UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
DC 20549




FORM
10-Q




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




For the quarterly period ended March 31, 2008




 ̈   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 107Austin,
      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, a non-accelerated
filer, or a smaller reporting company.  See the definition of
“accelerated filer”, “large accelerated filer”, and “smaller reporting company”
in rule 12b-2 of the Act.




Large
Accelerated Filer  o   
Accelerated Filer  þ




Non-accelerated
Filer  o     Smaller
Reporting Company  o







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 25, 2008, 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
            PageItem 1.Financial
      StatementsConsolidated
      Balance Sheets--March 31, 2008 and December 31,
      2007
            3Consolidated Statements of
      Operations--Three Months Ended
              March
      31, 2008 and 2007
            4Consolidated Statements of
      Cash Flows--Three Months Ended
              March
      31, 2008 and 2007
            5Notesto Consolidated
      Financial Statements
            6Item
      2.  Management’s Discussion and Analysis of Financial
      Condition
              and
      Results of Operations
            9Item
      3.  Quantitative and Qualitative Disclosures about Market
      Risk
            13Item
      4. Controls
      and Procedures
            13Part
      II.  Other InformationItem 1.Legal
      Proceedings
            14Item
      2. Unregistered Sales of Equity Securities and Use of
    Proceeds
            15Item
      6.  Exhibits
            15Signatures
            16










PART
I.  FINANCIAL INFORMATION




ITEM
1.  FINANCIAL STATEMENTS




NANO-PROPRIETARY,
INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS




ASSETS
            
            (Unaudited)
              March
      31,
              2008
            
            
            December
      31,
              2007Current
      assets:Cash
      and cash equivalents
            
            $
            2,528,839
            
            
            $
            3,020,096Accounts
      receivable, trade – net of allowance for doubtful accounts
            
            
            342,245
            
            
            
            253,963Prepaid
      expenses and other current assets
            
            
            57,099
            
            
            
            77,038Total current assets
            
            
            2,928,183
            
            
            
            3,351,097Property
      and equipment, net
            
            
            268,802
            
            
            
            278,456Other
      assets
            
            
            118,269
            
            
            
            115,305Total assets
            
            $
            3,315,254
            
            
            $
            3,744,858LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Accounts
      payable
            
            $
            721,531
            
            
            $
            447,106Obligations
      under capital lease
            
            
            30,248
            
            
            
            29,416Accrued
      liabilities
            
            
            103,458
            
            
            
            103,003Deferred
      Revenue
            
            
            269,153
            
            
            
            306,427Total current liabilities
            
            
            1,124,390
            
            
            
            885,952Obligations
      under capital lease, long-term
            
            
            22,123
            
            
            
            30,004Total
      Liabilities
            
            
            1,146,513
            
            
            
            915,956Commitments
      and contingencies
            
            
            –
            
            
            
            –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,
              107,173,549
      shares issued and outstanding at
              March
      31, 2008 and December 31, 2007, respectively
            
            
            107,174
            
            
            
            107,174Additional
      paid-in capital
            
            
            108,667,983
            
            
            
            108,580,565Accumulated
      deficit
            
            
            (106,606,416
            )
            
            
            (105,858,837
            )Total stockholders' equity
            
            
            2,168,741
            
            
            
            2,828,902Total liabilities and stockholders' equity
            
            $
            3,315,254
            
            
            $
            3,744,858







See notes
to consolidated financial statements.




3




NANO-PROPRIETARY,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(UNAUDITED)




For 
      the Three Months Ended
              March
      31,2008
            
            
            2007RevenuesGovernment
      contracts
            
            $
            545,824
            
            
            $
            517,416Contract
      Research
            
            
            184,358
            
            
            
            302,211Other
            
            
            139,832
            
            
            
            137,240Total
      Revenues
            
            
            870,014
            
            
            
            956,867Research
      and Development
            
            
            1,182,135
            
            
            
            1,075,501Selling,
      general and administrative expenses
            
            
            1,055,270
            
            
            
            1,238,683Operating
      costs and expenses
            
            
            2,237,405
            
            
            
            2,314,184Gain
      on sale of intellectual property and other assets
            
            
            100,000
            
            
            
            –Loss
      from operations
            
            
            (1,267,391
            )
            
            
            (1,357,317
            )Other
      income (expense), netInterest
      Expense
            
            
            (1,598
            )
            
            
            (269
            )Interest
      Income
            
            
            21,410
            
            
            
            11,699Litigation
      Settlement
            
            
            500,000
            
            
            
            –Loss
      from continuing operations before taxes
            
            
            (747,579
            )
            
            
            (1,345,887
            )Provision
      for taxes
            
            
            –
            
            
            
            –Net
      loss
            
            $
            (747,579
            )
            
            $
            (1,345,887
            )Loss
      per shareBasic
      and Diluted
            
            $
            (0.01
            )
            
            $
            (0.01
            )Weighted
      average shares outstandingBasic
      and Diluted
            
            
            107,173,549
            
            
            
            104,289,473





See notes
to consolidated financial statements.








