Nano Magic Inc. - Quarter Report: 2005 June (Form 10-Q)

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

ýQuarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2005

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

COMMISSION FILE NO. 1-11602

NANO-PROPRIETARY, INC.

(Exact name of registrant as specified in its charter)

TEXAS	76-0273345
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)

3006 Longhorn Blvd., Suite 107
Austin, Texas	78758
(Address of principal executive offices)	(Zip Code)

(512) 339-5020

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes

As of July 26, 2005, the registrant had 99,164,047 shares of common stock, par value $.001 per share, issued and outstanding.

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NANO-PROPRIETARY, INC.

INDEX

Part I. Financial Information			Page

	Item 1. Financial Statements

		Consolidated Balance Sheets--June 30, 2005 and December 31, 2004	3

		Consolidated Statements of Operations --Three Months and Six Months Ended June 30, 2005 and 2004	4

		Consolidated Statements of Cash Flows --Six Months Ended June 30, 2005 and 2004	5

		Notes to Consolidated Financial Statements	6

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		9

	Item 3. Quantitative and Qualitative Disclosures about Market Risk		13

	Item 4. Controls and Procedures		13

Part II. Other Information

	Item 1. Legal Proceedings		14

	Item 6. Exhibits		15

Signatures			16

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS			(Unaudited) June 30, 2005		December 31, 2004
Current assets:
	Cash and cash equivalents	$	1,877,768	$	901,585
	Accounts receivable, trade - net of allowance for doubtful accounts		61,631		6,735
	Prepaid expenses and other current assets		218,032		85,135

	Total current assets		2,157,431		993,455

	Property and equipment, net		119,282		141,373
	Other assets		9,540		9,540
	Total assets	$	2,286,253	$	1,144,368

	LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
	Accounts payable	$	206,723	$	140,597
	Obligations under capital lease		16,946		21,430
	Accrued liabilities		73,414		74,956
	Deferred Revenue		54,985		54,985

	Total current liabilities		352,068		291,968

Obligations under capital lease			-		5,944

Total Liabilities			352,068		297,912

Commitments and contingencies			-		-

Stockholders' (deficit):
Preferred stock, $1.00 par value, 2,000,000 shares authorized; No shares issued and outstanding			-		-
Common stock, $.00l par value, 120,000,000 shares authorized, 99,164,047 and 97,246,422 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively			99,164		97,246
Additional paid-in capital			84,351,809		80,822,625
Accumulated deficit			(82,516,788)		(80,073,415)

Total stockholders equity			1,934,185		846,456

Total liabilities and stockholders equity		$	2,286,253	$	1,144,368

See notes to consolidated financial statements.

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NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

			For the Three Months Ended June 30,				For the Six Months Ended June 30,
			2005		2004		2005		2004
Revenues
	Government contracts	$	69,243	$	65,798	$	87,610	$	131,678
	Royalties		-		-		3,897		-
	Other		19,301		34,920		65,852		46,698
	Total Revenues		88,544		100,718		157,359		178,376

Research and development			574,586		529,812		1,255,292		1,281,407
Selling, general and administrative expenses			498,181		340,107		1,359,083		784,032
Royalty expense			-		500,000		-		500,000

	Operating costs and expenses		1,072,767		1,369,919		2,614,375		2,565,439

Loss from operations			(984,223)		(1,269,201)		(2,457,016)		(2,387,063)

Other income (expense), net
	Interest Expense		(880)		(1,097)		(1,906)		(2,269)
	Interest Income		10,922		6,769		15,549		14,037
	Other		-		-		-		125

Loss from continuing operations before taxes			(974,181)		(1,263,529)		(2,443,373)		(2,375,170)

Provision for taxes			-		-		-		-

Net loss		$	(974,181)	$	(1,263,529)	$	(2,443,373)	$	(2,375,170)

Loss per share

	Basic and Diluted	$	(0.01)	$	(0.01)	$	(0.02)	$	(0.02)

Weighted average shares outstanding

	Basic and Diluted		99,081,410		96,536,111		98,501,019		96,273,901

See notes to consolidated financial statements.

