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<SEC-DOCUMENT>0000950137-06-010269.txt : 20070129
<SEC-HEADER>0000950137-06-010269.hdr.sgml : 20070129
<ACCEPTANCE-DATETIME>20060922155218
<PRIVATE-TO-PUBLIC>
ACCESSION NUMBER:		0000950137-06-010269
CONFORMED SUBMISSION TYPE:	CORRESP
PUBLIC DOCUMENT COUNT:		1
FILED AS OF DATE:		20060922

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>
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<DIV align="center" style="font-size: 10pt; margin-top: 18pt">&#091;Nanophase Letterhead&#093;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 12pt">September&nbsp;22, 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

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    <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>
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    <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>
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    <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>
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</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">Dear Mr.&nbsp;Cash:

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&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;), a 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
August&nbsp;23, 2006 (the &#147;Second 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 Second
Comment Letter and have included (in bold) the Staff&#146;s comment. We have taken the liberty of
addressing the first and fourth comments first, as the second and third comments require a few
introductory thoughts.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Statement of Stockholder&#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>1.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U><B>Staff Comment</B></U><B>. We reviewed your response to prior comment three. Please
confirm that there is not a liquidated damages clause in your registration rights
arrangement as addressed in EITF 05-4. In addition, please revise future filings to
disclose, your conclusion that there are no settlement alternatives available to Altana if
the shares they purchased are not registered and to summarize your conclusion regarding the
classification of these shares in permanent equity.</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>. The Company confirms that there is not a liquidated damages
provision in the Altana Registration Rights Agreement. We will revise future filings to (a)
disclose the Company&#146;s conclusion that no settlement alternatives are available to Altana if
the shares it purchased are not registered, and (b)&nbsp;summarize our conclusion that the
Company has treated the shares purchased by Altana as permanent equity.</TD>
</TR>

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<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><B>Note 18. Administrative Actions. Page F-25</B>
</DIV>


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

<TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>4.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U><B>Staff Comment</B></U><B>. We reviewed your response to prior comment eight. Please
revise future filings to clarify that you believe a material loss related to this matter is
remote.</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>. We will revise future filings to indicate our belief that the
likelihood of a material loss arising from this matter is remote.</TD>
</TR>

</TABLE>
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>Preface to Company&#146;s Response to Questions 2 and 3: Summary of Nanophase&#146;s Business Model.</B></U>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Before proceeding with the next two responses, management thought that the clarity of the
Company&#146;s position and reasoning would be enhanced by first summarizing Nanophase&#146;s business model.
The qualitative factors used by management in deciding appropriate application of GAAP stem
directly from the nature of how the Company develops markets. Nanophase does so by first working
with customers to apply the Company&#146;s nanomaterials to the customer&#146;s products in order to solve a
problem or otherwise achieve results desirable in the customer&#146;s particular market. Working with
customers to create such solutions ideally leads to eventual sales of the customer&#146;s products
containing nanomaterials. This, in turn, facilitates the customer&#146;s buying those nanomaterials
from the Company.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Almost none of our nanomaterials provide a ready-made &#147;drop-in&#148; solution for our customers.
Instead, most customers incorporate the Company&#146;s nanomaterials into their own products for use in
one of their own downstream customer&#146;s products, which thereafter are sold to end users. A small
amount of our revenue results from our customers incorporating the Company&#146;s nanomaterials into
their products for direct sales to end users. An even smaller amount of our revenue results from
our customers using our nanomaterials solely for R&#038;D purposes, without any collaboration from the
Company about how to apply our materials to achieve the results desired in the customer&#146;s market.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company&#146;s experience has taught management that the most productive way to succeed in the
marketplace is to work with partners to develop applications of nanomaterials that provide the
partners with solutions. Such solutions usually are applied through the partners&#146; chemical systems
that first must be optimized for use with nanomaterials. This process of working with customers to
apply our nanomaterials to achieve solutions with commercial value in a customer&#146;s market is
generally expensive, protracted and yields only occasional success. Typically, less than &#091;* * *&#093;
percent of our customer opportunities ultimately result in commercial products being sold by
Nanophase.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Through experience, we have identified partners with strong positions in their respective
applications markets that are conducive to exploiting the strengths of our nanomaterials. Unlike
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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<DIV align="left" style="font-size: 10pt; margin-top: 6pt">the Company, such partners have development, sales and distribution infrastructures and expertise
in their specific markets. Working with these partners often requires the Company to expend
significant effort in producing customized nanomaterials that meet customers&#146; performance
requirements. The typical adoption cycle (the time it takes from &#091;i&#093; our nanomaterials first being
sampled to our partners to &#091;ii&#093; their commercial introduction of a product incorporating our
nanomaterials), even when accelerated through partnering, ranges from &#091;* * *&#093; to<BR>
&#091;* * *&#093; years. Adoption cycles in a &#091;* * *&#093;-year range that result in high-six- to seven-figure sales dollars
represent stunning success to Nanophase management.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;It is within this framework that we discuss the ongoing development work that the Company does
in concert with its various partners. The success rate is low and requires extensive effort from
both parties. Between January&nbsp;1999, when we adopted this partnering model, and June&nbsp;30, 2006,
Nanophase incurred approximately $&#091;* * *&#093; in R&#038;D expenses. The vast majority of this expense was
incurred through working directly with our partners to develop applications using our
nanomaterials. Nanophase views this process of supporting our partners&#146; product development and
sales as an inherent part of the partnership. Nanophase recovers its sales development cost when
its nanomaterials are finally purchased in commercial quantities. The Company expects this
recovery to accelerate as volume sales increase and our partners&#146; products incorporating our
nanomaterials gain broader market acceptance.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;For the years 2003, 2004 and 2005, Nanophase&#146;s R&#038;D expense averaged just over $&#091;* * *&#093; per
year. We are on a &#091;* * *&#093; pace for 2006. This reflects the Company&#146;s targeting its R&#038;D resources
toward supporting our various partners. We have not materially changed this focus in R&#038;D dollars
or effort with the addition of Altana/BYK Chemie to our group of partners in 2004 or for the CMP
applications development discussed in the February&nbsp;2004 amendment to our Cooperation Agreement with
RHEM. This type of R&#038;D application support is an integral component of the Company&#146;s business
model and critical to obtaining sales resulting from productive relationships with our partners.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>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>2.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U><B>Staff Comment</B></U><B>. We reviewed your response to prior comment five. However, it
is still unclear to us how you determined the value of the additional rights and privileges
given to BYK Chemie. It appears to us that this calculation may need to be performed
independently from your calculation of the discount on the note that resulted because the
interest rate you received was below fair value.</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>. In addition to the promise to repay the cash component of the
Note, the Company also committed (i)&nbsp;to give &#147;first priority&#148; for use of the NAS reactor
system and related equipment purchased with the cash proceeds of the Note to manufacturing</TD>
</TR>

