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EX-24 - POWER OF ATTORNEY - Nano Magic Holdings Inc.appliednano_ex24.htm
EX-11 - COMPUTATION OF (LOSS) PER COMMON SHARE - Nano Magic Holdings Inc.appliednano_ex11.htm
EX-21 - SUBSIDIARIES - Nano Magic Holdings Inc.appliednano_ex21.htm
EX-32.1 - CERTIFICATION - Nano Magic Holdings Inc.appliednano_ex3201.htm
EX-31.1 - CERTIFICATION - Nano Magic Holdings Inc.appliednano_ex3101.htm
EX-4.4 - FORM OF CONVERTIBLE NOTE PAYABLE - Nano Magic Holdings Inc.appliednano_ex0404.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
x
Annual report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2009; or
 
o
Transition report under Section 13 or 15(d) of the Securities Exchange Act of 1934
 
COMMISSION FILE NO. 1-11602
 
APPLIED NANOTECH HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
TEXAS
76-0273345
(State of Incorporation)
(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  o    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  o   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  o
 
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.    o

 Indicate by check mark whether the registrant  has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.  Yes  o    No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
 
Large Accelerated Filer  o    Accelerated Filer o   
Non-accelerated Filer  þ     Smaller Reporting Company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes  o    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, 2009 of $0.28, was approximately $30 million. As of February 26. 2010, the registrant had 107,573,133 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
1
Item 1A.
 
Risk Factors
11
Item 1B.
 
Unresolved Staff Comments
16
Item 2.
 
Properties
17
Item 3.
 
Legal Proceedings
17
   
PART II
 
Item 4.
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
18
Item 5.
 
Selected Financial Data
20
Item 6.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
21
Item 6A.
 
Quantitative and Qualitative Disclosures About Market Risk
26
Item 7.
 
Financial Statements and Supplementary Data
27
Item 8.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
48
Item 8A(T).
 
Controls and Procedures
48
Item 8B.
 
Other Information
50
   
PART III
 
Item 9.
 
Directors, Executive Officers and Corporate Governance
51
Item 10.
 
Executive Compensation
53
Item 11.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
62
Item 12.
 
Certain Relationships and Related Transactions, and Director Independence
64
Item 13.
 
Principal Accountant Fees and Services
65
   
PART IV
 
Item 14.
 
Exhibits and Financial Statement Schedules
66

 
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 11 of this report.
 
Item 1.  Business.
 
DESCRIPTION OF BUSINESS
 
General
 
We are a nanotechnology company engaged in research and development. Our research is based on intellectual property and expertise that we have developed over the past 20 years. Our research is aimed at solving problems at the molecular level - in the area between the properties of matter that exist from the time several molecules are bound together until the first aggregate of the same molecules is created exhibiting the same chemical, physical and biological properties of the bulk material. The challenge of nanotechnology is how to controllably assemble fundamental nanoparticle building blocks in order to achieve new materials for new applications. As part of our research we perform services for others and develop products and materials based on our unique abilities in this area. During this process we generate intellectual property, and our ultimate goal is to generate sustainable recurring revenues by licensing this technology to others. Our work is currently focused in the areas of nanomaterials, nanoelectronics, sensors, nanoecology, and electron emission activities.
 
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”). Until late 2005, the majority of our research was related to FED technology and other display technologies and activities. During that time period we were at the forefront of the evolution of FED technology, and we accumulated significant intellectual property along the way. However, the display industry is dominated by a small number of large multinational corporations, and we were entirely dependent on one of those companies introducing  a product using our technology. In late 2005, we determined that we should diversify our activities to become less dependent on those companies.
 
From 2006 to the present, we have expanded our research to many other areas to capitalize on the knowledge that we gained during the first 18 years of our existence. 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 270 total U.S. and foreign patents, including 90 issued, and over 180 pending.
 
Business Model
 
At the present time, we are first and foremost a research and development company. We have an extensive portfolio of intellectual property that we have developed throughout the last 20 years, and we intend to develop a portfolio of recurring revenue streams by licensing our intellectual property to others. In addition, for certain high potential products and technologies, we are exploring the possibility of forming business units around some of these technologies to allow us to participate in the commercialization process beyond simply licensing our technology to others to manufacture products. We believe that, in some instances, these business units will allow us to create greater value through broader participation in the revenue stream and potentially decrease the time required to bring products to market. In addition, having an ownership interest in an entity that may be created related to the technology allows us to participate in the value created as the technology gains market acceptance and the entity grows. We have organized internal teams to focus on the development of these high potential technologies and entities based on them.

 
Page 1

 

 
Much of our intellectual property and research 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.
 
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 $3,662,323, $4,614,644, and $4,526,166 on research and development in the years ended December 31, 2009, 2008, and 2007, respectively. This represents approximately 59%, 54%, and 54% 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 2010 to be in excess of 60% of our operating costs. We seek to obtain funding for as much of our research as possible.
 
Business Segments
 
Our operations currently consist of three reportable business segments.
 
Applied Nanotech, Inc. ANI is the entire focus of our current 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 materials, electronics, sensor, medical, display, 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. EBT expanded into other display areas, but in 2002, we restructured EBT and limited ourselves to licensing EBT’s existing intellectual property. In 2006, we sold EBT’s intellectual property in two simultaneous transactions as discussed below. To the extent that EBT is basically inactive, information relative to this segment may not be that meaningful.
 
Other. We also incur general operating overhead that is not associated with any specific subsidiary 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.

   
2009
   
2008
   
2007
 
Revenues
                 
ANI
  $ 4,052,746     $ 3,957,832     $ 3,989,803  
EBT
  $     $     $  
Other
  $     $     $  
Total Revenues
  $ 4,052,746     $ 3,957,832     $ 3,989,803  
                         
Net income (loss) from continuing operations
                       
ANI
  $ (1,411,121 )   $ (1,520,726 )   $ (3,212,051 )
EBT
  $ 5,459     $ (1,296 )   $ (1,298 )
Other
  $ (746,943 )   $ (1,163,845 )   $ (1,043,542 )
Total
  $ (2,152,605 )   $ (2,685,867 )   $ (4,256,891 )
Assets
                       
ANI
  $ 780,848     $ 1,105,627     $ 778,863  
EBT
  $     $     $  
Other
  $ 112,519     $ 686,862     $ 2,965,995  
Total
  $ 893,367     $ 1,792,489     $ 3,744,858  

 
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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 five technology platforms. These platforms are:

 
·
Functional nanomaterials, including composites and thermal management;
 
·
Nanoelectronic applications;
 
·
Sensor technology;
 
·
Nanoecology; and
 
·
Electron emission activities, primarily in the display area.

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. For certain high potential products and technologies, we are exploring establishing business units that would enable us to participate in, and profit from, the commercialization process beyond just licensing.
 
Functional Nanomaterials
 
Nanocomposites
 
We are in the advanced stages of research into nanomaterials using carbon nanotube (“CNT”) 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 well versed in harnessing the unique properties of CNTs for a variety of applications. Our work with CNT composites has been in three main areas – epoxies, nylons, and glass fibers.
 
Epoxies – Epoxies are used in industries with huge worldwide markets, with applications including adhesives, paints, coatings, and composites. The objective of our CNT epoxy program has been to create composite materials to be used as an alternative to traditional materials. Our goal is to reinforce epoxy with CNTs to take advantage of CNTs mechanical properties while reducing the weight of materials needed for specific applications. We have developed patented processes and know-how which has enabled us to uniformly disperse CNTs throughout the epoxy to create significant improvements in strength, toughness, durability, vibration dampening, and other mechanical properties.
 
