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<SEC-DOCUMENT>0000950137-06-006874.txt : 20070129
<SEC-HEADER>0000950137-06-006874.hdr.sgml : 20070129
<ACCEPTANCE-DATETIME>20060615165356
<PRIVATE-TO-PUBLIC>
ACCESSION NUMBER:		0000950137-06-006874
CONFORMED SUBMISSION TYPE:	CORRESP
PUBLIC DOCUMENT COUNT:		1
FILED AS OF DATE:		20060615

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:		CORRESP

	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>CORRESP
<SEQUENCE>1
<FILENAME>filename1.htm
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<HTML>
<HEAD>
<TITLE>corresp</TITLE>
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<DIV style="font-family: 'Times New Roman',Times,serif">




<DIV align="left" style="font-size: 10pt; margin-top: 12pt">June&nbsp;15, 2006
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Securities and Exchange Commission<BR>
450 Fifth Street<BR>
Washington, D.C. 20549<BR>
ATTN: John Cash, Accounting Branch Chief

</DIV>
<DIV align="center">
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    <TD width="1%">&nbsp;</TD>
    <TD width="93%">&nbsp;</TD>
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<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"><B>RE:</B>
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><B>Nanophase Technologies Corporation</B></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"><B>Form&nbsp;10-K for the fiscal year ended December&nbsp;31, 2005</B></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"><B>Filed March&nbsp;15, 2006</B></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"><B>SEC File No.&nbsp;0-22333</B></TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt">Dear Mr.&nbsp;Cash:
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Nanophase Technologies Corporation (the &#147;Company&#148; or &#147;Nanophase&#148;), hereby files with the
Securities and Exchange Commission (the &#147;Commission&#148;), an initial response to the comments raised
by the Staff with respect to the above-referenced report (the &#147;10-K&#148;) in the Staff&#146;s comment letter
dated June&nbsp;5, 2006 (the &#147;Comment Letter&#148;). All responses to the accounting comments set forth in
this letter were prepared in consultation with our independent auditors. For ease of review, we
have numbered our responses below to correspond to the numbered comments set forth in the Comment
Letter.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Item&nbsp;9A. Controls and Procedures, page 31.</B></U>
</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>1.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>We note your Chief Executive Officer and Chief Financial Officer concluded that your
disclosure controls and procedures were effective to ensure that information required to be
disclosed in reports filed under the Exchange Act is recorded, processed, summarized and
reported within the specified time periods. Confirm to us, and revise future filings
annual and quarterly filings to clarify, if true, that your officers concluded that your
disclosure controls and procedures are also effective for the purpose of ensuring that
material information required to be in these reports is made known to management and
others, as appropriate, to allow timely decisions regarding required disclosures.
Alternatively, you may simply conclude that your disclosure controls are effective or
ineffective without defining them. Refer to Exchange Act Rule&nbsp;13a-</B><B>15(e)</B><B>.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company acknowledges the Staff&#146;s comment. We conclude that our disclosure controls and
procedures are effective for the purpose of ensuring that material information required to
be disclosed in reports filed under the Exchange Act is made</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">1
</DIV>

