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

Form 10-Q

Index

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 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 [ ] 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).

[ ] Yes [X] No

As of April 27, 2007, the registrant had 107,115,505 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--March 31, 2007 and December 31, 2006	3

		Consolidated Statements of Operations--Three Months Ended March 31, 2007 and 2006	4

		Consolidated Statements of Cash Flows--Three Months Ended March 31, 2007 and 2006	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 2. Unregistered Sales of Equity Securities and Use of Proceeds		15

	Item 6. Exhibits		15

Signatures			16

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS			(Unaudited) March 31, 2007		December 31, 2006
Current assets:
	Cash and cash equivalents	$	1,375,687	$	2,085,338
	Accounts receivable, trade - net of allowance for doubtful accounts		559,155		364,718
	Prepaid expenses and other current assets		42,332		79,301

	Total current assets		1,977,174		2,529,357

	Property and equipment, net		185,928		154,545
	Other assets		109,540		9,540
	Total assets	$	2,272,642	$	2,693,442

	LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
	Accounts payable	$	1,967,989	$	1,562,488
	Accrued liabilities		87,438		87,237
	Deferred Revenue		623,719		401,455

	Total current liabilities		2,679,146		2,051,180

Commitments and contingencies			-		-

Total Liabilities			2,679,146		2,051,180

Stockholders' (deficit):
Convertible 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, 104,393,474 and 104,257,607 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively			104,394		104,258
Additional paid-in capital			102,436,935		102,139,950
Accumulated deficit			(102,947,833)		(101,601,946)

Total stockholders' equity			(406,504)		642,262

Total liabilities and stockholders' equity		$	2,272,642	$	2,693,442

See notes to consolidated financial statements.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	For the Three Months Ended March 31,
	2007			2006
Revenues
Government contracts	$	517,416		$	63,582
Contract Research		302,211			65,000
Other		137,240			33,602
Total Revenues		956,867			162,184

Research and Development		1,075,501			782,054
Selling, general and administrative expenses		1,238,683			1,177,323

Operating costs and expenses		2,314,184			1,959,377

Loss from operations		(1,357,317	)		(1,797,193	)

Other income (expense), net
Interest Expense		(269	)		(113	)
Interest Income		11,699			3,140

Loss from continuing operations before taxes		(1,345,887	)		(1,794,166	)

Provision for taxes		-			-

Net loss	$	(1,345,887	)	$	(1,794,166	)
Loss per share

Basic and Diluted	$	(0.01	)	$	(0.02	)
Weighted average shares outstanding

Basic and Diluted		104,289,473			100,017,273

See notes to consolidated financial statements.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

					For the Three Months Ended March 31,
					2007				2006
Cash flows from operating activities:
	Net loss				$	(1,345,887)	$		(1,794,166)
		Adjustments to reconcile net loss to net
			cash used in operating activities:
			Depreciation and amortization expense			11,327			13,307
			Stock based compensation expense			189,868			446,148
			Changes in assets and liabilities:
				Accounts receivable, trade		(194,437)			(7,614)
				Prepaid expenses and other assets		(63,031)			36,764
				Accounts payable and accrued liabilities		405,702			122,890
				Deposits and Deferred Revenue		222,264			100,000

				Total adjustments		571,693			711,495

			Net cash used in operating activities			(774,194)			(1,082,671)

Cash flows from investing activities:
		Capital expenditures				(42,710)			(5.692)
		Net cash used in investing activities				(42,710)			(5,692)

Cash flows from financing activities:
		Repayment of notes payable and capital lease obligations				-			(4,049)
		Proceeds of stock issuance, net of costs				107,253			1,500,000

		Net cash provided by financing activities				107,253			1,495,951

Net increase (decrease) in cash and cash equivalents						(709,651)			407,588

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

Cash and cash equivalents, end of period					$	1,375,687		$	1,304,835

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 of the Company for the three-month periods ended March 31, 2007 and 2006, have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company’s management, all adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company as of March 31, 2007 and 2006, and for the periods then ended, have been made. Those adjustments consist of normal and recurring adjustments. The consolidated balance sheet of the Company as of December 31, 2006, has been derived from the audited consolidated balance sheet of the Company as of that date.

Certain information and note disclosures normally included in the Company’s 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 the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006, as filed with the Securities and Exchange Commission.

The results of operations for the three-month period ended March 31, 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 three months ended March 31, 2007 and 2006, was $269 and $113, respectively. During the three months ended March 31, 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.

3. Stockholders’ Equity

During the three months ended March 31, 2007, the Company issued 135,687 shares of its common stock and received $107,253 in connection with the exercise of stock options. In the three months ended March 31, 2006, the Company issued 750,000 restricted shares of its common stock and received net proceeds of $1,500,000 in an exempt offering under Regulation D of the Securities Act of 1933.

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 $189,868 in compensation expense in the period ended March 31, 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 for the fiscal year ended December 31, 2006. For options issued in 2007, the same assumptions were used except that risk free interest rates ranging from 4.58% to 4.79% were used and an annualized volatility rate of approximately 75% was used.

The Company recorded $446,148 in compensation expense in the period ended March 31, 2006, related to options issued under its stock-based incentive compensation plans.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

5. Contingencies

Litigation

The Company is a defendant in minor lawsuits described in greater detail in its 2006 annual report on Form 10-K. 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. The suit is now proceeding 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 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. Trial on the remaining counts is scheduled to begin on April 30, 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.

