**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549**

**FORM 10-QSB**

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

        For the quarterly period endedMarch 31, 2004

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

**COMMISSION FILE NO. 1-11602**

**NANO-PROPRIETARY, INC.**(Exact name of registrant as specified in its charter)

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

****

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

| **(512) 339-5020**                                     |
|--------------------------------------------------------|
|                                                        |
| *(Registrant's telephone number, including area code)* |

 

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

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

As of April 23, 2004, the registrant had 96,392,841 shares of common stock, par value$.001 per share, issued and outstanding.

Transitional Small Business Disclosure Format.

Yes  [  ]   No [X]

----

**NANO-PROPRIETARY, INC.INDEX**

| Part I.  Financial Information | **Page**                                                                                                                                                                                                                                    |
|-------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 1.  Financial Statements                                                                                                                                                                                                          |   |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Balance Sheets--March 31, 2004 and December 31,2003 | 3 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Statements of Operations--Three Months Ended           March 31, 2004 and 2003 | 4 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Statements of Cash Flows--Three Months Ended           March 31, 2004 and 2003 | 5 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Notes to Consolidated Financial Statements | 6 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 2.  Management’s Discussion and Analysis of FinancialCondition                      and Results of Operations | 8 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 3.  Controls and Procedures                                                                                                                                                                                                  | 12 |
|                                |                                                                                                                                                                                                                                        |   |   |
| Part II.  Other Information    |                                                                                                                                                                                                                                        |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 1. LegalProceedings                                                                                                                                                                                                                    | 13 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 2. Changes in Securitiesand Small Business Issuer Purchases of Equity Securities                                                                                                                                                       | 13 |
|                                     |                                                                                                                                                                                                                                             |  |
|                                | Item 6.  Exhibits and Reports on Form 8-K                                                                                                                                                                                              | 14 |
|                                |                                                                                                                                                                                                                                        |   |   |
| Signatures                          | 15                                                                                                                                                                                                                                          |

2
**PART I.  FINANCIAL INFORMATION**
**ITEM 1.  FINANCIAL STATEMENTS**
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

**ASSETS**

 

**(Unaudited) March 31, 2004**

**December 31, 2003**

Current assets:

 

 

 

 

 

Cash and cash equivalents

 $

3,904,919 

$

3,564,570 

 

Accounts receivable, trade – net of allowance for doubtful accounts

 

26,376 

 

41,132 

 

Prepaid expenses and other current assets

 

144,219 

 

100,201 

 

 

 

 

 

 

 

               Total current assets

 

4,075,514 

 

3,705,903 

 

 

 

 

 

 

 

Property and equipment, net

 

80,366 

 

77,314 

 

Other assets

 

800 

 

800 

 

               Total assets

$

4,156,680 

$

3,784,017 

 

 

 

 

 

 

 

**LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

$

280,829 

$

126,809 

 

Obligations under capital lease

 

19,868 

 

19,380 

 

Accrued liabilities

 

59,136 

 

57,646 

 

 

 

 

 

 

 

               Total current liabilities

 

359,833 

 

203,835 

 

 

 

 

 

 

Obligations under capital lease

 

22,204 

 

27,353 

 

 

 

 

 

 

 Total Liabilities

 

 382,037 

 

231,188 

 

 

 

 

 

 

Commitments and contingencies

 

– 

 

–  

 

 

 

 

 

Stockholders' (deficit):

 

 

 

 

     Convertible preferred stock, $1.00 par value, 2,000,000shares authorized;             No shares issued and outstanding

 

– 

 

–  

     Common stock, $.00l par value, 120,000,000 sharesauthorized,             96,312,877 and 95,612,990 shares issued and outstandingat             March 31, 2004 and December 31, 2003,respectively

 

96,313 

 

95,613 

Additional paid-in capital

 

80,251,360 

 

78,918,605 

Accumulated deficit

 

(76,573,030)

 

(75,461,389)

 

 

 

 

 

               Total stockholders' (deficit)

 

3,774,643 

 

3,552,829

 

 

 

 

 

               Total liabilities and stockholders' (deficit)

$

4,156,680 

$

3,784,017 

 See notes to consolidated financial statements.