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NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

					For the Six Months Ended June 30,
					2005				2004
Cash flows from operating activities:
	Net loss				$	(2,443,373)	$		(2,375,170)
		Adjustments to reconcile net loss to net
			cash used in operating activities:
			Depreciation and amortization expense			28,605			25,739
			Gain on sale of fixed assets			-			(125)
			Options issued for services			19,339			116,600
			Non-cash variable option pricing expense			33,825			(341,250)
			Changes in assets and liabilities:
				Accounts receivable, trade		(54,896)			(12,333)
				Prepaid expenses and other current assets		(132,897)			(124,425)
				Accounts payable and accrued liabilities		64,584			66,582

				Total adjustments		(41,440)			(269,212)

			Net cash used in operating activities			(2,484,813)			(2,644,382)

Cash flows from investing activities:
		Capital expenditures				(6,514)			(87,647)
		Proceeds from sale of fixed assets				-			125
		Net cash used in investing activities				(6,514)			(87,522)

Cash flows from financing activities:
		Repayment of notes payable				(10,428)			(9,439)
		Proceeds of stock issuance, net of costs				3,477,938			1,564,209

		Net cash provided by financing activities				3,467,510			1,554,770

Net increase (decrease) in cash and cash equivalents						976,183			(1,177,134)

Cash and cash equivalents, beginning of period						901,585			3,564,570

Cash and cash equivalents, end of period					$	1,877,768		$	2,387,436

See notes to consolidated financial statements.

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NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The consolidated financial statements for the three and six month periods ended June 30, 2005 and 2004 have been prepared by us without audit pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, all adjustments necessary to present fairly our financial position, results of operations, and cash flows as of June 30, 2005 and 2004, and for the periods then ended, have been made. Those adjustments consist of normal and recurring adjustments. The consolidated balance sheet as of December 31, 2004, has been derived from the audited consolidated balance sheet as of that date.

Certain information and note disclosures normally included in our annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statements should be read in conjunction with a reading of the financial statements and notes thereto included in our Annual Report on Form 10-K/A for the fiscal year ended December 31, 2004, as filed with the U.S. Securities and Exchange Commission.

The results of operations for the three and six month periods ended June 30, 2005, are not necessarily indicative of the results to be expected for the full year.

2. Supplemental Cash Flow Information

Cash paid for interest for the six months ended June 30, 2005 and 2004, was $1,906 and $2,269, respectively. During the six months ended June 30, 2005 and 2004, we had non-cash transactions related to variable option pricing and options issued to a consultant. These transactions are described in greater detail in Note 3.

3. Stockholders’ Equity

In the six months ended June 30, 2005, we issued 1,200,000 restricted shares of our common stock and received net proceeds of $3,000,000 in an exempt offering under Regulation D of the Securities Act of 1933. We issued 717,625 shares of our common stock and received $477,938 in connection with the exercise of employee stock options, primarily by former employees.

In the six months ended June 30, 2004, we issued 401,887 restricted shares of our common stock and received net proceeds of $1,065,000 in an exempt offering under Regulation D of the Securities Act of 1933. We issued 666,464 shares of our common stock and received $480,819 in connection with the exercise of employee stock options, primarily by former employees, and issued 20,000 shares and received $18,400 in connection with the exercise of warrants.

In April 2001, the Company repriced a total of 900,500 options to lower the exercise price of these options to $1.50, which was approximately 160% of the market price of the stock at the time of the repricing. The repricing of these options resulted in a new measurement date for accounting purposes and reclassification of these options as variable plan awards beginning on the date of the repricing. The Company previously accounted for these option grants as fixed plan awards. From the date of the repricing through December 31, 2003, the quoted value of the Company’s common stock exceeded the exercise price and remained above it, closing at $2.73 per share on December 31, 2003. The Company recorded $749,755 in non-cash option expense for the cumulative effects of the repricing and increased additional paid-in capital by the same amount in 2003. During the six months ended June 30, 2004, the price of the Company’s common stock declined and closed at $2.03 on June 30, 2004. The Company reversed $341,250 of the previously recorded expense in the six months ended June 30, 2004 as a result of this price decline. During the six months ended June 30, 2005, the priced of the Company’s common stock increased from its closing price of $2.17 on December 31, 2004 to $2.20 on June 30, 2005. As a result, the company recorded $33,825 in non-cash option expense and increased additional paid-in capital by the same amount in the six months ended June 30, 2005.

