Table
      of Contents


UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549




**FORM
      10-K**




ý
            Annual
                report under Section 13 or 15(d) of the Securities Exchange Act of
                1934
                for the fiscal year ended
              December
                31, 2006; or ̈
            Transition
                report under 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**
              (State
                of Incorporation)
            **76-0273345**
              (IRS
                Employer Identification Number)




**3006
      Longhorn Boulevard, Suite 107, Austin, Texas 78758**


(Address
      of principal executive office, including Zip Code)




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




Securities
      registered pursuant to Section 12(b) of the Exchange Act:


**Title
                of each class**
            **Name
                of Each Exchange on Which Registered**Common
                Stock, $0.001 par value
            OTC
                Bulletin Board




Securities
      registered pursuant to Section 12(g) of the Exchange Act: None




Indicate
      by check mark if the registrant is a well-known seasoned issuer as defined
      in
      Rule 405 of the Securities Act. Yes  ̈ No þ





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes  ̈ No þ





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


Yes þ No  ̈




Indicate
      by check mark if disclosure of delinquent filers in response to Item 405 of
      Regulation S-K is not contained in this form and will not be contained, to
      the
      best of registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any amendment to
      this
      Form 10-K.  ̈




Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer.


Large
      Accelerated Filer  ̈ Accelerated Filer þ Non-Accelerated Filer  ̈





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes  ̈ No þ




The
      aggregate market value of the Common Stock held by non-affiliates of the
      Registrant, based upon the average of the closing bid and asked price of the
      Common Stock on the OTC Bulletin Board system on June 30, 2006 of $1.76, was
      approximately $176 million.




As
      of February 28, 2007, the registrant had 104,258,982 shares of Common Stock
      issued and outstanding.




**Documents
      Incorporated by Reference**




No
      documents are incorporated by reference into this annual report on Form
      10-K
















**TABLE
      OF CONTENTS**


**Page****Part
                I.**Item
                1.
            Business
            1Item
                1A.
            Risk
                Factors
            10Item
                1B.
            Unresolved
                Staff Comments
            15Item
                2.
            Properties
            15Item
                3.
            Legal
                Proceedings
            16Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            17**PART
                II**Item
                5.
            Market
                for Registrant’s Common Equity, Related Stockholder
                Matters and Issuer Purchases of Equity Securities
            18Item
                6.
            Selected
                Financial Data
            19Item
                7.
            Management's
                Discussion and Analysis of Financial Condition and Results ofOperations
            20Item
                7A.
            Quantitative
                and Qualitative Disclosures About Market Risk
            26Item
                8.
            Financial
                Statements and Supplementary
                Data
            27Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting and FinancialDisclosure
            50Item
                9A.
            Controls
                and Procedures
            50Item
                9B.
            Other
                Information
            51**PART
                III**Item
                10.
            Directors,
                Executive Officers and Corporate
                Governance
            52Item
                11.
            Executive
                Compensation
            55Item
                12.
            Security
                Ownership of Certain Beneficial Owners and
                Management and Related Stockholder Matters
            63Item
                13.
            Certain
                Relationships and Related Transactions, and
                Director Independence
            65Item
                14.
            Principal
                Accountant Fees and Services
            65**PART
                IV**Item
                15.
            Exhibits
                and Financial Statement
                Schedules
            67




**Important
      Information Concerning Forward-Looking Statements**




Our
      disclosure and analysis in this report contains some forward-looking statements.
      Forward-looking statements give our current expectations or forecasts of future
      events. They use words such as “anticipate”, “believe”, “expect”, “estimate”,
“project”, “intend”, “plan”, and other words and terms of similar meaning in
      connection with any discussion of future operating or financial performance.
      In
      particular, these include statements relating to future actions, prospective
      products or product approvals, future performance or results of current and
      anticipated products, sales efforts, expenses, the outcome of contingencies
      such
      as legal proceedings, and financial results. From time to time, we also may
      provide oral or written forward-looking statements in other materials we release
      to the public.




Any
      or all of our forward-looking statements in this report and in any other public
      statements we make may turn out to be wrong. They can be affected by inaccurate
      assumptions we might make, or by known or unknown risks or uncertainties. Many
      factors mentioned in the risk factors are important in determining future
      results. Consequently, no forward-looking statement can be guaranteed. Actual
      future results may vary materially.




We
      undertake no obligation to publicly update any forward-looking statements,
      whether as the result of new information, future events, or otherwise. You
      are
      advised, however, to consult any further disclosures we make on related subjects
      in our 10-Q, 8-K, and 10-K reports to the SEC. Also note that we include a
      cautionary discussion of risks, uncertainties, and possibly inaccurate
      assumptions relevant to our business. These are factors that we think could
      cause our actual results to differ materially from expected and historical
      results. Other factors besides those listed here could also adversely affect
      us. ****
















**PART
      I.**




When
      used in this document, the words “anticipate”, “believe”, “expect”, “estimate”,
“project”, “intend”, “plan”, and similar expressions are intended to identify
      forward-looking statements. Such statements are subject to certain risks,
      uncertainties, and assumptions. Should one or more of these risks or
      uncertainties materialize, or should underlying assumptions prove incorrect,
      actual results may vary materially from those anticipated, believed, expected,
      estimated, projected, intended, or planned. For additional discussion of such
      risks, uncertainties, and assumptions, see “Important Information Concerning
      Forward-Looking Statements” included at the beginning of this report and “Risk
      Factors” beginning on page 10 of this report.




**Item
      1.** ***Business.***




**DESCRIPTION
      OF BUSINESS**




**General**




We
      are a nanotechnology company engaged in research based primarily on unique
      applications of carbon nanotube technology. Our research is based on
      intellectual property and expertise that we have developed over the years.
      As
      part of our research we perform services for others and develop products and
      materials based on this intellectual property. Our ultimate goal is to generate
      sustainable recurring revenues by licensing our technology to others.




We
      were incorporated in Texas in 1987 and completed our initial public offering
      in
      1993. Our initial focus was on a next generation display technology called
      field
      emission display (“FED”). The majority of our research over the years has been
      related to FED technology, and we have accumulated significant intellectual
      property in this area. FED technology has evolved significantly over the life
      of
      the company, and we have been at the forefront of that evolution, accumulating
      intellectual property at each step of the way. We believe our intellectual
      property will be required by any entity that develops a display using FED
      technology. As discussed in greater detail under the heading “Electron emission
      activities”, our FED technology includes both carbon nanotube based field
      emission displays and thin-film based field emission technology, such as the
      technology recently introduced by Canon and Toshiba referred to as
      SED.




While
      focusing primarily on FED technology, in the past several years we have
      performed research in many other areas. Much of this research was an outgrowth
      of our work in the FED area. This research was either related to other display
      technologies, used processes learned while we were working with FED technology,
      used raw materials used in our FED research, or capitalized on other unique
      capabilities within our organization. As a result we have developed significant
      intellectual property in other areas beyond that solely related to the FED
      technology. At present, we have over 300 total U.S. and foreign patents,
      including 113 issued, 130 pending, and 39 provisional.




**Business
      Model**




We
      are first and foremost a research and development company. We have an extensive
      portfolio of intellectual property that we have developed over the years, and
      we
      intend to develop a portfolio of recurring revenue streams by licensing our
      intellectual property to others.





Much
      of our intellectual property relates to next-generation technologies that are
      not in wide current use and as such, additional development work is required
      before products can be manufactured using these technologies. Our research
      and
      development efforts occur across a continuum moving from concept to
      commercialization as follows:





Concept
      → Laboratory → Development → Pilot /Introduction →
Commercialization





To
      aid in the process of moving our technologies from concept to commercialization,
      we frequently perform funded research for both government entities and large
      corporations. This enables us to focus our resources in areas that have the
      highest level of interest to others, and thus the highest probability for
      commercialization.





Page
            1







**Research
      and Development**




As
      a result of our focus on developing and protecting our intellectual property,
      we
      spend significant amounts on research and development. We spent $3,590,148,
      $2,635,412, and $2,737,029 on research and development in the years ended
      December 31, 2006, 2005, and 2004, respectively. This represents approximately
      41%, 41%, and 37% of our total operating costs and expenses in each of those
      years. We expect to continue to invest heavily in research and development,
      and
      we expect our research and development costs for 2007 to be approximately 50%
      of
      our operating costs.




**Business 
      Segments**




Our
      operations currently consist of three reportable business segments.




***Applied
      Nanotech, Inc*** *.* ANI is the main focus of our efforts. It was incorporated in January 1997 and
      is
      developing our proprietary carbon nanotube and related technologies.
      Accordingly, our research is focused in the broad area of carbon nanotube
      technology and its application to the display, electronics, sensor, medical,
      and
      other industries. Our development plans for our technologies are discussed
      later in this report.




***Electronic
      Billboard Technology, Inc*** .
      EBT was incorporated in January 1997 and initially focused on developing
      sun-readable display products for outdoor use.  Its primary product
      initially was an electronic billboard that would enable the outdoor advertising
      industry to exploit the Internet and information revolution by placing ads
      at
      different locations at different times. The focus of EBT was rapidly shifted
      to
      displays for indoor use that could be used as part of an overall point of
      purchase advertising program. We developed a patented product called the
      E-WindowTM, as well as patents surrounding the process of communicating with
      electronic displays for the purpose of placing advertisements. In 2002, we
      restructured EBT and stopped selling products directly and instead limited
      ourselves to licensing our intellectual property. We did this to focus on our
      business at ANI, which had higher short run potential and was less capital
      intensive. In 2006, we sold EBT’s intellectual property in two simultaneous
      transactions. This is discussed in greater detail below. To the extent that
      EBT
      is basically inactive, information relative to this segment may not be that
      meaningful.




***Other.*** We also incur general overhead to operate that is not associated with any
      spe cific
      subsid iary
      or other segment. This overhead is the approximate cost of being a public
      company, which is the amount in excess of that which might be incurred by a
      private company performing these same activities.






Following
      is a summary of revenues, net loss from continuing operations, and total assets
      for each segment for each of the last three years.




2006
              
              2005
              
              2004RevenuesANI
              
              $
              1,116,670
              
              $
              565,660
              
              $
              382,522EBT
              
              $
              —
              
              $
              —
              
              $
              —Other
              
              $
              —
              
              $
              —
              
              $
              —Total
                  Revenues
              
              $
              1,116,670
              
              $
              565,660
              
              $
              382,522Net
                  loss from continuing operationsANI
              
              $
              (6,113,472
              )
              $
              (4,326,467
              )
              $
              (4,931,370
              )EBT
              
              $
              933,720
              
              $
              (3,734
              )
              $
              (7,499
              )Other
              
              $
              (1,418,867
              )
              $
              (1,488,615
              )
              $
              (2,200,240
              )Total
              
              $
              (6,593,892
              )
              $
              (5,818,816
              )
              $
              (7,139,109
              )AssetsANI
              
              $
              1,101,205
              
              $
              301,870
              
              $
              310,005EBT
              
              $
              —
              
              $
              —
              
              $
              —Other
              
              $
              1,592,237
              
              $
              886,111
              
              $
              834,363Total
              
              $
              2,693,442
              
              $
              1,187,981
              
              $
              1,144,368












Page
            2







**Applied
      Nanotech, Inc.**




**Overall**




We
      are a nanotechnology company focusing our efforts on research, development
      of
      proof of concepts for proposed products, and licensing our technology to others.
      We are developing world-class technologies that generally fall under one of
      four
      technology platforms.These platforms are:




·
            Electron
                emission activities, primarily in the display
                area


·
            Sensor
                technology


·
            Functional
                nanomaterials


·
            Nanoelectronic
                applications




We
      intend to license our technology to others to allow them to manufacture products
      using our technology. We have no plans to establish any manufacturing facilities
      in the foreseeable future, and manufacturing is not a part of our core
      strategy. To the extent that manufacturing capabilities are needed for products
      using our technology, we intend to use manufacturing partnerships, joint
      ventures, or arrange to have products manufactured through contract
      manufacturers.




**Electron
      Emission Activities**




Our
      main focus for virtually the entire life of Nano-Proprietary has been on Field
      Emission Display (“FED”) technology. We have performed extensive research and
      accumulated significant intellectual property in this area. Field emission
      display is a next generation display technology that is ideally suited for
      use
      in large flat screen televisions, with “large” being defined as 50-inch diagonal
      or greater. TVs using FED technology are intended to compete with and improve
      on
      the plasma, projection, and CRT displays currently available in the large screen
      TV market. FED technology can also be used for large outdoor electronic displays
      in products such as roadside billboards, stadium displays, and other outdoor
      electronic signs. We have developed a broad patent portfolio covering numerous
      aspects of FED technology.




***Carbon-nanotube
      based large area flat screen color field emission
      displays.*** Because of cost advantages carbon nanotubes are currently the preferred method
      in the display industry for construction of large area flat screen color TVs
      using FED technology. As
      discussed in more detail in the Technology Agreements section below, we licensed
      6 patents from Till Keesmann in 2000. These patents are basic patents covering
      the use of emissions from carbon nanotubes. The U.S. Patent (No.
      RE38,223 E) was reissued in August 2003. This reissuance significantly strengthened and
      reinforced the basic nature of this patent. It is our belief that any company
      using carbon nanotubes in an emission mode, regardless of application, will
      be
      required to license this, and other patents from us. No companies have yet
      obtained the right to use this patent from us. As discussed in Item 3 to this
      Annual Report on Form 10-K, the Keesmann agreement is currently the subject
      of
      litigation. We have an equally significant patent that we refer to as the Raman
      Spectrum patent. This patent is also a basic patent. It is broader than the
      Keesmann patent in that it covers all carbon-based FEDs, regardless of whether
      the emission is from carbon nanotubes, carbon films, or other forms of
      carbon.




Other
      companies are developing large area color TVs that may be, in part, based on
      our
      carbon nanotube based field emission technology. Companies including Samsung,
      Dupont, Noritake, Motorola, and others have made public announcements related
      to
      the development of large area carbon nanotube based field emission displays,
      or
      manufacturing processes for such displays. To the extent that these companies,
      or any other companies, bring a TV to market using carbon nanotube based field
      emission display technology, they would be required to license one or more
      of
      our patents.




We
      have also developed our own proofs of concepts of carbon nanotube based field
      emission display TVs. We currently have both a 14-inch monochrome and a 14-inch
      color proof of concept that we built internally. We have also developed a
      25-inch color proof of concept in conjunction with a consortium of Japanese
      component manufacturers. Each member of the consortium contributed its own
      particular expertise to the proof of concept at its own expense. The purpose
      of
      the 25-inch color proof of concept was to demonstrate that scalability is not
      an
      issue with the carbon nanotube-based field emission display. It was built to
      specifications enabling it to be expanded to a 60-inch display; however, it
      was
      built at 25 inches due to cost considerations. In 2006 we signed a letter of
      intent with Da Ling Co. Ltd, a corporation based in Taiwan, to enter into an
      agreement to form a joint venture to construct and operate a pilot line for
      a
      carbon nanotube television using our technology and processes. A final agreement
      has not been reached but discussions are ongoing.







Page
            3







***Other
      large area flat screen color field emission displays.*** Canon, Inc. and Toshiba have jointly developed a large area flat screen color
      TV
      based on our FED technology. Canon and Toshiba have announced that they have
      formed a joint venture to manufacture components for this TV, have constructed
      a
      manufacturing line, and demonstrated their product on many
      occasions. We signed a non-exclusive license with Canon in 1999 that covered substantially
      all of our field emission patents, but excluded the basic carbon nanotube patent
      and specific applications for the other field emission display patents
      including, but not limited to, large area color displays. The license agreement
      with Canon was terminated in 2006 as a result of Canon’s breach of contract and
      is currently the subject of litigation. See Item 3 of this Annual Report on
      Form10-K for further information on this litigation.




***HyFEDTM*** -
      We have developed a new display technology that we call the HyFEDTM. We expect
      the HyFEDTM to be phased in as an improvement to the way our FED technology will
      be used in the large area color displays previously described. HyFEDTM combines
      what we believe to be the best properties of CRTs and our field emission
      technology. We expect the HyFEDTM to significantly cut the cost of the drivers
      used in a field emission display. Work on the HyFEDTM has been frozen until our
      basic FED technology is being used in the production of large area color TVs.
      We
      expect to license our HyFEDTM technology in the future, although there is no
      assurance that this will occur.




***Backlights
      for displays.*** Our
      carbon nanotube technology is ideally suited to be used as a backlight for
      other
      types of displays, such as LCDs. Use of CNTs in backlights would improve the
      luminious efficiency at lower power levels and eliminate the use of mercury
      and
      its related negative environmental impacts. We have developed a proof of concept
      using our proprietary functionalized CNTs as a backlight for an LCD, and we
      expect to continue performing significant research in this area in 2007. Many
      other companies have also performed research in this area. Successful
      development of a backlight device using carbon nanotubes by anyone will require
      a license to our intellectual property.




***PETS
      for medium resolution large area electronic billboards*** -
      The PET, or Picture Element Tube, is a basic display device that could be used
      in many applications in addition to electronic billboards. The carbon nanotube
      field emission technology provides several advantages over the existing
      technologies used in these areas. It generally has a higher image quality,
      better sunlight readability, lower cost, lower energy usage, improved viewing
      angle and excellent video capabilities. We do not intend to manufacture these
      PETs ourselves, but rather license other manufacturers to produce them. We
      have
      currently licensed a previous version of field emission display technology
      that
      is not based on carbon nanotubes to a large Japanese display manufacturer that
      is now working internally to complete development of the product. This license
      calls for royalties of 2% of the licensee’s sales of products using our
      technology. The licensee will receive credit against royalties due under the
      agreement for $2 million of research funding that the licensee provided to
      us
      from 2001 to 2003. Accordingly, no royalties will be due under the agreement
      until sales of the licensee’s products exceed $100 million.




***Lighting
      Devices.*** We
      have been working with Shimane Masuda Electronics, Co., Ltd. (“SME”) on carbon
      nanotube lighting devices since 2004. In 2005, SME established a pilot line
      for
      the development and production of carbon nanotube electron emission based
      lighting devices. Upon successful completion of the pilot period in 2006, SME
      entered into a license agreement covering a limited geographical area with
      us.
      Under this agreement, in addition to an upfront payment of approximately $84,000
      which we received in 2006, we will receive an additional payment of
      approximately $125,000 when SME begins production, and we will receive a royalty
      of 5% of SME’s sale of products that use this technology. The initial product
      being developed by SME is for a specific application for an existing customer;
      however, SME is expected to develop additional products once the initial product
      is introduced. Under the license agreement, SME is currently limited to
      manufacturing in Japan and sales in Asia.




***Competition.*** Because
      of the strength of our intellectual property in the FED area, our competition
      comes from other technologies, rather than other companies. Any company
      developing a carbon nanotube based FED large area flat screen color TV will
      be
      required to license our patents. There are other companies attempting to develop
      non-carbon nanotube based field emission display technologies. It is our opinion
      that these technologies will not be as cost efficient or demonstrate as high
      a
      level of brightness as the field emission technology using forms of carbon,
      whether carbon nanotube based or other carbon based methods such as the SED.
      However, even companies developing these non-carbon based field emission
      displays may be required to license other portions of our patent portfolio
      in
      order to bring a product to market.




In
      the large area flat screen color TV industry, the primary competition comes
      from
      plasma panel displays, LCD displays, organic LED displays, and color picture
      tubes. We believe FED technology, when fully developed, will primarily compete
      with plasma displays and LCD displays, and generally compares favorably visually
      and technically with both types of displays. In addition, carbon nanotube based
      field emission displays are expected to be less costly than plasma displays.
      LCD
      displays have quality issues related to the viewing angle and are generally
      not
      economical once the size exceeds 45 inches, and therefore are not considered
      strong competition because our technology is targeted at displays greater than
      50 inches. Several companies are currently developing backlights for LCDs using
      carbon nanotubes. Successful development of a carbon nanotube backlight would
      require a license to our intellectual property.







Page
            4







**Sensors**




***Overview.*** We
      have greatly expanded our work and intellectual property in the area of sensor
      technology. This is becoming an increasingly important part of our business,
      and
      we expect it to become even more important in the future. Our approach to sensor
      technology offers the unique advantage of manipulating materials at the
      molecular level at which sensing events occur. We are pursuing a multiplatform
      approach to address specific market needs. Some of the potential applications
      are as follows:




***Biosensors.*** Our carbon nanotube technology is ideally suited for use in biosensors. Sensors
      based on carbon nanotubes or other nanomaterials can be used to detect chemical,
      organic, or biological warfare agents, as well as explosives, hydrogen, ammonia
      and numerous other chemicals. We have developed several proof of concepts
      demonstrating the viability of our sensor technology, and are currently seeking
      development partners to license the technology and integrate it into specific
      products.




***Hydrogen
      sensors*** .
      These sensors are targeted for use in fuel cells for automobiles and for remote
      monitoring of large power transformers. We developed a hydrogen sensor in for
      use in the measurement of hydrogen in power transformer products. A significant
      portion of this work was done in conjunction with Kelman, Ltd., an international
      company that operates primarily in the area of power products, transformer
      services, and emission monitoring products. Almost all power transformer
      products throughout the world fall into one of two categories - those involving
      oxygen or those involving nitrogen. The sensor that we developed works well
      in
      transformers involving oxygen, but not in those involving nitrogen. Kelman
      was
      interested only in a universal solution. We believe that we have a potential
      universal solution; however, that solution will take additional development,
      and
      Kelman is not interested in sharing the cost of that development. As a result,
      we are no longer working with Kelman, and it is unlikely that our technology
      will ever be used in Kelman products. We are exploring relationships with sensor
      manufacturers for the application of our technology.




***Carbon
      Monoxide Sensors.*** We
      have developed a carbon monoxide sensor that is based on a “gated” metal oxide
      approach that allows the sensor to operate without heating, as compared with
      most carbon monoxide sensors that require heating to greater than 250 degrees
      Celsius. Our approach to the carbon monoxide sensor allows the sensor to operate
      at low power with instant-on operation. The sensor will be specific to carbon
      monoxide with no cross sensitivity to other gases and elements and is also
      easily portable and highly sensitive. We completed a phase I SBIR and are now
      working on a phase II project for the U.S. Air Force. When completed, we expect
      to be able to license our technology for both commercial and government
      purposes.




***Other
      sensors*** .
      We have demonstrated that carbon nanotubes can be used to develop sensors for
      chemical, organic, and biological warfare agents. We have also demonstrated
      that
      carbon nanotubes and other nanodetectors can be used for the remote detection
      of
      explosives, sensors used in environmental monitoring, health care, the food
      industry, biotech-biopharma applications, genetic biosensors, and immunosensors.
      We are currently seeking funding to take our research in this area to the next
      level of development, which would include proofs of concept, and product
      development. Ideally, we would do this with a development partner that would
      fund the development and license the technology for manufacturing upon
      completion, or in conjunction with a development partner under a government
      funding program. We most likely would have different development partners for
      different sensors that may be used in different industries.




***Competition.*** Our
      competition in the sensor area will come from a variety of technologies and
      companies depending on the purpose and use of the sensor. There are other
      technologies used in sensors; however, we believe carbon nanotube based sensors
      and other nanodetectors are more versatile, can sense a broader range of
      materials, and are more selective (sensitive) in their sensor results. We
      believe that selecting the right strategic partners for development of proof
      of
      concepts for our sensor technology is an important step in the market acceptance
      of sensors using our technology.




**Functional
      Nanomaterials**




We
      are in the advanced stages of research into nanomaterials using carbon nanotube
      and other composites. We believe that some of the first widespread use of
      nanotechnology by established companies will be in this area as they work to
      improve existing products, materials, and processes. A significant opportunity
      exists in this area for us to develop and license our technology. We are
      currently exploring opportunities with several companies in this
      area.







Page
            5





***Shimane
      Institute of Technology*** .
      We completed a preliminary research and development agreement with Shimane
      Institute for Industrial Technology (SIIT) to develop a new aluminum alloy
      using
      carbon nanotubes that has thermal conductivity 4-5 times greater than aluminum
      metal. SIIT is a technology organization fully supported by the government
      of
      Shimane Prefecture, Japan. We are beginning a second phase of the project in
      2007. Applications include any microelectronic device that generates heat,
      including circuit boards for computers and high powered radar. These alloys
      can
      also improve the strength of the aluminum without adding weight.





***PhotoscrubTM
      Technology.*** We
      developed a concept called PhotoscrubTM which is based on an air purification
      technology originally developed by one of our strategic partners, Andes Electric
      Co., Ltd. The PhotoscrubTM is a thin film coating on a flexible fiberglass cloth
      that decomposes pollutants at the molecular level in liquids and gases. We
      began
      a one year project to further develop this technology for the U.S. Army in
      November 2006 and will receive approximately $950,000 in funding for the
      project.





***Large
      Sporting Goods Manufacturer.*** In
      September 2005, we signed a development contract with a large sporting goods
      manufacturer to develop nanocomposites to be used in the manufacturer’s sporting
      equipment. The goal of the project, which involved three separate areas, was
      to
      improve the existing base materials currently used by the manufacturer to make
      the equipment stronger, lighter, and more powerful. We received $240,000 for
      the
      initial phase of the project, which was successfully completed in September
      2006
      and achieved the initial specifications required. In December 2006, we began
      a
      follow up project funded by the sporting goods manufacturer to integrate these
      improved materials into the manufacturing process. We expect to sign license
      agreements as we complete the projects.





***Competition.*** Since
      this is a developing area of nanotechnology, there are not established
      competitors. Our competition would come from companies working with other
      materials. Since each project is unique, there are not necessarily any
      established competitors in the market.




**NanoElectronic
      Applications**




We
      are working in several other areas that have grown out of our basic work in
      the
      FED area. These technologies are related to previously discussed applications
      in
      that they use common materials, such as carbon nanotubes, use similar processes,
      capitalize on knowledge that we have gained in our research in other areas,
      or
      take advantage of unique capabilities of our technical staff. Following is
      a
      summary of some of these technology areas.




***Conductive
      Inks.*** We
      entered into a research and development agreement in 2006 with a leading
      industrial chemical products company in Japan to develop technical inks that
      can
      be deposited using an additive process such as printing. The target market
      for
      technical inks are printed circuit boards, flexible electronics and displays,
      communications instrumentation, and RFIDs. This project started in October
      and
      is expected to last roughly one year. We will receive $500,000 for the
      project.




***Cathodes.*** We developed a carbon nanotube cold cathode electron source, which can be
      utilized for many non-display related applications such as x-ray tubes, medical
      devices, microelectronics, low-power thrusters, CRT electron guns, wireless
      communications, and polluted air scrubbing.




***Memory
      Chips.*** We had a license option agreement with the University of Texas at Austin to
      further the development of a next generation memory chip using the university’s
      information storage technology based on thin photo-conductive films. The
      ultimate goal was to make a low cost non-volatile memory device with increased
      capacity. We demonstrated an initial proof of concept of the technology;
      however, we discontinued our work on this project in 2006 when there was no
      longer any outside interest in funding the project.




***Competition.*** Numerous
      other companies are working with other technologies with the goal of achieving
      results similar to the goals of our technology. The ultimate success of products
      using our technology will be dependent upon the results of our research compared
      with results achieved by others.