3
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(UNAUDITED)**

 

 

**For  the Three Months Ended March 31,**

 
 
**2004**
  
**2003**

Revenues

 

 

 

 

 

 

Government contracts

$

65,880 

 

$

10,387 

 

Privately funded research

 

– 

 

 

400,000 

 

Royalties

 

– 

 

 

920 

 

Other

 

11,778 

 

 

33,145 

 

          Total Revenues

 

77,658 

 

 

444,452 

 

 

 

 

 

 

 

Cost of sales

 

123,306 

 

 

76,893  

Research and Development

 

628,289 

 

 

282,498 

Selling, general and administrative expenses

 

 443,925 

 

 

434,585 

Royalty expense

 

 – 

 

 

400,000 

 

 

 

 

 

 

 

Operating costs and expenses

 

1,195,520 

 

 

1,193,976 

 

 

 

 

 

 

 

Loss from operations

 

(1,117,862)

 

 

(749,524)

 

 

 

 

 

 

 

Other income (expense), net

 

 

 

 

 

 

Interest Expense

 

(1,172)

 

 

(26,140)
 
Interest Income

 

7,268 

 

 

– 

 

Other

 

125 

 

 

4,695 

 

 

 

 

 

 

 

 Loss from continuing operations before taxes

 

(1,111,641)

 

 

(770,969)

 

 

 

 

 

 

 

 Provision for taxes

 

 – 

 

 

 – 

 

 

 

 

 

 

 

 

 

Net loss

$

(1,111,641)

 

$

(770,969)

Loss per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

 

$

(0.01)

 

$

(0.01)

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

 

 

94,961,000 

 

 

79,738,707

See notes to consolidated financial statements.

4
 

**NANO-PROPRIETARY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

 

**For  the Three Months Ended March 31,**

 

**2004**

 
 
**2003**

Cash flows from operating activities:

 

 

 
 
 

 

 Net loss

 

 

$

(1,111,641)

$

(770,969)

 

 

Adjustments to reconcile net loss to net

 

 

 

 

 

 

 

cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization expense

 

11,678 

 

11,356 
   
Gain on sale of fixed assets
 
(125)
 
(4,695)

 

 

 

Common shares issued for patent option

 

– 

 

13,636  

 

 

 

Options issued for services

 

116,600 

 

– 
   
Non-cash variable option pricing expense
 
(165,750)
 
– 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, trade

 

14,756 

 

11,787 

 

 

 

 

Prepaid expenses and other current assets

 

 (44,018)

 

32,355 

 

 

 

 

Accounts payable and accrued liabilities

 

155,510 

 

202,233 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total adjustments

 

88,651 

 

266,672 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

(1,022,990)

 

(504,297)

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Capital expenditures

 

 

(14,730)

 

– 

 

 

Proceeds from sale of fixed assets

 

125 

 

4,695 

 

 

       Net cash used in investing activities

 

(14,605)

 

4,695 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Repayment of notes payable and capital lease obligations

 

(4,661)

 

(17,170)

 

 

Proceeds of stock issuance, net of costs

 

1,382,605 

 

504,250 

 

 

 

 

 

 

 

 

 

 

 

       Net cash provided by financingactivities

 

1,377,944 

 

487,080 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

340,349 

 

(12,522)

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

3,564,570 

 

15,868 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

$

3,904,919 

 

$

3,346 

See notes to consolidated financial statements.

5
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

1.       Basis of Presentation

               The consolidated financial statements of the Company for the three month periods ended March 31, 2004 and 2003 have been preparedby the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of theCompany’s management, all adjustments necessary to present fairly the financial position, results of operations, and cashflows of the Company as of March 31, 2004 and 2003 and for the periods then ended have been made. Those adjustments consist ofnormal and recurring adjustments. The consolidated balance sheet of the Company as of December 31, 2003 has been derived from theaudited 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 inaccordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statementsshould be read in conjunction with a reading of the financial statements and notes thereto included in the Company’s AnnualReport on Form 10-KSB for the fiscal year ended December 31, 2003 as filed with the U.S. Securities and ExchangeCommission.

               The results of operations for the three month period ended March 31, 2004 are not necessarily indicative of the results to beexpected for the full year.

2.       Supplemental Cash Flow Information

               Cash paid for interest for the three months ended March 31, 2004 and 2003 was $1,172 and $1,917, respectively. During the threemonth ended March 31, 2003, the Company had non-cash transactions related to the conversion of notes payable, including relatedaccrued interest, into shares of the Company’s common stock. During the three months ended March 31, 2004, the Company hadnon-cash transactions related to variable option pricing and options issued to a consultant. These transactions are described ingreater detail in Note 3.

