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SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended: September 30, 2006
 Commission File Number: 0-22333
 Nanophase Technologies Corporation
 (Exact name of registrant as specified in its charter)
 Delaware
    
    36-3687863(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 1319 Marquette Drive, Romeoville, Illinois 60446
(Address of principal executive offices, and zip code)
 Registrants telephone number, including area code: (630) 771-6708
 o þ
  o þ o
 o þ




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NANOPHASE TECHNOLOGIES CORPORATION
 QUARTER ENDED September 30, 2006
 INDEX
 PagePART I FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements
    
    
    3Unaudited Balance Sheets on September 30, 2006 and December 31, 2005
    
    
    3Unaudited Statements of Operation for the three months ended September 30, 2006 and
2005 and the nine months ended September 30, 2006 and 2005
    
    
    4Unaudited Statements of Cash Flows for the nine months ended September 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
    
    
    17Item 1. Legal ProceedingsItem 1A. Risk Factors
    
    
    17Item 5. Other Information
    
    
    17Item 6. Exhibits and Reports on Form 8-K
    
    
    17SIGNATURES
    
    
    18CertificationCertificationCertification
 2




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PART IFINANCIAL INFORMATION
 Item 1. Financial Statements
 NANOPHASE TECHNOLOGIES CORPORATION
BALANCE SHEETS
(Unaudited)
 September 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    702,669
    
    
    $
    340,860Investments
    
    
    9,516,137
    
    
    
    8,168,092Trade accounts receivable, less allowance for doubtful accounts
of $22,195 and $23,533 on September 30, 2006 and December 31, 2005, respectively
    
    
    1,098,164
    
    
    
    1,180,117Other receivable, net
    
    
    32,175
    
    
    
    Inventories, net
    
    
    950,467
    
    
    
    801,217Prepaid expenses and other current assets
    
    
    273,628
    
    
    
    414,363Total current assets
    
    
    12,573,240
    
    
    
    10,904,649Equipment and leasehold improvements, net
    
    
    7,755,373
    
    
    
    6,587,787Other assets, net
    
    
    656,042
    
    
    
    680,908$
    20,984,655
    
    
    $
    18,173,344LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of long-term debt
    
    $
    
    
    
    $
    200,254Current portion of deferred other revenue
    
    
    127,273
    
    
    
    56,757Current portion of capital lease obligations
    
    
    32,242
    
    
    
    Accounts payable
    
    
    694,000
    
    
    
    285,076Accrued expenses
    
    
    1,513,673
    
    
    
    1,152,127Total current liabilities
    
    
    2,367,188
    
    
    
    1,694,214Long-term debt, less current maturities and unamortized debt discount
    
    
    1,353,014
    
    
    
    1,265,875Long-term portion of capital lease obligations
    
    
    59,074
    
    
    
    Deferred other revenue, less current portion
    
    
    222,727
    
    
    
    293,2431,634,815
    
    
    
    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, 30,000,000 shares authorized;
18,929,477 and 17,976,592 shares issued and outstanding on
September 30, 2006 and December 31, 2005, respectively
    
    
    189,295
    
    
    
    179,766Additional paid-in capital
    
    
    77,958,955
    
    
    
    72,307,887Accumulated deficit
    
    
    (61,165,598
    )
    
    
    (57,567,641
    )Total stockholders equity
    
    
    16,982,652
    
    
    
    14,920,012$
    20,984,655
    
    
    $
    18,173,344
 See Notes to Financial Statements.
 3




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NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF OPERATIONS
(Unaudited)
 Three months ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue:Product revenue, net
    
    $
    2,329,738
    
    
    $
    1,579,552
    
    
    $
    6,546,100
    
    
    $
    5,105,312Other revenue
    
    
    96,052
    
    
    
    95,062
    
    
    
    276,161
    
    
    
    267,409Total revenue
    
    
    2,425,790
    
    
    
    1,674,614
    
    
    
    6,822,261
    
    
    
    5,372,721Operating expense:Cost of revenue
    
    
    1,705,725
    
    
    
    1,466,790
    
    
    
    5,220,154
    
    
    
    4,505,554Gross profit
    
    
    720,065
    
    
    
    207,824
    
    
    
    1,602,107
    
    
    
    867,167Research and development expense
    
    
    550,208
    
    
    
    486,346
    
    
    
    1,584,487
    
    
    
    1,457,026Selling, general and administrative expense
    
    
    1,143,530
    
    
    
