Index

**UNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

**FORM 10-QSB**

ý                                  Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of1934

       For the quarterly period ended June 30, 2003

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

**COMMISSION FILE NO. 1-11602**

**NANO-PROPRIETARY, INC.**(Exact name of Small Business Issuer as specified in charter)

| **TEXAS**                               |   | **76-0273345**         |
|-----------------------------------------|--------|------------------------|
| (State of                               |   | (IRS Employer          |
| Incorporation)                          |   | Identification Number) |
|                                    |   |                   |
| **3006 Longhorn Blvd., Suite 107**      |   |                   |
| **AUSTIN, TEXAS**                       |   | **78758**              |
| (Address of principal executive office) |   | (Zip Code)             |

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

**SI Diamond Technology,Inc.**(Former name, changed since last report)

Indicate bycheck mark whether the issuer: (1) filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for the past90 days.

Yes  [X]  No [  ]

As of July 31,2003, the registrant had 87,232,107 shares of common stock, par value $.001 pershare, issued and outstanding.

TransitionalSmall Business Disclosure Format.

Yes  [  ]   No [X]

----

 

**NANO-PROPRIETARY, INC.INDEX**

 

| Part I.  Financial Information | **Page**                                                                                                                                                                                                                                   |
|-------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                                                                                                       |   |   |
|                                | Item 1.  Financial Statements                                                                                                                                                                                                         |   |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                |                                                                                                                                                                                                                                       | Consolidated Balance Sheets--June 30, 2003and December 31, 2002 | 3 |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                |                                                                                                                                                                                                                                       | Consolidated Statements of Operations--Three Monthsand Six Months Ended           June 30, 2003 and 2002 | 4 |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                |                                                                                                                                                                                                                                       | Consolidated Statements of Cash Flows--Six Months Ended           June 30, 2003 and 2002 | 5 |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                |                                                                                                                                                                                                                                       | Notes to Consolidated Financial Statements | 6 |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                | Item 2.  Management’s Discussion and Analysis of Financial Condition                      andResults of Operations | 9 |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                | Item 3.  Controls andProcedures                                                                                                                                                                                                  | 13 |
|                                |                                                                                                                                                                                                                                       |   |   |
| Part II.  Other Information    |                                                                                                                                                                                                                                       |
|                                |                                                                                                                                                                                                                                       |   |   |
|                                | Item 1. Legal Proceedings                                                                                                                                                                                                                  | 14      
Item 2.Changes in Securities

14      
Item 4.  Submission of Matters toa Vote of Security Holders

15      
Item 6.  Exhibits and Reports on Form 8-K

15    
Signatures

16

2

Index

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

**ASSETS**
 
**(Unaudited) June 30, 2003**
 
**December 31, 2002**

Current assets:
     
Cash and cash equivalents

 $

1,018,942 

$

15,868 
 
Accounts receivable, trade – net of allowance for doubtfulaccounts              of $0 in 2003 and 2002
 
40,481 
 
32,316 
 
Prepaid expenses and other current assets
 
184,751 
 
95,232 
       
               Total current assets
 
1,244,174 
 
143,416 
       
Property and equipment, net
 
92,723 
 
115,239 
 
Officer receivable
 
31,250 
 
62,500 
 
Other assets
 
800 
 
800 
  
               Total assets
$1,368,947 $321,955        
**LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)**
          
Current liabilities:
     
Accounts payable

$

240,657 

$

584,878 
 
Current portion of long-term debt
 
13,607 
 
39,832 
 
Obligations under capital lease
 
18,439 
 
17,993 
 
Notes payable
 
1,000,000 
 
1,600,000 
 
Accrued liabilities
 
223,624 
 
493,564 
       
               Total current liabilities
 
1,496,327 
 
2,736,267       
Obligations under capital lease
 
37,293 
 
46,283 
       TotalLiabilities 
 1,533,620  
2,782,550       
Commitments and contingencies
 
– 
 
–        
Stockholders' (deficit):
    
     Convertible preferred stock, $1.00 par value, 2,000,000 shares authorized;             No shares issued and outstanding
 
– 
 
–   
     Common stock, $.00l par value, 120,000,000 shares authorized,             87,207,107 and 76,970,792 shares issued and outstanding at             June 30, 2003 and December 31, 2002, respectively
 
87,207 
 
76,971 
Additional paid-in capital
 
72,462,332 
 
68,709,621 

Accumulated deficit
 
(72,714,212)
 
(71,247,187)
     
               Total stockholders'  (deficit)
 
(164,673)
 
(2,460,595)
     
               Total liabilities and stockholders' (deficit)

$

1,368,947 
$
321,955 
See notes to consolidated financial statements.