In September 2005 we signed a development contract with a large sporting goods manufacturer to develop nanocomposites to be used in sporting equipment. This agreement culminated in a license agreement in October 2008 with this partner to use our technology in its tennis and badminton racquets. We expect this manufacturer to have products on the market in 2010 that will generate royalties for us. This development agreement served as the foundation of our work in the nanomaterials area.
 
Nylons – The addition of CNTs to nylons can enhance certain mechanical properties and the electrical conductivity of normally insulating material. Of all the types of nylons available, Nylon 6 is the most common, with an estimated 60% of the world volume and with uses in a variety of industries including textiles, carpeting, safety belts, fishing lines, and a variety of other applications. We have developed a patented process for coating nylon pellets with CNTs to improve electrical conductivity. Nylon 6 with improved electrical conductivity can be used for its anti-static qualities, electrostatic discharge, and electromagnetic/RF shielding.

 
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Glass Fibers – We have applied our knowledge in CNT enhanced composites to develop a strengthened fiberglass that can be used for applications with long lifetime requirements, such as wind turbine blades. Current wind blade research is focused on lowering the weight of materials to reduce overall cost and increase efficiency. Our early research has shown dramatic results in lowering the weight of materials using CNT strengthened materials, and we are continuing to apply resources with our partners, to further develop this technology.
 
Competition. There is a wide range of companies working with composite materials, including some working with CNT enhanced composites. Since each project is unique, our competition would come from different companies for different applications. Since we rely on patented technology, any competition would come from different composites, or different formulations of CNT composites. Some of the companies known to be working in the CNT composite area are Zyvex Performance Materials in Columbus Ohio, GSI Creos in Tokyo, Japan, and Amroy Europe, Ltd. in Finland.
 
Thermal Management
 
With a partner in Japan, we are marketing a unique patented thermal management material called CarbAl™. In 2009, R&D magazine recognized Carbal™ as one of the 100 most significant product innovations of 2009 with its R&D 100 Award. The inability to effectively control temperature is the number one cause of failure for electronics, resulting in more failures than dust, humidity, vibration, and other harmful conditions. CarbAl™ provides a passive thermal management solution for temperature control issues that plague electronics manufacturers and has the ability to reduce costs for, and extend the lives of many electronics applications.
 
Carbal™ is a carbon based metal nanocomposite comprised of 80% carbonaceous matrix and a dispersed metal component of 20% aluminum. Carbal™ has a unique combination of low density, high thermal diffusivity, high thermal conductivity, and a low coefficient of thermal expansion that results in a material that far exceeds the capabilities of conventional passive thermal management materials. There is an extensive worldwide market for thermal management materials and Carbal™ is ideal for applications in the electronics industry, in LED displays, and for concentrated photovoltaic solar cell systems.
 
Competition. Because Carbal™ is a new patented material, its competition comes from already existing active and passive thermal management systems. For example, computer equipment includes fans, while LED Billboards include air conditioning equipment. CPV solar cells are a developing product and thermal management remains a significant problem.
 
Nanoelectronics Applications
 
Conductive Inks
 
As a result of the move towards flexible electronics, soldering processes are slowly disappearing, and new processes that are digital in nature are needed to allow a move directly from design to the production line. One of the areas that we have chosen to focus on is conductive inks. Nanotechnology will play an important role in this process because only nanoparticles are capable of producing inks that are compatible with the nozzles used in digital printing.
 
To facilitate our development of conductive inks, we entered into a research and development agreement with a leading industrial chemical products company headquartered in Japan to develop conductive inks that can be deposited using an additive process such as ink-jet printing or screen printing. The target market for these technical inks includes printed circuit boards, flexible electronics and displays, communications instrumentation, and Radio Frequency Identification tags. Our work with this partner started with a feasibility study in early 2006 and culminated with a license agreement for copper inks and pastes in July 2009. As a result of this partnership, we have received over $2.5 million in research funding and $500,000 of a $1.5 million up-front license payment, with the balance of $1.0 million due in June 2010.
 
We chose to start this project by focusing on nanocopper inks using copper nanoparticles because of copper’s superior electrical conductivity properties, low cost, and because it is the material of choice in the printed circuit board industry. We have been able to achieve electrical conductivity properties similar to that of bulk copper with these inks. We have since expanded our work with conductive inks to other inks including nickel, silver, and others, as well as to various conductive pastes.

 
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Technical Inks Printing Solution (TIPS)
 
Conductive Inks have the power to revolutionize many types of electronics manufacturing. Our strategy is to provide a comprehensive solution for end users by not only developing inks, but assisting in the process from start to finish. As part of our concept, we have done extensive research on raw materials (nanoparticles). We have developed relationships with nanoparticle suppliers and are able to supply a variety of nanoparticles as a result of these relationships. In addition, we have done applications R&D on a variety of potential end user products to help develop specifications for the inks. We have also formed relationships with hardware manufacturers with the goal of providing seamless integration into high volume manufacturing for companies wishing to use conductive inks in their manufacturing processes.
 
We intend to develop a revenue stream that includes revenue from the sale of nano-particles, research revenue from applications development, commissions on the sale of hardware, and royalties from the sale of inks.
 
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 depends on the results of our research compared with results achieved by others. There are silver inks on the market today, but because of the high cost of silver relative to copper, a copper ink is likely to open up additional markets.
 
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:
 
Ion Mobility Sensors. We are currently developing sensors based on Ion Mobility Sensor technology and Differential Mobility Spectroscopy. These sensors are ideal for use when both high sensitivity and high selectivity (low false positives) are required. We are also improving on existing IMS and DMS technology by developing nonradioactive gas ionization sources to replace the radioactive isotopes that are currently used in these tools. We are currently involved in a project to develop a highly sensitive Mercaptan sensor for use in the natural gas industry.
 
We have also submitted a significant proposal to the U.S. government for funding to develop a breath analysis sensor for health monitoring using this technology. Breath analysis has the potential to significantly lower health care costs by providing early indications of potential changes in people’s health and providing that information digitally to health professionals.
 
Hydrogen sensors. These sensors are initially targeted for use in fuel cells for automobiles and for remote monitoring of large power transformers. We developed a hydrogen sensor for use in the measurement of hydrogen in power transformer products. We are currently working with a large manufacturer of instruments, controls, and monitoring systems used in the power transmission industry, and we have an all encompassing agreement covering development, technology transfer, and licensing with this partner. We expect this partner will introduce a product using our sensor in 2010 and that it will begin generating royalties for us.
 
Carbon Monoxide Sensors. We have developed a low-power carbon monoxide sensor that can last for 10,000 hours on a single battery. 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.
 
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.
 
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.

 
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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.
 
Nano-ecology
 
Photoscrub® Technology. We developed a concept called Photoscrub® which is based on an air purification technology originally developed by one of our strategic partners, Andes Electric Co., Ltd. The Photoscrub® 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 in the amount of roughly $950,000 to further develop this technology for the U.S. Army in November 2006. Based on the results of this first phase, we were awarded a contract in the amount of $1.45 million in January 2009 and are currently performing research under this contract.
 
Electron Emission Activities
 
Until recent years, our main focus for virtually the entire life of Applied Nanotech Holdings has been on electron emission activities. We have performed extensive research and accumulated significant intellectual property in this area.  The bulk of that activity has centered on Field Emission Display (“FED”) technology. FED 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. We believe our intellectual property in the electron emission area is mature and well developed. We are now dependent on a manufacturer to introduce a product using our technology. As such, we are no longer devoting any resources to further develop this technology, unless funded for a specific application. We are, however, closely monitoring developments in the industry to determine if a license is needed by a manufacturer for our technology.
 
Our electron emission activities can be divided into display activities and non-display activities.
 
