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

**FORM 10-QSB**

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

        For the quarterly period endedSeptember 30, 2003

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

**COMMISSION FILE NO. 1-11602**

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

 

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

****

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

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

 

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

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

As of October 27, 2003, the registrant had 95,433,218 shares of common stock, par value$.001 per share, issued and outstanding.

Transitional Small Business Disclosure Format.

Yes  [  ]   No [X]

----

 

**NANO-PROPRIETARY, INC.INDEX**

| Part I.  Financial Information | **Page**                                                                                                                                                                                                                                    |
|-------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 1.  Financial Statements                                                                                                                                                                                                          |   |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Balance Sheets--September 30, 2003 and December31, 2002 | 3 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Statements of Operations--Three Months and NineMonths Ended           September 30, 2003 and 2002 | 4 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Consolidated Statements of Cash Flows--Nine Months Ended           September 30, 2003 and 2002 | 5 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                |                                                                                                                                                                                                                                        | Notes to Consolidated Financial Statements | 6 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 2.  Management’s Discussion and Analysis of FinancialCondition                      and Results of Operations | 9 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 3.  Controls and Procedures                                                                                                                                                                                                  | 13 |
|                                |                                                                                                                                                                                                                                        |   |   |
| Part II.  Other Information    |                                                                                                                                                                                                                                        |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 1. LegalProceedings                                                                                                                                                                                                                    | 14 |
|                                |                                                                                                                                                                                                                                        |   |   |
|                                | Item 2. Changes in Securities                                                                                                                                                                                                               | 14 |
|                                     |                                                                                                                                                                                                                                             |  |
|                                | Item 6.  Exhibits and Reports on Form 8-K                                                                                                                                                                                              | 15 |
|                                |                                                                                                                                                                                                                                        |   |   |
| Signatures                          | 16                                                                                                                                                                                                                                          |

 

 

 

 

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

**ASSETS**

 

**(Unaudited) September 30, 2003**

**December 31, 2002**

Current assets:

 

 

 

 

      

Cash and cash equivalents

 $

2,825,913 

$

15,868 

 

Accounts receivable, trade – net of allowance for doubtful accounts              of $0 in 2003 and 2002

 

41,759 

 

32,316 

 

Prepaid expenses and other current assets

 

180,344 

 

95,232 

 

 

 

 

 

 

 

               Total current assets

 

3,048,016 

 

143,416 

 

 

 

 

 

 

 

Property and equipment, net

 

86,494 

 

115,239 

 

Officer receivable

 

31,250 

 

62,500 

 

Other assets

 

800 

 

800 

 

               Total assets

$

3,166,560 

$

321,955 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

$

155,007 

$

584,878 

 

Current portion of long-term debt

 

– 

 

39,832 

 

Obligations under capital lease

 

19,103 

 

17,993 

 

Notes payable

 

– 

 

1,600,000 

 

Accrued liabilities

 

215,958 

 

493,564 

 

 

 

 

 

 

 

               Total current liabilities

 

390,068 

 

2,736,267 

 

 

 

 

 

 

Obligations under capital lease

 

32,194 

 

46,283 

 

 

 

 

 

 

 Total Liabilities

 

 422,262 

 

2,782,550 

 

 

 

 

 

 

Commitments and contingencies

 

– 

 

–  

 

 

 

 

 

Stockholders' (deficit):

 

 

 

 

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

 

– 

 

–  

     Common stock, $.00l par value, 120,000,000 sharesauthorized,             94,014,661 and 76,970,792 shares issued and outstandingat             September 30, 2003 and December 31, 2002,respectively

 

94,015 

 

76,971 

Additional paid-in capital

 

76,576,775 

 

68,709,621 

Accumulated deficit

 

(73,926,492)

 

(71,247,187)

 

 

 

 

 

               Total stockholders' (deficit)

 

2,744,298 

 

(2,460,595)

 

 

 

 

 

               Total liabilities and stockholders' (deficit)

$

3,166,560 

$

321,955 

 

See notes to consolidated financial statements.