3

Index

**NANO-PROPRIETARY,INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OFOPERATIONS(UNAUDITED)**
   
**For  the ThreeMonths Ended June 30,**
  
**For  the SixMonths Ended June 30,**
  
**2003**
  
**2002**
  
**2003**
  
**2002**

Revenues
            
Government contracts

$

156,325 
 
$

121,663 
 
$

166,712 
 
$

208,066 
 
Privately funded research
 
– 
   
329,411 
  
400,000 
   
500,000 
 
Royalties
 
– 
  
– 
  
920 
  
– 
 
Other

 

4,055 
 
 

29,210 
 
 

37,200 
 
 

57,655 
 
          Total Revenues
 
160,380 
  
480,284 
  
604,832 
  
765,721 
             
Cost of sales
 
146,146 
  
305,859 
  
223,039 
  
579,583 

Selling, general and administrativeexpenses
 
420,167 
  
907,361 
  
854,752 
  
1,696,904 

Research and development
 
 275,400   
 536,507   
 557,898   
 912,591
Royalty expense
 
– 
  
–  
  
400,000 
  
–  
             
Operating costs and expenses
 
841,713 
  
1,749,727 
  
2,035,689 
  
3,189,078 
             
Loss from operations
 
(681,333)
  
(1,269,443)
  
(1,430,857)
  
(2,423,357)
             
Other income (expense), net
            
Interest Expense
  
(15,387)
  
(196,030)
   
(41,527)
  
(414,925)
 
Other
 
664 
  
(680)
  
5,359 
  
978 
              Loss fromcontinuing operations before taxes (696,056)  (1,466,153)  (1,467,025)  (2,837,304)               Provisionfor taxes  –    –   –    –              
Loss from continuing operations
 
(696,056)  
(1,466,153)  
(1,467,025)  
(2,837,304)             
Discontinued operations
           
Income from the operation of SBOA
 
–  
  
(21,810)  
–  
  
(19,601)               
Net loss

 
(696,056)
 
 
(1,487,963)
 
 
(1,467,025)
 
 
(2,856,905)
               
Less accretion on convertible preferredstock
 
–  
  
(16,245)
  
–  
  
(37,495)
               
Net loss applicable to commonshareholders

$
(696,056)
 
$
(1,504,208)
 
$
(1,467,025)
 
$
(2,894,400)

Loss per share
                             
Basic
  
$
(0.01)
 
$
(0.02)
 
$
(0.02)
 
$
(0.04)
 
Diluted
  
$
(0.01)
 
$
(0.02)
 
$
(0.02)
 
$
(0.04)

Weighted average shares outstanding
                           
Basic
  
 
85,552,973 
 
 
63,648,286 
 
 
82,661,901 
 
 
62,924,823 
 
Diluted
  
 
85,552,973 
 
 
63,648,286 
 
 
82,661,901 
 
 
62,924,823 

See notes to consolidated financial statements.

4

Index

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

**CONSOLIDATED STATEMENTS OFCASH FLOWS(UNAUDITED)**

 

**For  the Six Months Ended June 30,**
 
**2003**
 
**2002**

Cash flows from operating activities:
      Netloss  
$

(1,467,025)

$

(2,856,905)
  
Adjustments to reconcile net loss to net
       
cash used in operating activities:
       
Depreciation and amortization expense
 
22,516 
 
173,152 
   
Amortization of discount on debt
 
– 
 
292,913 
   
Net realized and unrealized (gain) loss on marketable securities
 
– 
 
(770)    
Shares issued for patent option
 
13,636  
– 
   
Changes in assets and liabilities:
        