Display Applications
 
The display industry is, in general, dominated by large multinational corporations primarily based in Asia and participation in manufacturing products for the display market involves significant capital investments. While display applications represent potentially huge markets for the use of our technology, realization of this potential will require one of these companies to introduce a product based on our technology. Our intellectual property in this area is well developed, and we believe that any manufacturer that develops a product based on electron emission activities involving carbon will require a license to our technology; however, any products using this technology are still at present, next generation products. We believe that the successful introduction of any display products using this technology will require the participation of existing display manufacturers or component suppliers. These manufacturers and suppliers have a variety of interests and the introduction of new display products may be affected by general economic conditions as well as the impact of these new products on other areas of their business. Potential applications in the display area include: large area CNT flat screen color field emission displays, large area surface conduction color field emission displays such as the one developed by Canon and Toshiba, backlights for displays, and picture element tubes for medium resolution large area electronic billboards.
 
Non-Display Applications
 
There is also a wide array of non-display related electron emission applications. These potential applications are spread among a much larger group of potential licensees, and the markets generally  are not as large as the display markets, although the markets are still very significant and would generate substantial royalties if products are introduced. We have performed research related to lighting applications, ion sources, traveling wave tubes, and are exploring other electron emission applications. We believe these applications may have the capability of generating license revenues sooner than display applications, may be easier to integrate into existing products, and may be in wide use sooner than display applications. While the breadth (number of patents) of our display related emission activity patents is currently greater than for non-display patents, our non-display Intellectual Property is growing and our basic Raman patent is expected to cover all of our electron emission activities.

 
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Key Intellectual Property
 
Our most significant patent in the electron emission area is a basic patent that we refer to as the Raman Spectrum Patent (U.S. Patent 5869922) covering emissions from a wide range of carbon forms. This patent covers field emission devices using various forms of carbon; including carbon nanotubes (CNT), carbon films, and other forms of carbon that fall within a particular range on the Untraviolet Raman band. This basic patent is fundamental and has broad applicability and wide geographic coverage, having been issued in the U.S., China, South Korea, and has been validated in several European countries. The patent application is also pending in Japan. In addition to this basic patent, we have a wide variety of other patents that compliment this basic patent in specific situations. We believe that any company developing a product that involves the emission of electrons from carbon is likely to require a license to our technology.
 
Competition. Because of the strength of our intellectual property in the electron emission area, our competition comes from other technologies, rather than from other companies. For displays, this completion comes from LCD displays, Plasma displays, LED displays, and color picture tubes.
 
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-Window™. We restructured EBT, stopped selling products directly, and instead limited ourselves to licensing EBT’s intellectual property. As discussed below, we sold EBT’s intellectual property in 2006.
 
Communication patents. We 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 similar patents that we applied for in Europe, Canada, Korea, and Japan. As discussed below, we sold this group of patents in 2006.
 
Sale of Intellectual Property. In 2006 we sold EBTs intellectual property in two simultaneous transactions to Novus Communications Technologies, Inc. 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, could allow us to request a return of the patents. We received a total of $6,000 in payments in 2009 from Novus Partners.
 
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.
 
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. We have received a total of $6,000 in payments from Novus Partners since the time of the initial payment in 2006, and we will not receive any additional royalties from Novus Partners until such time as they have revenue producing agreements or make minimum payments. While we anticipate receiving royalties in the future, we have no control over, or input into, the licensing activities of Novus Partners.

 
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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 develop 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, has not yet actively developed any of the technology acquired from us in 2006, and is not carrying on any significant business activities at the present time.
 
Technology Agreements
 
Till Keesmann. 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.
 
The Keesmann agreement was amended in 2008. As part of that amendment, the amount of future offsets available for expenses incurred prior to June 2008 was fixed at $300,000. In addition the amendment established licensing parameters under which we can sublicense the patents without any additional approval by Mr. Keesmann. The amendment also gave Mr. Keesmann the option of electing to receive an additional advance of $100,000 against future royalties. In September 2008, Mr. Keesmann elected to receive that advance, which is now also available for us to offset against future royalties. Finally, the amendment contains provision which would allow Mr. Keesmann to license the patents directly and remit 50% of the royalties to us beginning in June 2010, if certain minimum royalties are not achieved by that date. At this point, we have not made any additional payments and it is unlikely that the minimum royalty payment will be achieved by May 2010.
 
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 270 patents, including 90 issued patents and over 180 patent applications pending before foreign and United States Patent and Trademark Offices. 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.

 
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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.
 
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 $1,694,082 of revenue in 2009, $2,295,887 in 2008, and $2,328,010 in 2007, related to government contracts. These reimbursements represent all or a portion of the costs associated with such contracts. As of December 31, 2009, we have several government contracts in process that have approximately $1.8 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 26. 2010 we had 27 full-time employees, including 3 executive officers, and 3 part time employees. 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.

 
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Available Information
 
Our website is http://www.appliednanotech.net. 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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
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Item 1A.
Risk Factors
 
Our success is dependent on our principal technologies
 
Our technology platforms, which include nano-materials, nano-electronics, sensors, electron emission activities, and nano-ecology, are emerging technologies. Our financial condition and prospects are dependent upon licensing our intellectual property to others and introduction of the technology into the marketplace. Additional R&D needs to be conducted on some of our technologies before others can produce products using this technology. Market acceptance of products using our technology will be dependent upon 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
 
Some of our 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 our 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 likely 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 anticipate receiving up-front license fees and royalties in 2010.
 
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 all such licenses have not yet been finalized. Our development partners usually also have rights to any jointly developed property; however, any such jointly developed property would likely be based, at least in part, on our underlying technology which would require our partners to enter into a license 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 26. 2010, we had 30 full-time and part-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.

 
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We may not be able to provide system integration
 
In order to prove that our technologies work and will produce a complete product, we may be required to 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 elect not 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 on our own. 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 either contract with a qualified manufacturer, or enter into a joint venture or other similar arrangement.
 
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.
 
Public perception(s) of ethical and social issues may discourage the use of nanotechnology
 
Nanotechnology has received both positive and negative publicity and is increasingly the subject of public discussion and debate. Governments may, for social or health purposes, prohibit or regulate the use of nanotechnology. This may restrict our ability to license our technology, or the ability of our licensees to sell their products.
 
The loss of key personnel could adversely affect our business
 
Our future success will depend on our ability to continue 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, some 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.

 
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We have a history of net losses
 
We have a history of net losses, although these losses have been decreasing. From our inception through December 31, 2009, we incurred net losses of approximately $111 million. We have incurred net income and losses for the last ten years as shown below:

 
Year Ended December 31 
 
Net Income
(Loss)
     
2000
 
($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)
2007
 
($4,256,891)
2008
 
($2,685,867)
2009
 
($2,152,605)

 
Although we expect to be profitable in the future, we may not be. Our profitability in 2010 is dependent upon a combination of signing of additional license agreements and 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 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 funded our operations to date primarily through the proceeds from the sale of our equity securities and debt offerings. Our auditors have included a going concern paragraph in their opinion on our financial statements, which may impact our ability to obtain financing, if additional financing is needed in 2010 beyond that which we have already arranged as of the date of this filing.
 
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. We may enter into joint ventures or other business arrangements where we collaborate with others to sell or manufacture products. 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. Successful implementation of our strategy requires royalty bearing license agreements. We expect at least three of our licensees to introduce products into the marketplace in 2010; however, there is no guarantee that products will be introduced.
 
