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Table of Contents 
**UNITED        STATES**

**SECURITIES        AND EXCHANGE COMMISSION**

**WASHINGTON,        DC 20549**

**FORM        10-Q**

**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) |

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Table            of Contents 

**NANO-PROPRIETARY,        INC.**

**INDEX**

| Part                  I.  Financial Information | **Page**                                                                                                                                                    |
|------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                 |                                                                                                                                                        |   |   |
|                                                 | Item                  1.  Financial Statements                                                                                                         |   |
|                                                 |                                                                                                                                                        |   |   |
|                                                 |                                                                                                                                                        | Consolidated                  Balance Sheets--September 30, 2005 and                  December 31, 2004 | 3 |
|                                                 |                                                                                                                                                        |   |   |
|                                                 |                                                                                                                                                        | Consolidated                  Statements of Operations --Three Months                  and Nine Months EndedSeptember                  30, 2005 and 2004 |  4 |
|                                                 |                                                                                                                                                        |   |   |
|                                                 |                                                                                                                                                        | Consolidated                  Statements of Cash Flows -Nine Months                  EndedSeptember                  30, 2005 and 2004 |  5 |
|                                                 |                                                                                                                                                        |   |   |
|                                                 |                                                                                                                                                        | Notes                  to Consolidated Financial                  Statements | 6 |
|                                                 |                                                                                                                                                        |   |   |
|                                                 | Item                  2. Management’s Discussion and Analysis of Financial                  Conditionand                  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                  6.  Exhibits                                                                                                                     | 15 |
|                                                 |                                                                                                                                                        |   |   |
| Signatures                                           | 16                                                                                                                                                          |

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Table            of Contents 

**PART        I.  FINANCIAL INFORMATION**

**ITEM        1.  FINANCIAL STATEMENTS**

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

**CONSOLIDATED****BALANCE        SHEETS**

| **ASSETS**                                                                                                                                                                                                                                                                                                                                                                                                     |   | **(Unaudited)****September                  30,****2005** |        |  **December                  31,****2004** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------|-------------|-------------------------------------------------|--------|
| Current                  assets:                                                                                                                                                                                                                                                                                                                                                                               |   |                                                      |        |                                            |   |
| Cash                  and cash equivalents                                                                                                                                                                                                                                                                                                                                                                     |   | $                                                         | 932,638     |                                            | $      | 901,585 |   |
| Accounts                  receivable, trade - net of allowance for doubtful accounts                                                                                                                                                                                                                                                                                                                           |   |                                                      | 64,851      |                                            |   | 6,735 |   |
| Prepaid                  expenses and other current assets                                                                                                                                                                                                                                                                                                                                                     |   |                                                      | 132,493     |                                            |   | 85,135 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
|                                  Total current assets                                                                                                                                                                                                                                                                               |   |                                                      | 1,129,982   |                                            |   | 993,455 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| Property                  and equipment, net                                                                                                                                                                                                                                                                                                                                                                   |   |                                                      | 111,067     |                                            |   | 141,373 |   |
| Other                  assets                                                                                                                                                                                                                                                                                                                                                                                  |   |                                                      | 9,540       |                                            |   | 9,540 |   |
|                                  Total assets                                                                                                                                                                                                                                                                                       |   | $                                                         | 1,250,589   |                                            | $      | 1,144,368 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| **LIABILITIES                  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                                                                |   |                                                      |             |                                            |   |  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| Current                  liabilities:                                                                                                                                                                                                                                                                                                                                                                          |   |                                                      |             |                                            |   |  |   |
| Accounts                  payable                                                                                                                                                                                                                                                                                                                                                                              |   | $                                                         | 184,099     |                                            | $      | 140,597 |   |
| Obligations                  under capital lease                                                                                                                                                                                                                                                                                                                                                               |   |                                                      | 11,535      |                                            |   | 21,430 |   |
| Accrued                  liabilities                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      | 72,623      |                                            |   | 74,956 |   |
| Deferred                  Revenue                                                                                                                                                                                                                                                                                                                                                                              |   |                                                      | -           |                                            |   | 54,985 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
|                                  Total current liabilities                                                                                                                                                                                                                                                                          |   |                                                      | 268,257     |                                            |   | 291,968 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| Obligations                  under capital lease                                                                                                                                                                                                                                                                                                                                                               |   |                                                      | -           |                                            |   | 5,944 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
|  Total                  Liabilities                                                                                                                                                                                                                                                                                                                                                                       |   |                                                      | 268,257     |                                            |   | 297,912 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| Commitments                  and contingencies                                                                                                                                                                                                                                                                                                                                                                 |   |                                                      | -           |                                            |   | - |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
| Stockholders'                  (deficit):                                                                                                                                                                                                                                                                                                                                                                      |   |                                                      |             |                                            |   |  |   |
|      Preferred                  stock, $1.00 par value, 2,000,000 shares authorized;            No                  shares issued and outstanding                                                                                                                                                                         |   |                                                      | -           |                                            |   | - |   |
|      Common                  stock, $.00l par value, 120,000,000 shares authorized,            99,214,047                  and 97,246,422 shares issued and outstanding at            September                  30, 2005 and December 31, 2004, respectively |   |                                                      | 99,214      |                                            |   | 97,246 |   |
| Additional                  paid-in capital                                                                                                                                                                                                                                                                                                                                                                    |   |                                                      | 84,404,984  |                                            |   | 80,822,625 |   |
| Accumulated                  deficit                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      | (83,521,866 | )                                               |   | (80,073,415 | ) |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
|                                  Total stockholders equity                                                                                                                                                                                                                                                                          |   |                                                      | 982,332     |                                            |   | 846,456 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                           |   |                                                      |             |                                            |   |  |   |
|                                  Total liabilities and stockholders equity                                                                                                                                                                                                                                                          |   | $                                                         | 1,250,589   |                                            | $      | 1,144,368 |   |

