently responded to the third request.
While we will continue to vigorously defend our patent position, we may not be successful in
maintaining the scope of the claims of this patent during re-examination. While the Company intends
to vigorously defend its patent protection against such claims, it does not believe that these
patent claims pose a risk of material harm to he Company&#146;s business prospects or competitive
positions. If the scope of the Company&#146;s claims protected by the patent in question were
ultimately reduced through the pending re-examination proceedings before the USPTO, the Company
would still continue to be able to conduct its business as currently conducted, including the use
of the technology that is the subject of the patented claims. A reduction in the scope of the
claims protected by the Company&#146;s patent in question would limit the Company&#146;s ability to
assert infringement claims and suits against other parties using the same or sufficiently similar
technology. The Company believes that while patent protection is a valuable asset, a reduction in
the scope of the claims protected by the Company&#146;s patent in question would not materially alter
the competitive environment in which the Company operates or result in a material loss.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Furthermore, litigation may be necessary to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the proprietary rights of others,
or to defend against claims of infringement or invalidity. Such litigation could result in
substantial costs and diversion of resources and could harm our business, operating results and
financial condition. In addition, if others assert that our technology infringes their intellectual
property rights, resolving the dispute could divert our management team and financial resources.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In the future, we may license certain of our intellectual property, such as trademarks or
copyrighted material, to third parties. While we would attempt to ensure that any licensees
maintain the quality and value of our brand, these licenses might diminish this quality and value.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We may be subject to claims that one or more of the business methods used by us infringe upon
patents held by others. The defense of any claims of infringement made against us by third parties
could involve significant legal costs and require our management to divert time and other resources
from our business operations. Either of these consequences of an infringement claim could have a
material adverse effect on our operating results. If we are unsuccessful in defending any claims of
infringement, we may be forced to obtain licenses or pay royalties to continue to use our
technology. We may not be able to obtain any necessary licenses on commercially reasonable terms or
at all. If we fail to obtain necessary licenses or other rights, or if these licenses are costly,
our operating results may suffer either from reductions in revenue through our inability to serve
clients or from increases in costs to license third-party technology.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our industry is experiencing rapid changes in technology. If we are unable to keep pace with these
changes, our business will not grow.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Rapid changes have occurred, and are likely to continue to occur, in the development of
advanced materials and processes. Our success will depend, in large part, upon our ability to keep
pace with advanced materials technologies, industry standards and market trends and to develop and
introduce new
</DIV>

<P align="center" style="font-size: 10pt">20
</DIV>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">and improved products on a timely basis. We expect to commit substantial resources to develop
our technologies and product applications and, in the future, to expand our commercial
manufacturing capacity as volume grows. Our development efforts may be rendered obsolete by the
research efforts and technological advances of others and other advanced materials may prove more
advantageous than those we produce.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our market is highly competitive, and if we are unable to compete effectively, then our business
will not grow.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The advanced materials industry is new, rapidly evolving and intensely competitive, and we
expect competition to intensify in the future. The market for materials having the characteristics
and potential uses of our nanocrystalline materials is the subject of intensive research and
development efforts by both governmental entities and private enterprises around the world. We
believe that the level of competition will increase further as more product applications with
significant commercial potential are developed. The nanocrystalline product applications that we
are developing will compete directly with products incorporating both conventional and advanced
materials and technologies. While we are not currently aware of the existence of commercially
available competitive products with the same attributes as those we offer, other companies may
develop and introduce new or competitive products. Our competitors may succeed in developing or
marketing materials, technologies and better or less expensive products than the ones we offer. In
addition, many of our potential competitors have substantially greater financial and technical
resources, and greater manufacturing and marketing capabilities than we do. If we fail to improve
our current and potential nanocrystalline product applications at an acceptable price, or otherwise
compete with producers of conventional materials, we will lose market share and revenue to our
competitors.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We may need to raise additional capital in the future. If we are unable to obtain adequate funds,
we may be required to delay, scale-back or eliminate some of our manufacturing and marketing
operations or we may need to obtain funds through arrangements on less favorable terms or we may be
required to transfer equipment to our largest customer.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We expect to expend significant resources on research, development and product testing, and in
expanding current capacity or capability for new business. In addition, we may incur significant
costs in preparing, filing, prosecuting, maintaining and enforcing our patents and other
proprietary rights. If necessary, we may seek funding through public or private financing and
through contracts with government or other companies. Additional financing may not be available on
acceptable terms or at all. If we are unable to obtain adequate funds, we may be required to delay,
scale-back or eliminate some of our manufacturing and marketing operations or we may need to obtain
funds through arrangements on less favorable terms. If we obtain funding on unfavorable terms, we
may be required to relinquish rights to some of our intellectual property.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;To raise additional funds in the future, we would likely sell our equity or debt securities or
enter into loan agreements. To the extent that we issue debt securities or enter into loan
agreements, we may become subject to financial, operational and other covenants that we must
observe. In the event that we were to breach any of these covenants, then the amounts due under
such loans or debt securities could become immediately payable by us, which could significantly
harm us. To the extent that we sell additional shares of our equity securities, our stockholders
may face economic dilution and dilution of their percentage of ownership.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We currently have a supply agreement with BASF that contains provisions which could
potentially result in a mandatory license of technology and sale of production equipment to BASF
providing capacity sufficient to meet BASF&#146;s production needs. The license and related sale would
be &#147;triggered&#148; only in the event that we breach certain of our obligations under the supply
agreement or one of the following occurs:
</DIV>