Page
            6







**EBT**




***Electronic
      Display Products.*** EBT was formed to develop sun-readable display products for outdoor use. 
We quickly expanded our focus to large area displays for indoor use that would
      compete with Plasma and could be used as part of an overall point of purchase
      advertising program and developed a patented product called the E-WindowTM. We
      restructured EBT, stopped selling products directly, and instead limited
      ourselves to licensing our intellectual property. As discussed below, we sold
      EBT’s intellectual property in 2006.




***Communication
      patents.*** We have applied for patents covering a system of selling advertising for
      electronic displays over the internet and other digital networks. The first
      of
      the patents, which was filed in April 2000 with a priority date of April 1999,
      was issued in 2006. The allowed claims on this patent relate to methods, systems
      and computer programs that facilitate displaying advertising information on
      multiple indoor or outdoor electronic displays. There are also applied for
      similar patents and have applications pending in Europe, Canada, Korea, and
      Japan. As discussed below, we sold these patents in 2006.




***Sale
      of Intellectual Property.*** **** In 2006 we began discussions related to licensing our communication patents
      referred to above. Those discussions culminated in the sale of EBTs intellectual
      property in two simultaneous transactions to Novus Communications Technologies,
      Inc. in June 2006. In the first transaction, we sold our communications patents
      to Novus Partners, LLC, a majority owned subsidiary of Novus Communications.
      We
      received an upfront payment of $1,000,000 and the right to future royalties
      based on the revenue received by Novus Partners. The agreement also contains
      certain provisions related to future minimum royalty payments, which if not
      met,
      cause the patents to revert back to EBT. There are no minimum royalty payments
      due in 2007.




In
      the second transaction, we sold EBT’s remaining intellectual property and other
      assets, which consisted solely of items related to the intellectual property,
      such as drawings, etc. to Novus Displays, LLC, a newly formed organization
      owned
      by Novus Communications. In exchange for the remaining Intellectual property,
      we
      received $500,000 and a 25% ownership interest in Novus Displays. One of the
      patents that we sold in this transaction was a patent that had been assigned
      to
      us by Advanced Technology, Incubator, Inc. (“ATI”), a company owned by Dr. Zvi
      Yaniv, our Chief Operating Officer. In order to acquire the remaining interest
      in the patent and settle all potential future obligations to ATI, we issued
      200,000 shares of our common stock, valued at $400,000 to ATI. Dr. Yaniv also
      received a 5% ownership interest in Novus Displays as part of the
      transaction.




***Future
      Activities.*** EBT’s future activities are limited to participation in the digital signage
      industry through Novus Communications. Our communication patents are part of
      a
      larger package of related patents held by Novus Partners and any future income
      that we may receive is dependent on the ability of Novus Partners to license
      that patent package. At the present time, it is our understanding that Novus
      Partners has no revenue producing license agreements. We did not receive any
      royalties in 2006 from Novus Partners beyond the initial payment, and we will
      not receive any royalties from Novus Partners until such time as they do have
      revenue producing agreements. While we anticipate receiving income in 2007,
      we
      have no control over, or input into, the licensing activities of Novus
      Partners.




Our
      ownership interest in Novus Displays is a passive ownership interest and we
      have
      no active role in the day to day management. Our sale of our remaining
      intellectual property to Novus Displays was done to facilitate the sale of
      our
      communications patents to Novus Partners. We had no interest in devoting further
      resources to development of that technology. The sale to Novus Displays provided
      us the opportunity to receive additional future value from that technology,
      if
      it is successfully deployed by Novus Displays. We will receive no income from
      Novus Displays and only profit from an eventual sale of Novus Displays, if
      it
      occurs. To the best of our knowledge, Novus Displays has not yet been
      capitalized beyond its initial minimal capitalization and is not yet actively
      developing any of the technology acquired from us, or carrying on any
      significant business activities.




**Technology
      Agreements**




***Till
      Keesmann.***  We
      have licensed certain patents related to carbon nanotube technology from Till
      Keesmann (“the Keesmann patents”). We licensed 6 patents, including foreign
      filings, in 2000 in exchange for a payment of $250,000. The U.S. patent was
      reissued in August 2003. This reissuance significantly strengthened and
      reinforced this patent. Under the terms of the agreement, we are obligated
      to
      pay license fees equal to 50% of any royalties received by the Company
      specifically related to these patents. We are allowed to offset certain
      expenses, up to a maximum of $50,000 per year, against payments due under this
      agreement. The agreement also contains provisions related to minimum license
      fee
      payments, certain of which were deferred by Mr. Keesmann until after the
      reissuance of the patent was completed. A total of $1,000,000 of minimum
      payments has been made, with the last payment made in May 2004. No future
      minimum payments are due and the minimum payments made to date can be offset
      against future royalties due under the license agreement. As
      described in more detail in Item 3 of this Annual Report on Form 10-K, this
      agreement is the subject of current litigation.







Page
            7







***MCC*** *.*  We
      acquired 62 patents and patent applications related to the carbon film based
      field emission technology from MCC in 1998.  We are obligated to pay MCC a
      royalty of 2% of future commercial revenues related to these patents. We can,
      however, offset certain pre-defined expenses against these royalty payments.
      Based on the expenses incurred and cost of maintaining the patents, the
      possibility is remote that we will be required to pay MCC any royalties at
      any
      time in the future.




**Intellectual 
      Property Rights**




An
      important part of our product development strategy is to seek, when appropriate,
      protection for our products and proprietary technology through the use of
      various United States and foreign patents. Our patent portfolio consists of
      over
      300 patents, including 113 issued patents, 2 allowed patents, 130 patent
      applications pending before foreign and United States Patent and Trademark
      Offices, and 39 provisional patent applications. We also have several
      unsubmitted patent applications in process. The patents, allowances and
      applications relate to carbon nanotube field emission technology and other
      technologies. In addition, there are foreign counterparts to certain United
      States patents and applications. We consider our patent portfolio to be our
      most
      valuable asset.




The
      patenting of technology-related products and processes involves uncertain and
      complex legal and factual questions. To date, no consistent policy has emerged
      regarding the breadth of claims of such technology patents. Therefore, there
      is
      no assurance that our pending United States and foreign applications will issue,
      or what scope of protection any issued patents will provide, or whether any
      such
      patents ultimately will be upheld as valid by a court of competent jurisdiction
      in the event of a legal challenge. Interference proceedings, to determine
      priority of invention, also could arise in any of our pending patent
      applications. The costs of such proceedings would be significant and an
      unfavorable outcome could result in the loss of rights to the invention at
      issue
      in the proceedings. If we fail to obtain patents for our technology, and are
      required to rely on unpatented proprietary technology, there is no assurance
      that we can protect our rights in such unpatented proprietary technology, or
      that others will not independently develop substantially equivalent proprietary
      products and techniques, or otherwise gain access to our proprietary
      technology.




Competitors
      have filed applications for, or have been issued patents, and may obtain
      additional patents and proprietary rights relating to products or processes
      used
      in, necessary to, competitive with, or otherwise related to, our patents. The
      scope and validity of these patents, the extent to which we may be required
      to
      obtain licenses under these patents, or under other proprietary rights and
      the
      cost and availability of licenses are unknown. This may limit our ability to
      license our technology. Litigation concerning these or other patents could
      be
      protracted and expensive. If suit were brought against us for patent
      infringement, a challenge in the suit by us as to the validity of the other
      patent would have to overcome a legal presumption of validity. There can be
      no
      assurance that the validity of the patent would not be upheld by the court
      or
      that, in such event, a license of the patent to us would be available. Moreover,
      even if a license were available, the payments that would be required are
      unknown and could materially reduce the value of our  interest in the
      affected products. We do, however, consider our patents to be very strong and
      defendable in any action that may be brought against us. A major law firm has
      reviewed our patent portfolio and agreed to handle litigation related to certain
      of our patents on a contingency basis.




We
      also rely upon unpatented trade secrets. No assurances can be given that others
      will not independently develop substantially equivalent proprietary information
      and techniques or otherwise gain access to our trade secrets or disclose such
      technology or that we can meaningfully protect our rights to our unpatented
      trade secrets.




We require
      our employees, directors, consultants, outside scientific collaborators,
      sponsored researchers, and other advisors to execute confidentiality agreements
      upon the commencement of employment or consulting relationships with us. These
      agreements provide that all confidential information developed or made known
      to
      the individual during the course of the relationship is to be kept confidential
      and not disclosed to third parties except in specific circumstances. In the
      case
      of employees, the agreements provide that all inventions conceived by the
      individual shall be our exclusive property. There is no assurance, however,
      that
      these agreements will provide meaningful protection for our trade secrets in
      the
      event of unauthorized use or disclosure of such information.







Page
            8





**Government
      Regulation**




Products
      using our technology will be subject to extensive government regulation in
      the
      United States and in other countries. In order to produce and market existing
      and proposed products using our technology, our licensees must satisfy mandatory
      safety standards established by the U.S. Occupational Safety and Health
      Administration ("OSHA"), pollution control standards established by the U.S.
      Environmental Protection Agency ("EPA") and comparable state and foreign
      regulatory agencies. We may also be subject to regulation under the Radiation
      Control for Health and Safety Act administered by the Center for Devices and
      Radiological Health ("CDRH") of the U.S. Food and Drug Administration. We do
      not
      believe that carbon nanotube field emission products will present any
      significant occupational risks to the operators of such equipment.  In
      addition, the carbon nanotube field emission products are not expected to
      produce significant hazardous or toxic waste that would require extraordinary
      disposal procedures.   Nevertheless, OSHA, the EPA, the CDRH and other
      governmental agencies, both in the United States and in foreign countries,
      may
      adopt additional rules and regulations that may affect us and products using
      our
      technology. Additionally, our arrangements with our licensees and their
      affiliates may subject products using our technology to export and import
      control regulations of the U.S. and other countries. The cost of compliance
      with
      these regulations has not been significant in the past and is not expected
      to be
      material in the future.




A
      portion of our revenue has consisted of reimbursement of expenditures under
      U.S.
      government contracts. We recognized $583,236 of revenue in 2006, $208,211 in
      2005, and $305,721 in 2004, related to government contracts. These
      reimbursements represent all or a portion of the costs associated with such
      contracts. As of December 31, 2006, we have several grants in process that
      have
      approximately $2.3 million of revenue yet to be recognized. Government contracts
      are subject to delays and risk of cancellation. Also, government contractors
      generally are subject to various kinds of audits and investigations by
      government agencies. These audits and investigations involve review of a
      contractor's performance on its contracts, as well as its pricing practices,
      the
      costs it incurs and its compliance with all applicable laws, regulations and
      standards. We are, and in the future expect to be, audited by the
      government.




**Employees**




As
      of February 28, 2007 we had 35 full-time employees, including 3 executive
      officers. Within the next twelve months, based on new government contracts
      that
      we have received and expect to receive, we likely will hire two to four
      additional employees to support our plans for increasing research levels. We
      are
      not subject to any collective bargaining agreements and we consider our
      relations with our employees to be good.




**Available
      Information**




Our
      website is http://www.nano-proprietary.com .
      Our periodic reports and all amendments to those reports required to be filed
      or
      furnished pursuant to Section 13(a) or Section 15(d) of the Securities Exchange
      Act of 1934 are available free of charge through its website. During the period
      covered by this report, the Company made its periodic reports on Form 10-K,
      and
      Form 10-Q and its current reports on Form 8-K and amendments to those documents
      available on its website as soon as reasonably practicable after those reports
      were filed with or furnished electronically to the Securities and Exchange
      Commission. The Company will continue to make such reports and amendments to
      those reports available on its website as soon as reasonably practicable after
      those reports are filed with or furnished to the Securities and Exchange
      Commission. Material contained on our website is not incorporated by reference
      in this Annual Report on Form 10-K.







Page
            9







**Item
      1A.** ***RiskFactors***




**Our
      success is dependent on our principal technologies**




Our
      technology platforms, which include sensor technology, electron emission
      activities, nano-electronics, and functional nano-materials, are emerging
      technologies. Our financial condition and prospects are dependent upon licensing
      our intellectual property to others. Additional R&D needs to be conducted on
      many of our technologies before others can produce products using this
      technology. Market acceptance of products using our technology will be dependent
      upon the acceptance within the industries of those products of the quality,
      reliability, performance, efficiency, and breadth of application and
      cost-effectiveness of the products. There can be no assurances that these
      products will be able to gain commercial market acceptance.




**Products
      using our technology may not be accepted by the market**




Since
      our inception, we have focused our product development and R&D efforts on
      technologies that we believe will be a significant advancement over currently
      available technologies. With any new technology, there is a risk that the market
      may not appreciate the benefits or recognize the potential applications of
      the
      technology. Market acceptance of products using our technology will depend,
      in
      part, on the ability of our licensees to convince potential customers of the
      advantages of such products as compared to competitive products. It will also
      depend upon our ability to train manufacturers and others to use our
      products.




**Our
      technology development is in its early stages and the outcome is
      uncertain**




Our
      many applications of nanotechnologies, and certain products that use these
      technologies, will require significant additional development, engineering,
      testing and investment prior to commercialization. We are exploring the use
      of
      our technology in several different types of products. We have developed proof
      of concepts of potential products based on carbon nanotube technologies. In
      some
      cases, we are developing products jointly with others based on our technology.
      Upon successful completion of the development process, our development partners
      will be required to license our technology to produce and sell the products.
      Our
      development partners retain all rights to any intellectual property that they
      develop in the process.




If
      any of the potential products that are being developed using our technologies
      are successfully developed, it may not be possible for potential licensees
      to
      produce these products in significant quantities at a price that is competitive
      with other similar products. At the present time, the only significant revenue
      that we receive related to our technology is related to reimbursed research
      expenditures, and development fees. These revenues are identified in our
      quarterly filings on Form 10-Q and our annual filings on Form 10-K as revenues
      of our Applied Nanotech, Inc. subsidiary in the related “Management’s Discussion
      and Analysis of Financial Condition and Results of Operations” sections. We also
      anticipate receiving up-front license fees in 2007.




**Our
      development partners have certain rights to jointly developed property and
      to
      license our technology**




We
      have committed to license our technology to our development partners upon
      completion of certain development projects that are in process. The terms of
      any
      such license have not yet been determined. One of our past development partners,
      a large Japanese display company, has paid us $2.0 million for research services
      and has the right to offset this payment against any future license fee payments
      due as a result of an existing license agreement that we have with this company.
      Our development partners in the HYFEDTM project also have rights to any jointly
      developed property; however, any such jointly developed property would be based,
      at least in part, on our underlying technology and would require our partners
      to
      enter into an agreement with us. See also “Our technology development is in
      its early stages and the outcome is uncertain” above for further
      discussion.




**We
      have limited resources and our focus on particular products may result in our
      failure to capitalize on other opportunities**




We
      have limited resources available to successfully develop and commercialize
      our
      technology. As of February 28, 2007, we had 35 full-time employees. There is
      a
      wide array of potential applications for our technology and our limited
      resources require us to focus on specific product areas, while ignoring others.
      We focus our efforts on those projects for which we can obtain external funding
      since the availability of funding provides an external verification of the
      probability of commercial success of resulting products.







Page
            10










**We
      may not be able to provide system integration**




In
      order to prove that our technologies work and will produce a complete product,
      we must ordinarily integrate a number of highly technical and complicated
      subsystems into a fully integrated prototype. There is no assurance that we
      will
      be able to successfully complete the development work on some of our proposed
      products or that there will ultimately be any market for those
      products.




Many
      products that may be developed using our technology will need to be integrated
      into end-user products by manufacturers of those products. Although we intend
      to
      develop products to be integrated into existing manufacturing capabilities,
      manufacturers may be required to make modifications to, or expand their
      manufacturing capabilities. Manufacturers may not elect to integrate products
      using our technology into their end-user products, or they may not devote
      adequate resources to modifying their manufacturing capabilities so that our
      technologies can be successfully incorporated into their end-user products.
      The
      complexity of integration may delay the introduction of products using our
      technology.




**Rapid
      technological changes could render our technology obsolete; and we may not
      remain competitive**




The
      industries in which we compete are highly competitive and are characterized
      by
      rapid technological change. Our existing and proposed products will compete
      with
      other existing products and may compete against other developing technologies.
      Development by others of new or improved products, processes or technologies
      may
      reduce the size of potential markets for our products. There is no assurance
      that other products, processes or technologies will not render our proposed
      products obsolete or less competitive. Many of our competitors have greater
      financial, managerial, distribution, and technical resources than we do. We
      will
      be required to devote substantial financial resources and effort to further
      R&D. There is no assurance that we will successfully differentiate our
      technology from our competitors' technology, or that we will adapt to evolving
      markets and technologies, develop new technologies, or achieve and maintain
      technological advantages.




**We
      have limited manufacturing capacity and experience**




We
      have no established commercial manufacturing facilities; and we have no
      intention of establishing a manufacturing facility related to our field emission
      technology, sensors, nanomaterials which include using composites, or any other
      aspects of our technology. We are focusing our efforts on licensing our
      intellectual property to others for use in their manufacturing processes. To
      the
      extent that any of the products that we develop require manufacturing
      facilities, we intend to contract with a qualified manufacturer.




**The
      health effects of nanotechnology are unknown**




There
      is no scientific agreement on the health effects of nanomaterials, but some
      scientists believe that in some cases, nanomaterials may be hazardous to an
      individual’s health or the environment. The science of nanotechnology is based
      on arranging atoms in such a way as to modify or build materials not made in
      nature; therefore, the effects are unknown. The Company takes appropriate
      precautions for its employees working with carbon nanotubes and believes that
      any health risks related to carbon nanotubes used in potential products can
      be
      minimized. Future research into the effects of nanomaterials in general, and
      carbon nanotubes in particular, on health and environmental issues may have
      an
      adverse effect on products using our technology.




**The
      loss of key personnel could adversely affect our business**




Our
      future success will depend on our ability to attract and retain highly qualified
      scientific, technical and managerial personnel. Competition for such personnel
      may be intense. We may not be able to attract and retain all personnel necessary
      for the development of our business. In addition, much of the know-how and
      processes developed by us reside in our key scientific and technical personnel.
      The loss of the services of key scientific, technical and managerial personnel
      could have a material adverse effect on us until we are able to replace those
      personnel.







Page
            11







**We
      have a history of net losses**




We
      have a history of net losses. From our inception through December 31, 2006,
      we
      incurred net losses of approximately $101 million. Our only profitable year
      was
      1999, based on the strength of a license agreement of approximately $5.6 million
      signed in March 1999.  We have incurred net income and losses as shown
      below:




Year
                  Ended December 31
              
              Net
                  Income
                (Loss)1995
              
              ($14,557,426)1996
              
              ($14,583,506)1997
              
              ($7,306,232)1998
              
              ($4,361,742)1999
              
              $474,5992000
              
              ($9,471,279)2001
              
              ($6,047,698)2002
              
              ($5,452,890)2003
              
              ($4,017,374)2004
              
              ($7,139,109)2005
              
              ($5,818,816)2006
              
              ($6,593,892)




Although
      we expect to be profitable in the future, we may not be.  Our profitability
      in 2007 is dependent on the signing of additional license agreements or
      obtaining additional research funding. We may, however, continue to incur
      additional operating losses for an extended period of time as we continue to
      develop our technologies. We do, however, expect the magnitude of those losses,
      if they continue, to decrease. We have funded our operations to date primarily
      through the proceeds from the sale of our equity securities and debt offerings.
      We are primarily a contract research and development organization and are
      dependent on license agreements and research funding to achieve profitability.
        In order to continue development of our technology, we anticipate that
      substantial research and development expenditures will continue to be
      incurred.




**We
      have no current royalty agreements producing significant
      revenue**




Our
      strategy is dependent on licensing our technology to other companies and
      obtaining royalties based on products that these licensees develop and sell.
      We
      have no plans to manufacture and sell any products ourselves, and as such,
      we
      have no product revenues. While we do have existing licenses, none of the
      licensees are producing products at the present time and therefore none of
      the
      licenses are producing current revenue.




We
      expect to license our technology to be used in many applications. See additional
      discussion in the risk factor “Our technology development is in its early stages
      and the outcome is uncertain” above. It is our intention that all future license
      agreements will include a provision that requires the payment of ongoing
      royalties, although there is no assurance that will occur.




**We
      are dependent on the availability of materials and
      suppliers**




The
      materials used in producing current and future products using our technology
      are
      purchased from other vendors. We anticipate that the majority of raw materials
      used in products to be developed by us will be readily available to
      manufacturers. However, there is no assurance that the current availability
      of
      these materials will continue in the future, or if available, will be procurable
      at favorable prices.







Page
            12





**Our
      revenues have been dependent on government contracts in the
      past**




In
      many years, a significant portion of our revenues are derived from contracts
      with agencies of the United States government. Following is a summary of those
      revenues for the past twelve years:




Year
                  Ended December 31
              
              Revenues
                  from
                Government
                Contracts
              
              Percentage
                  of
                Total
                  Revenue1995
              
              $1,009,000
              
              33%1996
              
              $2,869,000
              
              50%1997
              
              $854,000
              
              24%1998
              
              $0
              
              0%1999
              
              $0
              
              0%2000
              
              $352,341
              
              13%2001
              
              $466,680
              
              15%2002
              
              $254,152
              
              18%2003
              
              $339,790
              
              44%2004
              
              $305,721
              
              80%2005
              
              $208,211
              
              37%2006
              
              $583,236
              
              52%




We
      currently have commitments for future government funding of approximately $2.3
      million. We do not intend to seek any government funding unless it directly
      relates to achievement of our strategic objectives.




Contracts
      involving the United States government are, or may be, subject to various risks
      including, but not limited to, the following:




·
            Unilateral
                termination for the convenience of the
                government


·
            Reduction
                or modification in the event of changes in the government's requirements
                or budgetary constraints


·
            Increased
                or unexpected costs causing losses or reduced profits under fixed-price
                contracts or unallowable costs under cost reimbursement
                contracts


·
            Potential
                disclosure of our confidential information to third
                parties


·
            The
                failure or inability of the prime contractor to perform its prime
                contract
                in circumstances  where we are a
                subcontractor


·
            The
                failure of the government to exercise options provided for in the
                contract.


·
            The
                right of the government to obtain a non-exclusive, royalty free,
                irrevocable world-wide license to technology developed under
                contracts  funded by the government if we fail to continue to develop
                the technology




**We
      are exposed to litigation liability**




As
      described in more detail in Item 3 of this Annual Report on Form 10-K, we are
      the plaintiff in two separate pieces of litigation. The first is against, Canon,
      Inc., and the second is against Till Keesmann. While there is risk associated
      with any litigation, we expect to prevail in both of these cases. If we were
      to
      not prevail in the Canon litigation, we would expect that would have no impact
      on our current financial condition beyond the additional costs incurred through
      the completion of the litigation. If we were not to prevail in the Keesmann
      litigation and Keesmann were allowed to terminate the existing agreement, we
      could lose any potential future revenue specifically associated with licensing
      the patents covered by the agreement. It would not; however, eliminate the
      need
      for any licensee of the Keesmann patents for use in the display industry to
      also
      license our patents as well. In addition, if Keesmann were allowed to terminate
      the patent, we would seek damages equal to the value that we bestowed upon
      the
      patent during the term of the license agreement. It is our opinion that the
      majority of the value of the Keesmann patent today is as a result of our work
      on
      the reissuance of the patent.




We
      have lawsuits that arise in the normal course of business. We have been subject
      to litigation in the past and have settled litigation in the past that has
      in
      rare instances resulted in material payments. We expect all current lawsuits
      to
      be resolved with no material negative impact on our financial statements, and
      we
      are unaware of any other potential significant litigation. If we were to become
      subject to a judgment that exceeds our ability to pay, that judgment would
      have
      a material impact on our financial condition and could affect our ability to
      continue in existence.





Page
            13







**We
      may have future capital needs and the source of that funding is
      uncertain**




We
      expect to continue to incur substantial expenses for R&D, product testing,
      and administrative overhead. The majority of R&D expenditures are for the
      development of our technologies. Some of the proposed products using our
      technology may not be available for commercial sale or routine use in the
      immediate future. Commercialization of existing and proposed products that
      would
      use our technology may require additional capital in excess of that currently
      available to us. A shortage of capital could prevent us from achieving
      profitability for an extended period of time. Because the timing and receipt
      of
      revenues from the sale of products using our technology will be tied to the
      achievement of certain product development, testing, manufacturing and marketing
      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 activities and/or
      seek additional financing from other sources. We may seek additional financing
      through the offer of debt, equity, or any combination of the two at any time,
      although we do not expect to seek any significant additional financing for
      the
      remainder of the year.




We
      have developed a plan to allow us to maintain operations until we are able
      to
      sustain ourselves, and we believe our current cash levels are sufficient to
      fund
      operations until we reach that point. We have the existing resources, including
      expected revenue, to continue operations for a period through at least the
      end
      of 2007. Our plan is primarily dependent on raising funds through the licensing
      of our technology and revenue generated from performing contract research
      services. We intend to raise additional capital through debt or equity
      offerings, only if necessary. We expect to sign significant license and
      development contracts within the next year, although there is no assurance
      that
      this will occur.




Our
      plan is based on current development plans, current operating plans, the current
      regulatory environment, historical experience in the development of electronic
      products and general economic conditions. Changes could occur which would cause
      certain assumptions on which this plan is based to be no longer valid. Our
      plan
      is primarily dependent on increasing revenues, licensing our technology, and
      raising additional funds through additional debt and equity offerings, only
      if
      necessary. If adequate funds were not available from operations or additional
      sources of financing, we may have to eliminate, or reduce substantially,
      expenditures for research and development, and testing of our products. We
      may
      have to obtain funds through arrangements with other entities that may require
      us to relinquish rights to certain of our technologies or products. These
      actions could materially and adversely affect us.




**We
      may be unable to enforce or defend our ownership and use of proprietary
      technology**




Our
      ability to compete effectively with other companies will depend on our ability
      to maintain the proprietary nature of our technology. Although we have been
      awarded patents, have filed applications for patents, or have licensed
      technology under patents that we do not own, the degree of protection offered
      by
      these patents or the likelihood that pending patents will be issued is
      uncertain. Competitors in both the United States and foreign countries, many
      of
      which have substantially greater resources and have made substantial investment
      in competing technologies, may already have, or may apply for and obtain patents
      that will prevent, limit or interfere with our licensees ability to make and
      sell our products using our technology. Competitors may also intentionally
      infringe on our patents. The defense and prosecution of patent suits is both
      costly and time-consuming, even if the outcome is favorable to us. In foreign
      countries, the expenses associated with such proceedings can be prohibitive.
      In
      addition, there is an inherent unpredictability in obtaining and enforcing
      patents in foreign countries. An adverse outcome in the defense of a patent
      suit
      could subject us to significant liabilities to third parties. Although third
      parties have not asserted infringement claims against us, there is no assurance
      that third parties will not assert such claims in the future. A major law firm
      has reviewed our patent portfolio and agreed to handle litigation related to
      certain of our patents on a contingency basis.