We expect to license our technology to be used in many applications. See additional discussion in the risk factor  above entitled “Our technology development is in its early stages and the outcome is uncertain”. 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 13

 

Our revenues have been dependent on government contracts in the past
 
In many years, a significant portion of our revenues were derived from contracts with agencies of the United States government. Following is a summary of those revenues for the past ten years:

Year Ended December 31
 
Revenues from
Government
Contracts
 
Percentage of
Total Revenue
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%
2007
 
$2,328,010
 
58%
2008
 
$2,295,887
 
58%
2009
 
$1,694,082
 
42%

 
We currently have commitments for future government funding of approximately $1.8 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 may be exposed to litigation liability
 
We have had 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.
 
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 requires 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.

 
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We have developed a plan to allow us to maintain operations until we are able to sustain ourselves. We have the existing resources to continue operations for a period through at least the end of 2010 and well into 2011. Expected revenues, excluding any new license agreements, will extend that period. Our plan is primarily dependent on raising funds through the licensing of our technology and revenue generated from performing contract research services. 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 licensee’s ability to make and sell our products using our technology. Competitors or potential licensees 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.
 
Changes in patent laws could have a negative impact on us
 
New legislation, regulations, or rules related to obtaining or enforcing patents could significantly increase our operating costs and make it more difficult to enforce or license our patents. If new legislation, regulations, or rules are implemented by either Congress, the United States Patent and Trademark Office, or the courts that impact the patent application process, the patent enforcement process, or the rights of patent holders, these changes could negatively affect our expenses and potential revenue.
 
We rely on unpatented proprietary technology
 
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 15

 

 
We have technologies subject to licenses
 
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.
 
The Keesmann agreement was amended in 2008. As part of that amendment, the amount of future offsets available for expenses incurred prior to June 2008 was fixed at $300,000. In addition the amendment established licensing parameters under which we can sublicense the patents without any additional approval by Mr. Keesmann. The amendment also gave Mr. Keesmann the option of electing to receive an additional advance of $100,000 against future royalties. In September 2008, Mr. Keesmann elected to receive that advance, which is now available for us to offset against future royalties. Finally, the amendment contains provision which would allow Mr. Keesmann to license the patents directly and remit 50% of the royalties to us beginning in June 2010, if certain minimum royalties are not achieved by that date. No additional royalties have been paid since then and it is unlikely that the minimum royalties will be achieved by May 2010.
 
Our business is subject to changing regulation of corporate governance and public disclosure
 
Because our common stock is publicly traded, we are subject to certain rules and regulations of federal and state entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities have continued to develop additional regulations and requirements in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002. Complying with these new regulations has resulted in, and is likely to continue to result in, increased general & administrative costs and a diversion of management time and attention from revenue generating and other business activities to compliance activities.
 
Our business is subject to economic uncertainties
 
A portion of our research revenues come from private sources, primarily large multinational corporations. In addition, our strategy is dependent upon the receipt of royalties related to the introduction of new products by these and other companies. During times of extreme economic uncertainty, some companies may cut back on spending on research projects, or delay the introduction of new products.
 
Item 1B.
Unresolved Staff Comments
 
None.
 


 
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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 2014. The lease calls for payments of $12,505 through February 2010, $13,432 from March 2010 through February 2012, and $14,461 for the period from March 2012 through February 2014.
 
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 continuously monitor our facility needs and may 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.
 
Item 3.
Legal Proceedings

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.
 


 
Page 17

 


PART II
 
Item 4.
Market for Registrant’s Common Equity, 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 “APNT”. 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
 
               
2008
 
First Quarter
 
$1.30
 
$0.86
 
   
Second Quarter
 
$1.30
 
$0.96
 
   
Third Quarter 
 
$1.15
 
$0.40
 
   
Fourth Quarter 
 
$0.55
 
$0.18
 
               
2009
 
First Quarter
 
$0.37
 
$0.19
 
   
Second Quarter
 
$0.36
 
$0.22
 
   
Third Quarter 
 
$0.35
 
$0.19
 
   
Fourth Quarter 
 
$0.33
 
$0.19
 
               
2010
 
First Quarter (through February 26. 2010)
 
$0.37
 
$0.20
 
 
As of February 26. 2010, the closing sale price for our common stock as reported on the OTC Bulletin Board system was $0.32. As of February 26. 2010, there were approximately 350 shareholders of record for our common stock. This does not include shareholders holding stock in street name in brokerage accounts. As of our last record of total shareholders, including those holding stock in street name, there were approximately 7,500 shareholders.
 
Cash Dividends
 
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.


 
Page 18

 

 
Performance Graph
 
The following graph shows a comparison, since December 31, 2004, of cumulative total return for Applied Nanotech Holdings, the NASDAQ Market Index, and an index for Commercial Physical Research (SIC code 8731).
 
Performance Graph
 
 
 
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
Applied Nanotech Holdings, Inc
100.00
99.08
64.52
49.77
11.06
10.60
NASDAQ Market Index
100.00
101.41
114.05
123.93
73.43
105.89
Commercial Physical Research (SIC Code 8731)
100.00
91.55
90.32
101.22
59.90
72.98
 
The performance graph assumes $100 invested on December 31, 2004 in our common stock, the NASDAQ Market Index, and an index based on a basket of stocks composing SIC Code 8731. The total return assumes reinvestment of dividends for the NASDAQ Market Index and the SIC Code Index. The total return is based on historical results and is not intended to indicate future performance. These dates represent arbitrary points in time and if different dates were presented, different results would be obtained.

Recent Sales of Unregistered Securities
 
We issued no unregistered shares of our securities in the fiscal quarter ended December 31, 2009.

 
Page 19

 

 
Item 5. Selected Financial Data

   
2009
   
2008
   
2007
   
2006
   
2005
 
                               
Revenues
  $ 4,052,746     $ 3,957,832     $ 3,989,803     $ 1,116,670     $ 565,660  
                                         
Net income (loss)
  $ (2,152,605 )   $ (2,685,867 )   $ (4,256,891 )   $ (6,593,892 )   $ (5,818,816 )
                                         
Income (loss) per share
  $ (0.02 )   $ (0.03 )   $ (0.04 )   $ (0.07 )   $ (0.06 )
                                         
Total assets
  $ 893,367     $ 1,792,489     $ 3,744,858     $ 2,693,442     $ 1,187,981  
                                         
Long-term obligations
  $ 196,958     $ 27,909     $ 30,004     $     $  
                                         
Net shareholders’ equity (deficit)
  $ (1,070,838 )   $ 858,286     $ 2,828,902     $ 642,262     $ 859,339  
                                         
Cash dividends per common share
  $     $     $     $     $  


 
 
 

 
Page 20

 

 
Item 6. 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, 2009, and the results of operations for the years ended December 31, 2009, 2008 and 2007. 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. Our  main areas of focus in our research are on nanomaterials, nanoelectronics, sensors, nanoecology, and electron emission activities. 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. We have also received upfront payments related to royalty agreements, but have not yet received royalties related to the sale of products produced using our technology.
 
OUTLOOK
 
We expect our total cash needs for 2010 to be approximately $6.2 million. We intend to fund those needs through a combination of our cash on hand, sales, reimbursements for research, and license agreements. We anticipate receiving significantly more revenue in 2010 than was received in 2009. 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 26. 2010, we have approximately $1.7 million in cash to cover potential revenue shortfalls that may occur for the year and we believe this cash is adequate for our needs in 2010. We have also raised cash through a convertible debt offering as described in the footnotes to the financial statements, and may raise additional cash through this offering.
 
We have a history of net operating losses. Our plan is to generate sufficient revenues in 2010 to achieve breakeven or better; however, losses may continue as we continue to develop our technologies. There can be no assurances that we will be profitable in 2010 or 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 our technology in 2010.
 
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, when combined with expected revenues sources, are expected to be 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. Our auditors have included a going concern paragraph in their opinion on our financial statements, which may impact our ability to obtain financing, if financing is needed in 2010 beyond that which we have already arranged as of the date of this filing.
 
