Nano Magic Inc. - Quarter Report: 2007 September (Form 10-Q)

nano_10q-093007.htm

Index

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2007

¨ 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.

x Yes

o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Act.

Large Accelerated Filer ¨ Accelerated Filer þ Non-Accelerated Filer ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

o Yes

x No

As of October 30, 2007, the registrant had 107,173,549 shares of common stock, par value $.001 per share, issued and outstanding.

NANO-PROPRIETARY, INC.

INDEX

Part I. Financial Information			Page

	Item 1. Financial Statements

		Consolidated Balance Sheets--September 30, 2007 and December 31, 2006	3

		Consolidated Statements of Operations --Three Months and Nine Months Ended September 30, 2007 and 2006	4

		Consolidated Statements of Cash Flows --Nine Months Ended September 30, 2007 and 2006	5

		Notes to Consolidated Financial Statements	6

	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		10

	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 4. Submission of Matters to a Vote of Security Holders		15

	Item 6. Exhibits		16

Signatures			17

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS	(Unaudited) September 30, 2007			December 31, 2006
Current assets:
Cash and cash equivalents	$	5,651,932		$	2,085,338
Accounts receivable, trade – net of allowance for doubtful accounts		511,921			364,718
Prepaid expenses and other current assets		140,346			79,301

Total current assets		6,304,199			2,529,357

Property and equipment, net		174,621			154,545
Other assets		109,540			9,540
Total assets	$	6,588,360		$	2,693,442

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,959,457		$	1,562,488
Accrued liabilities		88,762			87,237
Deferred revenue		724,329			401,455

Total current liabilities		2,772,458			2,051,180

Commitments and contingencies		–			–

Total Liabilities		2,772,458			2,051,180

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, 107,173,549 and 104,257,607 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively		107,174			104,258
Additional paid-in capital		108,646,258			102,139,950
Accumulated deficit		(104,937,530	)		(101,601,946	)

Total stockholders equity		3,815,902			642,262

Total liabilities and stockholders equity	$	6,588,360		$	2,693,442

See notes to consolidated financial statements.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,
	2007			2006			2007			2006
Revenues
Government contracts	$	664,541		$	109,182		$	1,741,115		$	180,296
Contract research		203,708			60,000			721,157			185,000
Other		181,500			44,659			460,382			125,738
Total Revenues		1,049,749			213,841			2,922,654			491,034

Research and development		1,136,220			962,458			3,207,932			2,616,767
Selling, general and administrative expenses		704,222			1,184,579			3,144,294			4,092,463

Operating costs and expenses		1,840,442			2,147,037			6,352,226			6,709,230

Gain on sale of intellectual property and other assets		–			–			–			(1,100,000	)

Loss from operations		(790,693	)		(1,933,196	)		(3,429,572	)		(5,118,196	)

Other income (expense), net
Interest Expense		(80	)		(222	)		(349	)		(518	)
Interest Income		30,863			2,380			94,337			7,927

Loss from continuing operations before taxes		(759,910	)		(1,931,038	)		(3,335,584	)		(5,110,787	)

Provision for taxes		–			–			–			–

Net loss	$	(759,910	)	$	(1,931,038	)	$	(3,335,584	)	$	(5,110,787	)

Loss per share

Basic and Diluted	$	(0.01	)	$	(0.02	)	$	(0.03	)	$	(0.05	)

Weighted average shares outstanding

Basic and Diluted		107,173,060			101,862,093			106,034,229			100,469,473

See notes to consolidated financial statements.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	For the Nine Months Ended September 30,
	2007			2006
Cash flows from operating activities:
Net loss	$	(3,335,584	)	$	(5,110,787	)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization expense		31,394			32,030
Stock based compensation expense		204,800			648,901
Issuance of shares to ATI		–			400,000
Changes in assets and liabilities:
Accounts receivable, trade		(147,203	)		(93,645	)
Prepaid expenses and other current assets		(161,045	)		(14,507	)
Accounts payable and accrued liabilities		398,494			1,551,906
Customer deposits and deferred revenue		322,784			284,832