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<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: #textcolor#; background: #bgcolor#">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>known to management and others, as appropriate, to allow timely decisions regarding required
disclosures. The Company will provide this requested clarification in subsequent filings.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Report of Independent Registered Public Accounting Firm, page F-3</B></U>
</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>2.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Revise future filings to ensure that the accountants&#146; report includes a conformed
signature as required by Rule&nbsp;2-</B><B>02(a)</B><B> of Regulation&nbsp;S-X.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company acknowledges the Staff&#146;s comment and will provide the requested clarifications
in subsequent filings.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Statement of Stockholders&#146; Equity, page F-7</B></U>
</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>3.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>We note that you are required to register the shares you sold to Altana in the 2004
private placement. Please tell us what consideration or alternatives will be available to
Altana if the shares are not registered and how you determined that classification in
permanent equity is appropriate.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company Response</U>: Using the FASB&#146;s EITF Abstract Issue No.&nbsp;00-19 (&#147;EITF 00-19&#148;) as a
guide, we reviewed EITF 00-19 (having excerpted some applicable paragraphs herein: &#182;12
through &#182;19, &#182;24 through &#182;26, &#182; 28 and &#182;31,
including, bold italicized items under
eight applicable paragraphs that the FASB marked in such manner as to emphasize their
importance, to ensure that classification of the shares relating to the 2004 Altana private
placement was properly determined to be part of permanent equity.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;12:</U> &#147;Contracts that include any provision that could require
net-cash<U> </U>settlement cannot be accounted for as equity of the company (that is, asset
or liability classification is required for those contracts), except in those limited
circumstances in which holders of the underlying shares also would receive cash....&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Pursuant to the Stock Purchase Agreement
dated March&nbsp;23, 2004 between Altana Chemie AG (&#147;Altana&#148;) and the Company (&#147;the Purchase
Agreement,&#148; Exhibit&nbsp;4.10 to the Nanophase 2003 annual report on Form 10-K), Nanophase issued
1,256,281 unregistered shares of Nanophase common stock (the &#147;Shares&#148;). As a separate
contractual covenant pursuant to the Registration Rights Agreement dated March&nbsp;23, 2004
(&#147;the Rights Agreement,&#148; Exhibit&nbsp;4.11 to the Nanophase 2003 annual report on Form 10-K)
entered into in connection with the Purchase Agreement requires that Nanophase file a
registration statement &#147;as soon as practicable&#148; after the second anniversary of the
agreement (3/24/2006). Cash in lieu of registered shares, or any net-cash settlement, was
never contemplated in the agreement.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;13:</U> &#147;Because any contract provision that could require net-cash
settlement precludes accounting for a contract as equity of the company .....all of the
following conditions must be met for a contract to be classified as equity:</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><I>&nbsp;</I></B></TD>
    <TD width="1%"><B><I>&nbsp;</I></B></TD>
    <TD><B><I>The contract permits the company to settle in unregistered shares</I></B>.&#148;</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">2
</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="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: The Rights Agreement requires that Nanophase
file a registration statement &#147;as soon as practicable&#148; after the second anniversary of the
agreement (3/24/2006). Altana was issued unregistered shares upon execution and funding of
both the Purchase Agreement and the Rights Agreement. The Rights Agreement implicitly
allows the Company to settle in unregistered shares by not providing a remedy in the event
that the Company&#146;s best efforts do not result in registration of the Shares. The covenants
in the Rights Agreement only require that Nanophase use our best efforts to cause the Shares
to be registered as soon as it is practicable after the second anniversary of the Rights
Agreement.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;14:</U> &#147;The events or actions necessary to deliver registered shares are
not controlled by a company and, therefore, except under the circumstances described in
paragraph 18 below, if the contract permits the company to net-share or physically settle
the contract only by delivering registered shares, it is assumed that the company will be
required to net-cash settle the contract. As a result, the contract must be classified as an
asset or a liability. Delivery of unregistered shares in a private placement to the
counterparty is within the control of a company, as long as a failed registration statement
(that is, a registration statement that was filed with the SEC and subsequently withdrawn)
has not occurred within six months prior to the classification assessment date...Accordingly,
assuming (a)&nbsp;a failed registration statement does not preclude delivery of unregistered
 shares, (b)&nbsp;the contract permits a company to net-share settle the contract by delivery of
unregistered shares, and (c)&nbsp;the other conditions in this Issue are met, the contract should
be classified as a permanent equity instrument.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Based upon the covenants in the Rights
Agreement, a successful registration statement is not a required outcome or a necessary
component of Nanophase fulfilling its obligation under the Rights Agreement. Unregistered
 shares were delivered on or about March&nbsp;24, 2004 and that delivery was not precluded, and
will not be required to be rescinded, in the event of a failed registration statement. The
Rights Agreement permits settlement by delivery of unregistered shares implicitly, the only
obligations of Nanophase, beyond delivery of the unregistered Shares, being the filing of a
registration statement as soon as practicable after March&nbsp;24, 2006 and the application of
its best reasonable efforts to effect registration. Therefore, the Shares, and the funds
related to the shares, were appropriately classified as permanent equity.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;15:</U> &#147;A contract may specify that the value of the unregistered shares
to be privately placed under share settlement is to be determined by the counterparty using
&#147;commercially reasonable means.&#148; That valuation is used to determine the number of
unregistered shares that must be delivered to the counterparty. The term commercially
reasonable means is sufficiently objective from a legal perspective to prevent a
counterparty from producing an unrealistic value that would then compel a company to
net-cash settle the contract. Similarly, a contractual requirement to determine the fair
value of unregistered shares by obtaining market quotations is sufficiently objective and
would not suggest that the settlement alternatives have different economic values.&#148;</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">3
</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="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard:</U> The Purchase Agreement explicitly values the
Shares at $7.96 per share, the cash purchase price per share. This valuation was a mutually
agreed upon valuation calculated using the historical weighted average of closing prices as
determined by the NASDAQ National Market at the date of the Purchase Agreement. This
valuation was the final, unalterable purchase price of the Shares. Therefore, there is no
possibility of the counterparty (Altana) producing an &#147;unrealistic value&#148; as contemplated in
EITF 00-19.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;16:</U> &#147;If a settlement alternative includes a penalty that would be
avoided by a company under other settlement alternatives, the uneconomic settlement
alternative should be disregarded in classifying the contract. In the case of delivery of
unregistered shares, a discount from the value of the corresponding registered shares that
is a reasonable estimate of the difference in fair values between registered and
unregistered shares (that is, the discount reflects the fair value of the restricted shares
determined using commercially reasonable means) is not considered a penalty.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: The Rights Agreement does not contemplate a
penalty relating to alternative forms of contract settlement.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;17:</U> &#147;The Task Force observed that if (a)&nbsp;a derivative contract<BR>
requires physical or net-share settlement by delivery of registered shares and does not
specify any circumstances under which net-cash settlement would be permitted or required and
(b)&nbsp;the contract does not specify how the contract would be settled in the event that the
company is unable to deliver registered shares, then net-cash settlement is assumed if the
company is unable to deliver registered shares (because it is unlikely that nonperformance
would be an acceptable alternative).</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Consequently, the derivative must be classified as an asset or a liability (subject to the
transition guidance in this Issue) because share settlement is not within the company&#146;s
control.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: There are no derivative instruments in either
the Purchase Agreement or the Rights Agreement.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;18:</U> &#147;The Task Force reached a consensus that if a derivative involves
the delivery of shares at settlement that are registered as of the inception of the
derivative transaction and there are no further timely filing or registration requirements,
the requirement of Issue 00-19 that share delivery be within the control of the company is
met, notwithstanding the Task Force&#146;s consensus in paragraph 14, above.</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><I>&nbsp;</I></B></TD>
    <TD width="1%"><B><I>&nbsp;</I></B></TD>
    <TD><B><I>The company has sufficient authorized and unissued shares available to settle the contract
after considering all other commitments that may require the issuance of stock during the
maximum period the derivative contract could remain outstanding</I></B>.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: There are no derivative instruments in either
the Purchase Agreement or the Rights Agreement. The Shares required to settle the contract</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">4
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<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: #textcolor#; background: #bgcolor#">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>were delivered in the form of unregistered shares that were fully authorized. No further
share issuance is contemplated in either the Purchase Agreement of the Rights Agreement.
The Company had sufficient authorized and un-issued shares available at March&nbsp;23, 2004 to
allow us to issue the Shares to Altana and fulfill its entire obligation to Altana in terms
of quantity of shares issued for the entire contemplated term of both agreements.
Therefore, the securities were appropriately classified as permanent equity.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;19:</U> &#147;If a company could be required to obtain shareholder approval to
increase the company&#146;s authorized shares in order to net-share or physically settle a
contract, share settlement is not controlled by the company. Accordingly, a company must
evaluate whether a sufficient number of authorized and unissued shares exists at the
classification assessment date to control settlement by delivering shares. In that
evaluation, a company must compare (a)&nbsp;the number of currently authorized but unissued
 shares, less the maximum number of shares that could be required to be delivered during the
contract period under existing commitments (for example, outstanding convertible debt that
is convertible during the contract period, outstanding stock options that are or will become
exercisable during the contract period, or other derivative financial instruments indexed
to, and potentially settled in, a company&#146;s own stocks) with (b)&nbsp;the maximum number of
 shares that could be required to be delivered under share settlement (either net-share or
physical) of the contract. If the amount in (a)&nbsp;exceeds the amount in (b)&nbsp;and the other conditions in this Issue are met, share settlement is within the control
of the company and the contract should be classified as a permanent equity instrument.
Otherwise, share settlement is not within the control of the company and asset or liability
classification is required.</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><I>&nbsp;</I></B></TD>
    <TD width="1%"><B><I>&nbsp;</I></B></TD>
    <TD><B><I>The contract contains an explicit limit on the number of shares to be delivered in a share
settlement.&#148;</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: The Shares required to settle the contract
were delivered in the form of unregistered shares that were fully authorized. No further
share issuance is contemplated in either the Purchase Agreement of the Rights Agreement.
Having no derivative component to either agreement, the Company had sufficient authorized
and un-issued shares available at March&nbsp;23, 2004 to allow us to issue the Shares to Altana
and fulfill its entire obligation to Altana in terms of quantity of shares issued for the
entire contemplated term of both agreements. At the time of fulfillment of this obligation,
the Company had enough shares authorized to meet all other known obligations requiring the
issuance of shares (in the case of Nanophase, there is no convertible debt and this
consideration was limited to shares available for grant under its Equity Compensation Plan).
Both the Purchase Agreement and the Rights Agreement contain an explicit limit on the
number of shares required to be delivered in a share settlement. Therefore, the securities
were appropriately classified as permanent equity.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;24:</U> <B><I>There are no required cash payments to the counterparty in the
event the company fails to make timely filings with the SEC.</I></B></TD>
</TR>