    1,043,907
    
    
    
    3,772,388
    
    
    
    3,381,243Lease accounting adjustment
    
    
    
    
    
    
    279,810
    
    
    
    
    
    
    
    279,810Loss from operations
    
    
    (973,673
    )
    
    
    (1,602,239
    )
    
    
    (3,754,768
    )
    
    
    (4,250,912
    )Interest income
    
    
    90,563
    
    
    
    73,054
    
    
    
    248,045
    
    
    
    209,471Interest expense
    
    
    (32,275
    )
    
    
    (5,309
    )
    
    
    (93,889
    )
    
    
    (26,022
    )Other (expense) income, net
    
    
    (328
    )
    
    
    (213
    )
    
    
    2,655
    
    
    
    29,253Loss before provision for income taxes
    
    
    (915,713
    )
    
    
    (1,534,707
    )
    
    
    (3,597,957
    )
    
    
    (4,038,210
    )Provisions for income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    $
    (915,713
    )
    
    $
    (1,534,707
    )
    
    $
    (3,597,957
    )
    
    $
    (4,038,210
    )Net loss per sharebasic and diluted
    
    $
    (0.05
    )
    
    $
    (0.09
    )
    
    $
    (0.20
    )
    
    $
    (0.23
    )Weighted average number of common shares outstanding
    
    
    18,380,334
    
    
    
    17,954,371
    
    
    
    18,128,994
    
    
    
    17,925,256
 See Notes to Financial Statements.
 4




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NANOPHASE TECHNOLOGIES CORPORATION
STATEMENTS OF CASH FLOWS
(Unaudited)
 Nine months endingSeptember 30,2006
    
    
    2005Operating activities:Net loss
    
    $
    (3,597,957
    )
    
    $
    (4,038,210
    )Adjustment to reconcile net loss to net cash (used in) operating activities:Depreciation and amortization
    
    
    921,366
    
    
    
    940,933Amortization of debt discount
    
    
    87,139
    
    
    
    Stock compensation expense
    
    
    444,901
    
    
    
    43,150Allowance for excess inventory quantities
    
    
    (247,841
    )
    
    
    (14,163
    )Equipment write-off
    
    
    6,128
    
    
    
    41,784Patent write-off
    
    
    111,162
    
    
    
    Changes in assets and liabilities related to operations:Trade accounts receivable
    
    
    (118,301
    )
    
    
    (523,360
    )Other receivable
    
    
    (32,175
    )
    
    
    3,498Inventories
    
    
    98,591
    
    
    
    (24,358
    )Prepaid expenses and other assets
    
    
    140,735
    
    
    
    256,312Accounts payable
    
    
    299,720
    
    
    
    199,754Accrued liabilities
    
    
    357,670
    
    
    
    291,462Net cash (used in) operating activities
    
    
    (1,528,862
    )
    
    
    (2,823,198
    )Investing activities:Acquisition of equipment and leasehold improvements
    
    
    (1,970,394
    )
    
    
    (405,346
    )Acquisition of patents
    
    
    (112,023
    )
    
    
    (79,752
    )Payment of accounts payable incurred for the purchase of equipment.and leasehold
improvements
    
    
    14,121
    
    
    
    Purchases of held-to-maturity investments
    
    
    (60,851,356
    )
    
    
    (140,113,213
    )Sales of held-to maturity investments
    
    
    59,503,311
    
    
    
    142,984,131Net cash (used in) provided by investing activities
    
    
    (3,416,341
    )
    
    
    2,385,820Financing activities:Principal payment on debt obligation, including capital leases
    
    
    (11,284
    )
    
    
    (11,826
    )Proceeds from borrowing
    
    
    102,600
    
    
    
    Proceeds from sale of common stock, net, and exercise of stock options
    
    
    5,215,696
    
    
    
    233,183Net cash provided by financing activities
    
    
    5,307,012
    
    
    
    221,357Increase (decrease) in cash and cash equivalents
    
    
    361,809
    
    
    
    (216,021
    )Cash and cash equivalents at beginning of period
    
    
    340,860
    
    
    
    475,185Cash and cash equivalents at end of period
    
    $
    702,669
    
    
    $
    259,164Supplemental cash flow information:Interest paid
    
    $
    2,262
    
    
    $
    26,022Supplemental non-cash investing and financing activities:Accounts receivable paid through offset of long-term debt
    