3.       Stockholders’ Equity

               In the three months ended March 31, 2004, the Company issued 401,887 restricted shares of its common stock and received netproceeds of $1,065,000 in an exempt offering under Regulation D of the Securities Act of 1933.  The Company issued 278,000shares of its common stock and received $299,205 in connection with the exercise of employee stock options, primarily by formeremployees of the Company, and issued 20,000 shares and received $18,400 in connection with the exercise of warrants.

               In April 2001, the Company repriced a total of 900,500 options to lower the exercise price of these options to $1.50, which wasapproximately 160% of the market price of the stock at the time of the repricing. The repricing of these options resulted in a newmeasurement date for accounting purposes and reclassification of these options as variable plan awards beginning on the date of therepricing. The Company previously accounted for these option grants as fixed plan awards. From the date of the repricing throughDecember 31, 2002, the quoted value of the Company’s common stock did not exceed the exercise price of the options and assuch no compensation expense was recognized at any period through that date. In 2003, the Company’s common stock priceexceeded the exercise price and remained above it, closing at $2.73 per share on December 31, 2003. The Company recorded $749,755in non-cash option expense for the cumulative effects of the repricing and increased additional paid-in capital by the same amountin 2003. During the quarter ended March 31, 2004, the price of the Company’s common stock declined and  closed at $2.39on March 31, 2004. The Company reversed $165,750 of the previously recorded expense in the quarter ended March 31, 2004, as aresult of this price decline.

               In the quarter ended March 31, 2004, the Company issued 100,000 options to a consultant with an exercise price of $3.08 per share.In connection with the options, the Company recorded $116,600 as an expense during the period.

               In the quarter ended March 31, 2003, the Company issued 2,089,517 restricted shares of its common stock and received net proceedsof $504,250 in exempt offerings under Regulation D of the Securities Act of 1933.  The Company also issued 3,483,746 shares ofcommon stock in connection with the payment of convertible notes payable and related accrued interest. The face amount of the noteswas $600,000 and the related accrued interest totaled $105,863. The Company also issued 100,000 shares valued at $55,000 inconnection with the payment of accounts payable and 71,021 shares valued at $13,636 in connection with a patentextension.

6
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

4.       Contingencies

*Litigation*

          The Company is a defendant inminor lawsuits described in greater detail in its 2003 annual report on Form 10-KSB. The Company expects any potential eventualpayment to have no material affect on the financial statements.

5.       Business Segments

Following is information related to the Company’s business segments for the threemonths ended March 31, 2004 and 2003:

 

 

ANI
 
EBT
 
All Other
 
Total

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$ 

77,658 

 

$ 

 - 

 

$

 - 

 

$ 

77,658 

 

 

 

 

 

 

 

 

 

Profit (Loss)

 

(1,029,273)

 

53,097 

 

(135,465)

 

(1,111,641)

 

 

 

 

 

 

 

 

 

Expenditures for

 

 

 

 

 

 

 

 

     long-lived assets

 

12,357 

 

- 

 

2,373 

 

14,730 

 

 

 

 

 

 

 

 

 

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 
 $
 444,452 

 

$ 

 - 

 

$ 

-  

 

 $
 444,452 

 

 

 

 

 

 

 

 

 

Profit (Loss)

 

(558,458)

 

(5,382)

 

  (207,129)

 

(770,969)

 

 

 

 

 

 

 

 

 

Expenditures for

 

 

 

 

 

 

 

 

     long-lived assets

 

- 

 

- 

 

-  

 

- 

6.       Subsequent Events

          For the period from April 1,2004 through April 23, 2004, the Company issued a total of 79,964 shares of common stock and received proceeds of $34,247 inconnection with the exercise of options under the Company’s stock option plans.

7.       Recently Issued AccountingStandards

            There are no recentaccounting pronouncements that have not been implemented by the Company that are expected to have a material impact on thefinancial statements of the Company.

7
**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

The following is management’s discussion and analysis of certain significant factorsthat have affected the Company’s financial position and operating results during the periods included in the accompanyingconsolidated financial statements.

**FORWARD-LOOKING STATEMENTS**

          This Form 10-QSB containscertain forward-looking statements that we believe are within the meaning of Section 27A of the Securities Act of 1933 and Section21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For thispurpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including thestatements 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 inthis Form 10-QSB containing the words "believes," "anticipates," "plans," "expects" and similar expressions constituteforward-looking statements, although not all forward-looking statements contain such identifying words. These forward-lookingstatements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating toour operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties.

