Letter To The Shareholders

A Periodic Update – March, 2013

A few months have passed since my last update and I wanted to take this opportunity to share our recent activities and plans for the year with everyone. I have been getting numerous questions about EZDiagnostix, Inc. (“EZDx”), the subsidiary we formed last year to commercialize our sensor technology, so I am going to emphasize that topic. Our other areas will be covered as well as they continue to show positive customer activity and are areas of growth. In addition, I will summarize our financial results for 2012..

EZDiagnostiX

EZDx is one of our most exciting areas with immediate market opportunities. To recap our activities to date, we formed EZDx in May 2012 to commercialize our sensor technology which is an important part of our long term commercialization strategy. This strategy requires different human resources and additional financial resources to shift from prototype development to market commercialization where we can capture greater value. In terms of human resources, we took the first step last year when we hired Alan Jernigan, a proven executive with sales, marketing, and commercialization experience, particularly in medical diagnostics and medical devices.

As I’ve discussed in the past, the company’s ultimate goal with EZDx is to commercialize healthcare applications, which have multi-billion dollar market potential. We have, however, chosen to start in the agricultural pathology detection market, where we have a high probability of success due to our existing collaborators and potential initial customers. We consider this a low risk market that provides diversification and allows us to add sales quickly, while still allowing further development of our R&D portfolio. Developing agricultural pathology first will also allow us to test our marketing and establish our brand, which will provide a foundation for moving us closer to healthcare applications.

While we will ultimately target healthcare, agricultural pathology itself involves very large markets, and a significant company can be built around these markets. The Citrus diagnostic testing industry alone is over a $200 million market. Our technology allows early detection of Huanglongbing (HLB), also known as citrus greening disease, by sensing volatile organic compounds given off by infected trees.

Citrus groves on three continents have been plagued by HLB. It first appeared in the U.S. in Florida in 2005 and since has spread throughout the state. HLB is estimated to kill 10% of Florida’s citrus trees every year, has played a major role in the eradication of over 300,000 citrus acres over the past few years, and losses related to HLB in Florida have amounted to over $300 million. Currently, HLB is beginning to spread to other areas of the country.

Existing efforts at fighting the disease revolve around searching for trees with visible symptoms; however, by the time symptoms are visible, the disease is at an advanced stage and likely has infected surrounding trees. At that point, depending on the situation, the disease is treated by the use of insecticides, nutrients, biological control methods, or the eradication of infected trees, all of which are very costly.

Our solution, developed in collaboration with the University of California at Davis, allows for the detection and diagnosis of HLB and other citrus diseases at the asymptomatic stage. Our product combines a sensor and software solution based on Differential Ion Mobility Spectroscopy (DMS) technology, using our proprietary nonradioactive source. This technology has the unprecedented capability of sensing particles at the parts per billion concentration level, while maintaining clear separation of relevant analytes. This effectively makes it an “electronic nose” which can be trained to detect specific agents that are indicative of certain substances and conditions, such as HLB in the citrus industry.

Early indications from citrus growers indicate this solution will provide tremendous value to the citrus industry. By flagging trees at the asymptomatic stage, eradication can be more effective and kept to the minimum by avoiding the spread of the disease. In addition for trees not eradicated, significant savings can be realized by using fewer pesticides, more targeted use of nutrients, and the reduction of other costly tests currently being used.

Earlier this year, we announced approximately $600,000 of funding from the California Citrus Research Board, which enables us to refine, test, and further develop our prototypes. We have made substantial progress and are testing our prototypes with excellent results in both Texas and California. In the U.S alone, citrus is almost a $3 billion market, with roughly 30% coming from California and 65% from Florida. The worldwide citrus industry is over 10 times the size of the U.S. industry. Top producing countries outside the U.S. include Brazil, China, and Mexico, leaving significant room for expansion of our markets once they are established in the United States.

The great thing about our solution is that it is an integrated single platform solution. Once we have trained the “electronic nose” for orange trees, we can then simply train it for other types of citrus, other types of crops, and ultimately healthcare applications. Another advantage of working in agricultural pathology is that it provides a platform for the immediate commercialization of our technology, as compared with medical applications which usually have a 2-3 year lead time, depending on the specific application, due to clinical trials and necessary FDA/CE mark regulatory approvals.

Our business model for EZDx revolves around a razor-razor blade model. We will provide both the instrument and a consumable (i.e., disposable collection tubes used in the devices), giving us two revenue streams related to the product, with higher margins on the consumable collection tubes. Using conservative estimates, we expect a minimum of $30 million in revenue related to Ag pathology alone within 3 years of product introduction.

Funding EZDx - We recently announced that we have retained WoodRock Securities to lead the fundraising efforts for EZDx’s development and growth. We are raising $5 million to optimize the manufacturing process at an established contract manufacturer to allow us to manufacture quantities of the product at a fraction of the current cost. This funding will also allow us begin developing a sales force to promote and sell the product as well as continue gathering data for future biomarkers related to agricultural pathology and our first medical applications. We would anticipate launch of the agricultural pathology product approximately 9 months after raising the necessary funds.

