----

----

Index

**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 |
|--|----------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|

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

**COMMISSION      FILE NO. 1-11602**

**NANO-PROPRIETARY,      INC.**

| **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) |

|              [X]  Yes                                               [                     ]   No |   |   |   |   |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|

|                                  [  ]   Yes                              [X]   No |   |   |   |   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|

----

**NANO-PROPRIETARY,      INC.**

**INDEX**

| Part                I.  Financial Information | **Page**                                                                                                                                                                                                                                                          |
|----------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                               |                                                                                                                                                                                                                                                              |   |   |
|                                               | Item                1.  Financial Statements                                                                                                                                                                                                                 |   |
|                                               |                                                                                                                                                                                                                                                              |   |   |
|                                               |                                                                                                                                                                                                                                                              | Consolidated                Balance Sheets--September                30, 2006 and December 31, 2005 | 3 |
|                                               |                                                                                                                                                                                                                                                              |   |   |
|                                               |                                                                                                                                                                                                                                                              | Consolidated                Statements of Operations --Three                Months and Nine Months Ended          September                30, 2006 and 2005 |  4 |
|                                               |                                                                                                                                                                                                                                                              |   |   |
|                                               |                                                                                                                                                                                                                                                              | Consolidated                Statements of Cash Flows --Nine                Months Ended          September                30, 2006 and 2005 |  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                                                                                                                                                                 | 14 |
|                                               |                                                                                                                                                                                                                                                              |   |
|                                               | Item                6.  Exhibits                                                                                                                                                                                                                             | 15 |
|                                               |                                                                                                                                                                                                                                                              |   |   |
| Signatures                                         | 16                                                                                                                                                                                                                                                                |

----

**PART      I.  FINANCIAL INFORMATION**

**ITEM      1.  FINANCIAL STATEMENTS**

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**CONSOLIDATED      **
**BALANCE      SHEETS**

| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                                                |   | **(Unaudited)****September                30,****2006** |         |  **December                31,****2005** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------|--------------|-----------------------------------------------|--------|
| Current                assets:                                                                                                                                                                                                                                                                                                                                                                            |   |                                                    |         |                                          |   |
| Cash                and cash equivalents                                                                                                                                                                                                                                                                                                                                                                  |        | $                                                       | 627,188      |                                               | $      | 897,247 |  |
| Accounts                receivable, trade - net of allowance for doubtful accounts                                                                                                                                                                                                                                                                                                                        |   |                                                    | 187,748      |                                          |   | 94,103 |   |
| Prepaid                expenses and other current assets                                                                                                                                                                                                                                                                                                                                                  |   |                                                    | 99,813       |                                          |   | 85,306 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
|                                Total current assets                                                                                                                                                                                                                                                                            |   |                                                    | 914,749      |                                          |   | 1,076,656 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
| Property                and equipment, net                                                                                                                                                                                                                                                                                                                                                                |   |                                                    | 134,837      |                                          |   | 101,785 |   |
| Other                assets                                                                                                                                                                                                                                                                                                                                                                               |   |                                                    | 9,540        |                                          |   | 9,540 |   |
|                                Total assets                                                                                                                                                                                                                                                                                    |   | $                                                       | 1,059,126    |                                          | $      | 1,187,981 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
| **LIABILITIES                AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                                                                                                                                                                                                                   |   |                                                    |              |                                          |   |  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
| Current                liabilities:                                                                                                                                                                                                                                                                                                                                                                       |   |                                                    |              |                                          |   |  |   |
| Accounts                payable                                                                                                                                                                                                                                                                                                                                                                           |   | $                                                       | 1,785,441    |                                          | $      | 231,131 |   |
| Obligations                under capital lease                                                                                                                                                                                                                                                                                                                                                            |   |                                                    | -            |                                          |   | 4,348 |   |
| Accrued                liabilities                                                                                                                                                                                                                                                                                                                                                                        |   |                                                    | 90,759       |                                          |   | 93,163 |   |
| Deferred                Revenue                                                                                                                                                                                                                                                                                                                                                                           |   |                                                    | 284,832      |                                          |   | - |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
|                                Total current liabilities                                                                                                                                                                                                                                                                       |   |                                                    | 2,161,032    |                                          |   | 328,642 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
| Commitments                and contingencies                                                                                                                                                                                                                                                                                                                                                              |   |                                                    | -            |                                          |   | - |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
| Stockholders'                Equity (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,            101,250,823                and 99,746,440 shares issued and outstanding at            September                30, 2006 and December 31, 2005, respectively |   |                                                    | 101,251      |                                          |   | 99,746 |   |
| Additional                paid-in capital                                                                                                                                                                                                                                                                                                                                                                 |   |                                                    | 98,915,684   |                                          |   | 95,767,647 |   |
| Accumulated                deficit                                                                                                                                                                                                                                                                                                                                                                        |   |                                                    | (100,118,841 | )                                             |   | (95,008,054 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
|                                Total stockholders equity (deficit)                                                                                                                                                                                                                                                             |   |                                                    | (1,101,906   | )                                             |   | 859,339 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                    |              |                                          |   |  |   |
|                                Total liabilities and stockholders equity (deficit)                                                                                                                                                                                                                                             |   | $                                                       | 1,059,126    |                                          | $      | 1,187,981 |   |