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

**Three months ended March 31, 2004 and 2003**

**OVERVIEW**

          During the three months endedMarch 31, 2004, our primary revenues were earned as a result of reimbursed research expenditures at our Applied Nanotech, Inc.(“ANI”) subsidiary. We continued to incur substantial expenses in support of the development of our proprietary CarbonNanotube Based Field Emission (“CFE”) Technology and other Carbon Nanotube Based Technologies. As more fully discussedin our Annual Report on Form 10-KSB for the year ended December 31, 2003, we expect to incur additional research and developmentexpenses throughout 2004 in developing our CFE technology. We are focused on licensing our technology and obtaining sufficientrevenue to cover our ongoing research expenditures.

**OUTLOOK**

          We expect our present cashbalances of approximately $3.5 million as of the date of this filing, when combined with expected revenue sources, to enable us tooperate for at least 12 months from the date of this filing.  We expect to achieve profitability in 2004. There can be noassurance that we will achieve profitability, or even break-even, in the future.  To the extent our revenues do not allow usto break-even, or if the timing of revenues does not match with expenses, we could be required to raise additional funds throughthe issuance of debt or equity securities to enable us to maintain operations at the present level. The mix of revenues receivedcould also cause the revenues required to break-even to increase. If revenue producing projects require unanticipated expenses, orheavier than anticipated use of outside services or materials, we may be unable to achieve profitability at the expected level ofrevenues.

          We have developed a plan toallow ourselves to maintain operations until we are able to sustain ourselves on our own revenue. Our plan is primarily dependenton raising funds through the licensing of our technology and reimbursed research contracts. Our current cash of approximately $3.5million as of the date of this filing is sufficient to allow us to maintain operations for at least 12 months from the date of thisfiling. We expect additional revenue producing projects or license agreements to be finalized during that time period. We believethat we have the ability to continue to raise funding, if necessary, to enable us to continue operations until our plan can becompleted.

8 
**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTSOF OPERATIONS (cont.)**

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

**RECENT DEVELOPMENTS**

          We completed aprivate placement of shares of our common stock in February 2004. As a result of this private placement we issued 401,887shares of our common stock in exchange for gross proceeds of $1,065,000.  Expensesassociated with this transaction were negligible. We expect that the proceeds of this transaction, when combined with our existingcash and expected revenues, will enable us to operate for at least 12 months from the date of this filing.

            InFebruary 2004, our independent auditors, Sprouse & Anderson, L.L.P., completed their audit and issued an unqualifiedopinion on our financial statements for the fiscal year ended December 31, 2003.The previous year’saudit opinion from Sprouse & Anderson, L.L.P, was a qualified opinion that expressed doubt about the Company’s ability tocontinue as a going concern. As a result of our improved financial condition, Sprouse & Anderson, L.L.P. was able to removetheir going concern qualification.

 
**RECENT ACCOUNTING PRONOUNCEMENTS**
            There are no recentaccounting pronouncements that have not been implemented by the Company that are expected to have a material impact on thefinancial statements of the Company.

 

 

 

9
**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS (cont.)**

**RESULTS OF OPERATIONS**

          Our loss for the quarter endedMarch 31, 2004 (the “2004 Period”) was $1,111,641 as compared with the loss of $770,969 for the quarter ended March 31,2003 (the “2003 Period”). Our total costs for the two periods were virtually the same, however our revenues were lowerduring the 2004 Period, which accounted for the increased loss.

          Our revenues for the quarterended March 31, 2004 totaled $77,658 compared to $444,452 for the same quarter of 2003. The revenues in both periods were all fromANI and substantially all the result of reimbursed research expenditures. The major difference between the two periods is that the2003 Period included $400,000 of revenue related to the completion of a major research contract with a large Japanese displaymanufacturer. During the 2004 Period, $65,880 of the revenue came from government contracts and $11,778 came from othermiscellaneous sources. During the 2003 Period, $10,387 of the revenue came from government contracts and $34,065 came from othermiscellaneous sources. At the present stage of the Company’s development, significant conclusions can’t be drawn fromcomparing revenues from period to period. Our business strategy is built on developing a royalty stream from licensing ourintellectual property. To supplement this, we also seek funding from both governmental and private sources to help fund ourresearch. Until we are able to develop a steady revenue stream from royalties, our revenues will tend to fluctuate greatly fromquarter to quarter. Our private research funding tends to come in large amounts at sporadic times.