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

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<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 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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Neither the Purchase Agreement nor the Rights
Agreement contemplate cash payments in the event the Company fails to make timely filings
with the SEC.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;25:</U> <B><I>There are no required cash payments to the counterparty if the
shares initially delivered upon settlement are subsequently sold by the counterparty and the
sales proceeds are insufficient to provide the counterparty with full return of the amount
due (that is, there are no cash settled &#147;top-off&#148; or &#147;make whole&#148; provisions).</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Neither the Purchase Agreement nor the Rights
Agreement require cash payments relating to any failure to register the shares.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;26:</U> <B><I>The contract requires net-cash settlement only in specific
circumstances in which holders of shares underlying the contract also would receive cash in
exchange for their shares.</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Neither the Purchase Agreement nor the
Rights Agreement require &#147;net cash settlement&#148; in any instance nor contemplate any cash
payment in exchange for their shares..</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U> </U></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;28:</U> <B><I>There are no provisions in the contract that indicated
that the counterparty has rights that rank higher than those of a shareholder of the stock
underlying the contract.</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Neither the Purchase Agreement nor the Rights
Agreement contain provisions indicating the counterparty has rights that rank higher than
those of the holders of the Company&#146;s common stock.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>EITF 00-19, &#182;31:</U> <B><I>There is no requirement in the contract to post collateral at any
point or for any reason.</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Application of the Standard</U>: Neither the Purchase Agreement nor the Rights
Agreement require the Company to post any collateral at any time in connection with the
Company&#146;s obligations under such agreements.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The respective CEOs of Altana and Nanophase have recently discussed the pending filing of a
registration statement relating to the Rights Agreement and have agreed to proceed at a time
that is most convenient to Nanophase in the near term.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Having met all the requirements of EITF 00-19, management believes that the Company
correctly classified the securities issued to Altana as permanent equity.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Response to Statement of Cash Flows, page F-8</B></U>
</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>4.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>We note that your supplemental non-cash investing and financing activities include
accounts receivable paid through the offset of long-term debt. Please tell us what</B></TD>
</TR>

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

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<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 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>&nbsp;</B></TD>
    <TD width="1%"><B>&nbsp;</B></TD>
    <TD><B>these amounts relate to and how you considered the impact on your revenue recognition
policy.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The amounts noted in &#147;Supplemental non-cash investing activities&#148; as accounts receivable
paid through the offset of long-term debt relate directly to the $1.3&nbsp;million loan the
Company received from BASF Corporation (&#147;BASF&#148;) in November of 2000. This loan was to fund
construction of a powder coating line, and related equipment, within the Company&#146;s
Romeoville, Illinois facility. This equipment is used to coat, test and package the
Company&#146;s materials produced for BASF, its largest customer.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The agreement between the Company and BASF required principal and interest to be paid to
BASF on a per-kilogram-of-material-shipped basis. As each shipment of coated materials was
shipped, the Company issued BASF a per kilogram credit (the &#147;Per kg Credit&#148;) (the amount
credited per kilogram remains confidentially treated). The Company and BASF are in
agreement as to how much of each shipment&#146;s credit was to be applied to principal and how
much was to be applied to interest. Given that BASF is a significant customer and the
portion of the Company&#146;s revenue relating to it is disclosed, as is the loan&#146;s rate of
interest (8.45%) and the fact that coated zinc oxide composes the great majority of revenue
from BASF, it would put Nanophase and BASF at a competitive disadvantage to disclose how
much per kilogram was to be credited, or &#147;paid back,&#148; periodically. With the amount of the
credits per kilogram disclosed, the quantities shipped, and the pricing of such material,
would be easy to determine algebraically.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>This loan did not have any impact on the Company&#146;s recognition of the revenue for coated
product shipped. The contract pricing agreed upon prior to the loan has been held at the
same levels, allowing for quantity discounts and inflationary increases, prior to the loan
being issued and after issuance of the loan.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The accounting accompanying coated product shipments is (ignoring COGS and inventory
impact):</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="2%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="60%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="30%">&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">Dr.
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Accounts Receivable
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top"><DIV style="margin-left:15px; text-indent:-15px">$&nbsp;&nbsp;Selling Price, less<BR>
the Per kg Credit</DIV></TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD><!-- 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>
</TR>
<TR valign="bottom">
    <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">L-T Liability (or S-T Portion of L-T Liability)
</TD>
    <TD>&nbsp;</TD>

<TD align="left" valign="top"><DIV style="margin-left:15px; text-indent:-15px">$&nbsp;&nbsp;Principal portion<br>
of the Per kg Credit</DIV></TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD><!-- Blank Space -->
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD>
    <TD valign="top"><DIV style="margin-left:0px; text-indent:-0px">&nbsp;
</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">Interest Expense
</TD>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">$&nbsp;&nbsp;Interest portion<br>
of the Per kg Credit</TD>
</TR>
<TR valign="bottom">
    <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>
    <TD>&nbsp;</TD>
    <TD align="left" valign="top">&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD>&nbsp;</TD><!-- 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>
</TR>

<TR valign="bottom">
    <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">Cr. Product Revenue
</TD>
    <TD>&nbsp;</TD>
    <TD align="center" valign="top">$ Selling Price</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>In terms of Nanophase&#146;s revenue recognition policy, sales of coated materials to BASF meet
all of the required criteria:</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">7
</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 style="margin-top: 6pt"><TABLE width="100%" border="0" cellpadding="0" cellspacing="0" style="font-size: 10pt">