4




NANO-PROPRIETARY,
INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)




For the
      Three Months Ended
              March
      31,2008
            
            
            2007Cash
      flows from operating activities:Net
      loss
            
            $
            (747,579
            )
            
            $
            (1,345,887
            )Adjustments
      to reconcile net loss to netcash
      used in operating activities:Depreciation
      and amortization expense
            
            
            16,049
            
            
            
            11,327Stock
      based compensation expense
            
            
            87,418
            
            
            
            189,868Changes
      in assets and liabilities:Accounts
      receivable, trade
            
            
            (88,282
            )
            
            
            (194,437
            )Prepaid
      expenses and other assets
            
            
            16,975
            
            
            
            (63,031
            )Accounts
      payable and accrued liabilities
            
            
            274,880
            
            
            
            405,702Deposits
      and Deferred Revenue
            
            
            (37,274
            )
            
            
            222,264Total
      adjustments
            
            
            269,766
            
            
            
            571,693Net
      cash used in operating activities
            
            
            (477,813
            )
            
            
            (774,194
            )Cash
      flows from investing activities:Capital
      expenditures
            
            
            (6,395
            )
            
            
            (42,710
            )Net
      cash used in investing activities
            
            
            (6,395
            )
            
            
            (42,710
            )Cash
      flows from financing activities:Repayment
      of notes payable and capital lease obligations
            
            
            (7,049
            )
            
            
            –Proceeds
      of stock issuance, net of costs
            
            
            –
            
            
            
            107,253Net
      cash provided by (used by) financing activities
            
            
            (7,049
            )
            
            
            107,253Net
      increase (decrease) in cash and cash equivalents
            
            
            (491,257
            )
            
            
            (709,651
            )Cash
      and cash equivalents, beginning of period
            
            
            3,020,096
            
            
            
            2,085,338Cash
      and cash equivalents, end of period
            
            $
            2,528,839
            
            
            $
            1,375,687







See notes
to consolidated financial statements.






5




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, 2008 and 2007, 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, 2008 and 2007, 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, 2007, 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, 2007, as filed with the Securities
and Exchange Commission.




The
results of operations for the three-month period ended March 31, 2008, 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, 2008 and 2007, was $1,598 and
$269, respectively. During the three months ended March 31, 2008 and 2007, 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




The
Company issued no shares of stock during the three months ended March 31, 2008.
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.




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 $76,968 in
compensation expense in the period ended March 31, 2008, 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, 2007. For options issued in 2008, the same
assumptions were used except that risk free interest rates ranging from 1.80% to
3.13% were used and an annualized volatility rate of approximately 75% was used.
The period ended March 31, 2008 also includes $10,450 of expense related to
restricted stock provided to non-employee Directors of the Company as
compensation.




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.






6







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 2007
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 asserted that the Canon/Toshiba joint-venture – SED, Inc. – was 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 the fall of 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”.




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 involved
numerous reciprocal agreements with Toshiba, would 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. Both parties have filed appeals related to the
litigation. All appeal briefs and responses have been filed with the Fifth
Circuit Court of Appeals and oral arguments in the case have been tentatively
scheduled for the week of June 2, 2008.




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.   The complaint, which resulted from Keesmann’s
attempted termination of the license in March 2006, seeks a declaratory judgment
that Keesmann had no right to terminate the exclusive license. 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.




7


NANO-PROPRIETARY,
INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)




5.       Contingencies
(continued)




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.  The Court granted a consent
order that prevents Keesmann from licensing the patents pending an injunction
hearing and decision.




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.
This second motion was withdrawn, without prejudice in March 2008.