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.

 
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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 performance-based option awards. We account for these options using the fair value method of accounting.
 
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 2007, 2008 or 2009. 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, 2009 accounts receivable.
 
LIQUIDITY AND CAPITAL RESOURCES
 
Our cash balance of $286,971 at December 31, 2009 was significantly lower than our cash balance of $710,111 at December 31, 2008, as a result of our decision to not raise additional equity in 2009. We had a working capital deficit of approximately $1.2 million at December 31, 2009, compared with working capital of roughly $0.5 million at December 31, 2008. Our current assets decreased by approximately $900,000 as a result of our decrease in cash and a reduction in accounts receivable. The December 31, 2008 accounts receivable balance included a license payment receivable from our sporting goods partner that was received in 2009. No similar receivable exists at December 31, 2009. Our current liabilities increased by approximately $900,000 as a result of increases in accounts payable and accrued expenses. The increase in accrued expenses was primarily the result of deferral of officer salaries and board of director’s compensation to conserve cash. The accounts payable increase was primarily the result of working capital management.
 
The principal source of our liquidity has been funds received from exempt offerings of our common stock; however, in 2009 or 2008, we did not raise any equity from private placements of our common stock. The last private placement of our common stock was in April 2007 when we raised $6.0 million. We did receive proceeds of approximately $60,000, and $300,000 from the exercise of stock options by current and former employees in 2008, and 2007, respectively. No options were exercised in 2009. We did receive $200,000 related to convertible notes in 2009 and an additional $1,550,000 subsequent to December 31, 2009.
 
As of February 26. 2010, our cash balance is approximately $1.7 million. We believe that our current cash level, when combined with known revenue is enough for us to operate at least through the end of 2010 and well into 2011. We expect to obtain additional revenue, beyond the known sources, and we expect to be able raise additional, if needed. If neither of those two things occur, we intend to cut expenses to a level to enable us to continue operations.
 
In the event that we need additional funds in 2010 beyond the amount that we have planned 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. 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 has decreased each of the last two years, to approximately $561,000 in 2009, as compared with $2.3 million in 2008, and $5.3 million in 2007. The cash used in operations was primarily the result of the net losses incurred in each year. Factors affecting this are discussed in the Results of Operations section below. In 2009, a substantial portion of the net loss was offset by management of working capital items, including reduction of accounts receivable, increase in accounts payable, and deferral of officer and board compensation resulting in an increase in accrued expenses. Payment of legal fees related to the Keesmann litigation also significantly impacted the cash used in operations in 2007. Approximately $1.1 million of legal fees incurred in 2006 were paid in 2007, which had the overall effect of increasing cash used in operations in 2007 by that amount. We have a plan to generate positive cash flow from operations in 2010; however, since that will require significantly increased revenues, there is no assurance that will be achieved.
 
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 2010. No material commitments exist as of December 31, 2009, for future purchases of capital assets.

 
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Our contractual obligations as of December 31, 2009 consist of notes payable (including interest), operating leases, and capital leases. The notes payable are convertible into common stock at a rate of $0.20 per share and may be converted before their due date in 2012. A summary of our obligations at December 31, 2009 is as follows:

   
Total
   
2010
   
2011
   
2012
   
2013
   
2014
 
Capital leases
  $ 63,417     $ 27,691     $ 20,230     $ 9,787     $ 5,709        
Operating leases
  $ 791,570     $ 187,179     $ 186,071     $ 193,589     $ 195,781     $ 28,950  
Convertible notes Payable
  $ 220,000                 $ 220,000              

 
We believe that we will have the cash available to meet our cash requirements for fiscal 2010.
 
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. Since EBT 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.
 
Revenues. Following is a summary of key revenue categories for the three years covered by this report.

   
2009
   
2008
   
2007
 
Government Revenues
  $ 1,694,082     $ 2,295,887     $ 2,328,010  
Other Contract Research
  $ 1,767,144     $ 824,358     $ 990,598  
License Fees and Royalties
  $ 500,000     $ 577,000     $  
Total Revenues
  $ 4,052,746     $ 3,957,832     $ 3,989,803  
                         
Revenue backlog at December 31
  $ 2,938,000     $ 3,272,000     $ 3,891,000  
 
 
All of the revenues during the 3-year period came from ANI. Our revenues were roughly similar in all years and the majority of the revenues came from research contracts.  Our license revenue in 2008 came from the license agreement with our sporting goods partner and in 2009 from our inks partner.
 
The revenue backlog as of December 31, 2009 results from several government programs and private contracts and is similar to prior years. The majority of these programs are currently in progress and generating revenue, with the remainder related to contracts awarded, but not yet started. The overwhelming majority of this backlog will be converted into revenue in 2010. We also have some highly likely contracts that have not yet been finalized, and therefore, are not included in the backlog numbers as of December 31, 2009. In addition, we expect our inks partner to make a payment of $1.0 million in June 2010 to complete its exclusive license. This expected payment is not included in our research backlog.
 
We expect revenue to be significantly higher in 2010 than in 2009, and we expect to generate minimum revenues in 2010 of $6.0 million at ANI. Of that, $2.3 million is already committed and in process, and the majority of the remaining $3.7 million has been specifically identified. There is no guarantee that these revenues will be obtained; however, we think it is equally as likely that revenues will exceed these numbers, as 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 the projected minimum of $6.0 million in revenue will be achieved. We are currently pursuing opportunities in several areas that could result in additional revenue in 2010.
 
We expect our revenues in all categories – government contracts, private research, and license agreements, to increase in 2010 over 2009 levels.

 
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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.
 
   
2009
   
2008
   
2007
 
                   
Total Research and development
  $ 3,662,323     $ 4,614,644     $ 4,526,166  

 
All research and development expenses were incurred by Applied Nanotech, Inc. Our level of research activity was roughly similar in 2008 and 2007, but down in 2009. In 2009, we continued to concentrate our efforts on funded projects and reduce unfunded research and development. This resulted in a reduction of research and development cost, even though revenues increased. In addition, our mix of research revenue in 2009 was less heavily weighted toward government contracts which frequently have lower margins.
 
We expect to continue to incur substantial expenses in support of additional research and development activities related to the commercial development of our technologies. We expect to incur at least similar amounts of research related expenditures in 2010 to those incurred in 2009. We may, however, incur more research and development expense in 2010 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.
 
Selling, general, and administrative. Following are some key components of selling, general, and administrative expense:

   
2009
   
2008
   
2007
 
                   
Stock based compensation
  $ 131,962     $ 418,252     $ 22,705  
Patent Expense
  $ 731,422     $ 789,006     $ 545,643  
Litigation related expenses
  $     $ 166,278     $ 1,110,946  
Other S, G, & A
  $ 1,677,432     $ 2,524,403     $ 2,179,426  
Total selling, general, and administrative
  $ 2,540,816     $ 3,897,939     $ 3,858,720  

 
Total selling, general and administrative expense was similar in 2007 and 2008, but decreased substantially in 2009 as a result of the factors discussed below.
 
One significant component of selling, general, and administrative expense is stock based compensation. Stock based compensation is significantly impacted by two factors. First, the number of options vested, or expected to vest, each year. Second, the fair value of the options vested. One of the factors impacting the fair value is the underlying price of our 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. Stock based compensation expense was low in 2007 as a result of a change in the estimate of the number of options related to a multiyear goal program that were expected to vest, resulting in a reversal of expenses booked in previous years. Stock based compensation was lower in 2009 than 2008, both because fewer options were granted and because our stock price was lower. We will incur stock based compensation expense in 2010, 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 2010 will depend on the goals achieved.