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

 

 

**For the Three Months Ended September 30,**

 

 

**For  the Nine Months Ended September 30,**

 

 

**2003**
  
**2002**
  
**2003**
  
**2002**

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

Government contracts

$

86,483 

 

$

46,086 

 

$

253,195 

 

$

254,152 

 

Privately funded research

 

– 

 

 

85,713 

 

 

400,000 

 

 

585,713 

 

Royalties

 

1,328 

 

 

– 

 

 

2,248 

 

 

– 

 

Other

 

384 

 

 

87,191 

 

 

37,584 

 

 

144,846 

 

          Total Revenues

 

88,195

 

 

218,990 

 

 

693,027 

 

 

984,711 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

93,640 

 

 

231,873 

 

 

316,679 

 

 

811,456 

Selling, general and administrative expenses

 

805,330 

 

 

1,043,764 

 

 

1,660,082 

 

 

2,740,668 

Research and development

 

 389,852 

 

 

 295,049 

 

 

 947,750 

 

 

1,207,640 

Impairment charge
 
–   
  
176,286 
  
–  
  
176,286  

Royalty expense

 

–  

 

 

–  

 

 

400,000 

 

 

–  

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses

 

1,288,822 

 

 

1,746,972 

 

 

3,324,511 

 

 

4,936,050 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(1,200,627)

 

 

(1,527,982)

 

 

(2,631,484)

 

 

(3,951,339)

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense), net

 

 

 

 

 

 

 

 

 

 

 

 

Interest Expense

 

(13,308)

 

 

(141,992)

 

 

(54,835)

 

 

(556,917)
 
Lawsuit Settlement

 

– 

 

 

435,240

 

 

– 

 

 

435,240
 
Net realized and unrealized gains (losses) on           marketable securities

 

– 

 

 

(4,167)

 

 

– 

 

 

(3,397)

 

Other

 

1,655 

 

 

201 

 

 

7,014 

 

 

409 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Loss from continuing operations before taxes

 

(1,212,280)

 

 

(1,238,700)

 

 

(2,679,305)

 

 

(4,076,004)

 

 

 

 

 

 

 

 

 

 

 

 

 

 Provision for taxes

 

 – 

 

 

 – 
 
 

 – 

 

 

 – 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations

 

(1,212,280)

 

 

(1,238,700)

 

 

(2,679,305)

 

 

(4,076,004)

 

 

 

 

 

 

 

 

 

 

 

 

 

Discontinued operations

 

 

 

 

 

 

 

 

 

 

 

      Loss on the disposal of SBOA

 

– 

 

 

(141,314)

 

 

– 

 

 

(141,314)

      Loss from the operation of SBOA

 

– 

 

 

(71,340)

 

 

– 

 

 

(90,941)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

(1,212,280)

 

 

(1,451,354)

 

 

(2,679,305)

 

 

(4,308,259)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less accretion on convertible preferred stock

 

– 

 

 

– 

 

 

– 

 

 

(37,495)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss applicable to common shareholders

$

(1,212,280)

 

$

(1,451,354)

 

$

(2,679,305)

 

$

(4,345,754)

Loss per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

 

$

(0.01)

 

$

(0.02)

 

$

(0.03)

 

$

(0.06)

Weighted average shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and Diluted

 

 

 

88,590,429 

 

 

73,767,176 

 

 

84,656,310 

 

 

70,429,339

See notes to consolidated financial statements.

4
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

 

**For  the Nine Months Ended September 30,**

 

**2003**

 
 
**2002**

Cash flows from operating activities:

 

 

 
 
 

 

 Net loss

 

 

$

(2,679,305)

$

(4,308,259)

 

 

Adjustments to reconcile net loss to net

 

 

 

 

 

 

 

cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization expense

 

33,940 

 

247,320 
   
Gain on sale of fixed assets
 
(4,695)
 
– 

 

 

 

Amortization of discount on debt

 

– 

 

352,343 

 

 

 

Net realized and unrealized (gain) loss on marketable securities

 

– 

 

3,397 

 

 

 

Common shares issued for patent option

 

13,636 

 

– 

 

 

 

Common shares issued for services

 

– 

 

21,000 

 

 

 

Non-cash loss on disposal of SBOA

 

– 

 

104,845 

 

 

 

Impairment charge

 

– 

 

176,286 
   
Non-cash variable option pricing expense
 
389,385 
 
– 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable, trade

 

(9,443)

 

150,292 

 

 

 

 

Inventories

 

– 

 

(46,739) 

 

 

 

 

Prepaid expenses and other current assets

 