We
      also rely on unpatented proprietary technology, and there is no assurance that
      others will not independently develop the same or similar technology, or
      otherwise obtain access to our proprietary technology. To protect our rights
      in
      these areas, we require employees, consultants, advisors and collaborators
      to
      enter into confidentiality agreements. These agreements may not provide
      meaningful protection for our trade secrets, know-how, or other proprietary
      information in the event of any unauthorized use, misappropriation or disclosure
      of such trade secrets, know-how, or other proprietary information. While we
      have
      attempted to protect proprietary technology that we develop or acquire and
      will
      continue to attempt to protect future proprietary technology through patents,
      copyrights and trade secrets, we believe that our success will depend upon
      further innovation and technological expertise.







Page
            14







**We
      have technologies subject to licenses**




As
      a licensee of certain research technologies through license and assignment
      agreements with Microelectronics and Computer Technology Corporation (“MCC”), we
      have acquired rights to develop and commercialize certain research technologies.
      In certain cases, we are required to pay royalties on the sale of products
      developed from the licensed technologies and fees on revenues from sublicensees.
      We also have to pay for the costs of filing and prosecuting patent applications.
      The agreement is subject to termination by either party, upon notice, in the
      event of certain defaults by the other party. We consider it unlikely that
      any
      royalty payments would be required to be made to MCC based on the substantial
      amounts of revenues that would have to be generated to offset the costs of
      maintaining the patents over the years.




We
      have also licensed certain patents related to carbon nanotube technology from
      Till Keesmann (“the Keesmann patents”). We licensed 6 patents, including foreign
      filings, in 2000 in exchange for a payment of $250,000. The U.S. patent was
      reissued in August 2003. This reissuance significantly strengthened and
      reinforced this patent. Under the terms of the agreement, we are obligated
      to
      pay license fees equal to 50% of any royalties received by the Company
      specifically related to these patents. We are allowed to offset certain
      expenses, up to a maximum of $50,000 per year, against payments due under this
      agreement. The agreement also contains provisions related to minimum license
      fee
      payments, certain of which were deferred by Mr. Keesmann until after the
      reissuance of the patent was completed. A total of $1,000,000 of minimum
      payments has been made, with the last payment made in May 2004. No future
      minimum payments are due and the minimum payments made to date can be offset
      against future royalties due under the license agreement. No license agreements
      have yet been signed that involve the Keesmann patents. This license agreement
      is currently the subject of litigation as described in greater detail in Item
      3
      of this Annual Report on Form 10-K.






**Item
      1B.** ***UnresolvedStaff
      Comments***




None.




**Item
      2.*********Properties***




We
      lease a facility in Austin that is used for our corporate headquarters and
      research and development activities under a lease expiring in February 2008.




We
      believe that these facilities are suitable for our current needs and will be
      adequate for our anticipated research, development, and administrative
      activities, at least through the end of the lease period.  We are currently
      studying our facility needs and likely will move to a different facility at
      the
      end of the lease period. We would expect a new facility to be similar in size
      to
      our existing facility. If we embark on significant new research that requires
      significant additional employees, we may have to establish additional
      facilities.




We
      do not currently invest in real estate or interests in real estate, real estate
      mortgages, or securities of or interests in persons primarily engaged in real
      estate activities. However, the Company has no policy, either for or against,
      making such investments .














Page
            15





**** **Item
      3.*********Legal
      Proceedings***





In
      April 2005, we filed suit against the Japanese camera and copier manufacturer
      Canon, Inc., and its wholly-owned U.S. subsidiary Canon USA, Inc., in the U.S.
      District Court for the Western District of Texas, Austin Division, seeking
      a
      declaratory judgment that new SED color television products being
      developed and manufactured by a Canon/Toshiba joint venture are not covered
      under a non-exclusive 1999 patent license agreement that we granted to
      Canon.  We assert that the Canon/Toshiba joint-venture - SED, Inc. -
      is not a licensed party under that agreement. The original complaint asserted
      additional claims related to whether the Canon/Toshiba joint venture’s
      television panels constituted excluded products under the 1999 license, as
      well
      as breach of covenant of good faith and fair dealing, tortious interference
      and
      a Lanham Act violation by Canon. Last year, Canon moved to dismiss Canon U.S.A.
      from the litigation, and moved to dismiss several of the counts asserted. The
      court denied the motion, in part, by ruling that Canon U.S.A. was an appropriate
      defendant and refusing to dismiss our claims for breach of the covenant of
      good
      faith and fair dealing. Our tortious interference and Lanham Act claims were
      dismissed, without prejudice.





After
      initial discovery, in April 2006, we amended the complaint to drop one count
      related to the definition of excluded products in the 1999 license, and add
      two
      counts for fraudulent inducement and fraudulent non-disclosure related to events
      and representations made during our negotiations on the license, including
      Canon’s failure to disclose an ongoing relationship with Toshiba. Canon moved to
      dismiss the fraud claims, and the Court denied Canon’s motion in May 2006. The
      suit is now proceeding under the amended complaint. Discovery was completed
      in
      August 2006. Upon completion of discovery, Canon filed a motion for summary
      judgment seeking to dismiss the claim that SED is not a licensed party under
      the
      agreement. Canon did not file a motion for summary judgment seeking to dismiss
      either of the fraud claims or the breach of covenant of good faith and fair
      dealing. In November 2006, the Court denied Canon’s partial motion for summary
      judgment, describing SED, Inc. as a “corporate fiction designed for the sole
      purpose of evading Canon’s contractual obligations”.





In
      January 2007, Canon filed another motion for partial summary judgment seeking
      a
      declaration that a reconstituted SED, Inc. which will be owned 100% by Canon,
      but still involving numerous reciprocal agreements with Toshiba, will be
      considered a Canon subsidiary. At the same time, we filed a motion for partial
      summary judgment, seeking the court’s affirmation of our termination of the
      license agreement due to Canon’s breach of contract in 2004. On February 22,
      2007 the Court issued a ruling denying Canon’s motion and granting our motion
      for partial summary judgment, ruling our termination of the contract effective
      December 1, 2006, to be valid. Trial on the remaining counts is to be scheduled
      on the first available open date on the Court’s calendar on or after April 2,
      2007.





In
      May 2006, we filed suit in the U.S. District Court for the Northern District
      of
      Illinois against Till Keesmann, a German citizen who in 2000 granted us an
      exclusive and perpetual license to certain of his U.S. and European patents
      in
      carbon nanotube cathode technology. Shortly after we filed suit against Canon
      in
      April 2005, Keesmann conveyed part of his interests in the Exclusive License
      to
      investors associated with a German patent evaluation firm, IP Bewertungs AG
      (“IPB”). Thereafter, IPB approached us with proposals to buy or auction our
      rights to Keesmann’s patents. On March 20, 2006, we announced a letter of intent
      to form a joint venture with a leading Asian display manufacturer, Da Ling
      Co.,
      Ltd., to develop display products utilizing our intellectual property. Two
      days
      later, Keesmann purported to terminate the exclusive license that he granted
      to
      us six years ago. Our May 2006 complaint seeks a declaratory judgment that
      Keesmann had no right to terminate the exclusive license, and we also filed
      for
      a Temporary Restraining Order and Preliminary Injunction to prevent Keesmann
      from taking any actions inconsistent with his obligations under the exclusive
      license. The Court granted a consent order that prevents Keesmann from licensing
      the patents pending an injunction hearing and decision. In June 2006, Keesmann
      filed an Answer and Counterclaim, denying that the purported termination was
      null and void, and asserting a counterclaim that asks the court to find that
      we
      breached the exclusive license by not actively marketing the Keesmann patents,
      among other things.





W e
      amended our complaint in December 2006 to include additional defendants, JK
      Patentportfolio GmbH & Co., Jochen Kamlah, NPV Nano Patent GmbH & Co.,
      and Arnold Amsinck. The amended complaint also contains additional claims
      including breach of contract, conversion, aiding and abetting conversion,
      conspiracy to commit conversion, misappropriation, aiding and abetting
      misappropriation, conspiracy to commit conversion, Lanham act violations,
      tortious interference with a prospective economic relationship, aiding and
      abetting tortious interference with a prospective economic relationship, and
      conspiracy to tortiously interfere with a prospective economic
      relationship.








Page
            16





In
      January 2007, the Court granted our motion for preliminary injunction, ruling
      that there is a reasonable likelihood that we will prevail on the merits of
      the
      case. The preliminary injunction enjoins Keesmann, his agents, employees, and
      all those acting in concert with him from terminating the license agreement,
      or
      otherwise acting in violation of the license agreement. In connection with
      this
      injunction, the Court set the bond, which is required by law, at $100,000.
      We
      posted the bond in February 2007.





From
      time to time the Company and its subsidiaries are also defendants in various
      lawsuits that may arise related to minor matters. It is expected that any such
      lawsuits would be settled for an amount no greater than the liability recorded
      in the financial statements for such matters.  If resolution of any of
      these suits results in a liability greater than that recorded, it could have
      a
      material impact on us.




**Item
      4.*********Submission
      of Matters to a Vote of Security Holders***




There
      were no matters submitted to a vote of security holders during the fourth
      quarter of 2006.







Page
            17







**PART
      II**






**Item
      5.*********Market
      for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases
      of Equity Securities***




Our
      common stock, $0.001 par value, trades on the OTC Bulletin Board system under
      the symbol “NNPP”. The following table sets forth, on a per share basis for the
      periods indicated, the high and low sale prices for the common stock as reported
      by the OTC Bulletin Board system. These quotations reflect inter-dealer prices,
      without retail mark-up, mark-down or commission and may not represent actual
      transactions.




**High**
            **Low****2005**
            First
                Quarter
            $3.53
            $2.01Second
                Quarter
            $3.99
            $1.56Third
                Quarter
            $2.81
            $1.86Fourth
                Quarter
            $2.45
            $1.97**2006**
            First
                Quarter
            $2.68
            $2.05Second
                Quarter
            $2.62
            $1.47Third
                Quarter
            $1.75
            $1.08Fourth
                Quarter
            $1.72
            $0.92**2007**
            First
                Quarter (through February 28, 2007)
            $2.11
            $1.20




On
      February 28, 2007, the closing sale price for our common stock as reported
      on
      the OTC Bulletin Board system was $1.89.  As of February 28, 2007, there
      were approximately 360 shareholders of record for our common stock. This does
      not include shareholders holding stock in street name in brokerage
      accounts.






We
      have never paid cash dividends on our common stock, and it is unlikely that
      we
      will pay any dividends in the foreseeable future. We currently intend to invest
      future earnings, if any, to finance expansion of our business. Any payment
      of
      cash dividends in the future will be dependent upon our earnings, financial
      condition, capital requirements, and other factors deemed relevant by our board
      of directors.






**Recent
      Sales of Unregistered Securities**




In
      the quarter ended December 31, 2006, we issued 3,006,784 shares of our common
      stock for $3,180,193 in private placements under Rule 506 of Regulation D of
      the
      Securities Act of 1933.





Douglas
                Nichols Pension Plan
            275,000Karrison
                Nichols and Douglas Nichols
            150,000Calvin
                Nickal
            201,923Kelley
                Drye & Warren LLP
            217,391James
                Miceli
            784,643Mark
                Wagner
            125,000Karen
                Reinhart
            31,250James
                P. Mulvihill
            10,000Frank
                Marx
            101,200Frank
                Marx SEP/IRA
            21,000Frank
                Marx Defined Benefit Pension Plan
            69,000Sarah
                Thomas
            326,923Patrick
                Dolan
            125,000Thomas
                F. Bijou
            71,429Patrick
                Stark
            38,462Howard
                Westerman
            107,692Ernst
                Ohnell
            53,846Henri
                Wedell
            161,538Visse
                M. Wedell
            26,923Kenneth
                Biermacher
            19,231Clinton
                Everton
            26,923Donald
                Shephard
            62,410












Page
            18









**Item6.**  ***Selected
      Financial Data***





**2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Revenues
                from continuing operations
            $
            1,116,670
            $
            565,660
            $
            382,522
            $
            773,95 
                9
            $
            1,414,848Income
                (loss) from continuing operations
            $
            (6,593,892)
            $
            (5,818,816)
            $
            (7,139,109)
            $
            (4,017,374)
            $
            (5,227,453)Income
                (loss) from continuing operations per share
            $
            (0.07)
            $
            (0.06)
            $
            (0.07)
            $
            (0.05)
            $
            (0.07)Total
                assets
            $
            2,693,442
            $
            1,187,981
            $
            1,144,368
            $
            3,784,017
            $
            321,955Long-term
                obligations
            $
            —
            $
            —
            $
            5,944
            $
            27,353
            $
            46,283Net
                shareholders’ equity (deficit)
            $
            642,262
            $
            859,339
            $
            846,456
            $
            3,552,829
            $
            (2,460,595)Cash
                dividends per common share
            $
            —
            $
            —
            $
            —
            $
            —
            $
            —








In
      2002,
      we sold our Sign Builders of America, Inc. subsidiary. All information related
      to Sign Builders has been removed from this summary as a result of its
      presentation as a discontinued operation. Also in 2002, we restructured our
      Electronic Billboard Technology, Inc. subsidiary. EBT no longer sells products
      or services, but seeks to license its intellectual property to others. Revenue
      from continuing operations includes $130,386 and $10,000 in 2003 and 2002,
      respectively. There was no revenue from EBT in all other years presented.





Page
            19





**Item7.** ***Management’s
      Discussion and
      Analysis of Financial Condition and Results of
      Operations***




The
      following discussion should assist in understanding our financial condition,
      liquidity, and capital resources as of December 31, 2006, and the results of
      operations for the years ended December 31, 2006, 2005 and 2004. The Notes
      to
      our Consolidated Financial Statements included later in this report contain
      detailed information that should also be read in conjunction with this
      discussion.




**OVERVIEW**




We
      are engaged in research and development related to nanotechnology products,
      primarily those involving carbon nanotubes, to be used in the display,
      electronics, sensor, and other industries. Our technology, as well as many
      of
      its potential applications, is still new and in the early stages of development.
      Our revenue has primarily consisted of development projects involving either
      the
      U.S. government or large multinational corporations.




As
      described in Item 3 of this Annual Report on Form 10-K, we are the plaintiff
      in
      significant litigation against Canon, Inc. We are confident of our position
      and
      expect to prevail when the matter goes to trial, which is expected to be in
      April 2007, although that result cannot be guaranteed. Because of the difficulty
      in predicting the amount that we will receive as a result of this litigation,
      we
      have ignored any positive effect resulting from the resolution of the litigation
      in the preparation of this discussion and analysis of our financial condition
      and results of operations.




**OUTLOOK**




We
      expect our cash needs for 2007 to be approximately $6.5 million, excluding
      costs
      related to litigation. We intend to fund those needs through a combination
      of
      sales, reimbursements for research, and license agreements. We anticipate
      receiving significantly more revenue in 2007 than was received in 2006. We
      have
      developed a plan to enable us to achieve positive cash flow from operations
      with
      approximately $6.5 million of revenue. As of February 28, 2007, we have
      approximately $1.7 million in cash to cover any potential revenue shortfall
      that
      may occur for the year. We do not expect to need to raise any additional equity
      in 2007, but that could change if conditions change.




Our
      plan is to generate sufficient revenues in 2007 to achieve breakeven or better;
      however, losses may continue as we continue to fund the development of field
      emission technology, sensors, nano-electronics, and nanomaterials. There can
      be
      no assurances that we will be profitable in the future.  Full commercial
      development of our technology may require additional funds in the future.  
We expect to continue our concentrated research and development of ANI’s
      technology in 2007.




We
      have developed a plan to allow ourselves to maintain operations until we are
      able to sustain ourselves on our own revenue. Our plan is primarily dependent
      on
      raising funds through the licensing of our technology and through reimbursed
      research arrangements. Our current cash balances are adequate to insure that
      we
      can maintain our operations at the present level. We believe that we have the
      ability to continue to secure short term funding, if needed, to enable us to
      continue operations until our plan can be completed if this plan takes longer
      than anticipated.




This
      plan is based on current development plans, current operating plans, the current
      regulatory environment, historical experience in the development of electronic
      products, and general economic conditions. Changes could occur which would
      cause
      certain assumptions on which this plan is based to be no longer valid. Our
      plan
      is primarily dependent on increasing revenues. Although we do not expect funding
      our operations to be a problem, if adequate funds are not available from
      operations, or additional sources of financing; we may have to eliminate, or
      reduce substantially, expenditures for research and development, testing of
      our
      products, or obtain funds through arrangements with other entities that may
      require us to relinquish rights to certain technologies or products. Such
      results could materially and adversely affect us.




**Critical
      Accounting Policies**




Our
      significant accounting policies are summarized in the footnotes to our financial
      statements. Some of the most critical policies are also discussed
      below.




***Stock
      based compensation*** -
      We routinely grant stock options to employees and others. We have granted
      options in the past and each year all employees have the opportunity to earn
      additional goal-based option awards. In December 2004, the FASB issued Statement
      of Financial Accounting Standards No. 123R (Revised 2004), Share-Based Payment
      ("SFAS No. 123R"), which requires that the compensation cost relating to
      share-based payment transactions be recognized in financial statements based
      on
      the provisions of SFAS 123 issued in 1995. Prior to 2006, we accounted for
      stock
      based compensation under the provisions of APB 25 and disclosed pro-forma
      compensation expense calculated using the Black-Scholes model in the footnotes
      to the financial statements.







Page
            20





Under
      the provisions of SFAS No. 123R, pro-forma presentation is no longer allowed,
      and we are required to record compensation expense for option grants in the
      financial statements using the fair value method. We adopted the provisions
      of
      SFAS No. 123R in the financial statements for the year ended December 31, 2006.
      We have adopted this statement using the modified retrospective method of
      implementation, whereby the 2004 and 2005 statements included here have been
      restated to give effect to the fair-value based method of accounting for awards
      granted, modified, or settled in that year as though they had been accounted
      for
      under FAS 123. We previously used the intrinsic value method to account for
      stock-based employee compensation.




***Other*** -
      As a matter of policy, we review our major assets for impairment. Our major
      operating assets are accounts receivable, and property and equipment. We
      depreciate our property and equipment over their estimated useful lives. We
      did
      not identify any impaired items in 2004, 2005 or 2006. We have not experienced
      significant bad debts expense, and we do not believe that we need an allowance
      for doubtful accounts for any exposure to loss in our December 31, 2006 accounts
      receivable.




**LIQUIDITY
      AND CAPITAL RESOURCES**




Our
      cash balance was $2,085,338 at December 31, 2006, which was significantly higher
      than the cash balance of $897,247 at December 31, 2005. Our working capital
      was
      approximately $500,000 at December 31, 2006, a slight decrease from the working
      capital of roughly $700,000 at December 31, 2005. During the same period, our
      current ratio decreased from approximately 3.3 to 1 to approximately 1.2 to
      1.
      The reason for the significant change in our working capital ratio is that
      both
      current assets and current liabilities increased substantially. Our cash balance
      increased significantly as a result of the increase in cash provided by
      financing activities, offset by a smaller amount of cash used in operations,
      both of which are discussed below. Our current liabilities increased
      substantially from December 31, 2005 to December 31, 2006, as a result of the
      deferred payment arrangement that we have with our attorneys in connection
      with
      the Keesmann litigation. The amount due under this arrangement was $1.1 million
      as of December 31, 2006. We expect to have the funds available to pay this
      when
      due. This arrangement is described in more detail below in the selling, general,
      and administrative expense section.




The
      principal source of our liquidity has been funds received from exempt offerings
      of common stock. Cash provided by financing activities was $5,026,489,
      $4,519,913, and $2,037,390 in 2006, 2005, and 2004, respectively. Of this,
      the
      majority came from private placements of our common stock in the amounts of
      $5,004,193, $4,000,000, and $1,065,000 in 2006, 2005, and 2004, respectively.
      The majority of the balance of the cash provided by financing activities in
      all
      years came from proceeds from the exercise of stock options by current and
      former employees. We would anticipate a substantially decreased level of private
      placement activity in 2007 and have no current plans to raise any additional
      funds from the sale of equity.




As
      of February 28, 2007, our cash balance is approximately $1.8 million. This
      combined with expected revenue is enough for us to operate into 2008, even
      if
      there were no significant new positive developments. We may receive additional
      funds from the exercise of employee stock options, although a significant
      portion of the funds received from stock option exercises in 2006, 2005 and
      2004
      was from former employees that had options expiring. There are minimal options
      held by former employees and only minimal options expiring in 2007. The level
      of
      option exercise activity is also highly correlated with the market price of
      our
      common stock.




In
      the unlikely event that we need additional funds in 2007 beyond the amount
      that
      we have as of the date of this filing and those that we expect to receive as
      revenues or from other sources, we may seek to sell additional debt or equity
      securities. We have no plans to do this, however. While we expect to be able
      to
      obtain any funds needed for operations, there is no assurance that any financing
      alternatives can be arranged on commercially acceptable terms. We believe that
      our success in reaching profitability will be dependent upon the viability
      of
      products using our technology and their acceptance in the marketplace.




Net
      cash used in operating activities was $3,736,466, $4,507,579 in 2005, and
      $4,581,513 in 2004. The cash used in operations was primarily the result of
      the
      net losses incurred in each year. This amount decreased in each of the three
      years, and we expect a continued reduction in cash used in operating activities,
      or even more likely a change to cash provided by operations in 2007 as the
      result of an expected increase in revenues and other significant events. We
      have
      a plan to generate positive cash from operations; however, since that will
      require significantly increased revenues, there is no assurance that will be
      achieved. Such significantly increased revenues would most likely result from
      license agreements with significant up-front payments, substantial research
      contracts, or litigation results. The cash used in operations was virtually
      unchanged from 2004 to 2005. The decrease in the cash used in operating
      activities from 2005 to 2006 was primarily the result of increased revenues
      in
      2006.







Page
            21







Cash
      used in investing activities was the result of the purchase of capital assets
      in
      all years. We would expect minimal cash to be used in investing activities
      in
      2006. No material commitments exist as of December 31, 2006, for future
      purchases of capital assets.




The
      only contractual cash obligations that we have as of December 31, 2006 are
      operating leases. We have no long-term debt, notes payable, or capital leases.
      A
      summary of our operating lease obligations at December 31, 2006 is as
      follows:




Total
            2007
            2008
            2009Operating
                leases
            $263,395
            $163,930
            $61,790
            $37,675




We
      believe that we currently have the cash available to meet our cash requirements
      for fiscal 2007.






**RESULTS
      OF OPERATIONS**




Business
      Segments. We have three reportable business segments, our Applied Nanotech, Inc.
      subsidiary, our Electronic Billboard Technology, Inc. subsidiary and our
      remaining activities, primarily corporate overhead. Because our Electronic
      Billboard Technology, Inc. subsidiary has only minimal activity, our management
      discussion and analysis related to results of operations is much more meaningful
      if done on a consolidated basis. To the extent that EBT activity had a
      significant impact on consolidated activity, it will be discussed in the context
      of the consolidated results. The only significant financial activity at EBT
      was
      the sale of its intellectual property in 2006.




Revenues. Following is a summary of key revenue categories for the three years covered
      by
      this report.


2006
              
              2005
              
              2004Government
                  Revenues
              
              $
              583,236
              
              $
              208,211
              
              $
              305,721Other
                  Contract Research
              
              $
              360,054
              
              $
              59,995
              
              $
              —License
                  Fees and Royalties
              
              $
              83,928
              
              $
              —
              
              $
              10,852Total
                  ANI Revenues
              
              $
              1,116,670
              
              $
              565,660
              
              $
              382,522Total
                  EBT Revenues
              
              $
              —
              
              $
              —
              
              $
              —Total
                  Revenues
              
              $
              1,116,670
              
              $
              565,660
              
              $
              382,522**Revenue
                  backlog at December 31**
              
              **$**
              **3,026,000**
              ****
              **$**
              **2,764,000**
              ****
              **$**
              **130,000**
              ****




All
      of the revenues during the 3-year period came from ANI. The government revenues
      in 2005 and 2004 were primarily all the result of one Phase II SBIR grant.
      The
      government revenues increased substantially in 2006 as a result of two new
      SBIR
      Phase II grants, another significant contract from the Army, and several SBIR
      Phase I grants. We would expect another significant increase in revenue from
      government contracts in 2007 as work continues on the existing contracts and
      new
      contracts are obtained. We also experienced a substantial increase in other
      contract research over the three year period as a result of our increased focus
      on that area. The revenue in 2005 came from our contract with a large sporting
      goods manufacturer. The revenue in 2006 resulted from the same contract with
      the
      sporting goods manufacturer and a contract with a large Japanese chemical
      manufacturer. We also received some license revenue in 2006 as a result of
      the
      license agreement that we signed with Shimane Masuda Electronics.




EBT
      changed its business model in 2002 and no longer sold products, but rather
      focused on licensing its technology. EBT sold its intellectual property in
      2006,
      as discussed below. EBT had no revenue in any of the years
      presented.




The
      revenue backlog as of December 31, 2006 results from several government programs
      and private contracts and represents an increase from prior years. All of these
      programs are currently in progress and generating revenue. The majority of
      this
      backlog will be converted into revenue in 2007. The backlog as of December
      31,
      2005 included several contracts for which notification had been received, but
      work had not yet commenced. As a result, work did not start on several of these
      contracts until mid to late 2006 and several of those contracts remain in the
      backlog as of December 31, 2006.







Page
            22







We
      expect revenue to be significantly higher in 2007 than in 2006, and we plan
      to
      generate minimum revenues in 2007 of $5.0 million at ANI. Of that $2.7 million
      is already committed and in process, and the remaining $2.3 million has been
      specifically identified. There is no guarantee that these revenues will be
      obtained; however, we think it is more likely that revenues will exceed these
      numbers, than it is that they fall short of them. Revenues could increase above
      these levels as a result of royalty agreements or additional research revenues,
      but there is no assurance that this will occur, or that even $5.0 million in
      revenue will be achieved. We are currently pursuing many opportunities in
      several areas that could result in additional revenue in 2007.




Of
      the $5.0 million of specifically identified revenues, we expect a minimum of
      $2.9 million to come from government contracts. Approximately $1.7 million
      of
      this is expected to result from contracts currently in process and $1.2 million
      from new contracts expected to be obtained.




The
      remaining specifically identified revenue of $2.1 million is expected to come
      from non-governmental sources. Of that, roughly $1.0 million of that revenue
      is
      from projects currently in process, including our contracts with the sporting
      goods company and the chemical manufacturer.




Cost
      of sales. Because we do not ship products or provide homogenous services, we do not incur
      costs of sales in the traditional sense. We do keep track of our costs on
      individual projects, but because there is a wide variation in cost percentages,
      presenting cost of sales information is not meaningful. Government sponsored
      research has nominal or no gross margins and is primarily just a reimbursement
      of costs. In some cases we charge nominal amounts for projects that have much
      higher costs because we are proving a concept that will be helpful to us in
      other areas, or are seeking a significantly larger follow up contract with
      the
      customer. In other instances we may perform research contracts that have
      significant positive margins because we are able to capitalize on work that
      we
      have done and knowledge that we have gained in the past. At the present stage
      of
      our development, it is more meaningful to look at total research and development
      costs in conjunction with revenues than to look at solely internally funded
      research projects and the cost of research associated with revenue producing
      contracts.