----

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**CONSOLIDATED      STATEMENTS OF      OPERATIONS**

**(UNAUDITED)**

|                                                                  |                                                                                      | **For the                Three Months****Ended                September 30,** |            |   | **For                 the Nine Months****Ended                September 30,** |
|-----------------------------------------------------------------------|-------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------|-----------------|--------|------------------------------------------------------------------------------------|
|                                                                  |                                                                                      | **2006**                                                                           |            |   | **2005**                                                                           |   |   | **2006** |   |   | **2005** |
| Revenues                                                              |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
|                                                                  | Government                contracts                                                       | $                                                                                  | 109,182    |   | $                                                                                  | 85,697  |   | $ | 180,296   |   | $ | 173,307  |
|                                                                  | Royalties                                                                                 |                                                                               | -          |   |                                                                               | -  |   |   | -    |   |   | 3,897  |
|                                                                  | Other                                                                                     |                                                                               | 104,659    |   |                                                                               | 160,220  |   |   | 310,738   |   |   | 226,072  |
|                                                                  |           Total                Revenues |                                                                               | 213,841    |   |                                                                               | 245,917  |   |   | 491,034   |   |   | 403,276  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
| Research                and development                               |                                                                                      | 962,458                                                                       |            |   | 666,020                                                                       |   |   | 2,616,767   |   |   | 1,956,216  |
| Selling,                general and administrative expenses           |                                                                                      | 1,184,579                                                                     |            |   | 1,106,375                                                                     |   |   | 4,092,463   |   |   | 2,728,584  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
|                                                                  | Operating                costs and expenses                                               |                                                                               | 2,147,037  |   |                                                                               | 1,772,395  |   |   | 6,709,230   |   |   | 4,684,800  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
| Gain                on sale of intellectual property and other assets |                                                                                      | -                                                                        |            |   | -                                                                             |   |   | (1,100,000)  |   |   | -  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
| Loss                from operations                                   |                                                                                      | (1,933,196)                                                                        |            |   | (1,526,478)                                                                        |   |   | (5,118,196)  |   |   | (4,281,524) |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
| Other                income (expense), net                            |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
|                                                                  | Interest                Expense                                                           |                                                                               | (222)           |   |                                                                               | (381) |   |   | (518)  |   |   | (2,287) |
|                                                                  | Interest                Income                                                            |                                                                               | 2,380      |   |                                                                               | 9,946  |   |   | 7,927   |   |   | 25,495  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
|  Loss                from continuing operations before taxes     |                                                                                      | (1,931,038)                                                                        |            |   | (1,516,913)                                                                        |   |   | (5,110,787)  |   |   | (4,258,316) |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |
|  Provision                for taxes                              |                                                                                      |  -                                                                       |            |   |  -                                                                       |   |   |  -    |   |   |  -  |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |   |   |
| Net                loss                                               | $                                                                                         | (1,931,038)                                                                        |            | $      | (1,516,913)                                                                        |   | $ | (5,110,787)  |   | $ | (4,258,316) |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
| Loss                per share                                         |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |   |   |
|                                                                  | Basic                and Diluted                                                          |                                                                               |            | $      | (0.02)                                                                             |   | $ | (0.02) |   | $ | (0.05) |   | $ | (0.04) |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
| Weighted                average shares outstanding                    |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |
|                                                                  |                                                                                      |                                                                               |            |   |                                                                               |   |   |   |   |   |   |   |   |   |
|                                                                  | Basic                and Diluted                                                          |                                                                               |            |   | 101,862,093                                                                   |   |   | 99,179,808  |   |   | 100,469,473 |   |   | 98,729,768  |

----

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**CONSOLIDATED      STATEMENTS OF CASH      FLOWS**