<P align="center" style="font-size: 10pt">21
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>our earnings for a twelve month period ending with our most recently
published quarterly financial statements are less than zero and our cash,
cash equivalents and investments are less than $2,000,000, or</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the acceleration of any debt maturity having a principal amount of more
than $10,000,000, or we become insolvent as defined in the supply
agreement.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In the event of a triggering event where we are required to sell to BASF production equipment
providing capacity sufficient to meet BASF&#146;s production needs, the equipment would be sold at 115%
of the equipment&#146;s net book value. Under another of the Company&#146;s supply agreements with BASF, upon
the Company&#146;s breach of its contractual obligations to BASF, the Company would be required to sell
BASF certain production equipment at the greater of 30% of the original book value of such
equipment and any associated upgrades to it or 115% of the equipment&#146;s net book value.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We believe that we have sufficient cash balances to avoid the first triggering event through
2006. If a triggering event were to occur and BASF elected to proceed with the license and related
sale mentioned above, we would lose both significant revenue and the ability to generate
significant revenue to replace that which was lost in the near term. Replacement of necessary
equipment that would be purchased and removed by BASF pursuant to this triggering event could take
six months to a year. Any additional capital outlays required to rebuild capacity would probably be
greater than the proceeds from the purchase of the assets pursuant to our agreement with BASF. This
shortfall might put us in a position where it would be difficult to secure additional funding given
what would then be an already tenuous cash position. Such an event would also result in the loss of
many of our key staff and line employees due to economic realities. We believe that our employees
are a critical component of our success and would be difficult to quickly replace and train. Given
the occurrence of such an event, we might not be able to hire and retrain skilled employees given
the stigma relating to such an event and its impact on us. We might elect to effectively reduce our
size and staffing to a point where we could remain a going concern in the near term.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We depend on key personnel, and their unplanned departure could harm our business.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Our success will depend, in large part, upon our ability to attract and retain highly
qualified research and development, management, manufacturing, marketing and sales personnel on
favorable terms. Due to the specialized nature of our business, we may have difficulty locating,
hiring and retaining qualified personnel on favorable terms. If we were to lose the services of any
of our key executive officers or other key personnel, or if we are unable to attract and retain
other skilled and experienced personnel on acceptable terms in the future, or if we are unable to
implement a succession plan to prepare qualified individuals to assume key roles upon any loss of
our key personnel, then our business, results of operations and financial condition would be
materially harmed. In addition, we do not currently have &#147;key-man&#148; life insurance policies covering
all of our executive officers or key employees, nor do we presently have any plans to purchase such
policies.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We face potential product liability risks which could result in significant costs that exceed our
insurance coverage, damage our reputation and harm our business.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We may be subject to product liability claims in the event that any of our nanocrystalline
product applications are alleged to be defective or cause harmful effects to humans or physical
environments. Because our nanocrystalline materials are used in other companies&#146; products, to the
extent our customers become subject to suits relating to their products, such as cosmetic,
skin-care and personal-care products, these claims may also be asserted against us. We may incur
significant costs including payment of
</DIV>