 
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The second major component of selling, general, and administrative expense during the periods presented is litigation related expense. We incurred significant amounts of litigation related expense in 2007 as a result of our litigation against both Canon, Inc. and Till Keesmann. The amount was significantly lower in 2008 because both of these cases were completed. The Canon case went to trial in 2007 and only minimal activity related to the appeal took place in 2008. The Keesmann litigation was settled in 2008. As a result, our litigation expense decreased significantly. We had no litigation in expense in 2009 and we currently have no significant litigation in process and expect litigation expense to be insignificant in 2010.
 
We also spend a significant amount on patents. Our patent expense increased from approximately $546,000 in 2007 to approximately $789,000 in 2008. This was the result of an increase in the number of patents and a substantial rate increase at our primary patent law firm. Our patent expense decreased to approximately $731,000 in 2009 as a result of a switch in the law firm handling our patents in the second half of the year. We expect patent expense to decrease further in 2010 as a result of this change. In addition, we are reviewing our patent portfolio and eliminating or selling any patents we no longer consider useful to us.
 
Other selling, general, and administrative expense increased from 2007 to 2008. The increase related to primarily to professional fees and royalty payments. Our other professional fees increased by approximately $250,000 also as a result of fees associated with the sale of portions of our intellectual property and marketing efforts. Finally, we made an advance royalty payment of $100,000 to Till Keesmann in connection with the amendment of our existing license agreement with Mr. Keesmann.
 
Our other selling, general, and administrative expenses decreased substantially from 2008 to 2009 as a result of significant cuts that we made. These were wide ranging reductions covering most areas. We combined the CEO and CFO positions when our previous CEO resigned, saving in excess of $200,000. We also reduced our professional fees. We did not incur the previously mentioned fees associated with the sale of intellectual property in 2009, or the royalties, that were incurred in 2008.
 
We expect selling, general and administrative expense in 2010 to be approximately $2.4 million, a slight reduction from 2009 levels as a result of the full year impact of our cost reduction efforts  in 2009. If revenues increase above anticipated levels, or other unanticipated transactions occur, our selling, general and administrative expenses could increase above expected levels.
 
Gain on sale of intellectual property and other assets. In 2008, we had total gains of $1,329,571 related to the sale of intellectual property and other assets. The majority of that, $1,225,999, came from a sale of a portion of our future interest in royalties from sublicensing the Keesmann patents. We also had a gain of $100,000 from the sale of certain patents which we were no longer using and which did not relate to any of our current active technology platforms. The balance of the gain in 2008 came from the sale of miscellaneous equipment.
 
In 2009, the gain resulted from a payment received related to intellectual property sold by our EBT subsidiary in 2006.
 
Other income. Following is a summary of other income for the last three fiscal years.
 
   
2009
   
2008
   
2007
 
                   
Interest expense
  $ (10,089 )   $ (7,180 )   $ (926 )
Interest Income
  $ 1,877     $ 46,493     $ 139,118  
Litigation settlement
  $     $ 500,000     $  

 
Our interest expense in all years was primarily associated with capital leases. We expect our interest expense will increase in 2010 because of the convertible notes payable that we issued in December 2009 and during 2010. Our interest income is earned as a result of the investment of excess cash balances. Our interest income was higher in 2007 as a result of the private placement of our common stock that was completed in April 2007 and resulted in higher average levels of invested funds throughout the remainder of the year. Our interest income decreased in 2008 and 2009 as cash balances decreased and interest rates decreased. We expect our interest income in 2010 to be negligible, given the current interest rate environment. The litigation settlement in 2008 was income from our settlement with the defendants in the Keesmann litigation.

 
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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, $3.3 million in 2007, $3.5 million in 2008, and $3.1 million in 2009. The reduction from the 2008 level results from a decrease in the number of employees, as well as other cost reduction initiatives. We expect payroll related expense in 2010 to remain at approximately $3.1 million. We expect our burn rate for 2010, excluding any revenue, to average slightly less than $500,000 per month. Based on this, we believe we can reach breakeven at a revenue level of $6.0 million, but there is no assurance that this will occur, or that we can achieve that level of revenue. Our burn rate, excluding any revenue, as of the date of this filing is closer to $425,000 per month. We expect expenditures to increase as additional revenue producing projects are obtained. This expenditure level is based on anticipated revenue levels. If these revenue levels are not attained, we will not incur many of these expenses, and our expense level will also be lower than anticipated.
 
SEASONALITY AND INFLATION
 
Applied Nanotech Holdings’ business is not seasonal in nature. Management believes that Applied Nanotech Holdings’ operations have not been affected by inflation.
 
ACCOUNTING PRONOUNCEMENTS 
 
 In June 2009, the Financial Accounting Standards Board (“FASB”) issued ASC 105 Accounting Standards Codification TM and Hierarchy of Generally Accepted Accounting Principles. The FASB Accounting Standards Codification TM (the “Codification”) has become the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in accordance with Generally Accepted Accounting Principles (“GAAP”). All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. Rules and interpretive releases of the SEC issued under the authority of federal securities laws, however, will continue to be the source of authoritative generally accepted accounting principles for SEC registrants. Effective September 30, 2009, all references to GAAP in our consolidated financial statements will include references to the new Codification. The Codification does not change or alter existing GAAP and, therefore, will not have an impact on our financial position, results of operations, or cash flows.
 
In May 2009, the FASB issued ASC 855, Subsequent Events, which provides guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. ASC 855 distinguishes events requiring recognition in the financial statements and those that may require disclosure in the financial statements. Furthermore, ASC 855 requires disclosure of the date through which subsequent events were evaluated. These requirements are effective for interim and annual periods after June 15, 2009. We have adopted these requirements and have evaluated subsequent events through February 26. 2010.
 
  Item 6A. 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.


 
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Item 7.
Financial Statements and Supplementary Data
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
OF APPLIED NANOTECH HOLDINGS, INC.
 
CONSOLIDATED FINANCIAL STATEMENTS 

Independent Auditor’s Report
28
Consolidated Balance Sheets - December 31, 2009 and 2008
29
Consolidated Statement of Operations - Years Ended December 31, 2009, 2008, and 2007
30
Consolidated Statements of Shareholders’ Equity - Years Ended December 31, 2009, 2008, and 2007
31
Consolidated Statements of Cash Flows - Years Ended December 31, 2009, 2008, and 2007
32
Notes to Consolidated Financial Statements
33

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
Page 27

 


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders
Applied Nanotech Holdings, Inc.
Austin, Texas
 
We have audited the accompanying consolidated balance sheets of Applied Nanotech Holdings, Inc. and Subsidiaries (collectively, the “Company”) as of December 31, 2009 and 2008 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, 2009. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 Applied Nanotech Holdings, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 2009 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 Company’s internal control over financial reporting as of December 31, 2009, 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 February 26. 2010 expressed an unqualified opinion on the effectiveness of internal control over financial reporting.
 
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has experienced recurring losses from operations and negative cash flow from operations. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plan in regard to these matters is also described in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
/s/ Padgett, Stratemann & Co, L.L.P.
 
Padgett, Stratemann & Co, L.L.P.
 