**(UNAUDITED)**

|                                                                | **For                 the Nine Months Ended****September                30,** |
|---------------------------------------------------------------------|------------------------------------------------------------------------------------|
|                                                                | **2006**                                                                           |   |   | **2005** |
| Cash                flows from operating activities:                |                                                                               |   |   |   |   |
|                                                                |  Net                loss                                                      |   |   | $ | (5,110,787) | $ | (4,258,316) |
|                                                                |                                                                               | Adjustments                to reconcile net loss to net |   |   |   |   |
|                                                                |                                                                               |   | cash                used in operating activities: |   |   |   |   |
|                                                                |                                                                               |   | Depreciation                and amortization expense |   | 32,030  |   | 42,258  |
|                                                                |                                                                               |   | Stock                based compensation expense |   | 648,901  |   | 899,254  |
|                                                                |                                                                               |   | Issuance                of shares to ATI |   | 400,000  |   | -   |
|                                                                |                                                                               |   | Changes                in assets and liabilities: |   |   |   |   |
|                                                                |                                                                               |   |   | Accounts                receivable, trade |   | (93,645) |   | (58,116) |
|                                                                |                                                                               |   |   | Prepaid                expenses and other current assets |   |  (14,507) |   |  (47,358) |
|                                                                |                                                                               |   |   | Accounts                payable and accrued liabilities |   | 1,551,906  |   | (13,816) |
|                                                                |                                                                               |   |   | Deferred                Revenue |   | 284,832  |   | -   |
|                                                                |                                                                               |   |   |   |   |   |   |   |
|                                                                |                                                                               |   |   | Total                adjustments |   | 2,809,517  |   | 822,222  |
|                                                                |                                                                               |   |   |   |   |   |   |   |
|                                                                |                                                                               |   | Net                cash used in operating activities |   | (2,301,270) |   | (3,436,094) |
|                                                                |                                                                               |   |   |   |   |   |   |   |
| Cash                flows from investing activities:                |                                                                               |   |   |   |
|                                                                |                                                                               | Purchases                of fixed assets |   | (65,082) |   | (11,952) |
|                                                                |                                                                               |        Net                cash used in investing activities |   | (65,082) |   | (11,952) |
|                                                                |                                                                               |   |   |   |   |   |   |   |
| Cash                flows from financing activities:                |                                                                               |   |   |   |
|                                                                |                                                                               | Repayment                of capital leases |   | (4,348) |   | (15,839) |
|                                                                |                                                                               | Proceeds                of stock issuance, net of costs |   | 2,100,641  |   | 3,494,938  |
|                                                                |                                                                               |   |   |   |   |   |   |   |
|                                                                |                                                                               |        Net                cash provided by financing activities |   | 2,096,293  |   | 3,479,099  |
|                                                                |                                                                               |   |   |   |   |   |   |   |
| Net                increase (decrease) in cash and cash equivalents |                                                                               | (270,059) |   | 31,053  |
|                                                                |                                                                               |   |   |   |   |   |   |   |
| Cash                and cash equivalents, beginning of period       |                                                                               | 897,247  |   | 901,585  |
|                                                                |                                                                               |   |   |   |   |   |   |   |
| Cash                and cash equivalents, end of period             | $                                                                                  | 627,188  |   | $ | 932,638  |

----

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**NOTES      TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

----

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**NOTES      TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

*Litigation*

----

**NANO-PROPRIETARY,      INC. AND SUBSIDIARIES**

**NOTES      TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

|                                                           |   | ANI                |          | EBT           |   | All                Other |   | Total              |
|----------------------------------------------------------------|--------|--------------------|---------------|---------------|--------|--------------------------|--------|--------------------|
| 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   |
|                                                           |   |               |          |          |   |                     |   |               |
| 2005                                                           |   |               |          |          |   |                     |   |               |
| Revenue                                                        | $      |               | 403,276  | $             |   |  -             | $      |               |  -  | $ |  | 403,276  |
|                                                           |   |               |          |          |   |                     |   |               |
| Profit                (Loss)                                   |   | (3,168,793)        |          |  -  |   | (1,089,523)              |   | (4,258,316)        |
|                                                           |   |               |          |          |   |                     |   |               |
| Expenditures                for                                |   |               |          |          |   |                     |   |               |
|      long-lived                assets |   | 8,297    |          | -        |   | 3,655               |   | 11,952        |

----

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

**FORWARD-LOOKING      STATEMENTS **

**Nine      months ended September 30, 2006 and 2005**

**OVERVIEW**

**OUTLOOK**

----

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

**RECENT      DEVELOPMENTS**

**RECENT      ACCOUNTING PRONOUNCEMENTS**

----

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

**FINANCIAL      CONDITION AND LIQUIDITY**

----

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

**RESULTS      OF OPERATIONS**

----

**ITEM      3.       ****QUANTITATIVE      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

**ITEM      4.       ****CONTROLS      AND PROCEDURES**

----

**PART      II. OTHER INFORMATION**

**ITEM      1.  LEGAL PROCEEDINGS**

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

----

**ITEM      6****.     EXHIBITS**

----

**SIGNATURES**

|                                                               | NANO-PROPRIETARY,                INC.(Registrant)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|--------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Date:     November                6, 2006 |      /s/                R.D.                Burck                                                                                                   R.D.                BurckChief                Executive Officer (Principal                Executive Officer) |
|                                                               |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Date:     November                6, 2006 |     /s/                Douglas P.                Baker                               Douglas                P. BakerChief                Financial Officer(Principal                Financial Officer and PrincipalAccounting                Officer)                                                                                                                                                                                                     |

----

**INDEX      TO EXHIBITS**

| Exhibit |                                                                       |
|---------|----------------------------------------------------------------------------|
| 11      | Computation                of (Loss) Per Common Share                      |
|    |                                                                       |
| 31.1    | Rule                13a-14(a)/15d-14(a) Certificate of R.D. Burck          |
|    |                                                                       |
| 31.2    | Rule                13a-14(a)/15d-14(a) Certificate of Douglas P. Baker    |
|    |                                                                       |
| 32.1    | Section                1350 Certificate of R.D. Burck                      |
|    |                                                                       |
| 32.2    | Section                1350 Certificate of Douglas P.                Baker |