A Quarterly Update – August 3, 2011

The three main topics covered in this quarterly update include our financial results for 2011, our business strategy, and our solar inks activity, including the recently announced license with YHCC. Most of the information in this letter has been communicated before, but I thought it would be helpful to summarize it in one spot and to repeat it for those that may be new investors.

Financial Results

We recently filed our 10Q with second quarter results and it was another excellent quarter for the company. Revenues for the first six months of 2011 were approximately $3.6 million, up from the $2.9 million in 2010. In the 2nd quarter the company achieved a very important milestone logging its first royalty revenues of approximately $262,000. This royalty revenue is entirely from Yonex and it represents the first royalties that the company has earned from the ongoing sale of products using our technology by our licensees. We are extremely pleased with the royalty amount during this quarter, which is in alignment with our calendar year 2011 royalty expectations from Yonex. We look forward to seeing this number grow in coming years.

The third quarter will be another strong revenue quarter for APNT, given the YHCC license that was signed in July. APNT’s revenue target for the year remains at $10 million, an approximate 25% year over year growth rate. To reach this target, we still require additional licenses to be signed this year; however the company still considers this to be an achievable revenue target.

The loss for the 2nd quarter period was a little over $1.0 million, and given that there were no upfront payments received by us during the period, a loss of that size is well within the normal range expected for a period that consists primarily of research revenues.

Our cash position remains strong, with approximately $4.2 million in cash as of June 30, 2011. If we reach our targeted revenue and income numbers, the company’s cash position would be well in excess of that at the end of 2011.

Business Strategy

I have covered the evolution of the company since 2006 in previous letters, and won’t repeat the entire history here, but one of the things we have focused on is working with companies that are willing to work in partnership with us. These companies tend to fall in the size range of $200 million to $500 million per year in sales. These size companies are ideal for us because they are large enough to have capital for R&D and licenses, but not so large as to have extensive internal resources outside their core competencies. In our experience, this size company is much more willing to enter into collaborative arrangements with us than are multi-billion dollar companies, which tend to focus more on ownership and control of the technology.

We have also moved our focus over the past few years from development of end products to the materials that will go into the end products. Our past history has shown that focusing on the end product leaves us overly dependent on single manufacturers. By focusing on the materials, such as composites, inks, etc., we have much more flexibility in broader, although more segmented, markets, allowing us to develop multiple types of the same materials to license to different parties for various applications. While the market for specific materials may not be as large as the market for an end product, the probability of signing multiple licenses is much higher than the probability of signing a license for a product in one category. This is demonstrated by the fact that we have already signed licenses for two different types of inks.

The obvious effect of these two strategic shifts is that we will generate more, but smaller, licenses than if we are dealing with a limited number of multibillion dollar companies in a huge market. I think our previous CEO, Tom Bijou, said it best at our December 2008 Investor Day and Webcast, when he said he would rather have 10 licenses that generate $2 to $3 million per year in annual royalties (once fully launched), rather than one license that will generate $20 to $30 million per year. That said, if an opportunity arises for a license that could lead to $20 to $30 million in royalties, we will gladly capitalize on it.

This strategy of diversification is working and we are successfully executing the plan that we put in place. We have just signed our third license agreement involving ongoing royalties with companies that fall within this size range and we also expect that, each of the Yonex, Ishihara, and YHCC licenses will fall right into these royalty parameters eventually. In fact, we are optimistic that each of the three license agreements will exceed the $2 to $3 million in annual royalties that I mentioned earlier. While we do expect these ranges to be the norm, royalty revenues from license agreements will always vary somewhat from expectations and certainly we do not limit ourselves to these ranges in negotiations.

Solar Inks / YHCC License

Our solar inks pilot facility combined with our recent YHCC license for solar inks and pastes provides a great example of our overall business model and strategy.

In late 2010, we received a $1.6 million Phase III commercialization award from the U.S. Department of Energy for our solar inks. This award was part of a 2010 government stimulus package and actually was awarded before the completion of our Phase II award because of our excellent progress, therefore during a period of several months, our Phase II and Phase III awards were running simultaneously. The purpose of the award was to establish a pilot facility that would expand our capability for providing samples, which are required for any user to consider adopting a new material or technology. In our existing research facility, we had the capability of providing roughly 100 grams of ink a week for samples. The pilot facility allows us to provide several kilograms per week in samples, which should accelerate the validation and prototyping process with potential users and enable us to deal with many more potential users at once.