San Antonio, Texas
 
February 26. 2010


 
Page 28

 

 APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
ASSETS
     
   
December 31,
 
   
2009
   
2008
 
Current assets:
           
Cash and cash equivalents
  $ 286,971     $ 710,111  
Accounts receivable, trade – net of allowance for doubtful accounts
    249,164       661,704  
Prepaid expenses and other current assets
    67,340       121,920  
Total current assets
    603,475       1,493,735  
Property and equipment, net
    267,008       278,853  
Other assets
    22,884       19,901  
Total assets
  $ 893,367     $ 1,792,489  
LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
               
Current liabilities:
               
Accounts payable
  $ 952,679     $ 438,878  
Obligations under capital lease
    21,939       35,012  
Accrued liabilities
    482,629       207,809  
Deferred revenue
    310,000       224,595  
Total current liabilities
    1,767,247       906,294  
Obligations under capital lease, long-term
    31,124       27,909  
Convertible Notes Payable
    165,834        
Total liabilities
    1,964,205       934,203  
Commitments and contingencies
           
                 
Shareholders’ equity (deficit) :
               
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, 107,473,133 and 107,395,216 shares issued and outstanding, respectively
    107,473       107,395  
Additional paid-in capital
    109,518,998       109,295,595  
Accumulated deficit
    (110,697,309 )     (108,544,704 )
Total shareholders’ equity(deficit)
    (1,070,838 )     858,286  
Total liabilities and shareholders’ equity (deficit)
  $ 893,367     $ 1,792,489  

 
 
See notes to consolidated financial statements.

 
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APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Year ended December 31,
 
 
 
2009
   
2008
   
2007
 
 
                 
Revenues
 
 
   
 
   
 
 
Contract research
  $ 1,767,144     $ 824,358     $ 990,598  
Government contracts
    1,694,082       2,295,887       2,328,010  
License fees and royalties
    500,000       577,000        
Other
    91,250       260,587       671,195  
 
                       
Total revenues
    4,052,746       3,957,832       3,989,803  
                         
Operating costs
                       
Research and development
    3,662,323       4,614,644       4,526,166  
Selling, general and administrative expenses
    2,540,816       3,897,939       3,858,720  
                         
Total operating costs
    6,203,139       8,512,583       8,384,886  
                         
Gain on sale of assets and other intellectual property
    6,000       1,329,571        
 
                       
Loss from operations
    (2,144,393 )     (3,225,180 )     (4,395,083 )
 
                       
Other income (expense):
                       
Interest income
    1,877       46,493       139,118  
Interest expense
    (10,089 )     (7,180 )     (926 )
Litigation settlement
          500,000        
 
                       
Total other income (expense)
    (8,212 )     539,313       138,192  
                         
Loss before taxes
    (2,152,605 )     (2,685,867 )     (4,256,891 )
 
                       
Provision for taxes
                 
 
                       
Net loss applicable to common shareholders
  $ (2,152,605 )   $ (2,685,867 )   $ (4,256,891 )
Earnings (loss) per share
                       
Basic and diluted
  $ (0.02 )   $ (0.03 )   $ (0.04 )
Weighted average common shares outstanding
                       
Basic and diluted
    107,427,877       107,292,686       106,321,400  
                         
See notes to consolidated financial statements.

 
Page 30

 

 

APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

   
Preferred
   
Common
   
Additional
   
Accumulated
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Paid-In Capital
   
Deficit
   
Total
 
                                           
Balance December 31, 2006
    -     $ -       104,257,607     $ 104,258     $ 102,139,950     $ (101,601,946 )   $ 642,262  
                                                         
Issuance of common stock options as compensation
    -       -       -       -       128,957       -       128,957  
Issuance of common stock as a result of the exercise of employee stock options
    -       -       307,244       307       304,116       -       304,423  
Issuance of common stock for cash
    -       -       2,608,698       2,609       5,997,391       -       6,000,000  
Issuance of restricted common stock as compensation
    -       -       -       -       10,151       -       10,151  
Net (loss)
    -       -       -       -       -       (4,256,891 )     (4,256,891 )
                                                         
Balance December 31, 2007
    -     $ -       107,173,549     $ 107,174     $ 108,580,565     $ (105,858,837 )   $ 2,828,902  
                                                         
Issuance of common stock as a result of the exercise of employee stock options
    -       -       170,000       170       61,080       -       61,250  
Issuance of common stock options as compensation
    -       -       -       -       605,393       -       605,393  
Issuance of restricted common stock as compensation
    -       -       51,667       51       48,557       -       48,608  
Net (loss)
    -       -       -       -       -       (2,685,867 )     (2,685,867 )
                                                         
Balance December 31, 2008
    -     $ -       107,395,216     $ 107,395     $ 109,295,595     $ (108,544,704 )   $ 858,286  
                                                         
Conversion rights associated with issuance of convertible notes
    -       -       -       -       35,000       -       35,000  
Issuance of common stock options as compensation
    -       -       -       -       160,505       -       160,505  
Issuance of restricted common stock as compensation
    -       -       77,917       78       27,898       -       27,976  
Net (loss)
    -       -       -       -       -       (2,152,605 )     (2,152,605 )
                                                         
Balance December 31, 2009
    -     $ -       107,473,133     $ 107,473     $ 109,518,998     $ (110,697,309 )   $ (1,070,838 )

See notes to consolidated financial statements.

 
Page 31

 

APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Year Ended
December 31,
 
   
2009
   
2008
   
2007
 
Cash flows from operating activities:
                 
Net loss
  $ (2,152,605 )   $ (2,685,867 )   $ (4,256,891 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Depreciation and amortization expense
    64,353       70,536       50,498  
Stock and options issued for services
    188,481       654,001       139,108  
Amortization of discount on debt
    834              
Changes in assets and liabilities:
                       
Accounts receivable, trade
    412,540       (407,741 )     110,755  
Prepaid expenses and other assets
    51,597       50,522       (103,502 )
Accounts payable
    513,801       (8,228 )     (1,115,382 )
Accrued expenses
    274,820       104,806       15,766  
Deferred Revenue and other current liabilities
    85,405       (81,832 )     (95,028 )
                         
Total adjustments
    1,591,831       382,064       (997,785 )
                         
Net cash used in operating activities
    (560,774 )     (2,303,803 )     (5,254,676 )
                         
Cash flows from investing activities:
                       
Capital expenditures
    (20,901 )     (35,943 )     (112,682 )
                         
Net cash used in investing activities
    (20,901 )     (35,943 )     (112,682 )
                         
Cash flows from financing activities:
                       
Proceeds from issuance of common stock
          61,250       6,304,423  
Proceeds of long term debt
    200,000              
Repayment of capitallease obligations
    (41,465 )     (31,489 )     (2,307 )
                         
Net cash provided by financing activities
    158,535       29,761       6,302,116  
Net increase (decrease) in cash and cash equivalents
    (423,140 )     (2,309,985 )     934,758  
Cash and cash equivalents, beginning of year
    710,111       3,020,096       2,085,338  
Cash and cash equivalents, end of year
  $ 286,971     $ 710,111     $ 3,020,096  

 
 
See notes to consolidated financial statements.


 
Page 32

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
1.
Organization, Operations, and Liquidity:
 
Applied Nanotech Holdings, Inc. and its subsidiaries (“the Company”) are engaged in the development of products for applications using nanomaterials, sensors, nanoelectronics, and proprietary field emission technology as well as the performance of significant research in those areas. We intend to obtain development revenues for applying our technology to specific applications for our development partners and to obtain royalty revenues from licensing this technology to those partners and 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 be required 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 may receive additional funds from the exercise of employee stock 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, research and development may be internally funded by us; however, our primary objective is to focus our resources on projects for which we receive funding.
 
The Company has a history of net losses and negative cash flow from operations, although these net losses and negative cash flows have been decreasing. These factors may raise doubt with some about our ability to continue as a going concern. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern, and do not include any adjustments that may be required if it were unable to continue as a going concern. Management believes that actions currently being taken will allow it to achieve profitability and allow the Company to continue as a going concern.

 
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, depreciation, and litigation reserves.

 
Page 33

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 
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 sometimes 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 any technology developed during the course of the program for its own purposes, but not any preexisting technology that we use in connection with the program. 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 nongovernmental entities generally allow the entity the first opportunity to license the technology from us upon completion of the project.
 