    $
    220,254
    
    
    $
    343,723Accounts payable incurred for the purchase of equipment and leasehold improvements
    
    $
    95,083
    
    
    $
    59,322
 See Notes to Financial Statements.
 5




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NANOPHASE TECHNOLOGIES CORPORATION
 NOTES TO FINANCIAL STATEMENTS
(Unaudited)
 (1) Basis of Presentation
   (2) Description of Business
    (3) Inventories
  September 30,
    
    
    December 31,2006
    
    
    2005Raw materials
    
    $
    188,920
    
    
    $
    498,144Finished goods
    
    
    1,105,046
    
    
    
    894,4131,293,966
    
    
    
    1,392,557Allowance for excess inventory quantities
    
    
    (343,499
    )
    
    
    (591,340
    )$
    950,467
    
    
    $
    801,217
 6




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(4) Share-Based Compensation
      Three months
    
    
    Nine monthsended
    
    
    endedSeptember 30, 2005
    
    
    September 30, 2005Net Loss:As reported
    
    
    ($1,534,707
    )
    
    
    ($4,038,210
    )Deduct total stock-based
employee compensation expense
determined under fair value
based method for all awards
    
    
    (115,122
    )
    
    
    (349,126
    )Pro forma net loss
    
    
    ($1,649,829
    )
    
    
    ($4,387,336
    )Loss per share:Basic  As reported
    
    
    (0.09
    )
    
    
    (0.23
    )Basic  Pro forma
    
    
    (0.09
    )
    
    
    (0.24
    )Diluted  As reported
    
    
    (0.09
    )
    
    
    (0.23
    )Diluted  Pro forma
    
    
    (0.09
    )
    
    
    (0.24
    )
 7




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Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2006
    
    2005
    
    2006
    
    2005Weighted-average risk-free
interest rate:
    
    
    4.76
    %
    
    
    4.21
    %
    
    
    4.76
    %
    
    
    4.21
    %Dividend yield:
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %Weighted-average expected life of
the option:
    
    7 years
    
    
    7 years

    
    
    7 years

    

    
    7 yearsWeighted-average expected stock
price volatility:
    
    
    60.13
    %
    
    
    78.72
    %
    
    
    60.13
    %
    
    
    78.72
    %Weighted-average fair value of
the options granted:
    
    $
    3.60
    
    
    $
    4.90
    
    
    $
    3.60
    
    
    $
    4.90
    8




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WeightedWeighted
    
    AverageAverage
    
    RemainingExercise
    
    Contractual
    
    AggregatePrice per
    
    Term
    
    IntrinsicOptions
    
    Shares
    
    Share
    
    (years)
    
    ValueOutstanding on January 1, 2006
    
    
    1,744,232
    
    
    $
    5.92Granted
    
    
    201,000
    
    
    $
    5.99Exercised
    
    
    (88,485
    )
    
    $
    3.20Forfeited or expired
    
    
    (6,396
    )
    
    $
    4.76Outstanding on September 30,
2006
    
    
    1,850,351
    
    
    $
    6.06
    
    
    
    5.19
    
    
    $
    1,644,887Exercisable on September 30,
2006
    
    
    1,511,490
    
    
    $
    6.09
    
    
    
    4.26
    
    
    $
    1,590,245
      (5) Significant Customers and Contingencies
   9




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(6) Business Segmentation and Geographical Distribution
   (7) Administrative Actions
  10




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(8) 2005 Lease Accounting Adjustment
  (9) New Accounting Pronouncement
 Fair Value Measurements
  Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Overview
  11




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Results of Operations
   12




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13




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Liquidity and Capital Resources
     14




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,
   15




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Safe Harbor Provision
  Item 3. Quantitative and Qualitative Disclosures About Market Risk
  Item 4. Controls and Procedures
  16




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PART II  OTHER INFORMATION
 Item 1. Legal Proceedings
  Item 1A. Risk Factors
  Item 5. Other Information
  Item 6. Exhibits and Reports on Form 8-K
 A. Exhibits.
    B. Reports on Form 8-K .
      17




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SIGNATURES
  NANOPHASE TECHNOLOGIES CORPORATIONDate:    November 7, 2006
    By:
    /s/    JOSEPH E. CROSSJoseph E. CrossPresident, Chief Executive Officer
(principal executive officer) and a Director Date:    November 7, 2006
    By:
    /s/    JESS A. JANKOWSKIJess A. JankowskiChief Financial Officer
(principal financial and chief accounting
officer) 18