</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="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Revenue is not recognized until goods are shipped and all goods are shipped FOB
Nanophase, therefore, title transfers via shipment.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>We have a long standing supply agreement with BASF which is persuasive evidence
of an existing arrangement.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>We have never had issues collecting monies due us from BASF, supporting
reasonable assurance of collectibility.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>All pricing is fixed annually and based upon annual quantities shipped, with
provisions for inflationary increases.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>In the Company&#146;s view, all key criteria for revenue recognition under SAB 104 have been met
in this case. The revenue relating to this loan would be identical whether we had written
BASF a check for principal and interest on this loan with every shipment (or on a ratable
timetable) or offset such principal and interest payments against amounts owed to the
Company by BASF.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Response to Note 7. Pledged Assets and Long-Term Debt, page F-17</B></U>
</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>5.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>We note that you recorded a debt discount and deferred revenue related to a promissory
note held by BYK Chemie. Fully explain to us the rights and obligations of each party
under this agreement. Please help us understand how you determined that the amount you
recorded as deferred revenue is appropriate based on their rights to the new equipment and
experimental products.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>Company&#146;s Response:</U> Effective October&nbsp;27, 2005, the Company entered into a
Promissory Note (&#147;Note&#148;) with BYK-Chemie USA (&#147;BYK&#148;), a subsidiary of Altana Chemie.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The following is a summary of the relevant terms of the Note:</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="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>BYK lent the Company $1,597,420.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Interest rate is stated at the average daily LIBOR during the calendar
quarter immediately preceding each quarter in which interest accrues, plus 100
basis points.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company will use the funds to buy, install and commission both an NAS
Reactor System and a dispersion line (collectively &#147;Equipment&#148;).</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>BYK is guaranteed first priority for the manufacturing of products to fill
orders submitted by BYK and to provide experimental products for their
evaluation.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Interest will start accruing one year after the date that installation and
commissioning of the Equipment has been completed.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Principal will be paid in cash installments consisting of:</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="16%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">o</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>1/3 of the balance outstanding on December&nbsp;31,
2008, due on January&nbsp;30, 2009</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="16%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">o</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>an additional 1/3 of the balance outstanding on
December&nbsp;31, 2008, due on April&nbsp;30, 2009</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">8
</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="16%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">o</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>remaining 1/3 of the balance outstanding on
December&nbsp;31, 2008, due on July&nbsp;30, 2009.</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="9%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Any remaining unpaid amount, Principal or accrued interest, after July&nbsp;30,
2009 will become immediately payable.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company is receiving the Principal under an interest-free period for a term
extending from the Effective Date through the date of commissioning the Equipment. We
have estimated the Commissioning Date to July&nbsp;1, 2006. Additionally, Altana Chemie owns
approximately 7% of the outstanding stock of Nanophase and management did not view BYK
(a subsidiary of Altana Chemie) as an independent party for purposes of this analysis.
Given the pre-existing relationship between the Company and BYK&#146;s parent, the stated
interest rate was evaluated as to whether it was a &#147;fair market&#148; interest rate. Based
upon feedback from the Company&#146;s existing bankers, investment managers, and leasing
agents, management determined that the stipulated rate was below &#147;fair market.&#148; The
issues to be dealt with were then the accounting for the interest-free period and the
below-market stated interest rate in the Note.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Accounting Principals Board Opinion No.&nbsp;21, &#147;Interest on Receivables and Payables&#148; (&#147;APB
21&#148;), discusses the appropriate accounting when the face amount of a note does not
reasonably represent the present value of the consideration given or received in the
exchange. This circumstance may arise if the note is non-interest bearing or has a
stated interest rate which is different from the rate of interest appropriate (&#147;fair
market&#148;) for the debt at the date of the transaction.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Given that the Company exchanged the note in return for cash, the following paragraph of
APB 21 applied:</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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>&#147;11. <I>Note exchanged for cash. </I>When a note is received or issued solely for cash
and no other right or privilege is exchanged, it is presumed to have a present
value at issuance measured by the cash proceeds exchanged. If cash and some
other rights or privileges are exchanged for a note, the value of the rights or
privileges should be given accounting recognition as described in paragraph 7.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>In addition to the promise to repay the Note, the Company also provided a &#147;right of
priority&#148; and a commitment to provide &#147;experimental products&#148; to BYK. APB 21 provides
the following guidance related to other rights and privileges:</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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>&#147;7. <I>Unstated rights or privileges. </I>A note issued solely for cash equal to its
face amount is presumed to earn the stated rate of interest. However, in some
cases the parties may also exchange unstated (or stated) rights or privileges,
which are given accounting recognition by establishing a note discount or
premium account. In such instances, the effective interest rate differs from the
stated rate. For example, a corporation may lend a supplier cash which is to be
repaid five years hence with no stated interest. Such a noninterest bearing loan</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">9
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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: #textcolor#; background: #bgcolor#">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>may be partial consideration under a purchase contract for supplier products at
lower than the prevailing market prices. In this circumstance, the difference
between the present value of the receivable and the cash loaned to the supplier
is appropriately regarded as an addition to the cost of products purchased
<I>(Nanophase comment: in this case, APB 21 refers to cost of products purchased
by BYK, which would equate to some form of revenue to Nanophase) </I>during the
contract term. The note discount is amortized as interest income over the
five-year life of the note.&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Therefore, the Company must give accounting recognition to the rights and privileges
also exchanged in the Note. Management determined the best methodology to value the
rights and privileges would be to include the following:</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Cash provided upon execution of the Note was deemed to be at fair value.
APB 21, paragraph 11 (above)&nbsp;states this explicitly.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The value exchanged for the &#147;right of first priority&#148; and to &#147;provide
experimental product&#148; can be directly attributed to the &#147;interest-free&#148; period
and the fact that stated interest rate of the Note is less than market-value
(i.e. BYK exchanged these items for the &#147;right of first priority&#148; and the
&#147;right to receive experimental product&#148; from the Company).</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Management&#146;s determination of the appropriate &#147;fair value&#148; interest factor,
which would allow management to appropriately discount the Note. This discount
would then provide the estimated value of the rights and privileges exchanged
with the Note.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company obtained interest rate information from its banker and investment manager,
Harris Bank (&#147;Harris&#148;) and Credit Suisse First Boston (&#147;CSFB&#148;), respectively. Harris
provides the Company with banking services, primarily checking accounts. However,
Harris also provides a variety of debt services to local industries. Harris determined
an appropriate market interest rate for a company similar to Nanophase would be
approximately 9%.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Additionally, CSFB provides investing services to the Company. CSFB provided various
interest rates offered to companies with &#147;Junk Bond&#148; status (i.e. high risk companies).
The rates provided by CSFB ranged from 5% to 10% depending on the Junk Bond rating of
the company.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Finally, the Company entered into an equipment lease near year-end with an outside third
party. The lease&#146;s stated interest rate is 9%.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Upon analysis of the estimated likely market interest inputs above, the Company
determined a 9% interest factor to be the most appropriate for discounting the Note.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Based on our calculations, we determined the value of the additional rights and
privileges stated in the Note to total approximately $350,000. Therefore, the Company
booked the following entry upon inception of the Note and receipt of cash:</TD>
</TR>