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<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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    <TD width="2%" style="background: transparent">&nbsp;</TD>
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    <TD width="1%">&nbsp;</TD>
    <TD>nanomaterials ordered by BYK, and (ii)&nbsp;to provide &#147;experimental&#148; nanomaterials to BYK for
its evaluation. APB 21 provides the following guidance related to other rights and
privileges:</TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 10%">&#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 supplier
cash which is to be repaid five years hence with no stated interest. Such a
noninterest bearing loan 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>&#091;Nanophase comment: in this
case, APB 21 applies to the cost of nanoproducts purchased by BYK, which
logically equates to revenue to Nanophase&#093; </I>during the contract term. The
note discount is amortized as interest income over the five-year life of the
note.&#148;
</DIV>

<DIV style="margin-top: 6pt">
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    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company gave accounting recognition to the rights exchanged in the BYK Note. Management
determined that the best methodology to value those rights would include the following:</TD>
</TR>

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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: #000000; background: transparent">
    <TD width="10%" 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, as
expressly provided under APB 21, paragraph 11.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="10%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Part of the value exchanged for the rights granted to BYK under the Note
(the rights to manufacturing &#147;priority&#148; and &#147;experimental&#148; nanoproducts) can be
attributed directly to the &#147;interest-free&#148; period and the stated interest rate
of the Note being less than market-value (<I>i.e</I>., in exchange for these rights,
BYK gave up its rights to a higher rate of interest and a longer period of
interest accrual). See our June&nbsp;15, 2006 response for a discussion of the
estimation of a fair value interest rate.</TD>
</TR>

<TR>
    <TD style="font-size: 6pt">&nbsp;</TD>
</TR><TR valign="top" style="font-size: 10pt; color: #000000; background: transparent">
    <TD width="10%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Absent further guidance from APB 21, we reviewed the FASB&#146;s exposure draft
on fair value measurements, which was recently issued as SFAS No.&nbsp;157 &#147;Fair
Value Measurements.&#148; The balance of the net value that Nanophase received in
exchange for giving BYK rights of &#147;first priority&#148; and to obtain the Company&#146;s
&#147;experimental products&#148; can be determined only through a &#147;Level 3&#148; estimate, as
discussed in the SFAS No.&nbsp;157.</TD>
</TR>

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<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 undertook to establish the net value of the rights exchanged under the Note by
considering the market approach, the income approach, and the cost approach to valuation.</TD>
</TR>

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    <TD width="2%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U>The Coatings Market and Nanophase&#146;s Relationship with BYK</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Referring back to our business model, here is a brief historical view of the
factors pertaining to the coatings market that are required to establish an appropriate
valuation. Many of the same factors inherent in Nanophase&#146;s access to the personal care and
sunscreen additives markets through the Company&#146;s partnership with BASF, and our inroad into
the CMP market through Nanophase&#146;s partnership with RHEM (see our response to Staff Comment
2 below in this letter), are analogous to way in which the Company expects to develop its
business in the coatings market&#151;through our partnership with BYK Chemie and Altana Chemie
(the combined companies, subsidiary and parent, are referred to here as &#147;BYK&#148;). Since 1997,
the year of our IPO, Nanophase had never experienced significant success in the coatings
market. Given the lack of sales and sales prospects in the coatings market by March&nbsp;2004,
when the Company entered its Joint Development Agreement with BYK, management viewed
allowing BYK exclusivity in a broadly defined portion of the coatings market to be of &#091;* *
*&#093; risk to Nanophase. Our assessment of this risk was made after over eight years of
unsuccessfully trying to develop customers interested in applying our nanomaterials to their
products sold in the coatings market. It became obvious that a partnership with a larger
entity already entrenched in the coatings market would be required for Nanophase to succeed
in this market. Access to a larger entity&#146;s R&#038;D and testing facilities and, more
importantly, its marketing and distribution infrastructure and channels were, in our view,
critical to eventually attaining any significant measure of nanomaterials sales in coatings
applications.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Company retained an investment bank concentrating in the chemicals industry to find
a partner to help us exploit the market for incorporating our nanomaterials into coatings.
Both through our consultants and directly, we contacted dozens of companies, gauged their
interest level, and where appropriate, began discussing the sort of mutually beneficial
relationships that were feasible. These companies all insisted on an exclusive relationship
in order to justify their investment in the resources necessary to bring to the coatings
market their products containing the Company&#146;s nanomaterials. We ultimately found that BYK
was the only company whose business model and expertise were conducive to partnering with
Nanophase to market high value-added coatings products containing our nanomaterials. BYK
told us that during its vetting process, it had researched &#091;* * *&#093; of high-tech
manufacturers of nanomaterials and advanced materials, sampled their materials, visited
roughly &#091;* * *&#093; of them, and determined that Nanophase was the only such nanomaterials
manufacturer that BYK was willing to commit to working with on a mutually exclusive basis.
They viewed our model and our approach to building business critical to achieving mutual
success.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;After the start of the Company&#146;s relationship with BYK in March&nbsp;2004, BYK bought &#091;* *
*&#093; quantities of our nanomaterials in 2004 ($&#091;* * *&#093;) and 2005 ($&#091;* * *&#093;).
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">BYK indicated that it anticipated its demand for additional nanomaterials would increase in
subsequent years, as the market developed for BYK&#146;s coatings products containing the
Company&#146;s nanomaterials. However, Nanophase recognized that such additional demand would
require the Company to buy additional equipment to produce the nanomaterials that both BYK
and we hoped eventually would be needed to fill BYK&#146;s future orders. This led the parties
to enter into the Note.
</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><U>The Note and Fair Value</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Based on the Company&#146;s business model and Nanophase&#146;s relationship with BYK,
management then began assessing the fair value of the rights granted to BYK during the
period of the BYK loan agreement (November&nbsp;3, 2005 to March&nbsp;31, 2012): &#147;first priority&#148; use
of our manufacturing equipment installed to fill orders that the Company did not yet have
but hoped to receive in the future from BYK; and our making available to BYK certain
&#147;experimental&#148; nanomaterials for its evaluation.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As previously discussed, there are no pre-existing commercial markets for the Company&#146;s
nanomaterials. Part of our model involves developing such markets through partnerships with
larger entities that will use our nanomaterials to formulate their products for targeted
solutions and applications in a particular market. Having no drop-in commercial products
and no pre-existing markets, management recognized that it could not rely on the market
approach to assess fair value.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We do know what our nanomaterials typically cost to make. However, we do not have
solid input to project the final selling prices of these coatings nanomaterials or the
quantities that may be saleable. Our previously existing significant customers occupy
portions of the personal care and sunscreen additives markets and the CMP market. None of
these markets are analogous to the coatings market. In terms of market size, Nanophase has
sold a total of &#091;* * *&#093; $&#091;* * *&#093; of nanomaterials to BYK in 2004 and 2005. Most of these
nanomaterials were produced inefficiently, consistent with their use primarily for
development and further qualification of new coatings applications. Even after completing
installation and commissioning of the Company&#146;s new NAS reactor and the related equipment
purchased with proceeds of the Note (expected to occur as of &#091;* * *&#093;), management does not
expect BYK to purchase enough nanomaterials to qualify it as a significant customer until &#091;*
* *&#093;. Moreover, by &#091;* * *&#093;, the Company still is likely to have limited visibility as to
the volume of our nanomaterials that BYK will purchase between &#091;* * *&#093; and the end of the
loan agreement with BYK in March&nbsp;2012.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;BYK has hired over &#091;* * *&#093; nanomaterials research and applications scientists since
early 2003. This brings BYK&#146;s total number of nanomaterials scientists to more than &#091;* *
*&#093;. BYK tells us that these scientists spend much of their time working to incorporate our
nanomaterials into BYK&#146;s coatings products to provide benefits to
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">BYK&#146;s customers. The amount of resources that BYK has and applies to bringing new products
containing our nanomaterials to the coatings market vastly exceeds the resources provided by
or available to Nanophase.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;When analyzing the applicable valuation input as a whole, we have established the
following:
</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>We have accurately estimated the value of the loan discount, and the
corresponding deferred revenue, to be $350,000 using quantitative factors. We had
market feedback for both the establishment of market loan terms and a market
interest rate;</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>As a result of this arrangement, Nanophase does not plan to expend any
additional resources other than those already dictated by its business model;</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The market for our nanomaterials in coatings is unknown and difficult to
estimate accurately, given the lack of historical data available;</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>It is unclear whether the relationship between Nanophase and BYK will ultimately
generate &#091;* * *&#093; to those of Nanophase&#146;s relationships with its other partners;</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The best estimate for the income generated through this arrangement will
continue to be margins received on product sales once markets are established,
quantities sold can be quantified and pricing can be reliably estimated;</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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The value of the equipment we bought and installed with the Note proceeds is not
yet known because no commercial market exists for the nanomaterials that we
anticipate eventually manufacturing with this equipment; 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="1%" nowrap align="left"><B>&#149;</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Nanophase has no known path to market its nanomaterials for formulation in
coatings applications absent our relationship with BYK.</TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;We understand that the determination of fair value, absent similar transactions or a
ready market from which to ascribe broad value to the net rights given, would rely on
consideration received and discounted future cash flows. Management has concluded that
future cash flows from sales are not accurately determinable at this time due to the
inherent variability of demand and the lack of a defined coatings market for our
nanomaterials. Furthermore, given Nanophase&#146;s view of the current and future landscape in
this relationship and these markets, any rights and privileges related to this arrangement
offered to BYK require no new expenditures on the part of Nanophase, therefore we ascribed
&#091;* * *&#093; to them. Because $350,000 in consideration was actually received from BYK (in the
form of a calculable note discount), we believe that this
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">number best provides an accurate valuation. Given this logic, all other value to the BYK
loan arrangement is &#091;* * *&#093; and therefore<BR>
&#091;* * *&#093; to the Company&#146;s financial statements.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Management believes that after a thorough review of relevant GAAP (including the FASB
No.&nbsp;SFAS 157 &#147;Fair Value Measurements,&#148; APB No.&nbsp;21 &#147;Interest on Receivables and Payables,&#148;
APB No.&nbsp;29 &#147;Accounting for Nonmonetary Transactions&#148; and the AICPA&#146;s AU Section&nbsp;328 (from
SAS No.&nbsp;101) on Auditing Fair Value Measurements and Disclosures), the $350,000 in
consideration received from BYK was appropriately recognized as &#091;* * *&#093; fair value and will
be accounted for ratably over the life of the Note. The interest expense being recognized
evenly over the Note&#146;s life and the other revenue being recognized from the date of the
commissioning of the equipment (expected to be &#091;* * *&#093;) through July of 2009, the expected
payment date of the final loan installment.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 12pt"><U><B>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>3.</B></TD>
    <TD width="1%">&nbsp;</TD>
    <TD><U><B>Staff Comment</B></U><B>. We reviewed your response to prior comment six. However, it is
still unclear to us how you determined that the reduction in the minimum purchase
requirements for 2005 and the two year contract extension had no value. Please advise or
demonstrate that recording the entire amount as revenue in 2004 did not materially impact
your financial statements.</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>.</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>The Company&#146;s Initial Exploration of CMP Market</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;In 1996, the Company began discussing with prospective customers in the
semiconductor consumables supply market the possibility of using the Company&#146;s nanoparticles
in the customers&#146; slurry products for chemical mechanical planarization (&#147;CMP&#148;) of
semiconductor wafers. Even after the Company became publicly-held (November&nbsp;1997), it
recognized that it could not penetrate this market alone because Nanophase had no presence
or name-recognition in the market. Similarly, the Company lacked the financial resources
(which it estimated as over $30,000,000) required to develop the infrastructure needed to
penetrate the CMP market without a strategic partner.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;By 2001, only &#091;* * *&#093; potential customers with a significant presence in the CMP market
had expressed any serious interest in discussing with the Company a possible future
strategic relationship. The Company&#146;s discussions with one of these potential customers, &#091;*
* *&#093;, ended in early 2002, when negotiations toward a supply agreement reached impasse. The
&#091;* * *&#093; potential customer was Rodel, Inc. (now-known as Rohm and Haas Electronic Materials
CMP Inc &#091;&#147;RHEM&#148;&#093;, a major force in the market for semiconductor pads, conditioners, products
for CMP of semiconductor wafers and other consumables.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>

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<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>The 2002 Cooperation Agreement</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;When the Company began discussing a possible relationship with RHEM in early 2002, RHEM
was not in the CMP slurry business. RHEM decided to enter this business as a compliment to
its other consumables products. Both RHEM and the Company also believed that using
Nanophase&#146;s nanoparticles in slurry products made by RHEM would result in slurry products
that would be highly desirable to RHEM&#146;s existing customers. The parties&#146; mutually
exclusive Cooperation Agreement, signed in June&nbsp;2002, reflected these views in reciting that
(at page 1) &#147;Nanophase and Rodel believe that use of Nanophase&#146;s Particles for applications
in the Field with Rodel&#146;s slurry products will result in superior products for sale to
Rodel&#146;s CMP customers&#148;.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The parties understood that RHEM&#146;s slurry products containing the Company&#146;s
nanoparticles would be different than anything previously available in the CMP market. The
parties also recognized that as RHEM&#146;s customers began testing RHEM&#146;s new slurry products,
numerous adjustments to those products&#151;and potentially, to the Company&#146;s component
nanoparticles&#151;would be required. Thus the Cooperation Agreement provided (at Section 11(a)
) that &#147;&#091;t&#093;hroughout the term of this Agreement, Nanophase agrees to use commercially
reasonable efforts and devote reasonable resources to maintain the Particles for
applications in the Field as &#145;state of the art&#146; or better, based on mutually agreed
specification.&#148; The Cooperation Agreement further provided (at Section 11(b) ) that if RHEM
were to notify the Company that RHEM had located &#147;competitive particles&#148; that performed
materially better than the Company&#146;s nanoparticles for application to a particular slurry
product, the Company would be obliged to produce nanoparticles with similar material
performance characteristics within &#091;* * *&#093; months or RHEM would be entitled to buy particles
from another supplier, with Nanophase still being required to supply its nanomaterials to
RHEM on a non-exclusive basis for the duration of the agreement. The Company understood
that if this contingency were to occur, its nanoparticles thereafter would be &#091;* * *&#093; in the
CMP market because, as a practical matter, &#091;* * *&#093; consumables supplier would buy
nanoparticles without an exclusive relationship.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;When the Company and RHEM entered into their Cooperation Agreement in 2002, RHEM and
the Company were optimistic about the prospects of RHEM&#146;s customers qualifying and buying
RHEM&#146;s slurry products containing the Company&#146;s nanoparticles. Yet, RHEM &#091;* * *&#093; customers
who had completed the lengthy process required to qualify a RHEM slurry product containing
the Company&#146;s nanoparticles. Based on RHEM&#146;s estimate of the time required for product
qualification and projected sales, RHEM agreed to buy the Company&#146;s nanoparticles at certain
volumes during 2002 &#151; 2005. However, both RHEM and the Company appreciated that the cycle
for adoption
</DIV>

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</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">and sale of RHEM&#146;s slurry products containing the Company&#146;s nanoparticles was unknown and
that neither RHEM nor the Company could accurately predict the timing of such customer
qualification and sales.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Accordingly, the 2002 Cooperation Agreement &#091;* * *&#093; require RHEM to buy &#091;* * *&#093;
nanoparticles from the Company during 2002 in order to maintain the parties&#146; mutually
exclusive relationship. &#091;* * *&#093; the Cooperation Agreement provided for the Company to
assist RHEM and its customers in expediting the product qualification process. <I>See</I>
Cooperation Agreement at Section&nbsp;1(c)(iii), where the Company undertakes to &#147;provide agreed
technical support to Rodel and its customers as to the use of &#091;the Company&#146;s&#093; Particles and
the &#091;RHEM&#093; Development Products.&#148;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Based on RHEM&#146;s projection of the time required for qualification and purchase of its
slurry products containing the Company&#146;s nanoparticles, the Cooperation Agreement
conditioned the parties&#146; mutually exclusive relationship on RHEM buying &#091;* * *&#093; kilograms of
nanoparticles by the end of 2003. <I>See </I>Cooperation Agreement, optimistically further
requiring RHEM to buy &#091;* * *&#093; kilograms of the Company&#146;s nanoparticles in 2004 and &#091;* * *&#093;
kilograms in 2005. <I>Id</I>.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The parties recognized that RHEM&#146;s ability to fulfill its purchase obligations would be
subject to the unpredictable rate of product acceptance by RHEM&#146;s customers. Therefore, the
Cooperation Agreement provided that if RHEM were to be unable to buy the quantity of
nanoparticles required to maintain the parties&#146; mutually exclusive relationship, then the
parties would &#147;meet in good faith to discuss the progress to date and possible adjustment of
any targets, goals or prices previously established with respect to development and sale of
Particles for applications in the Field (the &#145;Adjustment Discussions&#146;).&#148; Cooperation
Agreement at Section&nbsp;12(a).
</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><U>2003 Developments</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Between late 2002 and the end of 2003, RHEM did buy the &#091;* * *&#093; kilograms of
nanoparticles from the Company required to maintain exclusivity in 2003 under the
Cooperation Agreement. However, RHEM had used &#091;* * *&#093; those nanoparticles by early 2004
because the CMP market was taking considerably longer than RHEM had expected to qualify and
accept its new slurry products containing the Company&#146;s nanoparticles. In addition, by late
2003, although customer test results were promising, &#091;* * *&#093; RHEM customer had completed its
process for qualifying RHEM&#146;s slurry products containing the Company&#146;s nanoparticles. These
circumstances led RHEM to notify the Company in early 2004 that RHEM would &#091;* * *&#093; during
2004. The Company then initiated contractual Adjustment Discussions with RHEM in early
2004.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</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: #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>Amendment No.&nbsp;1 to Cooperation Agreement</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;During the parties&#146; Adjustment Discussions, the Company recognized that:
</DIV>

<DIV style="margin-top: 6pt">
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<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">A.</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Purchases of RHEM&#146;s slurry products containing the Company&#146;s
nanoparticles likely would require at least &#091;* * *&#093; additional years to ramp up
to the levels that RHEM had initially expected to achieve by &#091;* * *&#093;;</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.</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>As the Company had suspected at the outset of its relationship
with RHEM, RHEM&#146;s customers would not buy RHEM&#146;s slurry products containing the
Company&#146;s nanoparticles unless RHEM&#146;s supply of nanoparticles was secured
through an exclusive relationship between RHEM and 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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">C.</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>RHEM would not be in a position to buy additional nanoparticles
from the Company in &#091;* * *&#093; unless the Company were to incur the cost of
assisting RHEM during &#091;* * *&#093; with reformulating RHEM&#146;s slurry products
containing the Company&#146;s nanoparticles and supporting RHEM&#146;s sales efforts by
working directly with its 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="6%" style="background: transparent">&nbsp;</TD>
    <TD width="3%" nowrap align="left">D.</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>Even if the Company had considered ending its mutually
exclusive relationship with RHEM, doing so in &#091;* * *&#093; would not have resulted
in any &#091;* * *&#093; sales of nanoparticles for applications in the CMP market
through the Company working with &#091;* * *&#093; or other RHEM competitors (<I>i.e.,</I>
competitors&#146; customers would have had to complete their own multi-year
qualification process before buying competitors&#146; slurry products containing the
Company&#146;s nanoparticles), presuming that &#091;* * *&#093; or any other viable RHEM
competitors would entertain working with Nanophase on a non-exclusive basis;
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">E.</TD>
    <TD width="1%">&nbsp;</TD>
    <TD>The Company&#146;s greatest potential for selling its nanoparticles
in the CMP market during &#091;* * *&#093; would be promoted by continuing to work with
RHEM in &#091;* * *&#093; under an amended Cooperation Agreement.</TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Amendment No.&nbsp;1 to the Cooperation Agreement, signed on February&nbsp;25, 2004, reflects the
parties&#146; recognition that &#091;* * *&#093; would be devoted to collaborative development and
promotion of RHEM&#146;s slurry products containing the Company&#146;s nanoparticles. Accordingly,
Amendment No.&nbsp;1 provides that: RHEM will pay the Company $&#091;* * *&#093; during 2004 for continued
development work (Amendment No.&nbsp;1, paragraph 1); RHEM need not buy any nanoparticles in &#091;* *
*&#093; to maintain exclusivity (Amendment No.&nbsp;1, paragraph 2); RHEM will buy &#091;* * *&#093;
nanoparticles during 2005 to maintain exclusivity (<I>i.e</I>., &#147;at least $&#091;* * *&#093; in Particles for
applications in the Field or such other amount of sales of Particles as the parties shall
determine by mutual written
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


<P align="center" style="font-size: 10pt"><!-- Folio -->11<!-- /Folio -->
</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 align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">agreement no later than October&nbsp;15, 2004&#148;); (Amendment No.&nbsp;1, paragraph 2); and the
Cooperation Agreement is extended approximately two years to December&nbsp;2009 (Amendment No.&nbsp;1,
paragraph 3).
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;During 2004, the Company used the $&#091;* * *&#093; paid by RHEM: to fund the Company&#146;s
continued employment of &#091;* * *&#093; scientists whose time was dedicated to working with RHEM and
its customers; to work with RHEM in reformulating its slurry products containing the
Company&#146;s nanoparticles; to fund the Company&#146;s costs of meeting quarterly with RHEM to
refine its marketing strategies to promote acceptance of its slurry products containing the
Company&#146;s nanoparticles; and to fund the costs of the Company&#146;s joint sales calls with RHEM
on its CMP customers in &#091;* * *&#093;<I>.</I>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As stated in our letter to the SEC dated June&nbsp;15, 2006: &#147;The Company recognized, as
had occurred in previous new product development efforts, that the originally agreed to
expected quantities 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 $&#091;* * *&#093; in margin.&#148; Management agreed that the $&#091;* *
*&#093; in &#147;development funding&#148; would effectively replace the Company&#146;s margin on nanoparticles
that would have been sold had RHEM merely met its projections for 2003. The $&#091;* * *&#093; thus
enabled the Company to continue supporting its partnership with RHEM and thereby preserve a
realistic potential for subsequent nanoparticle sales in the CMP market.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;As part of the Company&#146;s efforts to preserve that potential, Nanophase agreed to make
two further changes to the Cooperation Agreement through Amendment No.&nbsp;1: (i)&nbsp;Amendment No.
1 maintained the parties&#146; mutually exclusive relationship in &#091;* * *&#093; while suspending for &#091;*
* *&#093; RHEM&#146;s obligation to buy a specified quantity of the Company&#146;s nanoparticles for use in
RHEM&#146;s slurry products; and (ii)&nbsp;Amendment No.&nbsp;1 extended the duration of the Cooperation
Agreement for approximately two years (from June&nbsp;24, 2007 to December&nbsp;31, 2009). The
Company believes that these two changes to the Cooperation Agreement were &#091;* * *&#093;. The
value of the 2005 purchase obligation negotiating deadline and the contract extension is
minimal because Amendment No.&nbsp;1 still requires RHEM to renegotiate its annual obligation
with the Company by October&nbsp;15 of each year in order to retain exclusivity. Given the lack
of visibility relating to this business&#151;plainly evidenced by the &#091;* * *&#093; initial volumes
projected compared to the volumes actually purchased&#151;the expectation that each October
15<SUP style="font-size: 85%; vertical-align: text-top">th</SUP> essentially brings a new agreement is inherent. As an additional point of
reference, both RHEM and &#091;* * *&#093;, the other consumables supplier with whom the Company had
initially explored entering into an exclusive relationship, had predicted near term product
sale volumes at &#091;* * *&#093; stated in the 2002 Cooperation Agreement. This further indicates
that those contractually stated quantities were &#091;* * *&#093;, at best.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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

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





<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The &#091;* * *&#093; nature of the above two changes to the Cooperation Agreement is further
confirmed by the point that if the Company had rejected Amendment No.&nbsp;1, Nanophase still
would have been unable to sell its nanoparticles in the CMP market during &#091;* * *&#093;. Thus,
the contract changes reflected in Amendment No.&nbsp;1 did not prevent the Company from realizing
any sales revenues otherwise available. In addition, by &#091;* * *&#093;, Nanophase&#146;s only practical
route to selling its nanoparticles in the CMP market was through continuing the Company&#146;s
strategic partnership with RHEM. The contract changes made by Amendment No.&nbsp;1 did not
eliminate any sales routes otherwise realistically open to the Company. Moreover, by &#091;* * *&#093;
the parties recognized that RHEM&#146;s projections would require at least &#091;* * *&#093; additional
years to be realized. The contract changes reflected in Amendment No.&nbsp;1 thus did not alter
the Company&#146;s view of the ultimate value to be obtained from the nanoparticles sold under
the Cooperation Agreement.
</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="2%" nowrap align="left">&nbsp;</TD>
    <TD width="2%">&nbsp;</TD>
    <TD><U>Amendment No.&nbsp;2 to Cooperation Agreement</U></TD>
</TR>

</TABLE>
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;By early in the last quarter of &#091;* * *&#093;, RHEM had a more accurate understanding of the
time its customers needed to qualify and accept RHEM&#146;s slurry products containing the
Company&#146;s nanoparticles. Accordingly, in October&nbsp;2004, RHEM and the Company negotiated and
signed Amendment No.&nbsp;2 to Cooperation Agreement, providing the minimum quantities of
nanoparticles that RHEM was required to buy from the Company during &#091;* * *&#093; and &#091;* * *&#093; to
maintain exclusivity. As the Company stated in its Form 8-K filed on October&nbsp;22, 2004 in
connection with Amendment No.&nbsp;2 to Cooperation Agreement, this Amendment reduced RHEM&#146;s
minimum purchase requirements necessary to maintain the Company&#146;s exclusivity obligations to
RHEM in 2005 and the &#147;reduction reflects the parties&#146; recognition of the difficulty in
precisely estimating the timing of product development and sales in the semiconductor
polishing market.&#148;
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 100%; border-top: 1px solid #000000">&nbsp;</DIV></DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


<P align="center" style="font-size: 10pt"><!-- Folio -->13<!-- /Folio -->
</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 align="center" style="font-size: 10pt; margin-top: 18pt"><U>Recap of RHEM&#146;s Projected Contractual Product Purchase Requirements</U>
</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="37%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="8%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="5%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
</TR>
<TR style="font-size: 8pt" valign="bottom">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">2002</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">2003</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">2004</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">2005</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="center" colspan="2" style="border-bottom: 1px solid #000000">2006</TD>
    <TD>&nbsp;</TD>
</TR>

<!-- End Table Head -->
<!-- Begin Table Body -->
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">6/24/02 Agreement</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">QTY (kgs)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD nowrap align="left">&nbsp;</TD>
    <TD align="right">('02 &#038; '03</TD>
    <TD nowrap>)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR style="font-size: 1px">
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="7" align="left" style="border-top: 1px solid #000000">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">$&#146;s in Revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">2/25/04 Amend. #1</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">QTY (kgs)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">$&#146;s in Revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">&nbsp;</TD>
    <TD colspan="12" align="left">$K&#091;***&#093; (dev.) $K&#091;***&#093; (non-binding)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="3" align="center">&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="3" align="center">&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD colspan="10" align="left">(2005 qty. TB confirmed by 10/15/04)</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:15px; text-indent:-15px">10/15/04 Amend. #2</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:30px; text-indent:-15px">QTY (kgs)</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom">
    <TD><DIV style="margin-left:30px; text-indent:-15px">$&#146;s in Revenue</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">n/a</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom"><!-- Blank Space -->
    <TD><DIV style="margin-left:15px; text-indent:-15px">&nbsp;</DIV></TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<TR valign="bottom" style="background: #cceeff">
    <TD><DIV style="margin-left:15px; text-indent:-15px">12/31/05 ACTUAL</DIV></TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD align="left">$</TD>
    <TD align="right">&#091;* * *&#093;</TD>
    <TD>K</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
    <TD>&nbsp;</TD>
</TR>
<!-- End Table Body -->
</TABLE>
</DIV>




<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;A key underlying question here is &#147;What is the fair value of what the Company has given
RHEM in exchange for the consideration received and the rights, net of obligations, provided
by the Cooperation Agreement, as amended?&#148;
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The only consideration provided to the Company under the 2002 Cooperation Agreement was
the product revenue to be received on quantities of nanoparticles that RHEM promised to
purchase. The entire agreement&#151;including RHEM&#146;s being in a position to make its contractual
purchases&#151;was premised on the parties&#146; collaborative development efforts. The demand for
RHEM&#146;s slurry products containing the Company&#146;s nanoparticles was unknown. This demand was
also difficult to project because RHEM was a new entrant to this area of the CMP market.
RHEM&#146;s market knowledge largely was drawn from its experience with pads, conditioners and
other products to be used in concert with slurries that RHEM hoped to develop by applying
the Company&#146;s nanoparticles. Slurries containing nanomaterials were either being supplied
by much larger competitors in the marketplace, or were being developed to target new
applications. RHEM and the Company jointly promised to devote commercially reasonable
efforts to develop RHEM&#146;s slurry products incorporating the Company&#146;s nanoparticles. Both
parties also agreed to be responsible for their own expenses in doing so. We understand
that RHEM has invested &#091;* * *&#093; $&#091;* * *&#093; in pilot equipment (which would result in &#091;* * *&#093;
$&#091;* * *&#093; depreciation expense, based on our estimates of useful lives) and assigned &#091;* * *&#093;
development personnel (regardless of cost, a greater amount of resources than the Company
could afford to apply to this relationship). The Company
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 100%; border-top: 1px solid #000000">&nbsp;</DIV></DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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