          We have one government programin progress at March 31, 2004, and we have a revenue backlog of $369,022 related to that contract. We had a total revenue backlogof approximately $900,000 as of March 31, 2003, $720,501 of which related to the same government contract. Our ability to performcontinued research, or fulfill our backlog, should not require significant additional personnel.

          For the 2004 Period, our costof sales were $123,306, or a gross margin of negative 59%, as compared with $76,893 or a gross margin of 83%, for the 2003 Period.The 2003 margin was much higher than normal because the majority of our revenue came from one single research project with a largeJapanese display manufacturer. This contract dealt with a technical area where we have performed extensive research, and therefore,we were able to complete this project with minimal outside expenditures. We would expect our future margins to be lower than this.The negative margin in the 2004 Period results from the nature of our existing government contract. We bill the contract and earnrevenue based on the direct labor hours that we spend on the project. This project also involves significant material andsubcontractor costs. To the extent that any of these type of costs are concentrated in any one period, it can significantly affectour gross margin for that period. In the quarter ended March 31, 2004, we had significant material and subcontractor costs. Thesecosts will even out over the life of the contract and we expect the contract as a whole to generate nominally positive margins overthe life of the contract.

            We incurred researchand development expenses  of $628,289 for  the 2004 Period, which was a substantial increase from the $282,498 incurredin the 2003 Period. One reason for this significant increase is the spending on our 14-inch and 25-inch prototypes of our colorhigh-definition CNT based flat screen TVs. We spent in excess of $250,000 on these prototypes in the quarter ended March 31, 2004.In addition, we have had significant spending related to our biosensor development. There were also delays in expected researchfunding revenues that resulted us in funding more of our research on our own during the quarter. We expect total research anddevelopment expense to remain high in the quarter ended June 30, 2004 and decline in the final two quarters of the year. The14-inch prototype is expected to be completed in the 2nd quarter of 2004 and the 25-inch prototype is expected to becompleted in the 3rd quarter of 2004. We also expect to receive significant research funding related to some of ourother projects, which will reduce our internally funded research and development cost in the 2nd half of2004. 

            Our  selling,general, and administrative expenses were $443,925 for the 2004 Period, compared with $434,585 for the 2003 Period. Even though theselling, general, and administrative expenses were substantially unchanged in total, the 2004 period was impacted by a non-cashitem in the amount of $165,750 related to variable options pricing. In April 2001, the Company repriced a total of 900,500 optionsto lower the exercise price of these options to $1.50, which was approximately 160% of the market price of the stock at the time ofthe repricing. The repricing of these options resulted in a new measurement date for accounting purposes and reclassification ofthese options as variable plan awards beginning on the date of the repricing. The Company previously accounted for these optiongrants as fixed plan awards. From the date of the repricing through December 31, 2002, the quoted value of the Company’scommon stock did not exceed the exercise price of the options, and as such no compensation expense was recognized at any periodthrough that date. In 2003, the Company’s common stock price exceeded the exercise price and remained above it, closing at$2.73 per share on December 31, 2003. The Company recorded $749,755 in non-cash option expense for the cumulative effects of therepricing and increased additional paid in capital by the same amount in 2003.

10
**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTSOF OPERATIONS (cont.)**

          During the quarter ended March31, 2004, the price of the Company’s common stock declined from its December 31, 2003 level and  closed at $2.39 onMarch 31, 2004. The Company reversed $165,750 of the previously recorded expense in the quarter ended March 31, 2004, as a resultof this price decline. There was no similar charge in 2003. Offsetting a substantial portion of the reduction in costs in the 2004Period related to the variable option pricing was a charge of $116,600 related to the value of options issued to a consultant inthe quarter ended March 31, 2004.

          Our royalty expense was$400,000 in the 2003 Period. There was no royalty expense in the 2004 Period. The royalty expense is a minimum payment due inconnection with the Keesman patent that was reissued in 2004. We expect royalty expense in future periods to be highly correlatedwith royalty income, however there is another minimum payment due in May 2004.

Our interest expense decreased substantially in the 2004 Period because virtually all debtwas paid or converted to equity in 2003. Our only remaining interest expense relates to capital leases. We had interest income in2004 as a result of the investment of excess funds in short term interest bearing instruments, primarily certificates of deposit,commercial paper, and money market funds.