Woodrock has advised us that if we find the right medical partner, it may be advisable to raise $15 million to accelerate the introduction of medical applications.

We interviewed a wide range of investment banks and believe that Woodrock Securities is an ideal choice. Based in Houston, they are an established boutique investment bank with a focus on growth and middle market companies. They have previously assisted companies in raising money in our two key areas, agriculture and healthcare, and have an extensive network of investment contacts. Woodrock will complete the necessary investment documents needed by potential investors in early April and they expect to raise the funds for EZDx by the end of July.

Applied Nanotech, Inc.

ANI is our research hub which provides the source for our commercialization activities. The revenue that we receive for research is critical to both funding our daily activities, as well as identifying new commercialization and growth areas. We continue to make significant progress in our research areas and we have established a broad base of technology as a platform for future commercialization and growth.

Composites

In the composites area, we are expanding beyond the sporting goods area, with specific emphasis on ballistic protection and other industrial areas. Our self-healing pipes project, funded by the N.E. Gas Association, while still in the development stage, holds significant potential. High density Polyethylene (HDPE) and other similar thermoplastic pipe systems have replaced steel and iron because of their cost and anticorrosion benefits for gas distribution and other applications.

Today, shipments of HDPE pressure pipe account for approximately one billion pounds per year of volume. One of the issues with HPDE pipe is slow crack growth as a result of long term stress. Introduction of self healing agents into HDPE pipe, along with carbon nanotubes, can simultaneously repair cracks and add strength to the pipe and both open new applications for HDPE pipe, as well as improve its use in existing applications. We were selected for this project because of our extensive background working in this area and our success with working with other composite materials.

Thermal Management

We continue to sell and provide samples of our thermal management material for many applications and have hired a new sales person in the thermal management area. We are finding significant interest from potential customers in value added services such as printing, coating and other items to be provided in conjunction with the material and expect sales to continue to grow in this area. Generally uses of our thermal management material require some sort of product or manufacturing process redesign and as such, likely will be incorporated in next generation products, as well as upgraded products. We have built an extensive pipeline with potential customers and we expect these opportunities to begin bearing fruit in 2013.

Nanoelectronics

Our inks area continues to expand. We are currently selling samples of our copper ink, have developed a new micro copper ink that is cheaper and better suited for some applications, and are making improvements to our existing solar inks and pastes.

YHCC, our licensee/partner in China, has completed its factory and is working with potential customers in China. We expect to begin receiving royalties from YHCC this year. We are also working with leading solar companies based in the U.S. with manufacturing facilities in Asia that would be served by YHCC. For example, Solexel, as discussed in our press release of January 2013, has improved its efficiency using our pastes. Finally, we are on target to receive the next $250,000 royalty payment from YHCC upon achievement of our silver paste technical targets, which will open up additional markets for them and increase our royalties.

We have also been invited to participate in the 2013 Navy Opportunity Forum (www.navyopportunityforum.com) in June where we will have the opportunity to present our capabilities to a wide range of defense contractors, including tier 1 and tier 2 suppliers, and investors.

Financial Results

We recently filed our 10K, which is our annual report with the SEC. We finished 2012 with revenues of $3.6 million and a loss of $5.1 million. A big portion of this loss was driven by our commercialization strategy in 2012, which included a potential acquisition. About $1 million of that loss came from EZDx, about half of which was related to the potential acquisition, with the rest related to formation, strategy, hiring, payroll, and other costs – all prior to the time that EZDx had any revenues. There is extensive discussion of the results in the 10K for those of you interested in more detail.

On the positive side, our revenues in all categories are increasing in 2013. Our backlog at the end of 2012 was substantially higher than it was at the end of 2011 and our research revenues are increasing. Our product sales which increased from 2011 to 2012, although not as much as we targeted, are increasing further in 2013. Our targeted revenue level for 2013 is a minimum of $7.0 million. That is almost double 2012; it is based on very specific assumptions with identified revenue sources. For example, we are expecting around $1.1 million of revenue from EZDx, which had no revenue in 2012; increased revenue from Yonex, royalties from YHCC and possibly Ishihara, as well as the previously mentioned increased royalty and product sale revenue.

As mentioned in my last letter in November, we cut expenses last fall to better match our revenues. We have scaled back our unfunded research activities and redeployed those resources into sales and marketing activities. We are now focused on the nuts and bolts activities of the company needed to build a profitable growing organization that results in commercialization of our research. Based on our targeted revenue level for 2013, we should be profitable this year with a positive operating cash flow of $1.4 million. These results will create a strong base for growth as we move forward.

We will end the first quarter of 2013 with more cash than we had at the end of 2012 and expect positive cash flow from operations in the first quarter. We manage our cash very carefully and as a result of our expense cuts last year are spending much less cash on a monthly basis than previously was the case.

Overview

We are off to a solid start in 2013, are running ahead of 2012, and are optimistic about the future. We made substantial investments in 2012 to generate long term revenue growth and we expect those activities to bear fruit in 2013 and beyond.

Finally, let me thank everyone for their patience and support as we build the foundation for growth and transition to a long-term profitable growing company.

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, 2012, 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.