Total adjustments		649,224			2,809,517

Net cash used in operating activities		(2,686,360	)		(2,301,270	)

Cash flows from investing activities:
Purchases of fixed assets		(51,470	)		(65,082	)
Net cash used in investing activities		(51,470	)		(65,082	)

Cash flows from financing activities:
Repayment of capital leases		–			(4,348	)
Proceeds of stock issuance, net of costs		6,304,424			2,100,641

Net cash provided by financing activities		6,304,424			2,096,293

Net increase in cash and cash equivalents		3,566,594			(270,059	)

Cash and cash equivalents, beginning of period		2,085,338			897,247

Cash and cash equivalents, end of period	$	5,651,932		$	627,188

See notes to consolidated financial statements.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The consolidated financial statements for the three and nine month periods ended September 30, 2007 and 2006 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 September 30, 2007 and 2006, 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, 2006, 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, 2006, as filed with the U.S. Securities and Exchange Commission.

The results of operations for the three and nine month periods ended September 30, 2007, 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 nine months ended September 30, 2007 and 2006, was $349 and $518, respectively. During the nine months ended September 30, 2007 and 2006, the Company had non-cash transactions related to share based payments covered by FAS 123R. These transactions are described in greater detail in Note 4. During the nine months ended September 30, 2006, we also had a non-cash transaction related to the issuance of shares in connection with the acquisition of patent as described in greater detail in Note 3.

3. Stockholders’ Equity

During the nine months ended September 30, 2007, we issued 2,608,698 restricted shares of common stock and received net proceeds of $6,000,000 in an exempt offering under Regulation D of the Securities Act of 1933. In connection with this offering, we also issued warrants enabling the holders to purchase 1,304,353 shares of our common stock at a price of $2.50 per share through April 2008. We also issued 307,244 shares of common stock and received proceeds of $304,424 in connection with the exercise of stock options during the nine months ended September 30, 2007. In the nine months ended September 30, 2006, we issued 1,250,000 restricted shares of common stock and received net proceeds of $2,074,000 in an exempt offering under Regulation D of the Securities Act of 1933. During the same period, we also issued 54,383 shares of common stock and received proceeds of $26,641 in connection with the exercise of stock options.

In June 2006, we issued 200,000 shares of our common stock valued at $400,000 to acquire the remaining interest in a patent that had been assigned to us. This patent was part of the intellectual property that we sold during the nine months ended September 30, 2006. This transaction is described in greater detail in Note 5.

4. Share-Based Payments

Effective January 1, 2006, the Company adopted FASB Statement of Financial Accounting Standards No. 123R (Revised 2004), Share-Based Payment, 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 recorded $204,800 in compensation expense in the nine months ended September 30, 2007 related to options issued under its stock-based incentive compensation plans. This includes expense related to both options issued in the current year and options issued in prior years for which the requisite service period for those options includes the current year. The fair value of these options was calculated using the Black-Scholes option pricing model. Information related to the assumptions used in this model is set forth in the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2006. For options issued in 2007, the same assumptions were used except that risk free interest rates of 4.58% to 4.79% were used and annualized volatility rates ranging from approximately 75% to 90% were used.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

4. Share-Based Payments (continued)

The Company recorded $648,901 in compensation expense in the nine months ended September 30, 2006 related to options issued under its stock-based incentive compensation plans.

5. Gain on Sale of Intellectual Property and Other Assets

In June 2006, our Electronic Billboard Technology, Inc. subsidiary sold all of its intellectual property in two simultaneous transactions. We received a total of $1.5 million in cash, the right to future royalties, and an ownership interest in a newly formed entity. One of the patents that we sold was a patent that had been assigned to us by Advanced Technology, Incubator, Inc. (“ATI”), a company owned by Dr. Zvi Yaniv, our Chief Operating Officer. In order to acquire the remaining interest in the patent and settle all potential future obligations to ATI, we issued 200,000 shares of our common stock, valued at $400,000 to ATI. The gain of $1.1 million recorded in the financial statements resulted from the cash payment received of $1.5 million, less the $400,000 cost associated with the acquisition of the patent rights.