Research
      and development. Following is a summary of research and development expenditures for the past
      three years.




2006
              
              2005
              
              2004ANI
                  Research and development
              
              $
              3,590,148
              
              $
              2,635,412
              
              $
              2,737,029EBT
                  Research and development
              
              $
              —
              
              $
              —
              
              $
              —Total
                  Research and development
              
              $
              3,590,148
              
              $
              2,635,412
              
              $
              2,737,029




Company
      sponsored research and development expenses at Applied Nanotech, Inc. increased
      substantially from 2005 to 2006, after decreasing slightly from 2004 to 2005.
      This increase in 2006 was a result of a much higher level of activity. As of
      the
      end of 2006, we had roughly 12 more employees than we had at the beginning
      of
      2005. Some of these employees were hired in late 2005, so 2006 included a full
      year of wages and benefits as compared with a partial year in 2005. Additional
      employees were hired in 2006, which included a partial year of cost as compared
      with zero cost in 2005. These employees are associated with new revenue
      producing projects. In 2006, we started 3 significant new government contracts
      and a significant new contract with a large chemical manufacturer. In late
      2005,
      we also started our project with our sporting goods manufacturer. This project
      alone had three new employees associated with it. Because of the higher level
      of
      activity, we also spent more on research materials.




We
      expect to continue to incur substantial expenses in support of additional
      research and development activities related to the commercial development of
      our
      field emission technology, sensors, nano-electronics, and functional
      nanomaterials. We expect to incur at least $4.1 million in research related
      expenditures in 2007. We expect our research expenditures to increase in 2007
      because of the new research contracts that we have obtained and because of
      additional contracts that we expect to obtain. We may, however, incur more
      research and development expense in 2007 than presently expected. We are
      pursuing numerous opportunities for research contracts and depending upon the
      nature of the contracts signed, we may require more research materials than
      expected, or we may require additional personnel.












Page
            23







Selling,
      general, and administrative .
      Following are key components of selling, general, and administrative
      expense:




2006
              
              2005
              
              2004Stock
                  based compensation
              
              $
              410,448
              
              $
              1,072,362
              
              $
              2,133,941Litigation
                  related expenses
              
              $
              1,933,603
              
              $
              172,816
              
              $
              —EBT
                  related S, G, & A
              
              $
              166,280
              
              $
              3,734
              
              $
              —Other
                  S, G, & A
              
              $
              2,718,683
              
              $
              2,530,908
              
              $
              2,171,059Total
                  selling, general, and administrative
              
              $
              5,229,014
              
              $
              3,779,820
              
              $
              4,305,000





Total
      selling, general and administrative expense declined from 2004 to 2005 and
      then
      increased significantly in 2006, however the total is significantly impacted
      by
      several factors that are discussed below.




The
      first significant component of selling, general, and administrative expense
      is
      stock based compensation. As previously discussed, we implemented the provisions
      of FAS 123R in 2006. These provisions require that we record compensation
      expense in our financial statements based on fair value accounting. The stock
      based compensation expense declined from 2004 to 2005 and again in 2006. This
      was based on two factors. First, the number of options vested, or expected
      to
      vest, declined each year. Second, the fair value of the options vested also
      decreased. One of the factors impacting the fair value is the price of the
      stock. As a general rule, options granted when the stock price is lower will
      have a lower fair value than options granted when the stock price is higher.
      The
      price of our stock generally declined from 2004 to 2005 and again in 2006.
      We
      will incur stock based compensation expense in 2007, but it is difficult to
      predict the amount. The majority of options that we grant are performance based
      options that vest upon the achievement of specified goals. The amount of expense
      that we incur in 2007 will depend on the goals achieved. As of December 31,
      2006, there were outstanding unvested options with a total fair value of
      approximately $1.7 million. This amount, in addition to the fair value of any
      new options granted that vest, may be recognized as an expense in 2007 or
      after.




The
      second major component of selling, general, and administrative expense during
      the periods presented is litigation related expense. We had no litigation
      expense in 2004, but in 2005 we initiated litigation against Canon, Inc. and
      incurred legal expenses of $172,816 related to that litigation. That litigation
      continued in 2006 and we incurred an additional $494,120 in expense related
      to
      the Canon litigation in 2006. We also initiated litigation against Till Keesmann
      in 2006 and incurred expense of $1,439,483 related to that litigation. Our
      attorneys are handling the Canon litigation on a contingency basis, however
      we
      are responsible for any out of pocket costs. The major costs incurred in the
      Canon litigation in 2005 and 2006 relate to translation expenses. Our attorneys
      are handling the Keesmann litigation on a modified contingency basis, whereby
      we
      defer payment on the professional fees and pay only the out of pocket expenses
      on a current basis. Any professional fees that have not been recovered through
      the contingency arrangement by November 2007 become due and payable at that
      point. As of December 31, 2006, there was approximately $1.1 million of deferred
      fees related to the Keesmann litigation in accounts payable.




We
      will incur additional litigation expense in 2007, however the amount can not
      be
      predicted with any degree of accuracy. See Item 3 of this Annual Report on
      Form
      10-K for the current status of both cases. If the Canon litigation proceeds
      through trial, we could incur up to $500,000 in additional out of pocket
      expenses. The amount of expense that we incur in 2007 related to the Keesmann
      case is subject to a wide range of variability depending on the progress and
      status of the case. If the case proceeds through trial, we could incur expense
      in an amount as large as 2006.




The
      increase in other selling, general, and administrative expenses from year to
      year generally related to payroll related items. The increase from 2004 to
      2005
      was primarily related to an additional executive officer that we hired effective
      May 1, 2005. This officer also was a consultant for the Company during the
      first
      four months of 2005. In addition to the increased number of employees, all
      administrative personnel received salary increases in 2005. The increase from
      2005 to 2006 largely related to turnover in the CEO position. We had three
      CEO’s
      during the year and there were periods of overlapping compensation, including
      a
      consulting arrangement with one of the departing CEOs. In addition, we paid
      an
      executive search fee in connection with hiring a new CEO.




We
      expect selling, general and administrative expense in 2007 to be approximately
      $2.5 million, excluding any stock based compensation expenses or litigation
      related expenses. This would be similar to 2005 levels.







Page
            24








Gain
      on sale of intellectual property and other assets .
      In 2002 EBT restructured its operations and stopped selling products and began
      focusing its efforts on licensing its intellectual property. In 2005, we began
      negotiating a license agreement related to part of our intellectual property.
      This ultimately resulted in an agreement in 2006 that was structured as a sale
      of the intellectual property to Novus Communications. The sale agreement called
      for an up-front payment and ongoing royalties based on a percentage of the
      revenue received by Novus Partners, a majority owned subsidiary of Novus
      Communications. As part of the agreement, we also sold the remainder of EBT’s
      intellectual property to Novus Displays, a newly formed subsidiary of Novus
      Communications. We
      received a total of $1.5 million in cash, the right to future royalties from
      Novus Partners, and an ownership interest in Novus Displays. One of the patents
      that we sold was a patent that had been assigned to us by Advanced Technology,
      Incubator, Inc. (“ATI”), a company owned by Dr. Zvi Yaniv, our Chief Operating
      Officer. In order to acquire the remaining interest in the patent and settle
      all
      potential future obligations to ATI, we issued 200,000 shares of our common
      stock, valued at $400,000 to ATI. The gain of $1.1 million recorded in the
      financial statements resulted from the cash payment received of $1.5 million,
      less the $400,000 cost associated with the acquisition of the patent
      rights.





Any
      future royalties received from Novus Partners will be reflected in our financial
      statements as a gain on the sale of intellectual property. We have received
      no
      additional payments from Novus Partners, beyond the initial payment that we
      received at the time that the license agreement was signed. We expect to receive
      royalty payments from Novus Partners in 2007; however, we cannot predict the
      amount of any such royalties, nor is there any guarantee that we will receive
      any royalties from Novus Partners. The patents that Novus Partners acquired
      from
      us are now part of a package of related patents. Licensing of that package
      is
      completely under the control of Novus Partners, and we are not part of that
      process. Our ability to receive royalties is dependent on Novus Partners signing
      revenue producing agreements. To our knowledge, no such revenue producing
      agreements exist as of this time.





Other
      income. Following is a summary of other income for the last three fiscal
      years.


2006
              
              2005
              
              2004Interest
                  expense
              
              $
              (604
              )
              $
              (2,590
              )
              $
              (4,584
              )Interest
                  Income
              
              $
              9,204
              
              $
              33,346
              
              $
              24,857





Our
      interest expense was associated with capital leases that ended in 2006.
      Accordingly, the interest expense decreased from year to year as the balance
      decreased. We expect no interest expense in 2007. Our interest income is earned
      as a result of the investment of excess cash balances. The amount of interest
      earned was lower in 2006 because our average cash balance was lower during
      the
      year. We expect interest income to remain insignificant.





Overview




The
      largest single component of cost that we incur is payroll related expense.
      Excluding the cost related to stock based compensation, we incurred payroll
      related expense of approximately, $1.9 million in 2004, $2.3 million in 2005,
      and $2.9 million in 2006. We expect payroll related expense in 2007 to be
      approximately $3.3 million as a result of anticipated new personnel. We expect
      our burn rate for 2007 to average about $550,000 per month, excluding litigation
      expenses and prior to any revenue. Based on this, we believe we can reach
      breakeven at a revenue level of $6.5 million, but there is no assurance that
      this will occur, or that we can achieve that level of revenue.




**SEASONALITY
      AND INFLATION**




Nano-Proprietary's
      business is not seasonal in nature. Management believes that Nano-Proprietary's
      operations have not been affected by inflation.




**ACCOUNTING
      PRONOUNCEMENTS**




In
      December 2004, the FASB issued Statement of Financial Accounting Standards
      No.
      123R (Revised 2004), Share-Based Payment ("SFAS No. 123R"), which requires
      that
      the compensation cost relating to share-based payment transactions be recognized
      in financial statements based on the provisions of SFAS 123 issued in 1995.
      As
      described in the notes to the financial statements, we adopted the provisions
      of
      FAS 123R in 2006 using the modified retrospect application method.





Page
            25











**Item7A.** ***Quantitative
      and Qualitative Disclosures About Market Risk*** ****





We
      do not use any derivative financial instruments for hedging, speculative, or
      trading purposes. Our exposure to market risk is currently
      immaterial.

























Page
            26





**Item
      8.*********Financial
      Statements and Supplementar Data***




**INDEX
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**OF
      NANO-PROPRIETARY, INC.**













**CONSOLIDATED
      FINANCIAL STATEMENTS**




Independent
                  Auditor’s Report
              28Consolidated
                  Balance Sheets - December 31, 2006 and 2005
              29Consolidated
                  Statement of Operations - Years Ended December 31, 2006, 2005,
                  and
                  2004
              30Consolidated
                  Statements of Shareholders’ Equity - Years Ended December 31, 2006, 2005,
                  and 2004
              31Consolidated
                  Statements of Cash Flows - Years Ended December 31, 2006, 2005,
                  and
                  2004
              32Notes
                  to Consolidated Financial Statements
              33


























Page
            27





**INDEPENDENT
      AUDITOR’S REPORT**




To
      the Board of Directors and Shareholders


Nano-Proprietary,
      Inc.


Austin,
      Texas






We
      have audited the accompanying consolidated balance sheets of Nano-Proprietary,
      Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2006 and
      2005 and the related consolidated statements of operations, shareholders’ equity
      and cash flows for each of the years in the three year period ended December
      31,
      2006.  These consolidated financial statements are the responsibility of
      the Company's management.  Our responsibility is to express an opinion on
      these financial statements based on our audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States).  Those standards require that
      we plan and perform the audit to obtain reasonable assurance about whether
      the
      financial statements are free of material misstatement.  An audit includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements.  An audit also includes assessing the accounting
      principles used and significant estimates made by management, as well as
      evaluating the overall financial statement presentation.  We believe that
      our audits provide a reasonable basis for our opinion.




In
      our opinion, the consolidated financial statements referred to above present
      fairly, in all material respects, the financial position of Nano-Proprietary,
      Inc. and Subsidiaries as of December 31, 2006 and 2005, and the results of
      its
      operations and its cash flows for each of the years in the three year period
      ended December 31, 2006 in conformity with accounting principles generally
      accepted in the United States of America.




We
      also have audited, in accordance with the standards of the Public Company
      Accounting Oversight Board (United States), the effectiveness of the Company’s
      internal control over financial reporting as of December 31, 2006, based on
      criteria established in Internal Control-Integrated Framework issued by the
      Committee of Sponsoring Organizations of the Treadway Commission (COSO), and
      our
      report dated March 5, 2007 expressed an unqualified opinion on management’s
      assertion of internal control over financial reporting and an unqualified
      opinion on the effectiveness of internal control over financial
      reporting.










Sprouse
      & Anderson, L.L.P.


Austin,
      Texas


March
      5, 2007










Page
            28





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


**CONSOLIDATED
      BALANCE SHEETS**




**ASSETS****December
                    31,****2006**
                
                **2005**Current
                    assets:Cash
                    and cash equivalents
                
                $
                2,085,338
                
                $
                897,247Accounts
                    receivable, trade - net of allowance for doubtful accounts
                
                
                364,718
                
                
                94,103Prepaid
                    expenses and other current assets
                
                
                79,301
                
                
                85,306Total
                    current assets
                
                
                2,529,357
                
                
                1,076,656Property
                    and equipment, net
                
                
                154,545
                
                
                101,785Other
                    assets
                
                
                9,540
                
                
                9,540Total
                    assets
                
                $
                2,693,442
                
                $
                1,187,981**LIABILITIES
                    AND SHAREHOLDERS’ EQUITY**Current
                    liabilities:Accounts
                    payable
                
                $
                1,562,488
                
                $
                231,131Obligations
                    under capital lease
                
                
                —
                
                
                4,348Accrued
                    liabilities
                
                
                87,237
                
                
                93,163Deferred
                    Revenue
                
                
                401,455
                
                
                —Total
                    current liabilities
                
                
                2,051,180
                
                
                328,642Commitments
                    and contingencies
                
                
                —
                
                
                —Total
                    liabilities
                
                
                2,051,180
                
                
                328,642Shareholders’
                    equity :Preferred
                    stock, $1.00 par value, 2,000,000 shares authorized;
                  no
                    shares issued and outstanding
                
                
                —
                
                
                —Common
                    stock, 120,000,000 shares authorized, $.001 par value,
                    104,257,607
                  and
                    99,746,440 shares issued and outstanding, respectively
                
                
                104,258
                
                
                99,746Additional
                    paid-in capital
                
                
                102,139,950
                
                
                95,767,647Accumulated
                    deficit
                
                
                (101,601,946
                )
                
                (95,008,054
                )Total
                    shareholders’ equity
                
                
                642,262
                
                
                859,339Total
                    liabilities and shareholders’ equity
                
                $
                2,693,442
                
                $
                1,187,981


















See
      notes to consolidated financial statements.







Page
            29







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


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**











**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004**RevenuesContract
                research
            
            $
            360,054
            
            $
            59,995
            
            $
            —Government
                contracts
            
            
            583,236
            
            
            208,211
            
            
            305,721License
                fees and royalties
            
            
            83,928
            
            
            —
            
            
            10,852Other
            
            
            89,452
            
            
            297,454
            
            
            65,949Total
                revenues
            
            
            1,116,670
            
            
            565,660
            
            
            382,522Operating
                costsResearch
                and development
            
            
            3,590,148
            
            
            2,635,412
            
            
            2,737,029Selling,
                general and administrative expenses
            
            
            5,229,014
            
            
            3,779,820
            
            
            4,305,000Royalty
                expense
            
            
            —
            
            
            —
            
            
            500,000Total
                operating costs
            
            
            8,819,162
            
            
            6,415,232
            
            
            7,542,029Gain
                on sale of assets and other intellectual property
            
            
            1,100,000
            
            
            —
            
            
            125Income
                (loss) from operations
            
            
            (6,602,492
            )
            
            (5,849,572
            )
            
            (7,159,382
            )Other
                income (expense):Interest
                income
            
            
            9,204
            
            
            33,346
            
            
            24,857Interest
                expense
            
            
            (604
            )
            
            (2,590
            )
            
            (4,584
            )Other
                income (loss)
            
            
            —
            
            
            —
            
            
            —Loss
                before taxes
            
            
            (6,593,892
            )
            
            (5,818,816
            )
            
            (7,139,109
            )Provision
                for taxes
            
            
            —
            
            
            —
            
            
            —Net
                (loss) applicable to common shareholders
            
            $
            (6,593,892
            )
            $
            (5,818,816
            )
            $
            (7,139,109
            )Earnings
                (loss) per shareBasic
                and diluted
            
            $
            (0.07
            )
            $
            (0.06
            )
            $
            (0.07
            )Weighted
                average common shares outstandingBasic
                and diluted
            
            
            100,895,795
            
            
            98,957,812
            
            
            96,609,237
































See
      notes to consolidated financial statements.







Page
            30










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




**CONSOLIDATED****STATEMENTS
      OF SHAREHOLDERS’ EQUITY**







Preferred
            
            Common
            
            Additional
            
            AccumulatedShares
            
            Amount
            
            Shares
            
            Amount
            
            Paid-In
                Capital
            
            Deficit
            
            TotalBalance
                December 31, 2003
            
            
            -
            
            
            -
            
            
            95,612,990
            
            
            95,613
            
            
            85,507,345
            
            
            (82,050,129
            )
            
            3,552,829Issuance
                of common stockoptions
                as compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,375,987
            
            
            -
            
            
            2,375,987Issuance
                of common stockas
                a result of the exercise ofemployee
                stock options
            
            
            -
            
            
            -
            
            
            1,211,545
            
            
            1,211
            
            
            972,138
            
            
            -
            
            
            973,349Issuance
                of common stock for cash
            
            
            -
            
            
            -
            
            
            421,887
            
            
            422
            
            
            1,082,978
            
            
            -
            
            
            1,083,400Net
                (loss)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (7,139,109
            )
            
            (7,139,109
            )Balance
                December 31, 2004
            
            
            -
            
            
            -
            
            
            97,246,422
            
            
            97,246
            
            
            89,938,448
            
            
            (89,189,238
            )
            
            846,456Issuance
                of common stockoptions
                as compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,288,760
            
            
            -
            
            
            1,288,760Issuance
                of common stockas
                a result of the exercise ofemployee
                stock options
            
            
            -
            
            
            -
            
            
            817,625
            
            
            818
            
            
            542,121
            
            
            -
            
            
            542,939Issuance
                of common stock for cash
            
            
            -
            
            
            -
            
            
            1,682,393
            
            
            1,682
            
            
            3,998,318
            
            
            -
            
            
            4,000,000Net
                (loss)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (5,818,816
            )
            
            (5,818,816
            )Balance
                December 31, 2005
            
            
            -
            
            
            -
            
            
            99,746,440
            
            
            99,746
            
            
            95,767,647
            
            
            (95,008,054
            )
            
            859,339Issuance
                of common stockoptions
                as compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            695,978
            
            
            -
            
            
            695,978Issuance
                of common stockas
                a result of the exercise ofemployee
                stock options
            
            
            -
            
            
            -
            
            
            54,383
            
            
            55
            
            
            26,589
            
            
            -
            
            
            26,644Issuance
                of common stock for cash
            
            
            -
            
            
            -
            
            
            4,039,393
            
            
            4,040
            
            
            5,000,153
            
            
            -
            
            
            5,004,193Issuance
                of common stock for
              accounts
                payable
            
            
            -
            
            
            -
            
            
            217,391
            
            
            217
            
            
            249,783
            
            
            -
            
            
            250,000Issuance
                of Common Stock for
              Patents
            
            
            -
            
            
            -
            
            
            200,000
            
            
            200
            
            
            399,800
            
            
            -
            
            
            400,000Net
                (loss)
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (6,593,892
            )
            
            (6,593,892
            )Balance
                December 31, 2006
            
            
            -
            
            $
            -
            
            
            104,257,607
            
            $
            104,258
            
            $
            102,139,950
            
            $
            (101,601,946
            )
            $
            642,262


















See
      notes to consolidated financial statements.







Page
            31










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


**CONSOLIDATED
      STATEMENTS OF** **CASH
      FLOWS**




**Year
                  Ended**
                **December
                  31,****2006**
              
              **2005**
              
              **2004**Cash
                  flows from operating activities:Net
                  loss
              
              $
              (6,593,892
              )
              $
              (5,818,816
              )
              $
              (7,139,109
              )Adjustments
                  to reconcile loss to net
                cash
                  used in operating activities:Depreciation
                  and amortization expense
              
              
              49,172
              
              
              56,260
              
              
              54,928(Gain)
                  loss on disposal of assets
              
              
              —
              
              
              —
              
              
              (125
              )Stock
                  and options issued for services
              
              
              695,978
              
              
              1,288,760
              
              
              2,375,987Stock
                  issued for patent
              
              
              400,000
              
              
              —
              
              
              —Changes
                  in assets and liabilities:Accounts
                  receivable, trade
              
              
              (270,615
              )
              
              (87,368
              )
              
              34,397Prepaid
                  expenses and other assets
              
              
              6,005
              
              
              (171
              )
              
              6,326Accounts
                  payable
              
              
              1,581,357
              
              
              90,534
              
              
              13,788Accrued
                  expenses
              
              
              (5,926
              )
              
              18,207
              
              
              17,310Customer
                  deposits and other current liabilities
              
              
              401,455
              
              
              (54,985
              )
              
              54,985Total
                  adjustments
              
              
              2,857,426
              
              
              1,311,237
              
              
              2,557,596Net
                  cash used in operating activities
              
              
              (3,736,466
              )
              
              (4,507,579
              )
              
              (4,581,513
              )Cash
                  flows from investing activities:Capital
                  expenditures
              
              
              (101,932
              )
              
              (16,672
              )
              
              (118,987
              )Proceeds
                  from sale of assets
              
              
              —
              
              
              —
              
              
              125Net
                  cash used in investing activities
              
              
              (101,932
              )
              
              (16,672
              )
              
              (118,862
              )Cash
                  flows from financing activities:Proceeds
                  from issuance of common stock
              
              
              5,030,837
              
              
              4,542,939
              
              
              2,056,749Repayment
                  of long-term notes payable and capital lease
                obligations
              
              
              (4,348
              )
              
              (23,026
              )
              
              (19,359
              )Net
                  cash provided by financing activities
              
              
              5,026,489
              
              
              4,519,913
              
              
              2,037,390Net
                  increase (decrease) in cash and cash equivalents
              
              
              1,188,091
              
              
              (4,338
              )
              
              (2,662,985
              )Cash
                  and cash equivalents, beginning of year
              
              
              897,247
              
              
              901,585
              
              
              3,564,570Cash
                  and cash equivalents, end of year
              
              $
              2,085,338
              
              $
              897,247
              
              $
              901,585


















See
      notes to consolidated financial statements.







Page
            32





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


**NOTES** **TO CONSOLIDATED FINANCIAL STATEMENTS**











**1.** **Organization,
      Operations, and Liquidity** **:**




Nano-Proprietary,
      Inc. and its subsidiaries (“the Company”) are engaged in the development of
      products for applications using proprietary field emission technology, sensors,
      nanoelectronics, and nanomaterials, as well as the performance of significant
      research in that area. We intend to obtain development revenues for applying
      our
      technology to specific applications for customers and royalty revenues from
      licensing this technology to others. We have also developed patented electronic
      sign technology and sold products using that technology, but have now sold
      that
      technology. We may receive additional income from the sale of that technology
      based on license revenues received by the purchaser of the
      technology.




Until
      we are able to operate profitably as a result of revenues from either reimbursed
      research or license agreements, we may continue to seek additional funds through
      the equity markets, or raise funds through debt instruments to allow us to
      maintain operations. There is no assurance that license agreements will be
      signed, that commercialization of our technology and products will result in
      income from operations, or that funds will be available in the equity or debt
      markets. Management believes it will continue to be able to secure additional
      short term funding, if necessary, to allow the Company to continue operations
      until we achieve profitability.




The
      principal source of our liquidity since the time of our initial public offering
      in 1993 has been from the funds received from exempt offerings of common stock,
      preferred stock, and convertible debt securities, as well as license and
      development revenues.  We will likely receive additional funds from the
      exercise of options. We may also seek to increase our liquidity through bank
      borrowings or other financings, although this is not likely.  There can be
      no assurance that any of these financing alternatives can be arranged on
      commercially acceptable terms.  We believe that our success in reaching
      profitability will depend on the viability of our technology and products using
      that technology, their acceptance in the marketplace, and our ability to obtain
      additional debt or equity financings in the future.




A
      portion of our research and development has been funded by others.  To the
      extent that other funding is not available, the research and development
      performed is internally funded by us.











**2.** **Summary
      of Significant Accounting Policies** **:**




Principles
      of consolidation




The
      accompanying consolidated financial statements include the accounts of the
      Company and its subsidiaries, Applied Nanotech, Inc. (“ANI”), and Electronic
      Billboard Technology, Inc. (“EBT”), after the elimination of all significant
      intercompany accounts and transactions. ANI is primarily involved in developing
      products for applications using the Company’s proprietary field emission
      technology, sensors, nanoelectronics, and nanomaterials which include
      composites. EBT was primarily involved in the commercialization of electronic
      digitized sign technology, but has now sold its technology.




Management’s
      estimates




The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets, liabilities, revenues, and expenses,
      as
      well as the disclosure of contingent assets and liabilities. Actual results
      could differ from those estimates. Significant estimates include NOL reserves,
      bad debt reserves, assumptions used in calculating share based compensation
      under FAS 123R, depreciation, and litigation reserves.














Page
            33





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**




**2.** **Summary
      of Significant Accounting Policies (continued)** **:**




Revenue
      recognition




Our
      revenues include reimbursements under agreements to perform research and
      development for government agencies and others. We do not perform research
      contracts that are contingent upon successful results. Larger projects are
      broken down in phases to allow the customer to determine at the end of each
      phase if they wish to move to the next phase. The agreements with federal
      government agencies generally provide that, upon completion of a technology
      development program, the funding agency is granted a royalty-free license to
      use
      the newly developed technology for its own purposes.  We retain all other
      rights to use, develop, and commercialize the technology and recognize revenue
      when it is earned pursuant to the terms of the contract. Agreements with other
      entities generally allow the other entity to license the technology from us
      upon
      completion of the project.




The
      Company revenues also include royalties from licensing its technology, revenue
      from the sale of products, and other miscellaneous revenues. Many of the
      company’s projects may involve a combination of these types of revenues.
      Revenues are recognized as follows.




Government
      Contracts - Revenue from government contracts is recognized when it is earned
      pursuant to the terms of the contract. Long-term projects, such as SBIR Phase
      II
      grants that usually range from $500,000 to $1,000,000 in total and usually
      extend for a period of approximately two years, are generally based on
      reimbursement of costs. These projects are usually billed monthly based on
      costs, hours, or some other measure of activity during the month. Short-term
      projects, such as SBIR Phase I grants that usually are less than $100,000 and
      usually extend for a period of approximately 6 months, are billed at periodic
      intervals as specified in the contract. As a general rule, we recognize revenue
      on these contracts based on the activity level of the contract during the period
      as compared with total estimated activity. This generally would be a measure
      of
      cost incurred as compared with total expected cost. The recognition of revenue
      may not correspond with the billings allowable under the contract. To the extent
      that billings exceed revenue earned, a portion of the revenue is deferred until
      such time as it is earned.




Other
      Research Contracts - Revenue from nongovernmental contracts is recognized when
      it is earned pursuant to the terms of the contract. Each contract is unique
      and
      tailored to the needs of the customer and goals of the project. Some contracts
      may call for a monthly payment for a fixed period of time. Other contracts
      may
      be for a fixed dollar amount with an unspecified time period, although there
      is
      frequently a targeted completion date. These contracts generally involve some
      sort of up front payment. Some contracts may call for the delivery of samples,
      or may call for the transfer of equipment or other items developed during the
      project to the customer. As a general rule, we recognize revenue on long term
      contracts based on the activity level of the contract during the period as
      compared with total estimated activity. This generally would be a measure of
      cost incurred as compared with total expected cost. However, to the extent
      there
      are other significant contract provisions such as the delivery of more than
      a
      nominal amount of samples or delivery of equipment, we would modify this as
      appropriate. For other short term contracts, generally less than $50,000, we
      recognize revenue when it is billed under the terms of the
      contract.




Royalty
      Revenue - The Company recognizes royalty revenues based on the shipment of
      products by a licensee at the time the underlying product upon which the royalty
      is based is shipped by the entity paying the royalty. For minimum royalty
      payments paid by a licensee that are required for the licensee to maintain
      exclusivity, royalty revenue is recognized at the time the minimum royalty
      payment, or notice of intended payment, is received. The Company recognizes
      royalty payments received at the time of the signing of a royalty agreement
      at
      the time of receipt, unless the terms of the agreement make it clear that the
      up-front payment was a prepayment of future royalties.




Product
      Sales - Revenue from product sales is recognized at the time the product
      shipped. The Company’s primary business is research and development and the
      licensing of its technology, not the sale of products. Product sales are
      generally insignificant in number, and are usually limited to the sale of
      samples, proofs of concepts, prototypes, or other items resulting from its
      research.




Other
      Revenue - Other miscellaneous revenue is recognized as deemed appropriate given
      the facts of the situation and is generally not material.







Page
            34





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**











**2.** **Summary
      of Significant Accounting Policies (continued)** **:**




Cash
      and cash equivalents




The
      Company considers all highly liquid investments purchased with a maturity of
      approximately three months or less to be cash equivalents.




Accounts
      receivable




The
      Company occasionally sells products to others on credit; however most sales
      are
      to large financially stable companies, or the Federal government. It is the
      Company's policy to record reserves for potential credit losses.  Since
      inception, the Company has experienced minimal credit losses. The Company
      considered no reserves to be necessary for any of the years
      presented.




Property
      and equipment




Property
      and equipment are recorded at cost, net of accumulated depreciation and
      amortization. Depreciation is provided on the straight-line method over the
      estimated useful lives of the assets, which range from three to seven years,
      or
      the lease term for leasehold improvements, if less.  Expenses for major
      renewals and betterments that extend the original estimated economic useful
      lives of the applicable assets are capitalized. Expenses for normal repairs
      and
      maintenance are charged to operations as incurred.  The cost and related
      accumulated depreciation of assets sold or otherwise disposed of are removed
      from the accounts, and any gain or loss is included in income.




Impairment




At
      each balance sheet date, the Company evaluates the carrying amount and the
      amortization period for its long-lived assets. If an indicator of impairment
      exists, it is recorded at that time. There were no impairment charges recorded
      in any of the years presented in these financial statements.




Income
      taxes




The
      Company accounts for income taxes using the liability method pursuant to
      Statement of Financial Accounting Standards (“SFAS”) No. 109.  Under this
      method, deferred income taxes are recorded to reflect the tax consequences
      on
      future years of temporary differences between the tax basis of the assets and
      liabilities and their financial amounts at year-end.  The Company provides
      a valuation allowance to reduce deferred tax assets to their net realizable
      value.




Research
      and development expenses




Costs
      of research and development for Company-sponsored projects are expensed as
      incurred.




Disclosures
      about fair value of financial instruments




The
      following methods and assumptions were used to estimate the fair value of each
      class of certain financial instruments for which it is practicable to estimate
      that fair value. For cash equivalents and accounts receivable,  the
      carrying amount approximates fair value because of the short-term nature of
      these instruments. The fair value of the Company’s capital lease obligations is
      estimated based on the quoted market prices for the same, or similar issues,
      or
      on the current rates offered to the Company for obligations of the same
      remaining maturities with similar collateral requirements. For all years
      presented, the fair value of the Company’s capital lease obligations approximate
      their carrying values.







Page
            35





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**











**2.** **Summary
      of Significant Accounting Policies (continued)** **:**




Income
      (loss) per common share




Basic
      per share amounts are computed, generally, by dividing net income or loss by
      the
      weighted average number of common shares outstanding.  Diluted per-share
      amounts assume the conversion, exercise, or issuance of all potential common
      stock instruments unless the effect is anti-dilutive, thereby reducing the
      loss
      or increasing the income per common share.  As described in Notes 7, 8 and
      9, the Company had options and warrants outstanding as indicated in the table
      below. However, because the Company incurred losses in all years presented,
      the
      inclusion of those potential common shares in the calculation of diluted loss
      per-share would have an anti-dilutive effect.  Therefore, basic and diluted
      per-share amounts are the same in all years presented.




2006
              
              2005
              
              2004Options
              
              
              7,713,912
              
              
              6,703,151
              
              
              5,398,703Warrants
              
              
              60,000
              
              
              95,000
              
              
              95,000Weighted
                  average exercise price
              
              
              1.58
              
              $
              1.57
              
              $
              1.29







Share-based
      payments




The
      Company has four stock based compensation plans described in greater detail
      in
      Note 8 to these financial statements. The Company uses the fair value method
      to
      account for stock-based compensation. The fair value of each award is estimated
      on the date of each grant using the Black Scholes option pricing model that
      uses
      the assumptions noted in the following table. Estimated volatilities are based
      on the historical volatility of the Company’s stock over the same period as the
      expected term of the options. The expected term of options granted represents
      the period of time that options granted are expected to be outstanding. The
      Company uses historical data to estimate option exercise behavior and to
      determine this term. The risk free rate used is based on the U.S. Treasury
      yield
      curve in effect at the time of the grant using a time period equal to the
      expected option term. The Company has never paid dividends and does not expect
      to pay any dividends in the future.




2006
              
              2005
              
              2004Expected
                  dividend yield
              
              0%
              
              0%
              
              0%Risk
                  Free Interest Rate
              
              4.6%-
                  5.2%
              
              3.5%
                  - 4.4%
              
              3.5%Expected
                  option term (in years)
              
              2.0
                  - 3.5
              
              1.5
                  - 3.5
              
              5Turnover/Forfeiture
                  Rate
              
              0%
              
              0%
              
              45%Expected
                  volatility
              
              70%
                  - 87%
              
              72%
                  - 100%
              
              72%Weighted-average
                  volatility
              
              78%
              
              99%
              
              72%






The
      Black-Scholes option valuation model and other existing models were developed
      for use in estimating the fair value of traded options that have no vesting
      restrictions and are fully transferable. These option valuation models require
      the input of, and are highly sensitive to, subjective assumptions including
      the
      expected stock price volatility. Nano-Proprietary’s stock options have
      characteristics significantly different from those of traded options, and
      changes in the subjective input assumptions could materially affect the fair
      value estimate.










Page
          36








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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**










**2.** **Summary
      of Significant Accounting Policies (continued)** **:**




Recently
      issued accounting pronouncements




Effective
      January 1, 2006, the Company adopted FASB Statement of Financial Accounting
      Standards No. 123R (Revised 2004), Share-Based Payment, which requires that
      the
      compensation cost relating to share-based payment transactions be recognized
      in
      financial statements based on the provisions of SFAS 123 issued in 1995. We
      have
      adopted this statement using the modified retrospective method of
      implementation, whereby the 2004 and 2005 statements included have been restated
      to give effect to the fair-value based method of accounting for awards granted,
      modified, or settled in that year as though they had been accounted for under
      FAS 123. We previously used the intrinsic value method to account for
      stock-based employee compensation.





The
      compensation cost that has been charged against income in accordance with FAS
      123R for the years ended December 31, 2006, 2005, and 2004 was $695,978,
      $1,288,760, and $2,375,987, respectively. This represents an increase in expense
      related to stock based compensation of $1,157,282 for 2005 and $2,527,083 for
      2004. In addition, if we had accounted for stock based compensation expense
      under the intrinsic value method in 2006, compensation expense would have
      decreased by $814,603. Implementation of the provisions of FAS 123R had no
      effect on cash flow from operations or cash flow from financing activities.
      Implementation did increase the loss from continuing operations, the loss before
      taxes, and the net loss in the years ended December 31, 2006, 2005, and 2004
      by
      $814,603, $1,157,282, and $2,527,083, respectively. Implementation of FAS 123R
      increased the both basic and diluted (loss) per share by ($0.01), ($0.01),
      and
      ($0.02) for the years ended December 31, 2006, 2005, and 2004,
      respectively.





The
      Company also increased both additional paid in capital and the accumulated
      deficit as of December 31, 2005 by $10,273,105 to reflect the cumulative effect
      of the implementation of FAS 123R as of that date. This amount represents the
      total share-based compensation expense that would have been recorded for the
      period from 1995 through 2005 if we had accounted for share based awards under
      FAS 123 during that period.







**3.** **Operating
      Lease Obligations** **:**




The
      Company leases various facilities and equipment under operating lease agreements
      having terms expiring at various dates through 2009. Rental expense was
      $124,805, $133,487, and $115,217 for the years ended December 31, 2006,
      2005 and 2004, respectively.




Future
      minimum lease payments under operating leases that have initial or remaining
      noncancelable lease terms in excess of one year at December 31, 2006, were
      as
      follows:




2007
            
            163,9302008
            
            61,7902009
                and thereafter
            
            37,675Total
                future minimum lease payments
            $
            263,395








Page
            37





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)**










**4.** **Capital
      Lease Obligations** **:**




Capital
      leases payable at December 31, 2006 and 2005 consisted of the
      following:


**2006**
              
              **2005**Capital
                  leases for copier equipment due inmonthly
                  installments of $1,932 through 2006.The
                  equipment value and lease obligation was determinedusing
                  a discount rate of 10%.  The equipment was included inoffice
                  equipment at December 31, 2005 at a cost of $94,383 and
                  with accumulated amortization of $91,018. The equipment was returned
                  in
                  2006 at the end of the lease.
              
              $
              —
              
              $
              4,368Less
                  interest
              
              
              —
              
              
              (20
              )Less
                  current portion
              
              
              —
              
              
              (4,348
              )Capital
                  Lease Obligations, long-term
              
              $
              —
              
              $
              —






**5.** **Details
      of Certain Balance Sheet Accounts** **:**




Additional
      information regarding certain balance sheet accounts at December 31, 2006 and
      2005 is as follows:




**December
                  31,****2006**
              
              **2005**Property
                  and equipment:Plant
                  and equipment
              
              $
              837,436
              
              $
              755,436Furniture
                  and office equipment
              
              
              106,146
              
              
              199,184Leasehold
                  Improvements
              
              
              14,382
              
              
              14,382Total
                  carrying cost
              
              
              957,964
              
              
              969,002Less
                  accumulated depreciation
              
              
              (803,419
              )
              
              (867,217
              )$
              154,545
              
              $
              101,785Accrued
                  liabilities:Payroll
                  and related accruals
              
              $
              63,237
              
              $
              65,507Other
              
              
              24,000
              
              
              27,656Total
              
              $
              87,237
              
              $
              93,163








Depreciation
      for the years ended December 31, 2006, 2005, and 2004 was $49,172, $56,260,
      and
      $54,928, respectively.





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            38





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**










**6.** **Income
      Taxes** **:**




The
      components of deferred tax assets (liabilities) at December 31, 2006 and 2005,
      were as follows:


**December
                  31,****2006**
              
              **2005**Deferred
                  tax assets:Net
                  operating loss carry forwards
              
              $
              32,904,000
              
              $
              30,849,000Stock
                  Based Compensation
              
              
              1,804,000
              
              
              1,586,000Research
                  and experimentation credits
              
              
              468,000
              
              
              468,000Capitalized
                  intangible assets
              
              
              149,000
              
              
              185,000Depreciation
                  assets
              
              
              5,000
              
              
              6,000Accrued
                  expenses not deductible until paid
              
              
              24,000
              
              
              24,000Total
                  deferred tax assets
              
              
              35,354,000
              
              
              33,118,000Deferred
                  tax liabilities:
              
              
              —
              
              
              —Net
                  deferred tax assets before valuation allowance
              
              
              35,354,000
              
              
              33,118,000Valuation
                  allowance
              
              
              (35,354,000
              )
              
              (33,118,000
              )Net
                  deferred tax asset$
              —
              
              $
              —




The
      following is a reconciliation of the amount of the income tax expense (benefit)
      that would result from applying the statutory federal income tax rates to pretax
      income (loss) and the reported amount of income tax expense (benefit) for the
      periods ended December 31, 2006, 2005, and 2004.


**December
                  31,****2006**
              
              **2005**
              
              **2004**Expected
                  income tax expense (benefit)
              
              $
              (2,242,000
              )
              $
              (1,978,000
              )
              $
              (2,427,000
              )Non-deductible
                  expenses
              
              
              10,000
              
              
              11,000
              
              
              7,000Expiration
                  of Tax Credit Carryforwards
              
              
              —
              
              
              1,000
              
              
              556,000Other
              
              
              (4,000
              )
              
              2,000
              
              
              1,000Increase
                  in Valuation Allowance
              
              
              (2,236,000
              )
              
              1,964,000
              
              
              1,863,000Total
                  Tax
              
              $
              —
              
              $
              —
              
              $
              —




As
      of December 31, 2006, the Company had net operating loss carry forwards of
      approximately $97 million that expire from 2007 through 2026, and are available
      to offset future taxable income. The majority of these carry forwards expire
      after 2009. Additionally, the Company has tax credit carry forwards related
      to
      research and development expenditures of approximately $468,000 that expire
      through 2011.




The
      Company’s IPO, completed in 1993, and subsequent issuances of stock have
      effected ownership changes under Internal Revenue Code Section 382. The
      ownership changes resulting from these stock issuances will likely limit the
      Company's ability to utilize any net operating loss carry forwards or credits
      generated before the changes in ownership.







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            39





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**










**7.** **Capital
      Stock** **:**




Preferred
      stock




The
      Company has authorization for the issuance of 2,000,000 shares of $1.00 par
      value preferred stock. There were no shares of preferred stock outstanding
      for
      any of the years presented.




Common
      stock




During
      2004, 2005, and 2006, the Company issued shares of its common stock in a series
      of private placements in exempt offerings under Regulation D of the Securities
      Act of 1933. These shares were issued at prices that represented a slight
      discount to the market price of the stock at the time of the offerings. All
      of
      these shares were registered to enable the shareholder to be able to sell the
      shares, with the latest registration statement declared effective February
      13,
      2007. The shares issued in 2006 include both shares issued for cash and shares
      issued in payment of accounts payable.




Shares
              
              Proceeds2006
              
              
              4,256,784
              
              $
              5,254,1932005
              
              
              1,682,393
              
              $
              4,000,0002004
              
              
              401,887
              
              $
              1,065,000




In
      2006 in an exempt offering under Regulation D of the Securities Act of 1933
      ,
      the Company also issued 200,000 shares in connection with the acquisition and
      resale of a patent. See Notes 18 and 19 for additional information.




At
      December 31, 2006, common stock was reserved for the following
      reasons:


Exercise
                  of stock warrants
              60,000Exercise
                  and future grants of stock options
              8,658,877Total
                  shares reserved
              8,718,877




**8.** **Stock
      Options** **:**




The
      Company sponsors four stock-based incentive compensation plans (the “Plans”),
      which are described below. The compensation cost that has been charged against
      income for these plans for the years ended December 31, 2006, 2005, and 2004
      was
      $695,978, $1,288,760, and $2,375,987, respectively. No income tax benefit was
      recognized in the income statement and no compensation was capitalized in any
      of
      the years presented. The company issues new shares for all options exercised
      and
      does not expect to repurchase any shares to facilitate future option
      exercises.




The
      plans allow the Company to grant either incentive stock options or non-qualified
      stock options. The incentive stock options are exercisable for up to ten years,
      at an option price per share not less than the fair market value on the date
      the
      option is granted. The incentive stock options are limited to persons who have
      been regular full-time employees of the Company or its present and future
      subsidiaries for more than one (1) year and at the date of the grant of any
      option are in the employ of the Company or its present and future subsidiaries.
      Historically, the Company has not granted incentive stock options. Non-qualified
      options may be granted to any person, including, but not limited to, employees,
      independent agents, consultants and attorneys, who the Company's Compensation
      Committee believes have contributed, or will contribute, to the success of
      the
      Company.  Non-qualified options may be issued at option prices of less than
      fair market value on the date of grant and are exercisable for up to ten years
      from date of grant. The option vesting schedule for options granted is
      determined by the Compensation Committee of the Board of Directors at the time
      of the grant. The plans provide for accelerated vesting of unvested options
      if
      there is a change in control, as defined in the plan.







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            40





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**




**8.** **Stock
      Options (continued)** **:**




In
      March 1992, the shareholders of the Company approved the 1992 Employees Stock
      Option Plan (the "1992 Employees Plan") for purposes of granting incentive
      or
      non-qualified stock options. The plan was amended several times by the Company’s
      Board of Directors to increase the number of shares authorized under the plan.
      The latest amendment, in December 1999, increased the authorized shares under
      the plan to 6,500,000. This plan expired in March 2002; however, options granted
      under this plan prior to expiration remain outstanding until they are exercised,
      forfeited, or the exercise period expires. At December 31, 2006, no shares
      remained available for grant under the 1992 Employees Plan.




In
      March 1992, the Board of Directors adopted the 1992 Outside Directors’ Stock
      Option Plan (the "1992 Directors Plan"), for purposes of granting non-qualified
      options to non-employee directors of the Company. The plan was amended several
      times, the latest being in December 1999. A total of 1,000,000 shares were
      reserved for issuance under the plan and were issued each year based on a
      formula defined by the plan. The stock options granted under the 1992 Directors
      Plan are exercisable for up to 10 years at an option price equal to the fair
      market value on the date the option is granted.  This plan expired in March
      2002; however, options granted under the plan prior to expiration remain
      outstanding until they are exercised, forfeited, or the exercise period expires.
      At December 31, 2006, no shares remained available for grant under the 1992
      Directors Plan.




In
      May 1998, the Board of Directors of the Company established the 1998 Officers
      and Directors Stock Option Plan (the “1998 Officers and Directors Plan”) and
      reserved a total of 1,200,000 shares for issuance under the Plan. The plan
      was
      amended in January 1999 by the Board of Directors of the Company to increase
      the
      shares reserved for issuance under the plan to 2,500,000. Options under this
      plan were granted at the discretion of the Board of Directors. No additional
      shares are currently available under this plan and no shares will become
      available under this plan in the future.




In
      September 2002, the Board of Directors of the Company established the 2002
      Equity Compensation Plan and reserved a total of 5,000,000 shares for issuance
      under the Plan, effective March 2002. The purpose of this plan was to replace
      the 1992 Employees Plan and the 1992 Directors Plan, both of which expired
      in
      March 2002. The plan was amended effective December 31, 2004 to increase the
      authorized shares to 8,000,000. A total of 944,965 shares remain available
      for
      grant under this at December 31, 2006.




The
      following table summarizes information about stock options outstanding, all
      of
      which are expected to ultimately vest, and those options currently exercisable
      under all four stock option plans at December 31, 2006:




**Options
                    Outstanding**
              **Options
                    Exercisable**Range
                  of
                Exercise
                  Prices
              Number
                Outstanding
                at
                  12/31/06
              Wgtd.  Avg.
                Remaining
                Contractual
                Life
              Wgtd.
                  Avg.
                Exercise
                  Price
              Number
                Exercisable
                at
                  12/31/06
              Wgtd.  Avg.
                Remaining
                Contractual
                Life
              Wgtd.
                  Avg.
                Exercise
                  Price$0.00
                  - $0.50
              749,706
              3.0
                  Years
              $0.44
              749,706
              3.0
                  Years
              $0.44$0.51
                  - $1.00
              1,124,083
              4.7
                  Years
              $0.83
              1,124,083
              4.7
                  Years
              $0.83$1.01
                  - $2.00
              2,870,000
              8.6
                  Years
              $1.31
              1,055,000
              6.3
                  Years
              $1.50$2.01
                  - $2.99
              2,970,123
              7.1
                  Years
              $2.41
              2,670,123
              7.1
                  Years
              $2.37Total
              7,713,912
              6.9
                  Years
              $1.58
              5,598,912
              6.9
                  Years
              $1.64Aggregrate
                  intrinsic value
              
              $1,757,176
              
              
              $1,374,158





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            41











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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**










**8.** **Stock
      Options (continued)** **:**




The
      following is a summary of stock option activity under all four
      plans:




Number
                  of
                Shares
              
              Wgtd.
                  Ave.
                Exercise
                PriceOptions
                  outstanding at December 31, 2003
              5,253,175
              
              $1.09Granted
              2,457,073
              
              $2.73Exercised
              (1,211,545)
              
              $0.80Cancelled
              (1,100,000)
              
              $2.94Options
                  outstanding at December 31, 2004
              5,398,703
              
              $1.52Granted
              2,872,073
              
              $2.25Exercised
              (817,625)
              
              $0.66Cancelled
              (750,000)
              
              $2.42Options
                  outstanding at December 31, 2005
              6,703,151
              
              $1.84Granted
              2,972,970
              
              $1.54Exercised
              (54,383)
              
              $0.49Cancelled
              (1,907,826)
              
              $2.43Options
                  outstanding at December 31, 2006
              7,713,912
              
              $1.58








The
      weighted-average grant-date fair value of options granted during the years
      ended
      December 31, 2006, 2005, and 2004 was $0.90, $1.43, and $1.65, respectively.
      The
      total intrinsic value of options exercised during the years ended December
      31,
      2006, 2005, and 2004 was $57,050, $1,552,038, and $1,805,865
      respectively.





As
      of December 31, 2006, there was $1,688,643 of total unrecognized compensation
      cost related to non-vested options granted under the plan. This cost is expected
      to be recognized over a period of weighted average period of approximately
      1.3
      years.





During
      the year ended December 31, 2006, we extended the contractual life of 20,000
      options granted to a consultant by one year. As a result of that modification,
      we recognized additional compensation expense of $1,750. During 2006, we also
      repriced 100,000 options granted to a consultant. At the time of the grant
      in
      2005, the options were priced above the market price of our common stock. In
      2006, we repriced those options to a price equal to the market price of our
      stock at the time of the original grant in 2005. As a result of this repricing,
      we recognized $9,000 of additional compensation expense.








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            42





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**







**9.** **Stock
      Warrants** **:**




Common
      stock warrants




In
      1996, the Company issued 35,000 warrants to an advisor in connection with the
      Company’s fundraising activities. These warrants enable the holder to purchase
      shares of the Company’s common stock at a price of $2.00 per share through 2006.
      These warrants expired unexercised at the end of January 2006. In 1997, the
      Company issued 75,000 additional warrants to this advisor in connection with
      services related to a joint venture agreement. A total of 15,000 of these
      warrants were exercised in 1999. These warrants enable the holder to purchase
      shares of the Company’s Common Stock at a price of $1.00 per share through 2007.
      The remaining 60,000 options expired unexercised in 2007.




In
      1999, the Company issued a total of 60,000 warrants to three separate
      individuals in connection with services rendered to the Company. The exercise
      price of these warrants was based on the fair market value of the Company’s
      common stock at the time of issuance and ranged from $0.92 to $2.15 per share.
      These warrants were exercisable for a period of 5 years from the date of
      issuance and were either exercised or expired in 2004.




The
      following is a summary of outstanding warrants:




**Number
                    of**
                  **Shares**
                
                **Exercise**
                  **Price**Warrants
                    outstanding at January 1, 2004
                
                
                155,000
                
                $
                0.92-2.15Exercised
                
                
                (20,000
                )
                $
                0.92Expired
                    or canceled
                
                
                (40,000
                )
                $
                2.15Warrants
                    outstanding at December 31, 2004
                
                
                95,000
                
                $
                0.92-2.15Exercised
                
                
                —
                
                
                —Expired
                
                
                —
                
                
                —Warrants
                    outstanding at December 31, 2005
                
                
                95,000
                
                $
                1.00-2.00Exercised
                
                
                —
                
                
                —Expired
                
                
                (35,000
                )
                $
                2.00Warrants
                    outstanding at December 31, 2006
                
                
                60,000
                
                $
                1.00




**10.** **Supplemental
      Cash Flow Information** **:**




Cash
      paid for interest was $604, $2,590, and $4,584 for 2006, 2005, and 2004,
      respectively.  The following non-cash transactions have been excluded from
      the accompanying consolidated statement of cash flows:




2006
              
              2005
              
              2004Non-cash
                  financing activities:Issuance
                  of common shares in payment of accounts payable
              
              $
              250,000
              
              $
              —
              
              $
              —











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            43





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**




**11.** **Commitments
      and Contingencies** **:**




Till
      Keesmann Agreement




In
      May 2000, we licensed the rights to 6 carbon nanotube patents from Till Keesmann
      in exchange for a payment of $250,000 payable in shares of our common stock.
      Under the terms of the agreement, we are obligated to pay license fees equal
      to
      50% of any royalties received by us specifically related to these patents.
      We
      are allowed to offset certain expenses, up to a maximum of $50,000 per year,
      against payments due under this agreement. The agreement also contained
      provisions related to minimum license fee payments. These minimum payments,
      totaling $1,000,000, have been made and no further minimum payments are due.
      We
      are allowed to offset these minimum payments against future royalty payments;
      however, once these minimum payments and the expenses have been offset, we
      may
      be liable for additional royalty payments. As discussed in more detail below,
      this agreement is currently under litigation.




Research
      and development commitments




As
      of December 31, 2006, the Company had several research contracts in process.
      The
      total amount of those contracts is $3,632,710. Of that total, $606,577 has
      been
      recognized as revenue and $3,026,133 will be recognized in the future. The
      revenue to be recognized from these research contracts in 2007 is expected
      to exceed the cost of this research.




Agreements
      with MCC




We
      entered into an agreement in 1994 with Microelectronics and Computer Technology
      Corporation (“MCC”) that was amended on several subsequent occasions to cross
      license and pool technologies. As part of this relationship with MCC, 62 Diamond
      Field Emission patents and patent applications were assigned directly to us
      and
      we agreed to pay a royalty fee of 2% of future commercial revenues related
      to
      the patents received. We have the right to offset one half of the costs of
      maintaining these patents against any royalties due under the agreement. No
      payments have been made to, or are due to MCC under this agreement, and the
      possibility is remote that any payments will ever be due under this
      agreement.