NANO-PROPRIETARY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

5. Contingencies (continued)

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 Northern District of Illinois has set a status conference on the case for May 24, 2007.

6. Business Segments

Following is information related to the Company’s business segments for the three months ended March 31, 2007 and 2006:

	ANI		EBT		All Other		Total
2007

Revenue	$	956,867	$	-	$	-	$	956,867

Profit (Loss)	(956,574)		(1,298)		(388,015)		(1,345,887)

Expenditures for
long-lived assets	42,710		-		-		42,710

2006

Revenue	$	162,184	$	-	$	-	$	162,184

Profit (Loss)	(1,229,535)		(7,199)		(557,432)		(1,794,166)

Expenditures for
long-lived assets	5,692		-		-		5,692

7. Subsequent Events

During the period from April 1, 2007 through April 27, 2007, we issued 2,608,698 shares of common stock and received $6,000,000 in connection with a private placement in an exempt offering under Regulation D of the Securities Act of 1933. In connection with this offering, we issued 1,304,349 warrants to purchase additional shares of our common stock at a price of $2.50 per share for a period of twelve months.

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 the Company’s 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.

Three months ended March 31, 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 for the year ended December 31, 2006, we expect to incur additional research and development expenses throughout 2006 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 in excess of $7 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. 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 in excess of $7.0 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 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 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.

In April 2007, we retained Citi’s investment banking division as our exclusive advisor to review various financial and strategic alternatives.

In April 2007, we issued 2,608,698 shares of common stock and received $6,000,000 in connection with a private placement in an exempt offering under Regulation D of the Securities Act of 1933. In connection with this offering, we issued 1,304,349 warrants to purchase additional shares of our common stock at a price of $2.50 per share for a period of twelve months. This was done for the primary purpose of enabling us to apply for listing on the American Stock Exchange.

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.

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

FINANCIAL CONDITION AND LIQUIDITY

Our cash position decreased during the period. At March 31, 2007 we had cash and cash equivalents of approximately $1.4 million as compared with cash and cash equivalents of $2.1million at December 31, 2006. This decrease in cash is primarily the result of cash used in operating activities.

We had cash flow from financing activities of approximately $100,000 during the quarter ended March 31, 2007 (the “2007 Period”), as compared with cash flow from financing activities of approximately $1.5 million during the quarter ended March 31, 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 $1,500,000 from the issuance of common stock related to private placements during the 2006 Period. The proceeds from stock issuance during the 2007 Period resulted from the exercise of stock options.

Our cash used in operating activities decreased from $1,082,671 in the 2006 Period to $774,194 in the 2007 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 2007 as a result of increasing revenues, while expenses increase at a much lower rate.

We used net cash of $5,692 for investing activities in the 2006 Period related to the purchase of research equipment, compared with cash used in investing activities related to equipment purchases of $42,710 in the 2007 Period. 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. We raised an additional $6.0 million equity in April 2007. Given our current cash balance, which is in excess of $7 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"). 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 2007. 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 2007 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.

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.

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

RESULTS OF OPERATIONS

Our loss from operations for the 2007 Period was $1,345,887 as compared with the loss from the operations of $1,794,166 for 2006 Period. Our total revenues for the 2007 Period were approximately $800,000 higher than in the 2006 Period; however our costs associated with the revenues were also higher during the 2007 Period. These increased revenues account for the decreased loss during the 2007 Period.

Our revenues for the quarter ended March 31, 2007, totaled $956,867 compared to $162,184 for the same quarter in 2006. The revenues in both periods were all from ANI and substantially all the result of reimbursed research expenditures. During the 2006 Period, $63,582 of the revenue came from government contracts and $98,602 came from other sources. In the 2007 Period, our revenue from government contracts increased to $517,416, and our revenue from other commercial sources increased to $439,451. At the present stage of our development, significant conclusions cannot be drawn by comparing revenues from period to period; however, we would expect the quarterly revenue for the balance of 2007 to remain at or above the first quarter level. 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. Our private research funding tends to come in large amounts at sporadic times.

We have a revenue backlog of approximately $2.6 million as of March 31, 2007 and we expect our revenue to continue at or above current levels in future quarters as a result of this backlog. We had a total revenue backlog of approximately $2.7 million as of March 31, 2006. Our ability to perform continued research, or fulfill our backlog, should not require significant additional personnel.

We incurred research and development expenses of $1,075,501 for the 2007 Period, which was an increase from the $782,054 incurred in the 2006 Period. This reflects a general increase in the level of 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.

Our selling, general, and administrative expenses were $1,238,683 for the 2007 Period, compared with $1,177,323 for the 2006 Period - a slight increase. Included in the 2007 Period are approximately $425,000 of litigation related expenses, an increase of roughly $325,000 from the 2006 Period. This increase in litigation related expenses was partially offset by a decrease of approximately $225,000 in stock based compensation.

Our interest income is insignificant, but increased 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. We expect our interest income to increase significantly for the balance of 2007 as a result of the private placement that we completed in April 2007. 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 be 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 over financial reporting or in other factors that could significantly affect these controls subsequent to the Evaluation Date. We have not identified any material weaknesses in our internal controls, and therefore, no corrective actions were taken.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Canon litigation

Keesmann litigation

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There were no sales of unregistered equity securities during the quarter ended March 31, 2007.

ITEM 6. EXHIBITS

(a) Exhibits: See Index to Exhibits on page 17 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: May 1, 2007	/s/ Thomas F. Bijou Thomas F. Bijou Chief Executive Officer (Principal Executive Officer)

Date: May 1, 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