</TABLE>
</DIV>


<P align="center" style="font-size: 10pt">10
</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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Dr.&nbsp;Debt Discount (Contra-Note Payable)&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; $350,000</TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 14%">Cr. Deferred Other Revenue &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;$350,000
</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company credited Deferred Other Revenue. These rights and privileges were provided
to a major customer, and relate to priority of manufacturing product to be sold to the
customer on an &#147;as needed&#148; basis, and to provide &#147;experimental product&#148; from which
future product revenue will be derived. Given that this revenue is not directly related
to a product sale per se, the Other Revenue designation represents the clearest
presentation. This is also consistent with the example provided by APB 21, paragraph 7.
However, the APB 21 example is a reversal of this situation, as the Company is
receiving a loan vs. providing a loan. Given the facts and principles involved, we drew
the conclusion from the example provided to support treating the value of the expected
rights and privileges given to BYK as Deferred Revenue, resulting in a &#147;Credit&#148; to the
balance sheet.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company also amortized part of the debt discount. The amortization was for the time
period elapsed from the Effective Date to year-end. The Company is amortizing the debt
discount over the period from November&nbsp;2005 through the maturity date of July&nbsp;31, 2009.
The Company is using the effective interest method to amortize the debt discount.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Finally, the Company did not amortize any of the Deferred Other Revenue in 2005. As the
Deferred Other Revenue relates to the &#147;right of first priority&#148; and the &#147;right to
experimental product,&#148; management determined that these rights could only be provided
upon commissioning of the Equipment. Therefore, the time period to amortize the
Deferred Other Revenue would begin upon commissioning the Equipment (estimated as July
1, 2006 by management) through the Note maturity date of July&nbsp;31, 2009, which is 37
months. The &#147;rights and privileges&#148; relate to a time period versus any actual or
estimated production volumes. Therefore, amortizing the &#147;rights and privileges&#148; on a
straight-line basis over the time period is the most systematic and rational methodology
for recognizing the Deferred Other Revenue.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company believes that both the calculation of the note payable discount and the
designation of such discount as Deferred Other Revenue were appropriate under APB 21
based on the guidance discussed above.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Response to Note 15. Significant Customers and Contingencies, page F-23</B></U>
</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>6.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>We note that you received and &#147;fully earned&#148; $600,000 during 2004 from RHEM. We also
note that your amended agreement with RHEM was extended through 2009. Please help us
understand how you determined that this payment was &#147;fully earned&#148; in 2004.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>This question addresses the earnings process relating to other revenue received from Rohm &#038;
Hass Electronic Materials CMP Inc. (&#147;RHEM&#148;) in 2004.</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">11
</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="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Historically, the great majority of the Company&#146;s products require a long
development/adoption cycle as Nanophase works with customers to explore the benefits of
using our nanomaterials in the customer&#146;s applications. This process often requires the
Company to expend a significant amount of effort in producing nanomaterials that meet
customers&#146; performance requirements. The typical development/adoption cycle can last as long
as 3 to 4&nbsp;years.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company&#146;s execution of a Cooperation Agreement (the &#147;Agreement&#148;) with RHEM, in June of
2002, marked its entry into the development of product for use in a &#147;slurry&#148; formulation to
be used in Chemical/Mechanical Planarization (&#147;CMP&#148;). This Agreement, and the related
development process followed the typical model outline in the preceding paragraph.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Given that there seemed to be only three major competitors in
this segment of the CMP market and two of them
had proven difficult for the Company either to deal with or reach, the third, RHEM, appeared to be the ideal
customer for the Company&#146;s entry into this new product segment.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Generally speaking, the Agreement required the development of specific particles (the
&#147;Particles&#148;) to be used in a &#147;slurry&#148; formulation by RHEM, for sale to its customers, for
use in a CMP process (the &#147;Field&#148;). The Agreement states that the Company will own the
intellectual property applicable to the manufacture of any particles created and RHEM will
own the intellectual property applicable to slurry formulation. The &#147;Recitals&#148; of the
agreement make it clear that the Company, as of the date it entered the Agreement,
manufactures and sells cerium oxide particles (the Particles that are the subject of the
Agreement) and/or dispersions of cerium oxide particles that were available for potential
use in products for use in CMP and further provided that RHEM believes that the use of the
Company&#146;s Particles, for applications in CMP with RHEM&#146;s slurry products, will result in
superior products for sale to RHEM&#146;s CMP customers.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The &#147;Cooperation&#148; section on page 2 of the agreement provides, in part, that:</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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Both parties will use all commercially reasonable efforts to cooperate with one
another to develop one or more commercial slurry products incorporating Particles for
applications in the Field. Note that this language in turn was defined as &#147;Development
Product&#148;. The development efforts were focused on the development of a slurry, not the
Particles,</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Nanophase had a general obligation to (i)&nbsp;provide RHEM with research samples of the
Development Product (ii)&nbsp;devote sufficient resources as may be agreed to provide for
the development effort and (iii)&nbsp;provide RHEM and its customers with technical support
as to the use of the Particles and Development Products, 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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Unless otherwise agreed, each party shall be responsible for its own expenses in
connection with the development effort.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Agreement did not explicitly contemplate that Development Products would not be
developed. Under the section titled &#147;Term and Termination&#148; on page 12, the Agreement
provided that the &#147;exclusivity&#148; provided for in the agreement would possibly terminate... in
the event that (a)&nbsp;no RHEM customer has qualified a CMP slurry product</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">12
</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: #textcolor#; background: #bgcolor#">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>incorporating the Particles and RHEM has not purchased at least 7,000 kilograms of Particles
from the Company as of December&nbsp;31, 2003, (b)&nbsp;if RHEM did not purchase at least 21,000
kilograms of Particles during 2004, (c)&nbsp;if RHEM did not purchase at least 61,000 kilograms
of Particles during 2005, and (d)&nbsp;similarly on a going forward basis for such amounts as the
parties agreed to. The initial term of the Agreement was for five years through June&nbsp;24,
2007 and the Agreement further provided &#147;subject to RHEM&#146;s complying with the purchase
minimums . . ., this Agreement will renew automatically at the end of the initial term for
consecutive additional five year periods of five years each, unless terminated by either
party upon written notice...&#148;</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Additionally, as previously mentioned the Agreement provides for exclusivity to both
parties. The Company would not sell the Particles to another customer within the Field, and
RHEM would not purchase Particles from other vendors. Exclusivity would remain in force for
the term of the Agreement, unless the minimum purchase requirements under the Agreement were
not met. The minimum purchase requirements are measured annually on a calendar year. The
Agreement provides for no recourse for the Company in the event that RHEM does not purchase
the required minimum purchase requirements, other than a loss of exclusivity.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Section&nbsp;11 of the Agreement provides for terms relating to &#147;Product Development and
Improvement&#148;. This section, amongst other things, requires the Company to use commercially
reasonable efforts and devote reasonable resources to maintain the Particles for
applications in the Field (defined as Particles for use in CMP) as &#147;state of the art&#148; or
better, based on mutually agreed specifications and provides for RHEM
to have a process to
communicate Particle performance deficiency which in turn provides the Company with an
opportunity within a defined timeframe to correct. Again, a failure to &#147;correct&#148; only
affects the exclusivity provisions.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company received no consideration to enter the Agreement other than the grant of
exclusivity from RHEM and the expectation that product orders would follow. Additionally,
the Company did not receive any reimbursement for expenses incurred by the Company. Prior
to shipping the required quantity of material in 2003, the Company had fulfilled all of its
requirements under the Agreement, had received RHEM&#146;s acceptance of the Particles, and
Development Products had been developed and shipped through December&nbsp;31, 2003.
Additionally, the Company was prepared to deliver the specified quantities as required per
the minimum purchase quantities under terms of the Agreement in 2004. Under the terms of
the Agreement, the first scheduled delivery of Particles was planned for calendar year 2004.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>In February&nbsp;2004, RHEM notified the Company that it would prefer not to meet the minimum
purchase requirements set forth for 2004. Nanophase then informed RHEM that exclusivity may
not be able to be maintained if RHEM could not meet its 2004 minimum purchase requirements.
The Company and RHEM then agreed to amend the Agreement (&#147;Amendment #1&#148;) to allow RHEM to
maintain exclusivity with the Company through 2004, and to be relieved of its calendar year
2004 purchase requirement, modified purchase minimums for 2005, and extended the Agreement
for an</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">13
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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: #textcolor#; background: #bgcolor#">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>additional 18&nbsp;months through December&nbsp;2009. In consideration of continuing such exclusivity
through 2004, RHEM agreed to provide $600,000 to be used &#147;to develop one or more commercial
slurry products incorporating Particles for applications in the Field.&#148; Note that this
language in turn was defined as &#147;Development Product&#148; in the Agreement. Three payments were
made in 2004, and the final payment was received in the 1<SUP style="font-size: 85%; vertical-align: text-top">st</SUP> quarter of 2005.
During 2004, the Company recognized $150,000 in revenue for each calendar quarter in 2004,
as the Company invoiced RHEM on each of the calendar quarters ending in 2004.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>On October&nbsp;15, 2004, the Company and RHEM modified the original Agreement again (&#147;Amendment
#2). Amendment #2 specifically stated the kilograms of product to be shipped for 2005 and
2006 in the following manner:</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>&#147;In 2005, exclusivity will be conditioned on RHEM&#146;s purchase from Nanophase of a
certain quantity of Particles for applications in the Field at a designated per
kilogram price, purchased on a scheduled basis each quarter, through December&nbsp;31,
2005;&#148;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>&#147;In 2006, exclusivity will be conditioned on RHEM&#146;s purchase of a minimum
quantity of Particles for such year on a schedule to be mutually agreed upon by
October&nbsp;15, 2005.&#148;</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Annual and quarterly kilogram quantities have been treated as confidential as
such disclosure of specific quantities, based upon RHEM&#146;s sales dollar volume being
disclosed in periodic filings due to their status as a &#147;significant customer,&#148;
could lead to indirect disclosure of key pricing (a straightforward albebraic
determination) information that would put Nanophase and RHEM at a competitive
disadvantage in the marketplace.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Amendment #2 was not unexpected, as it was specifically called for within Amendment #1 for
the purpose of providing for the specifics of the agreed to 2005 purchase requirements
needed to continue exclusivity in 2005.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>There have been no oral or written side agreements between RHEM and the Company relating to
the original Agreement or its Amendments. This contract represents the only ongoing
business relationship between RHEM and Nanophase.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The accounting for the original Agreement was to expense all costs as they were incurred and
no revenue was recognized, other than for minor shipments.</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><I>&nbsp;</I></B></TD>
    <TD width="1%"><B><I>&nbsp;</I></B></TD>
    <TD><B><I>The issue is the accounting for the $600,000 received in 2004. Was this &#147;earned&#148; in 2004 or
did it somehow relate to future periods?</I></B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The terms of the $600,000 consideration were placed into a paragraph in Amendment #1 titled,
&#147;Development Funding&#148;. In order to determine whether this provision in the Amendment
relates to future research and development performance, management considered the
qualitative elements surrounding Amendment #1.</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">14
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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="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The qualitative elements from management&#146;s discussions with RHEM and in the contracts are
the following:</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>RHEM risked losing exclusivity of the Particles under the terms of the original
Agreement due to its inability to fulfill the purchase minimums as specified.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>RHEM desired to maintain exclusivity with the Company. This
fact is confirmed by
the paragraph titled, &#147;Exclusivity,&#148; in Amendment #1. The development of a
slurry product incorporating a nanoparticle was important to RHEM
given that Hitachi, a
competitor in the CMP supply market and a chip manufacturer itself, was already said
to have a slurry product incorporating nanoparticles.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>RHEM approached the Company in order to reach an accommodation and amend the
Agreement. The Company did not initiate these discussions, as it had fulfilled the
original terms of the Agreement requiring the Company to be in a position to
produce Particles meeting RHEM&#146;s specifications. The Company complied with the
terms, and expected RHEM to comply.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>RHEM sought to maintain exclusivity of the contract with no consideration being
given, but eventually agreed to pay $600,000 for exclusivity through 2004 and retained
minimum purchase requirements to retain exclusivity in 2005 and beyond. The
Company&#146;s primary contention regarding additional consideration for the Amendment
related to the fact that the Particles held value in the market, and RHEM&#146;s
unwillingness to purchase the required Particles in 2004 would cause an economic
loss of margin on the possible sale of the Particles to other companies in the
marketplace. The original Agreement required minimum purchases for 2004 totaling
$3,045,000, none of which were met. As part of our considerations, we performed a
margin analysis on the lost revenue for 2004 that was agreed to in the original
Agreement. The consideration paid by RHEM to amend the Agreement is tied to this
analysis, even though the consideration did not allow the Company to fully recover
the lost margin. The Company recognized, as had occurred in previous new product
development efforts, that the originally agreed to quantities
expected to be
shipped had been based upon imperfect market knowledge and for purposes of its lost
margin calculations it used the 2003 quantity of material shipped to RHEM, which
resulted in an estimated $644,000 in margin. Amendment #1 did not modify the
pricing of the Particles, as provided for in the original Agreement.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Management established the pricing based on an &#147;expected&#148; normal margin and in
turn these margins would provide for a reasonable return on net capital employed.
Amendment #1 did not modify this. Additionally, Amendment #2 specifically stated
the price per kilogram as negotiated by both parties. The price per kilogram
remains consistent with the 2002 and 2003 pricing, as stated in the original
Agreement. Therefore, no discounting of future product sales appears to have
occurred, and the $600,000 received by the Company, therefore, is not attributable
to discounts on future sales.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Based on wording in Amendment #1 and Amendment #2, exclusivity remains
&#147;conditional.&#148; Based on RHEM&#146;s failure in 2004 to purchase sufficient product to</TD>
</TR>