<P align="center" style="font-size: 10pt">22
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">significant damages, in defending or settling product liability claims. We currently maintain
insurance coverage in the amount of $10&nbsp;million for product liability claims, which may prove not
to be sufficient. Even if a suit is without merit and regardless of the outcome, claims can divert
management time and attention, injure our reputation and adversely affect demand for our
nanocrystalline materials.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We are subject to governmental regulations. The costs of compliance and liability for noncompliance
with governmental regulations could have a material adverse effect on our business, results of
operations and financial condition.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Current and future laws and regulations may require us to make substantial expenditures for
preventive or remedial action. Our operations, business or assets may be materially and adversely
affected by governmental interpretation and enforcement of current or future environmental, health
and safety laws and regulations. In addition, our coating operations pose a risk of accidental
contamination or injury. The damages in the event of an accident or the costs to prevent or
remediate a related event could exceed both the amount of our liability insurance and our resources
or otherwise have a material adverse effect on our business, results of operations and financial
condition.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In addition, both of our facilities and all of our operations are subject to the plant and
laboratory safety requirements of various occupational safety and health laws. We believe we have
complied in all material respects with regard to governmental regulations applicable to us.
However, we may have to incur significant costs in defending or settling future claims of alleged
violations of governmental regulations and these regulations may materially restrict or impede our
operations in the future. In addition, our efforts to comply with or contest any regulatory actions
may distract personnel or divert resources from other more important initiatives.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The manufacture and use of certain products that contain our nanocrystalline materials are
subject to extensive governmental regulation, including regulations promulgated by the U.S. Food
and Drug Administration, the U.S. Environmental Protection Agency and the U.S. Occupational Safety
and Health Administration. As a result, we are required to adhere to the requirements of the
regulations of governmental authorities in the United States and other countries. These regulations
could increase our cost of doing business and may render some potential markets prohibitively
expensive.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if
an acquisition could be beneficial to our stockholders.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In October&nbsp;1998, we entered into a Rights Agreement, commonly referred to as a &#147;poison pill.&#148;
The provisions of this agreement and some of the provisions of our certificate of incorporation,
our bylaws and Delaware law could, together or separately:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>discourage potential acquisition proposals;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>delay or prevent a change in control; and</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>limit the price that investors might be willing to pay in the future
for shares of our common stock.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In particular, our board of directors is authorized to issue up to 24,088 shares of preferred
stock (less any outstanding shares of preferred stock) with rights and privileges that might be
senior to our common stock, without the consent of the holders of the common stock, including up to
2,500 shares of Series&nbsp;A Junior Participating Preferred Stock issuable under the 1998 Rights
Agreement.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In addition, Section&nbsp;203 of the Delaware General Corporations Law relating to business
combinations with related stockholders and the terms of our stock option plans relating to changes
of
</DIV>

<P align="center" style="font-size: 10pt">23
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">control may discourage, delay or prevent a change in control of our company.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Future sales of our common stock by existing stockholders could negatively affect the market price
of our stock and make it more difficult for us to sell stock in the future.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Sales of our common stock in the public market, or the perception that such sales could occur,
could result in a decline in the market price of our common stock and make it more difficult for us
to complete future equity financings. A substantial number of shares of our common stock and shares
of common stock subject to outstanding warrants and options may be resold pursuant to currently
effective registration statements. As of August&nbsp;1, 2006 there are:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>15,871,062 shares of common stock that have been issued in registered
offerings, upon the exercise of options under our equity incentive plan
or in private placements and are freely tradable in the public markets,</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>1,529,383 shares of common stock that may be issued on the exercise
of stock options outstanding and exercisable under our equity incentive
plan;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>906,002 shares of common stock that were issued pursuant to our
September&nbsp;8, 2003 private placement and the related warrant which was
exercised on September&nbsp;2, 2004. The resale of these shares has been
registered pursuant to a Registration Statement on Form S-3 which was
declared effective by the Securities and Exchange Commission on August
13, 2004; and</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="4%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>1,256,281 shares of common stock that were issued pursuant to our
March&nbsp;23, 2004 private placement and subsequently will be registered for
resale pursuant the terms of the Registration Rights Agreement executed
in connection with this private placement.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We cannot estimate the number of shares of common stock that may actually be resold in the
public market because this will depend on the market price for our common stock, the individual
circumstances of the sellers, and other factors. If stockholders sell large portions of their
holdings in a relatively short time, for liquidity or other reasons, the market price of our common
stock could decline significantly.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Bradford T. Whitmore has significant influence on all matters requiring stockholder approval
because he beneficially owns a large percentage of our common stock, and he may vote the common
stock in ways with which our other stockholders disagree.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As of August&nbsp;1, 2006, Bradford T. Whitmore, together with his affiliates, Grace Brothers,
Ltd. and Grace Investments, Ltd., beneficially owned approximately 19.7% of the outstanding shares
of our common stock. As a result, he has significant influence on matters submitted to our
stockholders for approval, including proposals regarding:
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>any merger, consolidation or sale of all or substantially all of our assets;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the election of members of our board of directors; and</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>any amendment to our certificate of incorporation.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The ownership position of Mr.&nbsp;Whitmore could delay, deter or prevent a change of control or
adversely affect the price that investors might be willing to pay in the future for shares of our
common
</DIV>