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Table            of Contents 

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

**CONSOLIDATEDSTATEMENTS        OF OPERATIONS**

**(UNAUDITED)**

|                                                                                        |   | **For the                  Three Months****Ended                  September 30,** |       | **For                   the Nine Months****Ended                  September 30,** |   |
|---------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|--------|
|                                                                                        |   | **2005**                                                                               |       |  **2004**                                                                         |   |  **2005** |   |  **2004** |   |
| Revenues                                                                                    |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Government                  contracts                                                       |   | $                                                                                      | 85,697     |                                                                                   | $      | 90,501 |   | $ | 173,307 |   | $ | 222,179 |   |
| Royalties                                                                                   |   |                                                                                   | -          |                                                                                   |   | 1,122 |   |   | 3,897 |   |   | 1,122 |   |
| Other                                                                                       |   |                                                                                   | 160,220    |                                                                                   |   | 8,850 |   |   | 226,072 |   |   | 55,548 |   |
|           Total                  Revenues |   |                                                                                   | 245,917    |                                                                                   |   | 100,473 |   |   | 403,276 |   |   | 278,849 |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Research                  and development                                                   |   |                                                                                   | 620,079    |                                                                                   |   | 635,105 |   |   | 1,875,371 |   |   | 1,916,512 |   |
| Selling,                  general and administrative expenses                               |   |                                                                                   | 640,481    |                                                                                   |   | 573,706 |   |   | 1,999,564 |   |   | 1,357,738 |   |
| Royalty                  expense                                                            |   |                                                                                   | -          |                                                                                   |   | - |   |   | - |   |   | 500,000 |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Operating                  costs and expenses                                               |   |                                                                                   | 1,260,560  |                                                                                   |   | 1,208,811 |   |   | 3,874,935 |   |   | 3,774,250 |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Loss                  from operations                                                       |   |                                                                                   | (1,014,643 | )                                                                                      |   | (1,108,338 | ) |   | (3,471,659 | ) |   | (3,495,401 | ) |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Other                  income (expense), net                                                |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Interest                  Expense                                                           |   |                                                                                   | (381       | )                                                                                      |   | (1,224 | ) |   | (2,287 | ) |   | (3,493 | ) |
| Interest                  Income                                                            |   |                                                                                   | 9,946      |                                                                                   |   | 9,028 |   |   | 25,495 |   |   | 23,065 |   |
| Other                                                                                       |   |                                                                                   | -          |                                                                                   |   | - |   |   | - |   |   | 125 |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
|  Loss                  from continuing operations before taxes                         |   |                                                                                   | (1,005,078 | )                                                                                      |   | (1,100,534 | ) |   | (3,448,451 | ) |   | (3,475,704 | ) |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
|  Provision                  for taxes                                                  |   |                                                                                   | -          |                                                                                   |   | - |   |   | - |   |   | - |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Net                  loss                                                                   |   | $                                                                                      | (1,005,078 | )                                                                                      | $      | (1,100,534 | ) | $ | (3,448,451 | ) | $ | (3,475,704 | ) |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Loss                  per share                                                             |   |                                                                                   |       |                                                                                   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Basic                  and Diluted                                                          |   | $                                                                                      | (0.01      | )                                                                                      | $      | (0.01 | ) | $ | (0.03 | ) | $ | (0.04 | ) |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Weighted                  average shares outstanding                                        |   |                                                                                   |       |                                                                                   |   |   |   |   |   |   |   |   |   |
|                                                                                        |   |                                                                                   |            |                                                                                   |   |  |   |   |  |   |   |  |   |
| Basic                  and Diluted                                                          |   |                                                                                   | 99,179,808 |                                                                                   |   | 96,800,352 |   |   | 98,729,768 |   |   | 96,450,666 |   |