In the six months ended June 30, 2005, the Company issued 20,000 options to a consultant, 10,000 with an exercise price of $2.54 per share and 10,000 with an exercise price of $2.86 per share. In connection with these options, the Company recorded $19,339 as an expense during the period. In the six months ended June 30, 2004, we issued 100,000 options to a consultant with an exercise price of $3.08 per share. In connection with the options, we recorded $116,600 as an expense during the period.

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NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

4. Contingencies

Litigation

We are a defendant in minor lawsuits described in greater detail in our 2004 annual report on Form 10-K/A. We expect any potential eventual payment to have no material affect on the financial statements.

On April 11, 2005, we filed suit against Canon, Inc. in the U.S. District Court for the Western District of Texas, Austin Division. We are seeking a declaratory judgment that new SED color television products, scheduled to be manufactured by Canon and/or Toshiba beginning in August 2005, are not covered under a 1999 patent license agreement that we have with Canon. We assert that Canon is improperly using our patented technology to produce surface conductor electron emitter display screens (SED) for a new generation of flat screen color televisions. We also assert that a joint venture formed by Canon and Toshiba Corporation to produce the SED display screens, SED, Inc., is not a licensed subsidiary under the 1999 agreement and that Canon is improperly transferring its license rights under Nano-Proprietary's patents to the joint venture and Toshiba. Canon filed its response on July 18, 2005 denying liability in the matter.

5. Business Segments

Following is information related to our business segments for the six months ended June 30, 2005 and 2004:

	ANI		EBT		All Other		Total
2005
Revenue	$	157,359	$	-	$	-	$	157,359

Profit (Loss)	(2,003,622)		-		(439,751)		(2,443,373)

Expenditures for
long-lived assets	5,232		-		1,282		6,514

2004
Revenue	$	178,376	$	-	$	-	$	178,376

Profit (Loss)	(2,290,539)		121,497		(206,128)		(2,375,170)

Expenditures for
long-lived assets	85,274		-		2,373		87,647

6. Recently Issued Accounting Standards

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (Revised 2004), Share-Based Payment ("SFAS No. 123R"), which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements based on the provisions of SFAS 123 issued in 1995. The Company currently accounts for stock-based compensation using APB 25 and discloses pro forma compensation expense quarterly and annually by calculating the stock option grants' fair value using the Black-Scholes model and disclosing the impact on net income and earnings (loss) per share in a Note to the Consolidated Financial Statements. Upon adoption, pro forma disclosure will no longer be an alternative. SFAS 123R is effective for the first annual period beginning after June 15, 2005. Accordingly, we will adopt this provision for its financial statements for the quarter ended March 31, 2006. The financial impact of adopting SFAS 123R cannot be predicted, however it will likely have a material impact on the Company’s financial statements.

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7. Subsequent Events

There have been no subsequent events requiring disclosure through July 25, 2005.

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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management’s discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements that we believe are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For this purpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding our strategy, future operations, future expectations or future estimates, financial position and objectives of management. Those statements in this Form 10-Q containing the words "believes," "anticipates," "plans," "expects" and similar expressions constitute forward-looking statements, although not all forward-looking statements contain such identifying words. These forward-looking statements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating to our operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties.