<P align="center" style="font-size: 10pt">24
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt">stock. Mr.&nbsp;Whitmore&#146;s interests may be significantly different from the interests of our
other stockholders and he may vote the common stock he beneficially owns in ways with which our
other stockholders disagree. Investors in the Company should also note that R. Janet Whitmore, one
of our directors, is the sister of Mr.&nbsp;Whitmore.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We have been involved in litigation. If we are involved in similar litigation in the future, the
expense of defending such litigation and the potential costs of judgments against us and the costs
of maintaining insurance coverage could have a material adverse effect on our financial
performance.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We have been involved in three securities class action lawsuits, one of which was a
consolidation of several related lawsuits. While all of these lawsuits have been settled and
dismissed with all settlements funded by our directors and officers liability insurance, we may be
the target of additional securities lawsuits in the future. If we are involved in similar
litigation in the future, the expense of defending such litigation, the potential costs of
judgments against us, the costs of maintaining insurance coverage and the diversion of management&#146;s
attention could have a material adverse effect on our financial performance.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Our stock price is volatile.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The stock markets in general, and the stock prices of technology-based companies in
particular, have experienced extreme volatility that often has been unrelated to the operating
performance of any specific public company. The market price of our common stock has fluctuated in
the past and is likely to fluctuate in the future as well. Our future financial performance and
stock price may be subject to significant volatility, particularly on a quarterly basis. Shortfalls
in our revenues in any given period relative to the levels expected by investors could immediately,
significantly and adversely affect the trading price of our common stock.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>Dilutive Effect of Private Placements</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;On September&nbsp;8, 2003 we sold 453,001 shares of our common stock to Grace Brothers, Ltd. at a
purchase price of $4.415 per share together with a warrant to purchase a like number of shares of
common stock during the next twelve months also at a price of $4.415 per share. This warrant was
exercised on September&nbsp;2, 2004 to acquire 453,001 newly issued shares of common stock. The share
price for the common stock was determined based on the fifteen-day market closing average for our
stock ending September&nbsp;5, 2003. On September&nbsp;8, 2003 and September&nbsp;2, 2004 the closing sale price
of our common stock as reported on NASDAQ, was $5.50 and $5.49 respectively, per share. On March
23, 2004 we sold 1,256,281 shares of our common stock to Altana at a purchase price of $7.96 per
share. On March&nbsp;23, 2004 the closing sale price of our common stock, as reported on NASDAQ, was
$8.26 per share. Each of these issuances of stock at below the then-current market price had a
dilutive effect on existing common stockholders.
</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><I>We have never paid dividends.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We currently intend to retain earnings, if any, to support our growth strategy. We do not
anticipate paying dividends on our stock in the foreseeable future.
</DIV>
<DIV align="left">
<A name="112"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;4. Submissions of Matters to a Vote of Security Holders</B>
</DIV>


<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">a)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The 2006 Annual Meeting of Stockholders of the Company was held on July&nbsp;24,
2006.</TD>
</TR>

</TABLE>
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">b)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The stockholders voted to re-elect two Class&nbsp;III directors to the Company&#146;s
Board of Directors. Results of the voting were as follows:</TD>
</TR>

</TABLE>
</DIV>

<P align="center" style="font-size: 10pt">25
</DIV>

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<DIV style="font-family: 'Times New Roman',Times,serif">
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="27%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="7%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="6%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000">Directors</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">For</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Authority Withheld</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Abstentions</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Broker Non-Votes</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Donald S. Perkins</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">13,465,231</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">305,483</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">Jerry K. Pearlman</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">13,467,266</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">303,448</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>