6. Contingencies

Litigation

In addition to the two cases described below, the Company is a defendant in minor lawsuits described in greater detail in its 2006 Annual Report on Form 10-K/A. The Company expects any potential eventual payment to have no material affect on the financial statements.

Canon Litigation

In April 2005, we filed suit against the Japanese camera and copier manufacturer Canon, Inc., and its wholly-owned U.S. subsidiary Canon USA, Inc., in the U.S. District Court for the Western District of Texas, Austin Division, seeking a declaratory judgment that new SED color television products being developed and manufactured by a Canon/Toshiba joint venture are not covered under a non-exclusive 1999 patent license agreement that we granted to Canon. We assert that the Canon/Toshiba joint-venture – SED, Inc. – is not a licensed party under that agreement. The original complaint asserted additional claims related to whether the Canon/Toshiba joint venture’s television panels constituted excluded products under the 1999 license, as well as breach of covenant of good faith and fair dealing, tortious interference and a Lanham Act violation by Canon. In Fall 2005, Canon moved to dismiss Canon U.S.A. from the litigation, and moved to dismiss several of the counts asserted. The court denied the motion, in part, by ruling that Canon U.S.A. was an appropriate defendant and refusing to dismiss our claims for breach of the covenant of good faith and fair dealing. Our tortious interference and Lanham Act claims were dismissed, without prejudice.

After initial discovery, in April 2006, we amended the complaint to drop one count related to the definition of excluded products in the 1999 license, and add two counts for fraudulent inducement and fraudulent non-disclosure related to events and representations made during our negotiations on the license, and leading up to and following the formation by Canon and Toshiba of their joint venture effort, including Canon’s failure to disclose an ongoing relationship with Toshiba and misrepresentations made to us about the joint venture’s structure and operation. Canon moved to dismiss the fraud claims, and the Court denied Canon’s motion in May 2006. Discovery was completed in August 2006. Upon completion of discovery, Canon filed a motion for partial summary judgment seeking to dismiss the claim that SED is not a licensed party under the agreement. Canon did not file a motion for summary judgment seeking to dismiss the other claims. In November 2006, the Court denied Canon’s partial motion for summary judgment, describing SED, Inc. as a “corporate fiction designed for the sole purpose of evading Canon’s contractual obligations”.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

6. Contingencies (cont.)

In January 2007, Canon filed another motion for partial summary judgment seeking a declaration that a reconstituted SED, Inc. which is purportedly owned 100% by Canon but which still involves numerous reciprocal agreements with Toshiba, will be considered a Canon subsidiary. At the same time, we filed a motion for partial summary judgment, seeking the Court’s affirmation of our termination of the license agreement due to Canon’s breach of contract in 2004. On February 22, 2007, the Court issued a ruling denying Canon’s motion and granting our motion for partial summary judgment, ruling our termination of the contract effective December 1, 2006, to be valid.

A trial on the case began on April 30, 2007 and a final judgment was entered in the case in May 2007. The final judgment reaffirmed Canon’s material breach of the patent license, while awarding no additional damages. Following the verdict, Canon filed a notice of intent to appeal, and we have done the same. Canon’s appellate brief was filed in August 2007, and our appellate brief was filed in October 2007.

Keesmann litigation

In May 2006, we filed suit in the U.S. District Court for the Northern District of Illinois against Till Keesmann, a German citizen who in 2000 granted us an exclusive and perpetual license to certain of his U.S. and European patents in carbon nanotube cathode technology. Shortly after we filed suit against Canon in April 2005, Keesmann conveyed part of his interests in the Exclusive License to investors associated with a German patent evaluation firm, IP Bewertungs AG (“IPB”). Thereafter, IPB approached us with proposals to buy or auction our rights to Keesmann’s patents. On March 20, 2006, we announced a letter of intent to form a joint venture with a leading Asian display manufacturer, Da Ling Co., Ltd., to develop display products utilizing our intellectual property.