 (53,862)

 

 (66,587)

 

 

 

 

Accounts payable and accrued liabilities

 

(269,482)

 

652,537 

 

 

 

 

Customer deposits and deferred revenue

 

– 

 

428,699 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total adjustments

 

99,479 

 

2,023,393 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in operating activities

 

(2,579,826)

 

(2,284,866)

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

Capital expenditures

 

 

(5,195)

 

(228,550)
  
Proceeds from sale of fixed assets
  
4,695 
 
– 

 

 

Proceeds from the sale of marketable securities

 

– 

 

46,313 

 

 

Purchase of marketable securities

 

– 

 

(25,860)

 

 

       Net cash used in investing activities

 

(500)

 

(208,097)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

Repayment of notes payable

 

(52,811)

 

(666,389)

 

 

Proceeds from notes payable and long-term debt

 

–  

 

1,150,000 

 

 

Proceeds of stock issuance, net of costs

 

5,443,182 

 

1,965,589 

 

 

 

 

 

 

 

 

 

 

 

       Net cash provided by financingactivities

 

5,390,371 

 

2,449,200 

 

 

 

 

 

 

 

 

 

Net increase (decrease) in cash and cash equivalents

 

2,810,045 

 

(43,763)

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

15,868 

 

261,861 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

$

2,825,913 

 

$

218,098 

See notes to consolidated financial statements.

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

1.       Basis of Presentation

               The consolidated financial statements of the Company for the three and nine month periods ended September 30, 2003 and 2002 havebeen prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. In theopinion of the Company’s management, all adjustments necessary to present fairly the financial position, results ofoperations, and cash flows of the Company as of September 30, 2003 and 2002 and for the periods then ended have been made. Thoseadjustments consist of normal and recurring adjustments. The consolidated balance sheet of the Company as of December 31, 2002 hasbeen derived from the audited consolidated balance sheet of the Company as of that date.

               Certain information and note disclosures normally included in the Company’s annual financial statements prepared inaccordance with generally accepted accounting principles have been condensed or omitted. These consolidated financial statementsshould be read in conjunction with a reading of the financial statements and notes thereto included in the Company’s AnnualReport on Form 10-KSB for the fiscal year ended December 31, 2002 as filed with the U.S.  Securities and ExchangeCommission.

               The results of operations for the three and nine month periods ended September 30, 2003 are not necessarily indicative of theresults to be expected for the full year.

2.       Supplemental Cash Flow Information

               Cash paid for interest for the nine months ended September 30, 2003 and 2002 was $3,335 and $24,152, respectively. During the ninemonths ended both September 30, 2003 and 2002, the Company had non-cash transactions related to the conversion of notes payable,including related accrued interest, into shares of the Company’s common stock. During the nine months ended September 30,2003, the Company also had a non-cash transactions related to variable option pricing and the issuance of common shares inconnection with the payment of accounts payable and accrued expenses. These transactions are described in greater detail in Note3.

3.       Stockholders’ Equity

               In the nine months ended September 30, 2003, the Company issued 6,860,039 restricted shares of its common stock and received netproceeds of $3,604,250 in exempt offerings under Regulation D of the Securities Act of 1933.  The Company issued 2,280,789shares of its common stock and received $1,838,932 in connection with the exercise of employee stock options. The Company alsoissued 7,707,020 shares of common stock in connection with the payment of convertible notes payable and related accrued interest.The face amount of the notes was $1,600,000 and the related accrued interest totaled $161,213. The Company also issued 125,000shares valued at $276,782 in connection with the payment of accounts payable and 71,021 shares valued at $13,636 in connection witha patent extension.

               In April 2001, the Company repriced a total of 900,500 options to lower the exercise price of these options to $1.50, which wasapproximately 160% of the market price of the stock at the time of the repricing. The repricing of these options resulted in a newmeasurement date for accounting purposes and reclassification of these options as variable plan awards beginning on the date of therepricing. The Company previously accounted for these option grants as fixed plan awards. From the date of the repricing throughJune 30, 2003, the quoted value of the Company’s common stock did not exceed above the exercise price of the options and assuch no compensation expense was recognized at any period through that date. In September 2003, the Company’s common stockprice exceeded the exercise price and remained above it, closing at $2.08 per share. The Company recorded $389,385 in non-cashoption expense for the cumulative effects of the repricing and increased additional paid in capital by the same amount in thequarter ended September 30, 2003.