Legal
      proceedings




*Canon
      litigation*




In
      April 2005, we filed suit against the Japanese camera and copier manufacturer
      Canon, Inc., and its wholly-owned U.S. subsidiary Canon USA, Inc., in the U.S.
      District Court for the Western District of Texas, Austin Division, seeking
      a
      declaratory judgment that new SED color television products being
      developed and manufactured by a Canon/Toshiba joint venture are not covered
      under a non-exclusive 1999 patent license agreement that we granted to
      Canon.  We assert that the Canon/Toshiba joint-venture - SED, Inc. -
      is not a licensed party under that agreement. The original complaint asserted
      additional claims related to whether the Canon/Toshiba joint venture’s
      television panels constituted excluded products under the 1999 license, as
      well
      as breach of covenant of good faith and fair dealing, tortious interference
      and
      a Lanham act violation by Canon. Last year, Canon moved to dismiss Canon U.S.A.
      from the litigation, and moved to dismiss several of the counts asserted. The
      court denied the motion, in part, by ruling that Canon U.S.A. was an appropriate
      defendant and refusing to dismiss our claims for breach of the covenant of
      good
      faith and fair dealing. Our tortious interference and Lanham Act claims were
      dismissed, without prejudice.





After
      initial discovery, in April 2006, we amended the complaint to drop one count
      related to the definition of excluded products in the 1999 license, and add
      two
      counts for fraudulent inducement and fraudulent non-disclosure related to events
      and representations made during our negotiations on the license, including
      Canon’s failure to disclose an ongoing relationship with Toshiba. Canon moved to
      dismiss the fraud claims, and the Court denied Canon’s motion in May 2006. The
      suit is now proceeding under the amended complaint. Discovery was completed
      in
      August 2006. Upon completion of discovery, Canon filed a motion for summary
      judgment seeking to dismiss the claim that SED is not a licensed party under
      the
      agreement. Canon did not file a motion for summary judgment seeking to dismiss
      either of the fraud claims or the breach of covenant of good faith and fair
      dealing. In November 2006, the Court denied Canon partial motion for summary
      judgment, describing SED, Inc. as a “corporate fiction designed for the sole
      purpose of evading Canon’s contractual obligations”.





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            44





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**











**11.** **Commitments
      and Contingencies (continued)** **:**





In
      January 2007, Canon filed another motion for partial summary judgment seeking
      a
      declaration that a reconstituted SED, Inc. which will be owned 100% by Canon,
      but still involving numerous reciprocal agreements with Toshiba, will be
      considered a Canon subsidiary. At the same time, we filed a motion for partial
      summary judgment, seeking the court’s affirmation of our termination of the
      license agreement due to Canon’s breach of contract in 2004. On February 22,
      2007, the Court issued a ruling denying Canon’s motion and granting our motion
      for partial summary judgment, ruling our termination of the contract effective
      December 1, 2006 to be valid. Trial on the remaining counts is to be scheduled
      on the first available open date on the Court’s calendar on or after April 2,
      2007.





*Keesmann
      litigation*




In
      May 2006, we filed suit in the U.S. District Court for the Northern District
      of
      Illinois against Till Keesmann, a German citizen who in 2000 granted us an
      exclusive and perpetual license to certain of his U.S. and European patents
      in
      carbon nanotube cathode technology. Shortly after we filed suit against Canon
      in
      April 2005, Keesmann conveyed part of his interests in the Exclusive License
      to
      investors associated with a German patent evaluation firm, IP Bewertungs AG
      (“IPB”). Thereafter, IPB approached us with proposals to buy or auction our
      rights to Keesmann’s patents. On March 20, 2006, we announced a letter of intent
      to form a joint venture with a leading Asian display manufacturer, Da Ling
      Co.,
      Ltd., to develop display products utilizing our intellectual property. Two
      days
      later, Keesmann purported to terminate the exclusive license that he granted
      to
      us six years ago. Our May 2006 complaint seeks a declaratory judgment that
      Keesmann had no right to terminate the exclusive license, and we also filed
      for
      a Temporary Restraining Order and Preliminary Injunction to prevent Keesmann
      from taking any actions inconsistent with his obligations under the exclusive
      license. The Court granted a consent order that prevents Keesmann from licensing
      the patents pending an injunction hearing and decision. In June 2006, Keesmann
      filed an Answer and Counterclaim, denying that the purported termination was
      null and void, and asserting a counterclaim that asks the court to find that
      we
      breached the exclusive license by not actively marketing the Keesmann patents,
      among other things.





W e
      amended our complaint in December 2006 to include additional defendants, JK
      Patentportfolio GmbH & Co., Jochen Kamlah, NPV Nano Patent GmbH & Co.,
      and Arnold Amsinck. The amended complaint also contains additional claims
      including breach of contract, conversion, aiding and abetting conversion,
      conspiracy to commit conversion, misappropriation, aiding and abetting
      misappropriation, conspiracy to commit conversion, Lanham act violations,
      tortious interference with a prospective economic relationship, aiding and
      abetting tortious interference with a prospective economic relationship, and
      conspiracy to tortiously interfere with a prospective economic
      relationship.





In
      January 2007, the Court granted our motion for preliminary injunction, ruling
      that there is a reasonable likelihood that we will prevail on the merits of
      the
      case. The preliminary injunction enjoins Keesmann, his agents, employees, and
      all those acting in concert with him from terminating the license agreement,
      or
      otherwise acting in violation of the license agreement. In connection with
      this
      injunction, the Court set the Bond, which is required by law, at $100,000.
      We
      posted the bond in February 2007.




*Other
      litigation*






On
      July 20, 1998, TFI Telemark, Inc. filed a complaint in the County Court at
      Law
      No. 2 of Travis County, Texas against the Company for debts of its now defunct
      subsidiary, Plasmatron. The Company was served with notice of this suit on
      August 5, 1998. The Company believes that no amounts are due to TFI; however,
      all amounts claimed as owing by TFI are recorded as liabilities in the
      consolidated financial statements of the Company. There has been no activity
      on
      this case in the last year. The Company believes the ultimate resolution of
      this
      matter will not have a material impact on the consolidated financial statements
      of the Company.






From
      time to time the Company and its subsidiaries are also defendants in various
      lawsuits that may arise related to minor matters. It is expected that all such
      lawsuits will be settled for an amount no greater than the liability recorded
      in
      the financial statements for such matters.  If resolution of any of these
      suits results in a liability greater than that recorded, it could have a
      material impact on us.







Page
            45





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**











**11.** **Commitments
      and Contingencies (continued)** **:**




Government
      contracts




Governmental
      contractors are subject to many levels of audit and investigation.  Among
      United States agencies that oversee contract performance are: the Defense
      Contract Audit Agency, the Inspector General, the Defense Criminal Investigative
      Service, the General Accounting Office, the Department of Commerce, the
      Department of Justice and Congressional Committees. The Company's management
      believes that an audit or investigation, if any, as a result of such oversight
      would not have any material adverse effect upon the Company's financial
      condition or results of operations.




**12.** **Concentrations
      of Credit Risk** **:**


The
      Company’s financial instruments that are exposed to concentrations of credit
      risk consist of cash and cash equivalents and receivables. The Company places
      its cash and cash equivalents with high credit quality financial institutions;
      however for periods of time during the year, bank balances on deposit were
      in
      excess of the Federal Deposit Insurance Corporation insurance limit. At December
      31, 2006 and 2004, amounts in excess of the FDIC limit of $1,345,529 and
      $175,058, respectively, were held at JP Morgan Chase. No amounts in excess
      of
      the FDIC limit were held in bank accounts at December 31, 2005. At December
      31,
      2006, the Company held $439,808 in excess of the Securities Investor Protection
      Corporation limits in an account at Charles Schwab & Co. Inc.




The
      Company’s receivables are uncollateralized and result primarily from its
      research and development projects performed primarily for U.S. Federal
      Government Agencies and services performed for large U.S. and multinational
      corporations. The Company has not incurred any material losses on these
      receivables.




**13.** **Research
      and Development Contracts** **:**




The
      Company makes significant expenditures for research and development. On
      occasion, the Company may seek funding for a portion of its research and
      development costs to reduce the cost of such expenditures to the Company. The
      Company only seeks funding for projects that it already intended to do, or
      for
      projects that would apply its technology for other uses in instances where
      that
      application would allow the Company to achieve technical milestones that are
      part of its strategic plan. A substantial portion of the Company’s funded
      research has been from government contracts. Under government contracts, the
      government has the right to utilize the results for its purposes and the Company
      has the right to utilize the technology for commercial purposes. 
Generally, when the Company contracts with other entities, the entity is also
      conducting its own internal research related to application of the Company’s
      technology to its products and such expenditures by the entity may exceed the
      amount of funding provided to the Company. Usually the entity has the right
      to
      license the technology at the conclusion of the project, if they desire. The
      costs of a particular research program may significantly exceed the funding
      received, however since the research was part of planned research, these
      contracts generally involve only nominal additional costs to the
      Company.




The
      following schedule summarizes certain information with respect to research
      and
      development contracts:


2006
              
              2005
              
              2004Contract
                  research revenues
              
              $
              943,290
              
              $
              268,206
              
              $
              305,721Costs
                  incurred charged to operations included in research and
                  development
              
              $
              879,592
              
              $
              254,656
              
              $
              278,928Amount
                  of additional funding commitments at December 31
              
              $
              3,026,133
              
              $
              268,258
              
              $
              129,090








Page
            46





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**











**14.** **Retirement
      Plan** **:**




The
      Company sponsors a defined contribution 401(k) profit sharing plan. No company
      contributions were made in any of the years presented.




**15.** **Significant
      Customers** **:**




Applied
      Nanotech, Inc. received research and development revenues from the U.S.
      Government in the three years as disclosed on the income statement. ANI’s
      revenues tend to be project oriented and are not necessarily recurring with
      a
      particular customer at the present time. During 2006, we received revenue of
      $248,454 from Yonex, Co., Ltd. Net revenue from a project with another customer,
      Shimane Masuda Electronics was $100,485 in 2006 and $109,970 in 2005. No revenue
      was received from this customer in 2004.




**16.** **Quarterly
      Financial Information (Unaudited)** **:**





First
            
            Second
            
            Third
            
            Fourth
            
            TotalQuarter
            
            Quarter
            
            Quarter
            
            Quarter
            
            Year2006Revenues
            
            $
            162,184
            
            $
            115,109
            
            $
            213,841
            
            $
            625,636
            
            $
            1,116,670Operating
                income (loss)
            
            
            (1,797,193
            )
            
            (1,387,807
            )
            
            (1,933,196
            )
            
            (1,484,296
            )
            
            (6,602,492
            )Net
                (loss)
            
            
            (1,794,166
            )
            
            (1,385,583
            )
            
            (1,931,038
            )
            
            (1,483,105
            )
            
            (6,593,892
            )Earnings
                (loss) per shareBasic
                and Diluted
            
            
            (0.02
            )
            
            (0.01
            )
            
            (0.02
            )
            
            (0.01
            )
            
            (0.07
            )2005Revenues
            
            $
            68,815
            
            $
            88,544
            
            $
            245,917
            
            $
            162,384
            
            $
            565,660Operating
                income (loss)
            
            
            (1,368,793
            )
            
            (1,386,251
            )
            
            (1,526,478
            )
            
            (1,568,050
            )
            
            (5,849,572
            )Net
                (loss)
            
            
            (1,365,194
            )
            
            (1,376,209
            )
            
            (1,516,913
            )
            
            (1,560,500
            )
            
            (5,818,816
            )Earnings
                (loss) per shareBasic
                and Diluted
            
            
            (0.01
            )
            
            (0.01
            )
            
            (0.02
            )
            
            (0.02
            )
            
            (0.06
            )2004Revenues
            
            $
            77,658
            
            $
            100,718
            
            $
            100,473
            
            $
            103,673
            
            $
            382,522Operating
                income (loss)
            
            
            (1,716,577
            )
            
            (1,945,201
            )
            
            (1,727,587
            )
            
            (1,769,337
            )
            
            (7,159,382
            )Net
                (loss)
            
            
            (1,710,356
            )
            
            (1,940,334
            )
            
            (1,719,783
            )
            
            (1,768,636
            )
            
            (7,139,109
            )Earnings
                (loss) per shareBasic
                and Diluted
            
            
            (0.02
            )
            
            (0.02
            )
            
            (0.02
            )
            
            (0.02
            )
            
            (0.07
            )





Annual
      Earnings (loss) per share may not equal the sum of the four quarterly amounts
      due to rounding.








Page
            47





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**







**17.** **Segment
      Information** **:**




The
      Company’s operations are classified into three principal reportable segments
      that provide slightly different services.




ANI
                
                EBT
                
                All
                    Other
                
                Total**2006**Revenue
                
                $
                1,116,670
                
                $
                -
                
                $
                -
                
                $
                1,116,670Interest
                    Expense
                
                
                573
                
                
                -
                
                
                31
                
                
                604Depreciation
                    and Amortization
                
                
                46,191
                
                
                -
                
                
                2,982
                
                
                49,173Research
                    and Development
                
                
                3,590,148
                
                
                -
                
                
                -
                
                
                3,590,148Net
                    Loss
                
                
                (6,113,472
                )
                
                933,720
                
                
                (1,418,867
                )
                
                (6,593,892
                )Assets
                
                
                1,101,205
                
                
                -
                
                
                1,592,237
                
                
                2,693,442Capital
                    Expenditures
                
                
                101,932
                
                
                -
                
                
                -
                
                
                101,932**2005**Revenue
                
                $
                565,660
                
                $
                -
                
                $
                -
                
                $
                565,660Interest
                    Expense
                
                
                2,193
                
                
                -
                
                
                397
                
                
                2,590Depreciation
                    and Amortization
                
                
                52,242
                
                
                -
                
                
                4,018
                
                
                56,260Research
                    and Development
                
                
                2,635,412
                
                
                -
                
                
                -
                
                
                2,525,292Net
                    Loss
                
                
                (4,326,457
                )
                
                (3,734
                )
                
                (1,488,615
                )
                
                (5,818,806
                )Assets
                
                
                301,870
                
                
                -
                
                
                886,111
                
                
                1,187,981Capital
                    Expenditures
                
                
                13,017
                
                
                -
                
                
                3,655
                
                
                16,672**2004**Revenue
                
                $
                382,522
                
                $
                -
                
                $
                -
                
                $
                382,522Interest
                    Expense
                
                
                3,949
                
                
                -
                
                
                635
                
                
                4,584Depreciation
                    and Amortization
                
                
                50,185
                
                
                -
                
                
                4,743
                
                
                54,928Research
                    and Development
                
                
                2,737,029
                
                
                -
                
                
                -
                
                
                2,611,583Net
                    Loss
                
                
                (4,931,370
                )
                
                (7,499
                )
                
                (2,200,240
                )
                
                (7,139,109
                )Assets
                
                
                310,005
                
                
                -
                
                
                834,363
                
                
                1,144,368Capital
                    Expenditures
                
                
                116,613
                
                
                -
                
                
                2,374
                
                
                118,987


Financial
      information is furnished to the chief operating officer for review regarding
      each subsidiary of the Company.




The
      ANI segment consists of the activities of ANI and includes license revenues
      and
      contract research revenues related to ANI’s technology. In both years,
      virtually all ANI revenues were contract research revenues. The Company’s EBT
      subsidiary previously sold electronic display products, but sold its technology
      in 2006. All other segments include the Company’s general overhead.




The
      accounting policies applied by each of the segments are the same as those used
      by the Company.







Page
            48





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


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)**











**18.** **Related
      Party Transactions** **:**




As
      part of a transaction to sell intellectual property owned by our EBT subsidiary,
      we entered into an agreement with a related party. One of the patents that
      we
      sold was a patent that had been assigned to us by Advanced Technology,
      Incubator, Inc. (“ATI”), a company owned by Dr. Zvi Yaniv, our Chief Operating
      Officer. In order to acquire the remaining interest in the patent and settle
      all
      potential future obligations to ATI, we issued 200,000 shares of our common
      stock, valued at $400,000 to ATI. We also paid $25,000 to ATI for additional
      services related to this transaction during the year.




**19.** **Gain
      on Sale of Intellectual Property and Other Assets:**




In
      June 2006, our Electronic Billboard Technology, Inc. subsidiary sold all of
      its
      intellectual property in two simultaneous transactions. We received a total
      of
      $1.5 million in cash, the right to future royalties, and an ownership interest
      in a newly formed entity. One of the patents that we sold was a patent that
      had
      been assigned to us by Advanced Technology, Incubator, Inc. (“ATI”), a company
      owned by Dr. Zvi Yaniv, our Chief Operating Officer. In order to acquire the
      remaining interest in the patent and settle all potential future obligations
      to
      ATI, we issued 200,000 shares of our common stock, valued at $400,000 to ATI.
      The gain of $1.1 million recorded in the financial statements resulted from
      the
      cash payment received of $1.5 million, less the $400,000 cost associated with
      the acquisition of the patent rights.





















Page
            49










**Item
      9.*****Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure.***




None




**Item9A.** ***Controls and Procedures.***




Management
      is responsible for establishing and maintaining effective disclosure controls
      and procedures, as defined under Rule 13a-15 of the Securities Exchange Act
      of 1934, that are designed to cause the material information required to be
      disclosed by Nano-Proprietary in the reports it files or submits under the
      Securities Exchange Act of 1934 to be recorded, processed, summarized, and
      reported to the extent applicable within the time periods required by the
      Securities and Exchange Commission’s rules and forms. In designing and
      evaluating the disclosure controls and procedures, management recognized that
      a
      control system, no matter how well designed and operated, can provide only
      reasonable, not absolute, assurance that the objectives of the control system
      are met. Because of the inherent limitations in all control systems, no
      evaluation of controls can provide absolute assurance that all control issues
      and instances of fraud, if any, with a company have been detected.




As
      of the end of the period covered by this report, Nano-Proprietary performed
      an
      evaluation under the supervision and with the participation of management,
      including the Chief Executive Officer and Chief Financial Officer, of the
      effectiveness of the design and operation of its disclosure controls and
      procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934.
      Based upon that evaluation, the Chief Executive Officer and Chief Financial
      Officer concluded that the disclosure controls and procedures were effective
      at
      the reasonable assurance level.




**Report
      on Management’s Assessment of Internal Control over Financial Reporting**




The
      management of Nano-Proprietary, Inc. is responsible for establishing and
      maintaining adequate internal control over financial reporting. Internal control
      over financial reporting is defined under applicable Securities and Exchange
      Commission rules as a process designed under the supervision of the Company’s
      Chief Executive Officer and Chief Financial Officer and effected by the
      Company’s Board of Directors, management and other personnel to provide
      reasonable assurance regarding the reliability of financial reporting and the
      preparation of the Company’s financial statements for external purposes in
      accordance with U.S. generally accepted accounting principles. The Company’s
      internal control over financial reporting includes those policies and procedures
      that:




•
            Pertain
                to the maintenance of records that, in reasonable detail, accurately
                and
                fairly reflect the transactions and dispositions of the assets of
                the
                Company;•
            Provide
                reasonable assurance that transactions are recorded as necessary
                to permit
                preparation of financial statements in accordance with U.S. generally
                accepted accounting principles, and that receipts and expenditures
                of the
                Company are being made only in accordance with authorizations of
                management and the directors of the Company; and•
            Provide
                reasonable assurance regarding prevention or timely detection of
                unauthorized acquisition, use or disposition of the Company’s assets that
                could have a material effect on the financial statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




As
      of December 31, 2006, management, with the participation of the Company’s
      Chief Executive Officer and Chief Financial Officer, assessed the effectiveness
      of the Company’s internal control over financial reporting based on the criteria
      for effective internal control over financial reporting established in “Internal
      Control — Integrated Framework,” issued by the Committee of Sponsoring
      Organizations (COSO) of the Treadway Commission. Based on the assessment,
      management determined that the Company’s internal control over financial
      reporting was effective as of December 31, 2006.




Sprouse
      & Anderson, L.L.P., the independent registered public accounting firm that
      audited the consolidated financial statements of the Company included in this
      Annual Report on Form 10-K, has issued an attestation report on management’s
      assessment of the Company’s internal control over financial reporting as of
      December 31, 2006. The report, which expresses unqualified opinions on
      management’s assessment and on the effectiveness of the Company’s internal
      control over financial reporting as of December 31, 2006, is included in
      this Item under the heading “Attestation Report of Independent Registered Public
      Accounting Firm” below.







Page
            50







**Changes
      in Internal Control over Financial Reporting**




No
      changes were made to the Company’s internal control over financial reporting (as
      defined in Rule 13a-15 under the Securities Exchange Act of 1934) during
      the last fiscal quarter that materially affected, or are reasonably likely
      to
      materially affect, the Company’s internal control over financial reporting.




**Attestation
      Report of Independent Registered Public Accounting Firm**




To
      the Board of Directors and Stockholders of Nano-Proprietary, Inc.:




We
      have audited management’s assessment, included in the accompanying Report on
      Management’s Assessment of Internal Control over Financial Reporting, that
      Nano-Proprietary, Inc. maintained effective internal control over financial
      reporting as of December 31, 2006, based on criteria established in *Internal
      Control — Integrated Framework,* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      Nano-Proprietary, Inc.’s management is responsible for maintaining effective
      internal control over financial reporting and for its assessment of the
      effectiveness of internal control over financial reporting. Our responsibility
      is to express an opinion on management’s assessment and an opinion on the
      effectiveness of the company’s internal control over financial reporting based
      on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our opinion, management’s assessment that Nano-Proprietary, Inc. maintained
      effective internal control over financial reporting as of December 31, 2006,
      is
      fairly stated, in all material respects, based on criteria established
      in *Internal Control — Integrated Framework,* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
      Also in our opinion, Nano-Proprietary, Inc. maintained in all material respects,
      effective internal control over financial reporting as of December 31, 2005,
      based on criteria established in *Internal
      Control — Integrated Framework,* issued
      by the Committee of Sponsoring Organizations of the Treadway Commission
      (COSO).




We
      have also audited, in accordance with the standards of the Public Company
      Accounting Oversight Board (United States), the consolidated balance sheets
      and
      the related consolidated statements of operations, shareholders’ equity, and
      cash flows of Nano-Proprietary, Inc., and our report dated March 5, 2007
      expresses an unqualified opinion.




Sprouse
      & Anderson, L.L.P.


Austin,
      Texas


March
      5, 2007




**Item9B.** ***Other Information.***




None





Page
            51










**PART
      II** **I**




**Item
                10.**
            ***Directors,
                Executive Officers and Corporate
                Governance***




The
      following sets forth the names, ages and certain information concerning the
      Directors and Executive Officers of Nano-Proprietary.




**Name**
              **Age**
              **Class**
              **Position**
              **Director/Officer
                  Since**
              **Term
                  Expires**Marc
                  W.  Eller
              51
              III
              Director,
                  Chairman,
              November
                  1995
              2007Thomas
                  F. Bijou
              56
              I
              Director,
                  Chief Executive Officer
              December
                  2006
              2007Dr. Zvi
                  Yaniv
              60
              II
              Director,
                  President,
                Chief
                  Operating Officer
              July
                  1996
              2007Douglas
                  P. Baker
              50
              III
              Director,
                Chief
                  Financial Officer
              June
                  1996
              2007Charles
                  C.  Bailey
              58
              I
              Director
              November
                  1999
              2007Ronald
                  J.  Berman
              50
              III
              Director
              May
                  1996
              2007Eddie
                  Lee
              44
              II
              Director
              October
                  2001
              2007Dr.
                  Robert Ronstadt
              65
              II
              Director
              January
                  2003
              2007Bradford
                  S. Lamb
              46
              I
              Director
              December
                  2006
              2007




______________________




Marc
      W. Eller served as the Company’s Chief Executive Officer from July 29, 1996
      through May 31, 2006. Mr. Eller is Chairman of the Board of Directors and has
      been a Director since November 1995. Prior to becoming CEO of the company,
      Mr.
      Eller was involved in commercial real estate investment and in investment
      banking activities for publicly traded companies. Mr. Eller has a B.A. degree
      in
      Economics.




Thomas
      F. Bijou has been Chief Executive Officer and a member of the Board of Directors
      since December 1, 2006. From 1997 through the present, Mr. Bijou has been Chief
      Executive Officer of BHM Associates, a company involved in funding and mentoring
      technology companies. In connection with these BHM activities, Mr. Bijou also
      served as Chairman of Knowledge Communications, Inc., an early pioneer in the
      distance learning marketplace. Mr. Bijou began his career at General Electric
      Company, but left GE in 1982 with several associates to form Tigon Corporation,
      a voicemail outsourcing company that was sold to Ameritech in 1988.




Dr.
      Zvi Yaniv has served as the Company’s President and Chief Operating Officer and
      a Director since July 29, 1996. Dr. Yaniv has degrees in physics, mathematics,
      and electro-optics as well as a Ph.D. in Physics. Prior to joining the Company,
      in May 1996, Dr. Yaniv operated a consulting practice and previously was
      President and CEO of Optical Imaging Systems Inc., a supplier of flat panel
      color liquid crystal displays to the avionics and defense
      industries.




Douglas
      P. Baker has been with the Company since June 17, 1996, and has been a Director
      since May 2006. Mr. Baker is a Certified Public Acountant. and has both a
      Bachelors in Business Administration and a Masters in Business Administration.
      Immediately prior to joining Nano-Proprietary, Inc., Mr. Baker was a divisional
      controller for MascoTech, Inc. from 1991 to 1996. Mr. Baker also has prior
      experience in public accounting and as CFO of a privately held
      company.




Charles
      C. Bailey has been an attorney in private practice since 1995. Prior to that
      Mr.
      Bailey had a 20-year career in government. Positions held include Assistant
      Criminal District Attorney and Chief Prosecutor in Lubbock County,  Texas;
      General Counsel for the Texas Department of Public Safety; Assistant General
      Counsel for Governor Bill Clements; and Director of Legal Services and Franchise
      Taxes for the Texas State Comptroller’s Office. His last position with the state
      of Texas, from 1993 to 1995, was Executive Assistant and General Counsel to
      Lt.
      Governor Bob Bullock.




Ronald
      J. Berman has been a Director since May 1996. Mr. Berman co-founded BEG
      Enterprises, Inc. with Marc W. Eller and was its President from 1989 until
      1998.  Mr. Berman currently is President of R.J. Berman Enterprises, Ltd.,
      a real estate development company, Inergi Fitness, and Walkers Warehouse. Mr.
      Berman earned a Juris Doctor degree in 1980 from the University of Detroit.







Page
            52







Eddie
      Lee is Chairman and CEO of Pacific Northern, Inc., a Company that he founded
      in
      1987.  Pacific Northern, Inc. is the largest visual display company serving
      the retail jewelry industry.




Dr.
      Robert Ronstadt has been a Director since January 2003. Dr. Ronstadt became
      Vice President of Technology Commercialization for Boston University in June
      2003.  At the same time, he became the Director of Boston University's
      Technology Commercialization Institute.  He was special advisor to the
      Chancellor of Boston University from January to May 2003. Prior to that,
      from 1998 to 2002, he was Director of the IC2 Institute at the University
      of Texas in Austin and the J. Marion West Chair of Constructive Capitalism.
      Dr.
      Ronstadt was a professor of entrepreneurship at the Pepperdine University School
      of Business Management from 1992 to 1998 and Babson College in Wellesley
      Massachusetts from 1975 to 1985.  From 1986 to 1992, he was the CEO of a
      software enterprise.