Two days later, Keesmann purported to terminate the exclusive license that he granted to us six years ago. Our May 2006 complaint seeks a declaratory judgment that Keesmann had no right to terminate the exclusive license, and we also filed for a Temporary Restraining Order and Preliminary Injunction to prevent Keesmann from taking any actions inconsistent with his obligations under the exclusive license. The Court granted a consent order that prevents Keesmann from licensing the patents pending an injunction hearing and decision. In June 2006, Keesmann filed an Answer and Counterclaim, denying that the purported termination was null and void, and asserting a counterclaim that asks the court to find that we breached the exclusive license by not actively marketing the Keesmann patents, among other things.

We amended our complaint in December 2006 to include additional defendants, JK Patentportfolio GmbH & Co., Jochen Kamlah, NPV Nano Patent GmbH & Co., and Arnold Amsinck. The amended complaint also contains additional claims including breach of contract, conversion, aiding and abetting conversion, conspiracy to commit conversion, misappropriation, aiding and abetting misappropriation, conspiracy to commit conversion, Lanham Act violations, tortious interference with a prospective economic relationship, aiding and abetting tortious interference with a prospective economic relationship, and conspiracy to tortiously interfere with a prospective economic relationship.

In January 2007, the Court granted our motion for preliminary injunction, ruling that there is a reasonable likelihood that we will prevail on the merits of the case. The preliminary injunction enjoins Keesmann, his agents, employees, and all those acting in concert with him from terminating the license agreement for the reasons asserted in the March 2006 default notice, or otherwise acting in violation of the license agreement. In connection with this injunction, the Court set a surety bond, which is required by law, at $100,000. We posted the bond in February 2007. Days after the Court issued the injunction, Keesmann again asserted a number of alleged defaults under the license. In April 2007, we filed a second motion for a temporary restraining order and preliminary injunction. The next status conference in the case is set for December 2007.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

7. Business Segments

Following is information related to our business segments for the nine months ended September 30, 2007 and 2006:

	ANI			EBT			All Other			Total
2007
Revenue	$	2,922,654		$	-		$	-		$	2,922,654

Profit (Loss)		(2,365,586	)		(1,298	)		(968,700	)		(3,335,584	)

Expenditures for
long-lived assets		51,470			-			-			51,470

2006
Revenue	$	491,034		$	-		$	-		$	491,034

Profit (Loss)		(4,902,384	)		933,720			(1,142,123	)		(5,110,787	)

Expenditures for
long-lived assets		65,082			-			-			65,082

8. Subsequent Events

There have been no subsequent events requiring disclosure through October 25, 2007.

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.

Nine months ended September 30, 2007 and 2006

OVERVIEW

We are primarily a nanotechnology company engaged in the development of proofs of concepts of products and materials , and the performance of services based principally on our intellectual property. During all periods presented, our primary revenues were earned as a result of reimbursed research expenditures at our Applied Nanotech, Inc. (“ANI”) subsidiary. As more fully discussed in our Annual Report on Form 10-K/A for the year ended December 31, 2006, we expect to incur additional research and development expenses throughout 2007 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 balances, which are approximately $5.5 million as of the date of this filing, when combined with expected revenue sources, to enable us to operate for the foreseeable future. We have a plan to achieve profitability in 2007, however that plan is now dependent a significant event, such as settlement of existing litigation of signing of a license agreement with a significant up-front payment. At the present time, profitability for 2007 is not considered probable. There can be no assurance that we will achieve profitability, or even break-even, in the future. 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, which is approximately $5.5 million as of the date of this filing, when combined with expected revenues, is sufficient to allow us to maintain operations for the foreseeable future. We expect additional revenue producing projects or license agreements to be finalized during 2007. 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.

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 our 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 March 2007, we signed an agreement with Mitsui & Co., Ltd. which gives Mitsui the exclusive right to extend royalty bearing licenses on our behalf, to companies headquartered in Japan. These licenses will allow the use of our carbon cold cathode intellectual property for the manufacture of lighting devices such as backlights for LCDs. This agreement was extended in July 2007.

During the quarter ended June 30, 2007, we signed an integrated sensor agreement covering development, technology transfer fees upon completion of the development process, and recurring license revenues once a product is introduced. The development portion of this project started in the quarter ended September 30, 2007 and is expected to be completed by the end of 2007.

We received two new Phase II SBIR contracts during the quarter ended September 30, 2007. The first contract in the amount of $749,947 was received in August from the Homeland Security Advanced Research Project Agency (HSARPA) and was for the continued development of a “Dual Sensor Module for Human Detection.” The second contract, received in September, in the amount of $996,973 was also from HSARPA and was for the continued development of a “Carbon Nanotube (CNT)-Based Gas Ionizer to Replace Radioactive Sources.”

In September 2007, as a result of our successful phase I project with a leading chemical company based in Japan, we entered into a phase II project with the same company. The contract is for the development of conductive inks and will result in a minimum of $635,000 in revenues over the next twelve months.

RECENT ACCOUNTING PRONOUNCEMENTS

There are no recent accounting pronouncements that we have not implemented that are expected to have a material impact on our financial statements.

FINANCIAL CONDITION AND LIQUIDITY

Our cash position increased during the nine-month period. At September 30, 2007 we had cash and cash equivalents in the amount of $5,651,932 as compared with cash and cash equivalents of $2,085,338 at December 31, 2006. This increase in cash is primarily the result of cash provided by financing activities, offset by cash used in operating activities.

We had cash flow from financing activities of approximately $6.3 million during the nine months ended September 30, 2007 (the “2007 Period”), as compared with cash flow from financing activities of approximately $2.1 million during the nine months ended September 30, 2006 (the “2006 Period”). The cash flow in both of these periods resulted from the issuance of common stock. As described in greater detail in the notes to the financial statements, we received net proceeds of $2.1 million from the issuance of common stock related to private placements during the 2006 Period and $6.0 million from private placements during the 2007 Period. The remaining proceeds of approximately $300,000 from stock issuance during the 2007 Period resulted from the exercise of stock options.

Our cash used in operating activities increased from approximately $2.3 million in the 2006 Period to approximately $2.7 million in the 2007 Period. This is primarily the result of operating factors discussed below in the “Results of Operations” section. A portion of these positive factors in 2007 were offset by the cash provided by the increase in accounts payable during the 2006 Period. A significant factor in the increased balance in accounts payable in both periods is the payment arrangement that we have with our attorneys related to the Keesman litigation. This is discussed in more detail below in the “Results of Operations” section. We would expect our cash used in operating activities to decrease in future quarters in 2007 as a result of increasing revenues, while expenses remain relatively constant.

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

Cash used in investing activities in both periods was insignificant and we expect cash used in investing activities to remain at relatively insignificant levels for the balance of 2007.

The principal source of our liquidity has been funds received from exempt offerings of common stock. Given our current cash balance, which is approximately $5.5 million, it is unlikely that we will need additional funds, however in the event that we do, 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"), however we intend to seek funding, in the form of research contracts, to offset as many of these expenses as possible. 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 2008. 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 2008 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 in the future. Profitability or break-even in 2007 is now dependent upon signing a license agreement with a significant up-front payment or the settlement of existing litigation.

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 at some point in the future. The combined effect of the foregoing may prevent us from achieving sustained profitability for an extended period of time.

RESULTS OF OPERATIONS

Our net loss for the third quarter ended September 30, 2007 of $759,910 was reduced from the loss of $1,931,038 for the same period last year. Our net loss of $3,335,584 for the nine months ended September 30, 2007 was also substantially lower than the loss of $5,110,787 for the nine months ended September 30, 2006. This decreased loss was the result of reasons set forth below. Absent a significant positive event, we expect our loss in the fourth quarter of 2007 to be similar to or less than that of the third quarter. In order to achieve break-even or profitability for the fourth quarter, we would need to sign a license agreement with a significant up-front payment or receive proceeds from the settlement of existing litigation.

Our revenues for the quarter ended September 30, 2007 totaled $1,049,749 compared to $213,841 for the same quarter in 2006. For the nine-month period ended September 30, 2007, our revenues were $2,922,654 as compared with $491,034 for the 2006 Period, a substantial increase. The revenues in both periods were all from ANI and substantially all the result of reimbursed research expenditures. The majority of revenues in the 2007 Period came from government contracts, whereas the revenues in the 2006 Period came from a mixture of government, private, and other sources; however revenues increased substantially in all categories.