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



</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>continue the grant of exclusivity to RHEM and no reasonable expectation that future
product purchases would be at the level contemplated in the agreement to continue
exclusivity, management does not believe that any value can be placed on the
&#147;exclusivity&#148; portion of the contract, other than the &#147;exclusivity&#148; provided for
2004.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company views Amendment #1 as a &#147;cure&#148; for RHEM&#146;s failure to place product
orders and accept delivery of product in 2004 and not as a Research and Development
Agreement or &#147;Development Funding Agreement.&#148; This conclusion is
supported by the fact that no additional research or development was required to provide
acceptable Particles under Amendment #1 or the original Agreement. Paragraph&nbsp;11
of the Agreement only provided that Nanophase use commercially reasonable efforts to
maintain the Particles as state of the art.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Loss of exclusivity would cause a set back on RHEM&#146;s development of commercial
applications using the Particles. Per discussions RHEM, management believes the
use of their &#147;slurry&#148; application containing the Company&#146;s Particles outperformed
other &#147;slurry&#148; applications. The loss of exclusivity of the Company&#146;s particles
would put RHEM back to &#147;square one&#148; in the development of the commercial
applications for their &#147;slurry&#148;. This would represent a loss of two years, as this
process began in 2002. Therefore, it was critical for RHEM to maintain
exclusivity.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Even though Amendment&nbsp;#1 was jointly authored, the use of the term &#147;Development
Funding&#148; in the Amendment was specifically requested by RHEM,
and it reflects
RHEM&#146;s desire that the relationship between RHEM and the Company continue to remain
a positive one.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company&#146;s Particles and the resultant Development Product are state of the
art to this day. As of December&nbsp;31, 2003 and subsequently, no further
development expenditures were necessary beyond our normal research and development
expenditures principally directed toward manufacturing process improvement. The
Company, based on reports on the Hitachi product, believes that the Development Product is
superior because it can be &#147;mixed&#148; into the ready to use formulation months ahead
of time and is ready for use, even after storage, by simply agitating the slurry.
Hitachi&#146;s product cannot be made in advance and must be put into final formulation
immediately prior to use. Further, the Company&#146;s management would argue that the
&#147;state of art&#148; requirement as of December&nbsp;31, 2003, looking forward based on
management&#146;s expectations at that point in time, and as of today, is an
&#147;inconsequential or perfunctory performance obligation,&#148; within the meaning and as
discussed in SAB No.&nbsp;104, Topic 13Ac3, because (a)&nbsp;the Particles sold in 2005 and
2006 are the same as those developed previously and shipped through December&nbsp;31,
2003, (b)&nbsp;there was never an expectation in our minds that these Particles would be
required to be changed and (c)&nbsp;in fact, the Company to date has never received a
&#147;Performance Deficiency Notice,&#148; as provided for in the
Agreement Section&nbsp;11, Paragraph
(b).</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Lastly, it should be noted that the Agreement in
Section&nbsp;8, Paragraphs (a)&nbsp;and
(c), provides that the Company, in the event of refusal to supply
Particles for applications in the Field,</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">16
</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: #textcolor#; background: #bgcolor#">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>or acknowledgement of insolvency, or a change in control,
upon RHEM giving written notice, will enter into a license (described
as &#147;self-executing&#148;) with RHEM, bearing a
royalty of 8% of &#147;the per kilogram dry weight price of the Particle&#148; that will enable RHEM
to manufacture the Particles for use in the Field. This is further indicative that
even at the time the original Agreement was entered into, as acknowledged in the
recitals, that RHEM felt that the Company already had a Particle of use to it in a
commercial slurry application.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The interpretation of any agreement, for purposes of determining accounting treatment, must
consider context, the intentions of the parties to the agreement and a consideration of
&#147;substance over form.&#148; The Company already had suitable Particles manufactured at the time
it entered the Agreement, the Company simply had to cooperate with RHEM in the development
of a slurry product &#150; by providing samples of Development Product and otherwise cooperating
in development efforts, and the Company had met all of its
obligations under the Agreement
as of December&nbsp;31, 2003 and has subsequently met its obligation, to date, without
significant expenditure, of maintaining the Particles at &#147;state of the art&#148;. Likewise,
Amendments #1 and #2 need to be similarly interpreted. The Company and RHEM have a mutual
interest in working together, maintaining the cooperation provided for in the original
Agreement, and we both recognized that we were overly-optimistic with regard to the
timeframe and quantities provided for in the original Agreement. The Amendments were all
about maintaining exclusivity and keeping things moving forward, which is at the heart of
maintaining the spirit of cooperation necessary to bring a product to market. The Company
believes that this contextual, substance over form type of consideration, supports the fact
that, despite the language in Amendment #1 Paragraph 1. that seems to indicate that the
$600,000 is in part to fund continued development of Particles, the
$600,000 was in fact wholly
attributable to &#147;consideration of Nanophase&#146;s agreements herein&#148; (language also contained in
Paragraph #1) that specifically related to the maintenance of exclusivity. Further, if the
$600,000 was in part for &#147;development funding,&#148; it is
highly unlikely that these development
activities could be viewed to extend past December&nbsp;31, 2004
since the reframed Agreement now
called for product shipment to commence in 2005, and therefore it would also seem that this
money, under a development funding scenario rejected by management, was also &#147;earned&#148; within
2004 and which would still be consistent with the Company&#146;s accounting to recognize this
revenue in 2004.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Management also considered whether the Agreement falls under the provisions of SFAS 68,
<I>Research &#038; Development Agreements </I>(&#147;SFAS 68&#148;). In general terms, SFAS 68 addresses the
accounting treatment for research and development funded by other parties. This does not
apply to the <I>original </I>Agreement, as there was no funding mechanism introduced upon
inception. Based on the considerations listed above, we also do not consider Amendment #1
or the $600,000 to fall under SFAS 68.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>As SFAS 68 does not apply, management believes revenue recognition criteria as outlined by
SEC Staff Accounting Bulletin No.&nbsp;104, <I>Revenue Recognition </I>(&#147;SAB 104&#148;), provides the
appropriate guidance for the accounting treatment for the consideration paid to the Company
from RHEM for Amendment&nbsp;#1 to the Agreement.</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">17
</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="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Under the provisions of SAB 104, the following criteria are generally required to recognize