Bradford
      S. Lamb has been a Director of the Company since December 2006, and is currently
      President of Columbia Power Technolgies, a position that he has held since
      November 2006. Prior to that, from 1993 to 2006, he was President of InteLex
      Corporation. Prior to InteLex, he spent 10 years with GE Medical systems in
      various capacities.




***Shareholder
      Director Nominating Procedures***





The
      Company does have a procedure in place for holders of the Company‘s common stock
      to recommend nominees to the Company’s Board of Directors. These procedures are
      set forth in Article 9(b) of the Company’s Restated Articles of Incorporation
      (the “Restated Articles”). A copy of the Company’s Restated Articles is filed as
      Exhibit 3(I) to this Annual Report on Form 10-K. As set forth in Article 9(b)
      of
      the Restated Articles, only persons who are nominated in accordance with the
      procedures set forth in that Article are eligible for election as Directors
      of
      the Company. Nominations of persons for election to the Board of Directors
      of
      the Company may be made at a meeting of shareholders by or at the direction
      of
      the Board of Directors or by any shareholder of the Company entitled to vote
      for
      the election of Directors at the meeting who complies with the notice procedures
      set forth in Article 9(b). Such nominations, other than those made by or at
      the
      direction of the Board of Directors, shall be made pursuant to timely notice
      in
      writing to the Secretary of the Corporation. To be timely, a shareholder's
      notice shall be delivered to or mailed and received at the principal executive
      offices of the Company not less than 60 days nor more than 90 days prior to
      the
      meeting; provided, however, that in the event that less than 70 days' notice
      or
      prior public disclosure of the date of the meeting is given or made to
      shareholders, notice by the shareholder to be timely must be so received not
      later than the close of business on the 10th day following the date on which
      such notice of the date of the meeting was mailed or such public disclosure
      was
      made. Such shareholder's notice shall set forth (i) as to each person whom
      the
      shareholder proposes to nominate for election or re-election as a Director,
      (A)
      the name, age, business address and residence address of such person, (B) the
      principal occupation or employment of such person, (C) the class and number
      of
      shares of the Company which are beneficially owned by such person, and (D)
      any
      other information relating to such person that is required to be disclosed
      in
      solicitations of proxies for election of Directors, or is otherwise required,
      in
      each case pursuant to Regulation 14A under the Securities Exchange Act of 1934,
      as amended (including without limitation such person's written consent to being
      named in the proxy statement as a nominee and to serve as a Director if
      elected); and (ii) as to the shareholder giving the notice, (1) the name and
      address, as they appear on the Company’s books, of such shareholder and (2) the
      class and number of shares of the Company which are beneficially owned by such
      shareholder. No person shall be eligible for election as a Director of the
      Company unless nominated in accordance with the procedures set forth in Article
      9(b) of the Restated Articles. The Chairman of the meeting shall, if the facts
      warrant, determine and declare to the meeting that a nomination was not made
      in
      accordance with the procedures prescribed herein, and if he should so determine,
      he shall so declare to the meeting and the defective nomination shall be
      disregarded.




***Committees***




The
      Board of Directors has three committees. The audit committee consists of Mr.
      Lamb and Mr. Bailey. The compensation committee consists of Mr. Lee and Mr.
      Berman. The nominating committee consists of Dr. Ronstadt and Mr. Bailey.







Page
            53







***Audit
      Committee Financial Expert***




At
      the present time, we do not have an audit committee member that is designated
      as
      an “audit committee financial expert” under applicable SEC rules. Both members
      of our audit committee qualify as “independent” as defined under applicable SEC
      rules. Our previous audit committee expert, Director David R. Sincox retired
      in
      2006 and no other members of the Board of Directors that qualify as independent
      also qualify as audit committee financial experts under applicable SEC rules.
      We
      intend to add a member to the Board of Directors in 2007 that qualifies as
      an
      audit committee financial expert.




***Code
      of Ethics***




We
      have adopted a Code of Ethics within the meaning of Item 406(b) of Regulation
      S-K of the Securities Exchange Act of 1934. This Code of Ethics applies to
      all
      directors, officers, and employees of the Company. A copy of this Code of Ethics
      is publicly available on our website at www.nano-proprietary.com .






**Section
      16(a) Beneficial Ownership Reporting Compliance**






Section
      16(a) of the Securities of Exchange Act of 1934 requires Nano-Proprietary’s
      officers, Directors, and persons who beneficially own more than 10 % of a
      registered class of Nano-Proprietary’s common stock, to file reports of
      ownership and changes in ownership with the Securities and Exchange Commission.
      Officers, Directors, and beneficial owners of more than 10% of
      Nano-Proprietary’s common stock are required by the Securities and Exchange
      Commission regulations to furnish Nano-Proprietary with copies of all Section
      16(a) forms that they file.




Based
      solely on review of the copies of such reports furnished to us, or written
      representations that no reports were required, we believe that for the period
      from January 1, 2006 through December 31, 2006, all Officers, Directors, and
      greater than 10% beneficial owners complied with all Section 16(a) filing
      requirements applicable to them.



















Page
            54





**Item
      11.*********Executive
      Compensation***


**Compensation
      Discussion and Analysis**





Objectives
      of Compensation Program





The
      primary objective of our compensation program for employees, including our
      compensation program for executive officers, is to attract, retain, and motivate
      qualified individuals and reward them in a manner that is fair to all
      stakeholders. We strive to provide incentives for every employee that rewards
      them for their contribution to the Company, while at the same time promoting
      an
      ownership mentality.





Elements
      of Compensation





There
      are three main components to our compensation package - base salaries, bonuses,
      and stock based compensation. A fourth, less significant component is other
      benefits and perquisites. Our compensation program is designed to be competitive
      with other employment opportunities and to align the interests of all employees,
      including executive officers, with the long-term interests of our shareholders.
      For our executive officers, we link a much higher percentage of total
      compensation to incentive compensation such as bonus and stock based
      compensation than we do for other employees.





Factors
      unique to 2006





We
      had three separate chief executive officers during 2006. At the beginning of
      the
      year, our CEO of 10 years, Marc Eller expressed his desire to spend less time
      on
      day-to-day operations and focus on his role as Chairman. Accordingly, we
      retained a performance-based executive search firm, Christian & Timbers, to
      locate a new CEO. As a result of the search, we hired R.D. Burck as CEO,
      effective June 1, 2006. Mr. Burck resigned effective November 30, 2006 and
      effective December 1, 2006, we hired Thomas F. Bijou as our new CEO. In the
      context of this discussion, we will discuss CEO compensation generally, but
      also
      address differences as they relate to Mr. Eller, Mr. Burck, and Mr.
      Bijou.





Base
      Salaries





We
      provide our executive officers with a level of cash compensation that
      facilitates an appropriate lifestyle and provides a reasonable minimum
      compensation. We make this determination based on a variety of factors including
      professional accomplishments, level of education, past experience and scope
      of
      responsibilities. The actual amount of base salary paid to each named executive
      officer is set forth in the summary compensation table included later in this
      section. The salary level for both our chief executive officer and our chief
      operating officer was set at a rate of $250,000 per year at the beginning of
      2005 and remained at that level in 2006. When Mr. Burck joined us in June 2006,
      his annualized salary was also at that rate. When Mr. Bijou joined us in
      December 2006, we entered into a slightly modified arrangement. Mr. Bijou is
      paid at an annualized rate of $288,000 per year; however that amount represents
      a combination of salary and management fee paid to an entity owned by Mr. Bijou.
      As part of the management fee, Mr. Bijou assumes responsibility for certain
      costs, including basic employee benefits that would normally be paid by us.
      We
      believe the amount that we pay Mr. Bijou is similar to the amounts paid to
      or on
      behalf our previous CEOs. The salary level for our chief financial officer
      was
      set at a rate of $180,000 per year at the beginning of 2005 and remained at
      that
      level for 2006. The base salary amounts for all three current executive officers
      for 2007 remains at 2006 levels.





Bonuses





We
      have a formula bonus plan covering all employees, including executive officers.
      This plan was established in 2004 and is based solely on the profitability
      of
      the company. This plan is designed to reward all employees when we are
      successful in reaching profitability. No bonuses have ever been paid under
      this
      plan, since we have incurred losses in each of the years since adoption of
      the
      plan. The maximum bonuses payable under this plan are $100,000 each for the
      chief executive and chief operating officers, and $75,000 for the chief
      financial officer. The maximum amounts would be payable if our net income is
      equal to, or exceeds $2.5 million. For purposes of this plan, net income is
      calculated using the accounting principles in effect at the time the plan was
      adopted, meaning stock based compensation using fair value as required by FAS
      123R is excluded from the calculation. There are no minimum amounts payable
      under the plan and the target amounts are equal to the maximum amounts payable.
      The compensation committee of the board of the directors also has the power
      to
      award discretionary bonuses; however, no such bonuses have been granted since
      2002 in the case of the CEO and the CFO, and since 2003 in the case of the
      COO.








Page
            55





Stock
      Based Compensation





All
      of our employees participate in our stock based compensation plans and receive
      awards of non-qualified stock options annually. We use non-qualified options
      because of the favorable tax treatment to us and the near universal expectation
      by employees in our industry that they will receive stock options. The
      overwhelming majority of these awards are performance based awards that only
      vest upon achievement of specific goals. For non-executive officer employees,
      these goals tend to be operational oriented goals relating to specific projects
      or potential projects. For executive officers, these goals are broad in nature
      and involve more substantial accomplishments. Following is a discussion of
      the
      option grants to executive officers.





In
      2004, our then current CEO, Marc Eller; our COO, Dr. Zvi Yaniv; and our CFO,
      Doug Baker; all received performance based grants under a multi-year option
      program covering the years from 2004 to 2007. The goals associated with these
      options related to break-even in various years and certain revenue targets.
      To
      the extent that any of those grants did not vest because the associated goals
      were not achieved in the applicable time period, options associated with those
      goals expired. However an equal number of new performance based options were
      granted with new or similar goals. The goals associated with these options
      were
      related to break-even in various years and certain revenue targets.





During
      2006, Mr. Eller, Dr. Yaniv, and Mr. Baker each received grants in connection
      with the program discussed in the previous paragraph. These grants replaced
      grants which expired unvested in 2006. These new grants vest based on two
      separate goals - break-even in 2007 using the same adjustment for stock based
      compensation as described in the bonus discussion and achievement of an earnings
      per share target. In Mr. Eller’s case, the new grants were made after he stepped
      down as CEO. Under normal circumstances, unvested options do not continue to
      vest, nor are new awards made, after termination of employment. However, in
      this
      instance, the original awards were part of a multiyear program, and ultimate
      achievement of the goals will be, at least in part, as a result of the base
      established during the period that Mr. Eller was CEO. As a result, one-half
      of
      Mr. Eller’s unvested options were allowed the continued possibility of vesting
      if the goals are achieved, and one-half of his unvested options were
      forfeited.





Upon
      commencement of employment as CEO in June 2006, Mr. Burck received options,
      the
      detail of which is set forth in the tables later in this section. A small
      portion of these options were time-based options which vest over a period of
      one
      year, while the majority were performance based options which vest based on
      several revenue, breakeven and profit related goals. Upon commencement of
      employment as CEO in December 2006, Mr. Bijou received options, the detail
      of
      which is also set forth in the tables later in this section. A small portion
      of
      these options were time-based options which vest over a period of one year,
      while the majority were performance based options which vest based on a goal
      of
      modified break-even cash flow from operations in 2007 and several earnings
      per
      share targets for 2007 and future years.





For
      purposes of this discussion of performance based option goals, we consider
      the
      goals related to revenue items, modified cash-flow from operations, or earnings
      per share targets to be part of our confidential strategic plans, and as such
      we
      do not disclose the specifics of the goals at this time. In general, our
      philosophy is to set common goals for all executive officers for all
      performance-based option grants. However in 2006, given that the existing
      executive officers were in the midst of a multiyear program and that we hired
      two new chief executive officers, our goals varied somewhat during the year.
      Some of the goals set in 2006 were established to take advantage of specific
      strengths of the executive and others, although different, were similar to
      existing goals. For example, the concept of breakeven cash flow from operations
      is very similar to the concept of break-even excluding stock based compensation.
      We would expect that in normal circumstances, future option grants will be
      based
      on common goals for all executive officers.





At
      the present time, we have no formal policy related to stock ownership for
      executive officers and in establishing grant levels, we generally do not
      consider the equity ownership levels of the executive officer, or the existence
      of fully vested prior awards.








Timing
      of Option Grants





We
      do not have a formal written policy related to the timing of option grants;
      however we do have certain time periods when options are normally granted.
      At
      the present time, we do not have any analysts that follow our stock and the
      release of our quarterly financial reports normally has no impact on the price
      of our stock. As such, we do not have trading windows, nor do we limit option
      grants to any sort of windows. There are two normal situations where options
      are
      granted. The first would be at the time a new employee, including executive
      officers, is hired. If a new employee receives options as part of starting
      employment, those options are granted either at, or shortly after, the
      employment start date.








Page
            56





The
      majority of options are performance based awards granted on an annual basis
      as
      part of a budgeting/goal setting process. For executive officers, the
      compensation committee meets annually to establish compensation levels,
      including salary, bonus, and options, for the year. This meeting normally occurs
      in the month of December prior to the start of the new year - for example in
      December 2006 for 2007 compensation. It could, however, occur as early as
      November as late as January. For all other employees, the goal setting process
      starts in December, but since it involves many more distinct goals and many
      more
      individuals; it is a longer process and as a result usually is not ready for
      submission to the Compensation Committee until January or later. All performance
      based awards for employees other than executive officers are annual awards
      that
      must either vest by the end of the calendar year, or they will expire unvested.
      At the time of the proposed award, we consider whether there are any known
      upcoming significant events, and have in the past delayed awards as a result
      of
      expected positive events.





All
      option grants for all employees are approved by the compensation committee
      of
      Board of Directors. The compensation committee does not delegate any of its
      powers for granting options to others.





Other
      Benefits and Perquisites





Since
      we have not yet reached profitability on a consistent basis, we take a
      relatively bare-bones approach to benefits for all employees, including
      executive officers. There are no benefit plans available to executive officers
      that are not available to all employees. Executive officers participate in
      the
      same benefit plans covering other employees. These benefits include limited
      health and dental insurance, group term life insurance, and limited long-term
      disability insurance. The only retirement plan that we maintain is a 401K plan
      funded entirely by employee elective deferrals. We have no company funded
      retirement plans or deferred compensation plans. We also do not provide any
      of
      the perks common at larger companies. The only perk that we provide is an auto
      allowance. We provide an auto allowance of $1,000 per month to our COO and
      $500
      per month to our CFO. Mr. Eller and Mr. Burck received auto allowances of $750
      per month during their tenure as CEO. The amounts paid as auto allowances are
      considered in setting the overall level of compensation for the executive
      officer. Mr. Bijou receives no auto allowance, but rather, that was considered
      in his previously discussed management contract.





Compensation
      Approval Process





The
      Compensation Committee of the Board of Directors approves all compensation
      and
      awards to executive officers. Regarding most compensation matters, including
      executive compensation, the CFO in consultation with the CEO, provides
      recommendations to the Compensation Committee. However, the Compensation
      Committee does not delegate any of its functions to others in setting
      compensation. We did not make formal use of any compensation consultants in
      determining executive compensation levels for any of the executive officers.
      We
      do, however, intend to undergo a thorough review of our executive compensation
      practices in 2007 to insure that our current compensation practices are
      reasonable and appropriate for our circumstances. We anticipate that this review
      will include benchmarking against other companies. This review may or may not
      include an independent analysis by compensation consultants.





As
      previously discussed, we hired two new CEOs during 2006. In the case of Mr.
      Burck, we used a search firm, Christian & Timbers. In the course of that
      search we discussed the compensation of Mr. Eller, our existing CEO, as well
      as
      a range of possible compensation for a new CEO. Christian & Timbers
      indicated that the compensation paid to Mr. Eller fell within the reasonable
      range. They indicated that the base salary was on the low end of the range,
      however when considering the total package, including options, it fell within
      the normal range. We did not hire Christian & Timbers to perform a specific
      analysis, nor did we receive any written report or specific recommendations
      from
      them. We did however consider their comments in setting the compensation of
      Mr.
      Burck. When we hired Mr. Bijou, we had preliminary discussions and meetings
      about the company, but did not discuss compensation. As a result of those
      discussions, Mr. Bijou made a proposal to us containing the terms that he was
      requesting to accept the CEO position. We believed that proposal to be
      reasonable and accepted the terms. The actual goals associated with the
      performance based options were the result of negotiation between Mr. Bijou
      and
      us and were approved by the Compensation Committee.





Compensation
      Committee Report





We
      have reviewed and discussed with management certain Compensation Discussion
      and
      Analysis provisions to be included in the Company’s 2006 Annual Report on Form
      10-K for the fiscal year ended December 31, 2006, filed pursuant to Section
      13
      or 15(d) of the Securities Exchange Act of 1934 (“Form 10-K”). Based on the
      reviews and discussions referred to above, we recommend to the Board of
      Directors that the Compensation Discussion and Analysis referred to above be
      included in the Company’s Form 10-K.





Compensation
      Committee


Ronald
      J. Berman, Eddie Lee





Page
            57










The
      following table sets forth the total cash compensation paid or to be paid,
      as
      well as certain other compensation paid or accrued, for services rendered during
      the fiscal years ended December 31, 2006, 2005 and 2004 by all individuals
      that
      served as Chief Executive Officer during 2006, the Chief Financial Officer,
      all
      individuals that were Named Executive Officers as of the end of the previous
      year, and all executive officers whose total annual salary and bonus exceeded
      $100,000 for the fiscal year ended December 31, 2006 (the "Named Executive
      Officers"):






**SUMMARY
      COMPENSATION TABLE**




Name
                & Principal Position
            
            Year
            
            Salary
            
            Option
              Awards
                (1)
            
            All
                Other
              Compensation
                (6)
            
            TotalThomas
                F. Bijou (2)
            
            2006
            
            $
            24,000
            
            $
            663,422
            
            $
            0
            
            $
            687,422Chief
                Executive OfficerR.D.
                Burck (3)
            
            2006
            
            $
            145,833
            
            $
            933,980
            
            $
            4,500
            
            $
            1,084,313Chief
                Executive OfficerMarc
                W. Eller (4)
            
            2006
            
            $
            125,000
            
            $
            135,989
            
            $
            99,500
            
            $
            360,489Chief
                Executive Officer
            
            2005
            
            $
            250,000
            
            $
            1,005,430
            
            $
            9,000
            
            $
            1,264,4302004
            
            $
            200,000
            
            $
            1,323,660
            
            $
            9,000
            
            $
            1,532,660Dr.
                Zvi Yaniv
            
            2006
            
            $
            250,000
            
            $
            265,369
            
            $
            12,000
            
            $
            527,369Chief
                Operating Officer
            
            2005
            
            $
            250,000
            
            $
            1,005,430
            
            $
            12,000
            
            $
            1,267,4302004
            
            $
            200,000
            
            $
            1,323,660
            
            $
            12,000
            
            $
            1,535,660Douglas
                P. Baker
            
            2006
            
            $
            180,000
            
            $
            132,684
            
            $
            6,000
            
            $
            318,684Chief
                Financial Officer
            
            2005
            
            $
            180,000
            
            $
            502,715
            
            $
            6,000
            
            $
            688,7152004
            
            $
            150,000
            
            $
            694,605
            
            $
            6,000
            
            $
            850,605John
                Ruberto (5)
            
            2006
            
            $
            67,500
            
            $
            90,206
            
            $
            80,000
            
            $
            237,706Vice
                President
            
            2005
            
            $
            120,000
            
            $
            827,806
            
            $
            0
            
            $
            947,806





(1)
      Amounts included in the option awards column are calculated utilizing the
      provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R,
“Share-Based Payments.” See Note 8 of the consolidated financial statements
      included in this annual report for the assumptions underlying valuation of
      equity awards. The amounts are calculated based on all options granted during
      the year without regard to whether the options vest or expire. As discussed
      in
      the Compensation Discussion and Analysis, the majority of options granted are
      performance based options associated with specific goals. To the extent that
      the
      goals are not achieved, the options do not vest and expire. The amount included
      for 2004 is based on the number of options awarded to Mr. Eller, Dr. Yaniv,
      and
      Mr. Baker of 750,000, 750,000, and 400,000, respectively. For Mr. Eller, 50,000
      of those options ultimately vested, 650,000 of those options expired, and 50,000
      options are still outstanding, but not yet vested. For Dr. Yaniv, 50,000 of
      those options ultimately vested, 600,000 of those options expired, and 100,000
      options are still outstanding, but not yet vested. For Mr. Baker, 50,000 of
      those options ultimately vested, 300,000 of those options expired, and 50,000
      options are still outstanding, but not yet vested.





The
      amount included for 2005 is based on the number of options awarded to Mr. Eller,
      Dr. Yaniv, Mr. Baker, and Mr. Ruberto of 700,000, 700,000, 350,000 and 535,000,
      respectively. For Mr. Eller, 200,000 of those options ultimately vested and
      500,000 of those options expired. For Dr. Yaniv, 200,000 of those options
      ultimately vested and 500,000 of those options expired. For Mr. Baker, 100,000
      of those options ultimately vested and 250,000 of those options expired. For
      Mr.
      Ruberto, 235,000 of those options ultimately vested and 300,000 of the options
      expired. All of the options granted to executive officers in 2004 and 2005
      are
      priced significantly above the current market price of the stock and none of
      the
      vested options have been exercised.





None
      of the options granted in 2006 to Mr. Eller, Mr. Bijou, Dr. Yaniv, or Mr. Baker
      have vested as of February 28, 2007. The amount included for Mr. Burck for
      2006
      is based on 600,000 options awarded. A total of 50,000 of these options were
      vested, 450,000 of these options expired, and 100,000 options are still
      outstanding, but not yet vested. The amount included in 2006 for Mr. Ruberto
      is
      based on changing the vesting terms in 2006 related to 100,000 of the options
      originally granted in 2005. Without this change in terms, the options would
      not
      have vested and would have expired.





(2)
      Mr. Bijou began employment as CEO on December 1, 2006.








Page
            58





(3)
      Mr. Burck began employment as CEO on June 1, 2006 and resigned effective
      November 30, 2006.





(4)
      Mr. Eller was CEO until May 31, 2006 and remained an employee until June 30,
      2006. We entered into a consulting contract with Mr. Eller, effective July
      1,
      2006. The contract called for payments of $10,000 per month through December
      2006. In addition, a $35,000 lump sum payment was made to Mr. Eller in December
      2006. The “All Other Compensation” column includes $95,000 in 2006 related to
      this contract. Mr. Eller also received an additional payment on March 1, 2007
      of
      $30,000 for services rendered in 2007.





(5)
      Mr. Ruberto began employment on May 1, 2005 and ended employment on May 15,
      2006. We also entered into a consulting contract with Mr. Ruberto that calls
      for
      payments of $10,000 per month from May 2006 through April 2007. The “All Other
      Compensation” column includes $80,000 in 2006 related to this
      contract.





(6)
      The “All Other Compensation” column includes the following items. For Mr. Burck,
      Dr. Yaniv, and Mr. Baker, all amounts for all years represent payment of
      automobile allowances. For Mr. Eller, payments of $95,000 under a consulting
      contract in 2006 are included. All other amounts in all years represent payment
      of an automobile allowance. For Mr. Ruberto, all amounts in this column
      represent payments under a consulting agreement.








**GRANTS
      OF PLAN-BASED AWARDS TABLE**





Name
            Grant
                Date
            Approval
              Date
            Estimated
                Future Payouts Under
              Equity
                Incentive Plan
              Awards
                (Shares) (1)
            All
                Other Option
              Awards
              Number
                of Shares
              Underlying
                Options
            Exercise
              Price
                of
              Option
              Awards
                (2)Threshold
            Target
            MaximumThomas
                F. Bijou
            11/30/2006
            11/27/2006
            
            
            
            200,000
            $1.1911/30/2006
            11/27/2006
            0
            300,000
            300,000
            
            $1.1911/30/2006
            11/27/2006
            0
            125,000
            125,000
            
            $1.1911/30/2006
            11/27/2006
            0
            125,000
            125,000
            
            $1.1911/30/2006
            11/27/2006
            0
            125,000
            125,000
            
            $1.1911/30/2006
            11/27/2006
            0
            125,000
            125,000
            
            $1.19R.D.
                Burck
            06/01/2006
            05/30/2006
            
            
            
            100,000
            $2.3806/01/2006
            05/30/2006
            0
            100,000
            100,000
            
            $2.3806/01/2006
            05/30/2006
            0
            100,000
            100,000
            
            $2.3806/01/2006
            05/30/2006
            0
            100,000
            100,000
            
            $2.3806/01/2006
            05/30/2006
            0
            100,000
            100,000
            
            $2.3806/01/2006
            05/30/2006
            0
            100,000
            100,000
            
            $2.38Marc
                W. Eller
            11/30/2006
            11/27/2006
            0
            100,000
            100,000
            
            $1.1911/30/2006
            11/27/2006
            0
            100,000
            100,000
            
            $1.19Dr.
                Zvi Yaniv
            11/30/2006
            11/27/2006
            0
            200,000
            200,000
            
            $1.1911/30/2006
            11/27/2006
            0
            200,000
            200,000
            
            $1.19Douglas
                P. Baker
            11/30/2006
            11/27/2006
            0
            100,000
            100,000
            
            $1.1911/30/2006
            11/27/2006
            0
            100,000
            100,000
            
            $1.19John
                Ruberto
            05/16/2006
            05/16/2006
            
            
            
            100,000
            $2.30








(1)
      Performance-based option awards that vest upon the achievement of established
      goals.


(2)
      The exercise price of the options are all greater than or equal to the market
      price on the date of the grant.





Page
            59





**OUTSTANDING
      EQUITY AWARDS AT FISCAL YEAR-END TABLE**




The
      following table sets forth information concerning the outstanding equity awards
      held by the Named Executive Officers at December 31, 2006.




