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SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-Q
 þQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended: June 30, 2006
 Commission File Number: 0-22333
 Nanophase Technologies Corporation
  Delaware
(State or other jurisdiction of
incorporation or organization)
    
    36-3687863
(I.R.S. Employer
Identification No.)
 1319 Marquette Drive, Romeoville, Illinois 60446
 (630) 771-6708
 o þ
  o þ o
 o þ




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##### 



NANOPHASE TECHNOLOGIES CORPORATION
 QUARTER ENDED JUNE 30, 2006
 INDEX
 PagePART I  FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements
    
    
    3Unaudited Balance Sheets as of June 30, 2006 and December 31, 2005
    
    
    3Unaudited Statements of Operations for the three months ended June 30, 2006 and 2005 and the six months ended
June 30, 2006 and 2005
    
    
    4Unaudited Statements of Cash Flows for the six months ended June 30, 2006 and 2005
    
    
    5Notes to Unaudited Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    16Item 4. Controls and Procedures
    
    
    16PART II  OTHER INFORMATION
    
    
    16Item 1. Legal Proceedings
    
    
    16Item 4. Submissions of Matters to a Vote of Security Holders
    
    
    25Item 5. Other Information
    
    
    26Item 6. Exhibits and Reports on Form 8-K
    
    
    26SIGNATURES
    
    
    28CertificationCertificationCertification
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PART I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 NANOPHASE TECHNOLOGIES CORPORATION
 
 BALANCE SHEETS
(Unaudited)
 June 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    542,962
    
    
    $
    340,860Investments
    
    
    5,625,574
    
    
    
    8,168,092Trade accounts receivable, less allowance for doubtful accounts of
$22,195 and $23,533 on June 30, 2006 and December 31, 2005,
respectively
    
    
    957,260
    
    
    
    1,180,117Inventories, net
    
    
    883,771
    
    
    
    801,217Prepaid expenses and other current assets
    
    
    344,692
    
    
    
    414,363Total current assets
    
    
    8,354,259
    
    
    
    10,904,649Equipment and leasehold improvements, net
    
    
    7,570,040
    
    
    
    6,587,787Other assets, net
    
    
    621,344
    
    
    
    680,908$
    16,545,643
    
    
    $
    18,173,344LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of long-term debt
    
    $
    
    
    
    $
    200,254Current portion of deferred other revenue
    
    
    113,514
    
    
    
    56,757Current portion of capital lease obligations
    
    
    31,527
    
    
    
    Accounts payable
    
    
    850,028
    
    
    
    285,076Accrued expenses
    
    
    1,315,111
    
    
    
    1,152,127Total current liabilities
    
    
    2,310,180
    
    
    
    1,694,214Long-term debt, less current maturities and unamortized debt discount
    
    
    1,323,001
    
    
    
    1,265,875Long-term portion of capital lease obligations
    
    
    67,408
    
    
    
    Deferred other revenue, less current portion
    
    
    236,486
    
    
    
    293,2431,626,895
    
    
    
    1,559,118Contingent liabilities
    
    
    
    
    
    
    Stockholders equity:Preferred stock, $.01 par value, 24,088 shares authorized and
no shares issued and outstanding
    
    
    
    
    
    
    Common stock, $.01 par value, 25,000,000 shares authorized;
18,009,348 and 17,976,592 shares issued and outstanding on
June 30, 2006 and December 31, 2005, respectively
    
    
    180,093
    
    
    
    179,766Additional paid-in capital
    
    
    72,678,360
    
    
    
    72,307,887Accumulated deficit
    
    
    (60,249,885
    )
    
    
    (57,567,641
    )Total stockholders equity
    
    
    12,608,568
    
    
    
    14,920,012$
    16,545,643
    
    
    $
    18,173,344
 See Notes to Financial Statements.
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NANOPHASE TECHNOLOGIES CORPORATION
 
 STATEMENTS OF OPERATIONS
(Unaudited)
 Three months ended June 30,
    
    
    Six months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue:Product revenue, net
    
    $
    2,298,315
    
    
    $
    1,999,456
    
    
    $
    4,216,362
    
    
    $
    3,525,760Other revenue
    
    
    92,587
    
    
    
    85,269
    
    
    
    180,109
    
    
    
    172,347Net revenue
    
    
    2,390,902
    
    
    
    2,084,725
    
    
    
    4,396,471
    
    
    
    3,698,107Operating expense:Cost of revenue
    
    
    1,846,678
    
    
    
    1,594,264
    
    
    
    3,514,429
    
    
    
    3,038,764Research and development expense
    
    
    487,133
    
    
    
    476,241
    
    
    
    1,034,279
    
    
    
    970,680Selling, general and administrative
expense
    
    
    1,241,403
    
    
    
    1,194,192
    
    
    
    2,628,857
    
    
    
    2,337,336Total operating expense
    
    
    3,575,214
    
    
    
    3,264,697
    
    
    
    7,177,565
    
    
    
    6,346,780Loss from operations
    
    
    (1,184,312
    )
    
    
    (1,179,972
    )
    
    
    (2,781,094
    )
    
    
    (2,648,673
    )Interest income
    
    
    74,769
    
    
    
    71,370
    
    
    
    157,482
    
    
    
    136,417Interest expense
    
    
    (30,391
    )
    
    
    (8,814
    )
    
    
    (61,615
    )
    
    
    (20,713
    )Other, net
    
    
    943
    
    
    
    29,453
    
    
    
    2,983
    
    
    
    29,466Loss before provision for income
taxes
    
    
    (1,138,991
    )
    
    
    (1,087,963
    )
    
    
    (2,682,244
    )
    
    
    (2,503,503
    )Provisions for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (1,138,991
    )
    
    $
    (1,087,963
    )
    
    $
    (2,682,244
    )
    
    $
    (2,503,503
    )Net loss per share  basic and
diluted
    
    $
    (0.06
    )
    
    $
    (0.06
    )
    
    $
    (0.15
    )
    
    $
    (0.14
    )Weighted average number of common
shares outstanding
    
    
    18,009,155
    
    
    
    17,913,818
    
    
    
    18,001,238
    
    
    
    17,910,459
 See Notes to Financial Statements.
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NANOPHASE TECHNOLOGIES CORPORATION
 
 STATEMENTS OF CASH FLOWS
(Unaudited)
 Six months ended June 30,2006
    
    
    2005Operating activities:Net loss
    
    $
    (2,682,244
    )
    
    $
    (2,503,503
    )Adjustment to reconcile net loss to net cash (used in)
operating activities:Depreciation and amortization
    
    
    613,251
    
    
    
    639,993Amortization of debt discount
    
    
    57,125
    
    
    
    Stock compensation expense
    
    
    325,646
    
    
    
    28,034Allowance for excess inventory
quantities
    
    
    (245,464
    )
    
    
    (1,736
    )Equipment write-off
    
    
    6,128
    
    
    
    13,163Patent write-off
    
    
    111,162
    
    
    
    Changes in assets and liabilities related to operations:Trade accounts receivable
    
    
    22,603
    
    
    
    (917,356
    )Other receivable
    
    
    
    
    
    
    3,498Inventories
    
    
    162,910
    
    
    
    638Prepaid expenses and other assets
    
    
    69,671
    
    
    
    (4,222
    )Accounts payable
    
    
    401,406
    
    
    
    280,554Accrued liabilities
    
    
    160,418
    
    
    
    65,526Net cash (used in) operating activities
    
    
    (997,388
    )
    
    
    (2,395,411
    )Investing activities:Acquisition of equipment and leasehold
improvements
    
    
    (1,433,168
    )
    
    
    (282,488
    )Acquisition of Patents
    
    
    (68,070
    )
    
    
    (65,197
    )Payment of accounts payable incurred for the purchase of
equipment and leasehold improvements
    
    
    14,121
    
    
    
    Purchases of investments
    
    
    (39,626,957
    )
    
    
    (109,769,600
    )Sales of investments
    
    
    42,169,475
    
    
    
    112,413,572Net cash provided by investing
activities
    
    
    1,055,401
    
    
    
    2,296,287Financing activities:Principal payment on debt obligations, including capital
leases
    
    
    (3,665
    )
    
    
    (10,321
    )Proceeds from borrowings
    
    
    102,600
    
    
    
    Proceeds from sale of common stock, net, and exercise of
stock options
    
    
    45,154
    
    
    
    36,784Net cash provided by financing activities
    
    
    144,089
    
    
    
    26,463Increase (decrease) in cash and cash
equivalents
    
    
    202,102
    
    
    
    (72,661
    )Cash and cash equivalents at beginning of
period
    
    
    340,860
    
    
    
    475,185Cash and cash equivalents at end of period
    
    $
    542,962
    
    
    $
    402,524Supplemental cash flow information:Interest paid
    
    $
    4,490
    
    
    $
    20,713Supplemental non-cash investing activities:Accounts receivable paid through offset of long-term
debt
    
    $
    200,254
    
    
    $
    238,342Accounts payable incurred for the purchase of equipment
and leasehold improvements
    
    $
    149,425
    
    
    $
    76,217
 See Notes to Financial Statements.
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NANOPHASE TECHNOLOGIES CORPORATION
 
 NOTES TO FINANCIAL STATEMENTS
(Unaudited)
 (1) Basis of Presentation
   (2) Description of Business
    (3) Inventories
  June 30, 2006
    
    
    December 31, 2005Raw materials
    
    $
    227,669
    
    
    $
    498,144Finished goods
    
    
    1,001,978
    
    
    
    894,4131,229,647
    
    
    
    1,392,557Allowance for excess inventory quantities
    
    
    (345,876
    )
    
    
    (591,340
    )$
    883,771
    
    
    $
    801,217
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NANOPHASE TECHNOLOGIES CORPORATION
 NOTES TO FINANCIAL STATEMENTS  (Continued)
(Unaudited)
 (4) Share-Based Compensation
      Three months
    
    
    Six monthsended
    
    
    endedJune 30, 2005
    
    
    June 30, 2005Net Loss:As reported
    
    ($
    1,087,963
    )
    
    ($
    2,503,503
    )Deduct total stock-based employee
compensation expense determined
under fair value based method for
all awards
    
    
    (116,112
    )
    
    
    (234,005
    )Pro forma net loss
    
    ($
    1,204,075
    )
    
    ($
    2,737,508
    )
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Three months
    
    
    Six monthsended
    
    
    endedJune 30, 2005
    
    
    June 30, 2005Loss per share:Basic  As reported
    
    
    (0.06
    )
    
    
    (0.14
    )Basic  Pro forma
    
    
    (0.07
    )
    
    
    (0.15
    )Diluted  As reported
    
    
    (0.06
    )
    
    
    (0.14
    )Diluted  Pro forma
    
    
    (0.07
    )
    
    
    (0.15
    )
    WeightedWeighted
    
    
    AverageAverage
    
    
    RemainingExercise
    
    
    Contractual
    
    
    AggregatePrice per
    
    
    Term
    
    
    IntrinsicOptions
    
    Shares
    
    
    Share
    
    
    (years)
    
    
    ValueOutstanding on January 1, 2006
    
    
    1,744,232
    
    
    $
    5.92Granted
    
    
    
    
    
    
    Exercised
    
    
    (21,386
    )
    
    $
    2.54Forfeited or expired
    
    
    (4,080
    )
    
    $
    5.25Outstanding on June 30, 2006
    
    
    1,718,766
    
    
    $
    5.96
    
    
    
    4.70
    
    
    $
    3,049,260Exercisable on June 30, 2006
    
    
    1,548,268
    
    
    $
    5.98
    
    
    
    4.25
    
    
    $
    2,807,571
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(5) Significant Customers and Contingencies
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(6) Business Segmentation and Geographical Distribution
   (7) Administrative Actions
  (8) New Accounting Pronouncement
  10




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
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Results of Operations
     12




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Liquidity and Capital Resources
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,
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Safe Harbor Provision
  15




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Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  
 PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  Item 1A. Risk Factors
  We have a limited operating history and may not be able to address difficulties encountered
by early stage companies in new and rapidly evolving markets.
  We have a history of losses that may continue in the future.
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We depend on a small number of customers for a high percentage of our sales, and the loss of
orders from a significant customer could cause a decline in revenue and/or increases in the
level of losses incurred.
    Any downturn in the markets served by us would harm our business.
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Our products often have long adoption cycles, which could make it difficult to achieve market
acceptance and makes it difficult to forecast revenues.
  We depend on collaborative development relationships with our customers and do not have a
substantial direct sales force or an established distribution network apart from the distribution
networks of our strategic partners. If we are unable to initiate or sustain such collaborative
relationships or if the terms of these relationships limit the distribution of our products or if
our strategic partners are unable to distribute our products efficiently, then we may be unable to
independently develop, manufacture or market our current and future nanocrystalline materials or
applications.
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If commodity metal prices increased at such a rate that we are unable to recover lost margins on a
timely basis or that our products became uncompetitive in their current marketplaces, our financial
and liquidity position and results of operations would be substantially harmed.
  If a catastrophe strikes either of our manufacturing facilities or if we were to lose our lease for
either facility due to non-renewal or other unforeseen events, we may be unable to manufacture our
materials to meet customers demands.
  If we are unable to expand our production capabilities to meet unexpected demand, we may be unable
to manage our growth and our business would suffer.
  Protection of our intellectual property is limited and uncertain.
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Our industry is experiencing rapid changes in technology. If we are unable to keep pace with these
changes, our business will not grow.
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Our market is highly competitive, and if we are unable to compete effectively, then our business
will not grow.
  We may need to raise additional capital in the future. If we are unable to obtain adequate funds,
we may be required to delay, scale-back or eliminate some of our manufacturing and marketing
operations or we may need to obtain funds through arrangements on less favorable terms or we may be
required to transfer equipment to our largest customer.
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
    
    our earnings for a twelve month period ending with our most recently
published quarterly financial statements are less than zero and our cash,
cash equivalents and investments are less than $2,000,000, or
    
    the acceleration of any debt maturity having a principal amount of more
than $10,000,000, or we become insolvent as defined in the supply
agreement.
   We depend on key personnel, and their unplanned departure could harm our business.
  We face potential product liability risks which could result in significant costs that exceed our
insurance coverage, damage our reputation and harm our business.
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We are subject to governmental regulations. The costs of compliance and liability for noncompliance
with governmental regulations could have a material adverse effect on our business, results of
operations and financial condition.
    We have implemented anti-takeover provisions which could discourage or prevent a takeover, even if
an acquisition could be beneficial to our stockholders.
  
    
    discourage potential acquisition proposals;
    
    delay or prevent a change in control; and
    
    limit the price that investors might be willing to pay in the future
for shares of our common stock.
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Future sales of our common stock by existing stockholders could negatively affect the market price
of our stock and make it more difficult for us to sell stock in the future.
  
    
    15,871,062 shares of common stock that have been issued in registered
offerings, upon the exercise of options under our equity incentive plan
or in private placements and are freely tradable in the public markets,
    
    1,529,383 shares of common stock that may be issued on the exercise
of stock options outstanding and exercisable under our equity incentive
plan;
    
    906,002 shares of common stock that were issued pursuant to our
September 8, 2003 private placement and the related warrant which was
exercised on September 2, 2004. The resale of these shares has been
registered pursuant to a Registration Statement on Form S-3 which was
declared effective by the Securities and Exchange Commission on August
13, 2004; and
    
    1,256,281 shares of common stock that were issued pursuant to our
March 23, 2004 private placement and subsequently will be registered for
resale pursuant the terms of the Registration Rights Agreement executed
in connection with this private placement.
  Bradford T. Whitmore has significant influence on all matters requiring stockholder approval
because he beneficially owns a large percentage of our common stock, and he may vote the common
stock in ways with which our other stockholders disagree.
  
    
    any merger, consolidation or sale of all or substantially all of our assets;
    
    the election of members of our board of directors; and
    
    any amendment to our certificate of incorporation.
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We have been involved in litigation. If we are involved in similar litigation in the future, the
expense of defending such litigation and the potential costs of judgments against us and the costs
of maintaining insurance coverage could have a material adverse effect on our financial
performance.
  Our stock price is volatile.
  Dilutive Effect of Private Placements
  We have never paid dividends.
  
 Item 4. Submissions of Matters to a Vote of Security Holders
 a)
    
    The 2006 Annual Meeting of Stockholders of the Company was held on July 24,
2006.
 b)
    
    The stockholders voted to re-elect two Class III directors to the Companys
Board of Directors. Results of the voting were as follows:
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Directors
    
    For
    
    Authority Withheld
    
    Abstentions
    
    Broker Non-VotesDonald S. Perkins
    
    
    13,465,231
    
    
    
    305,483
    
    
    
    
    
    
    
    Jerry K. Pearlman
    
    
    13,467,266
    
    
    
    303,448
    
    
    
    
    
    
    
    
  c)
    
    The stockholders also voted to authorize an amendment to the Companys
Certificate of Incorporation to increase the authorized number of shares of common
stock from 25,000,000 to 30,000,000. Results of the voting were as follows:
 For
    
    Against
    
    Abstentions
    
    Broker Non-Votes13,092,644
    
    
    612,017
    
    
    
    66,053
    
    
    
    
 d)
    
    The stockholders also voted to authorize an amendment to the 2004 Equity
Compensation Plan (the Plan) to (a) increase to 1,200,000 the aggregate number of
shares available to be issued under the Plan, (b) increase the annual limit on the
number of shares available to be issued under the Plan to 300,000, and (c) decrease
the cap on grants to any individual in any year to 10% of any class. Results of the
voting were as follows:
 For
    
    Against
    
    Abstentions
    
    Broker Non-Votes4,543,774
    
    
    669,693
    
    
    
    71,540
    
    
    
    8,485,707
 
 Item 5. Other Information
  
 Item 6. Exhibits and Reports on Form 8-K
 A.
    
    Exhibits.
 Exhibit 31.1
    
    Certification of Chief Executive Officer pursuant to Rules
13a-14(a) and 15d-14(a) under the Exchange Act.Exhibit 31.2
    
    Certification of Chief Financial Officer pursuant to Rules
13a-14(a) and 15d-14(a) under the Exchange Act.Exhibit 32
    
    Certification of the Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350.
 B.
    
    Reports onForm 8-K.
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SIGNATURES
  NANOPHASE TECHNOLOGIES CORPORATIONDate: August 8, 2006
    
    
    
    By:
    
    /s/ JOSEPH E. CROSSJoseph E. CrossPresident, Chief Executive Officer (principalexecutive officer) and a DirectorDate: August 8, 2006
    
    
    
    By:
    
    /s/ JESS A. JANKOWSKIJess A. JankowskiChief Financial Officer (principal financialand chief accounting officer)