               In the nine months ended September 30, 2002, the Company issued 1,009,911 shares of restricted common stock in payment ofconvertible notes payable and related accrued interest. The gross amount of the notes was $500,000 and related accrued interest was$33,750. During the same period, the Company also issued a total of 4,809,221 restricted shares of its common stock and receivednet proceeds of $1,829,339 in a series of exempt offerings under Regulation D of the Securities Act of 1933 and received $136,250and issued 230,000 shares as the result of the exercise of options during the period. The Company also issued 355,000 shares of itscommon stock to pay accounts payable in the amount of $112,250 and 75,000 shares of its common stock in payment for services valuedat $21,000.

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

****

3.       Stockholders’ Equity(continued)

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

4.       Notes Payable and Long Term Debt

               During the nine months ended September 30, 2003, all of the Company’s convertible notes payable were converted into shares ofthe Company’s common stock as described in greater detail in Note 3.

5.       Contingencies

*Litigation*

               The Company is a defendant in minor lawsuits described in greater detail in its 2002 annual report on Form 10-KSB. The Companyexpects any potential eventual payment to have no material affect on the financial statements.

6.       Business Segments

Following is information related to the Company’s business segments for the ninemonths ended September 30, 2003 and 2002:

 

 
ANI
 
EBT
 
All Other
 
Total

2003

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$ 

693,027 

 

$ 

 - 

 

$

 - 

 

$ 

693,027 

 

 

 

 

 

 

 

 

 

Profit (Loss)

 

(1,812,679)

 

(181,559) 

 

(685,067)

 

(2,679,305)

 

 

 

 

 

 

 

 

 

Expenditures for

 

 

 

 

 

 

 

 

     long-lived assets

 

5,195  

 

- 

 

- 

 

- 

 

 

 

 

 

 

 

 

 

2002

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$  

856,125

 

       $ 

128,586 

 

$ 

-  

 

$ 

984,711 

 

 

 

 

 

 

 

 

 

Profit (Loss)

 

(1,294,003)

 

(1,287,417)

 

  (1,494,584)

 

(4,076,004)

 

 

 

 

 

 

 

 

 

Expenditures for

 

 

 

 

 

 

 

 

     long-lived assets

 

52,327 

 

171,674 

 

2,771 

 

226,772 

7.       Related Party Transactions

               The Company made a non-interest bearing advance in the amount of $62,500 to its President and Chief Operating Officer, Dr. ZviYaniv. A portion of this advance was repaid in the quarter ended June 30, 2003.  The remaining portion of the advance has beenclassified as long-term because there are no scheduled repayment terms. Dr. Yaniv does have the opportunity to earn bonuses basedon the achievement of certain milestones. Any such bonuses that may be earned would be applied against this loan.

7
**NANO-PROPRIETARY, INC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)**

 

8.       Subsequent Events

          For the period from October 1,2003 through October 27, 2003, the Company issued a total of 747,058 restricted shares of its common stock and received netproceeds of approximately $1,208,000 in an exempt offering under Regulation D of the Securities Act of 1933. During the sameperiod, the Company also issued 671,499 shares of common stock and received proceeds of $531,497 in connection with the exercise ofoptions under the Company’s stock option plans.

9.       Recently Issued AccountingStandards

          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 FASB issuedStatement 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement will be effective after December31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on its financialstatements.

          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 Companysold the assets of its Sign Builders of America, Inc. subsidiary. The results of Sign Builders of America, Inc. for the three andnine month periods ended September 30, 2002 are included in the consolidated statements as a discontinued operation.
 
 

 

8
**ITEM 2:  MANAGEMENT'S DISCUSSION 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 containscertain forward-looking statements that we believe are within the meaning of Section 27A of the Securities Act of 1933 and Section21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created by such acts. For thispurpose, any statements that are not statements of historical fact may be deemed to be forward-looking statements, including thestatements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding our strategy,future operations, future expectations or future estimates, financial position and objectives of management. Those statements inthis Form 10-QSB containing the words "believes," "anticipates," "plans," "expects" and similar expressions constituteforward-looking statements, although not all forward-looking statements contain such identifying words. These forward-lookingstatements are based on our current expectations and are subject to a number of risks, uncertainties and assumptions relating toour operations, results of operations, competitive factors, shifts in market demand and other risks and uncertainties.