Accounts receivable, trade
 
(8,165) 
106,252 
    
Inventories
 
– 
 
39,094 
    
Prepaid expenses and other current assets
 
 (58,269) 
 (21,561)    
Accounts payable and accrued liabilities
 
(270,516)
 
419,958 
    
Customer deposits and deferred revenue

 

– 
 
(51,336)
             
Total adjustments
 
(300,798)
 
957,702 
            
Net cash used in operating activities
 
(1,767,823)
 
(1,899,203)
          
Cash flows from investing activities:
    
 
 
Capital expenditures
  
– 
 
(222,800)
  
Proceeds from the sale of marketablesecurities
 
– 
 
24,980 
  
Purchase of marketable securities
 
– 
 
(25,860)
  
       Net cash used in investing activities

 
– 

 
(223,680)
         
Cash flows from financing activities:
    
  
 
Repayment of notes payable
 
(34,769)
 
(99,190)
  
Proceeds from notes payable and long-term debt
 
–  
 
600,000 
  
Proceeds of stock issuance, net of costs
 
2,805,666 
 
1,408,339 
           
       Net cash provided by financing activities
 
2,770,897 
 
1,909,149 
         
Net increase (decrease) in cash and cash equivalents
 
1,003,074 
 
(213,734)
         
Cash and cash equivalents, beginning of period
 
15,868 
 
261,861 
         
Cash and cash equivalents, end of period

$

1,018,942 

 

$
48,127 

See notes to consolidated financial statements.

5

Index

**NANO-PROPRIETARY, INC. AND SUBSIDIARIES****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

1.     Basis of Presentation

        The consolidated financial statements of theCompany for the three and six month periods ended June 30, 2003 and 2002 have been prepared by the Company without audit pursuantto the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company’s management, alladjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company as of June 30,2003 and 2002 and for the periods then ended have been made. Those adjustments consist of normal and recurring adjustments. Theconsolidated balance sheet of the Company as of December 31, 2002 has been derived from the audited consolidated balance sheet ofthe Company as of that date.

        Certain information and note disclosuresnormally included in the Company’s annual financial statements prepared in accordance with generally accepted accountingprinciples have been condensed or omitted. These consolidated financial statements should be read in conjunction with a reading ofthe financial statements and notes thereto included in the Company’s Annual Report on Form 10-KSB for the fiscal year endedDecember 31, 2002 as filed with the U.S.  Securities and Exchange Commission.

        The results of operations for the three and sixmonth periods ended June 30, 2003 are not necessarily indicative of the results to be expected for the full year.

2.     Supplemental Cash Flow Information

        Cash paid for interest for the six months endedJune 30, 2003 and 2002 was $1,554 and $10,617, respectively. During the six months ended both June 30, 2003 and 2002, the Companyhad non-cash transactions related to the conversion of notes payable, including related accrued interest, into shares of theCompany’s common stock. These transactions are described in greater detail in Note 3. In the six months ended June 30, 2003,the Company also had a non-cash transactions related to the issuance of a common shares in connection with the payment of accountspayable and accrued expenses.

3.     Stockholders’ Equity

        In the six months ended June 30, 2003, theCompany issued 6,271,803 restricted shares of its common stock and received net proceeds of $2,604,250 in exempt offerings underRegulation D of the Securities Act of 1933.  The Company issued 309,745  shares of its common stock and received $201,416in connection with the exercise of employee stock options. The Company also issued 3,483,746 shares of common stock in connectionwith the payment of convertible notes payable and related accrued interest. The face amount of the notes was $600,000 and therelated accrued interest totaled $105,863. The Company also issued 100,000 shares valued at $237,782 in connection with the paymentof accounts payable and 71,021 shares valued at $13,636 in connection with a patent extension. In the six months ended June 30,2002, the Company also issued 1,009,911 shares of restricted common stock in payment of convertible notes payable and relatedaccrued interest. The gross amount of the notes was $500,000 and related accrued interest was $33,750.

        In June 2002, all remaining outstanding sharesof the Company’s Series G Convertible Preferred Stock were converted to common shares. A total of 850 preferred shares wereconverted into 1,267,617 shares of  common stock.