We have a revenue backlog of approximately $3.4 million as of September 30, 2007, up slightly from our backlog of $3.3 million as of September 30, 2006. We expect our backlog to increase significantly by December 31, 2007. Our ability to perform continued research, or fulfill our existing backlog, should not require significant additional personnel; however, if our backlog increases as expected, we will likely hire additional research personnel. We expect our revenue to continue to increase in future quarters as our backlog continues to grow.

We incurred research and development expenses of $3,207,932 in the 2007 Period, which was higher than the amount of $2,616,767 incurred in the 2006 Period. This reflects a general increase in the level of our activity and the costs associated with the new revenue producing projects. We expect research and development expenditures to continue to gradually increase for the remainder of the year as additional new projects begin. Significant new revenue producing research programs beyond those already identified could, however, cause research and development expenditures to increase further.

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

Our selling, general, and administrative expenses were $3,144,294 for the 2007 Period, compared with $4,092,463 for the 2006 Period – a decrease of approximately $1.0 million. A significant portion of our selling, general, and administrative expenses in both periods related to litigation. We had litigation related expenses of approximately $1.0 million in the 2007 Period and approximately $1.55 million in the 2006 Period. The majority of the litigation expense in the 2007 Period related to the Canon litigation and expenses associated with the trial. The majority of the litigation expense in the 2006 Period related to the Keesmann litigation and activity associated with the initial lawsuit and discovery. We expect litigation expenses to be low in the fourth quarter of 2007 as a result of the completion of the Canon trial and a relatively low level of expected activity in the Keesmann litigation. We have a modified fee arrangement with our attorneys related to the Keesmann litigation, whereby the cumulative fees on the case are not payable until November 2007. The amount payable in November 2007 is slightly less than $1.4 million. We have the funds set aside for this payment and will continue to have a strong cash position after the payment is made.

In addition to this decrease in litigation expense, there were reductions in other areas. Our stock based compensation expense decreased from approximately $350,000 in the 2006 Period to approximately $100,000 in the 2007 Period as a result of a combination of factors including fewer options granted, forfeiture of partially vested options, changes in assumptions related to unvested options, and options granted at lower stock prices, which results in a lower value for the options. In addition, our payroll and related expenses decreased from approximately $1.0 million in the 2006 Period to approximately $900,000 in the 2007 Period as a result of fewer administrative employees and other reduced costs. We would expect our selling, general and administrative expenses in the fourth quarter of 2007 to be equal to or lower than that of the third quarter of 2007.

We had a gain of $1.1 million in the 2006 Period as a result of the sale of the intellectual property of our Electronic Billboard Technology, Inc. subsidiary. We received total cash proceeds of $1.5 million in the transaction, but that was partially offset by $400,000 of costs related to a portion of the intellectual property sold. One of the patents sold by EBT was assigned to us by Advanced Technology Incubator, Inc, a Company owned by our Chief Operating Officer, Dr. Zvi Yaniv. In order to acquire the remaining interest in the patent and settle all potential future obligations to ATI, we issued 200,000 shares of our common stock, valued at $400,000 to ATI. We had no such gain in the 2007 Period.

Our interest income is insignificant, but increased substantially during the 2007 Period. Our interest income results from the investment of excess funds in short term interest bearing instruments, primarily certificates of deposit, commercial paper, and money market funds. The increase is a result of the increase in funds available for investment generated by the private placement that we completed in April 2007. We would expect our interest income to remain at current levels for the remainder of the year. Our interest expense was insignificant in both periods and is expected to remain so for the balance of the year.

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, as of the end of the period covered by 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.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Canon Litigation

After initial discovery, in April 2006, we amended the complaint to drop one count related to the definition of excluded products in the 1999 license, and add two counts for fraudulent inducement and fraudulent non-disclosure related to events and representations made during our negotiations on the license, and leading up to and following the formation by Canon and Toshiba of their joint venture effort, including Canon’s failure to disclose an ongoing relationship with Toshiba and misrepresentations made to us about the joint venture’s structure and operation. Canon moved to dismiss the fraud claims, and the Court denied Canon’s motion in May 2006. The suit proceeded under the amended complaint. Discovery was completed in August 2006. Upon completion of discovery, Canon filed a motion for summary judgment seeking to dismiss the claim that SED is not a licensed party under the agreement. Canon did not file a motion for summary judgment seeking to dismiss either of the fraud claims or the breach of covenant of good faith and fair dealing. In November 2006, the Court denied Canon’s partial motion for summary judgment, describing SED, Inc. as a “corporate fiction designed for the sole purpose of evading Canon’s contractual obligations”.

In January 2007, Canon filed another motion for partial summary judgment seeking a declaration that a reconstituted SED, Inc. which is purportedly owned 100% by Canon but still involving numerous reciprocal agreements with Toshiba, will be considered a Canon subsidiary. At the same time, we filed a motion for partial summary judgment, seeking the Court’s affirmation of our termination of the license agreement due to Canon’s breach of contract in 2004. On February 22, 2007, the Court issued a ruling denying Canon’s motion and granting our motion for partial summary judgment, ruling our termination of the contract effective December 1, 2006, to be valid.

Keesmann litigation

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS

On September 11, 2007 the Company held its 2007 Annual Meeting of Shareholders. The following items were presented to a vote of the holders (the “Shareholders”) of the Company’s issued and outstanding Common Stock:

(1)	Election of Directors.

(2)	To approve a proposal to amend the Company’s Amended and Restated Articles of Incorporation to eliminate the classification of the Board of Directors.

(3)	To approve a proposal to amend the Company’s Amended and Restated Bylaws to eliminate the classification of the Board of Directors.

(4)	To approve a proposal to amend the Company’s Amended and Restated 2002 Equity Compensation Plan to increase the number of shares authorized by such plan by 2,000,000 shares to 10,000,000, shares.

(5)	To ratify the appointment of Sprouse & Anderson, LLP as the Company’s independent public accountants for the fiscal year ending December 31, 2007.

The number of votes cast for each of the above is summarized in the table below. All numbers in the table below represent shares of Common Stock or the voting equivalent thereof:

Item Submitted to Shareholders	For	Against	Abstain	Non-Votes	Total


(1) Election of Directors
Election of Bradford S. Lamb	91,232,770	589,630	0	0	91,832,360
Election of Howard Westerman	91,247,170	585,190	0	0	91,832,360
Election of Douglas P. Baker	91,239,780	592,580	0	0	91,832,360
Election of Dr. Robert Ronstadt	91,270,370	561,990	0	0	91,832,360
Election of Dr. Zvi Yaniv	91,248,645	583,715	0	0	91,832,360
Election of Dr. Tracy Bramlett	91,253,830	578,530	0	0	91,832,360
Election of Ronald J. Berman	91,161,055	671,305	0	0	91,832,360
Election of Patrick V. Stark	91,265,970	566,390	0	0	91,832,360
Election of Thomas F. Bijou	91,237,205	595,155	0	0	91,832,360
(2) Approval of Elimination of
Classified Board of Directors	89,985,687	1,564,375	282,296	0	91,832,360
(3) Approval of Elimination of
Classified Board of Directors	90,009,127	1,557,174	266,058	0	91,832,360
(2) Approval of Amended 2002
Equity Compensation Plan	29,136,581	4,649,743	771,556	57,274,480	91,832,360
(3) Ratification of Sprouse & Anderson,
LLP as auditors	91,314,967	371,253	146,138	0	91,832,360

ITEM 6. EXHIBITS

Exhibits: See Index to Exhibits on page 18 for a descriptive response to this item.

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: October 30, 2007	/s/ Thomas F. Bijou Thomas F. Bijou Chief Executive Officer (Principal Executive Officer)

Date: October 30, 2007	/s/ Douglas P. Baker Douglas P. Baker Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

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 Thomas F. Bijou

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

32.1	Section 1350 Certificate of Thomas F. Bijou

32.2	Section 1350 Certificate of Douglas P. Baker

Nano Magic Inc. - Quarter Report: 2007 September (Form 10-Q)

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