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

**Nine months ended September 30, 2003 and 2002**

**OVERVIEW**

          During the nine months endedSeptember 30, 2003, our primary revenues were earned as a result of reimbursed research expenditures at our Applied Nanotech, Inc.(“ANI”) subsidiary. We continued to incur substantial expenses in support of the development of our proprietary CarbonNanotube Based Field Emission (“CFE”) Technology. As more fully discussed in our Annual Report on Form 10-KSB for theyear ended December 31, 2002, we expect to incur additional research and development expenses throughout 2003 in developing our CFEtechnology. We have restructured the company to focus on licensing our technology and obtaining sufficient to revenue to cover ourongoing research expenditures.

**OUTLOOK**

          We expect our present cashbalances of approximately $4 million as of the date of this filing, when combined with expected revenue sources, to enable us tooperate at least through 2004.  We expect to achieve profitability in 2004. There can be no assurance that we will achieveprofitability, or even break-even, in the future.  To the extent our revenues do not allow us to break-even, or if the timingof revenues does not match with expenses, we could 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 of revenues received could also cause the revenuesrequired to break-even to increase. If revenue producing projects require unanticipated expenses, or heavier than anticipated useof outside services or materials, we may be unable to achieve profitability at the expected level of revenues.

          We have developed a plan toallow ourselves to maintain operations until we are able to sustain ourselves on our own revenue. Our plan is primarily dependenton raising funds through the licensing of our technology and reimbursed research contracts. Our current cash of approximately $4million as of the date of this filing is sufficient to allow us to maintain operations through at least the end of 2004. We expectadditional revenue producing projects or license agreements to be finalized during that time period. We believe that we have theability to continue to raise funding, if necessary, to enable us to continue operations until our plan can be completed.
 
 

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

 

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

 

**RECENT DEVELOPMENTS**

          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 werenotified 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 patent was formallyreissued in August 2003. The reissuing process considerably enhanced the existing nine claims of the U.S. patent, as well as addedadditional claims. The reissuance of this patent solidifies our already strong position in the carbon nanotube field and expandsthe number of companies likely to license our technology in the future. Allowance of this reissuance also triggered a minimumroyalty payment of $400,000 due on this patent in 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 strategic partnership with MITSUI & CO. LTD., one of the largest tradinghouses in Japan and we are currently in the process of completing that study. In April 2003, we signed a technical cooperationagreement withMitsubishi Heavy Industries Ltd. (MHI), one of the largest industrial corporations in theworld, headquartered in Tokyo, Japan. We expect either one or both of these agreements to ultimately result in reimbursed researchprojects and license agreements for the Company.

          We completed aprivate placement of shares of our common stock in October 2003. As a result of this private placement we issued 1,335,295shares of our common stock in exchange for gross proceeds of $2,270,000.  Our netproceeds from this transaction were approximately $2,208,000 with $1,000,000 of these proceeds received as of September 30, 2003.We expect the proceeds of this transaction, when combined with our existing cash and expected revenues will enable us to operate atleast through the end of 2004.

**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 FASB issuedStatement 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement will be effective after December31, 2002. The Company does not believe that the adoption of this pronouncement will have a material effect on its financialstatements.

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

**RESULTS OF OPERATIONS**

          Our quarterly loss for thethird quarter ended September 30, 2003 was $1,212,280 as compared with the loss of $1,451,354 for the same period last year. Asdiscussed in more detail below, variable option accounting treatment of certain options resulted in a non-cash charge of $389,385.No similar charge existed in 2002. Without that charge, our loss would have been $822,895. Our loss of $2,679,305 for the ninemonths ended September 30, 2003 was reduced to approximately 60% of the loss  for the nine months ended September 30, 2002.These substantially reduced losses are the result of the restructuring at our EBT subsidiary and cost cutting in other areas. Weexpect the magnitude of our quarterly loss to decrease in the fourth quarter from that of the third quarter as we focus onincreasing our revenue through the remainder of the year.

          Our revenues for the thirdquarter ended September 30, 2003 totaled $88,195 compared to $218,990 for the third quarter of 2002. We earned $693,027 in revenuesduring the nine month period ended September 30, 2003, (the “2003 Period”) as compared with $984,711 during the ninemonth period ended September 30, 2002 (the “2002 Period”). During the 2003 Period, all of our revenues were from ANI.In the 2002 Period, we had revenue of $856,125 from ANI, and $128,586 from EBT. The ANI revenues in both periods were substantiallyall the result of reimbursed research expenditures. In the 2002 Period, $254,152 of these reimbursements were from governmentprograms, $585,713 was from a private research contract with a large Japanese display manufacturer, and $16,260 from miscellaneousproduct sales. In the 2003 Period, $253,195 of these reimbursements were from government programs, and $400,000 was from a privateresearch contract with the same display manufacturer. The remainder of the ANI revenue was from miscellaneous product sales androyalty agreements. During the 2002 Period, EBT received $128,856 from the sale of products and services, but had no revenue in the2003 Period.

          We had a total revenue backlogof $521,496 as of September 30, 2003, as compared with a total revenue backlog of $814,287 that existed at September 30, 2002. Thebacklog at the end of the 2003 Period consisted of government programs at ANI, while the backlog at the end of the 2002 Periodconsisted of private research contracts at ANI.  EBT had no backlog at either September 30, 2003 or 2002. The EBT businessmodel calls for EBT to license its technology, and as a result, it has no product sales and no backlog. Our ability to performcontinued research, or fulfill our backlog, should not require significant additional personnel.

          For the 2003 Period, our costof sales were $316,679, or a gross margin of 54%, as compared with $811,456 or a gross margin of 18%, for the 2002 Period. The 2003margin was much higher than normal because the majority of our revenue came from one single research project with a large Japanesedisplay manufacturer. This contract dealt with a technical area where we have performed extensive research, and therefore, we wereable to complete this project with minimal outside expenditures. We would expect our future margins to be lower than this,especially as it relates to government contracts that have little or no margin associated with them.

          Our  selling, general,and administrative expenses were $1,660,082 for the 2003 Period, compared with $2,740,668 for the 2002 Period. The primary reasonfor the reduction from 2002 to 2003 relates to the restructuring at EBT and the elimination of the sales and marketing costsassociated with EBT, as well as an overall reduction in general and administrative costs. Even though the selling, general, andadministrative expenses were substantially decreased in the 2003 Period, the period was still impacted by a non-cash charge in theamount of $389,385 related to variable options pricing. In April 2001, the Company repriced a total of 900,500 options to lower theexercise price of these options to $1.50, which was approximately 160% of the market price of the stock at the time of therepricing. The repricing of these options resulted in a new measurement date for accounting purposes and reclassification of theseoptions as variable plan awards beginning on the date of the repricing. The Company previously accounted for these option grants asfixed plan awards. From the date of the repricing through June 30, 2003, the quoted value of the Company’s common stock didnot exceed the exercise price of the options and as such no compensation expense was recognized at any period through that date. InSeptember 2003, the Company’s common stock price exceeded the exercise price and remained above it, closing at $2.08 pershare. The Company recorded $389,385 in non-cash option expense for the cumulative effects of the repricing and increasedadditional paid in capital by the same amount in the quarter ended September 30, 2003. Without this charge, selling, general, andadministrative expense would have been only $1,270,697. There was no similar charge in 2002.

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

11
**ITEM 2:  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTSOF OPERATIONS (cont.)**

          We incurred research anddevelopment expenses  of $947,750 for  the 2003 Period, which was a reduction from the $1,207,640 incurred in the 2002Period. This decrease results from the restructuring at EBT, which resulted in the elimination of all research and developmentrelated to the EBT products. We expect total research and development expense to remain constant for the balance of the year. We expect the overall research and development expense in 2003 to be lower than 2002 as a result of the restructuring atEBT.

          Our interest expense decreasedsubstantially in the 2003 Period because we issued no new debt, continued to pay on old debt, and converted a portion of our debtinto equity in 2003.

**FINANCIAL CONDITION AND LIQUIDITY**

          Our cash position increasedsubstantially during the period. At September 30, 2003, we had cash and cash equivalents in the amount of $2,825,913 as comparedwith cash and cash equivalents of $15,868 at December 31, 2002.  This substantial increase in cash is primarily the result ofcash provided by financing activities, offset by cash used in operating activities. The cash used in operations was primarily theresult of our net operating loss for the period. The cash used in operating activities during the 2003 Period of $2,579,826 wasslightly higher than the $2,284,866 used in the 2002 Period. While the 2003 Period had a smaller loss, the cash used in operationswas favorably impacted by advance payment from a customer and deferral of accounts payable.

          As described in greater detailin the notes to the financial statements, we received net proceeds of $5,443,182 from the issuance of common stock related toprivate placements and option exercises during the 2003 Period, as compared with $1,965,589 from the issuance of common stockduring the 2002 Period.  The Company issued 2,280,789 common shares as the result of option exercises during the 2003 Periodand has issued an additional 671,499 shares through October 27, 2003. Individuals that are not currently employees of the Companyexercised the majority of these options.  The Company sold its Sign Builders of America, Inc. subsidiary and reorganized itsElectronic Billboard Technology, Inc. operations in 2002. Virtually all employees terminated as a result of those actions haveuntil October 31, 2003 to exercise their vested options. This approaching deadline, combined with the increase in the price of theCompany’s stock contributed greatly to the number of options exercised.  We issued no new debt in the 2003 Period, asopposed to the 2002 Period when we issued $1,150,000 in new debt.

          We used net cash of $500 forinvesting activities in the 2003 Period. Cash used in investing activities during the 2002 Period was $208,097. The cash used inboth periods resulted primarily from the purchase of equipment.

          The principal source of ourliquidity has been funds received from exempt offerings of common and preferred stock. In the event that we need additional funds,we may seek to sell additional debt or equity securities. While we expect to be able to obtain any funds needed for operations,there can be no assurance that any of these financing alternatives can be arranged on commercially acceptable terms. We believethat our success in reaching profitability will be dependent on our patent portfolio and upon the viability of products using ourtechnology and their acceptance in the marketplace, as well as our ability to obtain additional debt or equity financings in thefuture, if needed. Our independent auditors, Sprouse & Anderson, L.L.P., expressed uncertainty as to the ability of the Companyto continue as a going concern based on accumulated  past losses from operations and our working capital deficiency. See“Independent Auditor’s Report.” We have received similar opinions from our auditors in each year since1995.

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

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

12
**ITEM 3.       Controls and Procedures**

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

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

 

 

 

 

 

 

 

 

 

 

 

 

13
**PART II.  OTHER INFORMATION**

ITEM 1.  LEGAL PROCEEDINGS

          None

ITEM 2.  CHANGES IN SECURITIES

          From January 1, 2003 throughSeptember 30, 2003, in a series of private placements only to accredited investors under Rule 506 of Regulation D of the SecuritiesAct of 1933, we issued a total of 6,860,039 shares of our common stock in exchange for $3,604,250. These shares were issued at adiscount to the market price of our common stock at the time of issuance. In addition, we issued 71,021 shares of common stockvalued at $13,636 in connection with a minimum payment due on a patent license agreement and 125,000 shares of common stock valuedat $276,782 in connection with payment of accounts payable. We paid no commissions relating to the sale of these securities. TheCompany filed registration statements in May and July 2003 to register the majority of these shares and to update the registrationof other previously registered shares. The Company intends to file a registration statement in November 2003 to register theremainder of these shares. Following is a listing of those shares:

 

                   

Common shares

Shareholder

 

issued

 

 

 

Argyll Equities LLC

 

895,722

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

Karrison Nichols
 
147,059

Donald T. Locke
 
25,000

 

 

 

 

 

14
ITEM 6.     EXHIBITS AND REPORTS ONFORM 8-K

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

       (b)     Reports on Form8-K:
 
None

 

 

 

 

 

 

 

 

 

 

15 
**SIGNATURES**

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

 

 

NANO-PROPRIETARY, INC. (Registrant) 

 

 

Date:     October 30, 2003 

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

  

 

Date:     October 30, 2003 

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

 
 
 

 

 

 

 

 

 

 

 

16
**INDEX TO EXHIBITS**

The following documents are filed as part of this Report:

Exhibit
 
 
 
 4.1

Form of Securities Purchase Agreementby and between the Company and the participants of October 2003 privateplacement of common stock
  
4.2

Form of Registration Rights Agreement by and between the Company and the participants ofOctober 2003 private placement of common stock
  
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