<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">Joseph E. Cross, James A. Henderson, James A. McClung and R. Janet Whitmore continued their
terms of office as directors of the Company after the 2006 Annual Meeting of Stockholders.
</DIV>

<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">c)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The stockholders also voted to authorize an amendment to the Company&#146;s
Certificate of Incorporation to increase the authorized number of shares of common
stock from 25,000,000 to 30,000,000. Results of the voting were as follows:</TD>
</TR>

</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="24%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="11%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="11%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000">For</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Against</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Abstentions</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Broker Non-Votes</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD align="center"><DIV style="margin-left:15px; text-indent:-15px">13,092,644</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">612,017</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">66,053</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#151;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">d)</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The stockholders also voted to authorize an amendment to the 2004 Equity
Compensation Plan (the &#147;Plan&#148;) to (a)&nbsp;increase to 1,200,000 the aggregate number of
shares available to be issued under the Plan, (b)&nbsp;increase the annual limit on the
number of shares available to be issued under the Plan to 300,000, and (c)&nbsp;decrease
the cap on grants to any individual in any year to 10% of any class. Results of the
voting were as follows:</TD>
</TR>

</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="24%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="11%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="11%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="9%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD nowrap align="center" style="border-bottom: 1px solid #000000">For</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Against</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Abstentions</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="3" style="border-bottom: 1px solid #000000">Broker Non-Votes</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD align="center"><DIV style="margin-left:15px; text-indent:-15px">4,543,774</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">669,693</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">71,540</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">8,485,707</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>

<DIV align="left">
<A name="113"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;5. Other Information</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;None.
</DIV>
<DIV align="left">
<A name="114"></A>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Item&nbsp;6. Exhibits and Reports on Form&nbsp;8-K</B>
</DIV>


<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>A.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Exhibits.</B></TD>
</TR>

</TABLE>
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="6%">&nbsp;</TD>
    <TD width="10%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="79%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit&nbsp;31.1
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certification of Chief Executive Officer pursuant to Rules
13a-14(a) and 15d-14(a) under the Exchange Act.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit&nbsp;31.2
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certification of Chief Financial Officer pursuant to Rules
13a-14(a) and 15d-14(a) under the Exchange Act.</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Exhibit&nbsp;32
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Certification of the Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section&nbsp;1350.</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV style="margin-top: 6pt">
<TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="3%" nowrap align="left"><B>B.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Reports on </B><B>Form 8-K</B><B>.</B></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">On June&nbsp;20, 2006, the Company furnished a Current Report on Form 8-K reporting under
Items 1.01 and 9.01 that on June&nbsp;16, 2006 it had received a fully-executed Z-COTE
HP-2 Brand Supply Agreement (dated effective May&nbsp;15, 2006) between the Company and
BASF Corporation, pursuant to which the Company will supply patent-pending surface
</DIV>

<P align="center" style="font-size: 10pt">26
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">engineered nanoparticles for current and future products for BASF&#146;s Z-COTE MAX
brand. A copy of the Supply Agreement is being furnished as Exhibit&nbsp;99.1 to this
report and is incorporated herein by reference.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">On April&nbsp;27, 2006, the Company furnished a Current Report on Form 8-K reporting
under Items 2.02 and 9.01 that on April&nbsp;27, 2006 it issued a press release
announcing first quarter 2006 revenues.
</DIV>


<P align="center" style="font-size: 10pt">27
</DIV>

<!-- PAGEBREAK -->
<P><HR noshade><P>
<H5 align="left" style="page-break-before:always"><A HREF="#tocpage">Table of Contents</A></H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">



<DIV align="left">
<A name="115"></A>
</DIV>

<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>SIGNATURES</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
</DIV>
<DIV align="center">
<TABLE style="font-size: 10pt" cellspacing="0" border="0" cellpadding="0" width="100%">
<!-- Begin Table Head -->
<TR valign="bottom">
    <TD width="47%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="3%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="36%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="10%">&nbsp;</TD>
</TR>
<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom">
    <TD valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="5" valign="top" align="left">NANOPHASE TECHNOLOGIES CORPORATION</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Date: August&nbsp;8, 2006
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">By:
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ JOSEPH E. CROSS
<DIV style="font-size: 1pt; border-top: 1px solid #000000">&nbsp;</DIV>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Joseph E. Cross</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">President, Chief Executive Officer (principal</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">executive officer) and a Director</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">Date: August&nbsp;8, 2006
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">By:
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">/s/ JESS A. JANKOWSKI
<DIV style="font-size: 1pt; border-top: 1px solid #000000">&nbsp;</DIV>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Jess A. Jankowski</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Chief Financial Officer (principal financial</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">and chief accounting officer)</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