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate and actual results may differ from those indicated by the forward-looking statements included in this Form 10-Q. In light of the significant uncertainties inherent in the forward-looking statements included in this Form 10-Q, you should not consider the inclusion of such information as a representation by us or anyone else that we will achieve such results. Moreover, we assume no obligation to update these forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

Six months ended June 30, 2005 and 2004

OVERVIEW

During the six months ended June 30, 2005, our primary revenues were earned as a result of reimbursed research expenditures at our Applied Nanotech, Inc. (“ANI”) subsidiary. We continued to incur substantial expenses in support of the development of our proprietary Carbon Nanotube Based Field Emission (“CFE”) Technology and other technologies. As more fully discussed in our Annual Report on Form 10-K/A for the year ended December 31, 2004, we expect to incur additional research and development expenses throughout 2005 in developing our technology. We are focused on licensing our technology and obtaining sufficient revenue to cover our ongoing research expenditures.

OUTLOOK

We expect our present cash balance of approximately $1.7 million as of the date of this filing, when combined with expected revenue sources, to enable us to operate at least through 2005. We have a plan to achieve profitability in 2006. There can be no assurance that we will achieve profitability, or even break-even, in the future. To the extent our revenues do not allow us to break-even, or if the timing of revenues does not match with expenses, we could be required to raise additional funds through the issuance of debt or equity securities to enable us to maintain operations at the present level. The mix of revenues received could also cause the revenues required to reach break-even to increase. If revenue producing projects require unanticipated expenses, or heavier than anticipated use of outside services or materials, we may be unable to achieve profitability at the expected level of revenues.

We have developed a plan to allow ourselves to maintain operations until we are able to sustain ourselves on our own revenue. Our plan is primarily dependent on raising funds through the licensing of our technology and reimbursed research contracts. Our current cash of approximately $1.7 million as of the date of this filing is sufficient to allow us to maintain operations through at least the end of the year and into 2006. We expect additional revenue producing projects or license agreements to be finalized during that time period. We believe that we have the ability to continue to raise funding, if necessary, to enable us to continue operations until our plan can be completed.

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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

This plan is based on current development plans, current operating plans, the current regulatory environment, historical experience in the development of electronic products and general economic conditions. Changes could occur which would cause certain assumptions on which this plan is based to be no longer valid. Although we do not expect funding our operations to be a problem, if adequate funds are not available from operations, or additional sources of financing, we may have to eliminate, or reduce substantially, expenditures for research and development, testing and production of its products, or obtain funds through arrangements with other entities that may require us to relinquish rights to certain of our technologies or products. Such results would materially and adversely affect us.

RECENT DEVELOPMENTS

In the quarter ended June 30, 2005, we received two new Small Business Innovation Research (SBIR) grants, totaling approximately $165,000, from the U.S. Air Force. One of these grants relates to the development of low-maintenance sensors, the other relates to carbon nanotube based radar applications. Both of the projects are expected to be completed within nine months.

In July 2005, our Applied Nanotech, Inc. subsidiary completed a license agreement with Kelman, Ltd for ANI’s proprietary Hydrogen Sensor technology. Under the terms of this agreement, Kelman has the exclusive right through June 30, 2006 to use ANI’s Hydrogen Sensors in power transformers. Kelman can extend this exclusivity period on a year by year basis by making certain pre-defined minimum royalty payments. ANI will also initially manufacture and sell hydrogen sensors to Kelman.

RECENT ACCOUNTING PRONOUNCEMENTS

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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

FINANCIAL CONDITION AND LIQUIDITY

Our cash position increased during the period. At June 30, 2005 we had cash and cash equivalents in the amount of $1,877,768 as compared with cash and cash equivalents of $901,585 at December 31, 2004. This increase in cash is primarily the result of cash provided by financing activities, offset by cash used in operating activities.

As described in greater detail in the notes to the financial statements, we received net proceeds of $3,477,938 from the issuance of common stock related to private placements and option exercises during the six months ended June 30, 2005 (the “2005 Period”), as compared with $1,564,209 from the issuance of common stock during the six months ended June 30, 2004 (the “2004 Period”). The majority of the common stock issued in the 2005 Period was the result of the private placement in February 2005 in which 1,200,000 shares of stock were issued in exchange for net proceeds of $3,000,000. We do not expect to raise any additional equity in 2005, however there may be additional proceeds from common stock as the result of the exercise of options.