4.     Notes Payable and Long Term Debt

        The Company has a convertible note payable inthe amount of $1,000,000 outstanding. This note and related accrued interest are convertible into shares of the Company’scommon stock at a rate of $0.25 per share.

6

Index

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

5.     Contingencies

Litigation

        The Company is a defendant in minor lawsuitsdescribed in greater detail in its 2002 annual report on Form 10-KSB. The Company expects any potential eventual payment to have nomaterial affect on the financial statements.

 6.     Business Segments

Following is information related to the Company’s business segments forthe six months ended June 30, 2003 and 2002:
  
ANI 
EBT 
All Other 
Total
2003                 Revenue  
$  
604,832  
$  
 -  
$ 
 -  
$  
604,832          Profit (Loss)  
(1,075,085) 
7,634  
(399,574) 
(1,467,025)          Expenditures for         
     long-lived assets
 
-    
-  
-  
-          
2002                 Revenue  
$   
715,736  
       $  
49,985  
$  
-     
$  
765,721           Profit (Loss)  
(684,330) 
(1,041,367) 
  (1,131,208) 
(2,856,905)         Expenditures for         
     long-lived assets
 
52,327  
166,401  
4,072    
222,800   
7.     Related Party Transactions

        The Company made a non-interest bearing advancein the amount of $62,500 to its President and Chief Operating Officer, Dr. Zvi Yaniv. A portion of this advance was repaid in thequarter ended June 30, 2003.  The remaining portion of the advance has been classified as long-term because there are noscheduled repayment terms. Dr. Yaniv does have the opportunity to earn bonuses based on the achievement of certain milestones. Anysuch bonuses that may be earned would be applied against this loan.

8.     Subsequent Events

        For the period from July 1, 2003 through July31, 2003, the Company issued a total of 25,000 restricted shares of its common stock and received net proceeds of approximately$25,000 in an exempt offerings under Regulation D of the Securities Act of 1933.

7

Index

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

 

9.     Recently Issued Accounting Standards

        In September 2001, the FASBissued Statement 143, Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligationassociated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Statement will beeffective for the Company's fiscal year ending December 2003.  The Company does not believe that the adoption of thispronouncement will have a material effect on its financial statements.

        In June 2002, theFASB issued Statement 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement will be effective afterDecember 31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on itsfinancial statements.

        In May 2003, the FASB issuedStatement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statementwill be effective for the first interim period beginning after June 15, 2003 and establishes standards for how an issuer classifiesand measures certain financial instruments with the characteristics of both liabilities and equity. The Company does not believethat the adoption of this pronouncement will have a material effect on its financial statements.

10.   Discontinued Operations

        In October 2002, the Company soldthe assets of its Sign Builders of America, Inc. subsidiary. The results of Sign Builders of America, Inc. for the three and sixmonth periods ended June 30, 2003 are included in the consolidated statements as a discontinued operation.
 
 

 

 

 

8

Index

**ITEM 2:  MANAGEMENT'SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTSOF 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 contains certain forward-looking statements that we believe are withinthe meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intendedto be covered by the safe harbors created by such acts. For this purpose, any statements that are not statements of historical factmay be deemed to be forward-looking statements, including the statements under "Management's Discussion and Analysis of FinancialCondition and Results of Operations" regarding our strategy, future operations, future expectations or future estimates, financialposition and objectives of management. Those statements in this Form 10-QSB containing the words "believes," "anticipates,""plans," "expects" and similar expressions constitute forward-looking statements, although not all forward-looking statementscontain such identifying words. These forward-looking statements are based on our current expectations and are subject to a numberof risks, uncertainties and assumptions relating to our operations, results of operations, competitive factors, shifts in marketdemand and other risks and uncertainties.

Although we believe that the assumptions underlying our forward-looking statements arereasonable, any of the assumptions could be inaccurate and actual results may differ from those indicated by the forward-lookingstatements included in this Form 10-QSB.  In light of the significant uncertainties inherent in the forward-looking statementsincluded in this Form 10-QSB, you should not consider the inclusion of such information as a representation by us or anyone elsethat we will achieve such results. Moreover, we assume no obligation to update these forward-looking statements to reflect actualresults, changes in assumptions or changes in other factors affecting such forward-looking statements.