and record revenue:</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Persuasive evidence of an arrangement exists,</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Delivery has occurred or services have been rendered,</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The seller&#146;s price is fixed and determinable, 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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Collectibility is reasonably assured.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>In addition to the above provisions under SAB 104, the Company believes the earnings process
is substantially complete with the billing of $150,000 for each quarter. Under Concepts
Statement 5, paragraph 83(b), &#147;revenues are considered to have been earned when the entity
has substantially accomplished what it must do to be entitled the benefits represented by
the revenues&#148;. The earnings process is substantially complete because of the following:</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>As stated previously, there were no other performance requirements under the
Agreement. Even though Amendment #1 discusses &#147;Development Funding,&#148; this
paragraph is not substantive as no further development performance was required.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Additionally, there is no value to the reduction in the minimum purchase
requirements for 2005 because of the conditional element of the exclusivity. Each
year, exclusivity is maintained by meeting minimum purchase requirements. Since
this is a conditional test and there is no persuasive evidence that RHEM will meet
the purchase requirements in 2005, then the parties would have to enter into
another round of negotiations. Additionally, RHEM has not shown an ability to meet
the terms of the Agreement, as it has already been amended twice. Given this fact,
no value could be assigned to the reduction in minimum purchase requirements.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Finally, even though Amendment #1 provided for an extension of the initial term
for two years, no value can be assigned to this modification. Minimum purchase
requirements for the extra year and price per kg are not provided in the Amendment,
and will require negotiation. Additionally, due to the fact that the Agreement has
been amended, there is not substantive evidence of RHEM&#146;s ability to meet the terms
of the Amendment in future periods.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>If the $600,000 is deemed to be for development funding, arguably the revenues were earned
in 2004 and would rightly offset any expense potentially thought to be incurred (rebutted by
management&#146;s position) in the year of 2004. Amendment #1 calls for the Company to ship
product in 2005 and the Company, as a result of original Agreement Section&nbsp;11. (a), cannot
change the manufacturing process in a way potentially affecting compliance with
specifications without 7&nbsp;months prior written notice. This would seem to argue against the
notion that there were ongoing development efforts, after commencement of product shipment
(to occur in 2005), that call for deferral of some or all of the $600,000 and recognition of
it in a future period to offset an expense to be incurred. To be sure, the Company will
continue to spend money on research and</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">18
</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: #textcolor#; background: #bgcolor#">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>development, but this will, as previously noted, be primarily focused on process improvement
which will result in its own reward as a result of production cost reductions.</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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Since the Company is satisfied that the earnings process was complete, the revenue, as
recognized ratably during 2004, was properly recorded.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Response to Note 17. Quarterly Financial Data, page F-25</B></U>
</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>7.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Revise future filing to present gross profits as required by </B><B>Item 302(a)</B><B> of Regulation
S-K.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company acknowledges the Staff&#146;s comment and will provide the requested clarifications
in subsequent filings.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Response to Note 18. Administrative Actions, page F-25</B></U>
</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>8.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><B>Please provide a more comprehensive description of how the patent claims being brought
against you could potentially harm your business and operating results and quantify the
amount of any damages being sought. In addition, based on your current disclosures, it is
not clear whether you believe a material loss related to this matter is probable,
reasonable possible or remote. If you believe a material loss is probable or reasonably
possible, revise future filings to provide all the disclosures required by SAB 5:Y and SFAS
5.</B></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">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>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 the Company&#146;s
business prospects or competitive position. 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 Patent and Trademark Office, the Company still would continue to be
able to conduct its business as currently conducted, including 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 merely 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. Since
the Company does not believe that a material loss is probable or
reasonably possible,
the Company further believes that disclosure under SAB 5:Y or SFAS 5 is not necessary.</TD>
</TR>

</TABLE>
</DIV>

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


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As request, the Company hereby acknowledges that:
</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the Company is responsible for the adequacy and accuracy of the disclosure in
our filings;</TD>
</TR>

</TABLE>
</DIV>
<P align="center" style="font-size: 10pt">19
</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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Staff comments or changes to disclosure in response to Staff comments do not
foreclose the Commission from taking any action with respect to the filing; 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="8%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>the Company may not assert Staff comments as a defense in any proceeding
initiated by the Commission or any person under the federal securities laws of the
United States.</TD>
</TR>

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



</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Nanophase is interested in assisting the Commission staff in completing the registration
process as expeditiously as possible. Thank you for your assistance in this matter.
</DIV>

<TABLE width="100%" border="0" cellspacing="0" cellpadding="1" 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" nowrap>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Very truly yours,<BR>
<BR>
<B>NANOPHASE TECHNOLOGIES CORPORATION</B><BR>
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD valign="top">By:&nbsp;&nbsp;</TD>
    <TD colspan="2" style="border-bottom: 1px solid #000000" align="left">/s/ Jess Jankowski
&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="2" align="left">Jess Jankowski, Chief Financial Officer&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR><TR>
    <TD align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="2" align="left">&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR>
    <TD colspan="5">&nbsp;</TD>
</TR>
</TABLE>


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


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