Our cash used in operating activities decreased from $2,644,382 in the 2004 Period to $2,484,813 in the 2005 Period. This is primarily the result of operating factors discussed below in the “Results of Operations” section. We would expect our cash used in operating activities to decrease in future quarters in 2005 as a result of increasing revenues, while expenses remain relatively constant.

We used net cash of $87,522 for investing activities in the 2004 Period related to the purchase of research equipment, compared with cash used in investing activities related to equipment purchases of $6,514 in the 2005 Period. We expect cash used in investing activities to remain at relatively insignificant levels for the balance of 2005.

The principal source of our liquidity has been funds received from exempt offerings of common stock. In the event that we need additional funds, we may seek to sell additional debt or equity securities. While we expect to be able to obtain any funds needed for operations, there can be no assurance that any of these financing alternatives can be arranged on commercially acceptable terms. We believe that our success in reaching profitability will be dependent on our patent portfolio and upon the viability of products using our technology and their acceptance in the marketplace, as well as our ability to obtain additional debt or equity financings in the future, if needed.

We expect to continue to incur substantial expenses for research and development ("R&D"). Further, we believe that certain products that may be developed by potential licensees of our technology may not be available for commercial sale or routine use for a period of one to two years. Others are expected to be available in 2005. While we would likely receive initial license payments, ongoing royalty streams related to those licenses will not be available until potential licensees have introduced products using our technology. Therefore, it is possible that the commercialization of our existing and proposed products may require additional capital in excess of our current funding. We do, however, have a plan to operate profitably in 2005 based on the receipt of research funding and other revenues. Achievement of at least break-even would enable us to continue our research without seeking additional debt or equity financing.

Because the timing and receipt of revenues from the license or royalty agreements will be tied to the achievement of certain product development, testing and marketing objectives, which cannot be predicted with certainty, there may be substantial fluctuations in our results of operations. If revenues do not increase as rapidly as anticipated, or if product development and testing require more funding than anticipated, we may be required to curtail our operations or seek additional financing from other sources. The combined effect of the foregoing may prevent us from achieving sustained profitability for an extended period of time.

RESULTS OF OPERATIONS

Our loss for the second quarter ended June 30, 2005 was $974,181 as compared with the loss of $1,263,529 for the same period last year. The biggest single factor in the larger loss in 2004 was the $500,000 minimum royalty payment made in the quarter ended June 30, 2004. No similar payment was included in the quarter ended June 30, 2005. Our loss of $2,443,373 for the six months ended June 30, 2005 was slightly higher than the loss of $2,375,170 for the six months ended June 30, 2004. This increased loss was the result of reasons set forth below. We expect our quarterly loss to be reduced in the third and fourth quarters of 2005.

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ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (cont.)

Our revenues for the quarter ended June 30, 2005 totaled $88,544 compared to $100,718 for the same quarter of 2004. For the six-month period ended June 30, 2005 (the “2005 Period”), our revenues were $157,359 as compared with $178,376 for the six-month period ended June 30, 2004 (the “2004 Period”). The revenues in both periods were all from ANI and substantially all the result of reimbursed research expenditures. The majority of revenues in both periods came from government contracts. At the present stage of our development, significant conclusions can’t be drawn from comparing revenues from period to period. Our business strategy is built on developing a royalty stream from licensing our intellectual property. To supplement this, we also seek funding from both governmental and private sources to help fund our research. Until we are able to develop a steady revenue stream from royalties, our revenues will tend to fluctuate greatly from quarter to quarter and may not be a significant source of operating cash for us. Our private research funding tends to come in large amounts at sporadic times.

We have three government programs in progress at June 30, 2005, and we have a revenue backlog of $208,861 related to those contracts. We have a total revenue backlog of $370,334 as of June 30, 2005. We had a total revenue backlog of $303,223 as of June 30, 2004, all of which related to one government contract. Our ability to perform continued research, or fulfill our backlog, should not require significant additional personnel.

We incurred research and development expenses of $1,255,292 for the 2005 Period, which was similar to the amount of $1,281,407 incurred in the 2004 Period. The majority of our research and development expenditures are relatively fixed and include salaries and related cost, facilities costs, etc. The variable portion relates to spending on outside materials and consultants and was relatively similar from year to year. We expect total research and development expense to remain relatively constant in the final two quarters of the year. Research and development expenditures could increase if we received funding for any significant new projects, however that would result in an increase in revenue as well.

Our selling, general, and administrative expenses were $1,359,083 for the 2005 Period, compared with $784,032 for the 2004 Period - an increase of $575,051. The majority of this increase, or $375,075, was the result of a non-cash item related to variable option pricing. In April 2001, we repriced a total of 900,500 options to lower the exercise price of these options to $1.50, which was approximately 160% of the market price of the stock at the time of the repricing. The repricing of these options resulted in a new measurement date for accounting purposes and reclassification of these options as variable plan awards beginning on the date of the repricing. The Company previously accounted for these option grants as fixed plan awards. In 2003, our common stock price exceeded the exercise price for the first time since the repricing and remained above it, closing at $2.73 per share on December 31, 2003. The Company recorded $749,755 in non-cash option expense for the cumulative effects of the repricing and increased additional paid in capital by the same amount in 2003.

During the six months ended June 30, 2004, the price of our common stock declined and closed at $2.03 on June 30, 2004. We reversed $341,250 of the previously recorded expense in the six months ended June 30, 2004, as a result of this price decline. During the 2005 Period, we recorded an additional expense of $33,825. The remainder of the increase relates primarily to human resource related costs, including salary and consulting fees paid to a new hire, as well as significant out of pocket expenses related to the Canon lawsuit, which were approximately $85,000 during the period.

Our royalty expense was $500,000 in the 2004 Period. The royalty expense results from minimum payments due in connection with our Keesman patent license. We had no such expense in the 2005 Period. No further future minimum royalty payments are due under this agreement, and we expect royalty expense in future periods to be highly correlated with royalty income.

Our interest expense and interest income remained substantially the same in the two periods. Our only remaining interest expense relates to capital leases. Our interest income is a result of the investment of excess funds in short term interest bearing instruments, primarily certificates of deposit, commercial paper, and money market funds. We expect both to remain relatively insignificant in the foreseable future.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not use any derivative financial instruments for hedging, speculative, or trading purposes. Our exposure to market risk is currently immaterial.

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, within 90 days of the filing date of this report (the "Evaluation Date"). Based upon this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the material information required to the included in our Securities and Exchange Commission ("SEC") reports is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms relating to the Company, including, our consolidated subsidiaries, and was made known to them by others within those entities, particularly during the period when this report was being prepared.

In addition, there were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date. We have not identified any significant deficiencies or material weaknesses in our internal controls, and therefore, there were no corrective actions taken.

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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ITEM 6. EXHIBITS

(a) Exhibits: See Index to Exhibits on page 17 for a descriptive response to this item.

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

	NANO-PROPRIETARY, INC. (Registrant)

Date: July 26, 2005	/s/ Marc W. Eller Marc W. Eller Chairman and Chief Executive Officer (Principal Executive Officer)

Date: July 26, 2005	/s/ Douglas P. Baker Douglas P. Baker Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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INDEX TO EXHIBITS

The following documents are filed as part of this Report:

Exhibit
11	Computation of (Loss) Per Common Share

31.1	Rule 13a-14(a)/15d-14(a) Certificate of Marc W. Eller

31.2	Rule 13a-14(a)/15d-14(a) Certificate of Douglas P. Baker

32.1	Section 1350 Certificate of Marc W. Eller

32.2	Section 1350 Certificate of Douglas P. Baker

Nano Magic Inc. - Quarter Report: 2005 June (Form 10-Q)

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