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Table            of Contents 

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

**CONSOLIDATEDSTATEMENTS        OF CASH FLOWS**

**(UNAUDITED)**

|                                                                                                     |   |   | **For                       the Nine Months Ended****September                      30,**  |   |
|----------------------------------------------------------------------------------------------------------|--------|--------|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                     |   |   | **2005**                                                                                        |   |   | **2004**  |   |
| Cash                      flows from operating activities:                                               |   |   |                                                                                                      |   |   |  |   |
|  Net                      loss                                                                      |   | $      | (3,448,451                                                                                           | )      | $ | (3,475,704 | ) |
| Adjustments                      to reconcile net loss to net                                            |   |   |                                                                                                      |   |   |  |   |
| cash                      used in operating activities:                                                  |   |   |                                                                                                      |   |   |  |   |
| Depreciation                      and amortization expense                                               |   |   | 42,258                                                                                               |   |   | 38,864 |   |
| Gain                      on sale of fixed assets                                                        |   |   | -                                                                                                    |   |   | (125 | ) |
| Options                      issued for services                                                         |   |   | 19,339                                                                                               |   |   | 116,600 |   |
| Non-cash                      variable option pricing expense                                            |   |   | 70,050                                                                                               |   |   | (297,300 | ) |
| Changes                      in assets and liabilities:                                                  |   |   |                                                                                                      |   |   |  |   |
| Accounts                      receivable, trade                                                          |   |   | (58,116                                                                                              | )      |   | (20,131 | ) |
| Prepaid                      expenses and other current assets                                           |   |   | (47,358                                                                                              | )      |   | (71,233 | ) |
| Accounts                      payable and accrued liabilities                                            |   |   | (13,816                                                                                              | )      |   | 115,185 |   |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Total                      adjustments                                                                   |   |   | 12,357                                                                                               |   |   | (118,140 | ) |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Net                      cash used in operating activities                                               |   |   | (3,436,094                                                                                           | )      |   | (3,593,844 | ) |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Cash                      flows from investing activities:                                               |   |   |                                                                                                      |   |   |  |   |
| Capital                      expenditures                                                                |   |   | (11,952                                                                                              | )      |   | (95,331 | ) |
| Proceeds                      from sale of fixed assets                                                  |   |   | -                                                                                                    |   |   | 125 |   |
|        Net                      cash used in investing activities     |   |   | (11,952                                                                                              | )      |   | (95,206 | ) |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Cash                      flows from financing activities:                                               |   |   |                                                                                                      |   |   |  |   |
| Repayment                      of notes payable                                                          |   |   | (15,839                                                                                              | )      |   | (14,337 | ) |
| Proceeds                      of stock issuance, net of costs                                            |   |   | 3,494,938                                                                                            |   |   | 1,640,709 |   |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
|        Net                      cash provided by financing activities |   |   | 3,479,099                                                                                            |   |   | 1,626,372 |   |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Net                      increase (decrease) in cash and cash equivalents                                |   |   | 31,053                                                                                               |   |   | (2,062,678 | ) |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Cash                      and cash equivalents, beginning of period                                      |   |   | 901,585                                                                                              |   |   | 3,564,570 |   |
|                                                                                                     |   |   |                                                                                                      |   |   |  |   |
| Cash                      and cash equivalents, end of period                                            |   | $      | 932,638                                                                                              |   | $ | 1,501,892 |   |