In 2005, Keesmann conveyed part of his
interests in the Exclusive License to investors associated with a German patent
evaluation firm, IP Bewertungs AG (“IPB”).  In December 2006, we
amended our original complaint to add these investors as additional defendants.
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. We completed a settlement agreement
with these additional defendants in February 2008. As a result of this
settlement agreement, we received a payment of $500,000 in exchange for dropping
all claims against these defendants. Mr. Keesmann did not participate in this
settlement and the litigation against Mr. Keesmann continues. No trial date has
been set for this matter.




6.       Business
Segments




Following
is information related to the Company’s business segments for the three months
ended March 31, 2008 and 2007:




ANI
            
            
            EBT
            
            
            All
      Other
            
            
            Total2008Revenue
            
            $
            870,014
            
            
            $
            -
            
            
            $
            -
            
            
            $
            870,014Profit
      (Loss)
            
            
            (440,541
            )
            
            
            (520
            )
            
            
            (306,518
            )
            
            
            (747,579
            )Expenditures
      forlong-lived
      assets
            
            
            6,395
            
            
            
            -
            
            
            
            -
            
            
            
            6,3952007Revenue
            
            $
            956,867
            
            
            $
            -
            
            
            $
            -
            
            
            $
            956,867Profit
      (Loss)
            
            
            (956,574
            )
            
            
            (1,298
            )
            
            
            (388,015
            )
            
            
            (1,345,887
            )Expenditures
      forlong-lived
      assets
            
            
            42,710
            
            
            
            -
            
            
            
            -
            
            
            
            42,710





8


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, 2008 and 2007




OVERVIEW




We
are primarily a nanotechnology company engaged in the performance of services
and development of technologies 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, 2007, we expect to incur additional research and
development expenses throughout 2008 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 $2 million as of the
date of this filing, when combined with expected revenue sources, to enable us
to operate at least through the end of 2008.  We have a plan to achieve
profitability in 2008. There can be no assurance that we will achieve
profitability, or even break-even, or that expected revenue sources will all
occur as planned. 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 $2.0 million as of the date
of this filing, when combined with expected revenues, is sufficient to allow us
to maintain operations at least through the end of 2008. We expect additional
revenue producing projects or license agreements to be finalized during 2008. 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.




9


ITEM
2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS O F
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 February 2008, we entered into a
partial settlement of the Keesmann litigation, which is described in more detail
in Part II, Item 1 of this report. As part of this settlement, we received a
payment of $500,000. The settlement also has the effect of simplifying the
remaining issues in the case and should reduce both the cost of, and time to,
ultimate resolution of the entire case.




During the quarter ended March 31,
2008, we extended the life on warrants due to expire on April 23, 2008. These
warrants were originally issued in connection with the private placement of our
common stock completed in April 2007. As part of that private placement, we
issued a total of 1,304,353 warrants, each enabling the holder purchase a share
of our common stock at a price of $2.50 per share. The expiration date of these
warrants was extended to December 31, 2008.




In February 2008, we received a notice
of allowance from the U.S. Patent Office related to our patent application
titled “Nanobiosensor and carbon nanotube thin film transistor.” This patent is
one of the basic patents that covers a wide variety  of biosensor
applications and combines a sensing element with a thin film transistor
structure to report and measure the results.




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.




10


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, 2008 we had cash and cash
equivalents of approximately $2.5 million as compared with cash and cash
equivalents of $3.0 million at December 31, 2007.  This decrease in
cash is primarily the result of cash used in operating activities.




Our cash
used in operating activities decreased from $774,194 in the 2007 Period to
$477,813 in the 2008 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 fluctuate in future quarters in 2008, depending
on the timing of receipt of various items. We expect reduced cash used in
operations, or positive cash flow from operations, later in 2008 as a result
of  increasing revenues, while expenses increase at a much lower
rate.




We used
cash in financing activities of $7,049 during the quarter ended March 31, 2008
(the “2008 Period”), as compared with cash flow from financing activities of
$107,253 during the quarter ended March 31, 2007 (the “2007 Period”). The cash
flow in the 2007 Period resulted from the issuance of common stock in connection
with the exercise of stock options. The cash used in the 2008 Period was the
result of payments on capital leases.




We used net cash of $42,710 for
investing activities in the 2007 Period related to the purchase of research
equipment, compared with cash used in investing activities related to equipment
purchases of $6,395 in the 2008 Period. We expect cash used in investing
activities to remain at relatively insignificant levels for the balance of
2008.




The
principal source of our liquidity has been funds received from exempt offerings
of common stock. Given our current cash balance, which is approximately $2
million, we do not expect that we will need to raise additional funds in 2008;
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 2008. While we would likely receive
initial license payments, ongoing royalty streams related to some licenses may
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.