Our pilot facility has been up and running since the beginning of May and everything is working as planned. In July, we installed a commercial 5 zone belt furnace for processing silicon wafers. This furnace is not required for us to make inks or pastes, but is invaluable to us in testing our inks and pastes so that we can communicate better with solar cell manufacturers and accelerate our processing and improve the samples we ship. Our pilot line was recently featured in a FOX news segment, the video of which can be found on our website.

Our focus on this project is on aluminum inks because silver inks already exist in the marketplace, although we believe that we can also apply our technology to silver inks and develop inks that are equal to or better than those in use today. Aluminum inks have the ability to make a significant impact in the photovoltaic solar cell industry by enabling noncontact printing methods. However, this will be a next generation product that requires customer validation and production modifications. Furthermore, there is a lot of development work required from the point that a successful technology in the lab can be applied in a production environment.

Another reason we focused on aluminum inks is because aluminum pastes are already being used in the photovoltaic solar cell industry. Pastes are a subset of the broad category of inks and are used in screen printing, a contact printing method. APNT’s breakthrough is in developing aluminum inks using nanoparticles that are capable of being printed using non-contact methods such as inkjet or aerosol jet printers. There is a detailed presentation from last year’s shareholders meeting on our website for more information on the benefits of this ink. However the ink is still in the development phase and there is extensive customer validation, prototyping, and testing required before it can be used in a manufacturing environment. Even after the completion of our current research contract in October 2011, there will be additional development work required, primarily falling into the category of product optimization. At present, our best estimate for an implementation time frame for these inks in a production environment is 2013.

In order to provide a bridge until the inks are on the market, we have also applied the technology that we use for the aluminum inks to making aluminum pastes and we have developed a paste that we believe has improved qualities over those on the market today. However there are several manufacturers of high quality pastes that have products on the market and as a practical matter, none of them are likely to incur the cost and ongoing royalty expense associated with a license of our paste when they are already selling significant amounts of pastes; this is why our strategic agreement with YHCC is so important.

While there are currently hundreds of aluminum paste manufacturers in China, the market is widely dispersed and there are only a dozen or so that supply significant quantities, leading to an overall shortage of high quality aluminum pastes in China. The quickest way for a chemical company, like YHCC, to enter the market is to license our technology. Our development work and pilot facility will be a significant benefit to them as they construct their facility in China and we expect them to capture significant market share over the next few years. This allows them to establish strong relationships with the solar cell manufacturers and should insure a seamless transition to the inks when the industry is ready for non-contact printing. YHCC has started with the aluminum paste, but we expect to add other inks and pastes over time. The business plans that we have put together make it very reasonable to assume that YHCC can put together an inks business that will reach revenue levels in excess of $100 million per year in the future. Based on our 3% royalty rate for this license, we may very well exceed the $2 to $3 million range that I mentioned earlier.

I frequently get questions about royalty rates. While we always aim to achieve the highest royalty rate possible, there are many things we have to consider in the negotiation process, such as, the size of the upfront payment, expected time period until royalties start, likelihood of success, market size, future relationship, territories, etc. Overall we are very happy with the terms of our YHCC license agreement.. We are especially pleased with the commitment that YHCC has shown, and continues to show, to the project and look forward to additional projects with them.

Conclusion

In conclusion, the company is more fundamentally sound than it has ever been with a strong balance sheet, a healthy backlog, a strong pipeline of potential licensees, and with products using our technology in the marketplace. We are working in many other areas than those mentioned in this update and as things continue to develop, we will make announcements at the appropriate times and will provide detailed updates as warranted.



Sincerely,
Doug Baker
Chief Executive Officer


Safe Harbor Statement

This letter contains forward-looking statements that involve risks and uncertainties concerning our business, products, and financial results. Actual results may differ materially from the results predicted. More information about potential risk factors that could affect our business, products, and financial results are included in our annual report on Form 10-K for the fiscal year ended December 31, 2010, and in reports subsequently filed by us with the Securities and Exchange Commission ("SEC"). All documents are available through the SEC's Electronic Data Gathering Analysis and Retrieval System (EDGAR) at www.sec.gov or from our website at www.appliednanotech.net. We hereby disclaim any obligation to publicly update the information provided above, including forward-looking statements, to reflect subsequent events or circumstances.

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