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Table            of Contents 

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

**NOTESTO        CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

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Table            of Contents 

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

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

*Litigation*

|                                                             |   | ANI    |       | EBT    |   | All                  Other |   | Total  |     |
|------------------------------------------------------------------|--------|--------|------------|--------|--------|----------------------------|--------|--------|----------|
| 2005                                                             |   |   |       |   |   |                       |   |   |     |
| Revenue                                                          |   | $      | 403,276    |   | $      | -                          |   | $      | -        |   | $ | 403,276 |   |
|                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| Profit                  (Loss)                                   |   |   | (2,791,244 | )      |   | -                          |   |   | (657,207 | ) |   | (3,448,451 | ) |
|                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| Expenditures                  for                                |   |   |            |   |   |                            |   |   |          |   |   |  |   |
|      long-lived                  assets |   |   | 8,297      |   |   | -                          |   |   | 3,655    |   |   | 11,952 |   |
|                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| 2004                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| Revenue                                                          |   | $      | 278,849    |   | $      | -                          |   | $      | -        |   | $ | 278,849 |   |
|                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| Profit                  (Loss)                                   |   |   | (3,122,054 | )      |   | 107,297                    |   |   | (460,947 | ) |   | (3,475,704 | ) |
|                                                             |   |   |            |   |   |                            |   |   |          |   |   |  |   |
| Expenditures                  for                                |   |   |            |   |   |                            |   |   |          |   |   |  |   |
|      long-lived                  assets |   |   | 92,958     |   |   | -                          |   |   | 2,373    |   |   | 95,331 |   |

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Table            of Contents 

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

**NOTES        TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

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Table            of Contents 

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

**FORWARD-LOOKING        STATEMENTS **

**Nine        months ended September 30, 2005 and 2004**

**OVERVIEW**

**OUTLOOK**

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Table            of Contents 

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

**RECENT        DEVELOPMENTS**

**RECENT        ACCOUNTING PRONOUNCEMENTS**

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Table            of Contents 

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

**FINANCIAL        CONDITION AND LIQUIDITY**

**RESULTS        OF OPERATIONS**

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Table            of Contents 

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

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Table            of Contents 

**ITEM        3.       **
**QUANTITATIVEAND        QUALITATIVE DISCLOSURES ABOUT MARKET        RISK**

**ITEM        4.       **
**CONTROLSAND        PROCEDURES**

*Evaluation        of Disclosure Controls and Procedures. *

*Changes        in Internal Control Over Financial Reporting. *

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Table            of Contents 

**PART        II. OTHER INFORMATION**

LEGAL 

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Table            of Contents 

ITEM        6.     EXHIBITS        AND REPORTS ON FORM 8-K

Index to Exhibits 

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**SIGNATURES**

|                                                                 | **NANO-PROPRIETARY,                  INC.**(Registrant)                                                                                                                                                                                           |
|----------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                 |                                                                                                                                                                                                                                              |
| Date:     October                  28, 2005 |      /s/                  Marc W. EllerMarc                  W. EllerChairman                  and Chief ExecutiveOfficer                  (Principal Executive Officer)                                                 |
|                                                                 |                                                                                                                                                                                                                                              |
| Date:     October                  28, 2005 |      /s/                  Douglas P. Baker Douglas                  P. BakerChief                  Financial Officer(Principal                  Financial Officer and PrincipalAccounting                  Officer) |

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Table            of Contents 

**INDEX        TO EXHIBITS**

| 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             |