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.




11


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




RESULTS
OF OPERATIONS




Our loss
from operations for the 2008 Period was $747,579 as compared with the loss from
the operations of $1,345,887 for 2007 Period. Our total revenues for the 2008
Period were slightly lower than in the 2007 Period; however our costs associated
with the revenues decreased by a similar amount during the 2008 Period. The
reasons for the decreased loss are discussed in more detail below.




Our
revenues for the quarter ended March 31, 2008, totaled $870,014 compared to
$956,867 for the same quarter in 2007. The revenues in both periods were all
from ANI and substantially all the result of reimbursed research expenditures.
During the 2007 Period, $517,416 of the revenue came from government contracts
and $439,451came from other private sources. In the 2008 Period, our revenue
from government contracts increased to $545,824, and our revenue from other
commercial sources decreased to $324,190. 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 2008 to increase 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 $3.2 million as of March 31, 2008 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 $2.6
million as of March 31, 2007. Our ability to perform continued research, or
fulfill our backlog, should not require significant additional
personnel.




We
incurred research and development expenses of $1,182,135 for the 2008 Period,
which was an increase from the $1,075,501 incurred in the 2007 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 $1,055,270 for the 2008
Period, compared with $1,238,683 for the 2007 Period – a decrease of about
$185,000. Included in the 2008 Period are approximately $150,000 of litigation
related expenses, a decrease of roughly $275,000 from the 2007 Period. This
decrease in litigation related expenses was partially offset by an increase in
other selling, general, and administrative expenses, including other
professional services.




Our interest income is insignificant,
but increased during the 2008 Period as a result of a higher average level of
invested cash balances. 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 remain at insignificant levels for the balance of 2008. Our interest
expense was insignificant in both periods and is expected to remain so for the
balance of the year.




During the 2008 Period, we also had a
gain of $100,000 from the sale of certain excess patents, which we were no
longer using and which did not relate to any of our current technology
platforms. The 2008 Period also included a gain of $500,000 from a partial
settlement related to the Keesmann litigation, which is discussed in greater
deal in Part II, Item 1 to this report.









12


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.




13


PART
II.  OTHER INFORMATION




ITEM
1.  LEGAL PROCEEDINGS




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 asserted that the Canon/Toshiba joint-venture – SED, Inc. – was 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 the fall of 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”.




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 involved
numerous reciprocal agreements with Toshiba, would 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. Both parties have filed appeals related to the
litigation. All appeal briefs and responses have been filed with the Fifth
Circuit Court of Appeals and oral arguments in the case have been tentatively
scheduled for the week of June 2, 2008.




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.   The complaint, which resulted from Keesmann’s
attempted termination of the license in March 2006, seeks a declaratory judgment
that Keesmann had no right to terminate the exclusive license. 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.




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.  The Court granted a consent
order that prevents Keesmann from licensing the patents pending an injunction
hearing and decision.




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.
This second motion was withdrawn, without prejudice in March 2008.




In 2005, Keesmann conveyed part of his
interests in the Exclusive License to investors associated with a German patent
evaluation firm, IP Bewertungs AG (“IPB”).  In December 2006, we
amended our original complaint to add these investors as additional defendants.
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. We completed a settlement agreement
with these additional defendants in February 2008. As a result of this
settlement agreement, we received a payment of $500,000 in exchange for dropping
all claims against these defendants. Mr. Keesmann did not participate in this
settlement and the litigation against Mr. Keesmann continues. No trial date has
been set for this matter.




14







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, 2008.









ITEM
6.     EXHIBITS




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




15


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:     April
      29, 2008
            /s/
      Thomas F. Bijou
              Thomas
      F. Bijou
              Chief
      Executive Officer (Principal Executive Officer)Date:     April
      29, 2008
            /s/
      Douglas P.
      Baker
              Douglas
      P. Baker
              Chief
      Financial Officer
              (Principal
      Financial Officer and Principal
              Accounting
      Officer)











16


INDEX
TO EXHIBITS




The
following documents are filed as part of this Report:




Exhibit11
            Computation
      of (Loss) Per Common Share31.1
            Rule
      13a-14(a)/15d-14(a) Certificate of Thomas F. Bijou31.2
            Rule
      13a-14(a)/15d-14(a) Certificate of Douglas P. Baker32.1
            Section
      1350 Certificate of Thomas F. Bijou32.2
            Section
      1350 Certificate of Douglas P.
Baker














17