Option
                  AwardsNumber
                  of Securities Underlying
                Unexercised
                  Options
              Equity
                  Incentive Plan
                Awards:
                  Number of
                Securities
                  Underlying
                Unexercised
                  Unearned
                OptionsName
              Number
                Exercisable
              Number
                Unexercisable
              Option
                Exercise
                  Price
              Option
                Expiration
                DateThomas
                  F. Bijou
              -
              200,000
              
              $1.19
              11/30/2016-
              -
              300,000
              $1.19
              11/30/2016-
              -
              125,000
              $1.19
              11/30/2016-
              -
              125,000
              $1.19
              11/30/2016-
              -
              125.000
              $1.19
              11/30/2016-
              -
              125,000
              $1.19
              11/30/2016R.D.
                  Burck
              50,000
              -
              
              $2.38
              06/01/2016100,000
              $2.38
              06/01/2016Marc
                  W. Eller (1)
              200,000
              -
              
              $2.73
              12/31/201350,000
              -
              
              $2.17
              12/31/2014200,000
              -
              
              $2.17
              01/01/20154,167
              -
              
              $1.39
              07/31/2016-
              -
              50,000
              $2.93
              01/23/2014-
              -
              100,000
              $1.19
              11/30/2016-
              -
              100,000
              $1.19
              11/30/2016Dr.
                  Zvi Yaniv (1)
              100,000
              -
              
              $0.50
              01/11/200930,000
              -
              
              $1.50
              02/02/2010200,000
              -
              
              $1.50
              06/27/201030,000
              -
              
              $0.96
              07/28/2013250,000
              -
              
              $2.73
              12/31/201350,000
              -
              
              $2.17
              12/31/2014200,000
              -
              
              $2.17
              01/01/2015-
              -
              100,000
              $2.93
              01/23/2014-
              -
              200,000
              $1.19
              11/30/2016-
              -
              200,000
              $1.19
              11/30/2016Douglas
                  P. Baker (1)
              30,000
              -
              
              $1.50
              02/02/201050,000
              -
              
              $1.50
              06/27/2010100,000
              -
              
              $0.63
              03/02/2011100,000
              -
              
              $0.92
              07/16/2011150.000
              -
              
              $0.73
              12/05/201132,000
              -
              
              $0.58
              02/12/201213,000
              -
              
              $0.96
              07/28/2013200,000
              -
              
              $2.73
              12/31/201350,000
              -
              
              $2.17
              12/31/2014100,000
              -
              
              $2.17
              01/01/2015-
              -
              50,000
              $2.93
              01/23/2014-
              -
              100,000
              $1.19
              11/30/2016-
              -
              100,000
              $1.19
              11/30/2016John
                  Ruberto
              35,000
              -
              
              $2.30
              05/15/2009100,000
              -
              
              $2.30
              05/15/200950,000
              -
              
              $2.30
              05/15/200950,000
              -
              
              $2.30
              05/15/2009




(1)
        Includes options still outstanding that were previously transferred by gift
        and
        reported on Form 4 by the Named Executive Officer.







Page
            60




**OPTION
      EXERCISE AND STOCK VESTED TABLE**




There
      were no options exercised in 2006 by Named Executive Officers and no restricted
      stock awards that vested. As such no table is included.




**PENSION
      BENEFITS TABLE**




We
      maintain no retirement plans covering Named Executive Officers or other
      employees, except for a 401K plan funded solely by elective employee
      contributions. As such no pension benefits table is included.




**NON-QUALIFIED
      DEFERRED COMPENSATION TABLE**




We
      do not maintain any non-qualified deferred compensation plans covering Named
      Executive Officers or other employees. As such, no deferred compensation table
      is included.




**POTENTIAL
      PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL**




None
      of the named executive officers have employment contracts, and therefore, there
      are no formal payments due on change in control or other employment termination.
      Our 2002 Equity Compensation Plan, which includes all employees, including
      executive officers, includes a provision which accelerates the vesting of all
      unvested options upon certain change in control events. Unvested options held
      by
      Named Executive Officers as of December 31, 2006 are reflected in the
      Outstanding Equity Awards at Fiscal Year-End Table included in this
      item.




It
      is our policy to pay severance upon termination when termination is initiated
      by
      us and is for other than cause. We have no formal guidelines, but rather each
      case is handled on an individual basis. Factors considered include position,
      length of service, reason for termination, possible future relationships, as
      well as other potential factors. Payments may be made in a lump sum or in
      periodic installments and are usually accompanied by a severance agreement
      that
      includes a release, a non-disparagement clause, and possibly a non-compete
      agreement. There are no minimum amounts payable to any of the executive
      officers; however, it is likely that if any of the Named Executive Officers
      were
      terminated by the Company for other than cause, payments would be made in
      connection with that termination.






**DIRECTOR
      COMPENSATION**




Name
              
              Fees
                  Earned or Paid in Cash
              
              Option
                  Awards (1)
              
              TotalChuck
                  Bailey
              
              $
                  600
              
              $39,659
              
              $
                  40,259Ronald
                  J. Berman
              
              $
                  650
              
              $39,659
              
              $
                  40,309Bradford
                  S. Lamb (2)
              
              $  
                  50
              
              -
              
              $       
                  50Eddie
                  Lee
              
              $
                  600
              
              $39,659
              
              $
                  40,259Dr.
                  Robert Ronstadt
              
              $
                  400
              
              $39,659
              
              $
                  40,059David
                  R. Sincox (3)
              
              $
                  300
              
              $39,659
              
              $
                  39,959




(1)
      Amounts included in the option awards column are calculated utilizing the
      provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123R,
“Share-Based Payments.” See Note 8 of the consolidated financial statements
      included in this annual report for the assumptions underlying valuation of
      equity awards. See the table titled “Security Ownership of Management” included
      in Item 12 of this report for stock option grants outstanding at year held
      by
      each Director.




(2)
      Mr. Lamb was appointed to the Board of Directors on December 1,
      2006.




(3)
      Mr. Sincox retired as a member of the Board of Directors effective July 31,
      2006.







Page
            61







All
      Directors who are not employees of the Company receive $150 per board meeting
      or
      committee meeting attended in person, and $50 per telephonic meeting. Reasonable
      expenses incurred by each Director in connection with his duties as a Director
      are also reimbursed by Nano-Proprietary.




All of
      Nano-Proprietary’s outside Directors participate in the 2002 Equity Compensation
      Plan, under which Nano-Proprietary may grant stock options to any Director.
      On
      July 31, 2006, each of the five outside Directors was granted an automatic
      grant
      of 50,000 options under the 2002 Equity Compensation Plan with an exercise
      price
      of $1.39 per share. These grants became exercisable in full on the date of
      the
      grant.




All
      of the Directors have retained the right to pursue additional business
      activities that are not competitive with the business of Nano-Proprietary,
      and
      do not adversely affect their performance as Directors. If, as, and when
      conflicts of interest arise, the nature of the conflict must be fully disclosed
      to the Board of Directors, and the person who is subject to the conflict must
      abstain from participating in any decision that may impact on his conflict
      of
      interest. Except for this disclosure and abstention policy, the Directors will
      not be in breach of any fiduciary duties owed to Nano-Proprietary or the
      shareholders by virtue of their participation in such additional business
      activities.




The
      compensation that we pay to our outside Directors is heavily weighted toward
      stock based compensation to minimize the amount of cash that we use, and it
      is
      designed to compensate the Directors for the risk that they assume as directors
      of a public company. The level of 50,000 options per year was set by the Board
      of Directors in April 2001, and ratified each successive year since then by
      the
      compensation committee of the Board of Directors. We intend to do a review
      of
      our compensation practices for Outside Directors in 2007, including benchmarking
      against other companies.




**Compensation
      Committee Interlocks and Insider Participation**





The
      Compensation Committee currently consists of Mr. Lee and Mr. Berman. Neither
      of
      them is or has been an officer or employee of Nano-Proprietary, nor does either
      have any relationships requiring disclosure under Item 404 of Regulation S-K.
      No
      interlocking relationship existed during the fiscal year ended December 31,
      2006, between Nano-Proprietary’s Board of Directors or Compensation Committee
      and the board of directors or compensation committee of any other
      company.











Page
            62







**Item
      12.*********Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters.***






**CERTAIN
      BENEFICIAL OWNERS**




The
      only persons or entities known to be the beneficial owner of 5% or more of
      the
      outstanding voting stock of the common stock of Nano-Proprietary, Inc. stock
      as
      of February 28, 2007, are listed below. For the purposes of this Annual Report
      on Form 10-K, beneficial ownership of securities is defined in accordance with
      the rules of the SEC to mean generally the power to vote or dispose of
      securities, regardless of any economic interest therein.




BeneficialOwnership
            
            Percent
                of OutstandingCommon
                StockPinnacle
                Fund, L.P.
            
            9,368,946
            
            8.99%Barry
                Kitt, General Partner
              4965
                Preston Park Blvd.,Suite 240
              Plano,
                TX 75093




**SECURITY
      OWNERSHIP OF MANAGEMENT**






Set
      forth below is certain information with respect to beneficial ownership of
      Nano-Proprietary’s common stock as of February 28, 2007, by each Director, each
      Named Executive Officer and by the directors and executive officers as a group.
      Unless otherwise indicated, each person or member of the group listed has sole
      voting and investment power with respect to the shares of common stock
      listed.




Name
              Options
                  Included
                in
                  Beneficial
                Ownership
                  (1)
              Common
                  Stock
                Beneficial
                Ownership
              Percentage
                of
                  ClassDr.
                  Robert Ronstadt
              175,000
              175,000
              *Bradford
                  S. Lamb
              -
              89,944
              *Thomas
                  F. Bijou
              50,000
              151,429
              *Charles
                  C. Bailey
              268,333
              268,333
              *Marc
                  W. Eller
              454,167
              471,667
              *Eddie
                  Lee
              266,667
              266,667
              *Ronald
                  J. Berman
              735,000
              1,154,925
              1.10%Dr.
                  Zvi Yaniv
              760,000
              956,000
              *Douglas
                  P. Baker
              725,000
              752,500
              *R.D.
                  Burck (2)
              50,000
              50,000
              *John
                  Ruberto
              235,000
              235,000
              *All
                  Executive Officers and
                Directors
                  as a group (11 persons)
              3,719,167
              4,571,465
              4.23%









*
            Less
                than 1%(1)
            This
                column lists shares that are subject to options exercisable within
                sixty
                (60) days of February 28, 2007, and are included in common stock
                beneficial ownership pursuant to Rule 13d-3(d)(1) of the Exchange
                Act.








Page
            63











**SECURITIES
      AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION
      PLANS**





**Equity
                  Compensation**
                **Plans
                  Not Approved by**
                **the
                  Shareholders of**
                **Nano-Proprietary**
              **Number
                  of Securities to**
                **be
                  issued upon exercise**
                **of
                  outstanding options**
              **Weighted-average**
                **exercise
                  price of**
                **outstanding
                  options**
              **Number
                  of Securities**
                **remaining
                  available**
                **for future
                  issuance under**
                **equity
                  compensation**
                **plans
                  (3)**(a)
              (b)
              (c)1992
                  Employee Plan (1)
              977,000
              $1.01
              -1992
                  Outside Directors
                Plan (2)
              323,333
              $1.10
              -1998
                  Directors and
                Officers Plan
              500,000
              $0.46
              -2002
                  Equity
                Compensation Plan
              5,913,579
              $1.80
              944,965Total
              7,713,912
              $1.59
              944,965









(1)
            The
                1992 Employee Plan was originally approved by shareholders and authorized
                3.0 million shares. The plan was subsequently amended twice by the
                Board
                to increase the authorized number of shares and is therefore classified
                as
                a plan not approved by our shareholders.(2)
            The
                1992 Outside Directors Plan was originally approved by shareholders
                and
                authorized 500,000 shares. The plan was subsequently amended by the
                Board
                to increase the authorized number of shares and is therefore classified
                as
                a plan not approved by our shareholders(3)
            This
                column excludes securities reflected in column
                (a)




There
      are no equity compensation plans approved by shareholders at the present
      time.




The
      1992 Employee Plan was created in 1992 for the purpose of granting incentive
      or
      non-qualified stock options to employees of, or contractors for, the Company.
      A
      total of 6.5 million shares were authorized under the plan. All options granted
      under this plan were priced at the fair market value of our common stock on
      the
      date of grant, or greater, and have a life of ten (10) years from their date
      of
      grant, subject to earlier termination as set forth in such plan. The plan
      expired in 2002; however, options granted prior to such plan’s expiration remain
      exercisable, subject to the terms of the respective option grants.




The
      1992 Outside Directors’ Plan was established in 1992 for the purpose of granting
      non-qualified options to non-employee Directors of the Company. A total of
      1.0
      million options were authorized under the plan. All options granted under this
      plan were priced at the fair market value of our common stock or greater on
      the
      date of grant and have a life of ten (10) years from their date of grant,
      subject to earlier termination as set forth in such plan.  The plan expired
      in 2002; however, options granted prior to such plan’s expiration remain
      exercisable, subject to the terms of the respective option grants.




In
      1998, the Company’s Board of Directors established the 1998 Directors’ and
      Officers Plan to award non-qualified options to Officers and Directors. All
      options granted under this plan were priced at the fair market value of our
      common stock, or greater, on the date of grant and have a life of ten (10)
      years
      from their date of grant, subject to earlier termination as set forth in such
      plan.  A total of 2.5 million options were granted under this plan; however
      no options remain available for granting under this plan.







Page
            64





In
      2002, the Company’s Board of Directors established the 2002 Equity Compensation
      Plan for the purpose of granting incentive or non-qualified stock options to
      employees or directors of the Company. All options granted under this plan
      were
      priced at the fair market value of our common stock, or greater, on the date
      of
      grant and have a life of up to ten (10) years from their date of grant, subject
      to earlier termination as set forth in such plan.  A total of 5,000,000
      options were initially authorized under this plan. This plan was amended
      December 31, 2004 to increased the authorized shares by 3,000,000 to a total
      of
      8,000,000 shares.




For
      a further description of each of the stock option plans described above, please
      see Note 8 to the Consolidated Financial Statements herein.




**Item
      13.*********Certain
      Relationships and Related Transactions, and Director
      Independence***




It
      is our written policy that all material related party transactions be approved
      by the Board of Directors, with any member of the Board affected by the related
      party transaction abstaining from the vote.




In
      October 1998, EBT entered into a Patent Assignment and Royalty Agreement with
      Advanced Technology Incubator, Inc., (“ATI”) a corporation based in Austin,
      Texas and owned by Dr. Zvi Yaniv, the Company’s President and Chief Operating
      Officer. Under the terms of the agreement, ATI agreed to assign U.S. Patent
      No.
      5,469,187 related to certain LCD technology to EBT in exchange for an initial
      payment of $200,000. In addition, ATI was entitled to receive a royalty of
      5% of
      gross revenue related to products using this patent. EBT could terminate this
      assignment at any time upon 30 days written notice to ATI. The assignment could
      have been terminated by ATI if, within two years of the first sale or lease
      of a
      display unit using this technology, cumulative royalty payments under the
      agreement did not total $500,000, or if payments did not equal $500,000 in
      any
      one-year period following the initial two-year period. If the assignment was
      terminated by ATI, EBT would have been granted a non-exclusive worldwide license
      to use the technology under terms similar to those contained in this agreement.
      There have been no sales or leases of display units using this technology;
      therefore, the two year period that could have resulted in minimum payments
      being due never started.




In
      2006, we sold the intellectual property of EBT. The purchaser was interested
      in
      acquiring all intellectual property, including this patent, as part of the
      package, but not in assuming the agreement that we had with ATI. In order to
      complete the transaction, we were required to acquire the remaining interest
      in
      the patent and settle all potential future obligations to ATI. To do this,
      we
      issued 200,000 shares of our common stock, valued at $400,000 to ATI. We also
      paid $25,000 to ATI for additional services related to this transaction during
      the year.





**Item
      14****.*********Principal
      Accountant Fees and Services***




**Audit
      Fees**




The
      aggregate fees billed to the Company by Sprouse & Anderson, L.L.P. for the
      audit of Nano-Proprietary’s annual financial statements and for the review of
      the financial statements included in its quarterly reports on Form 10-Q for
      the
      Fiscal Years ended December 31, 2006 and 2005 totaled $57,200 and $$42,700,
      respectively.




**Audit-Related
      Fees**




Nano-Proprietary
      did not incur or pay any fees to Sprouse & Anderson, L.L.P., and Sprouse
& Anderson, L.L.P. did not provide any services related to audit-related
      fees in the last two fiscal years.




**Tax
      Fees**




There
      were no fees billed to Nano-Proprietary by Sprouse & Anderson, L.L.P. for
      services rendered to Nano-Proprietary during the last two fiscal years for
      tax
      compliance, tax advice, or tax planning.




**All
      Other Fees**




There
      were no fees billed to Nano-Proprietary by Sprouse & Anderson, L.L.P. for
      services rendered to Nano-Proprietary during the last two fiscal years, other
      than the services described above under “Audit Fees.”







Page
            65







It
      is the audit committee’s policy to pre-approve all services provided by Sprouse
& Anderson, L.L.P. All services provided by Sprouse & Anderson, L.L.P.
      during the years ended December 31, 2006 and 2005 were pre-approved by the
      audit
      committee.




As
      of the date of this filing, Nano-Proprietary current policy is to not engage
      Sprouse & Anderson, L.L.P. to provide, among other things, bookkeeping
      services, appraisal or valuation services, or internal audit services. The
      policy provides that Nano-Proprietary engage Sprouse & Anderson, L.L.P. to
      provide audit, tax, and other assurance services, such as review of SEC reports
      or filings.




The
      Audit Committee considered and determined that the provision of the services
      other than the services described under “Audit Fees” is compatible with
      maintaining the independence of the independent auditors.















Page
            66







**PART
      IV**






**Item
      1****5.*********Exhibits
      and Financial Statement Schedules***




(a)
            The
                following documents are filed as part of this Annual Report on Form
                10-K:




(1)
            *All
                Financial Statements*




The
      response to this portion of Item 15 is set forth in Item 8 of Part II
      hereof.




(2)
            *Financial
                Statement Schedules*




Schedules
      for which provision is made in the applicable accounting regulations of the
      Securities and Exchange Commission are not required under the related
      instructions or are inapplicable, and therefore have been omitted.




(3)
            *Exhibits*




See
      accompanying Index to Exhibits on page 68 for a descriptive response to this
      item. The Company will furnish to any shareholder, upon written request, any
      exhibit listed in the accompanying Index to Exhibits upon payment by such
      shareholder of the Company’s reasonable expenses in furnishing any such exhibit.




(b)
            Reference
                is made to Item 15(a)(3) above.




(c)
            Reference
                is made to Item 15 (a)(2) above.




**SIGNATURES**






Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has caused this report to be signed on its behalf by the
      undersigned, thereunto duly authorized .




**NANO-PROPRIETARY,
                INC.**
              
              
              By:/s/
                Thomas F.
                Bijou
              Thomas
                F. Bijou, Chief Executive Officer
              March 6,
                2007




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.




Signature
            Title
            Date/s/**Thomas
                F. Bijou
              
              Thomas
                F. Bijou
            Chairman,
                Chief Executive
              Officer
                (Principal Executive Officer and Director)
            March
                6, 2007/s/
                Douglas P.  Baker
              
              Douglas
                P.  Baker
            Vice
                President and Chief Financial Officer
              (Principal
                Financial Officer and Principal Accounting Officer and
                Director)
            March
                6, 2007Marc
                W. Eller*
              Dr.
                Robert Ronstadt*
              Bradford
                S. Lamb*
              Eddie
                Lee*
              Ronald
                J.  Berman*
              Charles
                G.  Bailey*
              Dr. Zvi
                Yaniv*
            Directors
            March
                6, 2007




*By: //s// Douglas P. Baker


(Douglas P. Baker,


Attorney-in-Fact)




Page
            67





INDEX
      TO EXHIBITS




The
      exhibits indicated by an asterisk (*) have been previously filed with the
      Securities


and
      Exchange Commission and are incorporated herein by reference.




EXHIBIT
                NUMBER
              DESCRIPTION
                  OF EXHIBIT3(i).1
              Restated
                  Articles of Incorporation of Company, as filed March 1, 2006 with
                  the
                  Secretary of State for the State of Texas.3(ii).1
              Amended
                  and Restated Bylaws of the Company.4.1
                  *
              Form
                  of Certificate for shares of the Company’s common stock (Exhibit 4.1 to
                  the Company’s Registration Statement on Form SB-2[No.33-51446-FW] dated
                  January 7, 1993).4.2*
              Amended
                  and Restated Rights Agreement dated as of November 16, 2000, between
                  the
                  Company and American Securities Transfer, Incorporated, as Rights
                  Agent,
                  which includes as Exhibit A the form of Statement of Resolution
                  establishing and designating series of preferred stock as “Series  H
                  Junior Participating Preferred Stock” and fixing and determining the
                  relative rights and preferences thereof, as Exhibit B the form
                  of Rights
                  Certificate, and as Exhibit C the Summary of Rights to Purchase
                  Preferred
                  Shares. (Exhibit 4.1 to the Company’s Current Report on Form 8-K dated as
                  of November 16, 2000).4.3*
              Form
                  of Regulation D Subscription agreement by and between the Company
                  and the
                  participants of private placements. (Exhibit 4.3 to the Company’s Annual
                  Report on Form 10-K for the fiscal year ended December 31,
                  2004)4.4*
              Form
                  of Registration Rights Agreement by and between the Company and
                  the
                  participants of private placements. (Exhibit 4.4 to the Company’s Annual
                  Report on Form 10-K for the fiscal year ended December 31,
                  2004)10.1*
              Amended
                  and Restated 1992 Outside Directors’ Stock Option Plan (Exhibit 4.2 to the
                  Company’s Registration Statement on Form S-8 [No. 333-56547] dated June
                  9,
                  1998).10.2*
              1998
                  Directors and Officers Stock Option Plan (Exhibit 4.3 to the Company’s
                  Registration Statement on Form S-8 [No. 333-56547] dated June 9,
                  1998).10.3*
              Amended
                  and Restated 1992 Stock Option Plan (Exhibit 4.1 to the Company’s
                  Registration Statement on Form S-8 [No. 333-56457] dated June 9,
                  1998)10.4*
              Amended
                  and Restated 2002 Equity Compensation Plan. (Exhibit 10.4.to the
                  Company’s
                  Annual Report on Form 10-K for the fiscal year ended December 31,
                  2004)10.5*
              Patent
                  Assignment and Royalty Agreement between Electronic Billboard Technology,
                  Inc. and Advanced Technology, Incubator, Inc. dated as of October
                  6, 1998.
                  (Exhibit 10.18 to the Company’s Current Report on Form 10-KSB dated as of
                  March 31, 1999).10.6*
              Lease
                  agreement between the Company and Industrial Properties Corporation
                  dated
                  as of February 15, 2004. (Exhibit 10.11 to the Company’s Annual Report on
                  Form 10-KSB for the fiscal year ended December 31,
                  2004).10.7
              Amendment
                  No. 1 to the lease agreement between the Company and Industrial
                  Properties
                  Corporation dated as of December 15, 2006.10.8*
              Agreement
                  of Research and Development by and between the Applied Nanotech,
                  Inc. and
                  Futaba Corporation (Exhibit 10.1 to the Company’s Current Report on Form
                  8-K dated as of January  1, 2001).10.9*
              Agreement
                  of Research and Development by and between the Applied Nanotech,
                  Inc. and
                  Futaba Corporation for Phase II development (Exhibit 10.14 to the
                  Company’s Annual Report on From 10-KSB for the fiscal year ended December
                  31, 2001).10.10*
              Research/Development
                  and License Agreement entered into by Applied Nanotech, Inc. dated
                  as of
                  September 11, 2002 (Exhibit 10.1 to the Company’s Current Report on Form
                  8-K dated as of September 27, 2002).10.11*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Electrovac Ges.m.b.H. (Exhibit 10.2
                  to the
                  Company’s Current Report on Form S-2 date August 24,
                  2001)





Page
            68








EXHIBIT
                NUMBER
              DESCRIPTION
                  OF EXHIBIT10.12*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Imaging System Technology, Inc. (Exhibit
                  10.3
                  to the Company’s Current Report on Form S-2 date August 24,
                  2001)10.13*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Supertex, Inc. (Exhibit 10.4 to the
                  Company’s
                  Current Report on Form S-2 date August 24, 2001)10.14*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Schott Fiber Optics. (Exhibit 10.5
                  to the
                  Company’s Current Report on Form S-2 date August 24,
                  2001)10.15*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Lead Sangyo Co., Ltd. (Exhibit 10.6
                  to the
                  Company’s Current Report on Form S-2 date August 24,
                  2001)10.16*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Shanghai Novel Color Picture Tube
                  Co., Ltd.
                  (Exhibit 10.7 to the Company’s Current Report on Form S-2 date August 24,
                  2001)10.17*
              Agreement
                  for HyFEDTM Development Team Phase II by and between Field Emission Picture
                  Element Technology, Inc. and Shanghai Vacuum Electron Devices Co.,
                  Ltd.
                  (Exhibit 10.8 to the Company’s Current Report on Form S-2 date August 24,
                  2001)10.18*
              Nano-Proprietary,
                  Inc. Audit Committee Charter (Exhibit 10.23 to the Company’s Annual Report
                  on Form 10-KSB for the fiscal year ended December 31,
                  2002)10.19*
              Nano-Proprietary,
                  Inc. Compensation Committee Charter (Exhibit 10.18 to the Company’s
                  Current Report on Form 10-K for the fiscal year ended December
                  31,
                  2005).10.20*
              Nano-Proprietary,
                  Inc. Nominating Committee Charter (Exhibit 10.19 to the Company’s Current
                  Report on Form 10-K for the fiscal year ended December 31,
                  2005).10.21*
              Patent
                  License Agreement between SI Diamond Technology, Inc. and Till
                  Keesmann
                  (Exhibit 10 to the Company’s Quarterly Report on Form 10-QSB for the
                  quarter ended June 30, 2000)10.22*
              Second
                  Addendum to Patent License Agreement by and among Nano-Proprietary,
                  Inc.
                  and Till Keesmann (Exhibit 10.1 to the Company’s Current Report on Form
                  8-K dated as of November 18, 2002).10.23*
              Development,
                  Purchase, and License Agreement for Hydrogen Sensor Products and
                  related
                  Services between, Nano-Proprietary, Inc. Applied Nanotech, Inc.
                  and Kelman
                  Ltd. (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated as of
                  July 13, 2005).10.24*
              Asset
                  Purchase Agreement between Novus Communication Tehcnologies, Inc.,
                  Novus
                  Displays, LLC, Electronic Billboard Technology, Inc. and Nano-Proprietary,
                  Inc. (Exhibit 10.1 to the Company’s Current Report on Form 8-K dated as of
                  June 22, 2006)10.25*
              Asset
                  Purchase Agreement between Novus Communication Tehcnologies, Inc.,
                  Electronic Billboard Technology, Inc. and Nano-Proprietary, Inc.
                  (Exhibit
                  10.1 to the Company’s Current Report on Form 8-K dated as of June 22,
                  2006)11
              Computation
                  of (Loss) per Common Share14*
              Nano-Proprietary,
                  Inc. Code of Ethics (Exhibit 14 to the Company’s Annual Report on Form
                  10-KSB for the fiscal year ended December 31, 2004)21
              Subsidiaries
                  of the Company24
              Powers
                  of Attorney.31.1
              Rule
                  13a-14(a)/15d-14(a) Certificate of Thomas F. Bijou, Chief Executive
                  Officer31.2
              Rule
                  13a-14(a)/15d-14(a) Certificate of Douglas P. Baker, Chief Financial
                  Officer32.1
              Section
                  1350 Certificate of Thomas F. Bijou, Chief Executive
                  Officer32.2
              Section
                  1350 Certificate of Douglas P. Baker, Chief Financial
                  Officer