</BODY>
</HTML>
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.1
<SEQUENCE>2
<FILENAME>c07357exv31w1.htm
<DESCRIPTION>CERTIFICATION
<TEXT>
<HTML>
<HEAD>
<TITLE>exv31w1</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
<!-- PAGEBREAK -->
<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>Exhibit&nbsp;31.1</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>Certification of the Chief Executive Officer<BR>
Pursuant to<BR>
Rules&nbsp;13a-14(a) and 15d-14(a) under the Exchange Act</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;I, Joseph Cross, certify that:
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1.&nbsp;I have reviewed this quarterly report on Form 10-Q of Nanophase Technologies Corporation;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;2.&nbsp;Based on my knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;3.&nbsp;Based on my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;4.&nbsp;The registrant&#146;s other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules&nbsp;13a-15(e) and
15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15(d)-15(f)) for the registrant and have:
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a) Designed such disclosure controls and procedures, or caused such disclosure controls
and procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b) Designed such internal control over financial reporting, or caused such internal
control over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(c) Evaluated the effectiveness of the registrant&#146;s disclosure controls and procedures
and presented in this report our conclusions about the effectiveness of the disclosure
controls and procedures, as of then end of the period covered by this report based on such
evaluation; and
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(d) Disclosed in this report any change in the registrant&#146;s internal control over
financial reporting that occurred during the registrant&#146;s most recent fiscal quarter (the
registrant&#146;s fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant&#146;s internal control over
financial reporting; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;5.&nbsp;The registrant&#146;s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant&#146;s auditors and the audit
committee of registrant&#146;s board of directors (or persons performing the equivalent function):
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a) All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrant&#146;s ability to record, process, summarize and report financial information; and
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b) Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant&#146;s internal control over financial reporting.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Date: August&nbsp;8, 2006
</DIV>


<TABLE width="100%" border="0" cellspacing="0" cellpadding="0" style="font-size: 10pt">
<TR>
    <TD width="48%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="35%">&nbsp;</TD>
    <TD width="15%">&nbsp;</TD>
</TR>
<TR>
    <TD valign="top" align="left">&nbsp;</TD>
    <TD colspan="3" align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" style="border-bottom: 1px solid #000000" align="left">                 /s/ JOSEPH E. CROSS
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Joseph E. Cross&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Chief Executive Officer&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR>
    <TD colspan="5">&nbsp;</TD>
</TR>
</TABLE>


<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

</BODY>
</HTML>
</TEXT>
</DOCUMENT>
<DOCUMENT>
<TYPE>EX-31.2
<SEQUENCE>3
<FILENAME>c07357exv31w2.htm
<DESCRIPTION>CERTIFICATION
<TEXT>
<HTML>
<HEAD>
<TITLE>exv31w2</TITLE>
</HEAD>
<BODY bgcolor="#FFFFFF">
<!-- PAGEBREAK -->
<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>Exhibit&nbsp;31.2</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>Certification of the Chief Financial Officer<BR>
Pursuant to<BR>
Rules&nbsp;13a-14(a) and 15d-14(a) under the Exchange Act</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;I, Jess Jankowski, certify that:
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1.&nbsp;I have reviewed this quarterly report on Form 10-Q of Nanophase Technologies Corporation;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;2.&nbsp;Based on my knowledge, this report does not contain any untrue statement of a material fact
or omit to state a material fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading with respect to the period
covered by this report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;3.&nbsp;Based on my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for, the periods presented in this report;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;4.&nbsp;The registrant&#146;s other certifying officer(s) and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules&nbsp;13a-15(e) and
15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15(d)-15(f)) or the registrant and have:
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a) Designed such disclosure controls and procedures, or caused such disclosure controls
and procedures to be designed under our supervision, to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made known to us by
others within those entities, particularly during the period in which this report is being
prepared;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b) Designed such internal control over financial reporting, or caused such internal
control over financial reporting to be designed under our supervision, to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(c) Evaluated the effectiveness of the registrant&#146;s disclosure controls and procedures
and presented in this report our conclusions about the effectiveness of the disclosure
controls and procedures, as of then end of the period covered by this report based on such
evaluation; and
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(d) Disclosed in this report any change in the registrant&#146;s internal control over
financial reporting that occurred during the registrant&#146;s most recent fiscal quarter (the
registrant&#146;s fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the registrant&#146;s internal control over
financial reporting; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;5.&nbsp;The registrant&#146;s other certifying officer(s) and I have disclosed, based on our most recent
evaluation of internal control over financial reporting, to the registrant&#146;s auditors and the audit
committee of registrant&#146;s board of directors (or persons performing the equivalent function):
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(a) All significant deficiencies and material weaknesses in the design or operation of
internal control over financial reporting which are reasonably likely to adversely affect the
registrant&#146;s ability to record, process, summarize and report financial information; and
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 2%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;(b) Any fraud, whether or not material, that involves management or other employees who
have a significant role in the registrant&#146;s internal control over financial reporting.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Date: August&nbsp;8, 2006
</DIV>