**FINANCIAL CONDITION AND LIQUIDITY**

          Our cash position increasedduring the period. At March 31, 2004 we had cash and cash equivalents in the amount of $3,904,919 as compared with cash and cashequivalents of $3,564,570 at December 31, 2003.  This increase in cash is primarily the result of cash provided by financingactivities, offset by cash used in operating activities. The cash used in operations was primarily the result of our net operatingloss for the period. The cash used in operating activities during the 2004 Period of $1,022,990 was approximately twice the$504,297 used in the 2003 Period. This is the result of the previously discussed factors of reduced revenues and increased spendingon the CNT prototypes.

          As described in greater detailin the notes to the financial statements, we received net proceeds of $1,382,605 from the issuance of common stock related toprivate placements and option exercises during the 2004 Period, as compared with $504,250 from the issuance of common stock duringthe 2003 Period.  The Company issued 278,000 common shares as the result of option exercises during the 2004 Period and hasissued an additional 26,464 shares through April 19, 2004. Individuals that are not currently employees of the Company exercisedthe majority of these options.  We issued no new debt in either the 2004 or 2003 Period.

          We used net cash of $14,605for investing activities in the 2004 Period related to the purchase of research equipment. Cash provided by investing activitiesduring the 2003 Period was $4,695 related to the sale of excess equipment.

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

          We expect to continue to incursubstantial expenses for research and development  ("R&D"). Further, we believe that certain products that may bedeveloped by potential licensees of our technology may not be available for commercial sale or routine use for a period of one totwo years. Others are expected to be available in 2004. While we would likely receive initial license payments, ongoing royaltystreams related to those licenses will not be available until potential licensees have introduced products using our technology.Therefore, it is possible that the commercialization of our existing and proposed products may require additional capital in excessof our current funding. We do, however, expect to operate profitably in 2004 based on the receipt of research funding and otherrevenues. Achievement of at least break-even would enable us to continue our research without seeking additional debt or equityfinancing.

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

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**ITEM 3.       Controls and Procedures**

          Under the supervision and withthe participation of our management, including our principal executive officer and principal financial officer, we conducted anevaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, within 90 days of the filing date of this report (the"Evaluation Date"). Based upon this evaluation, our principal executive officer and principal financial officer concluded as of theEvaluation Date that our disclosure controls and procedures were effective such that the material information required to theincluded in our Securities and Exchange Commission ("SEC") reports is recorded, processed, summarized, and reported within the timeperiods specified in SEC rules and forms relating to the Company, including, our consolidated subsidiaries, and was made known tothem by others within those entities, particularly during the period when this report was being prepared.

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

 

 

 

 

 

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**PART II.  OTHER INFORMATION**

ITEM 1.  LEGAL PROCEEDINGS

          None

ITEM 2.  CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITYSECURITIES

          From January 1, 2004 throughMarch 31, 2004, in a series of private placements only to accredited investors under Rule 506 of Regulation D of the Securities Actof 1933, we issued a total of 401,887 shares of our common stock in exchange for $1,065,000. These shares were issued at a slightdiscount to the market price of our common stock at the time of issuance. The Company intends to file a registration statement inMay 2004 to register these shares. Following is a listing of those shares:

 

                   

Common shares

Shareholder

 

issued

 

 

 

Karrison Nichols

 

301,887

Southwell Partners

 

100,000

 

 

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ITEM 6.     EXHIBITS AND REPORTS ONFORM 8-K

       (a)     Exhibits: SeeIndex to Exhibits on page 16 for a descriptive response to this item.

       (b)     Reports on Form8-K:
 
None
 
 

 

 

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**SIGNATURES**

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

 

 

NANO-PROPRIETARY, INC. (Registrant)

 

 

Date:     April 27, 2004 

     /s/ Marc W.Eller                                  Marc W. Eller Chairman and Chief Executive Officer (Principal Executive Officer)

 

 

Date:     April 27, 2004

     /s/ Douglas P.Baker                                  Douglas P. Baker Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)

 

 

 

 

 

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**INDEX TO EXHIBITS**

 

The following documents are filed as part of this Report:

Exhibit
   
11

Computation of (Loss) Per Common Share
 
 

31.1

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

31.2

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

32.1

Section 1350 Certificate of Marc W. Eller
 
 

32.2

Section 1350 Certificate of Douglas P. Baker

 

 

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