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





<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">currently has &#091;* * *&#093; $&#091;* * *&#093; (acquisition cost) in capital equipment engaged in developing
and servicing this business. RHEM&#146;s obligations, as applied to the Cooperation Agreement,
have exceeded those of Nanophase.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The Cooperation Agreement has provided the Company with the additional exclusive right
to utilize RHEM&#146;s distribution channels and exploit its marketing efforts to sell the
Company&#146;s nanoparticles in the CMP market&#151;a market otherwise inaccessible to the Company.
Under all these circumstances, and especially given the unknown nature of net future cash
flows <I>vis a vis </I>future revenue, we believe that the value of the contract changes in
question under Amendment No 1 is immaterial. See the further discussion of future net cash
flows below.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The $&#091;* * *&#093; in development funding was intended to ensure that the Company would,
first and foremost, allow RHEM to retain exclusivity through &#091;* * *&#093;, while continuing
Nanophase&#146;s R&#038;D work in support of RHEM&#146;s application development within its customer base
in the CMP market. The Company would have lost approximately $&#091;* * *&#093; in theoretical gross
margin, based on the prior period&#146;s sales volume, absent any financial input from RHEM in &#091;*
* *&#093;. By offering to pay the Company this $&#091;* * *&#093;, RHEM was ensuring that Nanophase could
continue to honor its &#147;general obligation of cooperation&#148; absent nanoproduct sales to help
fund the Company&#146;s development efforts. Both parties recognize that it was impossible to
predict the speed with which RHEM&#146;s slurry products containing the Company&#146;s nanoparticles
would be qualified and purchased. Both parties also recognize that each is the best partner
for the other in the given Field. RHEM was doing nothing more than being a good partner in
ensuring that the Company received enough funds to facilitate maintaining its R&#038;D efforts on
RHEM&#146;s behalf.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Aside from consideration received ($&#091;* * *&#093;), there are no market inputs to help
management value the rights, net of obligations, transferred in Amendment No.1. We
understand that the determination of fair value, absent similar transactions or a ready
market from which to ascribe broad value to the net rights given, would rely on
consideration received and discounted future cash flows. We have concluded that future cash
flows from sales are not accurately determinable at this time due to the inherent
variability of demand. Furthermore, given Nanophase&#146;s view of the past, current and future
path to market and sales development with respect to CMP and RHEM, any rights and privileges
related to this arrangement offered to RHEM by the Company require no new expenditures on
the part of Nanophase, therefore we ascribed &#091;* * *&#093; value to that portion of the valuation.
Given this logic, all other value to Amendment No 1 to the Cooperation Agreement, aside
from replacement of the margin as discussed above, is &#091;* * *&#093; and therefore &#091;* * *&#093; to the
Company&#146;s financial statements.
</DIV>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV align="center"><DIV style="font-size: 3pt; margin-top: 16pt; width: 100%; border-top: 1px solid #000000">&nbsp;</DIV></DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>


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

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





<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;It is management&#146;s view, after a thorough review of relevant GAAP (including the
FASB&#146;s June&nbsp;23, 2004 exposure draft on Fair Value Measurements, APB No.&nbsp;29 Accounting for
Nonmonetary Transactions, the AICPA&#146;s AU Section&nbsp;328 (from SAS No.&nbsp;101) on Auditing Fair
Value Measurements and Disclosures), that the $&#091;* * *&#093; in consideration received relating to
Amendment No.&nbsp;1 to the Cooperation Agreement between the Company and RHEM was appropriately
fully recognized throughout 2004, the period in which it was materially earned.
</DIV>


<DIV align="left" style="font-size: 10pt; margin-top: 6pt; margin-left: 6%">&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;The balance of the value recognized by the Company in this, and all similar
arrangements involving partnering relationships, will occur upon selling product and
receiving margin.
</DIV>


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

<TABLE width="100%" border="0" cellspacing="0" cellpadding="0" style="font-size: 10pt">
<TR>
    <TD width="48%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="1%">&nbsp;</TD>
    <TD width="35%">&nbsp;</TD>
    <TD width="15%">&nbsp;</TD>
</TR>
<TR>
    <TD valign="top" align="left">&nbsp;</TD>
    <TD colspan="3" align="left">Very truly yours,<BR>
<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>

<DIV align="left" style="font-size: 10pt; margin-top: 6pt"><DIV style="width: 100%; border-bottom: 1px solid #000000; font-size: 1px">&nbsp;</DIV>

</DIV>
<DIV align="left" style="font-size: 10pt; margin-top: 6pt">&#091;* * *&#093; CONFIDENTIAL TREATMENT REQUESTED &#151; This confidential portion has been omitted from this
document and filed separately with the Commission.
</DIV>



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</DIV>


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