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    <TD width="48%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="35%">&nbsp;</TD>
    <TD width="15%">&nbsp;</TD>
</TR>
<TR>
    <TD valign="top" align="left">&nbsp;</TD>
    <TD colspan="3" align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" style="border-bottom: 1px solid #000000" align="left">                 /s/ JESS A. JANKOWSKI
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Jess A. Jankowski&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Chief Financial Officer&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR>
    <TD colspan="5">&nbsp;</TD>
</TR>
</TABLE>


<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

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<DOCUMENT>
<TYPE>EX-32
<SEQUENCE>4
<FILENAME>c07357exv32.htm
<DESCRIPTION>CERTIFICATION
<TEXT>
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<H5 align="left" style="page-break-before:always">&nbsp;</H5><P>

<DIV style="font-family: 'Times New Roman',Times,serif">

<DIV align="right" style="font-size: 10pt; margin-top: 12pt"><B>Exhibit&nbsp;32</B>
</DIV>


<DIV align="center" style="font-size: 10pt; margin-top: 18pt"><B>Certification Pursuant to 18 U.S.C. Section&nbsp;1350<BR>
(as adopted pursuant to Section&nbsp;906 of the Sarbanes-Oxley Act of 2002)</B>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In connection with this quarterly report of Nanophase Technologies Corporation (the
&#147;Company&#148;) on Form 10-Q for the quarter ending June&nbsp;30, 2006 as filed with the Securities and
Exchange Commission on the date hereof (the &#147;Report&#148;), we, Joseph E. Cross, Chief Executive Officer
of the Company, and Jess A. Jankowski, Chief Financial Officer of the Company, certify, pursuant to
18 U.S.C. &#167; 1350, as adopted pursuant to Section&nbsp;906 of the Sarbanes-Oxley Act of 2002, that, to
our knowledge:
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;1.&nbsp;The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities
Exchange Act of 1934; and
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;2.&nbsp;The information contained in the Report fairly presents, in all material respects, the
financial condition and result of operations of the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Date: August&nbsp;8, 2006
</DIV>


<TABLE width="100%" border="0" cellspacing="0" cellpadding="0" style="font-size: 10pt">
<TR>
    <TD width="48%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="35%">&nbsp;</TD>
    <TD width="15%">&nbsp;</TD>
</TR>
<TR>
    <TD valign="top" align="left">&nbsp;</TD>
    <TD colspan="3" align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" style="border-bottom: 1px solid #000000" align="left">                        /s/ Joseph E. Cross
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Joseph E. Cross&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Chief Executive Officer&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR>
    <TD colspan="5">&nbsp;</TD>
</TR>
<TR>
    <TD valign="top" align="left">&nbsp;</TD>
    <TD colspan="3" align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" style="border-bottom: 1px solid #000000" align="left">                        /s/ Jess A. Jankowski
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Jess A. Jankowski&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Chief Financial Officer&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR>
    <TD colspan="5">&nbsp;</TD>
</TR>
</TABLE>


<P align="center" style="font-size: 10pt">&nbsp;
</DIV>

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