**Six months ended June 30, 2003 and 2002**

**OVERVIEW**

During the six months ended June 30, 2003, ourprimary 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 Carbon Nanotube Based FieldEmission (“CFE”) Technology. As more fully discussed in our Annual Report on Form 10-KSB for the year ended December31, 2002, we expect to incur additional research and development expenses throughout 2003 in developing our CFE technology. We haverestructured the company to focus on licensing our technology and obtaining sufficient  revenue to cover our ongoing researchexpenditures.
**OUTLOOK**
We expect our external cash needs for 2003 to be approximately $3.3 million, including the amount necessary to maintain our licenseof the Keesman patent. We intend to fund this need through a combination of reimbursements for research, license agreements, andissuance of debt and equity securities.  As of the date of this filing, we have raised approximately $2.8 million of thisamount through private placements and a research project. A license agreement or development agreement with a substantial up-frontpayment could eliminate the need for additional outside capital.

We havedeveloped a plan to enable us to achieve break-even on revenues of $3.5 million, including the minimum royalty payment associatedwith the acquisition of the Keesman patent. There can be no assurance that wewill achieve break-even or be profitable in the future.  To the extent ourrevenues do not allow us to break-even, or if the timing of revenues is weightedtoward the latter part of the year, we may be required to raise additional funds through the issuance of debt or equitysecurities to enable us to maintain operations at the present level. The mix ofrevenues received could also cause the revenues required to break-even toincrease. If revenue producing projects require unanticipated expenses, orheavier than anticipated use of outside services or materials, we may be unableto achieve break-even at that level.

9

Index

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

Wehave developed a plan to allow ourselves to maintain operations until we areable to sustain ourselves on our own revenue. Our plan is primarily dependent onraising funds through the licensing of our technology and through additionaldebt and equity offerings. Our current cash, including commitments, issufficient to allow us to maintain operations for approximately three monthsfrom the date of this filing. We expect additional revenue producing projects orlicense agreements to be finalized during that time period. We believe that wehave the ability to continue to raise short term funding, if necessary, toenable us to continue operations until our plan can be completed.

This plan is based on current development plans, current operating plans, thecurrent regulatory environment, historical experience in the development ofelectronic products and general economic conditions. Changes could occur whichwould cause certain assumptions on which this plan is based to be no longervalid. Although we do not expect funding our operations to be a problem, ifadequate funds are not available from operations, or additional sources offinancing, we may have to eliminate, or reduce substantially, expenditures forresearch and development, testing and production of its products, or obtainfunds through arrangements with other entities that may require us to relinquishrights to certain of its technologies or products. Such results would materiallyand adversely affect us.

**RECENT DEVELOPMENTS**

On June 10, 2003 theshareholders of the Company approved change of the Company’s name from SI Diamond Technology, Inc. to Nano-Proprietary, Inc.This change was effective July 1, 2003 and as of that date the company began trading on the Over-the-Counter Bulletin Board underits new symbol, “NNPP”.

In April 2003, we were notified by the U.S.Patent office that it had issued a notice of allowance for the reissuance ofU.S. Patent No. 5,773,921, which we had licensed from Argus Holdings GmbH (“the Keesman patent”). The reissuingprocess considerably enhanced the existing nine claims of the U.S. patent, as well as added additional claims. The reissuance ofthis patent solidifies our already strong position in the carbon nanotube field and expands the number of companies likely tolicense our technology in the future. Allowance of this  reissuance also triggered a minimum royalty payment of $400,000 due on this patentin May 2003. This payment was made by the Company in cash on May 9, 2003.

In January 2003, we signed an agreement to study the formation of a strategicpartnership with MITSUI & CO. LTD., one of the largest trading houses in Japanand we arecurrently in the process of completing that study. In April 2003, we signed atechnical cooperation agreement withMitsubishi Heavy Industries Ltd. (MHI), one of the largestindustrial corporations in the world, headquartered in Tokyo, Japan. We expect either one or both of these agreements to ultimatelyresult in reimbursed research projects and license agreements for the Company.
**RECENT ACCOUNTING PRONOUNCEMENTS**
In September 2001, the FASBissued Statement 143, Asset Retirement Obligations. This Statement addresses financial accounting and reporting for obligationassociated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Statement will beeffective for the Company's fiscal year ending December 2003.  The Company does not believe that the adoption of thispronouncement will have a material effect on its financial statements.

In June 2002, the FASBissued Statement 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement will be effective afterDecember 31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on itsfinancial statements.

 InMay 2003, the FASB issued Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities andEquity. This statement will be effective for the first interim period beginning after June 15, 2003 and establishes standards forhow an issuer classifies and measures certain financial instruments with the characteristics of both liabilities and equity. TheCompany does not believe that the adoption of this pronouncement will have a material effect on its financialstatements.

10

Index

**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTSOF OPERATIONS (cont.)**
**RESULTS OF OPERATIONS**
Our quarterlyloss for the second quarter ended June 30, 2003 was $696,056, less than half ofthe loss of $1,487,963 for the same period last year and less than the loss of$770,969 for the first quarter ended March 31, 2003. Our loss of $1,467,025 for the six months ended June 30, 2003 was alsoapproximately half of the loss of $2,856,905 for the six months ended June 30, 2002. These substantially reduced losses are theresult of the restructuring at our EBT subsidiary and cost cutting in other areas. We expect the magnitude of the quarterly lossesto continue to decrease as we focus on increasing our revenue through the remainder of the year.

Our revenues for the second quarter ended June30, 2003 totaled $160,380 compared to $480,284 for the second quarter of 2002. We earned $604,832 in revenues during the six monthperiod ended June 30, 2003, (the “2003 Period”) as compared with $765,721 during the six month period ended June 30,2002 (the “2002 Period”). During the 2003 Period, all of our revenues were from ANI. In the 2002 Period, we had revenueof $715,736 from ANI, and $49,985 from EBT. The ANI revenues in both periods were substantially all the result of reimbursedresearch expenditures. In the 2002 Period, $208,066 of these reimbursements were from government programs, $500,000 was from aprivate research contract with a large Japanese display manufacturer, and $7,670 from miscellaneous product sales. In the 2003Period, $166,712 of these reimbursements were from government programs, and $400,000 was from a private research contract with thesame display manufacturer. The remainder of the ANI revenue was from miscellaneous product sales and royalty agreements. During the2002 Period, EBT received $49,985 from the sale of products and services, but had no revenue in the 2003 Period.

We had a total revenue backlog of $575,459 asof June 30, 2003, which represents a substantial increase from the total revenue backlog of $36,204 that existed at June 30, 2002.The backlog at the end of both periods consisted of government programs at ANI.  EBT had no backlog at either June 30, 2003 or2002. The EBT business model calls for EBT to license its technology, and as a result, it has no product sales and no backlog. Ourability to perform continued research, or fulfill our backlog, should not require significant additional personnel.

For the 2003Period, our cost of sales were $223,039, or a gross margin of 63%, as comparedwith $579,583 or a gross margin of 24%, for the 2002 Period. The 2003 margin wasmuch higher than normal because the majority of our revenue came from one singleresearch project with a large Japanese display manufacturer. This contract dealtwith a technical area where we have performed extensive research, and therefore,we were able to complete this project with minimal outside expenditures. Wewould expect our future margins to be lower than this, especially as it relatesto government contracts that have little or no margin associated with them.

 Our  selling, general, and administrativeexpenses were $854,752 for the 2003 Period, compared with $1,696,904 for the 2002 Period. The primary reason for the reduction from2002 to 2003 relates to the restructuring at EBT and the elimination of the sales and marketing costs associated with EBT, as wellas an overall reduction in general and administrative costs.

Our royalty expense was $400,000in the 2003 Period. There was no royalty expense in the 2002 Period. The royalty expense is a minimum payment due in connectionwith the recently allowed Keesman patent. We expect royalty expense in future periods to be highly correlated with royaltyincome.

We incurred research and developmentexpenses  of $557,898 for   the 2003 Period, which was a reduction from the $912,591 incurred in the 2002 Period. Thisdecrease results from the restructuring at EBT, which resulted in the elimination of all research and development related to theEBT products. We expect total research and development expense to decline for the balance of the year as we seek and receiveadditional revenues to fund our research.  We expect to continue to incur expense in 2003 in support of additional researchand development activities related to the commercial development of our CFE nanotube technology, however we expect the overallresearch and development expense in 2003 to be lower than 2002 as a result of the increased funding available to ANI.

Our interestexpense decreased substantially in the 2003 Period because we issued no newdebt, continued to pay on old debt, and converted a portion of our debt intoequity in 2003.

11

Index

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

       

**FINANCIAL CONDITION AND LIQUIDITY**

Our cashposition for the Period  increased substantially. At June 30, 2003, we hadcash and cash equivalents in the amount of $1,018,942 as compared with cash andcash equivalents of $15,868 at December 31, 2002.  This substantialincrease in cash is primarily the result of cash provided by financingactivities, offset by cash used in operating activities. The cash used inoperations was primarily the result of our net operating loss for the period.The cash used in operating activities during the 2003 Period of $1,767,823 wasslightly lower than the $1,899,203 used in the 2002 Period. The primary reasonfor the decrease was the reduced loss in the 2003 Period.

As described ingreater detail in the notes to the financial statements, we received netproceeds of $2,805,666 from the issuance of common stock related to privateplacements and option exercises during the 2003 Period, as compared with$1,408,339 from the issuance of common stock during the 2002 Period.  Weissued no new debt in the 2003 Period, as opposed to the 2002 Period when weissued $600,000 in new debt.

We used no cashfor investing activities in the 2003 Period. Cash used in investing activitiesduring the 2002 Period was $223,680. The cash used in the 2002 Period resultedprimarily from the purchase of equipment.

Theprincipal source of our liquidity has been funds received from exempt offerings of common and preferred stock. In the event that weneed additional funds, we may seek to sell additional debt or equity securities. While we expect to be able to obtain any fundsneeded for operations, there can be no assurance that any of these financing alternatives can be arranged on commerciallyacceptable terms. We believe that our success in reaching profitability will be dependent upon the viability of our products andtheir acceptance in the marketplace, and our ability to obtain additional debt or equity financings in the future. Our independentauditors, Sprouse & Anderson, L.L.P., expressed uncertainty as to the ability of the Company to continue as a going concernbased on accumulated  past losses from operations and our working capital deficiency. See “Independent Auditor’sReport.” We have received similar opinions from our auditors in each year since 1995.

We expect tocontinue to incur substantial expenses for research and development ("R&D"). Further, we believe that certain products that may be developed bypotential licensees of our technology may not be available for commercial saleor routine use for a period of one to two years. While we would likely receiveinitial license payments, ongoing royalty streams related to those licenses willnot be available until potential licensees have introduced products using ourtechnology. Therefore, it is anticipated that the commercialization of ourexisting and proposed products may require additional capital in excess of ourcurrent funding. We have however developed a plan to enable us to operate atbreak-even levels based on the receipt of research funding and other revenues.Achievement of break-even would enable us to continue our research with outseeking additional debt or equity financing.

The combinedeffect of the foregoing may prevent us from achieving sustained profitabilityfor an extended period of time. Because the timing and receipt of revenues fromthe license or royalty agreements will be tied to the achievement of certainproduct development, testing and marketing objectives, which cannot be predictedwith certainty, there may be substantial fluctuations in our results ofoperations. If revenues do not increase as rapidly as anticipated, or if productdevelopment and testing require more funding than anticipated, we may berequired to curtail our operations or seek additional financing from othersources.

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**ITEM 3. Controls and Procedures**
Under the supervisionand with the participation of our management, including our principal executive officer and principal financial officer, weconducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined inRules 13a-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 no significant changes in our internal controls or in other factorsthat could significantly affect these controls subsequent to the EvaluationDate. We have not identified any significant deficiencies or material weaknessesin our internal controls, and therefore, there were no corrective actions taken.

 

 

 

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**  PART II.  OTHER INFORMATION**
**ITEM 1. LEGAL PROCEEDINGS**
None
**ITEM 2.CHANGES IN SECURITIES**
From January 1, 2003 through June 30, 2003, in a series of privateplacements only to accredited investors under Rule 506 of Regulation D of theSecurities Act of 1933, we issued a total of 6,271,803 shares of our commonstock in exchange for $2,604,250. The shares were issued at a slight discount tothe market price of our common stock at the time of issuance. In addition, weissued 71,021 shares of common stock valued at $13,636 in connection with aminimum payment due on a patent license agreement and 100,000 shares of commonstock valued at $237,782 in connection with payment of accounts payable. We paidno commissions relating to the sale of these securities. The Company filed aregistration statement in May 2003 to register the majority of these shares andto update the registration of other previously registered shares. Following is alisting of those shares:
  
Common shares

Shareholder
 
issued
   Argyll Equities LLC 
454,545

Delta Traders
 
                     694,444

First London Securities
 
                     2,604,633

August Pellizzi
 
                     1,563,636

James Wikert
 
                     500,000

Joseph Ritchie
 
                     181,818

Warren DeMaio
 
                     181,818

Thomas DeMaio
 
                     90,909

Winstead, Sechrest & Minnick
 
                     100,000

Till Keesman
 
71,021

 

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**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS**
On July10, 2003 the Company held its 2003 Annual Meeting of Shareholders. The followingitems were presented to a vote of the holders (the “Shareholders”) of theCompany’s issued and outstanding Common Stock:

(1)The election of David R. Sincox and Charles C. Bailey to the Company’s Board of Directors as Class I Directors, whoseterms expire at the Company’s 2004 Annual Meeting of Shareholders.
(2)The election of Eddie Lee, Dr. Robert Ronstadt, and Dr. Zvi Yaniv to the Company’s Board of Directors as Class IIDirectors, whose terms expire at the Company’s 2005 Annual Meeting of Shareholders.
(3)The election of Marc W. Eller and Ronald J. Berman to the Company’s Board of Directors as Class III Directors, whose termsexpire at the Company’s 2006 Annual Meeting of Shareholders.
(4)Vote to change the name of the Company to Nano-Proprietary, Inc.
(5)The ratification of the appointment of Sprouse & Anderson, LLP as the Company’s independent auditors for the 2003fiscal year.
Thenumber of votes cast for each of the above is summarized in the table below. Allnumbers in the table below represent shares of Common Stock or the votingequivalent thereof):
Item Submitted toShareholdersForAgainstAbstain  Broker      Non-VotesTotal(1) Election of Directors     
Election of David R. Sincox       74,899,774
      115,699
00      75,015,473
      Election of Charles C. Bailey       74,899,774
      115,699
00      75,015,473
      Election of Eddie Lee      74,899,774
      115,699
00      75,015,473
      Election of Dr. Robert Ronstadt  74,899,774
      115,699
00      75,015,473
Election of Dr. Zvi Yaniv 74,899,774
      115,699
00      75,015,473
      Election of Marc W. Eller      74,899,774
      115,699
00 75,015,473
      Election of Ronald J. Berman       74,899,774
      115,699
00      75,015,473      (2) Approval      of Name Change       73,035,849
      1,934,039
      45,5850      75,015,473      (3) Ratification of Sprouse & Anderson, 
 
   
 LLP      Company as auditors       73,035,849
      1,934,039
      45,5850      75,015,473
 

**ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K**

       (a)     Exhibits:See Index to Exhibits on page 17 for a descriptive response to this item.
       (b)     Reportson Form 8-K:

                (1)Current Report on Form 8-K dated April9, 2003 (Item 5)
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**SIGNATURES**
Pursuant to the requirements of the Securities and Exchange Act of 1934, theRegistrant has duly caused this Report to be signed on its behalf by theundersigned thereunto duly authorized.
  NANO-PROPRIETARY, INC.      (Registrant)  Date:     August 4, 2003      /s/ Marc W.Eller                                        Marc W. Eller      Chairman and Chief Executive      Officer (Principal Executive Officer)  Date:     August 4, 2003      /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     Section 302 Certificate of Marc W. Eller

31.2    Section 302 Certificate of Douglas P. Baker

32.1     Section 906 Certificate of Marc W. Eller

32.2     Section 906 Certificate of Douglas P. Baker

 

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