The Company’s 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. 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 proportional performance on the contract, such as cost incurred 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. 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.
 
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 proportional performance on the contract, such as cost incurred 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, is due, which normally corresponds somewhat with the time that the payment is received. The Company recognizes license fees due at the time of the signing of a royalty agreement when the licensee has an enforceable commitment to pay, unless the terms of the agreement make it clear that the license fee is a prepayment of future royalties. This normally corresponds with, or is reasonably close to, the time of receipt of the payment.
 
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.

 
Page 34

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
2. 
Summary of Significant Accounting Policies (continued):
 
Other Revenue - Other miscellaneous revenue is recognized as deemed appropriate given the facts of the situation and is generally not material.
 
Cash and cash equivalents
 
The Company considers all highly liquid investments purchased with an original maturity of 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. 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. The Company has determined that no reserve for uncertain tax positions is required; however tax years 2006 through 2009 remain open for examination by the U.S. Internal Revenue Service.
 
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 and notes payable 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 and notes payable approximate their carrying values.

 
Page 35

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
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 8, 9 and 10, the Company had options and warrants outstanding as indicated in the table below. In addition, the Company has convertible notes payable, that if converted at December 31, 2009, would have resulted in an additional 1,004,495 shares outstanding. 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.
 
   
2009
 
2008
 
2007
             
Options
 
4,430,392
 
7,889,897
 
6,897,180
Warrants
 
1,304,353
 
1,304,353
 
1,304,353
Weighted average exercise price
 
$1.60
 
$1.52
 
$1.70
 

 
Share-based payments
 
The Company has three stock based compensation plans described in greater detail in Note 9 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. For restricted stock the fair market value is based on the market value of the stock granted on the date of the grant. For options, it is estimated 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.

   
2009
 
2008
 
2007
             
Expected dividend yield
 
0%
 
0%
 
0%
Risk Free Interest Rate
 
.37%-1.76%
 
1.1%- 3.3%
 
3.3%- 4.8%
Expected option term (in years)
 
2.0 - 3.5
 
0.75 - 3.5
 
3.5 - 5.0
Turnover/Forfeiture Rate
 
0%
 
0%
 
0%
Expected volatility
 
95% - 100%
 
75% - 89%
 
75% - 82%
Weighted-average volatility
 
98%
 
82%
 
79%
 

 
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. Applied Nanotech Holdings’ 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

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
2.
Summary of Significant Accounting Policies (continued):
 
Recently issued accounting pronouncements
 
In June 2009, the Financial Accounting Standards Board (“FASB”) issued ASC 105 Accounting Standards Codification TM and Hierarchy of Generally Accepted Accounting Principles. The FASB Accounting Standards Codification TM (the “Codification”) has become the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in according with Generally Accepted Accounting Principles (“GAAP”). All existing accounting standard documents are superseded by the Codification and any accounting literature not included in the Codification will not be authoritative. Rules and interpretive releases of the SEC issued under the authority of federal securities laws, however, will continue to be the source of authoritative generally accepted accounting principles for SEC registrants. Effective September 30, 2009, all references to GAAP in our consolidated financial statements will include references to the new Codification. The Codification does not change or alter existing GAAP and, therefore, will not have an impact on our financial position, results of operations, or cash flows.

In May 2009, the FASB issued ASC 855, Subsequent Events, which provides guidance on events that occur after the balance sheet date but prior to the issuance of the financial statements. ASC 855 distinguishes events requiring recognition in the financial statements and those that may require disclosure in the financial statements. Furthermore, ASC 855 requires disclosure of the date through which subsequent events were evaluated. These requirements are effective for interim and annual periods after June 15, 2009. We have adopted these requirements and have evaluated subsequent events through February 26. 2010.
 

 
3.
Operating Lease Obligations:
 
The Company leases various facilities and equipment under operating lease agreements having terms expiring at various dates through 2014. Rental expense was $194,649, $221,787, and $179,594 for the years ended December 31, 2009,  2008,  and 2007, respectively.
 
Future minimum lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 2009, were as follows:
 
2010
$
187,179
2011
 
186,071
2012
 
193,589
2013
 
195,781
2014
 
28,950
Total future minimum lease payments
$
791,570


 
4.
Convertible Notes Payable:
 
 
Notes payable at December 31, 2009 consisted of notes payable to shareholders. The notes are 30 month unsecured notes due in a lump sum in June 2012 that bear interest at a rate of 8%. These notes, including any accrued interest, are convertible into shares of common stock at the option of the note holder at a rate of $0.20 per share. The face amount of the notes is $200,000,  however the conversion rights were valued at $35,000 and recorded as a discount to the note at the time of issuance. $834 of that discount was amortized to interest expense as of December 31, 2009. There were no notes payable outstanding as of December 31, 2008.


 
Page 37

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


 
5.
Capital Lease Obligations:
 
Capital leases payable at December 31, 2009 and 2008 consisted of the following:

      
   
2009
   
2008
 
Capital lease equipment due in monthly installments of $816 through July 2013. The equipment value and lease obligation was determined using a discount rate of 14.08%. The equipment is included in plant and equipment at December 31, 2009 at a cost of $42,040 and with accumulated amortization of $8,408.
    $ 35,072     $ 44,859  
                   
Capital lease equipment due in monthly installments of $2,883 through November 2009. The equipment value and lease obligation was determined using a discount rate of 11.20%.
            31,709  
                   
Capital lease equipment due in monthly installments of $1,492 through July 2011. The equipment value and lease obligation was determined using a discount rate of 12.27%. The equipment is included in office equipment at December 31, 2009 at a cost of $47,120, with accumulated amortization of $2,819.
      28,345        
                   
Total capital leases
      63,417       76,568  
                   
Less interest
      10,354       13,647  
                   
Less current portion
      21,939       35,012  
                   
Capital lease obligations, long-term
    $ 31,124     $ 27,909  

 These leases result in minimum payments of $27,691, $20,230, $9,787, and $5,709 from 2010 to 2013.
 
6.
Details of Certain Balance Sheet Accounts:
 
Additional information regarding certain balance sheet accounts at December 31, 2009 and 2008 is as follows:

   
December 31,
 
   
2009
   
2008
 
Property and equipment:
           
Plant and equipment
  $ 1,088,216     $ 1,038,861  
Furniture and office equipment
    144,460       141,307  
Leasehold Improvements
    19,019       19,019  
Total carrying cost
    1,251,695       1,199,187  
Less accumulated depreciation
    (984,687 )     (920,334 )
    $ 267,008     $ 278,853  
                 
Accrued liabilities:
               
Payroll and related accruals
  $ 458,629     $ 183,809  
Other
    24,000       24,000  
Total
  $ 482,629     $ 207,809  
 
Depreciation and amortization for the years ended December 31, 2009, 2008, and 2007 was $64,353, $70,536, and $50,498, respectively. Equipment held under capital leases and accumulated amortization on that equipment is included in these totals.

 
Page 38

 
APPLIED NANOTECH HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
7.
Income Taxes:
 
The components of deferred tax assets (liabilities) at December 31, 2009 and 2008, were as follows:

   
December 31,
 
   
2009
   
2008
 
Deferred tax assets:
           
Net operating loss carry forwards
  $ 30,435,000     $ 32,309,000  
Stock based compensation
    1,939,000       1,882,000  
Research and experimentation credits
    125,000       270,000  
Partnership asset
    39,000       48,000  
Capitalized intangible assets
    37,000       74,000  
Depreciation assets
    1,000       4,000  
Accrued expenses not deductible until paid
    155,000       58,000  
Total deferred tax assets
    32,731,000       34,645,000  
                 
Deferred tax liabilities: