-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Kuq1nRJ58WzPLV0guTFWMaXR2FY8NDW97hTaXtwGwCiPhfaUTgxGrBuuhF7sIEmt SsvUM3Y5rPq2+sBjG5tfIw== 0001279715-04-000007.txt : 20040810 0001279715-04-000007.hdr.sgml : 20040810 20040809185826 ACCESSION NUMBER: 0001279715-04-000007 CONFORMED SUBMISSION TYPE: 10-12G/A PUBLIC DOCUMENT COUNT: 7 FILED AS OF DATE: 20040810 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL PATENT DEVELOPMENT CORP CENTRAL INDEX KEY: 0001279715 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS MANUFACTURING INDUSTRIES [3990] IRS NUMBER: 134005439 STATE OF INCORPORATION: DE FILING VALUES: FORM TYPE: 10-12G/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-50587 FILM NUMBER: 04962706 BUSINESS ADDRESS: STREET 1: 777 WESTCHESTER AVE. STREET 2: FOURTH FLOOR CITY: WHITE PLAINS STATE: NY ZIP: 10640 10-12G/A 1 form10a.txt NATIONAL PATENT DEVELOPMENT CORPORATION AMENDMENT NO. 2 ON FORM 10/A As filed with the Securities and Exchange Commission on , 2004 File No. 0-50587 [GRAPHIC OMITTED] UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10/A (Amendment No. 2) GENERAL FORM FOR REGISTRATION OF SECURITIES Pursuant to Section 12(b) or (g) of The Securities Exchange Act of 1934 NATIONAL PATENT DEVELOPMENT CORPORATION (Exact name of Registrant as specified in its charter) Delaware 13-4005439 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 777 Westchester Avenue, White Plains, NY 10604 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (914) 249-9700 Securities to be registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which To be so registered each class to be registered None Not Applicable Securities to be registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) INFORMATION REQUIRED IN REGISTRATION STATEMENT CROSS-REFERENCE SHEET BETWEEN INFORMATION STATEMENT AND ITEMS OF FORM 10 Item 1. Business The information required by this item is contained under "Summary," "Business," "Relationship between GP Strategies and National Patent Development," "Special Considerations" and "Available Information" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 2. Financial Information The information required by this item is contained under "Summary," "Capitalization," "Pro Forma Consolidated Financial Information," "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 3. Properties The information required by this item is contained under "Business--MXL Industries--Properties," "Business--Five Star Product--Properties," and "Business--Pawling Property" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 4. Security Ownership of Certain Beneficial Owners and Management The information required by this item is contained under "Security Ownership of Certain Beneficial Owners, Directors and Executive Officers of National Patent Development" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 5. Directors and Executive Officers The information required by this item is contained under "Management" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 6. Executive Compensation The information required by this item is contained under "Executive Compensation" and "Management" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 7. Certain Relationships and Related Transactions The information required by this item is contained under "Summary," "The Spin-Off," "Relationship Between GP Strategies and National Patent Development," "Description of Warrants," and "Description of Indebtedness" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 8. Legal Proceedings The information required by this item is contained under "Business--MXL Industries--Legal Proceedings," "Business--Five Star Product--Legal Proceedings," and "Relationship Between GP Strategies and National Patent Development--Claims Relating to Learning Technologies Acquisition" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 9. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters The information required by this item is contained under "Summary," "The Spin-Off," "Capitalization," "Dividend Policy," and "Description of Capital Stock" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 10. Recent Sales of Unregistered Securities The information required by this item is contained under "The Spin-Off--Actions to be taken Prior to the Spin-Off," and "Description of Capital Stock" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 11. Description of Registrant's Securities to be Registered The information required by this item is contained under "Description of Capital Stock" and "Anti-Takeover Effects of Certain Provisions" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 12. Indemnification of Directors and Officers The information required by this item is contained under "Indemnification of Officers and Directors" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 13. Financial Statements and Supplementary Data The information required by this item is contained under "Summary," "Pro Forma Consolidated Financial Information," "Selected Consolidated Financial Data" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Information Statement filed herewith as Exhibit 99.1, which is hereby incorporated by reference herewith. Item 14. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. Item 15. Financial Statements and Exhibits. (a) Financial Statements The following financial statements are included in the Information Statement and filed as a part of this Registration Statement on Form 10: (1) Pro Forma Consolidated Financial Information of National Patent Development Corporation; and (2) Consolidated Financial Statements of National Patent Development Corporation (b) Exhibits. The following documents are filed as exhibits hereto: Number Description 2.1 Form of Distribution Agreement between GP Strategies Corporation and the Registrant* 3.1 Form of Amended and Restated Certificate of Incorporation of National Patent Development Corporation* 3.2 Form of Amended Bylaws of National Patent Development Corporation** 4.1 Form of certificate representing shares of common stock, par value $0.01 per share, of National Patent Development Corporation** 4.2 Form of National Patent Development Corporation Warrant Certificate. Incorporated herein by reference to Exhibit 10.03 of GP Strategies Corporation Form10-Q for the quarter ended June 30, 2003 10.1 Form of Management Agreement between GP Strategies Corporation and the Registrant* 10.2 Form of Management Agreement between the Registrant and GP Strategies Corporation* 10.3 Financing and Security Agreement dated August 13, 2003 by and between General Physics Corporation, MXL Industries, Inc. and Wachovia Bank, National Association. Incorporated herein by reference to Exhibit 10.10 of GP Strategies Corporation Form 10-Q for the quarter ended June 30, 2003. 10.4 Form of Tax Sharing Agreement between GP Strategies Corporation and the Registrant* 10.5 Note and Warrant Purchase Agreement, dated as of August 8, 2003, among GP Strategies Corporation, the Registrant, MXL Industries, Inc., Gabelli Funds, LLC, as Agent, and the Purchasers listed in Schedule 1.2 thereof. Incorporated herein by reference to Exhibit 10 of GP Strategies Form 10-Q for the quarter ended June 30, 2003. 10.6 Mortgage, Security Agreement and Assignment of Leases dated August 14, 2003, between GP Strategies Corporation and Gabelli Funds, LLC. Incorporated herein by reference to Exhibit 10.04 of GP Strategies Corporation Form 10-Q for the quarter ended June 30, 2003. 10.7 Indemnity Agreement dated August 14, 2003 by GP Strategies Corporation for the benefit of the Registrant and MXL Industries, Inc. Incorporated herein by reference to Exhibit 10.07 of GP Strategies Corporation Form 10-Q for the quarter ended June 30, 2003. 10.8 National Patent Development Corporation 2003 Incentive Stock Plan* 10.9 Employment Agreement, dated as of November 28, 2001, between Charles Dawson and Five Star Group, Inc. Incorporated herein by reference to Exhibit 10.12 of Five Star Products, Inc. Form 10-K for the year ended December 31, 2001. 10.10 Loan and Security Agreement dated as of June 20, 2003 by and between Five Star Group, Inc. and Fleet Capital Corporation. Incorporated herein by reference to Exhibit 10.1 of Five Star Products, Inc. Form 10-Q for the quarter ended June 30, 2003. 10.11 Agreement of Subordination & Assignment dated as of June 20, 2003, by JL Distributors, Inc. in favor of Fleet Capital Corporation as Lender to Five Star Group, Inc. Incorporated herein by reference to Exhibit 10.1 of Five Star Products, Inc. Form 10-Q for the quarter ended June 30, 2003. 10.12 Lease dated as of February 1, 1986 between Vernel Company and Five Star Group, Inc., as amended on July 25, 1994. Incorporated herein by reference to Exhibit 10.6 of Five Star Products, Inc. Form 10-K for the year ended December 31, 1998. 10.13 Lease dated as of May 4, 1983 between Vornado, Inc., and Five Star Group, Inc. Incorporated herein by reference to Exhibit 10.7 of Five Star Products, Inc. Form 10-K for the year ended December 31, 1998. 10.14 Credit Agreement dated March 8, 2001 by and between Allfirst Bank and MXL Industries, Inc* 10.15 Mortgage, Security Agreement, Assignment of Leases and Rents and Fixture Filing dated June 26, 2001 by MXL Industries, Inc. to LaSalle Bank National Association* 10.16 Amended and Restated Investor Rights Agreement dated as of May 30, 2003 by and among Hydro Med Sciences and certain Institutional Investors** 10.17 Stock Purchase Option Agreement dated as of June 30, 2004 by and among GP Strategies Corporation, National Patent Development Corporation, Valera Pharmaceuticals Inc. and certain Institutional Investors** 21.1 List of Subsidiaries** 99.1 Information Statement** * previously filed ** filed herewith SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the Registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized. NATIONAL PATENT DEVELOPMENT COPORATION BY: Jerome I. Feldman Chief Executive Officer Dated: August 9, 2004 EX-99 2 ex99.txt NATIONAL PATENT DEVELOPMENT CORPORATION INFORMATION STATEMENT August 13, 2004 Dear GP Strategies Stockholder: On July 30, 2004 the board of directors of GP Strategies Corporation approved a spin-off that will result in GP Strategies becoming two independent, publicly traded companies: o GP Strategies, which will own and operate GP Strategies' manufacturing & process business and information technology business through its wholly-owned subsidiary, General Physics Corporation, as well as GP Strategies' simulation business through its majority owned subsidiary, GSE Systems Inc.; and o National Patent Development Corporation, which will own and operate GP Strategies' optical plastics business through its subsidiary, MXL Industries, Inc., will own a majority interest in Five Star Products, Inc., a publicly held company that is a leading distributor in the United States of home decorating, hardware, and finishing products, and will own certain of GP Strategies' other non-core assets. The separation of these businesses will be accomplished through a pro rata distribution, which we refer to as the distribution, of 100% of the outstanding common stock of National Patent Development to GP Strategies stockholders on the record date for the distribution. As a result of the distribution, GP Strategies stockholders will: o receive one share of National Patent Development common stock for every share of GP Strategies common stock or Class B capital stock they own; and o retain their GP Strategies shares and the preferred stock purchase rights associated with those shares. Shares of National Patent Development common stock will be quoted on the OTC Bulletin Board under the symbol " ." Shares of GP Strategies common stock will continue to be listed on The New York Stock Exchange under the symbol "GPX." No action is required on your part to receive your National Patent Development shares. You will not be required either to pay anything for the new shares or to surrender any certificates representing shares of GP Strategies stock. The enclosed Information Statement describes the distribution of shares of National Patent Development common stock and contains important information about National Patent Development and its business. I suggest that you read it carefully. If you have any questions regarding the distribution, please contact National Patent Development's transfer agent, Computershare Investor Services LLC, P.O. Box 2388, Chicago, IL 60690-5440, Telephone: 312-360-5430. Very truly yours, Scott N. Greenberg President and Chief Financial Officer GP Strategies Corporation [National Patent Development Letterhead] August 13, 2004 Dear National Patent Development Stockholder: We are delighted to welcome you as an initial stockholder of National Patent Development Corporation. We will conduct the National Patent Development business as a company separate from GP Strategies Corporation, and our common stock will be publicly traded for the first time on August 13, 2004. You will receive one share of National Patent Development common stock for every share of GP Strategies common stock or Class B capital stock you own on the close of business on August 10, 2004. Shares of our stock will be quoted on the OTC Bulletin Board under the symbol " ." We will conduct our optical plastics business through our subsidiary, MXL Industries, Inc. We will also own a majority interest in Five Star Products, Inc., a publicly held company that is a leading distributor in the Northeast of home decorating, hardware, and finishing products, and will hold certain of GP Strategies' other non-core assets. We are excited about the opportunities that our spin-off from GP Strategies provides, and are enthusiastic about what the future holds. We believe that we have great potential to grow and are excited about your growing with us as a National Patent Development Corporation stockholder. Congratulations on becoming one of the "founding" stockholders of National Patent Development Corporation! Very truly yours, Jerome I. Feldman Chief Executive Officer National Patent Development Corporation INFORMATION STATEMENT [NPDC LOGO] Common Stock (par value $.01 per share) At this time, National Patent Development Corporation is wholly-owned by GP Strategies Corporation. In this spin-off, GP Strategies will distribute 100% of the shares of National Patent Development common stock to GP Strategies stockholders. Each of you, as a holder of GP Strategies' common stock or Class B capital stock, will receive one share of National Patent Development common stock for every share of GP Strategies common stock or Class B capital stock you own on the close of business on August 10, 2004, the record date for the spin-off. We are sending you this Information Statement to describe the spin-off. We expect the spin-off to occur on or about August 13, 2004. You will receive your proportionate number of shares of National Patent Development common stock through our transfer agent's book-entry registration system. These shares will not be in certificated form. Following the spin-off, recipient shareholders may request to receive their shares of our common stock in certificated form. Immediately after the spin-off is completed, GP Strategies will not own any shares of National Patent Development common stock, and we will be a public company independent of GP Strategies. We refer to ourselves in this Information Statement as "we" or "National Patent Development." No stockholder action is necessary to receive your shares of National Patent Development common stock. This means that: o you do not need to pay anything to GP Strategies or to National Patent Development; and o you do not need to surrender any shares of GP Strategies' common stock or Class B capital stock to receive your shares of National Patent Development common stock. In addition, a stockholder vote is not required for the spin-off to occur. GP Strategies is not asking you for a proxy, and GP Strategies requests that you do not send a proxy. There has been no trading market for National Patent Development common stock. We have arranged to have our common stock quoted on the OTC Bulletin Board under the symbol " ." As you review this Information Statement, you should carefully consider the matters described in "Special Considerations" beginning on page 7. -------------------- These securities have not been approved or disapproved by the Securities and Exchange Commission or any state securities commission nor has the Securities and Exchange Commission or any state securities commission passed upon the accuracy or adequacy of this Information Statement. -------------------- This Information Statement does not constitute an offer to sell or the solicitation of an offer to buy any securities. Changes may occur after the date of this Information Statement and neither National Patent Development nor GP Strategies will update the information contained herein except in the normal course of their respective public disclosures. -------------------- Stockholders of GP Strategies with inquiries related to the spin-off should contact Lydia M. DeSantis at (914) 249-9700, or GP Strategies' stock transfer agent and registrar, Computershare Investor Services LLC, P.O. Box A3504, Chicago, IL 60690-3504, Telephone: 312-360-5430. Computershare Investor Services LLC is also acting as distribution agent for the spin-off. The date of this Information Statement is August 13, 2004. ii Table of Contents Page ---- AVAILABLE INFORMATION....................................................ii SUMMARY 1 HISTORICAL SELECTED FINANCIAL DATA........................................6 SPECIAL CONSIDERATIONS....................................................7 FORWARD-LOOKING STATEMENTS...............................................10 THE SPIN-OFF.............................................................10 RELATIONSHIP BETWEEN GP STRATEGIES AND NATIONAL PATENT DEVELOPMENT.............................................................15 CAPITALIZATION...........................................................18 DIVIDEND POLICY..........................................................19 PRO FORMA CONSOLIDATED FINANCIAL INFORMATION.............................19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................................23 BUSINESS ................................................................33 MANAGEMENT...............................................................45 EXECUTIVE COMPENSATION...................................................49 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, DIRECTORS AND EXECUTIVE OFFICERS OF NATIONAL PATENT DEVELOPMENT.......................55 DESCRIPTION OF CAPITAL STOCK.............................................58 DESCRIPTION OF WARRANTS..................................................59 DESCRIPTION OF INDEBTEDNESS..............................................59 ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS..............................61 INDEMNIFICATION OF OFFICERS AND DIRECTORS................................64 INDEPENDENT ACCOUNTANTS..................................................65 INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS OF NATIONAL PATENT DEVELOPMENT CORPORATION..........................................F-1 AVAILABLE INFORMATION We have filed a registration statement on Form 10 with the Securities and Exchange Commission, or the Commission, under the Securities Exchange Act of 1934, or the Exchange Act, with respect to the shares of our common stock being distributed to GP Strategies stockholders in the distribution. This Information Statement, which forms a part of the registration statement, does not contain all of the information set forth in the registration statement. This Information Statement contains summaries of the material terms and provisions of documents filed as exhibits to the registration statement. For further information, you should refer to the registration statement and the exhibits. Copies of these documents may be inspected without charge at the Commission's Public Reference Room located at 450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Reference Room by calling the Commission at (800) SEC-0330. Copies of this material are also available through the Internet at the Commission's website, the address of which is http://www.sec.gov. Following the spin-off, National Patent Development will be required to comply with the reporting requirements of the Exchange Act and will file annual, quarterly and other reports with the Commission. National Patent Development also will be subject to the proxy solicitation requirements of the Exchange Act and, accordingly, will furnish annual reports containing audited financial statements to its stockholders in connection with its annual meetings of stockholders. After the spin-off, such reports, proxy statements and other information will be available to be inspected and copied at the public reference facilities of the Commission or obtained by mail or over the Internet from the Commission, as described above. In addition, after the distribution, we intend to maintain an Internet website at http://www.npdc.com. No person is authorized by GP Strategies or National Patent Development to give any information or to make any representations other than those contained in this Information Statement. If given or made, such information or representations must not be relied upon as having been authorized. SUMMARY This section contains a summary of all material terms of the Information Statement. Because this is a summary, it does not contain all the information that may be important to you. You should read the entire Information Statement, including our historical and pro forma consolidated financial statements and the notes to those financial statements included in this Information Statement. Unless otherwise indicated, references in this document to "we," "us," "our," or "National Patent Development" mean National Patent Development Corporation and its subsidiaries. National Patent Development National Patent Development was incorporated on March 10, 1998 as a wholly-owned subsidiary of GP Strategies Corporation. In July 2002, GP Strategies announced that it was actively considering transferring certain of its non-core assets into National Patent Development and spinning-off National Patent Development to the stockholders of GP Strategies. On November 14, 2002, GP Strategies filed a ruling request with the Internal Revenue Service with respect to the federal tax consequences of the proposed spin-off, and received a favorable ruling on March 21, 2003. On February 12, 2004, National Patent Development was recapitalized whereby the authorized capital was changed to 10,000,000 shares of preferred stock and 30,000,000 shares of common stock. Following the distribution, we will own 100% of the stock of MXL Industries, Inc., or MXL. The primary business of MXL is the manufacture of polycarbonate parts requiring adherence to strict optical quality specifications, and the application of abrasion and fog resistant coatings to those parts. MXL also designs and constructs injection molds for a variety of applications. We will also own a 64% interest in Five Star Products, Inc., or Five Star, a publicly held company that is a leading distributor in the United States of home decorating, hardware, and finishing products, and certain of GP Strategies' other non-core assets, including an investment in a publicly held company, Millennium Cell Inc.; an approximately 19.6% interest in a private company, Valera Pharmaceuticals, Inc. (formerly Hydro Med Sciences, Inc.); certain real estate; and the right to certain proceeds, if any, from a litigation and arbitration claim. Our principal office is located at 777 Westchester Avenue, White Plains, NY 10604, and our telephone number is (914) 249-9700. The Spin-Off The following is a brief set of questions and answers about the spin-off. What is the spin-off? The spin-off is the method by which GP Strategies will be separated into two independent, publicly held companies: o GP Strategies, which will own and operate GP Strategies' manufacturing & process business and information technology business through its wholly-owned subsidiary, General Physics Corporation as well as GP Strategies' simulation business through its majority owned subsidiary, GSE Systems Inc.; and o National Patent Development, which will own and operate GP Strategies' optical plastics business through its subsidiary, MXL, and will own 64% of Five Star and certain of GP Strategies' other non-core assets. Why is GP Strategies spinning off National Patent o To permit GP Strategies to improve its Development? borrowing capacity, thereby satisfying its need to raise additional funds as well as achieving other corporate benefits. o To allow financial markets to evaluate GP Strategies and National Patent Development separately. o To give National Patent Development's management more flexibility to take advantage of growth opportunities. What will I receive in the spin-off? GP Strategies will distribute one share of National Patent Development common stock for every share of GP Strategies common stock or Class B capital stock owned as of the record date. You will continue to own your GP Strategies stock. How will GP Strategies distribute National Patent Development common stock to me? National Patent Development stock will be issued as uncertificated shares registered in book-entry form through the direct registration system. No certificates representing National Patent Development common stock will be mailed to registered holders of GP Strategies common stock in the ordinary course. If you are a stockholder of record of GP Strategies stock on the record date, National Patent Development's transfer agent, Computershare Investor Services LLC, will hold your book-entry shares. On or about August 13, 2004, Computershare Investor Services LLC will mail you a direct registration transaction advice reflecting your ownership interest in shares of National Patent Development common stock. When you receive this advice, you will receive information explaining the direct registration system and telling you how to obtain physical certificates if you desire to do so. You will not receive new GP Strategies stock certificates. Notwithstanding the foregoing, holders of legended stock certificates representing GP common stock or Class B stock will receive legended physical stock certificates representing their National Patent Development common stock. When is the record date? The record date is August 10, 2004. What if I hold my shares of GP Strategies stock through my stockbroker, bank or other nominee? If you hold your shares of GP Strategies stock through your stockbroker, bank or other nominee, you are probably not a stockholder of record and your receipt of National Patent Development common stock depends on your arrangements with the nominee that holds your shares of GP Strategies stock for you. We anticipate that stockbrokers and banks generally will credit their customers' accounts with National Patent Development common stock on or about August 13, 2004, but you should check with your stockbroker, bank or other nominee. Following the spin-off, you may instruct your stockbroker, bank or other nominee to transfer your shares of National Patent Development common stock into your own name. What is National Patent Development's dividend policy? We currently anticipate that no cash dividends will be paid on our common stock in the foreseeable future in order to conserve cash for the repayment of debt, future acquisitions, and capital expenditures. We expect that our Board of Directors will periodically reevaluate this dividend policy, taking into account our operating results, capital needs, debt restrictions and other factors. How will National Patent Development's common stock trade? National Patent Development common stock will be quoted on the OTC Bulletin Board under the symbol " ", and we expect that regular trading will begin on August 13, 2004. Will my shares of GP Strategies continue to trade after the spin-off? Yes, GP Strategies common stock will continue to be listed and trade on the New York Stock Exchange under the symbol "GPX." However, we cannot provide you with any assurance as to the price at which the GP Strategies shares will trade following the distribution. Is the spin-off taxable for U.S. tax purposes? No; the Internal Revenue Service has ruled that the spin-off will be tax-free for U.S. tax purposes. To review tax consequences in detail, see pages 13-14. What are the risks involved in owning National Patent Development common stock? The separation of National Patent Development from GP Strategies presents certain risks. For example, National Patent Development has no prior history of operating as an independent company. Certain other risks are associated with owning National Patent Development common stock due to the nature of its business and the markets in which it competes. You are encouraged to carefully consider these risks, which are described in greater detail on pages 8-10. Will GP Strategies and National Patent Development be related in any way after the spin-off? GP Strategies will not own any National Patent Development common stock after the spin-off, and National Patent Development will operate as an independent, publicly held company. Several of National Patent Development's directors and officers are also directors and officers of GP Strategies. GP Strategies will enter into agreements with National Patent Development to allocate responsibility for liabilities (including tax and other contingent liabilities associated with their respective businesses or otherwise to be assumed by National Patent Development or GP Strategies), to separate their businesses, and for GP Strategies and National Patent to provide management services to each other. GP Strategies and National Patent Development will also provide certain guarantees of each others' financial obligations. These agreements are described in greater detail on pages 15 -17. What do I need to do now? You are not required to take any action, although we urge you to read this entire document carefully. No stockholder approval of the distribution is required or sought. We are not asking you for a proxy and you are requested not to send us a proxy. No action is required on your part to receive your National Patent Development shares. You will not be required either to pay anything for the new shares or to surrender any shares of GP Strategies stock. What We Have Already Accomplished to Prepare for the Spin-Off Board Appointments GP Strategies elected seven directors to begin their service on National Patent Development's Board effective as of the spin-off. See pages 45-46. Senior Management Appointments The National Patent Development board of directors has elected Jerome I. Feldman as Chairman and Chief Executive Officer, Scott N. Greenberg as Chief Financial Officer, and Andrea D. Kantor as Vice President and General Counsel. See page 46. Information Regarding the Spin-Off and National Patent Development Before the spin-off, you should direct inquiries relating to the spin-off to: Computershare Investor Services LLC GP Strategies Corporation P.O. Box 2388 777 Westchester Avenue Chicago, IL 60690-2388 White Plains, NY 10604 Telephone: 312-360-5430 Telephone: 914-249-9700 Attn: Andrea Kantor After the spin-off, you should direct inquiries relating to an investment in National Patent Development common stock to: ......... National Patent Development Corporation ......... 777 Westchester Avenue ......... White Plains, NY 10604 ......... 914-249-9708 ......... Attn: Lydia DeSantis After the spin-off, the transfer agent and registrar for National Patent Development's common stock will be: Computershare Investor Services LLC P.O. Box 2388 Chicago, IL 60690-3504 Telephone: 312-360-5430 Historical Selected Financial Data The following tables present: 1) summary historical consolidated operations data for each of the last five fiscal years ended December 31, 2003 and for the three month periods ended March 31, 2004 and 2003 and 2) summary historical consolidated balance sheet data for each of the last five fiscal years ended December 31, 2003 and as of March 31, 2004. The historical financial information as of December 31, 2003, 2002 and 2001 and for each of the three years ended December 31, 2003 has been derived from our audited financial statements, which are included elsewhere in this Information Statement. The historical financial information for the three months ended March 31, 2004 and 2003, as of March 31, 2004, and as of and for the years ended December 31, 2000 and 1999 have been derived from our unaudited consolidated financial statements (the historical financial statements as of and for the years ended December 31, 2000 and 1999 are not included in this Information Statement). The unaudited consolidated financial statements have been prepared on a basis consistent with the audited financial statements and, in the opinion of management, include all adjustments necessary for a fair presentation of such data. Before the spin-off and the related corporate restructuring transactions, we operated as part of GP Strategies. Because the data reflect periods during which we did not operate as an independent company, the historical data may not reflect the results of operations or the financial condition that would have resulted if we had operated as a separate, independent company during the periods shown. We have presented unaudited pro forma financial information as of March 31, 2004 and for the year ended December 31, 2003 to give a better picture of what this information might have looked like if National Patent Development had been operated independently during this period. The data may not necessarily be indicative of our future results of operations or financial condition. You should read the summary financial and operations data in conjunction with our audited financial statements and the notes to the audited financial statements. You should also read the sections "Pro Forma Consolidated Financial Information" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." The summary financial and operations data is qualified by reference to these sections, the audited financial statements and the notes to the audited financial statements, each of which is included elsewhere in this Information Statement. Historical Selected Financial Data (in thousands, except per share data): (unaudited) - ----------------------------------------- ------------------------- ------------------------------------------------------------
Consolidated Statement of Three Months Ended Operations Data (1) March 31, Year Ended December 31,________ --------- ---------------------- ------------------------------- 2004 2003 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- ---- ---- - ----------------------------------------- ------------ ------------ ------------- ---------- ----------- ----------- ----------- Sales $29,121 $27,431 $103,698 $9,996 $11,184 $10,998 $10,353 Gross Margin 4,764 4,671 19,582 2,099 2,816 2,888 2,719 Interest expense 205 205 864 208 169 102 147 Income (loss) before income taxes and minority interest (204) 173 383 292 764 (1,468) 948 Net income (loss) (297) (48) (104) 147 369 (960) 569 Pro forma net income (loss) per share: Basic and diluted $ (.02) $ .00 $ (.01)$ .01 $ .03 $ (.08) $ .05
- ----------------------------------------- --------------- ---------------------
Consolidated Balance Sheet Data (1) March 31, December 31,_______________ --------- ----------------------------------------------------- 2004 2003 2002 2001 2000 1999 ---- ---- ---- ---- ---- ---- - ----------------------------------------- --------------- ------------ ------------ ---------- ------------ ------- - ----------------------------------------- --------------- ------------ ------------ ---------- ------------ ---------- Cash and cash equivalents $ 202 $ 602 $ 562 $ 536 $ 627 $ 817 Short-term borrowings 22,919 16,960 - - - 1,500 Working capital 10,479 10,565 3,954 14,139 10,866 9,793 Total assets 60,504 55,748 29,870 30,836 29,441 29,695 Long-term debt 3,103 3,203 2,670 2,875 59 172 Stockholders' equity 16,539 17,236 25,451 26,025 26,580 25,443
(1) On October 8, 2003, the Company increased its ownership interest in Five Star's outstanding common stock from 48% to 54%, resulting in a controlling financial interest in Five Star and accordingly commenced consolidating Five Star's financial statements with those of the Company. Five Star's results of operations are included in the 2003 consolidated statement of operations as though a controlling financial interest had been acquired by the Company at the beginning of such year and, accordingly, Five Star's sales, cost of sales and expenses are included for the twelve months ended December 31, 2003. Five Star comprises the Company's new Home Improvement Distribution Segment. The acquisition of a controlling financial interest was accounted for as a purchase transaction. The following table represents the Company's unaudited pro forma consolidated statements of operations for the years ended December 31, 2003 and 2002, as if the acquisition of a controlling financial interest in Five Star had been completed at the beginning of each period. The pro forma information is presented for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisition actually been made at such dates, nor is it necessarily indicative of future operating results (in thousands, except per share data): ------------------------------------ ----------------------------------- Year ended December 31, ------------------------------------ ----------------------------------- ------------------------------------ ------------------ ---------------- 2003 2002 ------------------------------------ ------------------ ---------------- ------------------------------------ ------------------ ---------------- Sales $103,698 $104,070 Income before minority interest 61 585 Minority interest (319) (180) Net income $ 32 $ 405 Net income per share Basic and diluted $ .00 $ .03 ------------------------------------ ------------------ ---------------- As a result of an issuer tender offer by Five Star, approximately 2,648,000 shares of Five Star common stock were tendered and acquired by Five Star effective March 31, 2004 at a cost of $657,000. The effect of such tender offer was to increase our ownership in Five Star to approximately 64% at March 31, 2004. SPECIAL CONSIDERATIONS Risks Related to the Distribution We will have increased expenses as an independent public company. This could impair our profitability. We do not have an operating history as an independent company. Our business has historically relied on GP Strategies for various financial, managerial and administrative services and has been able to benefit from the earnings, assets and cash flows of GP Strategies' other businesses. GP Strategies will not be obligated to provide assistance or services to National Patent Development after the spin-off, except as provided in certain agreements entered into by the companies in connection with the spin-off, including the agreement pursuant to which the distribution will be effected and an agreement by GP Strategies to provide certain management services to National Patent Development. See "Relationship Between GP Strategies and National Patent Development." We also may not be able to develop our own management after the termination of the agreement under which GP Strategies will provide management services. Following the spin-off, we will incur the costs and expenses associated with the management of a public company. The spin-off may result in some temporary disruption to the business operation, as well as to the organization and personnel structure, of National Patent Development, which may have an adverse effect on our financial condition. Our historical consolidated financial information may not be representative of our historical results as an independent company; therefore, it may not be reliable as an indicator of historical or future results. Our historical consolidated financial information included in this Information Statement may not reflect what our financial condition, results of operations and cash flows would have been on a historical basis had we operated our business as an independent company during the periods presented or what our financial condition, results of operations and cash flows will be in the future. This is because our historical consolidated financial statements include allocations for services provided or procured by GP Strategies, which we may not be able to procure or provide ourselves on the same basis. In addition, we have not made adjustments to our historical consolidated financial information to reflect other changes that will occur in our cost structure, financing and operations as a result of the spin-off. These changes could potentially include increased costs associated with reduced economies of scale and a higher cost of capital, and also changes in how we fund our operations and development and pursue our strategic objectives. Therefore, our historical consolidated financial statements may not be indicative of our future performance as an independent company. GP Strategies and you would have federal income tax liabilities if the Tax Ruling were revoked. GP Strategies has received a ruling from the Internal Revenue Service, or IRS, to the effect that, among other things, the spin-off will be tax free to GP Strategies and GP Strategies stockholders under Section 355 of the Internal Revenue Code of 1986. We refer to this ruling as the Tax Ruling. The Tax Ruling, while generally binding upon the IRS, is based upon factual representations and assumptions made in the ruling request. If those factual representations and assumptions were materially untrue, or the facts upon which the Tax Ruling is based are materially different from the facts at the time of the spin-off, the IRS could modify or revoke the Tax Ruling retroactively. If the spin-off failed to qualify under Section 355 of the Internal Revenue Code, corporate tax would be payable by the consolidated group of which GP Strategies is the common parent based upon the difference between the aggregate fair market value of the stock of National Patent Development and the adjusted tax basis of such stock to GP Strategies prior to the spin-off. The corporate level tax would be payable by GP Strategies. We have agreed to indemnify GP Strategies for this and other tax liabilities if they result from certain actions taken by National Patent Development. See "Relationship between GP Strategies and National Patent Development--Tax Sharing Agreement." In addition, under the Internal Revenue Code's consolidated return regulations, each member of GP Strategies' consolidated group (including National Patent Development) is severally liable for these tax liabilities. If National Patent Development is required to indemnify GP Strategies for these liabilities or otherwise is found liable to the IRS for these liabilities, the resulting obligation could materially adversely affect our financial condition. Additionally, if the spin-off were not to qualify under Section 355 of the Internal Revenue Code, then each owner of GP Strategies stock who receives shares of National Patent Development common stock in the spin-off would be treated as if such stockholder received a taxable distribution in an amount equal to the fair market value of National Patent Development common stock received on the date it is received. Risks Related to our Business MXL's revenue and financial condition could be adversely affected by the loss of business from significant customers. For the three months ended March 31, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001, revenue from MXL's three largest customers represented approximately 26%, 44%, 37%, 52%, and 54% of MXL's revenue, respectively. MXL's revenue has declined over the past three years, partly due to the loss of business from its most significant customers. MXL has no significant long-term supply contracts and therefore its operations are dependent on its clients' continued satisfaction with its services and their continued willingness to engage MXL, rather than its competitors, to deliver such services. MXL's source of raw materials may be limited. MXL's primary raw material is plastic resin (principally polycarbonate). In the past, MXL primarily relied on one supplier for its raw materials. Due to new entrants in the market to supply plastic resin, MXL currently uses two suppliers and could choose from one or more other suppliers for plastic resin. However, if the number of suppliers again declined to past levels, MXL would be dependent on limited sources of supply for its raw materials, and the failure of MXL to fulfill its raw material requirement could have a material adverse affect on its business and financial condition. If our subsidiaries are unable to compete successfully, our revenues may be adversely affected. Competition in the optical plastics industry is vigorous. MXL's customers require state-of-the-art technology. In order to keep pace with MXL's customers' needs, MXL is required to constantly develop and improve its technology, facilities and production equipment and methods. MXL's future success will depend upon its ability to gain expertise in technological advances rapidly and respond quickly to evolving industry trends and client needs. Competition within the do-it-yourself industry is intense. There are large national distributors commonly associated with national franchises such as Ace and TruServ as well as smaller regional distributors, all of whom offer products and services similar to those offered by Five Star. Moreover, in some instances, manufacturers will bypass distributors and choose to sell and ship their products directly to retail outlets. In addition, Five Star's customers face stiff competition from Home Depot, which purchases directly from manufacturers, and national franchises such as Ace and TruServ. Five Star competes principally through its strategically placed distribution centers and its extensive inventory of quality, name-brand products. Five Star will continue to focus its efforts on supplying its products to its customers at a competitive price and on a timely, consistent basis. Our subsidiaries' inability to compete successfully would materially adversely affect our business and financial condition. Risks Related to Our Stock Because there has not been any public market for our common stock, the market price and trading volume of our common stock may be volatile and you may not be able to resell your shares at or above the initial market price of our stock following the distribution. There has been no trading market for our common stock. In general, all shares of common stock distributed in the distribution will be freely tradeable and our common stock will be quoted on the OTC Bulletin Board. We cannot, however, predict the extent to which investors' interest will lead to a liquid trading market or whether the market price of our common stock will be volatile. The market price of our common stock could fluctuate significantly for many reasons, including in response to the risks described in this section and elsewhere in this Information Statement or for reasons unrelated to our operations, such as reports by industry analysts, investor perceptions or negative announcements by our customers, competitors or suppliers regarding their own performance, as well as industry conditions and general financial, economic and political instability. We have agreed to restrictions and adopted policies that could have possible anti-takeover effects. We have agreed to certain restrictions on our future actions to assure that the spin-off will be tax-free, including restrictions with respect to an acquisition of shares of National Patent Development common stock. If we fail to abide by these restrictions, and, as a result, the spin-off fails to qualify as a tax-free reorganization, National Patent Development will be obligated to indemnify GP Strategies for any resulting tax liability. The potential tax liability that could arise from an acquisition of shares of National Patent Development common stock, together with our related indemnification obligations, could have the effect of delaying, deferring or preventing a change in control of National Patent Development. See "Relationship between GP Strategies and National Patent Development--Tax Sharing Agreement." Several provisions of our Certificate of Incorporation and Bylaws could deter or delay unsolicited changes in control of National Patent Development. These include limiting the stockholders' powers to amend the Bylaws or remove directors, and prohibiting the stockholders from increasing the size of the Board of Directors or acting by written consent instead of at a stockholders' meeting. Our Board of Directors has the authority, without further action by the stockholders to fix the rights and preferences of and issue preferred stock. These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in control or management of National Patent Development, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. These provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interests. See "Anti-Takeover Effects of Certain Provisions" and "Description of Capital Stock." FORWARD-LOOKING STATEMENTS This Information Statement contains forward-looking statements that are not based on historical facts. We use words such as "expects," "intends" and "anticipates" to indicate forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by these forward-looking statements, including those discussed under "Special Considerations" and "Management's Discussions and Analysis of Financial Condition and Results of Operations." If any one or more of these expectations and assumptions proves incorrect, actual results will likely differ materially from those contemplated by the forward-looking statements. Even if all of the foregoing assumptions and expectations prove correct, actual results may still differ materially from those expressed in the forward-looking statements as a result of factors we may not anticipate or that may be beyond our control. While we cannot assess the future impact that any of these differences could have on our business, financial condition, results of operations and cash flows or the market price of shares of our common stock, the differences could be significant. We do not undertake to update any forward-looking statements made by us. THE SPIN-OFF Reasons for the Spin-Off The GP Strategies Board of Directors has determined that the distribution of 100% of the outstanding common stock of National Patent Development to owners of GP Strategies common stock and Class B capital stock will enable the management of each of GP Strategies and National Patent Development to operate and develop those businesses more effectively. The GP Strategies Board of Directors has concluded that the spin-off is in the best interests of GP Strategies, National Patent Development and GP Strategies' stockholders because it believes that: o by engaging in the spin-off, GP Strategies would improve its access to capital and can significantly improve its borrowing capacity, thereby satisfying its need to raise additional funds as well as achieving other corporate benefits; o having two separate public companies will enable financial markets to evaluate each company more effectively, thereby enhancing stockholder value over the long term for both companies and making the stock of each more attractive as currency for future acquisitions; o the spin-off will provide National Patent Development's management with increased strategic flexibility and decision-making power to realize significant growth opportunities; and o having a separate management and ownership structure for National Patent Development will provide equity based compensation that is more closely related to the business in which its employees work. The GP Strategies Board of Directors explored various alternatives to the spin-off, including the sale of MXL, Five Star, and the non-core assets, or distributing certain of those assets directly to our existing shareholders. The GP Strategies Board of Directors determined that a tax free spin-off would most enhance shareholder value and improve liquidity for the shareholders. Actions to Be Taken Prior to the Distribution Prior to the distribution of common stock of National Patent Development to the stockholders of GP Strategies, or the Distribution, GP Strategies and National Patent Development will have engaged in certain transactions in preparation for the spin-off. On October 17, 2003, GP Strategies transferred 1,000,000 of its shares in Millennium Cell and its investment in Valera Pharmaceuticals to MXL in repayment of approximately $10,000,000 of debt owed by GP Strategies to MXL. We refer to this transaction as the "Repayment." GP Strategies and National Patent Development agreed to allocate to National Patent Development $1,875,000 of the $7,500,000 received for the sale of certain notes and warrants to certain Gabelli funds. See "Relationship between GP Strategies and National Patent Development-Gabelli Transaction Mortgage" and "Description of Warrants." Prior to the Distribution, GP Strategies will transfer these funds to National Patent Development. We refer to this transaction as the "Gabelli Allocation." Prior to the Distribution, GP Strategies will transfer to National Patent Development the right to receive certain proceeds (if any) of a pending litigation and arbitration claim, all of the MXL stock, and certain other non-core assets, including its shares in Five Star and certain debt of Five Star, in exchange for all of the common stock of National Patent Development. Such sale of National Patent Development common stock is exempt from registration under Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering of securities. Finally, National Patent Development will transfer to MXL the interest in the litigation and arbitration claim and the non-core assets it received, in exchange for additional MXL stock. We refer to the transactions described in this paragraph as the "Contribution," and we refer to the Repayment, the Gabelli Allocation, and the Contribution collectively as the "Corporate Restructuring Transactions." Manner of Effecting the Spin-Off GP Strategies will effect the spin-off as of the close of business on August 13, 2004. At that time, GP Strategies will distribute all of the outstanding common stock of National Patent Development to the stockholders of GP Strategies on a pro-rata basis so that each holder of GP Strategies stock will receive one share of National Patent Development common stock for each share of GP Strategies common stock or Class B capital stock held as of the close of business on August 10, 2004. National Patent Development stock will be issued as uncertificated shares registered in book-entry form through the direct registration system. No certificates representing National Patent Development common stock will be mailed to registered holders of GP Strategies common stock in the ordinary course. If you are a stockholder of record of GP Strategies stock on the record date, National Patent Development's transfer agent, Computershare Investor Services LLC, will hold your book-entry shares. On or about August 13, 2004, Computershare Investor Services LLC will mail you a direct registration transaction advice reflecting your ownership interest in shares of National Patent Development common stock. When you receive this advice, you will receive information explaining the direct registration system and telling you how to obtain physical certificates if you desire to do so. You may also retain, transfer or sell the shares, or transfer the shares to a brokerage account. Notwithstanding the foregoing, holders of legended stock certificates representing GP common stock or Class B stock will receive legended physical stock certificates representing their National Patent Development common stock. No owner of GP Strategies stock will be required to pay any cash or other consideration for shares of National Patent Development received in the spin-off or to surrender or exchange any shares of GP Strategies stock to receive shares of National Patent Development. The actual total number of shares of National Patent Development common stock to be distributed will depend on the number of shares of GP Strategies stock outstanding on August 10, 2004. The shares of National Patent Development common stock distributed in the spin-off will be fully paid and nonassessable and will not be entitled to preemptive rights. See "Description of Capital Stock." Distribution Agreement The spin-off will be made pursuant to a distribution agreement between GP Strategies and National Patent Development, which we refer to as the Distribution Agreement. The Distribution Agreement: o sets forth the principal corporate transactions that are intended to be effected prior to the spin-off, including the Corporate Restructuring Transactions, o provides for execution and delivery of certain of the agreements described in "Relationship between GP Strategies and National Patent Development," o provides for the allocation of certain assets and liabilities between National Patent Development and GP Strategies, and for the transfer to and assumption by the appropriate company of those assets and liabilities, o establishes the procedures to effect the spin-off, and o provides for the distribution of the National Patent Development common stock to the stockholders of GP Strategies. Under the Distribution Agreement, the distribution is subject to the satisfaction or waiver by the GP Strategies Board of Directors of certain conditions. These include, among other customary conditions, the following: o the registration statement filed with the Securities and Exchange Commission in order to register the National Patent Development common stock shall have been declared effective and no stop order shall be entered, initiated or threatened, o quotation of the National Patent Development common stock on the OTC Bulletin Board, o the Tax Ruling shall continue to be in effect, o the Corporate Restructuring Transactions shall be completed, o the National Patent Development Certificate of Incorporation and Bylaws shall be in effect, and o the National Patent Development Board of Directors, as named under "Management--Directors," and the National Patent Development officers, as named under "Management--Executive Officers," shall have been elected. Under the Distribution Agreement, GP Strategies and National Patent Development have each agreed to retain certain books and records and to make available to the other its personnel, property, books, records, and other data and information relating to operations before the distribution as may be required for the requesting party's business (but not for competitive purposes). Each has also agreed to make generally available its officers, directors, employees, and agents for fact finding, consultation or interviews, and as witnesses in connection with certain legal actions. Each of GP Strategies and National Patent Development has also agreed to indemnify the other in connection with the liabilities it assumes and any breach by it of the Distribution Agreement or other agreements entered into in connection with the spin-off. In particular, GP Strategies and National Patent Development each agreed that neither would take any action that might cause the spin-off of National Patent Development to not qualify as a tax-free distribution under Section 355 of the Internal Revenue Code. Should one party take an action which causes the spin-off not to so qualify, then that party would be liable to the other for any taxes incurred by the other from the failure of the spin-off to qualify as a tax-free distribution. The Distribution Agreement specifies procedures with respect to claims subject to indemnification and related matters. The Distribution Agreement provides that it may be terminated or amended, modified, or abandoned at any time prior to the Distribution in the sole discretion of GP Strategies, without National Patent Development's approval or the approval of GP Strategies' stockholders. In the event of a termination of the Distribution Agreement, no party shall have any liability of any kind to any other party. After the Distribution, the Distribution Agreement generally may not be terminated except by an agreement in writing signed by GP Strategies and National Patent Development. Results of Spin-Off After the spin-off, National Patent Development will be a separate public company. Immediately after the spin-off, the number and identity of stockholders of record of National Patent Development will be the same as the number and identity of stockholders of record of GP Strategies on August 10, 2004, the record date for the spin-off, and the number of shares of National Patent Development common stock issued and outstanding will equal the number of shares of GP Strategies common stock and Class B capital stock issued and outstanding on such record date. As of the close of business on August 10, 2004, GP Strategies had ____ stockholders of record and ____ shares of common stock and Class B capital stock issued and outstanding. The spin-off will not affect the number of outstanding shares of GP Strategies stock or the rights of GP Strategies stockholders. Shares of GP Strategies common stock will continue to be listed on the New York Stock Exchange under the symbol "GPX." Other Consequences The exercise price of outstanding GP Strategies options and warrants will be adjusted based on the relative fair market values of the GP Strategies stock before and after the spin-off. National Patent Development has also agreed to issue certain warrants following effectiveness of the spin-off. See "Description of Warrants." Material Federal Income Tax Consequences of the Spin-Off The following summary discusses the material U.S. federal income tax consequences of the spin-off of National Patent Development to United States Holders of GP Strategies common stock or Class B capital stock. This discussion is based on the Internal Revenue Code, the Treasury Regulations promulgated thereunder, judicial opinions, published positions of the IRS, and all other applicable authorities as of the date of this document, all of which are subject to change (possibly with retroactive effect). As used in this document, the term "United States Holder" means: o a citizen or resident of the United States; o a corporation, or other entity taxable as a corporation for U.S. federal income tax purposes, created or organized in or under the laws of the United States or of any political subdivision thereof; or o an estate or trust the income of which is subject to United States federal income taxation regardless of its source. The term United States Holder also includes certain former citizens and residents of the United States. This discussion does not describe all of the tax consequences that may be relevant to a holder in light of his particular circumstances or to holders subject to special rules, such as: o certain financial institutions; o insurance companies; o tax-exempt organizations; o dealers in securities or foreign currencies; o persons holding GP Strategies common stock or Class B capital stock as part of a hedge; o United States Holders whose functional currency is not the U.S. dollar; o partnerships or other entities classified as partnerships for U.S. federal income tax purposes; o persons subject to the alternative minimum tax; o stockholders who acquired their GP Strategies common stock or Class B capital stock through the exercise of options or otherwise as compensation or through a tax-qualified retirement plan; or o holders of options granted under any GP Strategies benefit plan. In addition, this summary is limited to stockholders that hold their GP Strategies common stock or Class B capital stock as capital assets. This discussion also does not address any tax consequences arising under the laws of any state, local or foreign jurisdiction. Accordingly, each GP Strategies stockholder is strongly urged to consult with a tax adviser to determine the particular federal, state, local or foreign income or other tax consequences to him or her of the spin-off. GP Strategies has obtained the Tax Ruling from the IRS to the effect that the spin-off will be tax-free to GP Strategies and its stockholders under Sections 355 and 368(a) of the Internal Revenue Code. The Tax Ruling's continuing validity is subject to factual representations and assumptions. Neither GP Strategies nor National Patent Development is aware of any facts or circumstances that would cause such representations and assumptions to be untrue. Assuming the continuing effectiveness of the Tax Ruling, for U.S. federal income tax purposes, the tax consequences of the spin-off are as follows: o no gain or loss will be recognized by, and no amount will be included in the income of, GP Strategies upon the spin-off of National Patent Development other than gains, if any, related to certain intercompany transactions that will be triggered by the spin-off; o no gain or loss will be recognized by, and no amount will be included in the income of, United States Holders of GP Strategies common stock or Class B capital stock upon their receipt of shares of National Patent Development common stock in the spin-off; o a United States Holder of GP Strategies common stock or Class B capital stock will apportion the tax basis of such holder's GP Strategies common stock or Class B capital stock on which National Patent Development common stock is distributed between such holder's GP Strategies stock and the National Patent Development common stock received in the spin-off in proportion to the fair market values of such GP Strategies stock and National Patent Development common stock on the date of the spin-off; and o the holding period of the shares of National Patent Development common stock received by a United States Holder of GP Strategies common stock or Class B capital stock in the spin-of will include the period during which such holder held the GP Strategies common stock or Class B capital stock on which the National Patent Development common stock is distributed. Current Treasury Regulations require each holder of GP Strategies common stock or Class B capital stock who receives National Patent Development common stock in the spin-off to attach to his or her federal income tax return for the year in which the National Patent Development spin-off occurs a detailed statement setting forth such data as may be appropriate in order to show the applicability of Section 355 of the Code to the National Patent Development spin-off. GP Strategies will provide the appropriate information to each of its stockholders of record. If the spin-off failed to qualify under Section 355 of the Internal Revenue Code, corporate tax would be payable by the consolidated group of which GP Strategies is the common parent based upon the difference between the aggregate fair market value of the stock of National Patent Development and the adjusted tax basis of such stock to GP Strategies prior to the spin-off. The corporate level tax would be payable by GP Strategies. We have agreed to indemnify GP Strategies for this and other tax liabilities if they result from certain actions taken by National Patent Development. See "Relationship between GP Strategies and National Patent Development--Tax Sharing Agreement." In addition, under the Internal Revenue Code's consolidated return regulations, each member of GP Strategies' consolidated group (including National Patent Development) is severally liable for these tax liabilities. If National Patent Development is required to indemnify GP Strategies for these liabilities or otherwise is found liable to the IRS for these liabilities, the resulting obligation could materially adversely affect our financial condition. Additionally, if the spin-off were not to qualify under Section 355 of the Internal Revenue Code, then each owner of GP Strategies stock who receives shares of National Patent Development common stock in the spin-off would be treated as if such stockholder received a taxable distribution in an amount equal to the fair market value of National Patent Development common stock received on the date it is received. In such a case, the distribution will be a taxable dividend to the stockholder to the extent that the distribution is made out of current or accumulated earnings and profits of GP Strategies. If the amount of the distribution exceeds current and accumulated earnings and profits, the excess amount will be a tax-free return of capital to the extent of the stockholder's tax basis in the GP Strategies stock and then any remaining amount will be taxable gain to the stockholder. No loss will be recognized. Any gain recognized by a stockholder will be capital gain, provided the GP Strategies shares are held as capital assets. Capital gains are long term if the GP Strategies stock is held for more than twelve months at the time of the distribution. For individuals, the maximum federal income tax rate applicable to long-term capital gains and dividends is generally 15%. Quotation of National Patent Development Common Stock There currently is no public market for National Patent Development's common stock and we do not intend to list National Patent Development common stock on a securities exchange or Nasdaq. However, National Patent Development common stock will be quoted on the OTC Bulletin Board. The prices at which the National Patent Development common stock will trade following the spin-off will be determined by the marketplace and may be influenced by many factors, including the depth and liquidity of the market for National Patent Development common stock, investor perceptions of National Patent Development, its business and prospects, results of operations, and general economic and market conditions. Prior to the record date for the spin-off, GP Strategies stock will continue to trade on a regular basis reflecting the combined value of GP Strategies and National Patent Development. The Transfer Agent and Registrar for the National Patent Development common stock will be Computershare Investor Services LLC, P.O. Box 2388, Chicago, IL 60690-5430, Telephone: 312-360-5430. As of August 10, 2004, there were ___ record holders of GP Strategies stock, which equals the number of prospective record holders of National Patent Development common stock immediately after the spin-off. National Patent Development common stock distributed in the spin-off generally will be freely transferable under the Securities Act of 1933, or the Securities Act, except for securities received by persons who may be deemed to be affiliates of National Patent Development pursuant to Rule 405 under the Securities Act. Persons who may be deemed to be affiliates of National Patent Development after the spin-off generally include individuals or entities that control, are controlled by, or are under common control with National Patent Development, including directors of National Patent Development. Persons who are affiliates of National Patent Development will be permitted to sell their shares of National Patent Development common stock received in the spin-off only pursuant to an effective registration statement under the Securities Act or pursuant to an exemption from the registration requirements of the Securities Act, such as the exemption provided by Rule 144 under the Securities Act (subject to the conditions set forth in Rule 144, other than its holding period requirements). Reasons for Furnishing this Document This document is being furnished by GP Strategies solely to provide information to GP Strategies stockholders who will receive National Patent Development common stock in the spin-off. It is not, and is not to be construed as, an inducement or encouragement to buy or sell any securities of GP Strategies or National Patent Development. We believe that the information contained in this document is accurate as of the date on the cover. Changes may occur after that date, and neither GP Strategies nor National Patent Development will update the information except as is required in the normal course of their public disclosure practices. RELATIONSHIP BETWEEN GP STRATEGIES AND NATIONAL PATENT DEVELOPMENT Prior to the spin-off, National Patent Development will continue to be a wholly-owned subsidiary of GP Strategies. In the past, GP Strategies and entities that will become National Patent Development's subsidiaries as a result of the Corporate Restructuring Transactions, including MXL and Five Star (which became a majority-owned subsidiary of GP Strategies commencing in the fourth quarter of 2003), have engaged in various transactions with each other. These relationships, which include financial and managerial support by GP Strategies of these subsidiaries, will cease in their current forms at the time of the spin-off, except for certain financial guarantees of each others' obligations. GP Strategies and National Patent Development have entered or will enter into contracts that will govern certain relationships between them following the Distribution, including the Distribution Agreement and the agreements described below. National Patent Development and GP Strategies believe that these agreements are at fair market value and are on terms comparable to those that would have been reached in arm's-length negotiations had the parties been unaffiliated at the time of the negotiations. The Distribution Agreement and the other agreements described below are included as exhibits to National Patent Development's registration statement on Form 10 of which this Information Statement is a part. The Agreements will be effective on or before the date of the Distribution. See "The Spin-Off--Distribution Agreement." Management Agreements National Patent Development's executive officers are also executive officers of GP Strategies and will remain on the payroll of GP Strategies. The executive officers will not receive any salary from National Patent Development; however, they will provide National Patent Development with management services under a management agreement between GP Strategies and National Patent Development to be entered into prior to completion of the spin-off. GP Strategies will charge National Patent Development a management fee to cover an allocable portion of the compensation of these officers, based on the time they spend providing services to National Patent Development, in addition to an allocable portion of certain other corporate expenses. In connection with the spin-off, National Patent Development will also enter into a separate management agreement with GP Strategies pursuant to which National Patent Development will provide certain general corporate services to GP Strategies. Under this management agreement, National Patent Development will charge GP Strategies a management fee to cover an allocable portion of the compensation of its employees, based on the time they spend providing services to GP Strategies, in addition to an allocable portion of corporate overhead related to services performed for GP Strategies and its subsidiaries. Both management fees will be paid quarterly. Any disagreements over the amount of such fees will be subject to arbitration. See the Unaudited Pro Forma Statements of Operations for the year ended December 31, 2003 included elsewhere in this Information Statement for the estimated impact of the management agreements on the operations of National Patent Development. Each of the management agreements will each have an initial term of three years, and, after two years, will be terminable by each of GP Strategies and National Patent Development, upon six months' prior written notice. GPS provides legal, tax, business development, insurance and employee benefit administration services to Five Star pursuant to a management services agreement for a fee of up to $10,000 per month. The agreement is automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of any renewal thereof. The agreement was renewed for 2003 and 2004. The management fee will increase to $25,000 per month effective July 1, 2004. Prior to the Distribution, GP Strategies will transfer to National Patent Development the rights and obligations under the management services agreement with Five Star. Credit Agreement As of December 31, 2003, MXL provided security for General Physics' Financing and Security Agreement, or the Credit Agreement. The Credit Agreement provides for a maximum outstanding balance of $25 million and was secured by certain of the assets of General Physics and the accounts receivable of MXL. The Credit Agreement is also guaranteed by GP Strategies. MXL provided a limited guaranty up to the value of its account receivable collateral securing the Credit Agreement. For the continuation of the bank's security interest in MXL's accounts receivable and the continuation of its limited guarantee after the spin-off, General Physics paid MXL an annual guarantee fee of 2% of the value of the borrowing base collateral attributable to MXL, calculated monthly. At General Physics' option, General Physics could eliminate MXL's accounts receivable from the borrowing base under the Credit Agreement, provided that General Physics made a mandatory prepayment under the Credit Agreement to eliminate any borrowing base deficiency. At such point, all obligations of MXL relating to the Credit Agreement would terminate, MXL's limited guaranty of the Credit Agreement would become void, and General Physics would no longer be required to pay to MXL the guarantee fee. In March 2004 General Physics eliminated MXL's accounts receivable from the borrowing base, no mandatory prepayment was required by General Physics, and the guarantee fee was eliminated. Tax Sharing Agreement The following is a summary of the Tax Sharing Agreement that will be entered into between GP Strategies and National Patent Development. National Patent Development is currently included in GP Strategies' federal consolidated income tax group and National Patent Development's tax liability will be included in the consolidated federal income tax liability of GP Strategies until the time of the spin-off. The Tax Sharing Agreement will provide for tax sharing payments between GP Strategies and National Patent Development for periods prior to the spin-off, so that National Patent Development will be generally responsible for the taxes attributable to its lines of business and entities comprising it and GP Strategies will be generally responsible for the taxes attributable to its lines of business and the entities comprising it. GP Strategies and National Patent Development will agree that taxes related to intercompany transactions that are triggered by the National Patent Development spin-off will be generally allocated to GP Strategies. GP Strategies and National Patent Development will agree that joint non-income tax liabilities will generally be allocated between GP Strategies and National Patent Development based on the amount of such taxes attributable to each group's line of business. If the line of business with respect to which the liability is appropriately associated cannot be readily determined, the tax liability will be allocated to GP Strategies. Under the Distribution Agreement, GP Strategies and National Patent Development each agreed that neither would take any action that might cause the spin-off of National Patent Development to not qualify as a tax-free distribution under Section 355 of the Code. Should one party take an action which causes the spin-off not to so qualify, then that party would be liable to the other for any taxes incurred by the other from the failure of the spin-off to qualify as a tax-free distribution. Gabelli Transaction Mortgage Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, GP Strategies issued and sold to four Gabelli funds $7,500,000 aggregate principal amount of 6% Conditional Subordinated Notes due 2008, or the Gabelli Notes, and 937,500 warrants, or the GP Warrants, each entitling the holder thereof to purchase (subject to adjustment) one share of GP Strategies common stock. See "Description of Warrants." The Gabelli Notes are secured by a mortgage on GP Strategies' property located in Pawling, New York that will be contributed to MXL in connection with the spin-off. See "Business--Pawling Property." MXL will assume the mortgage, but without liability for repayment of the Gabelli Notes or any other obligations of GP Strategies under the Note and Warrant Purchase Agreement (other than foreclosure on such property). If there is a foreclosure on the mortgage for payment of the Gabelli Notes, GP Strategies has agreed to indemnify MXL for loss of the value of the property. GP Strategies and National Patent Development agreed to allocate to National Patent Development $1,875,000 of the $7,500,000 received for the Gabelli Notes and GP Warrants. Prior to the Distribution, GP Strategies will transfer these funds to National Patent Development pursuant to the Gabelli Allocation. Financial Guarantees GP Strategies has guaranteed the leases for Five Star's New Jersey and Connecticut warehouses, totaling approximately $1,589,000 per year through the first quarter of 2007, and an aggregate of $116,000 for certain equipment leases through April 2004. GP Strategies' guarantee of such leases was in effect when the Five Star business was conducted by a wholly-owned subsidiary of GP Strategies. In 1998, GP Strategies sold substantially all of the operating assets of the Five Star business to the predecessor corporation of Five Star. As part of this transaction, the landlord of the New Jersey and Connecticut facilities and the lessor of the equipment did not consent to the release of GP Strategies' guarantee. GP Strategies has also guaranteed the mortgages for MXL's Illinois and Pennsylvania properties through June 2006 and March 2011, respectively, as well as $700,000 in debt entered into by MXL on October 1, 2003 in connection with the acquisition of certain assets from AOtec, LLC. GP Strategies' guarantees will continue after the spin-off. Claims Relating to Learning Technologies Acquisition On January 3, 2001, GP Strategies commenced an action alleging that MCI Communications Corporation, or MCI, MCI's Systemhouse subsidiaries, or Systemhouse, and Electronic Data Systems Corporation, as successor to Systemhouse, or EDS, committed fraud in connection with GP Strategies' 1998 acquisition of Learning Technologies from the defendants for $24.3 million. GP Strategies seeks actual damages in the amount of $117.9 million plus interest, punitive damages in an amount to be determined at trial, and costs. The complaint, which is pending in the New York State Supreme Court, alleges that the defendants created a doctored budget to conceal the poor performance of the United Kingdom operation of Learning Technologies. The complaint also alleges that the defendants represented that Learning Technologies would continue to receive new business from Systemhouse even though the defendants knew that the sale of Systemhouse to EDS was imminent and that such new business would cease after such sale. In February 2001, the defendants filed answers denying liability. No counterclaims against the plaintiffs have been asserted. Although discovery had not yet been completed, defendants made a motion for summary judgment, which was submitted in April 2002. The motion was denied by the court due to the MCI bankruptcy described below, but with leave to the other defendants to renew. The defendants other than MCI then made an application to the court to stay the fraud action until a later-commenced arbitration, alleging breach of the acquisition agreement and of a separate agreement to refer business to General Physics on a preferred provider basis and seeking actual damages in the amount of $17.6 million plus interest, is concluded. In a decision dated May 9, 2003, the court granted the motion and stayed the fraud action pending the outcome of the arbitration. Limited discovery was conducted in connection with the arbitration. The arbitration hearings began on May 17, 2004 and concluded on May 24, 2004 before JAMS, a private dispute resolution firm. MCI filed for bankruptcy protection in July 2002. As a result, the action was automatically stayed as to MCI. GP Strategies and its subsidiary, General Physics, both filed timely Proofs of Claim in the United States Bankruptcy Court against MCI and WorldCom, Inc., among others. On or around April 22, 2003, MCI served objections to these Proofs of Claim. On May 15, 2003, GP Strategies and General Physics submitted their opposition to the objections. GP Strategies and General Physics subsequently made a motion in Bankruptcy Court to lift the automatic stay to permit the litigation to proceed against MCI. In February 2004, the Bankruptcy Court granted the motion of GP Strategies and General Physics to the extent that they sought to have the stay lifted so that the state court could rule on the merits of MCI's summary judgment motion. On February 19, 2004, GP Strategies and General Physics notified the state court of the Bankruptcy Court's decision. GP Strategies will make a capital contribution to National Patent Development, which in turn will transfer to MXL, the right to receive the first $5 million of any proceeds (net of litigation expenses), and 50% of any proceeds (net of litigation expenses) in excess of $15 million, received with respect to the foregoing claims. CAPITALIZATION The following table sets forth (a) the capitalization of National Patent Development as of March 31, 2004, which gives effect to the Contribution, and (b) our pro forma capitalization at that date, which also gives effect to (i) the Gabelli Allocation and (ii) the Distribution. The capitalization table below should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations," our historical consolidated financial statements, and our unaudited pro forma consolidated financial statements and the notes to those financial statements included elsewhere in this Information Statement. The capitalization table below may not be indicative of our capitalization or financial condition had the Contribution been completed on the date assumed. The capitalization table below may not reflect the capitalization or financial condition that would have resulted had we been operated as a separate, independent entity at that date and is not necessarily indicative of our future capitalization or financial condition. As of March 31, 2004 ---------------------------------- (unaudited, in thousands, except per share data)
Actual Pro Forma(1) Preferred stock, authorized 10,000,000 shares, par value $.01 per share; none issued Common stock, authorized 30,000,000 shares, par value $.01 per share; issued and outstanding 17,618,166 shares (pro forma)(2) $176 Paid in capital 20,015 Stockholder's investment $18,316 Accumulated deficit (797) (797) Accumulated other comprehensive income (980) (980) ------- -------- Total stockholders' equity $16,539 $18,414 ======= ======= - --------------------
(1) See the pro forma consolidated financial information and notes thereto included elsewhere herein. (2) The number of shares outstanding is based upon the number of shares of GP Strategies common stock and Class B capital stock outstanding at March 31, 2004. The actual number of shares ultimately to be issued by National Patent Development and distributed will depend on the number of shares of GP Strategies common stock and Class B capital common stock outstanding on the record date of the Distribution. DIVIDEND POLICY We do not anticipate paying any dividends on our common stock in the foreseeable future because we expect to retain our future earnings for use in the operation and expansion of our business, including the repayment of debt, future acquisitions, and capital expenditures. The payment and amount of any dividends will be subject to the discretion of our board of directors. We expect that our Board of Directors will periodically reevaluate this dividend policy, taking into account our financial condition, results of operations, cash requirements, capital needs, debt restrictions, prospects, and other factors. PRO FORMA CONSOLIDATED FINANCIAL INFORMATION (Unaudited) The historical financial statements of National Patent Development assume that the Contribution had occurred as of the beginning of the period or at the date indicated. The following unaudited Pro Forma Consolidated Statement of Operations for the year ended December 31, 2003 presents the results of operations of National Patent Development assuming (a) additional overhead to be incurred by National Patent Development in connection with the spin-off (we refer to this additional overhead as the "Additional Overhead") and (b) the Distribution had occurred as of the beginning of the period presented. The Additional Overhead reflects management's belief that the operations of National Patent Development after the spin-off will require greater overhead than the overhead allocation historically associated with the National Patent Development business. The Pro Forma Consolidated Statement of Operations for the three months ended March 31, 2004 is not presented because the historical Consolidated Statement of Operations for the period reflects a level of corporate allocations from GP Strategies for which no Additional Overhead is believed necessary. The following unaudited Pro Forma Consolidated Balance Sheet as of March 31, 2004 presents the balance sheet of National Patent Development assuming the Gabelli Allocation and the Distribution had also occurred on that date. In the opinion of management, the unaudited Pro Forma Consolidated Financial Statements include all material adjustments necessary to reflect, on a pro forma basis, the impact of the Additional Overhead, the Gabelli Allocation, and the Distribution on National Patent Development's historical financial information. The adjustments are described in the Notes to the Pro Forma Consolidated Financial Information (Unaudited) and are set forth in the "Pro Forma Adjustments" columns. The unaudited Pro Forma Consolidated Financial Information of National Patent Development should be read in conjunction with the historical financial statements of National Patent Development beginning on page F-1. We have presented unaudited pro forma financial information to give you a better picture of what our financial statements might have looked like if the Additional Overhead, the Gabelli Allocation, and the Distribution had occurred as of such dates. Actual results may have differed from pro forma results. You should not rely on the pro forma financial information as being indicative of the financial position that would have resulted, the results of operations that would have been attained or future results after the spin-off. NATIONAL PATENT DEVELOPMENTCORPORATION PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2003 (in thousands, except share data) (unaudited)
Pro forma Pro forma Historical Adjustments Consolidated Sales $103,698 $103,698 Cost of sales 84,116 84,116 ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Gross margin 19,582 19,582 Selling, general and administrative (18,274) (1,600)(A) (19,662) 212 (B) Interest expense (864) (864) Other income (61) (61) ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Income (loss) before income taxes and minority interest 383 (1,388) (1,005) ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Income tax (benefit) expense 176 83 (C) 259 ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Income (loss) before minority interest 207 (1,471) (1,264) ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Minority interest (311) (8)(D) (319) ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Net income(loss) $(104) $ (1,479) $ (1,583) ------------------------------------------ -------------- -------------------- ---------------- ------------------------------------------ -------------- -------------------- ---------------- Pro forma net (loss) per share: Basic and diluted $ (.09) ======- Number of common shares outstanding (E) 17,618,166 ==========
NATIONAL PATENT DEVELOPMENT CORPORATION PRO FORMA CONSOLIDATED BALANCE SHEET AS OF MARCH 31, 2004 (in thousands) (unaudited)
Pro forma Pro forma Historical Adjustments Consolidated Assets Current assets Cash and cash equivalents $ 202 $1,875(F) $2,077 Accounts and other receivables, net 19,425 19,425 Inventories 27,967 27,967 Receivable from GP Strategies 1,486 1,486 Deferred tax assets 213 213 Prepaid expenses and other current assets 349 349 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- Total current assets 49,642 1,875 51,517 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- Marketable securities available for sale 2,028 2,028 Property, plant and equipment, net 5,643 5,643 Other assets 3,191 3,191 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- $60,504 $1,875 $62,379 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- Liabilities and stockholders' equity Current liabilities Current maturities of long-term debt $ 394 $ 394 Short-term borrowing 22,919 22,919 Accounts payable and accrued expenses 15,850 15,850 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- Total current liabilities 39,163 39,163 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- Long-term debt less current maturities 3,103 3,103 Deferred tax liability 114 114 Interest rate swap, at market 196 196 Minority interest 1,389 1,389 Stockholder's equity Common stock 176(G) 176 Capital in excess of par value 18,140(G) 20,015 1,875(F) Stockholder's investment 18,316 (18,423)(G) Accumulated deficit (797) (797) Accumulated other comprehensive loss (980) (980) --------------------------------------------------- -------------- ---------------- --------------- Total stockholders' equity 16,539 1,875 18,414 --------------------------------------------------- -------------- ---------------- --------------- --------------------------------------------------- -------------- ---------------- --------------- $60,504 $1,875 $62,379 --------------------------------------------------- -------------- ---------------- ---------------
Notes to Pro forma Consolidated Financial Statements: (A) To reflect estimated Additional Overhead consisting of (i) certain general corporate expenses necessary for National Patent Development to operate on a stand-alone basis, including compensation of certain corporate personnel transferred to National Patent Development, net of management fee estimated to be charged to GP Strategies for services performed plus (ii) estimated allocation of compensation and other expenses related to executive officers of both National Patent Development and GP Strategies, who will remain on the payroll of GP Strategies, for services estimated to be performed for National Patent Development. (B) To reduce the depreciation expense relating to property, plant and equipment to reflect the reduction in property, plant and equipment resulting from the allocation of negative goodwill arising in purchase accounting. (C) To record the tax effect of the negative goodwill arising in purchase accounting, which reduced property, plant and equipment. (D) To record additional minority interest to reflect a 54% ownership interest in Five Star for the full fiscal year 2003. (E) Pro forma basic and diluted (loss) per share is based upon the number of shares of GP Strategies common stock and Class B capital stock outstanding at March 31, 2004. (F) Adjustment to reflect the Gabelli Allocation of $1,875,000, which will be transferred to National Patent Development by GP Strategies prior to the Distribution. See "Actions to Be Taken Prior to the Distribution." (G) To reflect the issuance of 17,618,166 shares of common stock based upon the number of shares of GP Strategies common stock and Class B capital stock outstanding on March 31, 2004. The actual number of shares ultimately to be issued by National Patent Development and distributed will depend on the number of shares of GP Strategies common stock and Class B capital stock outstanding on the record date of Distribution. The pro forma consolidated financial statements do not reflect warrants to purchase common stock that will be issued to certain Gabelli funds in connection with the spin-off. Such warrants may have a dilutive effect. See "Description of Warrants." MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis together with the audited consolidated financial statements and notes thereto included elsewhere in this Information Statement. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of this Information Statement entitled "Special Considerations" and "Forward-Looking Statements." General Overview The following is a discussion and analysis of the separate historical consolidated financial statements of National Patent Development and should be read in conjunction with those financial statements, which are found elsewhere in this Information Statement. The historical financial statements included herein may not be indicative of the results of operations, financial position and cash flows of National Patent Development in the future or had it operated as a separate, independent company during the periods presented. GP Strategies has provided to National Patent Development general management, legal, treasury, tax, and financial reporting services. GP Strategies' costs have been allocated to National Patent Development and included in the discussion herein on a basis that management believes is reasonable based on the historical business of National Patent Development. This allocation may not necessarily equal the costs that would have been or will be incurred by National Patent Development on a stand-alone basis. Management believes that the overhead of National Patent Development after the spin-off will be greater than the overhead based on the historical business of National Patent Development. The historical financial information included herein gives effect to the Contribution and the Repayment, but does not reflect the Additional Overhead, the Gabelli Allocation, or the Distribution, all of which are reflected in the unaudited pro forma financial information as of March 31, 2004 and for the year ended December 31, 2003. National Patent Development was incorporated on March 10, 1998 as a wholly-owned subsidiary of GP Strategies Corporation. In July 2002, GP Strategies announced that it was actively considering transferring certain of its non-core assets into National Patent Development and spinning-off National Patent Development to the stockholders of GP Strategies. On November 14, 2002, GP Strategies filed a ruling request with the Internal Revenue Service with respect to the federal tax consequences of the proposed spin-off, and received a favorable ruling on March 21, 2003. On February 12, 2004, National Patent Development was recapitalized whereby the authorized capital was changed to 10,000,000 shares of preferred stock and 30,000,000 shares of common stock. Following the Distribution, we will own 100% of the stock of MXL and a 64% interest in Five Star. We will operate in two segments: the Optical Plastics segment, composed of MXL, and the Home Improvement Distribution segment, composed of our interest in Five Star. We will also own certain of GP Strategies' other non-core assets, including an investment in a publicly held company, Millennium Cell; an approximately 19.6% interest in a private company, Valera Pharmaceuticals; certain real estate; and the right to certain proceeds, if any, from a litigation and arbitration claim. National Patent Development monitors Millennium Cell for progress in the commercialization of Millennium Cell's emerging technology and monitors Valera Pharmaceuticals for progress in the FDA approval process. MXL Overview The primary business of MXL is the manufacture of polycarbonate parts requiring adherence to strict optical quality specifications, and the application of abrasion and fog resistant coatings to those parts. MXL also designs and constructs injection molds for a variety of applications. Some of the products that MXL produces include: o facemasks and shields for recreation purposes and industrial safety companies, o precision optical systems, including medical optics, military eye wear and custom molded and decorated products, and o tools, including optical injection mold tools and standard injection mold tools. MXL's manufactures and sells its products to various commercial and government customers, who utilize MXL's parts to manufacture products that will be ultimately delivered to the end-user. MXL's government customers include various offices of the Department of Defense, while MXL's commercial customers are primarily in the recreation, safety, and security industries. MXL's commitments to its customers, consisting of unfilled sales orders or backlog, amounted to approximately $1.7 million as of December 2003. Some of MXL's consumer based products are considered to be at the high-end of their respective markets. As a result, sales of MXL's products may decline together with a decline in discretionary consumer spending; therefore a key performance indicator that the Company's management uses to manage the business is the level of discretionary spending in key markets, specifically the United States and Japan. Other key performance measures used by the Company's management to run the business include: o consumer confidence indices in key markets, o sales levels of complementary items in the recreational vehicle market, such as motorcycles, RV's and snowmobiles, o levels of defense spending, and o new OSHA safety standards. MXL believes that the principal strengths of its business are its state-of-the-art injection molding equipment, advanced production technology, high quality standards, and on time deliveries. However, due to the focused nature of the market, MXL has a limited customer base and tends to be adversely affected by a loss in business from its significant customers. As a result of losses of business from certain of its key customers, MXL sales and operating profits for the past three years have shown a declining trend, reflecting a loss in market share. To reverse the declining sales trend, a new management team with significant sales and marketing experience has been established in 2004. To further grow, MXL not only intends to regain market share in its existing market, but to leverage its expertise as a molder and coater of optical quality products by expanding into other markets and products. However, due to the spin-off, MXL may have less financial resources at its disposal with which to support and grow the business, as National Patent Development will have a smaller market capitalization and less access to capital markets than GP Strategies. Five Star Overview Five Star is a publicly held company that is a leading distributor in the United States of home decorating, hardware, and finishing products. Five Star offers products from leading manufacturers in the home improvement industry and distributes those products to retail dealers, which include lumber yards, "do-it yourself" centers, hardware stores and paint stores. Five Star has grown to be one of the largest independent distributors in the Northeast United Stated by providing a complete line of competitively priced products, timely delivery and attractive pricing and financing terms to its customers. The following key factors affect Five Star's financial and operation performance: o its ability to negotiate the lowest prices from its suppliers, o its ability to increase revenue by obtaining new customers, while maintaining a level fixed cost structure by utilizing its existing warehouses, o the housing market in general, o consumers' confidence in the economy, o consumers' willingness to invest in their homes, and o weather conditions that are conducive to home improvement projects. The following key performance measures are utilized by the Company's management to run Five Star's business: o new U.S. housing starts, o sales of existing homes, o sales of high margin products to its customers, o purchases from each vendor, and o performance benchmarks used by Home Depot and Lowe's, such as number of stores and square footage, as well as financial benchmarks. Five Star operates in the Home Improvement market, which has grown in recent years and for which the Home Improvement Research Institute predicts average annual industry growth of nearly 5% for the next several years. Nonetheless, Five Star faces intense competition from large national distributors, smaller regional distributors, and manufacturers that bypass the distributor and sell directly to the retail outlet. The principal means of competition for Five Star are its strategically placed distribution centers and its extensive inventory of quality, name-brand products. In addition, Five Star's customers face stiff competition from Home Depot and Lowe's, which purchase directly from manufacturers. As a result of such competition, while the Home Improvement market has expanded significantly in recent years, Five Star's revenue has increased only incrementally, and such revenue would have declined if Five Star had not entered into new geographic sales territories as described below. In spite of this, the independent retailers that are Five Star's customers remain a viable alternative to Home Depot and Lowe's, due to the shopping preferences of and the retailer's geographic convenience for some consumers. Five Star has continued to expand its sales territory with an addition of a sales force servicing the Mid-Atlantic States, as far south as North Carolina, which has generated additional annual revenues of approximately $9 million since 2002. Five Star services this territory from its existing New Jersey warehouse, enabling Five Star to leverage its fixed costs over a broader revenue base. To further expand, Five Star will attempt to grow its revenue base in the Mid-Atlantic States, to acquire complementary distributors and to expand the distribution of its use of private-label products sold under the "Five Star" name. However, due to the spin-off, Five Star may have less financial resources at its disposal with which to support and grow the business, as National Patent Development will have a smaller market capitalization and less access to capital markets than GP Strategies. Acquisition On October 8, 2003, we converted $500,000 principal amount of the then $3,500,000 Senior Unsecured 8% Note due June 30, 2005, as amended, or the Five Star Note, of Five Star into 2,000,000 shares of Five Star common stock, which 26increased our ownership in Five Star from approximately 48% to approximately 54% of the then outstanding Five Star common stock (we refer to our obtaining ownership of a majority of the outstanding Five Star common stock as the Five Star Majority Ownership). As a result, effective October 8, 2003, Five Star was consolidated in our financial statements. The amount outstanding from Five Star under the Five Star Note decreased from a balance of $4,500,000 at December 31, 2002 due to repayments of $1,000,000 prior to the conversion described above, $500,000 due to such conversion and a $200,000 repayment subsequent to such conversion. As of March 31, 2004 and December 31, 2003 the amount outstanding from Five Star to JL Distributors, Inc., our wholly-owned subsidiary, under the Five Star Note was $2,800,000. We converted $500,000 principal amount of the Five Star Note because we believed that the common stock of Five Star represented an attractive investment opportunity based on its valuation at that time. Five Star Tender Offer On February 6, 2004, Five Star announced that it would repurchase up to 5,000,000 shares, or approximately 30%, of its outstanding common stock, through a tender offer for the shares at $0.21 per share, originally set to expire on March 16, 2004. On March 17, 2004, Five Star announced that it had increased the price it was offering to pay for the shares in the tender offer to $0.25 per share and had extended the offer to March 31, 2004. Approximately 2,648,000 shares of Five Star common stock were tendered and acquired by Five Star. The effect of the tender offer was to increase our ownership in Five Star to approximately 64%. If National Patent Development increases its ownership to at least 80% of Five Star's common stock, Five Star would become, for federal tax purposes, part of the affiliated group of which National Patent Development is the common parent. As a member of such affiliated group, Five Star would be included in National Patent Development's consolidated federal income tax returns, Five Star's income or loss would be included as part of the income or loss of the affiliated group and any of Five Star's income so included might be offset by the consolidated net operating losses, if any, of the affiliated group. Five Star has agreed to enter into a tax sharing agreement with GP Strategies (to be assigned to National Patent Development as part of the spin-off) pursuant to which Five Star will make tax sharing payments to National Patent Development, if Five Star becomes a member of the consolidated group, equal to 80% of the amount of taxes Five Star would pay if Five Star were to file separate consolidated tax returns but did not pay as a result of being included in the National Patent Development affiliated group. The following table represents National Patent Development's pro forma consolidated statement of operations for the three months ended March 31, 2004, assuming the Five Star tender offer had been completed at the beginning of the period, and we had a 64% ownership interest in Five Star. The pro forma information is presented for comparative purposes only and does not purport to be indicative of what would have occurred had the tender offer actually been made at such date, nor is it necessarily indicative of future operating results (in thousands, except per share data): --------------------------------------- ----------------- Sales $29,121 Loss before minority interest (178) Minority interest (93) --------------------------------------- ----------------- --------------------------------------- ----------------- Net loss $ (271) --------------------------------------- ----------------- --------------------------------------- ----------------- Net loss per share Basic and diluted $ (.02) --------------------------------------- ----------------- Consolidated Results of Operations Three Months Ended March 31, 2004 compared to Three Months Ended March 31, 2003 National Patent Development had losses before income taxes and minority interest of $204,000 for the three months ended March 31, 2004 as compared to income before income taxes and minority interest of $173,000 for the three months ended March 31, 2003. The decrease in profitability of $377,000 is primarily related to the following factors: (i) increased selling, general and administrative expenses of $373,000, partly due to higher allocation of expenses from GP Strategies and (ii) a decrease in investment and other income of $97,000, primarily due to a net loss on sales of stock of Millennium Cell, and Hemispherx Biopharma, Inc., or HEB. The decrease was partially offset by a higher gross margin of $93,000 which increased in proportion with the increase in revenue of the Home Improvement Distribution segment (consisting of Five Star). Sales. For the three months ended March 31, 2004, sales increased by $1,690,000 from $27,431,000 for the three months ended March 31, 2003 to $29,121,000, mainly due to increased Home Improvement Distribution segment revenue of $1,776,000. The increase was primarily a result of increased sales to Five Star's existing customer base. Sales to existing customers have increased mainly due to Five Star offering more product lines for the retailers to stock, as well as Five Star conducting small local trade shows for its customers to create additional sales. Revenue was favorably affected by clement weather in the Northeast during the three months ended March 31, 2004, causing an increase in home improvement projects. The increase was offset by a decrease in Optical Plastics segment (consisting of MXL) revenue of $86,000. The decrease in Optical Plastics segment revenue was caused by lower levels of purchases from several key customers, due to prior year product introductions, which increased purchases by those customers, and a discontinuance of a product line associated with diabetes treatment produced by one of MXL's most significant customers following the first quarter of 2003. The decrease was partly offset by increased revenue from MXL's Massachusetts facility, purchased in September 2003. Gross margin. For the three months ended March 31, 2004, gross margin increased by $93,000 from $4,671,000 for the three months ended March 31, 2003 to $4,764,000 due to increased Home Improvement Distribution segment gross margin of $160,000. The increase in gross margin dollars was mainly due to the increase sales. Gross margin as a percentage of sales declined from 17.1 % for the three months ended March 31, 2003 to 16.6% for the three months ended March 31, 2004, mainly due to higher costs of merchandise purchases for the period, as well as a slight increase in warehousing expenses, in particular repairs and maintenance and utilities. Five Star includes warehousing expenses as part of cost of goods sold. The increase was offset by a decrease in Optical Plastics segment gross margin of $67,000. The decrease in Optical Plastics segment gross margin was primarily driven by a decrease in revenue, as well as product mix, as gross margin percentage decreased from 16.4% in the first quarter of 2003 to 13.9% in the first quarter of 2004. Selling, general and administrative. For the three months ended March 31, 2004, selling, general and administrative expenses increased by $373,000 from $4,295,000 for the three months ended March 31, 2003 to $4,668,000 partially due to increased allocations of GP Strategies corporate selling, general and administrative expenses of $188,000. The Home Improvement Distribution segment's selling, general and administrative expenses increased by $105,000 primarily due to increased legal and professional fees, salesman commissions, computer expenses and shipping expenses. The Optical Plastics segment's selling, general and administrative expenses increased by $80,000 primarily due to increased salaries and employee benefits, as well as rent associated with MXL's Massachusetts facility. Investment (loss) and other income, net. National Patent Development incurred investment and other losses of $95,000 the three months ended March 31, 2004 mainly due to a net loss on sales of Millennium and HEB stock, as compared to other income of $2,000 for the three months ended March 31, 2003. Income taxes. National Patent Development had an effective tax rate of (12.7)% and 57.8% for the three months ended March 31, 2004 and March 31, 2003, respectively. The rate was primarily due to non-deductible expenses and impairment and realized losses for equity investments for which no benefit had been provided. Year Ended December 31, 2003 compared to Year Ended December 31, 2002 National Patent Development had income before income taxes and minority interest of $383,000 for the year ended December 31, 2003 as compared to income before income taxes and minority interest of $292,000 for the year ended December 31, 2002. The increase in profitability of $91,000 is primarily related to an increase in operating profit of $2,068,000 from the consolidation of Five Star following the Five Star Majority Ownership. The increase in profitability was partially offset by the following factors: (i) increased interest expense of $656,000 mainly due to the consolidation of Five Star following the Five Star Majority Ownership, (ii) a decrease in income from equity investee and investment income of $509,000, from a gain of $448,000 mainly due to Five Star income from equity investee, to a loss of $61,000 mainly due to a net loss on sales of Millennium and HEB stock and (iii) a decrease in operating profit at MXL of $460,000, due to lower sales and increased selling, general and administrative expenses. Sales. For the year ended December 31, 2003, sales increased by $93,702,000 from $9,996,000 for the year ended December 31, 2002 to $103,698,000 mainly due to the consolidation of Five Star's revenue of $95,085,000 into National Patent Development's financial statements as a result of the Five Star Majority Ownership. Five Star's revenue was essentially flat from 2002, increasing by approximately $9 million due to Five Star's expansion of its sales territory with an addition of a sales force servicing the Mid-Atlantic States, offset by a loss in revenue of approximately $8 million from its existing customer base concentrated in the Northeast. The decrease in MXL's revenue of $1,383,000 was primarily due to a discontinuance of a product line associated with diabetes treatment produced by one of MXL's most significant customers, which accounted for a loss in revenue of $1,196,000. The remainder of the decline was due to less significant losses in revenue from MXL's other top ten customers, mainly due to a decline in the overall economy, which caused a reduction in discretionary spending for high-end products which MXL manufactures. Gross margin. For the year ended December 31, 2003, gross margin increased by $17,483,000 from $2,099,000 for the year ended December 31, 2002 to $19,582,000 mainly due to the consolidation of Five Star gross margin of $17,719,000 into National Patent Development's financial statements as a result of the Five Star Majority Ownership. Five Star's gross margin increased by $1,106,000 from 2002 mainly due to increased revenue and a reduction in cost of goods sold, mainly due to improved purchasing efficiencies from Five Star's vendors. The purchasing efficiencies, including quantity and other discounts, were the primary reason for the increase in gross margin percentage from 17.6% in 2002 to 18.6% in 2003. The increase in Five Star gross margin was partially offset by increased warehousing costs, with increases in payroll and related expenses, rent and utilities, and repairs and maintenance expenses. The increase in gross margin was offset by a decrease in MXL's gross margin of $236,000, mainly due to the decline in MXL revenue. MXL's gross margin percentage rose slightly from 21% in 2002 to 21.6% in 2003 due to the discontinued product line which traditionally caused lower gross margin percentages to MXL. Selling, general and administrative. For the year ended December 31, 2003, selling, general and administrative expenses increased by $16,227,000 from $2,047,000 for the year ended December 31, 2002 to $18,274,000 mainly due to the consolidation of Five Star's selling, general and administrative expenses of $15,598,000 into National Patent Development's financial statements as a result of the Five Star Majority Ownership. Five Star's selling, general and administrative expenses increased by $933,000 from 2002 due to increases in salary and bonuses, sales personnel and expenses incurred for business development, sales territory expansion and computer system upgrades. Corporate selling, general and administrative expenses increased by $445,000, mainly due to increased allocations of GP Strategies corporate selling, general and administrative expenses. MXL's selling, general and administrative expenses increased by $184,000 primarily due to increases in employee benefits, bad debt expense, general insurance and rent. Investment (loss) and other income, net and income (loss) related to equity investee. For the year ended December 31, 2003, National Patent Development had zero income related to equity investee due to the consolidation of Five Star into National Patent Development's financial statements as a result of the Five Star Majority Ownership, as compared to income related to equity investee of $439,000 for the year ended December 31, 2002. In addition, National Patent Development incurred investment and other losses of $61,000 in 2003 mainly due to a net loss on sales of Millennium and HEB stock, a decrease of $70,000 from investment income of $9,000 in 2002. Income taxes. National Patent Development had an effective tax rate of 46.0% and 49.7% for the years ended December 31, 2003 and December 31, 2002, respectively. The rate was primarily due to state and local taxes, non-deductible expenses and impairment and realized losses for equity investments for which no benefit had been provided. Year Ended December 31, 2002 compared to Year Ended December 31, 2001 National Patent Development had income before income taxes of $292,000 for the year ended December 31, 2002 as compared to income before income taxes of $764,000 for the year ended December 31, 2001. The decrease in profitability of $472,000 was primarily related to a decrease in gross margin at MXL of $717,000 from $2,816,000 to $2,099,000 for the year ended December 31, 2002, an increase in selling, general and administrative expenses of $83,000, an increase in income related to equity investee of approximately $180,000 to $439,000 and an increase in investment (loss) and other income, net of $187,000 to $9,000 from $(178,000) for the year ended December 31, 2001. Sales. For the year ended December 31, 2002, sales declined from $11,184,000 to $9,996,000 or by $1,188,000. The decrease is primarily related to the overall downturn in the economy, which caused a reduction in orders from MXL's most significant customers. The decline in the economy caused a reduction in discretionary spending for high-end products which MXL manufactures. Gross margin. Gross margin of $2,099,000 for the year ended December 31, 2002 decreased by $717,000, compared to gross margin of $2,816,000 for the year ended December 31, 2001. The reduction in gross margin was partially a result of the reduction in MXL's sales levels for the period. MXL's gross margin percentage declined from 25% in 2001 to 21% in 2002 due to a shift in product mix to lower margin products from one of MXL's most significant customers. Selling, general and administrative expenses. For the year ended December 31, 2002, selling, general and administrative expenses of $2,047,000 increased $83,000 from $1,964,000 for the year ended December 31, 2001. The increase was primarily attributable to increases in corporate selling, general and administrative expenses of $37,000, mainly due to a higher allocation of GP Strategies corporate selling, general and administrative expenses of $35,000 and a decrease in a non-cash credit of approximately $13,000 relating to a deferred compensation plan of GP Strategies in which certain employees of MXL participated. MXL's selling, general and administrative expenses increased by $46,000, mainly due to increased payroll expenses, including temporary help. Investment (loss) and other income, net and income (loss) related to equity investee. Investment (loss) and other income, net for the year ended December 31, 2002 increased $187,000 to $9,000 compared to $(178,000) for the year ended December 31, 2001. The increase was primarily as a result of the recognition of an impairment loss of $200,000 from its Avenue Entertainment marketable security investment during the year ended December 31, 2001. Income (loss) related to equity investee for the year ended December 31, 2002 increased $180,000 to $439,000 from $259,000 for the year ended December 31, 2001. The increase was related to a write-down of $200,000 in the investment in Five Star during the year ended December 31, 2001. In addition, effective January 1, 2002 upon adoption of FASB Statement No. 142 the amortization of goodwill allocable to excess of the carrying value of investment in Five Star ceased. Income taxes. National Patent Development had an effective tax rate of 49.7% and 51.7% for the years ended December 31, 2002 and December 31, 2001, respectively. The rate was primarily due to certain nondeductible items, and in 2001, the effect of an impairment loss on the Avenue Entertainment marketable security for which no tax benefit has been provided. Liquidity and Capital Resources At March 31, 2004, National Patent Development had cash and cash equivalents totaling $202,000, 1,014,771 shares of common stock of Millennium Cell with a market value of $1,827,000 and a receivable from GP Strategies of $1,486,000. In addition, National Patent Development has been allocated $1,875,000 of the $7,500,000 received for the Gabelli Note pursuant to the Gabelli Allocation. National Patent Development believes the aforementioned resources, together with the cash received from the sale of other assets, will be sufficient to fund the working capital and other requirements of National Patent Development for at least the next twelve months. From time to time National Patent Development may attempt to raise capital with potential equity financings, although no such equity financings are currently anticipated. For the three months ended March 31, 2004, National Patent Development's working capital decreased by $86,000 to $10,479,000 from $10,565,000 as of December 31, 2003. The working capital decrease was primarily a result of a net loss for the period; additions to property, plant and equipment; and repayment of long term debt. The decrease in cash and cash equivalents of $400,000 for the three months ended March 31, 2004 resulted from net cash used in operations of $5,817,000; cash used in investing activities of $390,000, consisting of additions to property, plant and equipment of $124,000 and advances to GP Strategies of $1,138,000, offset by proceeds on sale of investments of $872,000; and cash provided by financing activities of $5,807,000, consisting of proceeds of short term borrowing of $5,959,000, offset by repayments of long-term debt of $95,000 and distributions to GP Strategies of $57,000. Management discussion of critical accounting policies The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates. Certain of our accounting policies require higher degrees of judgment than others in their application. These include valuation of accounts receivable, accounting for investments, and impairment of long-lived assets which are summarized below. In addition, Note 1 to the audited financial statements, included elsewhere in this Information Statement, includes further discussion of our significant accounting policies. Revenue recognition Revenue on product sales is recognized at the point in time when the product has been shipped, title and risk of loss has been transferred to the customer, and the following conditions are met: persuasive evidence of an arrangement exists, the price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Allowances for estimated returns and allowances are recognized when sales are recorded. Valuation of accounts receivable Provisions for allowance for doubtful accounts are made based on historical loss experience adjusted for specific credit risks. Measurement of such losses requires consideration of National Patent Development's historical loss experience, judgments about customer credit risk, and the need to adjust for current economic conditions. The allowance for doubtful accounts as a percentage of total gross trade receivables was 4.1 %( unaudited), 5.6% and 1.3% at March 31, 2004, December 31, 2003 and December 31, 2002, respectively. Impairment of long-lived tangible assets Impairment of long-lived tangible assets with finite lives results in a charge to operations whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived tangible assets to be held and used is measured by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by determining the amount by which the carrying amount of the assets exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of their carrying amount or fair value less cost of sale. The measurement of the future net cash flows to be generated is subject to management's reasonable expectations with respect to National Patent Development's future operations and future economic conditions which may affect those cash flows. As of March 31, 2004, National Patent Development holds undeveloped land in Pawling, New York available for sale with a carrying amount of approximately $2.9 million, which management believes is less than its fair value, less cost of sale. However, such land is subject to a mortgage securing indebtedness of GP Strategies. See "Description of Indebtedness." Accounting for investments National Patent Development's investment in marketable securities are classified as available-for-sale and recorded at their market value with unrealized gains and losses recorded as a separate component of stockholder's equity. A decline in market value of any available-for-sale security below cost that is deemed to be other than temporary results in an impairment loss which is charged to earnings. National Patent Development has recorded impairment losses of $200,000 in 2001 on one of its marketable security investments. In addition, National Patent Development has recorded impairment losses of $200,000 in 2001 on its investment in Five Star, which was then accounted for using the equity method. Management determined those losses to be other than temporary declines. On October 8, 2003 National Patent Development acquired additional shares of Five Star, bringing its ownership to 54%. Five Star is consolidated into National Patent Development's consolidated financial statements and is no longer accounted for as an equity investment effective as of that date. Determination of whether an investment is impaired and whether an impairment is other than temporary requires management to evaluate evidence as to whether an investment's carrying amount is recoverable within a reasonable period of time considering factors which include the length of time that an investment's market value is below its carrying amount and the ability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. On October 17, 2003, National Patent Development received GP Strategies' shares of Valera Pharmaceuticals pursuant to the Repayment and recorded such shares at zero representing their carrying amount to GP Strategies after reflecting Valera losses. National Patent Development currently owns 100% of Valera's common stock (19.6% assuming conversion of Valera outstanding preferred stock) but no longer has financial and operating control of Valera. As a condition of a private placement of preferred stock in December 2001, GP Strategies contractually gave up operating control over Valera through an Investors Rights Agreement. National Patent Development accounts for its investment in Valera under the equity method. However, as National Patent Development has not guaranteed obligations of Valera and has not otherwise committed to provide further support for Valera, it has discontinued recognizing additional losses of Valera. If Valera subsequently reports net income, National Patent Development shall resume applying the equity method only after its share of that net income equals the share of net losses not recognized during the period the equity method was suspended. Recent accounting pronouncements In June 2001, the FASB issued Statement No. 143, Accounting for Asset Retirement Obligations, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This Statement applies to all entities that have legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development or normal use of the asset. This statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. This statement is effective for National Patent Development in fiscal 2003. The application of SFAS No. 143 did not have and is not expected to have a material impact on National Patent Development's Consolidated Financial Statements. During April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS No. 145"). Among other items, SFAS No. 145 updates and clarifies existing accounting pronouncements related to reporting gains and losses from the extinguishment of debt and certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of SFAS No. 145 are generally effective for fiscal years beginning after May 15, 2002, with earlier adoption of certain provisions encouraged. The application of SFAS No. 145 did not have an impact on National Patent Development's Consolidated Financial Statements. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities ("SFAS No. 146"). This Statement requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. National Patent Development is required to adopt the provisions of SFAS No. 146 for exit or disposal activities, if any, initiated after December 31, 2002. The adoption of SFAS No. 146 did not impact the consolidated financial position or results of operations, although it can be expected to impact the timing of liability recognition associated with future exit activities, if any. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of SFAS No. 123" ("SFAS No. 148"), and the transition guidance and annual disclosure provisions are effective for National Patent Development for the quarterly interim periods beginning in 2003. SFAS No. 148 amends SFAS Statement No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation" and provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. In addition, the statement amends the disclosure requirements of SFAS No. 123 to require more prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used. National Patent Development continues to account for stock-based compensation using APB Opinion No. 25 and has not adopted the recognition provisions of SFAS No. 123, as amended by SFAS No. 148. National Patent Development has adopted the disclosure provisions of SFAS No. 148 for the 2003 fiscal year. In April 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No. 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. In particular, this Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative. It also clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003 and did not have an impact on National Patent Development's Consolidated Financial Statements. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how a company classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify certain financial instruments as a liability (or as an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have an impact on National Patent Development's Consolidated Financial Statements. In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees Including Indirect Guarantees of Indebtedness of Others" ("FIN No. 45"). FIN No. 45 elaborates on the disclosures for interim and annual reports regarding obligations under certain guarantees issued by a guarantor. Under FIN No. 45, the guarantor is required to recognize a liability for the fair value of the obligation undertaken in issuing the guarantee at the inception of a guarantee. The recognition and measurement provisions of FIN No. 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of FIN No. 45 did not have an impact on National Patent Development's Consolidated Financial Statements. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN No. 46"). FIN No. 46 explains how to identify variable interest entities and how an enterprise assesses its interests in a variable interest entity to decide whether to consolidate that entity. FIN No. 46 requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. The provisions of FIN No. 46 are effective immediately for all entities with variable interests in variable interest entities created after December 31, 2002. The provisions of FIN No. 46 are effective for public entities with a variable interest in a variable interest entity created prior to January 1, 2003 no later than the end of the first annual reporting period beginning after December 15, 2003. National Patent Development evaluated FIN No. 46 and does not anticipate that its application will affect its financial statements. If it is determined that National Patent Development should consolidate any such entity, National Patent Development would recognize certain assets and debt on its consolidated balance sheet and a cumulative adjustment for the accounting change in the consolidated statement of operations. In November 2002, the EITF reached a consensus on Issue No. 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables." This Issue provides guidance on when and how to separate elements of an arrangement that may involve the delivery or performance of multiple products, services and rights to use assets into separate units of accounting. The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The transition provision allows either prospective application or a cumulative effect adjustment upon adoption. The adoption of Issue No. 00-21 did not have an impact on National Patent Development's Consolidated Financial Statements. Quantitative and Qualitative Disclosures About Market Risk National Patent Development is exposed to the impact of interest rate, market risks and currency fluctuations. In the normal course of business, National Patent Development employs internal processes to manage its exposure to interest rate, market risks and currency fluctuations. National Patent Development's objective in managing its interest rate risk is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. National Patent Development is exposed to the impact of currency fluctuations because of its sales to customers in foreign countries. Five Star is a party to an interest rate swap agreement designated as a cash flow hedge whereby changes in the cash flows of the swap will offset changes in the interest rate payments on Five Star's variable-rate revolving loan, thereby reducing the Five Star's exposure to fluctuations in LIBOR. Changes in the fair value of the interest rate swap are recognized in the accumulated other comprehensive income, net of income taxes. Effective July 1, 2004 through June 30, 2008, Five Star will pay a fixed interest rate of 3.38% to Fleet National Bank on notional principal of $12,000,000. In return, Fleet National Bank will pay to Five Star a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the Loan and Security Agreement entered into by Five Star on June 20, 2003 is not included in, and will be paid in addition to, this fixed interest rate of 3.38%. As of March 31, 2004, National Patent Development had $12,024,000 of variable rate borrowings, not hedged by an interest rate swap. National Patent Development estimates that for every 1% fluctuation in general interest rates, assuming debt levels at March 31, 2004, interest expense would vary by $120,240. BUSINESS We are currently a wholly-owned subsidiary of GP Strategies. Following the Distribution, we will own MXL, a 64% interest in Five Star, as well as certain of GP Strategies' non-core assets, including an investment in a publicly held company, Millennium Cell, an approximately 19.6% interest in a private company, Valera Pharmaceuticals, certain real estate and the right to certain of the proceeds from a litigation claim. MXL Industries General Our wholly-owned subsidiary, MXL, is a molder and precision coater of optical plastics. MXL is a specialist in the manufacture of polycarbonate parts requiring adherence to strict optical quality specifications, and in the application of abrasion and fog resistant coatings to those parts. Polycarbon is the most impact resistant plastic utilized in optical quality molded parts. MXL's products include shields, face masks and non-optical plastic products, produced for over 50 clients in the safety, recreation, and military industries. Additionally, MXL's Midwest operations, previously known as The Woodland Mold and Tool Division of MXL, have the capability to design and construct injection molds for a variety of applications (optical and non-optical). Established over thirty years ago, MXL evolved into one of the leading coaters of polycarbonate and acrylic parts. A growing insistence on quality coating results led MXL to also establish itself as a specialist in the injection molding of optical quality polycarbonate, thus enabling MXL to control the process from start to finish. At its Lancaster, PA facility, molding machines are housed in a climate controlled clean environment designed and built by MXL. Coating lines also feature a controlled, enclosed environment and are CFC -free. MXL's Chicago division, Woodland Mold and Tool, was acquired by MXL in 1987 as MXL's business grew to include in-house optical injection molding. Chicago's capabilities range from the production of long-life tooling for standard molding applications to the design, construction and repair and polishing of sophisticated optical mold. On September 15, 2003, MXL acquired certain of the precision custom optical assemblies inventory, machinery and equipment of AOtec for $1.1 million in cash and notes, subject to adjustment. AOtec, located in the Massachusetts area, is a successor to the American Optical Corporation, one of the pioneers in optics research and development for over 160 years. MXL leased space in Massachusetts for the newly purchased equipment. MXL paid $100,000 of the purchase price in cash and issued three notes, in the amount of $450,000, $275,000 and $275,000 each, due October 1, 2003, August 5, 2004 and August 5, 2005, respectively (which we refer to as the AOtec Notes). The AOtec Notes bear interest on the unpaid principal amount at the rate of 4% per annum. On October 1, 2003, MXL borrowed $700,000 from a bank (which we refer to as the AOtec Debt) and used the proceeds to pay the $450,000 note. The AOtec Debt is payable monthly for three years and is secured by the machinery and equipment purchased from AOtec. GP Strategies guaranteed the AOtec Debt. MXL's contracts in the military and commercial arena often require either vacuum deposited beam-splitter coatings, vacuum deposited anti-reflective coatings, laser eye protection, or a combination of these technologies in addition to MXL's historic capabilities of providing difficult and optically correct molded and coated components. Prior to the acquisition of the equipment and intellectual property assets from AOtec, MXL was required to enter into subcontracting arrangements to secure these technologies. The laser eye protection technology, vacuum deposition processing, and equipment acquired from AOtec, will enable MXL to better service purchase orders for precision pilot visors for next generation military fighter and attack aircraft, which require beam-splitter and anti-reflective coatings and will shortly require laser eye protection.` MXL has earned a reputation as a leading toolmaker, molder and coater for optical quality products in the United States by consistently meeting its customer's requirements, even in the case of the most difficult designs and compound curve optics. This expertise has allowed MXL to expand its customer base beyond the United States to Japan, the United Kingdom, Europe, the Middle East, Mexico, Canada, Australia and other locales. MXL's net sales in the regions it does business for the three months ended March 31, 2004 and 2003 and for fiscal years ended December 31, 2003, 2002 and 2001, based upon the customers' locations, are as follows (in thousands):
Three Months Ended _ __March 31,___ Year Ended December 31,____ ---------------- ---------- --------------------------- 2004 2003 2003 2002 2001 ---- ---- ---- ---- ---- (unaudited) United States $1,552 $1,987 $6,930 $8,264 $9,465 Far East 322 169 1,230 1,266 1,150 Other North America 124 31 217 172 46 Western Europe 130 22 211 163 278 Middle East 2 7 25 131 245 ------- -------- ----- -- ----- --- ------ --- Total $2,130 $2,216 $8,613 $9,996 $11,184 ====== ====== ====== ====== =======
MXL has been continuously and actively engaged in its optical plastics business since 1968. GP Strategies has owned all of the MXL stock since 1973. Industry Overview and Competition The optical quality molding business requires expertise, experience and an environment totally committed to the task. It requires the construction of a facility designed and constructed expressly for precision injection molding and personnel with the technical expertise to run such facility. The markets for the products currently manufactured and sold by MXL are characterized by extensive competition. The principal competitive factors of MXL are its reputation for quality, service and integrity. MXL is able to provide its customers with a breadth of experience, from mold design through mold construction, to injection molding, coating, laser eye protection and/or high technology optical coating. MXL is able to accomplish the most complex projects for its customers. In addition, MXL's engineering, performance, availability and reliability are important competitive factors. Many existing and potential competitors have greater financial, marketing and research resources than MXL. Business Strengths MXL has earned a reputation as one of the leading toolmakers, molders and coaters for optical quality products in the Unites States by consistently meeting its customers' requirements, even in the case of the most difficult designs and compound curve optics. As a pioneer in the optical plastic coating business, MXL offers expertise in designing new parts and products for its customers. MXL has spent over 30 years developing and perfecting its coating technology and materials. The market for optical injection molding, tooling and coating is focused, leading to intense competition. The following are major competitive strengths and characteristics of MXL. o Reputation for Quality and Service. MXL's on-going commitment to quality has enabled it to meet the rigorous requirements of its most valued customers and has earned it a reputation as the premier optical injection molder in the industry. MXL has a reputation for on-time delivery, and its return rate is exceptionally low, representing less than 1% of sales volume. As these customers continue to focus on product quality, MXL's past performance and long-term improvement programs should further strengthen customer relationships. o Superior Technical Skills and Expertise. The engineering experience of MXL's senior management has enabled MXL to take advantage of state-of-the-art injection molding technology and effectively develop cost-effective and efficient production facilities. MXL's proprietary HYDRON(R) permanent anti-fog coating absorbs moisture to form a barrier against fogging. o ISO 9002 Certification. MXL's Pennsylvania and Massachusetts facilities are ISO 9002 certified-a universally accepted quality assurance designation indicating the highest quality manufacturing standards. A certification by the International Standards Organization means that a company maintains a quality system that is regularly assessed for compliance to ISO standards. Meeting the ISO standard of quality confirms MXL's commitment to manufacturing excellence. o Integrated Plastics Business. The combination of MXL's original business and its recently acquired equipment and technology from AOtec, has created an integrated business which offers clients a full range of design, production and marketing services for molded and coated optical plastic products. o Modern Automated Manufacturing. MXL's presses and coating lines, state-of-the-art for the molding business, are efficiently designed and well maintained. The equipment can be quickly reconfigured to meet specific job requirements. o Well-Qualified Management Team. MXL's senior management has extensive experience in all aspects of the plastic molding and coating industry. The senior management team has in excess of 10 years of direct experience in the industry. o Attractive Growth Opportunities. With the leadership of the senior management, MXL is poised to enter any plastic molding and coating business. Its acquisition of certain of the AOtec assets was a logical extension of its position as a leading provider of optical quality injection molds by allowing MXL to further expand its business into the military arena. MXL believes that the combination of its proprietary "Anti-Fog" coating, precise processing of the "Anti-Scratch" coatings, precise molding and proprietary grinding and polishing methods for its injection tools as well as its vacuum deposited anti-reflection coatings and laser eye protection technology will provide it with the opportunity to expand into related products. Strategy MXL intends to leverage its expertise as a molder and coater of optical quality products by expanding into other markets and products. The performance of MXL in the future will depend on its ability to develop and market new products that will gain customer acceptance and loyalty, as well as its ability to adapt its product offerings to meet changing pricing conditions and other factors. Markets and Products MXL focuses its manufacturing capabilities in three distinct capacities: injection molding, precision coating of optical plastics, and tool and mold design and manufacture. Injection Molding. MXL has the capability to manufacture a wide variety of custom injection molding plastics for the recreation, industrial safety and defense industries. Some of the products that MXL produces include facemasks and shields for recreation purposes and industrial safety companies. All of MXL's custom molding involves poly-carbon, which is a difficult resin to mold and has required the development of sophisticated manufacturing skills. MXL's closed-loop process control system monitors and provides quality-assurance for every critical variable from resin drying, through mold temperature and alignment, to robotic part removal. MXL's specially designed clean room environment automatically removes dust and holds temperature and humidity constant throughout the year. Precision Coating. MXL's two coating lines allow it to offer a wide range of coating technologies to its customers. These services include dual coating processes, urethane hard coat, silicone hard coat, permanent anti-fog, and finish application design. 80% of MXL's coating business is for abrasion resistant purposes and 20% is for anti-fog applications. MXL's two coating lines were designed and built in-house, and allow for maximum flexibility and quality throughout the coating process. All functions are controlled by state-of-the-art programmable controllers and A.C. Linear drives and robotics. These highly flexible dip and spray operations can deliver a variety of coatings for parts as large as eight inches by twenty-six inches, including anti-scratch on all surfaces, anti-fog on all surfaces, one coating on one side only or dual coating with anti-scratch on one side and anti-fog on the opposite side. Tool Manufacturing. The Midwest operations use nine tool and die makers to produce optical injection mold tools and standard injection mold tools in sizes up to 36 inches x 36 inches x 36 inches. AOtec. MXL serves as the prime contractor for several major development programs in industry and government at its Massachusetts facility which is separated into several independent groups: precision optical systems, including medical optics, military eye wear and custom molded and decorated products. In order to maintain its competitive position, MXL has traditionally invested in state of the art equipment, including molding presses ranging from 60 to 485 tons, automation equipment, clean room facilities, and vacuum and dip coating equipment. MXL utilizes computer aided design software to design its optical products. In addition, modern computer controlled molding machinery is used to fabricate precision optic components. Manufacturing and Raw Materials MXL's primary raw materials are plastic resin (principally polycarbonate), silicone hard coatings and HYDRON(R) anti-fog coating. MXL is able to fulfill its requirements for plastic resin through arrangements with various distributors and is able to fulfill its requirements for silicone hard coating from manufacturers. The prices for MXL's primary raw materials do not significantly fluctuate, and have been relatively steady in the past two years due to increased competition in the market that supplies MXL's raw materials. MXL manufactures its proprietary HYDRON(R), which is applied as a fog resistant coating to its optical products. Customers As the market for optical injection molded plastics is relatively focused, MXL serves virtually all of the major users. The customer base of MXL includes over 50 commercial customers in 27 states and Japan, the United Kingdom, Europe, the Middle East, Mexico, Canada and Australia. These commercial customers are primarily in the recreation, safety, and security industries. MXL's largest three customers comprised approximately 13%, 12% and 12%, respectively, of its total sales in 2003, and its largest customer comprised approximately 11% of its total sales in the first quarter of 2004. MXL's government customers include various offices of the Department of Defense. MXL is required to comply with various federal regulations including military specifications and Federal Acquisition Regulations for military end use applications. There are no government contracts subject to renegotiation or termination at the election of the government. Sales and Distribution Because of the narrow niche MXL serves, its sales and marketing effort concentrates on industry trade shows, such as the Society of Plastics Engineers, and advertising in industry journals. Its senior management team, as well as four marketing and sales executives, are responsible for the sales and marketing effort. It also utilizes one sales representative to market its products. Backlog MXL's sales order backlog as of December 31, 2003 was approximately $1,703,000 and most of the orders were expected to be completed during fiscal 2004. Patents, Trademarks, and other Intellectual Property The names MXL and HYDRON are registered trademarks. In connection with the AOtec transaction, MXL entered into an exclusive, royalty-free perpetual license (with the right to grant sublicenses) to use the trademarks AOTEC(TM) and AOGUARD(TM) for military eye protection products, electro-optical systems and precision molded and coated plastic components. Environmental Matters and Governmental Regulations For its manufacturing work as a subcontractor in the military industry, MXL is required to comply with various federal regulations including Military Specifications and Federal Acquisition Regulations for military end use applications. In addition, MXL's activities may subject it to federal, state and local environmental laws and regulations. MXL believes that it is in compliance in all material respects with such government regulations and environmental laws. Employees As of December 31, 2003, MXL employed approximately 92 persons, including 49 at its Lancaster facility, 10 in its Chicago facility and 33 at its new Massachusetts facility. Of the MXL employees, 47 are in production or shipping, with the remainder serving in executive, administrative office and sales capacities. None of MXL's employees are subject to collective bargaining agreements. MXL believes its relationship with its employees is good. Properties In 1976, MXL purchased a 4.5 acre property in Lancaster, Pennsylvania and constructed a two-story, 35,000 square foot facility, which serves as both headquarters and operating facilities. MXL added a 15,000 square foot addition in 1997. The facility includes five injection presses and two coating lines which are housed in a climate controlled clean environment and were designed and built in-house. The Chicago division, formerly its Woodland Mold and Tool division, purchased in September 1988 a single tract, 55,000 square foot facility in Downer's Grove, Illinois, which is its headquarters and operating facility. In September 2003, MXL entered into a one year lease with two renewal options for a 55,000 square foot storage and manufacturing facility in Southbridge, Massachusetts for its newly purchased equipment from AOtec. MXL's Pennsylvania and Massachusetts facilities are ISO 9002 certified, indicating achievement of the highest standards of manufacturing excellence. MXL believes that all of its facilities and equipment are in good condition and are well maintained and able to continue to operate at present levels and as anticipated by our present business strategy. Legal Proceedings MXL is from time to time subject to litigation or other legal proceedings arising in the ordinary course of business. National Patent Development believes that the outcome of such proceedings will not have a material adverse effect on its financial condition, results of operations and cash flows. Five Star Products General Five Star is engaged in the wholesale distribution of home decorating, hardware and finishing products. It serves over 3,500 independent retail dealers in twelve states, making Five Star one of the largest distributors of its kind in the Northeast. Five Star operates two state -of -the -art warehouse facilities, located in Newington, CT and East Hanover, NJ. All operations are coordinated from Five Star's New Jersey headquarters. In the first quarter of 2000, Five Star expanded its sales territory with the addition of an established, dedicated sales force servicing the Mid-Atlantic States, as far south as Virginia. This new addition to the sales force generates revenues of approximately $7 million annually. Five Star services this new territory from its 236,000 square foot East Hanover, New Jersey facility, from which it also services the Northeast, enabling Five Star to leverage its fixed costs over a broader revenue base. Five Star offers products from leading manufacturers such as Cabot Stain, William Zinsser & Company, DAP, General Electric Corporation, American Tool, USG, Stanley Tools, Minwax and 3M Company. Five Star distributes its products to retail dealers, which include lumber yards, "do-it yourself" centers, hardware stores and paint stores principally in the northeast region. It carries an extensive inventory of the products it distributes and provides delivery, generally within 24 to 72 hours. Five Star has grown to be one of the largest independent distributors in the Northeast by providing a complete line of competitively priced products, timely delivery and attractive pricing and financing terms to its customers. Much of Five Star's success can be attributed to a continued commitment to provide customers with the highest quality service at reasonable prices. As one of the largest distributors of paint sundry items in the Northeast, Five Star enjoys cost advantages and favorable supply arrangements over the smaller distributors in the industry. This enables Five Star to compete as a "low cost" provider. Five Star uses a fully computerized warehouse system to track all facets of its distribution operations. Five Star has enhanced the sophistication of its warehouse and office facilities to take full advantage of economies of scale, speed the flow of orders and to compete as a low cost distributor. Nearly all phases of the selling process from inventory management to receivable collection are automated and tracked; all operations are overseen by senior management at the New Jersey facility. Five Star is able to capitalize on manufacturer discounts by strategically timing purchases involving large quantities. Management takes a proactive approach in coordinating all phases of Five Star's operations. For example, sales managers require all sales representatives to call on customers once every week. Each salesperson transmits his or her orders through Five Star's automated sales system, to the IBM AS/400 computer located at the New Jersey facility. The salesperson system combines the ability to scan product codes in the customers' stores and download the information to a laptop computer for final transmission. Based on the floor plan of each warehouse and the location of products therein, the computer designs a pattern for the orders to be picked. The orders are then relayed to the appropriate location and typically picked in the evening. The warehouse facilities are well-maintained and skillfully organized. A bar-coded part number attached to the racking shelves identifies the location of each of the approximately 23,000 stock keeping units (SKUs). The products are loaded onto Five Star's trucks in the evening in the order that they will be unloaded, and are delivered directly to the customers locations the following morning. Five Star purchased its business from GP Strategies in 1998 for approximately $16,500,000 in cash and the Five Star Note in the original principal amount of $5,000,000. On October 8, 2003, we converted $500,000 principal amount of Five Star Note into 2,000,000 shares of Five Star common stock which increased our ownership in Five Star from approximately 48% to approximately 54% of the outstanding Five Star common stock. As a result, as of and for the year ended December 31, 2003 Five Star is consolidated in our financial statements. As a result of a tender offer made by Five Star to purchase Five Star common stock which expired on March 31, 2004, we further increased our ownership in Five Star to approximately 64%. In addition, we continue to own the remaining $2.8 million principal amount of the Five Star Note. On June 20, 2003, Five Star obtained a new Loan and Security Agreement (which we refer to as the Loan Agreement) with Fleet Capital Corporation. The Loan Agreement has a five-year term, with a maturity date of June 30, 2008. The Loan Agreement provides for a $25,000,000 revolving credit facility, which allows Five Star to borrow based upon specified percentages of eligible inventory and eligible accounts receivable, as defined therein. The interest rates under the Loan Agreement are LIBOR plus a credit spread for borrowings not to exceed $15,000,000 and the prime rate plus a credit spread for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star achieves and maintains certain performance benchmarks. In addition, under a Subordination Agreement between the GP Strategies and Fleet Capital Corporation dated June 20, 2003, Five Star may make annual cash payments of principal to GP Strategies provided Five Star achieves certain financial performance benchmarks. The Five Star Note and all the shares of Five Star common stock owned by GP Strategies, along with GP Strategies' rights under the Subordination Agreement, will be transferred to National Patent Development prior to the spin-off. See "Description of Indebtedness." At March 31, 2004 and December 31, 2003, approximately $22,644,000 and $16,685,000 was outstanding under the Loan Agreement and approximately $1,980,000 and $480,000 was available to be borrowed, respectively. Industry Overview and Competition The paint sundry items distribution industry is closely related to the do-it-yourself retail market, which has tended to exhibit elements of counter-cyclicality. In times of recession, consumers tend to spend more on home improvements if they cannot afford to trade up to bigger homes. In times of economic strength, consumers tend to spend heavily on home improvements because they believe they can afford to complete their home improvement projects. According to the National Retail Hardware Association, total retail sales by home improvement retailers were $199 billion in 2002, and are projected to grow at a 5.7% compound rate through 2006. Painting is the quintessential do-it-yourself project. Painting has to be done more frequently than most remodeling jobs, and it is a relatively inexpensive way to update the appearance of a home. For these reasons, the paint and paint sundry items industry tends to be counter-cyclical and a solid growth segment of the do-it-yourself market. Competition within the do-it yourself industry is intense. There are large national distributors commonly associated with national franchises such as Ace and TruServ as well as smaller regional distributors, all of whom offer similar products and services. Moreover, in some instances manufacturers will bypass the distributor and choose to sell and ship their products directly to the retail outlet. In addition, Five Star's customers face stiff competition from Home Depot, which purchases directly from manufacturers. The principal means of competition for Five Star are its strategically placed distribution centers and its extensive inventory of quality, name-brand products. Five Star will continue to focus its efforts on supplying its products to its customers at a competitive price and on a timely, consistent basis. While other paint sundry items distributors sell to the same retail networks as Five Star, they are at a distinct disadvantage due to Five Star's experience, sophistication and size. Hardware stores that are affiliated with the large, dealer-owned distributors such as Ace also utilize Five Star's services because they are uncomfortable with relying solely on their dealer network. Most cooperative-type distributors lack the level of service and favorable credit terms that independent hardware stores enjoy with Five Star. Five Star effectively competes with the dealer-owned distributors because it provides more frequent sales calls, faster deliveries, better financing terms and a full line of vendors and products to choose from. Business Strengths As one of the largest distributors of paint sundry items in the Northeast, Five Star enjoys cost advantages and favorable supply arrangements over the smaller distributors in the industry. This enables Five Star to compete as a "low cost" provider. Five Star uses a fully computerized warehouse system to track all facets of its distribution operations. Five Star has enhanced the sophistication of its warehouse and office facilities to take full advantage of economies of scale, speed the flow of orders and to compete as a low cost distributor. Nearly all phases of the selling process from inventory management to receivable collection are automated and tracked; all operations are overseen by senior management at the New Jersey facility. Five Star is able to capitalize on manufacturer discounts by strategically timing large quantity purchases. Strategy Five Star carries an extensive inventory of the products it distributes and provides delivery, generally within 24 to 72 hours. Five Star believes that it will continue to grow its business by providing a complete line of competitively priced products, timely delivery and attractive pricing and financing terms to its customers. In the future, Five Star will attempt to acquire complementary distributors and to expand the distribution of its use of private-label products sold under the "Five Star" name. Through internal growth and acquisitions, Five Star has already captured a leading share in its principal market the Northeast. This growth-oriented acquisition strategy of acquiring complementary distributors has allowed Five Star to compete against a substantial number of its competitors. Markets, Products and Sales The do-it-yourself industry relies on distributors to link manufacturer's products to the various retail networks. The do-it-yourself market operates on this two-step distribution process, i.e., manufacturers deal through distributors who in turn service retailers. This occurs principally because most retailers are not equipped to carry sufficient inventory in order to be cost effective in their purchases from manufacturers. Thus, distributors add significant value by effectively coordinating and transporting products to retail outlets on a timely basis. Five Star distributes and markets products from hundreds of manufacturers to all of the various types of retailers from regional paint stores, to lumber yards, to independent paint and hardware stores. The marketing efforts are directed by regional sales managers. These individuals are responsible for designing, implementing and coordinating marketing policies. They work closely with senior management to coordinate company-wide marketing plans as well as to service Five Star's major multi-state customers. In addition, each regional sales manager is responsible for overseeing the efforts of his sales representatives. The sales representatives, by virtue of daily contact with Five Star's customers, are the most integral part of Five Star's marketing strategy. It is their responsibility to generate revenue, ensure customer satisfaction and expand the customer base. Each representative covers an assigned geographic area. The representatives are compensated based solely on commission. Five Star has experienced low turnover in its sales force; most representatives have a minimum of five years' experience with Five Star. Many sales representatives had retail experience in the paint or hardware industry when they were hired by Five Star. Five Star's size, solid reputation for service, large inventory and attractive financing terms provide sales representatives with tremendous advantages relative to competing sales representatives from other distributors. In addition, the representatives' efforts are strengthened by company-sponsored marketing events. For example, each year in the first quarter, Five Star invites all of its customers to special trade shows for Five Star's major suppliers, so that suppliers may display their products and innovations. Five Star also participates in advertising circular programs in the spring and the fall which contain discount specials and information concerning new product innovations. Management Information System All of Five Star's inventory control, purchasing, accounts payable and accounts receivable are fully automated on an IBM AS/400 computer system. In addition, Five Star's software alerts buyers to purchasing needs, and monitors payables and receivables. This system allows senior management to control closely all phases of Five Star's operations. Five Star also maintains a salesperson-order-entry system, which allows the salesperson to scan product and then download the information to a laptop. The laptop contains all product and customer information and interacts with the AS/400. Purchasing Five Star relies heavily upon its purchasing capabilities to gain a competitive advantage relative to its competitors. Five Star's capacity to stock the necessary products in sufficient volume and its ability to deliver them promptly upon demand is one of the strongest components of service in the distribution business, and is a major factor in Five Star's success. Since retail outlets depend upon their distributor's ability to supply products quickly upon demand, inventory is the primary working capital investment for most distribution companies, including Five Star. Through its strategic purchasing decisions, Five Star carries large quantities of inventory relative to its competitors and thus can boast fill ratios of approximately 95%. All purchasing decisions based on current inventory levels, sales projections, manufacturer discounts and recommendations from sales representatives, are made by the merchandising group, located in New Jersey, in order to coordinate effectively Five Star's activities. In addition to senior management's active involvement, regional sales managers play an extremely critical role in this day-to-day process. Five Star has developed strong, long-term relationships with the leading suppliers since its predecessor company, J. Leven, was founded in 1912. As a major distributor of paint sundry items, suppliers rely on Five Star to introduce new products to market. Furthermore, suppliers have grown to trust Five Star's ability to penetrate the market. As a result, Five Star is often called on first by manufacturers to introduce new products into the marketplace. For example, Minwax, Best Liebco and Cabot Stain have utilized Five Star to introduce and distribute some of their new product innovations. Customers Five Star's largest customer accounted for approximately 3.6% of its sales in 2003 and its 10 largest customers accounted for approximately 12.4% of its sales. All such customers are unaffiliated and Five Star does not have a long-term contractual relationship with any of them. Backlog Five Star does not have any significant backlog. Patents, Trademarks, and other Intellectual Property Except for its line of private-label products, Five Star does not have any material patents, trademarks or other intellectual property. Five Star intends to expand the distribution of its line of private-label products sold under the "Five Star" name. Environmental Matters and Governmental Regulations Five Star's activities may subject it to federal, state and local environmental laws and regulations and OSHA regulations. Five Star believes that it is in compliance in all material respects with such environmental and federal laws and regulations. Employees Five Star employed approximately 260 people as of December 31, 2003. Management-employee relations are considered good at both of Five Star's warehouse facilities. The Teamsters union represents approximately 94 union employees at the New Jersey warehouse facility. The Connecticut warehouse facility is completely non-unionized. Five Star has never experienced a labor strike at its facilities. Five Star's contract with Local No. 11, affiliated with the International Brotherhood of Teamsters expires on December 19, 2008. Properties Five Star leases 236,000 square feet in New Jersey, 111,000 square feet in Connecticut, 1,300 square feet of sales offices in New York and 800 square feet in Maryland. Five Star's operating lease for the New Jersey facility expires in March, 2007, and the annual rent is $1,187,000. Five Star's lease for the Connecticut facility expires in February, 2007, and its annual rent is $402,000. The New York sales office pays $19,000 per year in rent and the Maryland office pays $11,000. The facilities leased by Five Star are considered to be suitable and adequate for their intended uses and are considered to be well maintained and in good condition. Legal Proceedings Five Star is from time to time subject to litigation or other legal proceedings arising in the ordinary course of business. National Patent Development believes that the outcome of such proceedings will not have a material adverse effect on its financial condition, results of operations, and cash flows. Other Assets Valera Pharmaceuticals We own 100% of the common stock of Valera Pharmaceuticals (formerly Hydro Med Sciences, Inc.), which amounts to a 19.6% ownership interest assuming conversion of Valera outstanding preferred stock and exercise of stock options held by employees of Valera. Valera is a specialty pharmaceutical company focused on the acquisition, development and commercialization of novel prescription pharmaceuticals, particularly for the treatment of urological conditions and disorders. Valera intends to develop new formulations using its hydron drug delivery technology, which is a subcutaneous implant that controls the amount, timing and location of the release of drug compounds into the body. Valera's lead product is a twelve-month implant that delivers the luteinizing hormone releasing hormone, or LHRH, histrelin for the palliative treatment of metastatic prostate cancer. LHRH agonists are the premium standard of care in the palliative treatment for metastatic breast cancer. On December 16, 2003, Valera submitted its New Drug Application (NDA) for Vantas(TM), the name for Valera's long-acting LHRH implant for treating prostate cancer. Valera has indicated in a press release that it expects to receive a response from the FDA by year-end 2004. Prior to June 2000, Valera operated as a division of GP Strategies. In connection with an offering of GP Strategies 6% Convertible Subordinated Exchangeable Notes due June 2003, Valera was incorporated as a separate company and became a wholly-owned subsidiary of GP Strategies through GP Strategies' ownership of 100% of the common stock of Valera. Following the spin-off, National Patent Development will hold all of this common stock. In December 2001, Valera completed a $7 million private placement of Series A convertible preferred stock to certain institutional investors. As a condition of the private placement, GP Strategies contractually gave up operating control over Valera through an Investors Rights Agreement, which gave GP Strategies the right to designate one director on Valera's board of directors and gave the other stockholders the right to designate the other directors. After the spin-off, National Patent Development will be subject to the Investors Rights Agreement. Accordingly, while on completion of the spin-off we will own 100% of Valera's common stock, we will not have financial and operating control of Valera. In the second quarter of 2003, Valera completed a private placement offering pursuant to which Valera raised approximately $12 million in gross proceeds from the sale of Series B convertible preferred stock. As part of such transaction, GP Strategies was granted an option until March 31, 2004 (with a closing by June 30, 2004), to purchase up $5 million of the Series B convertible preferred stock at the offering price of $0.725 per share, which was subsequently verbally extended to June 30, 2004. On June 30, 2004, GP Strategies transferred a portion of its option to an institutional investor, which exercised such option and purchased from Valera 3,448,276 shares of Series B convertible preferred stock for $0.725 per share. The balance of the option expired unexercised. In consideration of such transfer, such institutional investor granted us an option until October 28, 2004 to purchase up to 2,068,966 shares of Series B convertible preferred stock owned by such institutional investor for prices ranging from $0.725 to $0.7685 per share. There can be no assurance that the financing necessary for us to purchase such shares can be obtained or that the option will be exercised. Assuming conversion of all of the outstanding shares of Series A and Series B convertible preferred stock and exercise of stock options held by employees of Valera the Company would own approximately 19.6% of Valera. Assuming we exercise the option to purchase 2,068,966 shares of the Series B convertible preferred stock and conversion of all of the outstanding shares of Series A and Series B convertible preferred stock, and exercise of stock options held by employees of Valera, we would own approximately 23.6% of Valera. Millennium Cell Millennium Cell is a publicly traded emerging technology company engaged in the business of developing innovative fuel systems for the safe storage, transportation and generation of hydrogen for use as an energy source. At December 31, 2002, we had 293,271 shares of Millennium Cell with a market value on that date of $698,000. On October 17, 2003, National Patent Development received pursuant to the Repayment an additional 1,000,000 shares of common stock of Millennium Cell with a market value on that date of approximately $3,500,000. At December 31, 2003, we had 1,188,271 shares of common stock of Millennium Cell with a market value of $2,769,000. At March 31, 2004, we had 1,014,771 shares of common stock of Millennium Cell with a market value of $1,837,000. Pawling Property We own an approximately 980 acre parcel of undeveloped land in Pawling, New York, which includes an approximately 50 acre lake, Little Whaley Lake. The Boy Scouts of America operated a camp located along the western side of Little Whaley Lake, which was closed in the early 1980's, and the site is currently unoccupied. GP Strategies purchased this property in 1986. In connection with the sale of the Gabelli Notes and GP Warrants, GP Strategies mortgaged this property to the holders of the Gabelli Notes, and GP Strategies transferred it to us subject to that mortgage. See "Relationship between GP Strategies and National Patent Development-Gabelli Transaction Mortgage." MANAGEMENT Directors The National Patent Development Board initially consists of seven directors. National Patent Development's Certificate of Incorporation provides that the number of directors may be fixed by or in the manner provided in the Bylaws. The Bylaws provide that the Board may increase or decrease the number of directors by resolution. There is no cap on the number of directors. On the Distribution Date, the directors will be the persons named below.
Principal Occupation or Name Age Employment for the Past Five Years Harvey P. Eisen 61 Harvey P. Eisen has been Chairman and Managing Member of Bedford Oak Management, LLC since 1998. Prior thereto, Mr. Eisen served as Senior Vice President of Travelers, Inc. and of Primerica prior to its merger with Travelers in 1993. Mr. Eisen has over thirty years of asset management experience, is often consulted by the national media for his views on all phases of the investment marketplace, and is frequently quoted in The Wall Street Journal, The New York Times, PensionWorld, U.S. News & World Report, Financial World and Business Week, among others. Mr. Eisen also appears regularly on such television programs as Wall Street Week, CNN, and CNBC. Mr. Eisen is a trustee of the University of Missouri Business School where he established the first accredited course on the Warren Buffet Principles of Investing. He has been a Director of GP Strategies since July 2002. He is also a trustee of Rippowam Cisqua School in Bedford, New York and the Northern Westchester Hospital Center. Jerome I. Feldman 75 Jerome I. Feldman is founder and since 1959 has been Chief Executive Officer and a Director of GP Strategies. He has also been Chairman of the Board of GP Strategies since 1999 and was President of GP Strategies from 1959 until 2001. He has been Chairman of the Board of Five Star since 1994, a director of GSE Systems, Inc. since 1994, and Chairman of the Board of GSE since 1997. Mr. Feldman is also Chairman of the New England Colleges Fund and a Trustee of Northern Westchester Hospital Center. Scott N. Greenberg 47 Scott N. Greenberg has been a Director of GP Strategies since 1987 and President and Chief Financial Officer since 2001. He was Executive Vice President and Chief Financial Officer from 1998 to 2001, Vice President and Chief Financial Officer from 1989 to 1998, and Vice President, Finance from 1985 to 1989. He has been a director of GSE since 1999 and was a director of Five Star from 1998 to March, 2003. Roald Hoffmann 66 Roald Hoffmann has been the Frank H. T. Rhodes Professor of Humane Letters and Professor of Chemistry since 2001, and from 1974 to 2001 was the John Newman Professor of Physical Science at Cornell University. Dr. Hoffmann is a member of the National Academy of Sciences and the American Academy of Arts and Sciences. In 1981, he shared the Nobel Prize in Chemistry with Dr. Kenichi Fukui. He has been a director of GP Strategies Corporation since 1988. Ellen Havdala 38 Ellen Havdala is a Managing Director of Equity Group Investments, L.L.C., an affiliate of EGI - Fund (02-04) Investors, L.L.C. Ms. Havdala joined Equity in 1990 as a member of the Zell/Chilmark Fund, L.P. During her tenure at Equity and its affiliated companies, she has served as Vice President of Scott Sports Group, Inc. and Executive Vice President of Equity International Properties, Ltd. Thomas C. Kinnear 61 Thomas C. Kinnear is Eugene Applebaum Professor of Entrepreneurial Studies, Executive Director of the Samuel Zell and Robert H Lurie Institute for Entrepreneurial Studies, and Professor of Marketing at the University of Michigan Business School. Mr. Kinnear has worked in consulting and executive development for firms such as: Aetna, Amgen, AT&T, Alcatel, Chrysler, Domino's Pizza, Inc., Eli Lilly, General Motors, General Electric, Helmac Products, Kodak, L'Air Liquide (France), Mann + Hummel, and Travelers. He also has served or is serving as a member of the Board of Directors or Corporate Advisory Boards for several companies and community organizations including: Avail Networks, Inc., Bard Manufacturing, Inc., Bluegill Technologies, Inc., Copernicus, Inc., Domino's Pizza, Inc., Ecliptic Systems, Inc., Greenhills School, Helmac Products, Inc., Interpretive Software, Inc., Network Express, Inc., and TAL Materials. Talton R. Embry 58 Talton R. Embry has been Chairman of Magten Asset Management Corp. since 1978. Mr. Embry is a director of First Union Real Estate Equity and Mortgage Investments and ORBIMAGE, Inc. He was formerly co-chairman and a director of Revco Drug Stores (now CVS Corp.). He has been a director of Anacomp, BDK Holdings, Capsure Holdings (now CAN Surety), Combinued Broadcasting, Salant, Texscan, Thermadyne, Varco International and Westpoint Stevens.
Committees of the National Patent Development Board The National Patent Development Board of Directors will have three standing committees: an Audit Committee, a Compensation Committee, and an Investment Committee. The following are the functions of the standing committees of the National Patent Development Board. Audit Committee. The Audit Committee will act in accordance with a written charter, which will set forth the responsibilities of the Audit Committee. These responsibilities will include, among other things: o reviewing the independence, qualifications, services, fees and performance of the independent auditors; o appointing, replacing and discharging the independent auditors; o approving the professional services provided by the independent auditors; o reviewing the scope of the annual audit and quarterly reports and recommendations submitted by the independent auditors; and o reviewing our financial reporting, the system of internal financial controls, and accounting policies, including any significant changes, with management and the independent auditors. The Audit Committee will initially consist of Messrs. Hoffmann, Embry, and Kinnear. Compensation Committee. The Compensation Committee will assist the Board and management in overseeing the appropriateness and cost of compensation and benefits, particularly for executive officers. It will, among other things: o assess the performance of, and have the authority to act with respect to the compensation of, our executive officers; o generally review benefits and compensation for all of our executive officers; o administer our stock option plan and any other incentive plans and o make awards under the stock option plan. The Compensation Committee will initially consist of Messrs. Hoffmann, Eisen, and Embry. Investment Committee. The Investment Committee will review all our prospective investments of more than $1 million. The Investment Committee will initially consist of Ms. Havdala and Messrs. Kinnear and Feldman. Compensation of Directors Each of our non-employee directors will receive an annual fee of $5,000, payable quarterly, half of which will be paid in cash and half in shares of our common stock. Non-employee directors will also receive $1,000 for each Board meeting and committee meeting attended. Employee directors will receive no compensation for their service on our Board. Executive Officers On the effective date of the Distribution, Mr. Feldman will be our Chief Executive Officer and Mr. Greenberg will be our Chief Financial Officer. The other executive officers of National Patent Development are expected to be as follows: Andrea D. Kantor will be our Vice President and General Counsel. Ms. Kantor has been Vice President and General Counsel of GP Strategies since 2001, and was Vice President and Corporate Counsel from 1999 to 2001, and Associate General Counsel from 1988 to 1999. She has been a director of GSE since October 2003. Ms. Kantor practiced law as a corporate associate in New York City at Schulte Roth & Zabel LLP, and prior to that at Sidley Austin Brown & Wood LLP. Ms. Kantor is a member of the Association of the Bar of the City of New York and a member of the Corporate and Securities Law Committee of the American Corporate Counsel Association. Age 46. Steve Cliff has been the President of MXL from 1983 through June 30, 2004, and was previously Vice President, Manufacturing of MXL. Mr. Cliff will become a consultant for MXL for a two-year period beginning July 1, 2004. James Eberle has been appointed President of MXL effective July 1, 2004, but will not be considered an executive officer of National Patent Development. Charles Dawson has been President of Five Star Products since January, 2002 and Vice President and a director of Five Star since 1999. Since 1993, Mr. Dawson has held several managerial positions with Five Star. Age 47. EXECUTIVE COMPENSATION General The following table and notes present the aggregate compensation paid in 2002 by MXL and Five Star to their presidents. These persons will be considered executive officers of National Patent Development following the spin-off. National Patent Development's other executive officers have not received any significant salary or bonus from National Patent Development or any of its subsidiaries, and immediately after the spin-off will not receive any compensation from National Patent Development or any of its subsidiaries. They will, however, provide certain services to National Patent Development pursuant to the provisions of the management agreement with GP Strategies and the cost of these services will be allocated to National Patent Development. See "Relationship between GP Strategies and National Patent Development--Management Agreements." Summary Compensation Table
Long-Term Compensation Annual Compensation Awards Salary Bonus Stock All Other Name and Principal Position Year ($) ($) (#) ($) - --------------------------- ---- --------- ------- ----------------- ------------------ Charles Dawson 2003 234,018 40,000 -0- 695(2) President of Five Star 2002 226,615 20,000 -0- 602(2) 2001 188,009 -0- 150,000(1) 404(2) Steven Cliff 2003 226,614 0 -0- 7,980 (3) President of MXL 2002 225,367 30,000 -0- 6,270 (3) 2001 224,159 -0- -0- 5,985 (3)
(1) Consists of options to purchase shares of common stock granted pursuant to Five Star's 1994 Non-Qualified Stock Option Plan. (2) Consists of premiums for executive life insurance. (3) Consists of matching contributions to 401(k) Savings Plan. Option Grants in 2003 No options were granted to the named executive officers in 2003. Employment Agreements Charles Dawson. As of November 28, 2001, Charles Dawson and Five Star entered into an employment agreement pursuant to which Mr. Dawson is employed as President of Five Star for a period commencing January 1, 2002 until December 31, 2005, (the "Employment Term"), unless sooner terminated. Commencing January 1, 2002, Mr. Dawson's base salary is $225,000, with annual increases of at least 3% effective on the second year of the Employment Term. Mr. Dawson will receive a target bonus of $100,000, calculated based upon the following two components: (1) earnings growth of Five Star and (2) an achievement by Five Star of certain goals, weighted 75% and 25% respectively. Mr. Dawson's target bonus for the years 2004 and 2005, will be $120,000, and $130,000, respectively, which will be determined by components and weighting factors based upon the goals and objectives of Five Star, mutually agreed upon. Pursuant to the employment agreement, Five Star granted Mr. Dawson under Five Star's option plan, five-year options to purchase 150,000 shares of Five Star's common stock at an exercise price of $0.14 per share. Such options vest 20% per annum, commencing on November 28, 2001. Five Star is also required to provide Mr. Dawson with an automobile. Five Star may terminate the employment agreement for cause which is defined as (i) breach by Mr. Dawson of any of the terms of the employment agreement, provided that Five Star has given fifteen days notice prior to termination for any breach of any of the terms of the employment agreement which are capable of cure, (ii) gross neglect by Mr. Dawson of his duties continuing for 30 days after written warning issued to Mr. Dawson setting forth the conduct constituting such gross neglect, (iii) conviction of Mr. Dawson for any felony or any crime involving moral turpitude, (iv) the conviction of Mr. Dawson of any offense involving the property of Five Star or any of its affiliates,(v) the commission by Mr. Dawson of any act of fraud or dishonesty, (vi) the engagement by Mr. Dawson in misconduct resulting in serious injury to Five Star, or (vii) the physical or mental disability of Mr. Dawson, whether totally or partially, if he is unable to perform substantially his duties for a period of (i) two consecutive months or (ii) shorter periods aggregating three months during any twelve month period, such termination to be effective thirty days after written notice of such decision delivered to Mr. Dawson. If Mr. Dawson is terminated for cause, he shall not be entitled to any compensation, including without limitation, the bonus, if any, after the date of termination for the year in which the termination takes place. If Mr. Dawson's employment is terminated by his death or disability, Five Star is required to pay Mr. Dawson his base salary then in effect for the month during which termination occurred, and four months thereafter. In the event that termination occurs more than six months after the start of the then-current contract year, Mr. Dawson shall receive a bonus for that year prorated through the date of termination. If Five Star terminates the employment agreement for any reason, other than those set forth in the employment agreement, Five Star is obligated to continue to pay Mr. Dawson's base salary as then in effect for the period commencing from the date of termination and ending on the termination date of the employment agreement and shall only be obligated to pay the Bonus, if any, through the date of termination on a pro rata basis. National Patent Development Executive Incentive Compensation Plan On November 3, 2003, the sole stockholder and the Board of Directors of National Patent Development adopted National Patent Development's 2003 Incentive Stock Plan, or the 2003 Plan. The aggregate number of shares of National Patent Development common stock available for issuance under the 2003 Plan will not exceed 1,750,000. The 2003 Plan is integral to National Patent Development's compensation strategies and programs and will maintain the flexibility that National Patent Development needs to keep pace with its competitors and effectively recruit, motivate and retain the caliber of employees essential for achievement of National Patent Development's success. The Board of Directors believes that the 2003 Plan will enhance the long-term stockholder value of National Patent Development by offering participants opportunities to acquire a proprietary interest in National Patent Development and to link their interests and efforts to the long-term interests of National Patent Development's stockholders. The 2003 Plan will permit awards of incentive stock options, nonqualified stock options, restricted stock, stock units, performance shares, performance units and other incentives payable in cash or in shares of National Patent Development's common stock. Stockholder approval of the 2003 Plan permits performance-based awards available under the 2003 Plan to qualify for deductibility under Section 162(m) of the Internal Revenue Code. Awards and grants under the 2003 Plan are referred to collectively as "Awards." Those eligible for Awards under the 2003 Plan include any employee, officer or director of National Patent Development or any entity that is directly or indirectly controlled by National Patent Development. Consultants, agents, advisors and independent contractors who provide services to National Patent Development are also eligible to receive Awards. Persons who receive Awards are referred to as "Participants." Shares Available for Issuance The aggregate number of shares of common stock available for issuance under the 2003 Plan will not exceed 1,750,000. No Participant may receive in any one calendar year Awards relating to more than 250,000 shares of Company stock. If there is any change in National Patent Development stock by reason of any stock split, stock dividend, spin-off, recapitalization, merger, consolidation, combination, or exchange of shares, distribution to stockholders other than a normal cash dividend or other change in National Patent Development's corporate or capital structure, the maximum number and kind of securities (i) available for issuance under the 2003 Plan, (ii) available for issuance as incentive stock options, (iii) that may be subject to Awards received by any Participant in any one calendar year, (iv) that may be subject to different types of Awards and (v) that are subject to any outstanding Award and the price of each security may be equitably adjusted by the Compensation Committee in its discretion. Shares covered by an Award will not count against the shares available for issuance under the 2003 Plan until they are actually issued and delivered to a Participant. If an Award granted under the 2003 Plan lapses, expires, terminates or is forfeited, surrendered or canceled without having been fully exercised or without the issuance of all of the shares subject to the Award, the shares covered by such Award will again be available for use under the 2003 Plan. In addition, shares that are (i) tendered by a Participant or retained by National Patent Development as payment for the purchase price of an Award or to satisfy tax withholding obligations, (ii) covered by an Award that is settled in cash, or (iii) reacquired by National Patent Development on the open market using cash proceeds received by National Patent Development from the exercise of Stock Options, will be available for issuance under the 2003 Plan. Administration The 2003 Plan will be administered by the Compensation Committee of the Board of Directors. Awards Performance Share and Performance Unit Awards. The Compensation Committee may grant Awards of performance shares and/or performance units to Participants. Each Award of performance shares will entitle the Participant to a payment in the form of shares of National Patent Development stock upon the attainment of specified performance goals. Each Award of performance units will entitle the Participant to a cash payment upon the attainment of specified performance goals. No Participant who is a "covered employee" for purposes of Section 162(m) of the Internal Revenue Code may earn more than $500,000 pursuant to a performance unit award in any one calendar year. The performance units may be paid in National Patent Development stock, at the discretion of the Compensation Committee. Restricted Stock and Stock Unit Awards. Restricted stock consists of shares of National Patent Development stock that are transferred or sold by National Patent Development to a Participant, but are subject to substantial risk of forfeiture and to restrictions on their sale or other transfer by the Participant. Stock Units are the right to receive shares of National Patent Development stock, cash or a combination of shares and cash at a future date in accordance with the terms of such grant upon the attainment of certain conditions specified by the Compensation Committee. Upon a Participant's satisfaction of any terms, conditions and restrictions, as determined by the Compensation Committee, the shares covered by a restricted stock Award will be transferred to the Participant, and stock units will be paid in cash, shares of National Patent Development stock or a combination of both. The Compensation Committee may determine whether restricted stock or stock unit Awards accrue dividends or dividend equivalents with respect to the shares of National Patent Development stock underlying any Award. Stock Options. The Compensation Committee may grant stock options to Participants either in the form of incentive stock options or nonqualified stock options. The exercise price of any shares subject to a stock option may be no less than 100% of the fair market value of the shares for the date the stock option is granted. For purposes of the 2003 Plan, for National Patent Development stock traded on the OTC Bulletin Board, fair market value means the average of the closing bid and asked prices on such date (or, if no shares were traded that day, on the last sale date, provided it was within a reasonable period of time before the grant date); if National Patent Development stock is traded on a national exchange or on the Nasdaq market, fair market value means the closing price of such stock on the date the stock option is granted (or, if no shares were traded that day, on the last sale date, provided it was within a reasonable period of time before the grant date); if National Patent Development stock is not traded in the OTC Bulletin Board and is not listed on a national exchange or on the Nasdaq market (or if it is so listed or traded, but no shares were traded within a reasonable period of time before the grant date), fair market value is determined by the Compensation Committee from all relevant available facts. The term of a stock option cannot exceed ten years. At the time of grant, the Compensation Committee in its sole discretion will determine when stock options are exercisable and when they expire. Performance Criteria. Awards of performance shares, performance units, restricted stock, stock units and other Awards under the 2003 Plan may be made subject to the attainment of performance goals relating to one or more business criteria within the meaning of Section 162(m) of the Internal Revenue Code. These business criteria are profits (including, but not limited to, profit growth, net operating profit or economic profit); profit-related return ratios; return measures (including, but not limited to, return on assets, capital, equity or sales); cash flow (including, but not limited to, operating cash flow, free cash flow or cash flow return on capital); earnings (including, but not limited to, net earnings, earnings per share, or earnings before or after taxes); net sales growth; net income (before or after taxes, interest, depreciation and/or amortization); gross or operating margins; productivity ratios; share price (including, but not limited to, growth measures and total stockholder return); expense targets; margins; operating efficiency; customer satisfaction; and working capital targets. Any performance criteria may be used to measure the performance of National Patent Development as a whole or any business unit of National Patent Development. Any performance criteria may include or exclude nonrecurring items, which are items deemed by the Compensation Committee not to be reflective of National Patent Development's core operating performance, including exogenous events, acquisitions, divestitures, changes in accounting principles or extraordinary items determined under generally accepted accounting principles. Amendment and Termination of the 2003 Plan The Board or the Compensation Committee may amend the 2003 Plan, except that if any applicable statute, rule or regulation, including those of any securities exchange, requires stockholder approval with respect to any amendment of the 2003 Plan, then to the extent so required, stockholder approval will be obtained. The 2003 Plan specifically provides that the Compensation Committee may not, without the prior approval of National Patent Development's stockholders, cancel any outstanding option for the purpose of reissuing the option to the Participant at a lower exercise price or reduce the exercise price of an outstanding option. Unless sooner terminated by the Board, the 2003 Plan will terminate ten years from the date stockholders approve the 2003 Plan. Federal Income Tax Consequences National Patent Development has been advised by counsel that the material tax consequences as they relate to Awards under the 2003 Plan to National Patent Development and to its employees who are U.S. citizens under current U.S. federal income tax laws are as follows: Performance Shares, Restricted Stock and Stock Units. A Participant who receives an Award of performance shares, restricted stock or stock units does not generally recognize taxable income at the time the Award is granted. Instead, the Participant recognizes ordinary income in the first taxable year in which his or her interest in the shares underlying the Award becomes either (i) freely transferable or (ii) no longer subject to substantial risk of forfeiture. The amount of taxable income is equal to the fair market value of the shares less the cash, if any, paid for the shares. A Participant may elect to recognize income at the time he or she receives restricted stock in an amount equal to the fair market value of the restricted stock (less any cash paid for the shares) on the date the Award is granted. National Patent Development receives a compensation expense deduction in an amount equal to the ordinary income recognized by the Participant in the taxable year in which restrictions lapse (or in the taxable year of the Award if, at that time, the Participant had filed a timely election to accelerate recognition of income). Incentive Stock Options. A Participant does not generally recognize taxable income upon the grant or upon the exercise of an incentive stock option. Upon the sale of shares subject to an incentive stock option, the Participant recognizes income in an amount equal to the difference, if any, between the exercise price of the shares and the fair market value of those shares on the date of sale. The income is taxed at long-term capital gains rates if the Participant has not disposed of the stock within two years after the date of the grant of the incentive stock option and has held the shares for at least one year after the date of exercise and National Patent Development is not entitled to a federal income tax deduction. The holding period requirements are waived when a Participant dies. The exercise of an incentive stock option may in some cases trigger liability for the alternative minimum tax. If a Participant sells shares subject to an incentive stock option before having held them for at least one year after the date of exercise and two years after the date of grant, the Participant recognizes ordinary income to the extent of the lesser of (i) the gain realized upon the sale; or (ii) the difference between the exercise price and the fair market value of the shares on the date of exercise. Any additional gain is treated as long-term or short-term capital gain depending upon how long the Participant has held the shares prior to disposition. In the year of disposition, National Patent Development receives a federal income tax deduction in an amount equal to the ordinary income that the Participant recognizes as a result of the disposition. Nonqualified Stock Options. A Participant does not recognize taxable income upon the grant of a nonqualified stock option. Upon the exercise of a nonqualified stock option, the Participant recognizes ordinary income to the extent the fair market value of the shares received upon exercise of the nonqualified stock option on the date of exercise exceeds the exercise price. National Patent Development receives an income tax deduction in an amount equal to the ordinary income that the Participant recognizes upon the exercise of the nonqualified stock option. General. National Patent Development may not deduct compensation of more than $1 million that is paid to an individual who, on the last day of the taxable year, is either National Patent Development's chief executive officer or is among one of the four other most highly-compensated officers for that taxable year. The limitation on deductions does not apply to certain types of compensation, including qualified performance-based compensation. National Patent Development believes that Awards in the form of performance stock, performance units, performance-based restricted stock, performance-based stock units and stock options may qualify as performance-based compensation and, as such, be exempt from the $1 million limitation on deductible compensation. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, DIRECTORS AND EXECUTIVE OFFICERS OF NATIONAL PATENT DEVELOPMENT The current stockholders of GP Strategies, including certain of the executive officers and directors of National Patent Development, will receive shares of National Patent Development common stock in the spin-off. In addition certain directors and executive officers of National Patent Development may be granted options to purchase shares of National Patent Development common stock. The following table sets forth the beneficial ownership of National Patent Development common stock by each person National Patent Development believes will own beneficially more than 5% of National Patent Development's common stock, based on their ownership of GP Strategies common stock and Class B capital stock as of March 31, 2004. Footnotes refer to filings made with the Securities and Exchange Commission, or SEC, with respect to securities of GP Strategies. Name and Address Amount and Nature of Percent of of Beneficial Owner Beneficial Ownership Class Bedford Oak Partners, L.P. 2,431,500 shares(1) 13.8% 100 South Bedford Road Mt. Kisco, NY 10549 Gabelli Asset Management, Inc. 1,869,445 shares(2) 10.6% One Corporate Center Rye, NY 10580 EGI-Fund (02-04) Investors, L.L.C. 1,390,000 shares(3) 7.9% Two N. Riverside Plaza Chicago, IL 60606 Caxton International Limited 1,251,200 shares(4) 7.1% 315 Enterprise Drive Plainsboro, NJ 08536 Dimensional Fund Advisors, Inc. 878,955 shares(5) 5.0% 1299 Ocean Avenue Santa Monica, CA 90401 - ---------- (1) Based on a Schedule 13D filed jointly by Bedford Oak Partners, L.P. ("Bedford Oak"), Bedford Oak Advisors, LLC and Harvey P. Eisen with the SEC on July 25, 2002. Mr. Eisen is deemed to have beneficial ownership of such shares by virtue of his position as managing member of Bedford Oak Advisors, LLC, the investment manager of Bedford Oak. (2) Based on a Schedule 13D filed jointly by Gabelli Funds, LLC, GAMCO Investors, Inc. , MJG Associates, Inc., Gabelli Advisers, Inc., Gabelli Group Capital Partners, Inc. , Gabelli Asset Management, Inc. and Mario J. Gabelli. Mario Gabelli directly or indirectly controls or acts as chief investment officer for these entities. Includes 1,394,745 shares estimated to be issuable upon exercise of warrants to purchase shares of National Patent Development common stock. See "Description of Warrants." (3) Based on a Schedule 13D filed jointly by EGI-Fund (02-04) Investors, L.L.C., or the EGI Purchaser, ( EGI Managing Member (02-04), L.L.C. and SZ Investments, L.L.C. with the SEC on May 13, 2002 and information supplied by such entities. EGI Managing Member is the managing member of EGI Purchaser and SZ Investments is the managing member of EGI Managing Member. Samuel Zell is the President of EGI Purchaser, Managing Member and SZ Investments. and is the Chairman of the Board of Directors of Equity Group Investments, L.L.C. SZ Investments is owned by various trusts for the benefit of Samuel Zell and his family. (4) Based on a Schedule 13D/A filed jointly by Caxton International Limited, Caxton Associates, L.L.C., Bruce S. Kovner, Caxton Equity Growth (BVI) Ltd. and Caxton Equity Growth LLC. Mr. Kovner is Chairman of Caxton Corporation. Caxton Corporation is the manager and majority owner of Caxton Associates. (5) Based on a Schedule 13G filed by Dimensional Fund Advisors Inc. ("Dimensional") with the SEC on February 3, 2003. Dimensional has stated that the shares are owned by advisory clients of Dimensional and that Dimensional disclaims beneficial ownership of such shares. The following table sets forth the beneficial ownership of National Patent Development common stock by each National Patent Development director, each of National Patent Development's executive officers, and all National Patent Development directors and executive officers as a group, based on their ownership of GP Strategies common stock and Class B capital stock as of March 31, 2004. Total Number of Shares of Common stock Percent of Common Beneficially Stock Name Owned Owned Harvey P. Eisen............. 2,432,999(1) 13.8% Jerome I. Feldman........... 611,242(2) 3.5% Scott N. Greenberg.......... 27,059(3) * Roald Hoffmann.............. 3,116 * Ellen Havdala............... - (4) * Andrea D. Kantor............ 5,301(5) * Charles Dawson.............. - * Steven Cliff................ 2,739 (6) * Thomas C. Kinnear........ - * Talton R. Embry........... - * Directors and Executive Officers as a Group (10 persons)............... 3,082,456 (4)(7) 17.5% - ---------- *The number of shares owned is less than one percent of the outstanding shares. (1) Includes 2,431,500 shares of common stock beneficially owned by Bedford Oak. Mr. Eisen is deemed to have beneficial ownership of such shares by virtue of his position as managing member of Bedford Oak Advisors, LLC, the investment manager of Bedford Oak. See footnote 1 to 5% stockholders table. (2) Includes 1,173 shares of common stock held by members of Mr. Feldman's family, and 4,419 shares of common stock allocated to Mr. Feldman's account pursuant to the provisions of the GP Retirement Savings Plan (the "GP Plan"). Mr. Feldman disclaims beneficial ownership of the 1,173 shares of common stock held by members of his family. (3) Includes 4,000 shares of common stock held by members of Mr. Greenberg's family, and 5,341 shares of common stock allocated to Mr. Greenberg's account pursuant to the provisions of the GP Plan. Mr. Greenberg disclaims beneficial ownership of the 4,000 shares of common stock held by members of his family. (4) Does not include 1,390,000 shares of common stock beneficially owned by EGI. Ms. Havdala disclaims beneficial ownership of such shares. (5) Includes 5,301 shares of common stock allocated to Ms. Kantor's account pursuant to the provisions of the GP Plan. (6) Includes 2,739 shares of common stock allocated to Mr. Cliff's account pursuant to the provisions of the GP Plan. (7) Includes 17,800 shares of common stock allocated pursuant to the provisions of the GP Plan. DESCRIPTION OF CAPITAL STOCK Authorized Shares Under National Patent Development's Certificate of Incorporation, the authorized capital stock of National Patent Development consists of 30,000,000 shares of common stock, par value $.01 per share, and 10,000,000 shares of preferred stock, $.01 par value per share. GP Strategies currently owns all outstanding shares of common stock. No shares of preferred stock have been issued. Immediately after the spin-off, based on the number of shares of common stock and Class B capital stock of GP Strategies outstanding at August 10, 2004 and the distribution ratio of one share of National Patent Development common stock for every share of GP Strategies common stock and Class B capital stock, approximately 17,672,837 shares of the National Patent Development common stock and no shares of the preferred stock will be issued and outstanding. GP Strategies will not own shares of National Patent Development common stock after the spin-off. Common Stock Each outstanding share of National Patent Development common stock entitles the holder to one vote on all matters requiring a vote of stockholders. Since the common stock does not have cumulative voting rights, the holders of shares having more than 50% of the voting power, if they choose to do so, may elect all the directors of National Patent Development and the holders of the remaining shares would not be able to elect any directors. See "Security Ownership of Certain Beneficial Owners, Directors and Executive Officers of National Patent Development." Subject to the rights of holders of any series of preferred stock that may be issued in the future, the holders of the common stock are entitled to receive dividends when, as and if declared by the Board of Directors out of funds legally available therefor. See "Dividend Policy." In the event of a voluntary or involuntary liquidation of National Patent Development, all stockholders are entitled to a pro rata distribution of the assets of National Patent Development remaining after payment of claims of creditors and liquidation preferences of any preferred stock. Holders of common stock have no conversion or preemptive rights. Preferred Stock The Certificate of Incorporation authorizes the Board, without any vote or action by the holders of common stock, to issue preferred stock from time to time in one or more series. The Board is authorized to determine the number of shares and to fix the powers, designations, preferences and relative, participating, optional or other special rights of any series of preferred stock. Issuances of preferred stock would be subject to any applicable rules of organizations on which National Patent Development stock is then quoted or listed. Depending upon the terms of preferred stock established by the Board of Directors, any or all series of preferred stock could have preference over the common stock with respect to dividends and other distributions and upon liquidation of National Patent Development. If any shares of preferred stock are issued with voting powers, or if additional shares of common stock are issued, the voting power of the outstanding common stock would be diluted. National Patent Development believes that the availability of preferred stock will provide increased flexibility to facilitate possible future financings and acquisitions and to meet other corporate needs that might arise. Transfer Agent and Registrar Computershare Investor Services LLC will be the transfer agent and registrar for the National Patent Development common stock immediately following the spin-off. DESCRIPTION OF WARRANTS Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, GP Strategies issued and sold to four Gabelli funds $7,500,000 aggregate principal amount of 6% Conditional Subordinated Notes due 2008, or the Gabelli Notes, and 937,500 warrants, or the GP Warrants. The aggregate purchase price of the Gabelli Notes and GP Warrants was $7,500,000. Such sale was exempt from registration under Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving a public offering of securities. The Note and Warrant Purchase Agreement provides that, on completion of the spin-off, National Patent Development will issue warrants, or the Warrants, to the holders of the GP Warrants. The Warrants will entitle the holders to purchase, in the aggregate, a number of shares of National Patent Development common stock equal to 8% of the number of shares outstanding at completion of the spin-off, subject to reduction for any GP Warrants exercised prior to the spin-off. The Warrants will be issued to the holders of the GP Warrants on the record date for the spin-off, and allocated among them pro-rata based on the respective number of GP Warrants held by them on such date. The exercise price of the Warrants will be 160% of the average closing price of the National Patent Development common stock over the 20 consecutive trading days commencing on the record date of the spin-off. The Warrants will be exercisable at any time after their exercise price is calculated through August 2008. The Warrants will contain anti-dilution provisions for stock splits, reorganizations, mergers, and similar transactions. National Patent Development has agreed to file a registration statement to register the resale of the shares of its common stock issuable on exercise of the Warrants, and to certain other registration rights in favor of the holders of the Warrants. The Gabelli Notes are secured by a mortgage on GP Strategies property located in Pawling, New York that will be contributed to MXL in connection with the spin-off. MXL will assume the mortgage, but without liability for repayment of the Gabelli Notes or any other obligations of GP Strategies under the Note and Warrant Purchase Agreement (other than foreclosure on such property). If there is a foreclosure on the mortgage for payment of the Gabelli Notes, GP Strategies has agreed to indemnify MXL for loss of the value of the property. DESCRIPTION OF INDEBTEDNESS On March 8, 2001, MXL entered into a loan in the amount of $1,680,000, secured by a mortgage covering the real estate and fixtures on its property in Pennsylvania. At March 31, 2004, $1,380,000 of such loan was outstanding. The loan requires monthly repayments of $8,333 plus interest at 2.5% above the one month LIBOR rate and matures on March 8, 2011, when the remaining amount outstanding of approximately $680,000 is due in full. The loan is guaranteed by GP Strategies. The proceeds of the loan were used to repay a portion of the GP Strategies' short-term borrowings under its prior credit agreement. On July 3, 2001, MXL entered into a loan in the amount of $1,250,000, secured by a mortgage covering the real estate and fixtures on its property in Illinois. At March 31, 2004, $1,178,000 of such loan was outstanding. The loan requires monthly payments of principal and interest in the amount of $11,046 with interest at a fixed rate of 8.75% per annum, and matures on June 26, 2006, when the remaining amount outstanding of approximately $1,100,000 is due in full. The loan is guaranteed by GP Strategies. The proceeds of the loan were used to repay a portion of the GP Strategies' short-term borrowings under its prior credit agreement. On September 15, 2003, MXL purchased machinery, equipment and inventory from AOtec, located in the Massachusetts area, for a purchase price of $1,100,000, subject to adjustment. On August 1, 2003, MXL paid $100,000 of the purchase price and issued three notes, in the amounts of $450,000, $275,000 and $275,000, due October 1, 2003, August 5, 2004 and August 5, 2005, respectively (collectively, the "AOtec Notes"). The AOtec Notes bear interest on the unpaid principal amount at the rate of 4% per annum. On October 1, 2003, MXL borrowed $700,000, or the AOtec Debt, from a bank to finance the purchase price and used the proceeds to pay the $450,000 Note. The AOtec Debt is payable monthly for three-years and is secured by the machinery and equipment purchased from AOtec. GP Strategies guaranteed the AOtec Debt. On June 20, 2003, Five Star obtained a new loan and security agreement with Fleet Capital Corporation. The agreement has a maturity date of June 30, 2008 and provides for a $25,000,000 revolving credit facility, which allows Five Star to borrow based upon specified percentages of eligible inventory and eligible accounts receivable, as defined therein. The interest rates under the agreement consist of LIBOR plus a credit spread for borrowings not to exceed $15,000,000 and the prime rate plus a credit spread for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star achieves and maintains certain performance benchmarks. At March 31, 2004 and December 31, 2003, approximately $22,644,000 and $16,685,000 was outstanding under the loan and security agreement and approximately $1,980,000 and $480,000 was available to be borrowed, respectively. On June 20, 2003, GP Strategies entered into an Agreement of Subordination and Assignments, or the Subordination Agreement, with Five Star and its lenders that permits the annual repayment of principal on the Five Star Note. Pursuant to the provisions of the Subordination Agreement, in each of June and July 2003, GP Strategies received a partial repayment from Five Star in the amount of $500,000, reducing the outstanding principal amount of the Five Star Note from $4,500,000 to $3,500,000. On October 8, 2003, GP Strategies exchanged $500,000 principal amount of the Five Star Note for 2,000,000 shares of Five Star common stock, reducing the outstanding principal amount of the Five Star Note to $3,000,000. Pursuant to the provision of the Subordination Agreement, in December 2003, GP Strategies received a partial repayment from Five Star in the amount of $200,000, further reducing the outstanding principal amount of the Five Star Note to $2,800,000. The Five Star Note and all the shares of Five Star common stock owned by GP Strategies, along with GP Strategies' rights under the Subordination Agreement, will be transferred to National Patent Development prior to the spin-off. As of December 31, 2003 MXL provided security for General Physics' Financing and Security Agreement. The Financing and Security Agreement provides for a maximum outstanding balance of $25 million and was secured by certain of the assets of General Physics and the accounts receivable of MXL. The Financing and Security Agreement is also guaranteed by GP Strategies. MXL provided a limited guaranty up to the value of its account receivable collateral securing the Financing and Security Agreement. For the continuation of the bank's security interest in MXL's accounts receivable and the continuation of its limited guarantee after the spin-off, General Physics paid MXL a guarantee fee of 2% of the value of the borrowing base collateral attributable to MXL, calculated monthly. At General Physics' option, General Physics could eliminate MXL's accounts receivable from the borrowing base under the Financing and Security Agreement, provided that General Physics made a mandatory prepayment under the Financing and Security Agreement to eliminate any borrowing base deficiency. At such point, all obligations of MXL relating to the Financing and Security Agreement terminated, MXL's limited guaranty of the Financing and Security Agreement became void, and General Physics was no longer required to pay to MXL the guarantee fee. In March 2004 General Physics eliminated MXL's accounts receivable from the borrowing base, no mandatory prepayment was required by General Physics, and the guarantee fee was eliminated. Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, GP Strategies issued and sold to four Gabelli funds $7,500,000 aggregate principal amount of Gabelli Notes, and 937,500 GP Warrants, each entitling the holder thereof to purchase (subject to adjustment) one share of GP Strategies common stock. See "Description of Warrants." The Gabelli Notes are secured by a mortgage on GP Strategies property located in Pawling, New York that will be contributed to MXL in connection with the spin-off. MXL will assume the mortgage, but without liability for repayment of the Gabelli Notes or any other obligations of GP Strategies under the Note and Warrant Purchase Agreement (other than foreclosure on such property). If there is a foreclosure on the mortgage for payment of the Gabelli Notes, GP Strategies has agreed to indemnify MXL for loss of the value of the property. GP Strategies has guaranteed the leases for Five Star's New Jersey and Connecticut warehouses, totaling approximately $1,347,000 per year through the first quarter of 2007, and an aggregate of $116,000 for certain equipment leases through April 2004. GP Strategies' guarantee of such leases was in effect when Five Star was a wholly-owned subsidiary of GP Strategies. In 1998, GP Strategies sold substantially all of the operating assets of the Five Star business to the predecessor corporation of Five Star. As part of this transaction, the landlord of the New Jersey and Connecticut facilities and the lessor of the equipment did not consent to the release of GP Strategies' guarantee. ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS National Patent Development's Certificate of Incorporation and Bylaws and the Delaware General Corporation Law contain provisions that may discourage or delay the acquisition of control of National Patent Development by means of a tender offer, open market purchases, a proxy contest or otherwise. Purposes of Provisions The relevant provisions of the Certificate of Incorporation and Bylaws are intended to discourage certain types of transactions that may involve an actual or threatened change of control of National Patent Development and to encourage any person who might seek to acquire control of National Patent Development to negotiate with the Board of Directors. Management of GP Strategies and National Patent Development believe that generally the interests of the stockholders would be served best if any change in control results from negotiations with the National Patent Development Board of the proposed terms, such as the price to be paid, the form of consideration and the anticipated tax effects of the transaction. However, to the extent that these provisions do discourage takeover attempts, they could make it more difficult to accomplish transactions that are opposed by the incumbent Board and could deprive stockholders of opportunities to realize takeover premiums for their shares or other advantages that large accumulations of stock would provide. The Certificate of Incorporation and the Bylaws will be effective on or before the Distribution Date, and are filed as exhibits to National Patent Development's registration statement on Form 10 of which this Information Statement is a part. Delaware Section 203 Section 203 of the Delaware General Corporation Law provides that, subject to certain exceptions, a corporation shall not engage in any "business combination" with any "interested stockholder" for a three-year period following the time that such stockholder becomes an interested stockholder unless: o prior to such time, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; o upon consummation of the transaction which resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding certain shares); or o on or subsequent to such time, the business combination is approved by the board of directors of the corporation and by the affirmative vote of at least 66 2/3% of the outstanding voting stock which is not owned by the interested stockholder. Section 203 generally defines an "interested stockholder" to include: o any person that is the owner of 15% or more of the outstanding voting stock of the corporation, or is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within three years immediately prior to the relevant date; and o the affiliates and associates of any such person. o Section 203 generally defines a "business combination" to include: o mergers and sales or other dispositions of 10% or more of the assets of the corporation with or to an interested stockholder; o certain transactions resulting in the issuance or transfer to the interested stockholder of any stock of the corporation or its subsidiaries; o certain transactions which would result in increasing the proportionate share of the stock of the corporation or its subsidiaries owned by the interested stockholder; and o receipt by the interested stockholder of the benefit (except proportionately as a stockholder) of any loans, advances, guarantees, pledges, or other financial benefits. Under certain circumstances, Section 203 makes it more difficult for a person who would be an "interested stockholder" to effect various business combinations with a corporation for a three-year period, although the certificate of incorporation or stockholder-adopted bylaws may exclude a corporation from the restrictions imposed thereunder. Neither our Certificate of Incorporation nor our Bylaws exclude us from the restrictions imposed under Section 203. It is anticipated that the provisions of Section 203 may encourage companies interested in acquiring us to negotiate in advance with the Board of Directors since the stockholder approval requirement would be avoided if the Board approves, prior to the time the acquirer becomes an interested stockholder, either the business combination or the transaction that results in the acquirer becoming an interested stockholder. Number of Directors; Removal; Vacancies The Board currently consists of seven persons. Our Certificate of Incorporation provides that the Board, by resolution, may increase or decrease the authorized number of directors and that stockholders do not have the right to increase or decrease the number of directors. Directors may be removed only for cause and only by a vote of the holders of two-thirds of the stockholders entitled to vote thereon. Interim vacancies on the Board, or vacancies created by an increase in the number of directors, may be filled by a majority of the directors then in office. Stockholder Action The Certificate of Incorporation requires all stockholder action to be taken at an annual or special meeting of stockholders and prohibits stockholder action by written consent. The Certificate of Incorporation and Bylaws also provide that special meetings of stockholders may be called by the Board of Directors, the Chairperson or the President. Stockholders may not call special meetings. The provisions prohibiting stockholder action by written consent and not permitting any stockholder or group thereof to call a special meeting may have the effect of delaying consideration of a stockholder proposal until the next annual meeting of the stockholders. Amendment of Bylaws The Certificate of Incorporation also authorizes stockholders to adopt, amend, or repeal Bylaws, but only by the affirmative vote of the holders of 75% of the voting power of the shares of capital stock entitled to vote thereon. The Board of Directors is also authorized to adopt, amend, or repeal Bylaws. Stockholder Proposals and Nominations National Patent Development's Bylaws establish an advance notice procedure for nominations of candidates for election as directors at, and for proposals to be brought before, an annual meeting of stockholders. This procedure provides that only such nominations may be considered and such business may be conducted at an annual meeting as have been specified in the notice of such meeting or brought before the meeting by or at the direction of the Board or by a stockholder who has given to the Secretary of National Patent Development timely written notice, in proper form, of the same. To be timely, notice of nominations or other business to be brought before an annual meeting must be received by the Secretary of National Patent Development not less than 90 days prior to the anniversary of the preceding year's annual meeting or, if the annual meeting date is not within 30 days before or after such anniversary date, within 10 days after public disclosure of the annual meeting date. To be in proper form, each notice must set forth: o if such notice relates to a stockholder proposal a brief description of the business proposed to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, o If such notices relates to a nomination for director, the name, age, business address and residence address, and principal occupation or employment of the nominee, the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by the nominee and any other information relating to the nominee that would be required to be disclosed in a proxy statement or other filings require to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act, and the rules and regulations promulgated thereunder. o the name and record address of such stockholder, o the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by such stockholder, o if such notices relates to a stockholder proposal a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of such stockholder in such business, o If such notice relates to a nomination for director, a description of all arrangements or understandings between such stockholder and each proposed nominee and any other person or persons (including their names0 pursuant to which the nomination(s) are to be made by such stockholder, o If such notice relates to a nomination for director, any other information relating to such stockholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder, o If such notice relates to a nomination for director, a written consent of each proposed nominee to being named as a nominee and to serve as a director if elected, and o a representation that such stockholder intends to appear in person or by proxy at the annual meeting to make such nomination or bring such business before the meeting. Preferred Stock and Additional Common Stock The Board's authority to issue of shares of common stock and preferred stock and to fix by resolution the terms and conditions of each series of preferred stock may either impede or facilitate the completion of a merger, tender offer or other takeover attempt. For example, the issuance of new shares might impede a business combination if the terms of those shares include series voting rights that would enable the holder to block business combinations or the issuance of new shares might facilitate a business combination if those shares have general voting rights sufficient to cause an applicable percentage vote requirement to be satisfied. The Board of Directors will make any determination regarding issuance of additional shares based on its judgment as to the best interest of its stockholders, customers, employees or other constituencies. INDEMNIFICATION OF OFFICERS AND DIRECTORS Indemnification Our Certificate of Incorporation and Bylaws provide for indemnification of our officers and directors to the extent permitted by Delaware law for expenses (including counsel fees and disbursements), judgments, fines, and amounts paid in settlement. The Certificate of Incorporation and Bylaws also provide with respect to officers and directors covered by indemnity that: o the rights conferred on the covered officers and directors thereby are not exclusive of any other rights which the officer or director may have or thereafter acquire under any statute, provision of the Certificate of Incorporation, the Bylaws, agreement, vote of stockholders or disinterested directors, or otherwise, o such indemnification will not be paid if it is determined by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to the proceeding giving rise to such indemnification, or (b) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (c) by the stockholders, that indemnification of the director or officer is not proper in the circumstances because he has not met the applicable standards of conduct set forth in Delaware law, o expenses will be advanced if the officer or director undertakes to repay such expenses if it is determined that such director or officer is not entitled to be indemnified, and o any repeal or modification of the relevant provisions of the Bylaws will not adversely affect any right or protection thereunder of any covered officer or director in respect of any act or omission occurring prior to the time of such repeal or modification. Elimination of Liability in Certain Circumstances The Certificate of Incorporation eliminates the personal liability of directors to National Patent Development or its stockholders for monetary damages for breach of fiduciary duty, except that directors remain liable for: o breaches of their duty of loyalty to National Patent Development and its stockholders, o acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law, o for unlawful distributions, under a provision of the Delaware General Corporation Law that makes directors personally liable and which expressly sets forth a negligence standard with respect to such liability, and o transactions from which a director derives improper personal benefit. These provisions pertain only to breaches of duty by directors as directors and not in any other corporate capacity, including as officers. As a result of the inclusion of these provisions, stockholders may be unable to recover monetary damages against directors for actions taken by them which constitute negligence or gross negligence or which are in violation of their fiduciary duties, although it may be possible to obtain injunctive or other equitable relief with respect to such actions. If equitable remedies are found not to be available to stockholders in any particular case, stockholders may not have any effective remedy against the challenged conduct. INDEPENDENT REGISTERED PUBLIC ACCOUNTANTING FIRM The Board of Directors of National Patent Development Corporation has selected EISNER LLP, an independent accounting firm, to audit National Patent Development's financial statements for the year ended December 31, 2003. EISNER LLP has served as independent accountants of National Patent Development Corporation since August 12, 2003. INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS National Patent Development Corporation Page Report of Independent Registered Public Accounting Firm F-2 Consolidated Statements of Operations - Years ended December 31, 2003, 2002 and 2001 and three months ended March 31, 2004 and March 31, 2003 (unaudited) F-3 Consolidated Statements of Comprehensive Income (Loss )- Years ended December 31, 2003, 2002 and 2001 and three months ended March 31, 2004 and March 31, 2003 (unaudited) F-3 Consolidated Balance Sheets - December 31, 2003 and 2002 and March 31, 2004 (unaudited) F-4 Consolidated Statements of Cash Flows - Years ended December 31, 2003, 2002 and 2001 and three months ended March 31, 2004 and March 31, 2003 (unaudited) F-5 Consolidated Statements of Changes in Stockholder's Equity - Years ended December 31, 2003, 2002 and 2001 and three months ended March 31, 2004 (unaudited) F-8 Notes to Consolidated Financial Statements F-9 SUPPLEMENTARY DATA Selected Quarterly Financial Data (unaudited) F-34 Schedule II - Valuation and Qualifying Accounts F-35 Five Star Products, Inc. Report of Independent Registered Public Accounting Firm F-37 Consolidated Balance Sheets - December 31, 2002 and 2001 F-38 Consolidated Statements of Operations - Years ended December 31, 2002 and 2001 F-39 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2002 and 2001 F-40 Consolidated Statements of Cash Flows - Years ended December 31, 2002 and 2001 F-41 Notes to Consolidated Financial Statements F-42 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholder of National Patent Development Corporation: We have audited the accompanying consolidated balance sheets of National Patent Development Corporation and subsidiaries (the "Company") as of December 31, 2003 and 2002 and the related consolidated statements of operations, comprehensive loss, cash flows and stockholder's equity for each of the years in the three year period ended December 31, 2003. Our audit also included the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Patent Development Corporation and subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 2003, in conformity with accounting principles generally accepted in the Unites States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. As discussed in Note 8 to the consolidated financial statements, effective January 1, 2002 the Company changed its accounting method for goodwill. New York, New York May 19, 2004, except for Note 1, as to which the date is July 30, 2004 NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
Three Months Ended March 31, Year Ended December 31, - ----------------------------------------------------- ---------------------------- --------------------------------------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- 2004 2003 2003 2002 2001 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- ---------------------------- --------------- -------------- -------------- (unaudited) Sales $29,121 $27,431 $103,698 $9,996 $11,184 Cost of sales 24,357 22,760 84,116 7,897 8,368 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Gross margin 4,764 4,671 19,582 2,099 2,816 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Selling, general and administrative expenses (4,668) (4,295) (18,274) (2,047) (1,964) Income related to equity investee 439 259 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Operating profit 96 376 1,308 491 1,111 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Interest expense (205) (205) (864) (208) (169) Investment and other income (loss) (95) 2 (61) 9 (178) - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Income (loss) before income taxes and minority (204) 173 383 292 764 interest Income tax expense (benefit) (26) 100 176 145 395 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Income (loss) before minority interest (178) 73 207 147 369 Minority interest (119) (121) (311) - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Net income (loss) $(297) $(48) $(104) $147 $369 - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- - ----------------------------------------------------- -------------- ------------- --------------- -------------- -------------- Pro forma net income (loss) per share Basic and diluted (unaudited) $ (.02) $.00 $ (.01) $ .01 $ .03 CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (in thousands) Three Months Ended March 31, Year Ended December 31, - -------------------------------------------------------- ----------------------------- --------------------------------------------- - -------------------------------------------------------- --------------- ------------- --------------- -------------- -------------- 2004 2003 2003 2002 2001 - -------------------------------------------------------- --------------- ------------- --------------- -------------- -------------- - -------------------------------------------------------- ----------------------------- --------------- -------------- -------------- (unaudited) Net income (loss) $(297) $(48) $(104) $147 $369 Other comprehensive income (loss), before tax: Net unrealized loss on available-for-sale-securities (486) (170) (902) (833) (1,475) Reclassification adjustment for loss on securities sold included in net loss 140 Net unrealized gain (loss) on interest rate swap, net of minority interest (162) 43 --------------- ------------- --------------- -------------- -------------- --------------- ------------- --------------- -------------- -------------- Comprehensive loss before tax (805) (218) (963) (686) (1,106) Income tax benefit related to items of other comprehensive loss 63 66 116 325 575 --------------- ------------- --------------- -------------- -------------- --------------- ------------- --------------- -------------- -------------- Comprehensive loss $(742) $(152) $(847) $(361) $(531) ====== ====== ====== ====== ====== See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands)
March 31, December 31, - ---------------------------------------------------------------- ------------------ ------------------------------------- - ---------------------------------------------------------------- ------------------ ------------------ ------------------ 2004 2003 2002 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ (unaudited) Assets Current assets Cash and cash equivalents $ 202 $ 602 $ 562 Accounts and other receivables less allowance for doubtful accounts of $790, $739 and $37 19,425 13,192 2,544 Inventories 27,967 28,300 1,380 Receivable from GP Strategies Corporation 1,486 709 Deferred tax assets 213 80 Prepaid expenses and other current assets 349 845 247 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Total current assets 49,642 43,728 4,733 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Receivable from GP Strategies Corporation 10,116 Investment in and note receivable from equity investee 6,260 Marketable securities available for sale 2,028 2,981 756 Property, plant and equipment, net 5,643 5,725 4,829 Goodwill 182 182 182 Other assets 3,009 3,132 2,994 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ $60,504 $55,748 $29,870 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Liabilities and stockholder's equity Current liabilities Current maturities of long-term debt $ 394 $ 389 $ 205 Short term borrowings 22,919 16,960 Accounts payable and accrued expenses 15,850 15,814 574 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Total current liabilities 39,163 33,163 779 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Long-term debt less current maturities 3,103 3,203 2,670 Deferred tax liability 114 102 970 Interest rate swap, at market 196 Minority interest 1,389 2,044 Stockholder's equity (Note 14(b)) Stockholder's investment 18,316 18,124 18,565 Retained earnings (deficit) (797) (353) 6,678 Accumulated other comprehensive income (loss) (980) (535) 208 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ Total stockholder's equity 16,539 17,236 25,451 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ - ---------------------------------------------------------------- ------------------ ------------------ ------------------ $60,504 $55,748 $29,870 - ---------------------------------------------------------------- ------------------ ------------------ ------------------ See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Three Months Ended March 31, Year ended December 31, - ------------------------------------------------------------ --------------------------- ----------------------------------------- - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ 2004 2003 2003 2002 2001 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ --------------------------- ------------- -------------- ------------ (unaudited) Cash flows from operations: Net income (loss) $(297) $(48) $(104) $147 $369 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 174 133 593 510 351 Minority Interest (119) 48 Income related to equity investee, prior to acquiring a controlling financial interest (109) (256) (55) (59) Net loss on marketable securities 97 36 Deferred income taxes (18) (19) (296) 77 (50) Allocation of expenses and taxes from GP Strategies 463 223 1,150 593 944 Impairment charge 400 Changes in other operating items, net of effects of acquisitions in 2003: Accounts and other receivables (6,232) (2) 2,620 (293) 293 Inventories 333 (133) (6,348) 354 (191) Prepaid expenses and other assets 282 (36) 225 (69) (113) Accounts payable and accrued expenses (500) 111 5,027 147 (418) - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Net cash provided by (used in) operations (5,817) 120 2,695 $1,411 $1,526 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Cash flows from investing activities: Additions to property, plant and equipment, net (124) (42) (525) $(368) $(435) Proceeds from sales of fixed assets 203 Proceeds from sale of investments 872 521 Advances to GP Strategies (1,138) (206) (1,310) (400) (3,698) Payments for acquisition of AOtec assets, net of cash ($6) acquired in Five Star acquisition (544) Repayment of note from Five Star Products 1,000 Recovery of investment in Five Star Products 475 475 33 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Net cash provided by (used in) investing activities (390) 227 (180) $(735) $(4,133) - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Cash flows from financing activities: Distribution to GP Strategies (57) (565) (1,985) (360) (477) Proceeds from issuance of long-term debt 700 3,338 Proceeds from (repayment of) short-term borrowings 5,959 (932) Repayment of long-term debt (95) (58) (258) (290) (345) - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Net cash (used in) provided by financing activities 5,807 (623) (2,475) (650) 2,516 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Net (decrease) increase in cash and cash equivalents (400) (276) 40 26 (91) Cash and cash equivalents at beginning of period 602 562 562 536 627 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ Cash and cash equivalents at end of period $202 $286 $602 $562 $536 - ------------------------------------------------------------ ------------- ------------- ------------- -------------- ------------ See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Three Months Ended March 31, Year ended December 31, - ---------------------------------------------------------------------- ----------------------- ------------------------------------ - ---------------------------------------------------------------------- ----------- ----------- ------------ ----------- ----------- 2004 2003 2003 2002 2001 - ---------------------------------------------------------------------- ----------- ----------- ------------ ----------- ----------- - ---------------------------------------------------------------------- ----------------------- ------------ ----------- ----------- (unaudited) Supplemental disclosures of cash flow information: Cash paid during the period for: Interest $260 $47 $ 398 $208 $169 Income taxes - - 201 2 38 Non-cash investing activities: Conversion of Five Star Products Note Receivable into common stock of Five Star Products 500 500 Repayment of receivable from GP Strategies with marketable and other securities 10,000 Contribution of HEB shares from GP Strategies 550 Acquisition of minority interest in Five Star Products pursuant to the tender offer 657 Purchase of certain assets from AOtec: Fixed assets $900 Inventory 350 Accrued expenses (150) Issuance of notes (exclusive of $450,000 note paid in 2003) (550) ------ Cash paid $ 550 ======= See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY THREE MONTHS ENDED MARCH 31, 2004 (UNAUDITED) AND YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (in thousands)
Accumulated Retained other Total Stockholder's earnings comprehensive stockholder's investment (deficit) income (loss) equity - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at December 31, 2000 $19,018 $5,946 $1,616 $26,580 - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Net unrealized loss on available for sale securities, net of tax (900) (900) Net income 369 369 Allocation of expenses from GP Strategies 46 46 Reclassification (a) (384) 384 Income tax provision deemed contributed by GP Strategies 407 407 Distributions to GP Strategies (477) (477) - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at December 31, 2001 $18,610 $6,699 $716 $26,025 - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Net unrealized loss on available for sale securities, net of tax (508) (508) Net income 147 147 Allocation of expenses from GP Strategies 81 81 Reclassification (a) 168 (168) Income tax provision deemed contributed by GP Strategies 66 66 Distributions to GP Strategies (360) (360) - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at December 31, 2002 $18,565 $6,678 $208 $25,451 - ------------------------------------------------------- ------------------ ------------- -------------------- ------------------ See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY THREE MONTHS ENDED MARCH 31, 2004 (UNAUDITED) AND YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001 (in thousands)
Accumulated Retained other Total Stockholder's earnings comprehensive stockholder's investment (deficit) income (loss) equity - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at December 31, 2002 $18,565 $6,678 $208 $25,451 - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Net unrealized loss on available for sale securities, net of tax (769) (769) Net unrealized gain on interest rate swap, net of tax and minority interest 26 26 Net loss (104) (104) Allocation of expenses from GP Strategies 449 449 Reclassification (a) 427 (427) Balance of receivable from GP Strategies in excess of carryover basis of assets received in repayment (6,500) (6,500) Income tax benefit deemed distributed to GP Strategies (16) (16) Capital contribution by GP Strategies 550 550 Distributions to GP Strategies (1,985) (1,985) Other 134 134 - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at December 31, 2003 $18,124 $(353) $(535) $17,236 - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Net unrealized loss on available for sale securities, net of tax (486) (486) Reclassification adjustment for loss on securities sold included in net loss, net of tax 140 140 Net unrealized loss on interest rate swap, net of tax and minority interest (99) (99) Net loss (297) (297) Allocation of expenses from GP Strategies 327 327 Reclassification (a) 147 (147) Income tax benefit deemed distributed to GP Strategies (225) (225) Distributions to GP Strategies (57) (57) - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ Balance at March 31, 2004 18,316 $(797) $(980) 16,539 - --------------------------------------------------------- ------------------ ------------- -------------------- ------------------ (a) Principally represents net income (loss) attributable to non-core assets not operated as separate entities. See accompanying notes to consolidated financial statements.
NATIONAL PATENT DEVELOPMENT CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Information as it relates to the three months ended March 31, 2004 and 2003 is unaudited) 1. The Company and basis of presentation In July 2002, the Board of Directors of GP Strategies Corporation ("GPS" or "GP Strategies") approved a spin-off of certain of its non-core assets into a separate corporation to be named National Patent Development Corporation ("National Patent Development" or the "Company"). GP Strategies will own and operate the manufacturing & process business and information technology business through its subsidiary, General Physics Corporation, and retain a 58% interest in GSE Systems Inc. The Company will own and operate the optical plastics business through its wholly-owned subsidiary, MXL Industries, Inc. ("MXL"), the home improvement distribution business through its partially owned subsidiary Five Star Products, Inc. and will also own certain other non-core assets. The separation of these businesses will be accomplished through a pro-rata distribution (the "Distribution") of 100% of the outstanding common stock of National Patent Development to the stockholders of GPS on the record date for the Distribution. On November 14, 2002, GPS filed a ruling request with the Internal Revenue Service (the "IRS"). On March 21, 2003, the IRS issued a favorable tax ruling which would enable the Distribution to be tax-free. As a result, each GPS stockholder would receive tax-free one share of National Patent Development common stock for every share of GPS common stock or Class B capital stock owned on the record date of the Distribution. National Patent Development was incorporated on March 10, 1998 as a wholly-owned subsidiary of GPS. On February 12, 2004, National Patent Development was recapitalized whereby the authorized capital was changed to 10,000,000 shares of preferred stock and 30,000,000 shares of common stock. On July 30, 2004, GPS contributed the following non-core assets to National Patent Development in exchange for 17,672,837 shares of common stock: 1. 100% of the outstanding common stock of MXL. 2. 9,133,417 common shares of Five Star Products, Inc. ("Five Star" or "FSP") (a publicly traded corporation) representing an approximately 64% ownership interest (see Notes 4 and 6). 3. 293,271 common shares of Millennium Cell Inc. (a publicly traded corporation) (see Note 5). 4. 1,067,900 common shares of Avenue Entertainment Group, Inc. (a publicly traded corporation) (see Note 5). 5. 100% of the common stock of JL Distributors, Inc. whose sole asset is a $2,800,000 senior unsecured 8% note from Five Star due June 30, 2005, as amended (see Note 4). 6. An option to acquire 500,000 shares of common stock (an approximate 4% interest) of Red Storm Scientific Inc., a privately held company (see Note 14(c)). 7. Approximately 1,000 acres of undeveloped real property located in Pawling, New York, which is being held for sale (see Note 16(b)). 8. 100% of the common stock of Chestnut Hill Reservoir Company whose sole asset is certain undeveloped property located in New England which is being held for sale. 1. The Company and basis of presentation (Continued) National Patent Development then transferred all of the above assets other than the MXL stock to MXL for additional MXL stock. Prior to the contribution, National Patent Development was inactive and had no operations. In addition to the above, GPS intends prior to the Distribution to make a capital contribution to National Patent Development, which in turn will transfer to MXL, $1,875,000 in cash (the "Gabelli Allocation") and the right to receive certain proceeds of pending litigation and arbitration claims (see Notes 15 and 16(b)). This allocation is not reflected in the accompanying consolidated financial statements. The accompanying consolidated financial statements present the historical results of operations, cash flows, assets, liabilities and changes in stockholder's equity of MXL combined with the non-core assets and their effect on results of operations and cash flows as if the contribution referred to above had occurred at the beginning of the periods presented. Commencing in 2003, as a result of the acquisition of a controlling financial interest in Five Star, its accounts have been consolidated in the accompanying financial statements as described below. In 2002 and 2001, the investment in Five Star was accounted for by the equity method. Results of operations reflect charges for allocations of corporate expense incurred by GPS (see Note 14(a)). All significant intercompany balances and transactions have been eliminated. Consolidated stockholder's equity consists of GPS's carrying value for its investment in the non-core assets contributed together with its investment in and retained earnings of MXL together with the retained earnings of Five Star from the date of consolidation. Reference to National Patent Development or the Company in the notes refers to MXL, Five Star and the non-core assets contributed to National Patent Development. On October 8, 2003, GPS exchanged $500,000 principal amount of the $3,500,000 Senior Unsecured 8% Note due June 30, 2005, as amended, of Five Star for 2,000,000 shares of Five Star common stock, increasing GPS's ownership in Five Star from approximately 48% to approximately 54% of the then outstanding Five Star common stock and obtained a controlling financial interest. As a result, commencing as of such date the accounts of Five Star have been consolidated in the Company's financial statements. As permitted by Accounting Research Bulletin No. 51 "Consolidated Financial Statements", Five Star's results of operations are included in the 2003 consolidated statement of operations as though a controlling financial interest had been acquired by the Company at the beginning of such year and, accordingly, Five Star's sales, cost of sales and expenses are included for the twelve months ended December 31, 2003. Minority interest in earnings includes, in addition to the 46% interest in Five Star not owned by the Company, pre acquisition earnings attributable to the acquired 6% interest. This method presents results which are more indicative of the current status of the Company, and facilitates future comparison with subsequent years. The minority interest balance as of March 31, 2004 and December 31, 2003 reflected in the consolidated balance sheets is comprised of the 36 percent (after completion of the tender offer described in Note 6) and the 46 percent minority share in Five Star which the Company did not own, respectively. MXL owns 100% of the common stock of Valera Pharmaceuticals, Inc. ("Valera") (which amounts to a 19.6% ownership interest assuming conversion of Valera outstanding preferred stock and exercise of stock options held by employees of Valera); however, it no longer has financial and operating control of the entity. On December 27, 2001, Valera completed a $7 million private placement of Valera Series A Convertible Preferred Stock to certain institutional investors. As a condition of the private placement, GPS contractually gave up operating control over Valera through an Investors Rights Agreement, 1. The Company and basis of presentation (Continued) and accordingly, MXL, which acquired 100% of the common stock of Valera on October 17, 2003 from GPS in partial repayment of a receivable due from GPS, accounts for its investment in Valera under the equity method (see Note 4). The financial statements included herein may not necessarily be indicative of the results of operations, financial position and cash flows of National Patent Development in the future or had it operated as a separate, independent company during the periods presented. 2. Description of business and a summary of significant accounting policies Description of business. MXL is a specialist in the manufacture of polycarbonate parts requiring strict adherence to optical quality specifications, and in the application of abrasion and fog resistant coating to these parts. Products include shields and face masks and non-optical plastic products. Five Star is engaged in the wholesale distribution of home decorating, hardware and finishing products. It serves over 3,500 independent retail dealers in twelve states in the Northeast. Products distributed include paint sundry items, interior and exterior stains, brushes, rollers, caulking compounds and hardware products Cash and cash equivalents. Cash and cash equivalents consist of cash and highly liquid debt instruments with original maturities of three months or less. Marketable securities. Marketable securities consist of U.S. corporate equity securities. The Company classifies its marketable securities as trading or available-for-sale investments. Trading and available-for-sale securities are recorded at their fair value. Trading securities are held principally for the purpose of selling them in the near term. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and are reported as a separate component of stockholders' equity in accumulated other comprehensive income, net of the related tax effect, until realized. A decline in the market value of any available-for-sale security below cost, that is deemed to be other than temporary, results in a reduction in carrying amount to fair value. The impairment is charged to earnings, and a new cost basis is established. Realized gains and losses are derived using the average cost method for determining the cost of securities sold. Available-for-sale securities consist of the common stock of Millennium Cell Inc. and Avenue Entertainment Group, Inc. Trading securities, which consist of the common stock of Hemispherx Biopharma, Inc., are included in other current assets at December 31, 2003. National Patent Development fully disposed of its trading securities in the three months ended March 31, 2004. Inventories. Inventories are valued at the lower of cost or market, using the first-in, first-out method. Revenue recognition. Revenue on product sales is recognized at the point in time when the product has been shipped, title and risk of loss has been transferred to the customer, and the following conditions are met: persuasive evidence of an arrangement exists, the price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Allowances for estimated returns and allowances are recognized when sales are recorded. Shipping and handling costs. Shipping and handling costs are included as a part of selling, general and administrative expense. These cost amounted to $1,124,000 (unaudited) and $1,120,000 (unaudited) for the three months ended March 31, 2004 and March 31, 2003, respectively, and $4,514,000, $82,000 and $73,000 for the years ended December 31, 2003, 2002 and 2001, respectively. 2. Description of business and a summary of significant accounting policies (Continued) Property, plant and equipment. Property, plant and equipment are carried at cost. Major additions and improvements are capitalized while maintenance and repairs which do not extend the lives of the assets are expensed as incurred. Gain or loss on the disposition of property, plant and equipment is recognized in operations when realized. Depreciation. The Company provides for depreciation of property, plant and equipment primarily on a straight-line basis over estimated useful lives of 5 to 40 years for buildings and improvements and 3 to 7 years for machinery, equipment and furniture and fixtures. Long-Lived Assets. The recoverability of long-lived assets, other than goodwill, is assessed whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is measured by determining the amount by which the carrying value of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value, less costs to sell. The Company has investments in land with a carrying value of $2.9 million included in other assets in the Consolidated Balance Sheets which are currently held for sale (see Note 16(b)). Management believes the fair value of these investments exceed their carrying value. Fair value of financial instruments. The carrying value of cash and cash equivalents, accounts receivable and accounts payable approximate estimated fair values because of short maturities. The carrying value of the receivable from GPS approximates estimated fair value (see Note 14(b)). The carrying value of short term borrowings approximates estimated fair value because borrowings accrue interest which fluctuates with changes in LIBOR or prime. The carrying value for the Company's long-term debt, certain of which have variable interest rates, approximates fair value. Marketable securities, other than those accounted for on the equity basis, are carried at fair value based upon quoted market prices. The interest rate swap is carried at fair value representing the amount the Company would receive or pay to terminate the swap. Five Star interest rate swap. The interest rate swap entered into by Five Star in connection with its loan agreement (see Note 8) is being accounted for under SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 requires all derivatives to be recognized in the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a cash flow hedge, changes in the fair value of the derivative are recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is immediately recognized in earnings. Changes in the fair value of the interest rate swap, which has been designated as a cash flow hedge, were recognized in other comprehensive income. 2. Description of business and a summary of significant accounting policies (Continued) Stock based compensation. The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, in accounting for options to acquire GP Strategies common stock granted to MXL employees under the GP Strategies stock option plan. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. The difference between the quoted market price as of the date of the grant and the contractual purchase price of shares is charged to operations over the vesting period. SFAS No. 123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123. Pro forma net income (loss) and earnings (loss) per share disclosures as if the Company recorded compensation expense based upon the fair value of the GPS stock-based awards pursuant to SFAS No. 123 has not been presented since no options have been granted to MXL employees during the periods presented and previously granted options to MXL employees vested immediately. Pro forma net income and earnings per share disclosures as if compensation expense was recorded based on the fair value of options granted under the Five Star Products, Inc. 1994 Five Star Plan (see Note 11) have been presented in accordance with the provisions of SFAS No. 123, is as follows for the three months ended March 31, 2004 and for the year ended December 31, 2003 (in thousands, except per share amounts):
Three months ended Year ended March 31, December 31, 2004 2003 Net loss - As reported $(297) $(104) Compensation expense, net of tax Five Star stock options (2) (1) (10) (1) -------- -------- Pro forma net loss $(299) $ (114) Basic and diluted loss per share As reported $(.02) $ (.01) Pro forma net loss per share $(.02) $ (.01)
(1) Expense relates to option grants made by Five Star prior to the acquisition of a controlling interest in Five Star by the Company. Pro forma per share data (unaudited). Pro forma basic and diluted income (loss) per share is based upon the weighted average number of shares issued being equal to the weighted average number of outstanding shares of GPS common stock and Class B capital stock, as if the distribution had occurred prior to the periods presented. Pro forma income (loss) per share for the three months ended March 31, 2004 and 2003, and for the years ended December 31, 2003, 2002 and 2001 are as follows (in thousands, except per share amounts): 2. Description of business and a summary of significant accounting policies (Continued)
Three Months ended March 31, Year ended December 31, 2004 2003 2003 2002 2001 ---- ---- ---- ---- ---- (unaudited) Basic and Diluted EPS Net income (loss) $(297) $(48) $(104) $147 $369 Weighted average shares outstanding, basic and diluted 17,574 16,581 17,139 15,370 13,209 Basic and diluted income (loss) per share $(.02) $.00 $(.01) $.01 $(.03)
Comprehensive income. Comprehensive income consists of net income (loss) and net unrealized gains (losses) on available-for-sale securities and the interest rate swap Income taxes. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date (see Note 9.) Use of 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 and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Concentrations of credit risk. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments, accounts receivable from customers and the receivable from GP Strategies. The Company places its cash investments with high quality financial institutions and limits the amount of credit exposure to any one institution. See Note 14(b) with respect to the repayment of the receivable from GP Strategies. Interim financial information. The financial information as of March 31, 2004 and for the three months ended March 31, 2004 and 2003 is unaudited but includes all adjustments (consisting of normal recurring accruals) that management considers necessary for a fair presentation of its financial position, results of operations, cash flows and changes in shareholder's equity. Results for the three months ended March 31, 2004 are not necessarily indicative of results to be expected for the full fiscal year 2004 or for any future period. 3. Inventories Inventories are comprised of the following (in thousands): March 31, December 31, --------- ------------ 2004 2003 2002 ---- ---- ---- (unaudited) Raw materials 944 921 $784 Work in process 464 383 131 Finished goods 26,559 26,996 465 ------ ------ -------- $27,967 $28,300 $1,380 ======= ======= ====== 4. Investments in and note receivable from equity investee Five Star Products On September 30, 1998, GP Strategies sold substantially all of the operating assets of the Five Star business to American Drug, an entity which was then 37.5% owned by GP Strategies, and received a five- year 8% unsecured senior note in the original principal amount of $5,000,000 (the "Five Star Note") as partial consideration. American Drug then changed its name to Five Star Products, Inc. On August 31, 1998, GP Strategies entered into a voting agreement with Five Star (the "Voting Agreement") pursuant to which GP Strategies agreed that for a period of three years it would vote its shares of Five Star common stock (i) such that not more than 50% of Five Star's directors would be officers or directors of GP Strategies and (ii) on all matters presented to a vote of stockholders, other than the election of directors, in the same manner and in the same proportion as the remaining stockholders of Five Star vote. On June 30, 2002, GP Strategies and Five Star extended the Voting Agreement until June 30, 2004. The Five Star Note was amended in November 2001 to provide for the extension of its maturity date until September 30, 2004, and on March 31, 2004 the maturity date of the Five Star Note was further extended until June 30, 2005. Under a separate Subordination Agreement between GP Strategies and the banks providing Five Star's $25,000,000 revolving loan, Five Star may make annual cash payments of principal to GP Strategies provided Five Star achieves certain financial performance benchmarks. On August 2, 2002, GP Strategies exchanged $500,000 principal amount of the Five Star Note for 2,272,727 shares of Five Star's common stock, reducing the outstanding principal amount of the Five Star Note to $4,500,000 and increasing GP Strategies ownership of the Five Star common stock to 7,133,417 shares, approximately 48% of the then outstanding shares. The transaction valued the Five Star common stock at $0.22 a share, which was at a premium to the market value at that time. At December 31, 2002, the Company owned approximately 48% of Five Star. Pursuant to the provisions of the Subordination Agreement, on June 27, 2003, July 2, 2003 and July 7, 2003, Five Star made principal payments on the Five Star Note to GP Strategies in the amounts of $500,000, $300,000, and $200,000, respectively, reducing the outstanding principal amount of the Five Star Note to $3,500,000. On October 8, 2003, GP Strategies exchanged $500,000 principal amount of the Five Star Note for 2,000,000 shares of Five Star common stock, reducing the outstanding principal balance of the Five Star Note to $3,000,000 and increasing GP Strategies' ownership of Five Star's 4. Investment in and note receivable from equity investee (Continued) common stock to 9,133,417 shares, approximately 54% of the then outstanding shares. In consideration for GP Strategies agreeing to exchange at a price of $0.25 per share, which was at a significant premium to the market price of the Five Star common stock on the day prior to approval of the transaction, Five Star agreed to terminate the Voting Agreement and thereby GP Strategies obtained a controlling financial interest in Five Star. Accordingly, as described in Note 1, Five Star's financial statements have been consolidated with those of the Company commencing as of such date. On July 30, 2004, GP Strategies will transfer the Five Star Note to National Patent Development (See Note 1), accordingly, the Five Star Note has been eliminated from the consolidated balance sheet as of March 31, 2004 and December 31, 2003 as an intercompany balance. The balance of the Five Star Note is $2,800,000 as of March 31, 2004 and December 31, 2003, and no principal repayments are required prior to the June 30, 2005 maturity date. The Company accounted for its investment in Five Star using the equity method prior to obtaining a controlling financial interest. A write down on this investment of $200,000 was recorded in 2001, which is included in (loss) income related to equity investee. Such write down reflected a loss in value which management determined to be other than a temporary decline. GPS's excess of its investment in Five Star over its basis of the underlying net assets, was approximately $208,000 at December 31, 2002. In 2003, 2002 and 2001, the Company received $475,000, $33,000 and $115,000, respectively, representing a recovery of a portion of its investment in Five Star. Information relating to the Company's investment in Five Star as of December 31, 2002 and for the years ended December 31, 2002 and 2001 is as follows (in thousands): December 31, 2002 2001 ------------------------------------------ ------------- -------------- ------------------------------------------ ------------- -------------- Long-term note receivable $4,500 Number of shares 7,133 Carrying value of shares $1,760 Valuation of shares, based on quoted market price $ 571 Interest income on note (1) $ 384 $ 400 Equity interest in net income (2) $ 55 $ 59 Write down of investment (1) $ (200) (1) Included in income related to equity investee. (2) Net of depreciation of property, plant and equipment and amortization of goodwill (attributable to excess of the carrying value of investment in Five Star over underlying equity in its net assets) of $107,000 and $96,000 for years ended December 31, 2002 and 2001, respectively. Effective January 1, 2002, upon adoption of FASB Statement No. 142, amortization of goodwill ceased (see Note 7). Condensed financial information for Five Star as of December 31, 2002 and for the years ended December 31, 2002 and 2001 is as follows (in thousands): 4. Investment in and note receivable from equity investee (Continued) 2002 2001 ---- ---- Current assets $34,214 Non current assets 1,152 Current liabilities 27,585 Non current liabilities 4,500 Stockholders' equity 3,281 Sales $94,074 $94,908 Gross profit 16,613 16,054 Net income 391 417 Valera Pharmaceuticals Valera is a specialty pharmaceutical company engaged in the development and commercialization of prescription pharmaceuticals principally utilizing Valera's patented Hydron drug delivery technology. Valera's lead product is a twelve-month implant that delivers the luteinizing hormone releasing hormone, or LHRH, histrelin for the palliative treatment of metastatic prostate cancer. LHRH agonists are the premium standard of care in the palliative treatment for metastatic breast cancer. On December 16, 2003, Valera submitted its New Drug Application (NDA) for Vantas(TM), the name for Valera's long-acting LHRH implant for treating prostate cancer. Valera has indicated in a press release that it expects to receive a response from the FDA by year-end 2004. Prior to June 2000, Valera operated as a division of GP Strategies. In connection with an offering of GP Strategies 6% Convertible Subordinated Exchangeable Notes due June 2003, Valera was incorporated as a separate company and became a wholly-owned subsidiary of GP Strategies through GP Strategies' ownership of 100% of the common stock of Valera. In December 2001, Valera completed a $7 million private placement of Series A convertible preferred stock to certain institutional investors. As a condition of the private placement, GP Strategies contractually gave up operating control over Valera through an Investors Rights Agreement, which gave GP Strategies' the right to designate one director on Valera's board of directors and gave the other stockholders the right to designate the other directors, and subsequent thereto accounted for the investment under the equity method. As a result of Valera operating losses, GP Strategies investment was written down to zero. In the second quarter of 2003, Valera completed a private placement offering pursuant to which Valera raised approximately $13.5 million in gross proceeds from the sale of Series B convertible preferred stock. As part of such transaction, GP Strategies was granted an option until March 31, 2004, to purchase up to $5 million of the Series B convertible preferred stock at the offering price of $0.725 per share, which was subsequently verbally extended to June 30, 2004. On June 30, 2004, GP Strategies transferred a portion of its option to an institutional investor, which exercised such option and purchased from Valera 3,448,276 shares of Series B convertible preferred stock for $0.725 per share. The balance of the option expired unexercised. In consideration of such transfer, such institutional investor granted National Patent Development an option until October 28, 2004 to purchase up to 2,068,966 shares of Series B convertible preferred stock owned by such institutional investor for prices ranging from $0.725 to $0.7685 per share. 4. Investment in and note receivable from equity investee (Continued) The Series A preferred stock and Series B preferred stock, both of which are convertible into Valera's common stock at any time, have voting rights on an as-converted basis on all matters submitted to the stockholders and are also entitled to receive dividends on an as-converted basis with shares of common stock when, as and if declared by the Board of Directors. In addition the Series B preferred stock accrues cumulative dividends at the rate of 10% of the Series B stated value, payable when and as declared by the Board of Directors. In the event of liquidation, the holders of the preferred stock shall be entitled to receive preferential distributions before any payment shall be made in respect of the common stock. Assuming conversion of all of the outstanding shares of Series A and Series B convertible preferred stock and exercise of stock options held by employees of Valera the Company would own approximately 19.6% of Valera. Assuming the Company exercises the option to purchase 2,068,966 shares of the Series B convertible preferred stock and conversion of all of the outstanding shares of Series A and Series B convertible preferred stock, and exercise of stock options held by employees of Valera, the Company would own approximately 23.6% of Valera. As described in Note 14(b), on October 17, 2003, MXL received from GPS in partial payment of a note receivable the common shares of Valera and recorded such shares at zero representing their carrying amount to GPS. As a result of the Investors Rights Agreement referred to above, the Company is accounting for its investment in Valera under the equity method. However as the Company has not guaranteed obligations of Valera and has not otherwise committed to provide further support for Valera, it has discontinued recognizing additional losses of Valera. If Valera subsequently reports net income, the Company shall resume applying the equity method only after its share of that net income equals the share of net losses not recognized during the period the equity method was suspended. 5. Marketable securities Marketable securities, which are carried at market value, were comprised of the following (in thousands): Available-for-sale securities March 31, December 31, 2004 2003 2002 ---- ---- ---- (unaudited) Millennium Cell Inc. $1,827 $2,769 $698 Avenue Entertainment Group, Inc. 201 212 58 --------- -------- ------ $2,028 $2,981 $756 ====== ====== ==== Millennium Cell Inc. ("Millennium") Millennium is a publicly traded emerging technology company engaged in the business of developing innovative fuel systems for the safe storage, transportation and generation of hydrogen for use as an energy source. At December 31, 2002 and 2001 the Company held 293,271 shares of Millennium with a market value on those dates of $698,000 and $1,531,000, respectively and unrealized gains of $341,000 5. Marketable securities (Continued) and $1,174,000, respectively. On October 17, 2003 the Company received from GP Strategies in partial payment of a receivable an additional 1,000,000 shares of common stock of Millennium with a market value on that date of approximately $3,500,000. From October 17, 2003 through December 31, 2003 the Company sold 105,000 of such Millennium shares for $272,000 and recognized a loss of $95,000, which is included in Investment and other income (loss). At December 31, 2003 the Company held 1,188,271 shares of common stock of Millennium Cell, representing approximately a 3% interest in the company, with a market value of $2,769,000 and an unrealized loss of $721,000, which resulted from reductions in market value during the year ended December 31, 2003. For the three months ended March 31, 2004 the Company sold 173,500 shares of Millennium shares received in October 2003 for $468,000 and recognized a loss of $140,000, which is included in Investment and other income (loss). At March 31, 2004, the Company held 1,014,771 shares of common stock of Millennium Cell with a market value of $1,827,000, representing approximately a 3% ownership interest and an unrealized loss of $1,056,000 reflecting further unrealized losses during the three months ended March 31, 2004. The Company believes that the reduction in market value of Millennium correlates with the general trend of the market for emerging technology companies and reflects the volatility of Millennium's stock price. The Company has evaluated the near-term prospects of Millennium in relation to the severity and duration of the impairment. Based on that evaluation and the Company's ability and intent to hold this investment for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider its investment in Millennium to be other-than-temporarily impaired at December 31, 2003 and March 31, 2004. Avenue Entertainment Group, Inc ("Avenue") The Company owns 1,060,500 shares of Avenue, which is an independent entertainment company that produces feature films, series for television, made for television/cable movies and one hour profiles of Hollywood stars. Impairment losses of $200,000 on the stock of Avenue were charged to operations during the year ended December 31, 2001 and are included in Investment and other income (loss), net. As of December 31, 2002, the market value of Avenue approximated its adjusted cost. As of December 31, 2003 and March 31, 2004 the market value of Avenue approximated $212,000 and $201,000, respectively, resulting in an unrealized gain of $154,000 and $143,000, respectively. Trading securities Hemispherx Biopharma Inc. ("HEB") In the fourth quarter of 2003 MXL received a capital contribution of 267,296 shares of HEB from GP Strategies with a market value of $550,000 and subsequently sold 107,700 of the shares for $249,000. For the year ended December 31, 2003, the Company realized a gain of $27,000 on the sale of these shares and unrealized holding gains of $32,000 on the remainder of the shares, which are both included in Investment and other income (loss). The approximately 160,000 shares remaining are classified as trading securities at December 31, 2003. These shares had a fair value of approximately $361,000 at December 31, 2003 and were sold in the first quarter of 2004 for $404,000. The Company recorded a realized gain of $43,000 on the sale of these shares, which is included in Investment and other income (loss). 6. Five Star acquisition As described in Note 4, on October 8, 2003, the Company increased its ownership interest in Five Star's outstanding common stock from 48% to 54%, obtained a controlling financial interest in Five Star and accordingly commenced consolidating Five Star's financial statements with those of the Company. The increase in ownership occurred because the Company believed that the common stock of Five Star represented an attractive investment opportunity based on its valuation at that time. Five Star comprises the Company's new Home Improvement Distribution Segment. The acquisition of a controlling financial interest was accounted for as a purchase transaction, and accordingly, the net assets acquired were recorded at their fair value at the date of the acquisition. The excess of the net assets acquired over carrying value of the Company's investment in Five Star was recorded as a reduction to property, plant and equipment. The components of the net assets at date of acquisition, minority interest and the Company's cost of its acquired interest were as follows (in thousands): Accounts receivable $13,267 Inventory 20,222 Property, plant & equipment and other assets 1,228 - --------------------------------------------------------------- ------------- Total assets 34,717 - --------------------------------------------------------------- ------------- Short term borrowings 17,616 Accounts payable and accrued expenses 10,063 Debt to GP Strategies 3,000 - --------------------------------------------------------------- ------------- - --------------------------------------------------------------- ------------- Total liabilities assumed 30,679 - --------------------------------------------------------------- ------------- - --------------------------------------------------------------- ------------- Five Star net assets 4,038 - --------------------------------------------------------------- ------------- - --------------------------------------------------------------- ------------- Less minority interest in net assets 1,996 - --------------------------------------------------------------- ------------- - --------------------------------------------------------------- ------------- Cost of net assets acquired $2,042 - --------------------------------------------------------------- ------------- The following table represents the Company's unaudited pro forma consolidated statements of operations for the years ended December 31, 2003 and 2002, as if the acquisition of a controlling financial interest in Five Star had been completed at the beginning of each period. The pro forma information is presented for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisition actually been made at such dates, nor is it necessarily indicative of future operating results (in thousands, except per share data): ------------------------------------------ ----------------- ---------------- Years ended December 31, 2003 2002 ------------------------------------------ ----------------- ---------------- ------------------------------------------ ----------------- ---------------- Sales $103,698 $104,070 Income before minority interest 61 585 Minority interest (319) (180) Net income $ 32 $ 405 Net income per share Basic and diluted $ .00 $ .03 ------------------------------------------ ----------------- ---------------- On February 6, 2004 Five Star announced that it will repurchase up to 5,000,000 shares, or approximately 30% of its common stock currently outstanding, through a tender offer for the shares at $0.21 per share, originally set to expire on March 16, 2004. On March 17, 2004 Five Star announced that it had increased the price it was offering to pay for the shares in the tender offer to $0.25 per share and extended the offer to March 31, 2004. Based on the final tabulation 6. Five Star acquisition (Continued) by the depositary for the tender offer, approximately 2,648,000 shares of common stock were tendered and acquired by Five Star effective March 31, 2004 at a cost of $657,000, which was paid on April 6, 2004. The effect of the tender offer was to increase the Company's ownership in Five Star to approximately 64%. The minority interest in Five Star has been adjusted to reflect the tender offer in the accompanying balance sheet at March 31, 2004. 7. Property, plant and equipment Property, plant and equipment consist of the following (in thousands): March 31, December 31, 2004 2003 2002 ---- ---- ---- (unaudited) Land $ 915 $ 915 $ 915 Buildings and improvements 4,239 4,228 3,525 Machinery and equipment 7,819 7,755 6,843 Furniture and fixtures 1,129 1,071 199 -------- ------- -------- -------- ------- -------- 14,102 13,969 11,482 -------- ------- -------- -------- ------- -------- Accumulated depreciation and amortization (8,459) (8,244) (6,653) -------- ------- -------- -------- ------- -------- 5,643 $ 5,725 $4,829 8. Goodwill Goodwill, which represents the excess of cost over the fair value of the identifiable net assets of a business acquired by MXL, was being amortized through December 31, 2001 on a straight line basis over 20 years. Effective January 1, 2002, the Company adopted FASB Statement No. 142, Goodwill and Other Intangible Assets. Statement No. 142 requires that goodwill no longer be amortized but instead tested for impairment at least annually in accordance with the provisions of Statement No. 142. The Company did not recognize any impairment as a result of the adoption of this statement. In addition, Statement 142 requires that upon adoption, the excess of cost over the underlying equity in net assets of an investee accounted for using the equity method that has been recognized as goodwill no longer be amortized. For the years ended December 31, 2003 and 2002 the Company performed a test for potential impairment of goodwill and determined that there was no impairment. The Company will continue to perform such impairment tests on an annual basis with the date of assessment being December 31. The changes in the carrying amount of goodwill during the period are as follows (in thousands): Balance as of December 31, 2000 202 Amortization (20) ----- Balance as of December 31, 2001, 2002 and 2003 and March 31, 2004 $182(a) ==== a) Reduced by accumulated amortization of $208 8. Goodwill (Continued) Pro forma net income for the year ended December 31, 2001, as adjusted to remove the amortization of goodwill, would increase net income for the period by $20,000 to $389,000, which would not have an impact on the Company's pro forma basic and diluted earnings per share. 9. Long-term debt and short term borrowings Long-term debt is comprised of the following (in thousands):
March 31, December 31, 2004 2003 2002 ---- ---- ---- (unaudited) MXL Pennsylvania Mortgage (a) $1,380 $1,405 $1,505 MXL Illinois Mortgage (b) 1,178 1,185 1,212 AOtec Debt (c) 868 922 Other 71 80 158 - ----------------------------------------------- ----------------- -------------- ------------- - ----------------------------------------------- ----------------- -------------- ------------- 3,497 3,592 2,875 Less current maturities (394) (389) (205) - ----------------------------------------------- ----------------- -------------- ------------- - ----------------------------------------------- ----------------- -------------- ------------- $3,103 $3,203 $2,670 - ----------------------------------------------- ----------------- -------------- -------------
(a) On March 8, 2001, MXL mortgaged its real estate and fixtures on its property in Pennsylvania for $1,680,000. The loan requires monthly repayments of $8,333 plus interest at 2.5% above the one month LIBOR rate and matures on March 8, 2011, when the remaining amount outstanding of approximately $680,000 is due in full. The loan is guaranteed by GPS. (b) On July 3, 2001, MXL mortgaged its real estate and fixtures on its property in Illinois for $1,250,000. The loan requires monthly payments of principal and interest in the amount of $11,046 with interest at a fixed rate of 8.75% per annum, and matures on June 26, 2006, when the remaining amount outstanding of approximately $1,100,000 is due in full. The loan is guaranteed by GPS. (c) In September 2003, MXL purchased machinery, equipment and inventory from AOtec LLC ("AOtec"), located in the Massachusetts area, for $1,100,000, subject to adjustment. In connection with this purchase, the Company valued the machinery and equipment at approximately $900,000, the inventory at approximately $350,000 and recorded an accrued expense of $150,000. MXL paid $100,000 of the purchase price in cash and issued three notes, in the amount of $450,000, $275,000 and $275,000 each, due October 1, 2003, August 5, 2004 and August 5, 2005, respectively (collectively, the "AOtec Notes"). The AOtec Notes bear interest on the unpaid principal amount at the rate of 4% per annum. On October 1, 2003, MXL borrowed $700,000 from a bank under an agreement to finance the purchase price (the "AOtec Debt") and used a portion of the proceeds to pay the $450,000 note. The AOtec Debt bears interest at the rate of 5.89 % per annum, is payable monthly for three-years and is secured by the machinery and equipment purchased from AOtec. GPS guaranteed the AOtec Debt. The Aotec Note due August 5, 2004 of $275,000 is classified as short term borrowings on the Company's Consolidated Balance Sheets and is not included in the table above. 9. Long-term debt and short term borrowings (Continued) Aggregate annual maturities of long-term debt at December 31, 2003 are as follows (in thousands): 2004 $ 389 2005 687 2006 1,411 2007 100 2008 100 Thereafter 905 -------------------------------- Total $3,592 Short-term borrowings On June 20, 2003, Five Star obtained a new Loan and Security Agreement (the "Loan Agreement") with Fleet Capital Corporation. The Loan Agreement has a five-year term, with a maturity date of June 30, 2008. The Loan Agreement provides for a $25,000,000 revolving credit facility, which allows Five Star to borrow based upon specified percentages of eligible inventory and eligible accounts receivable, as defined therein. The interest rates under the Loan Agreement are LIBOR plus a credit spread for borrowings not to exceed $15,000,000 and the prime rate plus a credit spread for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star achieves and maintains certain performance benchmarks. At March 31, 2004 and December 31, 2003, approximately $22,644,000 and $16,685,000 was outstanding under the Loan Agreement and approximately $1,980,000 and $480,000 was available to be borrowed, respectively. Five Star's assets having a book value of $44,431,000 and $38,732,000 at March 31, 2004 and December 31, 2003, respectively, are pledged as collateral for the outstanding borrowings. Under the Loan Agreement, Five Star is subject to covenants requiring minimum net worth, limitations on losses, if any, and minimum or maximum values for certain financial ratios. In connection with the Loan Agreement, Five Star also entered into a derivative transaction with Fleet National Bank on June 20, 2003. The derivative transaction is an interest rate swap which has been designated as a cash flow hedge. Effective July 1, 2004 through June 30, 2008, Five Star will pay a fixed interest rate of 3.38% to Fleet National Bank on notional principal of $12,000,000. In return, Fleet National Bank will pay to Five Star a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the Loan Agreement is not included in and will be paid in addition to this fixed interest rate of 3.38%. At December 31, 2003, the interest rate swap had a fair value of $122,000, which is included in other assets. As a result of expected future decreases in LIBOR during the three months ended March 31, 2004, the value of the swap declined by $318,000 resulting in a value of $196,000 at March 31, 2004 which is reflected as a liability. 10. Income taxes MXL's operating results together with those of the non-core assets historically have been included in consolidated federal income tax returns filed by GPS. In addition, MXL files separate state income tax returns in Pennsylvania and Illinois. Income tax expense (benefit) in the accompanying financial statements has been computed as if MXL filed its own separate federal and state income tax returns including transactions related to the non-core assets. As GPS does not own 80% of its common stock, Five Star files its own separate consolidated federal income tax return, as well as separate state and local income tax returns. 10. Income taxes (Continued) Through March 31, 2004, no tax sharing agreement was in effect and no amounts were charged or credited to MXL as if it filed its own separate federal income tax returns. Accordingly, the provision for current federal income taxes (exclusive of amounts pertaining to Five Star for 2003 and 2004) and current state and local income taxes related to the results of non-core assets has been accounted for as an adjustment to stockholder's investment. The components of income tax expense (benefit) are as follows (in thousands):
Three Months Ended March 31, Year Ended December 31, 2004 2003 2003 2002 2001 (unaudited) Current Federal (6) 99 $359 $57 $374 State and local (2) 20 113 11 71 - ------------------------------------------ -------------- ------------- ------------- ------------- -------------- Total current (8) 119 472 68 445 - ------------------------------------------ -------------- ------------- ------------- ------------- -------------- Deferred Federal (14) (16) (246) 64 (42) State and local (4) (3) (53) 13 (8) - ------------------------------------------ -------------- ------------- ------------- ------------- -------------- Total deferred (18) (19) (296) 77 (50) - ------------------------------------------ -------------- ------------- ------------- ------------- -------------- Total income tax (benefit) expense (26) 100 $176 $145 $395 - ------------------------------------------ -------------- ------------- ------------- ------------- -------------- The deferred expense (benefit) excludes activity in the net deferred tax liability relating to tax on appreciation (depreciation) in available-for-sale securities and the interest rate swap, which is recorded directly to stockholder's equity. The difference between the expense (benefit) for income taxes computed at the statutory rate and the reported amount of tax expense (benefit) is as follows:
Three Months Ended March 31, Year Ended December 31, 2004 2003 2003 2002 2001 - ------------------------------------------------------------------- ------------ ----------- ----------- ----------- ------------ - ------------------------------------------------------------------- ------------------------ ----------- ----------- ------------ (unaudited) Federal income tax rate (35.0%) 35.0% 35.0% 35.0% 35.0% State and local taxes, net of federal benefit (1.9) 6.0 7.0 5.2 6.0 Non-deductible expenses 21.0 5.7 9.3 7.6 2.7 Impairment and realized losses for investment in partially owned companies for which no benefit has been provided 16.6 3.4 - 8.6 Other (13.4) 11.1 (8.7) 1.9 (.6) - ------------------------------------------------------------------- ------------ ----------- ----------- ----------- ------------ - ------------------------------------------------------------------- ------------ ----------- ----------- ----------- ------------ Effective tax rate expense (benefit) (12.7%) 57.8% 42.0% 49.7% 51.7% - ------------------------------------------------------------------- ------------ ----------- ----------- ----------- ------------
10. Income taxes (Continued) The tax effects of temporary differences between the financial reporting and tax bases of assets and liabilities that are included in the net deferred tax (liability) asset are summarized as follows:
March 31, December 31, 2004 2003 2002 - ------------------------------------------------------------------------ -------------- ------------ ------------ (unaudited) Deferred tax assets: Property and equipment $ 164 $ 176 $ - Allowance for doubtful accounts 78 78 14 Accrued liabilities 45 45 2 Interest rate swap 82 - - Investment in partially owned companies 356 221 - Inventory 47 47 11 - ------------------------------------------------------------------------ -------------- ------------ ------------ Deferred tax assets 772 567 27 - ------------------------------------------------------------------------ -------------- ------------ ------------ - ------------------------------------------------------------------------ -------------- ------------ ------------ Deferred tax liabilities: Property and equipment - - 221 Interest rate swap 51 - Investment in partially owned companies 278 278 776 - ------------------------------------------------------------------------ -------------- ------------ ------------ - ------------------------------------------------------------------------ -------------- ------------ ------------ Deferred tax liabilities 278 329 997 - ------------------------------------------------------------------------ -------------- ------------ ------------ - ------------------------------------------------------------------------ -------------- ------------ ------------ Net deferred tax assets (liabilities) 494 238 (970) - ------------------------------------------------------------------------ -------------- ------------ ------------ - ------------------------------------------------------------------------ -------------- ------------ ------------ Less valuation allowance (395) (260) - - ------------------------------------------------------------------------ -------------- ------------ ------------ - ------------------------------------------------------------------------ -------------- ------------ ------------ Net deferred tax assets (liabilities) $ 99 $ (22) $ (970) - ------------------------------------------------------------------------ -------------- ------------ ------------
Under the Internal Revenue Code's consolidated return regulations, each member of GP Strategies consolidated group (including MXL) is jointly and severally liable for the consolidated federal income tax liabilities. GPS, National Patent Development and their respective subsidiaries intend to enter into a Tax Sharing Agreement that defines the parties' rights and obligations with respect to deficiencies and refunds of federal, state and other taxes relating to the National Patent Development business for tax years prior to the spin-off and with respect to certain tax attributes of National Patent Development after the spin-off. In general, GPS will be responsible for filing consolidated federal tax returns and paying any associated taxes for periods through the date of the spin-off (the "Distribution Date"). National Patent Development will be required to pay GPS an amount equivalent to federal taxes relating to National Patent Development and its subsidiaries allocated taxable income includable in GPS's consolidated federal income tax return for the taxable period that ends on the Distribution Date. National Patent Development is responsible for filing its own tax returns and paying taxes for periods beginning on or after the Distribution Date. GPS and National Patent Development will agree to cooperate with each other and to share information in preparing such tax returns and in dealing with other tax matters. GPS and National Patent Development will be responsible for their own taxes other than those described above. National Patent Development has agreed not to take any actions or enter into any transactions that would cause the spin-off not to qualify as tax-free. National Patent Development also has agreed to indemnify GPS to the extent that any action National Patent Development takes gives rise to a tax incurred by GPS with respect to the spin-off. If National Patent Development increases its ownership to at least 80% of Five Star's common stock, Five Star would become, for federal tax purposes, part of the affiliated group of which National Patent Development is the common parent. 10. Income taxes (Continued) As a member of such affiliated group, Five Star would be included in National Patent Development's consolidated federal income tax returns, Five Star's income or loss would be included as part of the income or loss of the affiliated group and any of Five Star's income so included might be offset by the consolidated net operating losses, if any, of the affiliated group. Five Star has agreed to enter into a tax sharing agreement with GP Strategies (to be assigned to National Patent Development as part of the spin-off) pursuant to which Five Star will make tax sharing payments to National Patent Development once Five Star becomes a member of the consolidated group equal to 80% of the amount of taxes Five Star would pay if Five Star were to file separate consolidated tax returns but did not pay as a result of being included in National Patent Development affiliated group. 11. Capital Stock, stock option and employee benefit plans The Board of Directors without any vote or action by the holders of common stock is authorized to issue preferred stock from time to time in one or more series and to determine the number of shares and to fix the powers, designations, preferences and relative, participating, optional or other special rights of any series of preferred stock. Under GPS's non-qualified stock option plan, employees of MXL were granted options to purchase shares of common stock of GPS. Although the plan permits options to be granted at a price not less than 85% of the fair market value, the plan options primarily are granted at the fair market value of the common stock at the date of the grant and are exercisable over periods not exceeding ten years from the date of grant. Changes in options outstanding granted to MXL employees during the years ended December 31, 2001, 2002, and 2003 are as follows:
Number Number Weighted Average Price Range Of Options Of Options Exercise Years Per share Outstanding Exercisable Price Remaining - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- December 31, 2000 $ 9.98 -13.125 5,000 5,000 $12.33 2 years - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- Expired $13.125 (3,750) $13.125 - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- December 31, 2001 $ 9.98 1,250 1,250 $ 9.98 1 year - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- Expired $ 9.98 (1,250) $ 9.98 - -------------------------------------------- ------------------ --------------- --------------- --------------- -------------- December 31, 2002, December 31, 2003 and - - - - March 31, 2004 - - -------------------------------------------- ------------------ --------------- --------------- --------------- --------------
On November 3, 2003, GPS and the Board of Directors of National Patent Development adopted an Incentive Stock Plan under which 1,750,000 shares of common stock will be available for grant to employees, directors and outside service providers. The plan will permit awards of incentive stock options, nonqualified stock options, restricted stock, stock units, performance shares, performance units and other incentives payable in cash or in shares of National Patent Development's common stock. Five Star Stock Option plan On January 1, 1994, Five Star's Board of Directors adopted the Five Star Products, Inc. 1994 Five Star Plan (the "Five Star Plan"), which became effective August 5, 1994. On January 1, 2002, the Board of Directors amended the Five Star Plan increasing the total number of shares of common stock to 4,000,000 shares reserved for issuance, subject to adjustment in the event of stock splits, stock dividends, recapitalizations, reclassifications or other 11. Capital Stock, stock option and employee benefit plans (Continued) capital adjustments. Unless designated as "incentive stock options" intended to qualify under Section 422 of the Internal Revenue Code, options granted under the Five Star Plan are intended to be nonqualified options. Options may be granted to any director, officer or other key employee of Five Star and its subsidiaries, and to consultants and other individuals providing services to Five Star. The term of any option granted under the Five Star Plan will not exceed ten years from the date of the grant of the option and, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock of Five Star, three years from the date of grant. The exercise price of any option will not be less than the fair market value of the Common Stock on the date of grant or, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock, 110% of such fair market value. Options granted vest 20% on date of grant with the balance vesting in equal annual installments over four years. Activity relating to stock options granted by Five Star commencing at the date the Company acquired a controlling financial interest follows:
Options Outstanding Number of Weighted Average Shares Exercise Price -------------------------------------------------------------- ------------------- ------------------------ October 8, 2003 2,930,000 $.16 -------------------------------------------------------------- ------------------- ------------------------ Granted Exercised Terminated (1,400,000) .13 -------------------------------------------------------------- ------------------- ------------------------ December 31, 2003 and March 31, 2004 1,530,000 .19 -------------------------------------------------------------- ------------------- ------------------------ Exercisable at December 31, 2003 and March 31, 2004 975,000 $.22 -------------------------------------------------------------- ------------------- ------------------------
The following table summarizes information about the Five Star Plan's options at December 31, 2003:
Weighted Weighted Weighted Average Average Average Exercise Number Exercise Years Number Exercise Price Outstanding Prices Remaining Exercisable Price -------------- ----------------- -------------- --------------- ---------------- ---------------- -------------- ----------------- -------------- --------------- ---------------- ---------------- $.14 925,000 .14 2.95 460,000 .14 .15 50,000 .15 3.24 50,000 .15 .16 150,000 .16 3.64 60,000 .16 .33 405,000 .33 .29 405,000 .33 -------------- ----------------- -------------- --------------- ---------------- ---------------- -------------- ----------------- -------------- --------------- ---------------- ---------------- 1,530,000 $.19 .90 975,00 $.22
Five Star Employee Benefit Plan Five Star maintains a 401(k) Savings Plan for employees who have completed one year of service. The Savings Plan permits pre-tax contributions to the plan of 2% to 50% of compensation by participants pursuant to Section 401(k) of the Internal Revenue Code. Five Star matches 40% of the participants' first 6% of 11. Capital Stock, stock option and employee benefit plans (Continued) compensation contributed, not to exceed an amount equivalent to 2.4% of that participant's compensation. Five Star's contribution to the plan was approximately $125,000 for the year ended December 31, 2003 and $29,000 and $30,000 for the three months ended March 31, 2004 and 2003, respectively. 12. Commitments Five Star has several noncancellable leases for real property and machinery and equipment. In addition MXL has a noncancellable lease for real property and two noncancellable leases for machinery and equipment. Such leases expire at various dates with, in some cases, options to extend their terms. Minimum rentals under long-term operating leases are as follows (in thousands): Real Machinery & property equipment Total ----------------------- ------------------ ---------------- -------------- ----------------------- ------------------ ---------------- -------------- 2004 $1,807 $883 $2,690 2005 1,608 492 2,100 2006 1,605 284 1,889 2007 314 253 567 2008 63 63 Thereafter ----------------------- ------------------ ---------------- -------------- ----------------------- ------------------ ---------------- -------------- Total $5,334 $1,975 $7,309 ----------------------- ------------------ ---------------- -------------- Several of the leases contain provisions for rent escalation based primarily on increases in real estate taxes and operating costs incurred by the lessor. Rent expense was approximately $500,000 (unaudited) and $414,000 (unaudited) for the three months ended March 31, 2004 and 2003, respectively, and $3,037,000, $81,000 and $71,000 for the years ended December 31, 2003, 2002 and 2001, respectively. GPS has guaranteed the leases for Five Star's New Jersey and Connecticut warehouses, having annual rentals of $1,589,000 and expiring in the first quarter of 2007. 13. Segment Information The operations of the Company currently consist of the following two business segments, by which the Company is managed. The Optical Plastics Segment, which consists of MXL, manufactures precision coated and molded optical plastic products. MXL is a specialist in the manufacture of polycarbonate parts requiring adherence to strict optical quality specifications, and in the application of abrasion and fog resistant coatings to those parts. The Home Improvement Distribution Segment, which consists of Five Star, distributes paint sundry items, interior and exterior stains, brushes, rollers, caulking compounds and hardware products on a regional basis. The Company acquired additional shares of Five Star in fourth quarter of 2003, bringing its ownership to 54% (see Note 4). Five Star's operations are consolidated in the Company's financial statements commencing January 1, 2003. 13. Segment Information (Continued) The following tables set forth the sales and operating profit attributable to each line of business (in thousands):
Three Months Ended March 31, Year Ended December 31, - ----------------------------------------------- -------------------------- --------------------------------------- - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- 2004 2003 2003 2002 2001 - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- - ----------------------------------------------- -------------------------- ------------ ----------- -------------- (unaudited) Sales Optical Plastics $ 2,130 $ 2,216 $ 8,613 $9,996 $11,184 Home Improvement Distribution 26,991 25,215 95,085 - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- $29,121 $27,431 $103,698 $9,996 $11,184 - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- Operating Profit Optical Plastics $ (304) $ (157) $ (280) $ 180 $ 1,172 Home Improvement Distribution 700 644 2,068 439(a) 259(a) Corporate and other (300) (111) (480) (128) (320) - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- $ 96 $ 376 $ 1,308 $ 491 $ 1,111 - ----------------------------------------------- ------------- ------------ ------------ ----------- -------------- (a) Income related to equity in net income of Five Star
Additional information relating to the Company's business segments is as follows (in thousands):
March 31, December 31, 2004 2003 2002 -------------------------------------------------- ------------------ ------------- -------------- -------------------------------------------------- ------------------ ------------- -------------- (unaudited) Total Assets Optical Plastics $13,324 $14,261 $20,632 Home Improvement Distribution 44,431 38,732 6,260 (b) Corporate and other 2,925 2,755 2,978 -------------------------------------------------- ------------------ ------------- -------------- -------------------------------------------------- ------------------ ------------- -------------- $60,504 $55,748 $29,870 -------------------------------------------------- ------------------ ------------- -------------- (b) Represents investment in and note receivable from Five Star
Three Months Ended March 31, Year Ended December 31, - ------------------------------------------------- ------------------------- -------------------------------------- - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ 2004 2003 2003 2002 2001 - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ - ------------------------------------------------- ------------------------- ------------ ------------ ------------ (unaudited) Additions to property, plant, and equipment Optical Plastics $ 47 $ 42 $ 1,135 $368 $435 Home Improvement Distribution 77 159 - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ $124 $ 42 $1,294 $368 $435 - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ Depreciation and amortization Optical Plastics $149 $133 $ 565 $510 $351 Home Improvement Distribution 25 28 - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------ $174 $133 $ 593 $510 $351 - ------------------------------------------------- ------------ ------------ ------------ ------------ ------------
13. Segment Information (Continued) For the year ended December 31, 2003 and the three months ended March 31, 2004 and 2003, no customer accounted for 10% or more of the Company's sales. The Company's major customers of the Optical Plastics segment accounted for the following percentage of total sales for the years ended December 31, 2002 and 2001: Year Ended December 31, 2002 2001 ---- ---- A 23% 27% B 21% 17% C 8% 10% -- --- Total 52% 54% === === Information about the Company's net sales in different regions, which are attributable to countries based upon location of customers, is as follows (in thousands):
Three Months Ended March 31, Year Ended December 31, - ---------------------------------------------- ------------------------ ------------------------------------------ - ---------------------------------------------- ----------- ------------ ------------- -------------- ------------- 2004 2003 2003 2002 2001 - ---------------------------------------------- ----------- ------------ ------------- -------------- ------------- - ---------------------------------------------- ------------------------ ------------- -------------- ------------- (unaudited) United States $28,543 $27,202 $102,015 $8,264 $9,465 Far East 322 169 1,230 1,266 1,150 Other North America 124 31 217 172 46 Western Europe 130 22 211 163 278 Middle East 2 7 25 131 245 - ---------------------------------------------- ----------- ------------ ------------- -------------- ------------- - ---------------------------------------------- ----------- ------------ ------------- -------------- ------------- $29,121 $27,431 $103,698 $9,996 $11,184 - ---------------------------------------------- ----------- ------------ ------------- -------------- ------------- All assets of the Company are in the United States.
14. Related party transactions (a) GPS provides certain administrative services including but not limited to tax and financial accounting, legal, human resources, employee benefits and insurance. The costs of these services were allocated to National Patent Development based on specific identification and, to the extent that such identification was not practical, on the basis of sales or other method which management believes to be a reasonable reflection of the utilization of services provided or the benefit received by National Patent Development. These allocations resulted in charges of $349,000, $161,000, $680,000, $321,000 and $286,000 being recorded in selling, general and administrative expenses in the accompanying consolidated statements of operations for the three months ended March 31, 2004 and 2003 and the years ended December 31, 2003, 2002 and 2001, respectively. Allocated expenses in excess of amounts which reduced the receivable balance due from GPS (see (b) below) have been recorded as a capital contribution resulting in an increase to stockholder's investment. The expenses allocated to National Patent Development for these services are not necessarily indicative of the expenses that would have been incurred if National Patent Development had been a separate, independent entity and had otherwise managed these functions. 14. Related party transactions (Continued) GPS provides legal, tax, business development, insurance and employee benefit administration services to Five Star pursuant to a management services agreement for a fee of up to $10,000 per month. The agreement is automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of any renewal thereof. The agreement was renewed for 2003 and 2004. The management fee will increase to $25,000 per month effective July 1, 2004. Prior to the Distribution, GP Strategies will transfer to National Patent Development the rights and obligations under the management services agreement with Five Star. Fees paid by Five Star to GPS under this agreement, which are included in selling, general and administrative expenses, totaled $100,000 for the year ended December 31, 2003 and $30,000 and $33,000 for the three months ended March 31, 2004 and 2003, respectively. At December 31, 2003 and March 31, 2004 fees due to GPS, which are included in accounts payable and accrued expenses, amounted to $308,000 and $257,000, respectively. In connection with the spin-off, certain general corporate expenses previously incurred by GP Strategies at the holding company level, including compensation of certain corporate personnel, will be incurred by National Patent Development. National Patent Development will enter into a management agreement with GP Strategies pursuant to which National Patent Development will provide certain general corporate services to GP Strategies. Under this management agreement, National Patent Development will charge GP Strategies a management fee to cover an allocable portion of the compensation of its employees, based on the time they spend providing services to GP Strategies, in addition to an allocable portion of corporate overhead related to services performed for GP Strategies and its subsidiaries. National Patent Development's executive officers are also executive officers of GP Strategies and will remain on the payroll of GP Strategies. The executive officers will not receive any salary from National Patent Development; however, they will provide National Patent Development with management services under a separate management agreement between GP Strategies and National Patent Development to be entered into prior to completion of the spin-off. GP Strategies will charge National Patent Development a management fee to cover an allocable portion of the compensation of these officers, based on the time they spend providing services to National Patent Development, in addition to an allocable portion of certain other corporate expenses. Both management fees will be paid quarterly. Any disagreements over the amount of such fees will be subject to arbitration. Each of the management agreements will each have an initial term of three years, and, after two years will be terminable by each of GP Strategies and National Patent Development, upon six months prior written notice. See the Unaudited Pro Forma Statements of Operations for the year ended December 31, 2003 included elsewhere herein for the estimated impact of the management agreements on the operations of National Patent Development. (b) The receivable from GPS, which arose principally from cash advances by MXL, is non-interest bearing. Transactions affecting the receivable, together with the average balances, follow (in thousands): 14. Related party transactions (Continued)
Three Months ended March 31, Year Ended December 31, --------------------- ------------------------------------------------- --------------------- ------------- -- -------------- -- -------------- 2004 2003 2002 2001 --------------------- ------------- -------------- -------------- Balance at beginning of period $ 709 $10,116 $10,162 $6,955 Management fee and other charges from GPS (1) (361) (717) (446) (491) Repayments (10,000) Advances 1,138 1,310 400 3,698 ------- -------- ---------- --------- Balance at end of period $ 1,486 $ 709 $ 10,116 $ 10,162 ------- -------- -------- -------- Average balance $ 1,266 $ 7,734 $ 10,096 $ 9,424 ======= ======= ======== =========
(1) Includes a management fee paid to GPS by MXL of $60,000 for the three months ended March 31, 2004 and $240,000 for each of the fiscal years ended December 31, 2003, 2002 and 2001, respectively. On October 17, 2003, GPS transferred 100% of the outstanding common stock in Valera (formerly Hydro Med Sciences, Inc.) valued at $6.5 million (based on an independent valuation) and 1,000,000 shares of common stock of Millennium with a quoted market price of $3.50 per share to MXL in repayment of $10 million of the receivable. The balance of the receivable will be settled through future transactions and/or paid in cash. MXL recorded the Valera investment at zero and the Millennium common shares at $3,500,000, representing their carrying amounts to GPS, and accounted for the excess of the $10,000,000 balance of the receivable over such carrying amounts as a distribution to GPS with a corresponding reduction of $6,500,000 in stockholder's equity. (c) In 2002, GPS and Redstorm Scientific, Inc. ("RSS") entered into an agreement pursuant to which GPS agreed to provide general business and administrative support to RSS. RSS is a privately held computational drug design company focused on utilizing bio-informatics and computer aided molecular design to assist pharmaceutical and biotechnology companies. GPS performed and completed all necessary services for RSS during the third quarter of 2002. In consideration for such services, RSS agreed to grant GPS a five-year option to purchase 500,000 shares of RSS common stock (an approximate 4% interest) at $1 per share. GPS also has an option to purchase additional equity in RSS upon the occurrence of certain events. GPS ascribed no value to the options, due to the adverse financial condition of RSS at that time. Michael Feldman is the Chief Executive Officer of RSS and owns approximately 25.5% of the outstanding common stock of RSS. Michael Feldman is the son of Jerome Feldman, Chief Executive Officer and a director of the Company and GPS. Jerome Feldman owns less than 1% of the outstanding common stock of RSS. In addition, Roald Hoffmann, a director of the Company and GPS, is also a director of RSS and has options to purchase shares of RSS common stock. 15. Litigation GP Strategies will make a capital contribution to National Patent Development, which in turn will transfer to MXL, the right to receive the first $5 million of any proceeds (net of litigation expenses), and 50% of any proceeds (net of 15. Litigation (Continued) proceeds (net of litigation expenses) in excess of $15 million, received with respect to the claims described below. On January 3, 2001, GP Strategies commenced an action alleging that MCI Communications Corporation ("MCI"), MCI's Systemhouse subsidiaries ("Systemhouse"), and Electronic Data Systems Corporation, as successor to Systemhouse ("EDS"), committed fraud in connection with GP Strategies' 1998 acquisition of Learning Technologies from the defendants for $24.3 million. GP Strategies seeks actual damages in the amount of $117.9 million plus interest, punitive damages in an amount to be determined at trial, and costs. The complaint alleges that the defendants created a doctored budget to conceal the poor performance of the United Kingdom operation of Learning Technologies. The complaint also alleges that the defendants represented that Learning Technologies would continue to receive new business from Systemhouse even though the defendants knew that the sale of Systemhouse to EDS was imminent and that such new business would cease after such sale. In February 2001, the defendants filed answers denying liability. No counterclaims against the plaintiffs have been asserted. Although discovery had not yet been completed, defendants made a motion for summary judgment, which was submitted in April 2002. The motion was denied by the court due to the MCI bankruptcy described below, but with leave to the other defendants to renew. The defendants other than MCI then made an application to the court to stay the fraud action until a later-commenced arbitration, alleging breach of the acquisition agreement and of a separate agreement to refer business to General Physics on a preferred provider basis and seeking actual damages in the amount of $17.6 million plus interest, is concluded. In a decision dated May 9, 2003, the court granted the motion and stayed the fraud action pending the outcome of the arbitration. Limited discovery was conducted in connection with the arbitration. The arbitration hearings began on May 17, 2004 and concluded on May 24, 2004 before JAMS, a private dispute resolution firm. MCI filed for bankruptcy protection in July 2002. As a result, the action was automatically stayed as to MCI. GP Strategies and its subsidiary, General Physics, both filed timely Proofs of Claim in the United States Bankruptcy Court against MCI and WorldCom, Inc., among others. On or around April 22, 2003, MCI served objections to these Proofs of Claim. On May 15, 2003, GP Strategies and General Physics submitted their opposition to the objections. GP Strategies and General Physics subsequently made a motion in Bankruptcy Court to lift the automatic stay to permit the litigation to proceed against MCI. In February 2004, the Bankruptcy Court granted the motion of GP Strategies and General Physics to the extent that they sought to have the stay lifted so that the state court could rule on the merits of MCI's summary judgment motion. On February 19, 2004, GP Strategies and General Physics notified the state court of the Bankruptcy Court's decision. National Patent Development is not a party to any legal proceeding, the outcome of which is believed by management to have a reasonable likelihood of having a material adverse effect upon the financial condition of National Patent Development. 16. GPS borrowings (a) As of December 31, 2002, the stock of MXL and its assets together with all of the non-core assets collateralized the outstanding bank debt under the GPS credit facility. In addition, MXL was a guarantor of the bank debt. In August 2003, GPS entered into a new credit facility which replaced the existing facility and in connection therewith the security interests of the banks were terminated and MXL was released from its guarantee under the previous credit facility. MXL provided a limited guarantee of the bank debt under the new credit facility of up to $1.5 million of its accounts receivable, which were pledged as collateral for the new bank debt. However, the guarantee was released in March 2004 as MXL's accounts receivable were no longer needed in the borrowing base. (b) Pursuant to a Note and Warrant Purchase Agreement dated August 8, 2003, GPS issued and sold to four Gabelli funds $7,500,000 aggregate principal amount of 6% Conditional Subordinated Notes due 2008 (the "Notes") and 937,500 warrants ("GP Warrants"), each entitling the holder thereof to purchase (subject to adjustment) one share of GPS's common stock. The aggregate purchase price for the Notes and GP Warrants was $7,500,000. GP Strategies and National Patent Development agreed to allocate to National Patent Development pursuant to the Gabelli Allocation $1,875,000 of the $7,500,000 received for the Notes and Warrants. This allocation is not reflected in the accompanying consolidated financial statements. The Notes are secured by a non-recourse mortgage on the property located in Pawling, New York (the "Property") which was transferred to MXL. MXL has no liability for repayment of the Notes or any other obligations of GPS under the Note and Warrant Purchase Agreement (other than foreclosure on such property). If there is a foreclosure on the mortgage for payment of the Notes, GPS has agreed to indemnify MXL for loss of the value of the Property. At any time that less than $1,875,000 principal amount of Notes are outstanding, GPS may defease the obligations secured by the mortgage and obtain a release of the lien of the mortgage by depositing with an agent for the Noteholders bonds or government securities with an investment grade rating by a nationally recognized rating agency which, without reinvestment, will provide cash on the maturity date of the Notes in an amount not less than the outstanding principal amount of the Notes. The Note and Warrant Purchase Agreement provides that, on completion of the spin-off, National Patent Development will issue warrants ("National Patent Development Warrants") to the holders of the GP Warrants. The National Patent Development Warrants will entitle the holders to purchase, in the aggregate, a number of shares of National Patent Development common stock equal to 8% of the number of shares of such stock outstanding at completion of the spin-off, subject to reduction for any GP Warrants exercised prior to the spin-off. The National Patent Development Warrants will be issued to the holders of the GP Warrants on the record date for the spin-off, and allocated among them pro-rata based on the respective number of GP Warrants held by them on such date. The exercise price of the National Patent Development Warrants will be 160% of the average closing price of the National Patent Development common stock over the 20 consecutive trading days commencing on the record date of the spin-off. The National Patent Development Warrants will be exercisable at any time after their exercise price is calculated through August 2008. The National Patent Development Warrants will have anti-dilution provisions similar to those of the GP Warrants. National Patent Development has agreed to provide the holders of the National Patent Development Warrants with registration rights similar to those provided by GPS to the holders of the GP Warrants. NATIONAL PATENT DEVELOPMENT CORPORATION SELECTED QUARTERLY FINANCIAL DATA (Unaudited) (in thousands) - --------------------------------- -------------------------------------------------------------------- - --------------------------------- --------------------------------------------------------------------
Three months ended March 31, June 30, September 30, December. 31, 2003 2003 2003 2003 - --------------------------------- -------------- -------------- ------------------ ------------------- - --------------------------------- -------------- -------------- ------------------ ------------------- Sales $27,431 $26,494 $27,310 $22,463 Gross margin 4,671 4,552 5,267 5,092 - --------------------------------- -------------- -------------- ------------------ ------------------- - --------------------------------- -------------- -------------- ------------------ ------------------- Net income (loss) $ (48) $ (58) $ 74 $ (72) - --------------------------------- -------------- -------------- ------------------ ------------------- - --------------------------------- -------------- -------------- ------------------ ------------------- Pro forma net income (loss) per share: Basic and Diluted $ .00 $ .00 $ .00 $ (.01) --------- ---------- -------- ---------- (Unaudited) (in thousands) - --------------------------------- ---------------------------------------------------------------------- - --------------------------------- ---------------------------------------------------------------------- Three months ended March 31, June 30, September 30, December. 31, 2002 2002 2002 2002 - --------------------------------- -------------- -------------- -------------------- ------------------- - --------------------------------- -------------- -------------- -------------------- ------------------- Sales $2,756 $2,714 $2,221 $2,305 Gross margin 546 700 445 408 - --------------------------------- -------------- -------------- -------------------- ------------------- - --------------------------------- -------------- -------------- -------------------- ------------------- Net income (loss) 57 98 19 (27) - --------------------------------- -------------- -------------- -------------------- ------------------- - --------------------------------- -------------- -------------- -------------------- ------------------- Pro forma net income (loss) per share: Basic and Diluted $ .00 $ .01 $ .00 $ .00 ------- ------ ------ ------
NATIONAL PATENT DEVELOPMENT CORPORATION SCHEDULE II Valuation and qualifying accounts (in thousands)
Additions Additional Charged to Balance at Beginning Allowance Costs & End of of Period Acquired (a) Expenses Deductions (b) Period Year ended December 31, 2003: Allowance for doubtful accounts 37 700 163 (161) 739 - ------------------------------------------------------------------------------------------------------------------- Year ended December 31, 2002: Allowance for doubtful accounts 99 16 (78) 37 - ------------------------------------------------------------------------------------------------------------------- Year ended December 31, 2001: Allowance for doubtful accounts 56 43 - 99 - ------------------------------------------------------------------------------------------------------------------- (a) Represents the allowance for doubtful accounts of Five Star at date of consolidation. (b) Write-off of uncollectible accounts, net of recoveries.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Five Star Products, Inc. We have audited the accompanying consolidated balance sheets of Five Star Products, Inc. and subsidiaries (the "Company") as of December 31, 2002 and 2001, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Five Star Products, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Eisner LLP New York, New York March 17, 2004 except for Note 14(d), as to which the date is March 31, 2004. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data)
December 31, December 31, 2002 2001 ----------- ------------- ASSETS Current assets Cash $ 16 $ 60 Accounts receivable, less allowance for doubtful accounts of $640 and $631 10,162 11,215 Inventory 23,664 23,325 Prepaid expenses and other current assets (including due from affiliates of $33 in 2002) 372 445 -------- -------- Total current assets 34,214 35,045 Machinery and equipment, net 866 904 Deferred income taxes 244 193 Other assets 42 42 --------- ----------- $ 35,366 $ 36,184 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities Short-term borrowings $ 13,808 $ 16,414 Accounts payable and accrued expenses (including due to affiliates of $354 in 2001) 13,777 12,348 -------- -------- Total current liabilities 27,585 28,762 -------- -------- Long-term debt to GP Strategies 4,500 5,000 --------- --------- Stockholders' equity Common stock, authorized 30,000,000 shares, par value $.01 per share; 15,292,882 shares issued and 15,023,651 outstanding in 2002 and 13,020,155 shares issued and outstanding in 2001 153 130 Capital in excess of par value 8,069 7,589 Accumulated deficit (4,906) (5,297) Treasury stock, at cost (35) - ----------- ----------- Total stockholders' equity 3,281 2,422 --------- -------- $ 35,366 $ 36,184 ======== ======= See accompanying notes to the consolidated financial statements.
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) Year Ended December 31, 2002 2001 ----------- -------- Sales $ 94,074 $ 94,908 Cost of goods sold 77,461 78,854 --------- --------- Gross margin 16,613 16,054 Selling, general and administrative expenses (14,665) (13,576) Management fee to GP Strategies (98) (72) Interest expense (including amounts to affiliates of $384 and $400) (1,131) (1,692) --------- ----- Income before income taxes 719 714 Income tax expense (328) (297) ------- ----- Net income $ 391 $ 417 ======== ======== Earnings per share Basic and diluted $ .03 $ .03 --------- --------- See accompanying notes to the consolidated financial statements. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2002 and 2001 (in thousands, except number of shares)
Common Stock Treasury Stock ------------ -------------- Capital in excess Accumu- Total Number of shares Par of par lated Number of Stockholders' value value deficit shares Cost Equity - ----------------------------------------- ----------------- -------- -------- ------- --------- -------- ----------------- Balance at December 31, 2000 13,020,155 $130 $7,589 $(5,714) - $ - $2,005 - ----------------------------------------- ----------------- -------- ---------- ---------- --------- -------- ----------------- - ----------------------------------------- ----------------- -------- ---------- --------- --------- -------- ----------------- Net income 417 417 - ----------------------------------------- ----------------- -------- ----------- --------- -------- --------- ----------------- - ----------------------------------------- ----------------- -------- ----------- --------- -------- ---------- ---------------- Balance at December 31, 2001 13,020,155 130 7,589 (5,297) - 2,422 - ----------------------------------------- ----------------- -------- --------- ---------- --------- -------- ----------------- - ----------------------------------------- ----------------- -------- ---------- -------- --------- -------- ------------------ Net income 391 391 Purchase of treasury stock 269,231 (35) (35) Issuance of common stock in payment of indebtedness to GP Strategies 2,272,727 23 477 500 Issuance of compensatory stock options 3 3 - ----------------------------------------- ----------------- -------- ---------- ---------- ---------- -------- -------------- - ----------------------------------------- ----------------- -------- ----------- --------- ---------- -------- -------------- Balance at December 31, 2002 15,292,882 $153 $8,069 $(4,906) 269,231 $(35) $3,281 - ----------------------------------------- ----------------- -------- ----------- --------- ---------- -------- -------------- See accompanying notes to the consolidated financial statements.
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year Ended December 31,
2002 2001 ---------- ------- Cash flows from operating activities: Net income $ 391 $ 417 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 267 263 Deferred income taxes (51) (30) Issuance of compensatory stock options 3 - Changes in other operating items: Accounts receivable 1,053 (100) Inventory (339) 285 Prepaid expenses and other current assets 73 (107) Accounts payable and accrued expenses 1,429 (661) ----- ---- Net cash provided by operating activities 2,826 67 ----- ----- Cash flows from investing activities: Additions to machinery and equipment (229) (169) ------- ------ Cash flows from financing activities: Net (repayments of) proceeds from short-term borrowings (2,606) 111 Purchase of treasury stock (35) - ----------- ------ Net cash (used in) provided by financing activities (2,641) 111 --------- --- Net (decrease) increase in cash (44) 9 Cash at beginning of period 60 51 ------ --------- Cash at end of period $ 16 $ 60 ========== ======== Supplemental disclosures of cash flow information: Cash paid during the periods for: Interest $ 1,148 $ 1,863 ======== ======= Income tax $ 171 $ 562 ========= ======== Non-cash financing activity: Exchange of long-term debt to GP Strategies for common stock $ 500 $ - ========= ========= See accompanying notes to the consolidated financial statements.
FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 1. Acquisition of the assets and business of Five Star Five Star Products, Inc. (the "Company" or "Five Star") owns 100% of Five Star Group, Inc. which is a wholesale distributor of home decorating hardware and finishing products in the northeastern United States. The Company's business was purchased on September 30, 1998 from GP Strategies Corporation ("GP Strategies") for approximately $16,476,000 in cash and a $5,000,000 unsecured promissory note (the "Note"). Under a separate Subordination Agreement with GP Strategies in favor of the banks providing the Company's $25,000,000 revolving loan (see Note 3), which Note is subordinate to the revolving loan, Five Star may make annual payments of principal to GP Strategies if the Company achieves certain financial performance benchmarks. On August 2, 2002 the Company entered into a transaction to reduce its long-term debt to GP Strategies. The principal amount of the Note was reduced by $500,000 to $4,500,000. In connection with this debt reduction, GP Strategies received 2,272,727 shares of the Company's common stock. The transaction valued the Company's common stock at $0.22 per share, which was a premium to the open market value at that time. At December 31, 2002, GP Strategies owned approximately 48% of the Company's common stock. 2. Summary of significant accounting policies Principles of consolidation. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Inventory. Inventory is valued at the lower of cost, using the first-in, first-out (FIFO) method, or market. Inventory consists solely of finished products. Machinery and equipment. Fixed assets are carried at cost less accumulated depreciation. Major additions and improvements are capitalized, while maintenance and repairs that do not extend the lives of the assets are expensed currently. Gain or loss, if any, on the disposition of fixed assets is recognized currently in operations. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets. Income taxes. Income taxes are provided for based on the asset and liability method of accounting pursuant to Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes". Under SFAS No. 109, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Use of estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 2. Summary of significant accounting policies (Continued) Concentration of credit risk. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of accounts receivable. Sales are made principally to independently owned paint and hardware stores in the northeast United States. Stock-based compensation. The Company has elected to continue to account for its stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock Issued to Employees". Under the provisions of APB No. 25, employee compensation is measured as the excess, if any, of the quoted market price of the Company's common stock at the date of the grant over the amount an employee must pay to acquire the stock. Had the Company determined compensation cost based on the fair value method at the grant date for its stock options under SFAS No. 123, the Company's net income would have been changed to the pro forma amounts indicated below (in thousands, except per share amounts): 2002 2001 ---- ---- Reported net income $ 391 $ 417 Stock-based employee compensation determined under the fair-value based method, net of tax (33) (5) -------- --------- Pro forma net income $ 358 $ 412 ====== ====== Basic and diluted income per share As reported $ .03 $ .03 Pro forma $ .03 $ .03 The weighted-average fair value of options granted in 2002 and 2001 was approximately $.08 and $.11, respectively, using the Black-Scholes option-pricing model with the following assumptions: 2002 2001 ---- ---- Volatility 73% 106% Risk-free interest rate 2.52% - 4.14% 4.24% Expected life in years 3 5 Dividend yield 0 0 Revenue recognition. Revenue on product sales is recognized at the point in time when the product has been shipped, title and risk of loss has been transferred to the customer, and the following conditions are met: persuasive evidence of an arrangement exists, the price is fixed and determinable, and collectibility of the resulting receivable is reasonably assured. Allowances for estimated returns and allowances are recognized when sales are recorded. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 2. Summary of significant accounting policies (Continued) Shipping and handling costs. Shipping and handling costs are included as a part of selling, general and administrative expense. These costs amounted to $4,441,000 and $4,471,000 for the years ended December 31, 2002 and 2001, respectively. Earnings per share. Basic earnings per share (EPS) is based upon the weighted average number of common shares outstanding during the period. Diluted EPS is based upon the weighted average number of common shares outstanding during the period assuming the issuance of common shares for all dilutive potential common shares outstanding. Options outstanding at December 31, 2002 and 2001 to purchase approximately 1,700,000 and 1,025,000, shares of common stock, respectively, were not included in the diluted per share computation because their effect would be anti-dilutive. Advertising costs. The Company expenses advertising costs as incurred. Advertising expense was $57,000 and $43,000 for the years ended December 31, 2002 and 2001, respectively. 3. Short-term borrowings On November 1, 2001, the Company's wholly-owned subsidiary, Five Star Group, Inc., renewed its Loan and Security Agreement (the "Loan Agreement") by and among three banks, which now matures on September 30, 2004. The Loan Agreement provides for a $25,000,000 revolving credit facility, which allows Five Star to borrow based upon a formula of up to 50% and, under certain circumstances, 55% of eligible inventory and 80% of eligible accounts receivable, as defined in the Loan Agreement. The interest rates under the Loan Agreement are based upon LIBOR or the Prime rate, and can be reduced in the event Five Star achieves and maintains certain performance benchmarks. At December 31, 2002, approximately $13,808,000 was outstanding under the Loan Agreement and approximately $3,900,000 was available to be borrowed. As of December 31, 2002, the LIBOR-based rates averaged 3.56% and the Prime-based rate was 4.25%. The weighted average interest rate on the Company's short-term debt at December 31, 2002 was 3.78%. Substantially all of the Company's assets are pledged as collateral for these borrowings. Under the Loan Agreement Five Star is subject to covenants requiring minimum net worth, limitations on losses, if any, and minimum or maximum values for certain financial ratios. 4. 401(k) plan The Company maintains a 401(k) Savings Plan for employees who have completed one year of service. The Savings Plan permits pre-tax contributions to the Savings Plan of 2% to 50% of compensation by participants pursuant to Section 401(k) of the Internal Revenue Code. The Company matches 40% of the participants' first 6% of compensation contributed, not to exceed an amount equivalent to 2.4% of that participant's compensation. The Savings Plan is administered by a trustee appointed by the Board of Directors of the Company and all contributions are held by the trustee and invested at the participants' directions in various mutual funds. The Company's expense associated with the Savings Plan was approximately $110,000 and, $137,000 for the years ended December 31, 2002 and 2001, respectively. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 5. Machinery and equipment Machinery and equipment consist of the following (in thousands):
December 31, Estimated 2002 2001 useful lives ---- ---- ------------ Machinery and equipment $ 308 $ 304 5-7 years Furniture and fixtures 735 521 5 years Leasehold improvements 839 828 3-9 years ------- ----- 1,882 1,653 Less accumulated depreciation and amortization (1,016) (749) ------- -------- $ 866 $ 904 ======= ======= Depreciation and amortization expense for the years ended December 31, 2002 and 2001 was $267,000 and $263,000, respectively.
6. Long-term debt, related party The Company has an unsecured note payable to JL Distributors, Inc., a wholly-owned subsidiary of GP Strategies in the amount of $4,500,000. The note bears interest at 8%, payable quarterly, with the principal due September 30, 2004. The note is subordinated to the indebtedness under the Loan Agreement (see note 3). Interest expense for the years ended December 31, 2002 and 2001 was $384,000 and $400,000, respectively. A subordination agreement between the Company and GP Strategies permits the annual repayment of principal under certain circumstances (see Note 1). In August 2002, the principal amount of this indebtedness was reduced from $5,000,000 to $4,500,000 through issuance by the Company of 2,272,727 shares of its common stock to GP Strategies (see Notes 1 and 14). 7. Related party transactions (a) Transactions with affiliates Transactions with GP Strategies and its subsidiaries, other than loans, as disclosed elsewhere in the financial statements, during the years ended December 31, 2002 and 2001 are summarized below (in thousands): December 31, 2002 2001 ---- ---- Transactions with GP Strategies Management fees incurred $ 98 $ 72 Interest expense incurred 384 400 FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 7. Related party transactions (Continued) As of January 1, 1994, the Company and GP Strategies entered into a three-year Management Services Agreement pursuant to which certain direct and indirect services will be provided to the Company by GP Strategies. The services to be provided by GP Strategies include legal, tax, business development, insurance and employee benefit administration services. The Company pays GP Strategies a fee of up to $10,000 per month during the term of the agreement. The Agreement is automatically renewable for successive one-year terms unless one of the parties notifies the other in writing at least six months prior to the end of the initial term of any renewal thereof. The Agreement was renewed for 2002 and 2003. Fees incurred to GP Strategies under this agreement totaled $98,000 and $72,000 for each of the years ended December 31, 2002 and 2001. At December 31, 2002, the amount receivable from GP Strategies, which is included in prepaid expenses and other current assets, was $33,000. At December 31, 2001, the amount due to GP Strategies for expenses and interest, which is included in accounts payable and accrued expenses, was $354,000. (b) Other related party transactions On February 8, 2002, the Company entered into a Consulting and Severance Agreement (the "Agreement") with Richard Grad, the former President and Chief Executive Officer of the Company. Pursuant to the Agreement, Mr. Grad will receive $145,000 per year for consulting services to be rendered to the Company and a severance fee at the rate of $5,000 per year, for a five-year period ending December 31, 2006. In addition, in August, 2002, Mr. Grad was granted options to purchase 150,000 shares of the Company's Common Stock at the quoted market price on the date of grant, which options will vest annually over the term of the Agreement in equal installments. Such options were valued at an aggregate amount of $13,000. The Agreement also provided for the repurchase by the Company of 192,308 shares of the Company's Common Stock held by Mr. Grad for an aggregate purchase price of $25,000. During this five-year period, Mr. Grad is also receiving certain benefits, including medical benefits, life insurance and use of an automobile. On February 8, 2002, the Company entered into a Consulting and Severance Agreement (the "Agreement") with Cynthia Krugman, the former Controller of the Company. Pursuant to the Agreement, Ms. Krugman will receive $105,000 per year for consulting services to be rendered to the Company and a severance fee of $5,000 per year, for an eighteen-month period ending June 30, 2003. The Agreement also provided for the repurchase by the Company of 76,923 shares of the Company's Common Stock held by Ms. Krugman for an aggregate purchase price of $10,000. During this period, Ms. Krugman is receiving certain benefits, including medical benefits. Ms. Krugman is the daughter of Richard Grad. Severance fees payable to Mr. Grad and Ms. Krugman under the aforementioned agreements are included in accrued expenses at December 31, 2002. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 8. Income taxes The components of income tax expense (benefit) are as follows (in thousands): Years ended December 31, 2002 2001 -------------------------------------------------------------- Current Federal $ 286 $ 251 State and local 93 76 -------- -------- Total current expense 379 327 ------- ------- Deferred Federal (38) (23) State and local (13) (7) ---------- ---------- Total deferred (benefit) (51) (30) -------- --------- Total income tax expense $ 328 $ 297 ------- ------- As of December 31, 2002 and 2001, the Company had approximately $244,000 and $193,000, respectively, of deferred tax assets net of valuation allowances. The tax effects that gave rise to these deferred tax assets and the valuation allowance consist of the following (in thousands): December 31, 2002 2001 ------ -------- Deferred tax assets Allowance for doubtful accounts $ 35 $ 31 Machinery and equipment 158 115 Deferred compensation 39 38 Accrued compensation 10 - Inventory 41 47 ------- ------- Deferred tax assets 283 231 ------ ------ Valuation allowance (39) (38) ---------- ------ Net deferred tax assets after valuation allowance $ 244 $ 193 ======= ======= A reconciliation between the Company's tax provision and the U.S. statutory rate follows: Years ended December 31, 2002 2001 ------------------------------------------------------------------- Tax at U.S. statutory rate $ 245 $ 243 State and local taxes net of Federal benefit 51 49 Items not deductible 19 27 Valuation allowance adjustment 1 - Other 12 (22) -------------------------------------------------------------------- Income taxes $ 328 $ 297 ------------------------------------------------------------------- FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 8. Income taxes (Continued) Under SFAS No. 109, a valuation allowance is provided when it is more likely than not that some portion of deferred tax assets will not be realized. The Company has provided a full valuation allowance at December 31, 2002 and December 31, 2001 for the deferred tax asset relating to the deferred compensation as the realization of such asset is uncertain. The valuation allowance increased $1,000 for the year ended December 31, 2002. The valuation allowance for the year ended December 31, 2001 decreased by $122,000 as a result of the expiration during 2001 of the underlying warrants which gave rise to the deferred tax asset relating to certain deferred compensation. 9. Major customers For the years ended December 31, 2002 and 2001 no customer accounted for more than 10% of the Company's revenue. 10. Stock option plan On January 1, 1994, the Company's Board of Directors adopted the Five Star Products, Inc. 1994 Stock Option Plan (the "Stock Option Plan"), which became effective August 5, 1994. On January 1, 2002, the Board of Directors amended the Stock Option Plan increasing the total number of shares of Common Stock to 4,000,000 shares reserved for issuance, subject to adjustment in the event of stock splits, stock dividends, recapitalizations, reclassifications or other capital adjustments. Unless designated as "incentive stock options" intended to qualify under Section 422 of the Internal Revenue Code, options granted under the Stock Option Plan are intended to be nonqualified options. Options may be granted to any director, officer or other key employee of the Company and its subsidiaries, and to consultants and other individuals providing services to the Company. The term of any option granted under the Stock Option Plan will not exceed ten years from the date of the grant of the option and, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock of the Company, three years from the date of grant. The exercise price of any option will not be less than the fair market value of the Common Stock on the date of grant or, in the case of incentive stock options granted to a 10% or greater holder in the total voting stock, 110% of such fair market value. Options granted during 2002 and 2001 vest 20% on date of grant with the balance vesting in equal annual installments over four years. All options granted prior to 1999 were fully vested as of December 31, 2002. Activity relating to stock options granted by the Company: FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 10. Stock options and warrants (Continued)
Number of Weighted-Average Shares Exercise Price ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Balance at December 31, 2000 2,125,000 .19 ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Granted 450,000 .14 Cancelled (75,000) .33 ------------ ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Balance at December 31, 2001 2,500,000 .18 ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Granted 675,000 .15 Cancelled (245,000) .27 ----------- ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Balance at December 31, 2002 2,930,000 .16 ========= ------------------------------------------------- ---------------- ------------------------- ------------------------------------------------- ---------------- ------------------------- Exercisable at December 31, 2002 2,060,000 .16 ============ ------------------------------------------------- ---------------- -------------------------
The following table summarizes information about the Plan's options at December 31, 2002:
Number Exercise Weighted-Average Number Exercise Outstanding Price Years Remaining Exercisable Price ------------------ --------------- ------------------------- --------------- ----------------- ------------------ --------------- ------------------------- --------------- ----------------- 1,400,000 .13 .44 1,400,000 $.13 925,000 .14 3.95 275,000 .14 50,000 .15 4.24 25,000 .15 150,000 .16 4.64 30,000 .16 405,000 .33 1.29 330,000 .33 ------------------ --------------- ------------------------- --------------- ----------------- ------------------ --------------- ------------------------- --------------- ----------------- 2,930,000 $.16 1.95 2,060,000 $.16 ------------------ --------------- ------------------------- --------------- -----------------
11. Earnings per share Earnings per share (EPS) for the years ended December 31, 2002 and 2001 are as follows (in thousands, except per share amounts): Year ended December 31, 2002 2001 ---- ---- Basic EPS Net income $ 391 $ 417 Weighted average shares outstanding 13,742 13,020 -------- -------- Basic earnings per share $ .03 $ .03 ---------- ---------- Diluted EPS Net income $ 391 $ 417 --------- --------- FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 11. Earnings per share (Continued) Year ended December 31, 2002 2001 ---- ---- Weighted average shares outstanding 13,742 13,020 Dilutive effect of stock options (a) 74 153 --------- --------- Weighted average shares outstanding, diluted 13,816 13,173 -------- -------- Diluted earnings per share $ .03 $ .03 --------- ---------- (a) Diluted earnings per share are based upon the weighted average number of common shares outstanding during the period, assuming the issuance of common shares for all dilutive potential common shares outstanding. 12. Commitments and contingencies The Company has several noncancellable leases which cover real property, machinery and equipment. Such leases expire at various dates and some of them have options to extend their terms. Minimum rental obligations under long-term operating leases are indicated in the table below (in thousands). Figures for real property include estimated amounts of supplemental lease obligations, such as pro-rated assessments for property taxes or common-area expenses. Real Machinery and property equipment Total - ----------------------------------------------------------------------------- 2003 $ 1,616 $1,098 $ 2,714 2004 1,589 796 2,385 2005 1,589 376 1,965 2006 1,589 29 1,618 2007 314 7 321 -------------------------------------------------------------------- Total $ 6,697 $ 2,306 $ 9,003 During 2002 and 2001, the Company incurred $2,882,000 and $2,721,000, respectively, of rental expenses. GP Strategies has guaranteed the leases for the Company's New Jersey and Connecticut warehouses, totaling approximately $1,589,000 per year through the first quarter of 2007. FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 13. Valuation and Qualifying Accounts The following is a summary of the allowance for doubtful accounts related to accounts receivable for the years ended December 31 (in thousands): 2002 2001 ---- ---- Balance at beginning of year $ 631 $ 681 Charged (credited) to expense 438 (47) Uncollectible accounts written off, net of recoveries (429) (3) ----- ------- Balance at end of year $ 640 $ 631 ====== ======== 14. Subsequent events (a) The Company's Board of Directors has authorized the repurchase of up to 1,000,000 shares of the Company's common stock. In January, 2003, the Company purchased 76,000 shares of its common stock on the open market at prices per share ranging from $0.08 to $0.10. In February, 2003, the Company purchased 10,000 shares of its common stock on the open market at a price per share of $0.10. (b) On June 20, 2003, the Company's wholly-owned subsidiary, Five Star Group, Inc., obtained a new Loan and Security Agreement (the "new Loan Agreement") with Fleet Capital Corporation as sole lender to replace the Loan and Security Agreement by and among three banks which was to have matured on September 30, 2004 (the "old Loan Agreement"). The new Loan Agreement has a five-year term, with a maturity date of June 30, 2008. The new Loan Agreement provides for a $25,000,000 revolving credit facility, which allows Five Star Group, Inc. to borrow based upon a formula of up to 55% of eligible inventory and 80% of eligible accounts receivable, as defined therein. The interest rates under the new Loan Agreement consist of LIBOR plus a credit spread of 2% for borrowings not to exceed $15,000,000 and the prime rate for borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit spreads can be reduced in the event that Five Star Group, Inc. achieves and maintains certain performance benchmarks. Substantially all of the Company's assets are pledged as collateral for those borrowings. Under the Loan Agreement Five Star is subject to covenants requiring minimum net worth, limitations on losses, if any, and minimum or maximum values for certain financial ratios. In connection with the new Loan Agreement, Five Star Group, Inc. also entered into a derivative transaction with Fleet National Bank on June 20, 2003. The derivative transaction is an interest rate swap and has been designated as a hedge. Effective July 1, 2004 through June 30, 2008, Five Star Group, Inc. will pay a fixed interest rate of 3.38% to Fleet National Bank on notional principal of $12,000,000. In return, Fleet National Bank will pay to Five Star Group, Inc. a floating rate, namely, LIBOR, on the same notional principal amount. The credit spread under the new Loan Agreement is not included in, and will be paid in addition to, this fixed interest rate of 3.38%. (c) On June 30, 2003, the Company entered into an Agreement of Subordination and Assignment (the "Agreement") with JL Distributors, Inc., whereby in accordance with the provisions of the Agreement on June 27, 2003, July 2, 2003 and July 7, 2003 Five Star Group, Inc. made principal payments in the amounts of $500,000, $300,000, and $200,000 reducing the outstanding principal amount of the note FIVE STAR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) 14. Subsequent events (Continued) payable to JL Distributors, Inc. from $4,500,000 to $3,500,000. On October 8, 2003, the Company entered into a transaction to reduce the principal amount of the note payable by $500,000 to a new principal amount of $3,000,000. In exchange, GP Strategies received 2,000,000 shares of the Company's common stock. In consideration for GP Strategies' agreeing to exchange the debt for common stock at a conversion price of $0.25 per share, which was more than twice the $0.11 closing market price of the Company's common stock on the day prior to approval of the transaction, the Company agreed to terminate the voting agreement between GP Strategies and itself, described below. The voting agreement, which by its terms would in any case have terminated on June 30, 2004, provided that GP Strategies (i) would vote its shares of the Company's common stock so that not more than 50% of the members of the Company's board of directors would be officers or directors of GP Strategies and (ii) would vote on matters other than the election of directors in the same proportion as the Company's other shareholders. The transaction was approved by a Special Committee of the Company's board of directors; the Special Committee consisted of an independent non-management director who is unaffiliated with GP Strategies. As a result of this transaction, GP Strategies' ownership of the Company increased to approximately 54% from approximately 48% of the Company's outstanding shares of common stock, and the Company has become a subsidiary of GP Strategies. (d) On February 6, 2004 the Company announced that it will repurchase up to 5,000,000 shares, or approximately 30% of its common stock currently outstanding, through a tender offer for the shares at $0.21 per share, originally set to expire on March 16, 2004. On March 17, 2004 the Company announced that it had increased the price it was offering to pay for the shares in the tender offer to $0.25 per share and extended the offer to March 31, 2004. Based upon the final tabulation by the depository for the tender offer, 2,627,790 shares of common stock valued at $656,947 were tendered by the Company as of March 31, 2004. EX-3 3 ex3-2.txt NATIONAL PATENT DEVELOPMENT CORPORATION BY-LAWS Exhibit 3.2 AMENDED AND RESTATED BY-LAWS of NATIONAL PATENT DEVELOPMENT CORPORATION As adopted August 5, 2004 NATIONAL PATENT DEVELOPMENT CORPORATION A Delaware Corporation BY-LAWS ARTICLE I STOCKHOLDERS Section 1.1 Annual Meeting. An annual meeting of stockholders for the purpose of electing directors and of transacting such other business as may come before it shall be held each year at such date, time, and place, either within or without the State of Delaware, or by means of remote communication, as may be specified by the Board of Directors. Section 1.2 Business at Annual Meetings (a) No business may be transacted at an annual meeting of stockholders, other than business that is either (i) specified in the notice of meeting given pursuant to Section 1.4 of these By-laws, (ii) otherwise properly brought before the annual meeting by or at the direction of the Board of Directors (or any duly authorized committee thereof), or (iii) otherwise properly brought before the annual meeting by any stockholder of the Corporation (A) who is a stockholder of record on the date of the giving of the notice provided for in this Section 1.2 and on the record date for the determination of stockholders entitled to vote at such meeting and (B) who complies with the written notice procedures set forth in Section 1.2(b) of these By-laws. (b) In addition to any other applicable requirements, for business to be properly brought before an annual meeting by a stockholder, such stockholder must have given timely notice thereof in proper written form to the Secretary of the Corporation. To be timely, a stockholder's notice to the Secretary must be delivered to or mailed and received at the principal executive offices of the Corporation not less than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders; provided, however, that, if the annual meeting is called for a date that is not within 30 days before or after such anniversary date, notice by the stockholder, to be timely, must be so received not later than the close of business on the tenth day following the day on which public disclosure of the date of the annual meeting was first made. To be in proper written form, a stockholder's notice to the Secretary must set forth, as to each matter such stockholder proposes to bring before the annual meeting, (i) a brief description of the business proposed to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and record address of such stockholder, (iii) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by such stockholder, (iv) a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of such stockholder in such business, and (v) a representation that such stockholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting. (c) If the Chairman of an annual meeting determines that business was not properly brought before the annual meeting as a result of non-compliance with Section 1.2(b) of these By-laws or for any other reason, the Chairman shall declare to the meeting that the business was not properly brought before the meeting and such business shall not be transacted or discussed. Section 1.3 Special Meetings. Special meetings of stockholders for any purpose or purposes may be held at any time upon call of the Chairman of the Board, if any, the President, the Secretary, or a majority of the entire Board of Directors, at such time and place either within or without the State of Delaware as may be stated in the notice. No stockholder or group of stockholders shall have the right to call a special meeting of stockholders. No business may be conducted at any special meeting except as may be stated in the notice of such special meeting given in accordance with Section 1.4 of these By-Laws. If the Chairman of a special meeting determines that business was not properly brought before the special meeting because it was not stated in the notice of such special meeting or for any other reason, the Chairman shall declare to the meeting that the business was not properly brought before the meeting and such business shall not be transacted or discussed. The Board of Directors may, in its sole discretion, determine that the meeting shall not be held at any place but shall instead be held by means of remote communication. Section 1.4 Notice of Meetings. Written notice of stockholders meetings, stating the place, if any, date, and hour thereof, the means of remote communication, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such meeting, and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be given by the Chairman of the Board, if any, the President, any Vice President, the Secretary, or an Assistant Secretary, to each stockholder entitled to vote thereat at least ten days but not more than sixty days before the date of the meeting, unless a different period is prescribed by law. Section 1.5 Quorum. Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws, at any meeting of stockholders, the holders of a majority of the aggregate voting power of the outstanding shares of stock entitled to vote at the meeting shall be present or represented by proxy in order to constitute a quorum for the transaction of any business. In the absence of a quorum, a majority in interest of the stockholders present or the chairman of the meeting may adjourn the meeting from time to time in the manner provided in Section 1.6 of these By-Laws until a quorum shall attend. Section 1.6 Adjournment. Any meeting of stockholders, annual or special, may adjourn from time to time to reconvene at the same or some other place, or by means of remote communication, and notice need not be given of any such adjourned meeting if the time and place, if any, thereof, and the means of remote communications, if any, by which stockholders and proxy holders may be deemed to be present in person and vote at such adjourned meeting, are announced at the meeting at which the adjournment is taken. At the adjourned meeting, the Corporation may transact any business which might have been transacted at the original meeting. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. Section 1.7 Organization. The Chairman of the Board, if any, or in his absence the President, or in their absence any Vice President, shall call to order meetings of stockholders and shall act as chairman of such meetings. The Board of Directors or, if the Board fails to act, the stockholders may appoint any stockholder, director, or officer of the Corporation to act as chairman of any meeting in the absence of the Chairman of the Board, the President, and all Vice Presidents. The Secretary of the Corporation shall act as secretary of all meetings of stockholders, but, in the absence of the Secretary, the chairman of the meeting may appoint any other person to act as secretary of the meeting. Section 1.8 Voting. Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws and except for the election of directors, at any meeting duly called and held at which a quorum is present, a majority of the votes cast at such meeting upon a given question by the holders of outstanding shares of stock of all classes of stock of the Corporation entitled to vote thereon who are present in person or by proxy shall decide such question. At any meeting duly called and held for the election of directors at which a quorum is present, directors shall be elected by a plurality of the votes cast by the holders (acting as such) of shares of stock of the Corporation entitled to elect such directors. Section 1.9 Remote Communication If authorized by the Board of Directors in its sole discretion, and subject to such guidelines and procedures as the Board of Directors may adopt, stockholders and proxyholders may, by means of remote communication: (a) participate in a meeting of stockholders; and (b) be deemed present in person and vote at a meeting of stockholders, whether such meeting is to be held at a designated place or solely by means of remote communication, provided that (i) the Corporation shall implement reasonable measures to verify that each person deemed present and permitted to vote at the meeting by means of remote communication is a stockholder or proxyholder, (ii) the Corporation shall implement reasonable measures to provide such stockholders and proxyholders a reasonable opportunity to participate in the meeting and to vote on matters submitted to the stockholders, including an opportunity to read or hear the proceedings of the meeting substantially concurrently with such proceedings, and (iii) if any stockholder or proxyholder votes or takes other action at the meeting by means of remote communication, a record of such vote or other action shall be maintained by the Corporation. ARTICLE II BOARD OF DIRECTORS Section 2.1 Number and Term of Office The business, property, and affairs of the Corporation shall be managed by or under the direction of a Board of Directors. The Board, by resolution adopted by the vote of a majority of the then authorized number of directors, may increase or decrease the number of directors. Stockholders shall not have the right to increase or decrease the number of directors. The directors shall be elected by the holders of shares entitled to vote thereon at the annual meeting of stockholders, and each shall serve (subject to the provisions of Article IV) until the expiration of his term of office as specified in the Certificate of Incorporation and until his respective successor has been elected and qualified. Section 2.2 Advance Notice of Director Nominations (a) Only persons who are nominated in accordance with the following procedures shall be eligible for election as Directors of the Corporation, except as may be otherwise provided in the Certificate of Incorporation of the Corporation. Nominations of persons for election to the Board of Directors may be made at any annual meeting of stockholders or at any special meeting of stockholders called for the purpose of electing Directors, (i) by or at the direction of the Board of Directors (or any duly authorized Committee thereof) or (iii) by any stockholder of the Corporation (A) who is a stockholder of record on the date of the giving of the notice provided for in this Section 2.2 and on the record date for the determination of stockholders entitled to vote at such meeting and (B) who complies with the written notice procedures set forth in Section 2.2(b) of these By-laws. (b) In addition to any other applicable requirements, for a nomination to be made by a stockholder, such stockholder must have given timely notice thereof in proper written form to the Secretary of the Corporation. To be timely, a stockholder's notice to the Secretary must be delivered to or mailed and received at the principal executive offices of the Corporation (i) in the case of an annual meeting, not less than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders; provided, however, that in the event that the annual meeting is called for a date that is not within 30 days before or after such anniversary date, notice by the stockholder in order to be timely must be so received not later than the close of business on the tenth day following the day on which public disclosure of the date of the annual meeting was first made; and (ii) in the case of a special meeting of stockholders called for the purpose of electing Directors, not later than the close of business on the tenth day following the day on which public disclosure of the date of the special meeting was made. To be in proper written form, a stockholder's notice to the Secretary must set forth: (i) as to each person whom the stockholder proposes to nominate for election as a Director (1) the name, age, business address and residence address of the person, (2) the principal occupation or employment of the person, (3) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by the person and (4) any other information relating to the person that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of Directors pursuant to Section 14 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and the rules and regulations promulgated thereunder; and (ii) as to the stockholder giving the notice (1) the name and record address of such stockholder, (2) the class or series and number of shares of capital stock of the Corporation which are owned beneficially or of record by such stockholder, (3) a description of all arrangements or understandings between such stockholder and each proposed nominee and any other person or persons (including their names) pursuant to which the nomination(s) are to be made by such stockholder, (4) a representation that such stockholder intends to appear in person or by proxy at the meeting to nominate the persons named in its notice and (5) any other information relating to such stockholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of Directors pursuant to Section 14 of the Exchange Act and the rules and regulations promulgated thereunder. Such notice must be accompanied by a written consent of each proposed nominee to being named as a nominee and to serve as a Director if elected. (c) No person shall be eligible for election as a Director of the Corporation at any meeting of stockholders unless nominated in accordance with the procedures set forth in this Section 2.2. If the Chairman of the meeting determines that a nomination was not made in accordance with the foregoing procedures, the Chairman shall declare to the meeting that the nomination was defective and such defective nomination shall be disregarded. Section 2.3 Chairman of the Board. The directors may elect one of their members to be Chairman of the Board of Directors. The Chairman shall be subject to the control of and may be removed by the Board of Directors. He shall perform such duties as may from time to time be assigned to him by the Board. Section 2.4 Meetings. Regular meetings of the Board of Directors may be held without notice at such time and place, if any, as shall from time to time be determined by the Board. Special meetings of the Board of Directors shall be held at such time and place, if any, as shall be designated in the notice of the meeting whenever called by the Chairman of the Board, if any, the President, or by a majority of the then authorized number of directors. Section 2.5 Notice of Special Meetings. The Secretary, or in his absence any other officer of the Corporation, shall give each director notice of the time and place, if any, of holding of special meetings of the Board of Directors at least one day before the meeting. Unless otherwise stated in the notice thereof, any and all business may be transacted at any meeting without specification of such business in the notice. Section 2.6 Quorum and Organization of Meetings. A majority of the total number of members of the Board of Directors as constituted from time to time shall constitute a quorum for the transaction of business, but, if at any meeting of the Board of Directors (whether or not adjourned from a previous meeting) there shall be less than a quorum present, a majority of those present may adjourn the meeting to another time and place, if any, and the meeting may be held as adjourned without further notice or waiver. Except as otherwise provided by law or in the Certificate of Incorporation or these By-Laws, a majority of the directors present at any meeting at which a quorum is present may decide any question brought before such meeting. Meetings shall be presided over by the Chairman of the Board, if any, or in his absence by the President, or in the absence of both by such other person as the directors may select. The Secretary of the Corporation shall act as secretary of the meeting, but in his absence the chairman of the meeting may appoint any person to act as secretary of the meeting. Section 2.7 Committees. The Board of Directors may designate one or more committees, each committee to consist of one or more of the directors of the Corporation. The Board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board of Directors, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business, property, and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have power or authority in reference to (a) approving or adopting, or recommending to stockholders, any action or matter expressly required by the General Corporation Law of the State of Delaware to be submitted to stockholders for approval or (b) adopting, amending, or repealing these By-Laws. Each committee which may be established by the Board of Directors pursuant to these By-Laws may fix its own rules and procedures. Notice of meetings of committees, other than of regular meetings provided for by the rules, shall be given to committee members. All action taken by committees shall be recorded in minutes of the meetings. Section 2.8 Action Without Meeting. Nothing contained in these By-Laws shall be deemed to restrict the power of members of the Board of Directors or any committee designated by the Board to take any action required or permitted to be taken by them without a meeting. Section 2.9 Telephone Meetings. Nothing contained in these By-Laws shall be deemed to restrict the power of members of the Board of Directors, or any committee designated by the Board, to participate in a meeting of the Board, or committee, by means of conference telephone or other communications equipment by means of which all persons participating in the meeting can hear each other. ARTICLE III OFFICERS Section 3.1 Executive Officers. The executive officers of the Corporation shall be a President, one or more Vice Presidents, a Treasurer, and a Secretary, each of whom shall be elected by the Board of Directors. The Board of Directors may provide that the Chairman of the Board, if any, shall be an executive officer, and the Board of Directors may elect or appoint such other officers (including a Chief Executive Officer, Chief Financial Officer, Controller, and one or more Assistant Treasurers and Assistant Secretaries) as it may deem necessary or desirable. Each officer shall hold office for such term as may be prescribed by the Board of Directors from time to time. Any person may hold at one time two or more offices. Section 3.2 Powers and Duties. The officers and agents of the Corporation shall each have such powers and authority and shall perform such duties in the management of the business, property, and affairs of the Corporation as generally pertain to their respective offices, as well as such powers and authorities and such duties as from time to time may be prescribed by the Board of Directors. ARTICLE IV RESIGNATIONS, REMOVALS, AND VACANCIES Section 4.1 Resignations. Any director or officer of the Corporation, or any member of any committee, may resign at any time by giving notice in writing or by electronic transmission to the Board of Directors, the President, or the Secretary of the Corporation. Any such resignation shall take effect at the time specified therein or, if the time be not specified therein, then upon receipt thereof. The acceptance of such resignation shall not be necessary to make it effective. Section 4.2 Removals. The Board of Directors, by a vote of not less than a majority of the entire Board, at any meeting thereof, or by consent in writing or by electronic transmission, at any time, may, to the extent permitted by law, remove with or without cause from office or terminate the employment of any officer or member of any committee and may, with or without cause, disband any committee. A director may be removed only for cause and only by the affirmative vote of the holders of two-thirds of the voting power of the shares of capital stock entitled to vote thereon. Section 4.3 Vacancies. Any vacancy in the office of any director or officer through death, resignation, removal, disqualification, or other cause, and any additional directorship resulting from increase in the number of directors, may be filled at any time by a majority of the directors then in office (even though less than a quorum remains) or, in the case of any vacancy in the office of any director when there are no directors then in office, by the stockholders, and, subject to the provisions of this Article IV, the person so chosen shall hold office until such person's successor shall have been elected and qualified; or, if the person so chosen is a director elected to fill a vacancy, such person shall (subject to the provisions of this Article IV) hold office for the unexpired term of such person's predecessor. ARTICLE V CAPITAL STOCK Section 5.1 Stock Certificates. The certificates for shares of the capital stock of the Corporation shall be in such form as shall be prescribed by law and approved, from time to time, by the Board of Directors. Section 5.2 Transfer of Shares. Shares of the capital stock of the Corporation may be transferred on the books of the Corporation only by the holder of such shares or by the holder's duly authorized attorney, upon the surrender to the Corporation or its transfer agent of the certificate representing such stock properly endorsed. Section 5.3 Fixing Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion, or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which, unless otherwise provided by law, in the case of notice of a meeting shall not be more than sixty nor less than ten days before the date of such meeting, and in the case of any other action shall not be more than sixty days prior to such action. Section 5.4 Lost Certificates. The Board of Directors or any transfer agent of the Corporation may direct a new certificate or certificates representing stock of the Corporation to be issued in place of any certificate or certificates theretofore issued by the Corporation, alleged to have been lost, stolen, or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate to be lost, stolen, or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors (or any transfer agent of the Corporation authorized to do so by a resolution of the Board of Directors) may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen, or destroyed certificate or certificates, or such owner's legal representative, to give the Corporation a bond in such sum as the Board of Directors (or any transfer agent so authorized) shall direct to indemnify the Corporation against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen, or destroyed or the issuance of such new certificates, and such requirement may be general or confined to specific instances. Section 5.5 Regulations. The Board of Directors shall have power and authority to make all such rules and regulations as it may deem expedient concerning the issue, transfer, registration, cancellation, and replacement of certificates representing stock of the Corporation. ARTICLE VI MISCELLANEOUS Section 6.1 Corporate Seal. The corporate seal shall have inscribed thereon the name of the Corporation and shall be in such form as may be approved from time to time by the Board of Directors. Section 6.2 Fiscal Year. The fiscal year of the Corporation shall be the calendar year, unless otherwise determined by resolution of the Board of Directors. Section 6.3 Notices and Waivers Thereof. Whenever any notice whatever is required by law, the Certificate of Incorporation, or these By-Laws to be given to any stockholder, director, or officer, such notice, except as otherwise provided by law, may be given by mail (in the case of stockholders), overnight delivery service, personal service, facsimile, or electronic transmission, addressed to such address as appears in the records of the Corporation; provided that notice may be given to a stockholder by facsimile or electronic transmission only if such stockholder has consented to such method of delivery. Any notice given by mail shall be deemed to have been given when it shall have been deposited in the United States mail with postage thereon prepaid; any notice given by overnight delivery service shall be deemed to have been given the day of guaranteed delivery by such service; any notice given by personal service shall be deemed to have been given when it shall have been delivered; and any notice given by a facsimile or electronic transmission shall be deemed given (a) if by facsimile, when directed to a facsimile telecommunication number at which the stockholder, director, or officer has consented to receive notice; (b) if by electronic mail, when directed to an electronic mail address at which the stockholder, director, or officer has consented to receive notice; (c) if by posting on an electronic network together with separate notice to the stockholder, director, or officer of such specific posting, upon the later of such posting and the giving of such separate notice; and (d) if by any other form of electronic transmission, when directed to the stockholder, director, or officer. An affidavit of the secretary or an assistant secretary or of the transfer agent or other agent of the Corporation that the notice has been given shall, in the absence of fraud, be prima facie evidence of the facts stated therein. Whenever any notice is required to be given by law, the Certificate of Incorporation, or these By-Laws, a written waiver thereof, signed by the person entitled to such notice, or given by electronic transmission, whether before or after the meeting or the time stated therein, shall be deemed equivalent in all respects to such notice to the full extent permitted by law. Section 6.4 Stock of Other Corporations or Other Interests. Unless otherwise ordered by the Board of Directors, the President, the Secretary, and such attorneys or agents of the Corporation as may be from time to time authorized by the Board of Directors or the President, shall have full power and authority on behalf of this Corporation to attend and to act and vote in person or by proxy at any meeting of the holders of securities of any corporation or other entity in which this Corporation may own or hold shares or other securities, and at such meetings shall possess and may exercise all the rights and powers incident to the ownership of such shares or other securities which this Corporation, as the owner or holder thereof, might have possessed and exercised if present. The President, the Secretary, or such attorneys or agents, may also execute and deliver on behalf of this Corporation powers of attorney, proxies, consents, waivers, and other instruments relating to the shares or securities owned or held by this Corporation. ARTICLE VII AMENDMENTS The stockholders of the Corporation are authorized to adopt, amend, or repeal By-Laws of the Corporation, but only by the affirmative vote of the holders of 75% of the voting power of the shares of capital stock entitled to vote thereon. The Board of Directors is also authorized to adopt, amend, or repeal By-Laws of the Corporation. ARTICLE VIII INDEMNIFICATION Section 8.1 Indemnification Generally. The Corporation shall indemnify each person who was or is made a party or is threatened to be made a party to or is involved in any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative (hereinafter a "Proceeding"), by reason of the fact that he or she, or a person of which he or she is the legal representative, is or was a director or officer, or had agreed to serve as a director or officer, of the Corporation or is or was serving or has agreed to serve at the request of the Corporation as a director or officer of another corporation or of a partnership, joint venture, trust, or other enterprise, including service with respect to employee benefit plans, or by reason of any act alleged to have been taken or omitted in such capacity, whether the basis of such Proceeding is alleged action in an official capacity as a director or officer or alleged action in any other capacity while serving as a director or officer, to the maximum extent authorized by the General Corporation Law of the State of Delaware, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than such law permitted the Corporation to provide prior to such amendment), against all cost, expense, liability, and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties, and amounts paid or to be paid in settlement) reasonably incurred by such person or on his or her behalf in connection with such Proceeding, and such indemnification shall continue as to a person who has ceased to be a director or officer shall inure to the benefit of his or her heirs, executors, and administrators. The termination of any Proceeding by judgment, order, settlement, or conviction, or upon a plea of nolo contendre or its equivalent, shall not, of itself, create a presumption that the person did not meet any standard of conduct for indemnification imposed by the General Corporation Law. Notwithstanding the foregoing, except with respect to a Proceeding to enforce a right to indemnification under this Article Eighth, the Corporation shall not be required by this Article Eighth to indemnify any person with respect to, or to advance expenses incurred by such person (including attorneys' fees) in connection with, any Proceeding initiated by such person against the Corporation, or any counterclaim, cross-claim, affirmative defense, or similar claim of the Corporation in connection with such Proceeding, unless such Proceeding was authorized by the Board of Directors by a vote of a majority of the directors having no interest in such Proceeding or, if all of the directors have an interest in such Proceeding, by a vote of a majority of the directors then in office. Section 8.2 Indemnification for Costs, Charges, and Expenses for Successful Party. Notwithstanding the other provisions of this Article Eighth, to the extent that a director or officer of the Corporation has been successful on the merits or otherwise, including, without limitation, the dismissal of an action without prejudice, in defense of any Proceeding referred to in Section 8.1, or in the defense of any claim, issue, or matter therein, he shall be indemnified against all costs, charges, and expenses (including attorneys' fees) actually and reasonably incurred by him or on his behalf in connection therewith. Section 8.3 Determination of Right to Indemnification. Any indemnification under Section 8.1 or 8.2 (unless ordered by a court) shall be paid by the Corporation unless a determination is made (a) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit, or proceeding, or (b) if such a quorum is not obtainable, or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (c) by the stockholders, that indemnification of the director or officer is not proper in the circumstances because he has not met the applicable standards of conduct set forth in the General Corporation Law. Section 8.4 Advance of Costs, Charges, and Expenses. Costs, charges, and expenses (including attorneys' fees) incurred by a person referred to in Section 8.1 of this Article Eighth in defending a civil or criminal Proceeding (including investigations by any government agency and all costs, charges, and expenses incurred in preparing for any threatened Proceeding) shall be paid by the Corporation in advance of the final disposition of such Proceeding; provided, however, that the payment of such costs, charges, and expenses incurred by a director or officer in his or her capacity as a director or officer (and not in any other capacity in which service was or is rendered by such person while a director or officer) in advance of the final disposition of such Proceeding shall be made only upon receipt of an undertaking by or on behalf of the director or officer to repay all amounts so advanced if it shall ultimately be determined that such director or officer is not entitled to be indemnified by the Corporation as authorized in this Article Eighth, and subject to the last sentence of Section 8.1. No security shall be required for such undertaking and such undertaking shall be accepted without reference to the recipient's financial ability to make repayment. The Board of Directors may, in the manner set forth above, and subject to the approval of such director or officer, authorize the Corporation's counsel to represent such person in any Proceeding, whether or not the Corporation is a party to such Proceeding. Section 8.5 Procedure for Indemnification. Any indemnification under Section 8.1 or advance of costs, charges, and expenses under Section 8.4 shall be made promptly, and in any event within 60 days, upon the written request of the director or officer directed to the Secretary of the Corporation. The right to indemnification or advances as granted by this Article Eighth shall be enforceable by the director or officer in any court of competent jurisdiction if the Corporation denies such request, in whole or in part, or if no disposition thereof is made within 60 days. Such person's costs and expenses incurred in connection with successfully establishing his or her right to indemnification or advances, in whole or in part, in any such action shall also be indemnified by the Corporation. It shall be a defense to any such action (other than an action brought to enforce a claim for the advance of costs, charges, and expenses under Section 8.4 where the required undertaking, if any, has been received by the Corporation) that the claimant has not met the standard of conduct, if any, set forth in the General Corporation Law, but, to the extent permitted by applicable law, the burden of proving that such standard of conduct has not been met shall be on the Corporation. To the extent permitted by applicable law, neither the failure of the Corporation (including its Board of Directors, its independent legal counsel, and its stockholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he or she has met the applicable standard of conduct, if any, set forth in the General Corporation Law, nor the fact that there has been an actual determination by the Corporation (including its Board of Directors, its independent legal counsel, and its stockholders) that the claimant has not met such applicable standard of conduct, shall be a defense to the action or create a presumption that the claimant has not met the applicable standard of conduct. Section 8.6 Other Rights; Continuation of Right of Indemnification. The indemnification provided by this Article Eighth shall not be deemed exclusive of any other rights to which a person seeking indemnification may be entitled under any law (common or statutory), agreement, vote of stockholders or disinterested directors, or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding office, and shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of the estate, heirs, executors, and administrators of such person. All rights to indemnification and the advance of costs, charges, and expenses under this Article Eighth shall be deemed to be a contract between the Corporation and each director and officer of the Corporation who serves or served in such capacity at any time while this Article Eighth is in effect. No amendment or repeal of this Article Eighth or of any relevant provisions of the General Corporation Law or any other applicable laws shall adversely affect or deny to any director or officer any rights to indemnification which such person may have, or change or release any obligations of the Corporation under this Article Eighth with respect to any costs, charges, expenses (including attorneys' fees), judgments, fines, and amounts paid in settlement which arise out of any Proceeding based in whole or substantial part on any act, actual or alleged, which takes place before or while this Article Eighth is in effect. The provisions of this Section 8.6 shall apply to any such Proceeding whenever commenced, including any such Proceeding commenced after any amendment or repeal of this Article Eighth. The right to indemnification and advancement of expenses conferred on any person by this Article Eighth shall not limit the Corporation from providing any other indemnification permitted by law. Section 8.7 Definitions. For purposes of this Article Eighth: "the Corporation" includes any constituent corporation (including any constituent of a constituent) absorbed in a consolidation or merger which, if its separate existence continued, would have had power and authority to indemnify its directors or officers, so that any person who is or was a director or officer of such constituent corporation, or is or was serving at the request of such constituent corporation as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise, shall stand in the same position under the provisions of this Article Eighth with respect to the resulting or surviving corporation ass he would have with respect to such constituent corporation if its separate existence had continued; "other enterprises" includes employee benefit plans, including but not limited to any employee benefit plans of the Corporation; "serving at the request of the Corporation" includes, but is not limited to, any service which imposes duties on, or involves services by, a director or officer of the Corporation with respect to an employee benefit plan, its participants, or beneficiaries, including acting as a fiduciary there; "fines" shall include any penalties and any excise or similar taxes assessed on a person with respect to an employee benefit plan; a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in Section 8.1; and service as a partner, trustee, manager, or member of management or similar committee of a partnership, joint venture, trust, or limited liability company, or as a director, officer, manager, partner, trustee, or manager of an entity which is a partner, trustee, member, or joint venturer, shall be considered service as a director or officer of the partnership, joint venture, trust, limited liability company, or other enterprise. Section 8.8 Saving Clause. If this Article Eighth or any portion hereof shall be invalidated on any ground by a court of competent jurisdiction, then the Corporation shall nevertheless indemnify each director and officer of the Corporation as to costs, charges, expenses (including attorneys' fees), judgments, fines, and amounts paid in settlement with respect to any action, suit, or proceeding, whether civil, criminal, administrative, or investigative, including an action by or in the right of the Corporation, to the full extent permitted by any applicable portion of this Article Eighth that shall not have been invalidated and to the full extent permitted by applicable law. Section 8.9 Indemnification of Other Persons. If authorized by the Board of Directors, the Corporation may indemnify and advance expenses to any other person whom it has the power to indemnify under the General Corporation Law to the fullest extent permitted by such statute. Section 8.10 Insurance. The Corporation may purchase and maintain insurance, at its expense, to protect itself and any director, officer, employee, or agent of the Corporation or another corporation, partnership, joint venture, trust, or other enterprises against any expense, liability or claim, whether or not the Corporation would have the power to indemnify such person under the General Corporation Law. EX-4 4 ex4-1.txt NATIONAL PATENT DEVELOPMENT CORPORATION SPECIMEN STOCK CERTIFICATE Exhibit 4.1 COMMON STOCK COMMON STOCK THIS CERTIFICATE IS TRANSFERABLE IN CHICAGO AND NEW YORK Shares Certificate Number **600620****** ZQ 000271 ***600620***** NATIONAL PATENT DEVELOPMENT CORPORATION ****600620**** INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE *****600620*** ******600620** THIS CERTIFIES THAT MR. SAMPLE & MRS. SAMPLE & MR. SAMPLE & MRS.SAMPLE CUSIP 637132 10 1 SEE REVERSE FOR CERTAIN DEFINITIONS is the owner of * * * SIX HUNDRED THOUSAND SIX HUNDRED AND TWENTY * * * FULLY-PAID AND NON-ASSESSABLE SHARES OF THE PAR VALUE OF $.01 EACH OF COMMON STOCK OF National Patent Development Corporation transferable on the books of the Corporation in person or by duly authorized attorney upon surrender of this Certificate properly endorsed. This Certificate and the shares represented hereby are issued and shall be held subject to all of the provisions of the Restated Certificate of Incorporation and amendments thereto (copies of which are on file at the office of the Corporation), to all of which the holder of this Certificate assents by acceptance hereof. This Certificate is not valid unless countersigned by the Transfer Agent and Registrar. Witness the facsimile seal of the Corporation and the facsimile signatures of its duly authorized officers. FACSIMILE SIGNATURE TO COME [CORPORATE SEAL] DATED Chairman of the Board & Chief Executive Officer COUNTERSIGNED AND REGISTERED: COMPUTERSHARE INVESTOR SERVICES, LLC. (CHICAGO) TRANSFER AGENT AND REGISTRAR FACSIMILE SIGNATURE TO COME Secretary By___________________________________________ AUTHORIZED SIGNATURE EX-10 5 ex10-8.txt NPDC INCENTIVE STOCK OPTION AGREEMENT Exhibit 10.8 NATIONAL PATENT DEVELOPMENT CORPORATION 2003 INCENTIVE STOCK PLAN Section 1. Purpose of the Plan The purpose of this 2003 Incentive Stock Plan (the "Plan") is to attract, retain and motivate employees, officers, directors, consultants, agents, advisors and independent contractors of National Patent Development Corporation (the "Company") by providing them the opportunity to acquire a proprietary interest in the Company and to link their interests and efforts to the long-term interests of the Company's stockholders. Section 2. Definitions As used in the Plan, "Award" means any Option, Stock Appreciation Right, Restricted Stock, Stock Unit, Performance Share, Performance Unit, dividend equivalent, cash-based award or other incentive payable in cash or in shares of Company Stock as may be designated by the Committee from time to time. "Board" means the Board of Directors of the Company. "Code" means the Internal Revenue Code of 1986, as amended from time to time. "Committee" shall mean the Compensation Committee of the Board, which Committee shall consist solely of two or more outside directors within the meaning of Treas. Reg. ss. 1.163-27(e)(3). "Common Stock" means the Common Stock, par value $.01 per share, of the Company. "Company" means National Patent Development Corporation, a Delaware corporation. "Company Stock" shall mean the Common Stock. "Covered Employee" means a "covered employee" as that term is defined in Section 162(m)(3) of the Code or any successor provision. "Effective Date" has the meaning set forth in Section 18. "Exchange Act" means the Securities Exchange Act of 1934, as amended from time to time. "Fair Market Value" of Company Stock of either class, as of a date of determination, shall mean the following: (a) Class Listed and Shares Traded On Date Of Determination. If such class of Company Stock is listed and traded on a national securities exchange (as such term is defined by the Exchange Act) or on the Nasdaq Stock Market on the date of determination, the Fair Market Value per share shall be the last sale price of a share of such class of Company Stock on the applicable national securities exchange or Nasdaq Stock Market on the date of determination at the close of trading on such date. If such class of Company Stock is traded in the over-the-counter market, the Fair Market Value per share shall be the average of the closing bid and asked prices on the date of determination. (b) Class Listed But No Shares Traded On Date Of Determination. If such class of Company Stock is listed on a national securities exchange or on the Nasdaq Stock Market but no shares of such class of Company Stock are traded on the date of determination but there were shares traded on dates within a reasonable period before the date of determination, the Fair Market Value shall be the last sale price of such class of Company Stock on the most recent trade date before the date of determination at the close of trading on such date. If such class of Company Stock is regularly traded in the over-the-counter market but no shares of such class of Company Stock are traded on the date of determination (or if records of such trades are unavailable or burdensome to obtain) but there were shares traded on dates within a reasonable period before the date of determination, the Fair Market Value shall be the average of the closing bid and asked prices of such class of Company Stock on the most recent date before the date of determination. If such class of Company Stock is listed on a national securities exchange or on the Nasdaq Stock Market or are traded in the over-the-counter market but no shares of such class of Company Stock are traded on the date of determination or within a reasonable period before the date of determination, then the Committee shall determine the Fair Market Value of such class of Company Stock from all relevant available facts, which may include opinions of independent experts as to value and may take into account any recent sales and purchases of such class of Company Stock to the extent they are representative. (c) Class Not Listed. If such class of Company Stock is not listed on a national securities exchange or on the Nasdaq Stock Market and is not regularly traded in the over-the-counter market, then the Committee shall determine the Fair Market Value of such class of Company Stock from all relevant available facts, which may include the average of the closing bid and ask prices reflected in the over-the-counter market on a date within a reasonable period either before or after the date of determination or opinions of independent experts as to value and may take into account any recent sales and purchases of such class of Company Stock to the extent they are representative. "Grant Date" means the date on which the Committee completes the corporate action authorizing the grant of an Award or such later date specified by the Committee, provided that conditions to the exercisability or vesting of Awards shall not defer the Grant Date. "Incentive Stock Option" means an Option granted with the intention that it qualify as an "incentive stock option" as that term is defined in Section 422 of the Code or any successor provision. "Nonqualified Stock Option" means an Option other than an Incentive Stock Option. "Nonrecurring Items" means nonrecurring items deemed not reflective of the Company's core operating performance, including, but not limited to, exogenous events, acquisitions, divestitures, changes in accounting principles or "extraordinary items" determined under generally accepted accounting principles. "Option" means a right to purchase Company Stock granted under Section 7. "Participant" means any eligible person as set forth in Section 5 to whom an Award is granted. "Performance Criteria" has the meaning set forth in Section 11.1. "Performance Share" has the meaning set forth in Section 10.1. "Performance Unit" has the meaning set forth in Section 10.2. "Plan" means this National Patent Development Corporation 2003 Incentive Stock Plan. "Related Company" means any entity that is directly or indirectly controlled by the Company, as determined under section 424 of the Code. "Reload Option" means an Option granted to a Participant who exercises a previously held Option by surrendering Company Stock for all or part of the exercise price, pursuant to the provisions of Section 7.8. "Restricted Stock" means an Award of shares of Company Stock granted under Section 9, the rights of ownership of which may be subject to restrictions prescribed by the Committee. "Securities Act" means the Securities Act of 1933, as amended from time to time. "Stock Appreciation Right" has the meaning set forth in Section 8.1. "Stock Unit" means an Award granted under Section 9 denominated in units of Common Stock. "Substitute Awards" means Awards granted or shares of Common Stock issued by the Company in assumption of, or in substitution or exchange for, awards previously granted by a company acquired by the Company or with which the Company combines in accordance with the rules of section 424 of the Code. "Termination of Service," unless otherwise defined by the Committee or in the instrument evidencing the Award or in a written employment or services agreement, means a termination of employment or service relationship with the Company or a Related Company for any reason, whether voluntary or involuntary. Any question as to whether and when there has been a Termination of Service for the purposes of an Award and the cause of such Termination of Service shall be determined by the Committee, and such determination shall be final. Transfer of a Participant's employment or service relationship between wholly owned subsidiaries of the Company, or between the Company and any wholly owned subsidiary of the Company, shall not be considered a Termination of Service for purposes of an Award. Unless the Committee determines otherwise, a Termination of Service shall be deemed to occur if the Participant's employment or service relationship is with an entity that has ceased to be a Related Company. Section 3. Administration 3.1 Administration of the Plan The Plan shall be administered by the Committee. 3.2 Administration and Interpretation by Committee Except for the terms and conditions explicitly set forth in the Plan, the Committee shall have full power and exclusive authority, subject to such orders or resolutions not inconsistent with the provisions of the Plan and the Code as may from time to time be adopted by the Board, to (a) select the eligible persons as set forth in Section 5 to whom Awards may from time to time be granted under the Plan; (b) determine the type or types of Award to be granted to each Participant under the Plan; (c) determine the number of shares of Company Stock to be covered by each Award granted under the Plan; (d) determine whether shares of Company Stock to be covered by each Award granted under the Plan shall be shares of Common Stock; (e) determine the terms and conditions of any Award granted under the Plan; (f) approve the forms of agreements for use under the Plan; (g) determine whether, to what extent and under what circumstances Awards may be settled in cash, shares of Company Stock or other property or canceled or suspended; (h) determine whether, to what extent and under what circumstances cash, shares of Company Stock, other property and other amounts payable with respect to an Award shall be deferred either automatically or at the election of the Participant; (i) interpret and administer the Plan and any instrument or agreement entered into under the Plan; (j) establish such rules and regulations and appoint such agents as it shall deem appropriate for the proper administration of the Plan; (k) delegate ministerial duties to such of the Company's officers as it so determines; and (l) make any other determination and take any other action that the Committee deems necessary or desirable for administration of the Plan. Decisions of the Committee shall be final, conclusive and binding on all persons, including the Company, any Participant, any stockholder and any eligible person. Section 4. Shares Subject to the Plan 4.1 Authorized Number of Shares Subject to adjustment from time to time as provided in Section 15, the maximum number of shares of Company Stock available for issuance under the Plan shall be 1,750,000. 4.2 Share Usage (a) Shares of Common Stock covered by an Award shall not be counted as used unless and until they are actually issued and delivered to a Participant. If any Award lapses, expires, terminates or is canceled prior to the issuance of shares thereunder or if shares of Common Stock are issued under the Plan to a Participant and thereafter are reacquired by the Company, the shares subject to such Awards and the reacquired shares shall again be available for issuance under the Plan. Any shares of Common Stock (i) tendered by a Participant or retained by the Company as full or partial payment to the Company for the purchase price of an Award or to satisfy tax withholding obligations in connection with an Award, (ii) covered by an Award that is settled in cash, or (iii) reacquired by the Company on the open market using cash proceeds received by the Company from the exercise of Options shall be available for Awards under the Plan. The number of shares available for issuance under the Plan shall not be reduced to reflect any dividends or dividend equivalents that are reinvested into additional shares or credited as additional Restricted Stock, Stock Units, Performance Shares or Performance Units. All shares issued under the Plan may be either authorized and unissued shares or issued shares reacquired by the Company. (b) Notwithstanding the foregoing, the maximum number of shares that may be issued upon the exercise of Options shall equal the aggregate share number stated in Section 4.1, subject to adjustment as provided in Section 15; and provided, further, that for purposes of Section 4.3, any such shares shall be counted in accordance with the requirements of Section 162(m) of the Code. 4.3 Limitation Subject to adjustment as provided in Section 15, no Participant shall be eligible to receive in any one calendar year Awards relating to more than 250,000 shares of Company Stock. Section 5. Eligibility An Award may be granted to any employee, officer or director of the Company or a Related Company whom the Committee from time to time selects. An Award may also be granted to any consultant, agent, advisor or independent contractor for bona fide services rendered to the Company or any Related Company that (a) are not in connection with the offer and sale of the Company's securities in a capital-raising transaction and (b) do not directly or indirectly promote or maintain a market for the Company's securities. The above are "eligible persons." Section 6. Awards 6.1 Form and Grant of Awards The Committee shall have the authority, in its sole discretion, to determine the type or types of Awards to be granted under the Plan. Such Awards may be granted either alone or in addition to or in tandem with any other type of Award. 6.2 Evidence of Awards Awards granted under the Plan shall be evidenced by a written instrument that shall contain such terms, conditions, limitations and restrictions as the Committee shall deem advisable and that are not inconsistent with the Plan. Section 7. Options 7.1 Grant of Options The Committee may grant Options designated as Incentive Stock Options or Nonqualified Stock Options. 7.2 Option Exercise Price The exercise price for shares purchased under an Option shall be as determined by the Committee, but shall not be less than 100% of the Fair Market Value of the Common Stock issuable pursuant to the Option on the Grant Date, except in the case of Substitute Awards. In no event shall the Committee, without the prior approval of the Company's stockholders, cancel any outstanding Option for the purpose of reissuing the Option to the Participant at a lower exercise price or reduce the exercise price of an outstanding Option. 7.3 Term of Options Subject to earlier termination in accordance with the terms of the Plan and the instrument evidencing the Option, the maximum term of an Option shall be as established for that Option by the Committee and set forth in the instrument that evidences that Option or, if not so established, shall be ten years from the Grant Date. 7.4 Exercise of Options The Committee shall establish and set forth in each instrument that evidences an Option the time at which, or the installments in which, the Option shall vest and become exercisable, any of which provisions may be waived or modified by the Committee at any time. To the extent an Option has vested and become exercisable, the Option may be exercised in whole or from time to time in part by delivery as directed by the Company to the Company or a brokerage firm designated or approved by the Company of a written stock option exercise agreement or notice, in a form and in accordance with procedures established by the Committee, setting forth the number of shares with respect to which the Option is being exercised, the restrictions imposed on the shares purchased under such exercise agreement, if any, and such representations and agreements as may be required by the Committee, accompanied by payment in full as described in Section 7.5. An Option may be exercised only for whole shares and may not be exercised for less than a reasonable number of shares at any one time, as determined by the Committee. 7.5 Payment of Exercise Price The exercise price for shares purchased under an Option shall be paid in full as directed by the Company to the Company or a brokerage firm designated or approved by the Company by delivery of consideration equal to the product of the Option exercise price and the number of shares purchased. Such consideration must be paid before the Company will issue the shares being purchased and must be in a form or a combination of forms acceptable to the Committee as indicated in the instrument evidencing the Option for that purchase, which forms may include: (a) check; (b) wire transfer; (c) tendering by attestation shares of Company Stock already owned by the Participant that on the day prior to the exercise date have a Fair Market Value equal to the aggregate exercise price of the shares being purchased under the Option; or (d) to the extent permitted by applicable law, delivery of a properly executed exercise notice, together with irrevocable instructions to a brokerage firm designated or approved by the Company to deliver promptly to the Company the aggregate amount of sale or loan proceeds to pay the Option exercise price and any tax withholding obligations that may arise in connection with the exercise, all in accordance with the regulations of the Federal Reserve Board. 7.6 Post-Termination Exercise The Committee shall establish and set forth in each instrument that evidences an Option whether the Option shall continue to be exercisable, and the terms and conditions of such exercise, after a Termination of Service, any of which provisions may be waived or modified by the Committee at any time. 7.7 Incentive Stock Options The terms of any Incentive Stock Options shall comply in all respects with the provisions of Section 422 of the Code, or any successor provision, and any regulations promulgated thereunder. Any such Incentive Stock Option by its terms must not be exercisable after the expiration of ten years from the Grant Date for the Incentive Stock Option, must not be exercisable by anyone other than the grantee otherwise than by will or the laws of descent and distribution, must be exercisable, during the grantee's lifetime, only by the grantee, and must state that it is an Incentive Stock Option. Individuals who are not employees of the Company or one of its parent or subsidiary corporations (as such terms are defined for purposes of Section 422 of the Code) may not be granted Incentive Stock Options. To the extent that the aggregate Fair Market Value of Company Stock with respect to which Incentive Stock Options are exercisable for the first time by a Participant during any calendar year exceeds $100,000 or, if different, the maximum limitation in effect at the time of grant under the Code (the Fair Market Value being determined as of the Grant Date for the Option), such portion in excess of $100,000 shall be treated as Nonqualified Stock Options. 7.8 Reload Options. When the Committee grants an Option, it may designate in the instrument that evidences such Option whether a Reload Option accompanies the Option and any limitations that will apply to such Reload Option. Unless otherwise designated by the Committee in the instrument that evidences an Option, such Option shall not be subject to any Reload Options. If it so desires, the Committee may permit multiple, successive Reload Options for an Option, and may designate such in the instrument that evidences an Option; but if no number of Reload Options is specified in the instrument that provides for such Reload Option, then the Option shall be subject to only one Reload Option. If the Committee has designated an Option as having an accompanying Reload Option, the Reload Option shall be for the same number of shares as is surrendered by the Participant in payment of the exercise price of the Option (but not for shares surrendered for tax or other withholding obligations) upon its exercise. The Reload Option shall have the same terms and conditions as the related original Option, including the expiration date of the original Option, except that (i) the exercise price for a Reload Option shall be the Fair Market Value of the Company Stock as of the date of grant of such Reload Option, and (ii) the Reload Option shall become fully exercisable no earlier than six months after its date of grant. Section 8. Stock Appreciation Rights 8.1 Grant of Stock Appreciation Rights The Committee may grant stock appreciation rights ("Stock Appreciation Rights" or "SARs") to Participants at any time on such terms and conditions as shall be set forth in the instrument evidencing the Award. An SAR may be granted in tandem with an Option or alone ("freestanding"). The grant price of a tandem SAR shall be equal to the exercise price of the related Option, and the grant price of a freestanding SAR shall be equal to the Fair Market Value of the Common Stock, on the Grant Date. An SAR may be exercised upon such terms and conditions and for the term as the Committee determines in its sole discretion; provided, however, that, subject to earlier termination in accordance with the terms of the Plan and the instrument evidencing the SAR, (a) the term of a freestanding SAR shall be as established for that SAR by the Committee or, if not so established, shall be ten years, and (b) in the case of a tandem SAR, (i) the term shall not exceed the term of the related Option and (ii) the tandem SAR may be exercised for all or part of the shares subject to the related Option upon the surrender of the right to exercise the equivalent portion of the related Option, except that the tandem SAR may be exercised only with respect to the shares for which its related Option is then exercisable. 8.2 Payment of SAR Amount Upon the exercise of an SAR, a Participant shall be entitled to receive payment from the Company in an amount determined by multiplying: (a) the excess of the Fair Market Value of the Common Stock on the date of exercise over the grant price by (b) the number of shares with respect to which the SAR is exercised. At the discretion of the Committee, the payment upon exercise of an SAR may be in cash, in shares of equivalent value, in some combination thereof or in any other manner approved by the Committee in its sole discretion. Section 9. Restricted Stock and Stock Units 9.1 Grant of Restricted Stock and Stock Units The Committee may grant Restricted Stock and Stock Units on such terms and conditions and subject to such repurchase or forfeiture restrictions, if any (which may be based on continuous service with the Company or a Related Company or the achievement of any of the Performance Criteria set forth in Section 11.1), as the Committee shall determine in its sole discretion, which terms, conditions and restrictions shall be set forth in the instrument evidencing the Award. 9.2 Issuance of Shares Upon the satisfaction of any terms, conditions and restrictions prescribed with respect to Restricted Stock or Stock Units, or upon a Participant's release from any terms, conditions and restrictions of Restricted Stock or Stock Units, as determined by the Committee, and subject to the provisions of Section 13, (a) the shares of Restricted Stock covered by each Award of Restricted Stock shall become freely transferable by the Participant, and (b) Stock Units shall be paid in cash, shares of Company Stock or a combination of cash and shares of Company Stock as the Committee shall determine in its sole discretion. Any fractional shares subject to such Awards shall be paid to the Participant in cash. 9.3 Dividends and Distributions Participants holding shares of Restricted Stock or Stock Units may, if the Committee so determines, be credited with dividends paid with respect to the underlying shares or dividend equivalents while they are so held in a manner determined by the Committee in its sole discretion. The Committee may apply any restrictions to the dividends or dividend equivalents that the Committee deems appropriate. The Committee, in its sole discretion, may determine the form of payment of dividends or dividend equivalents, including cash, shares of Company Stock, Restricted Stock or Stock Units. 9.4 Waiver of Restrictions Notwithstanding any other provisions of the Plan, the Committee, in its sole discretion, may waive the repurchase or forfeiture period and any other terms, conditions or restrictions on any Restricted Stock or Stock Unit under such circumstances and subject to such terms and conditions as the Committee shall deem appropriate; provided, however, that the Committee may not adjust performance goals for any Restricted Stock or Stock Unit intended to be exempt under Section 162(m) of the Code for the year in which the Restricted Stock or Stock Unit is settled in such a manner as would increase the amount of compensation otherwise payable to a Participant. Section 10. Performance Shares and Performance Units 10.1 Grant of Performance Shares The Committee may grant Awards of performance shares ("Performance Shares") and designate the Participants to whom Performance Shares are to be awarded and determine the number of Performance Shares, the length of the performance period and the other terms and conditions of each such Award. Each Award of Performance Shares shall entitle the Participant to a payment in the form of shares of Company Stock upon the attainment of performance goals and other terms and conditions specified by the Committee. Notwithstanding satisfaction of any performance goals, the number of shares issued under an Award of Performance Shares may be adjusted on the basis of such further consideration as the Committee shall determine in its sole discretion. However, the Committee may not, in any event, increase the number of shares earned upon satisfaction of any performance goal by any Covered Employee. 10.2 Grant of Performance Units The Committee may grant Awards of performance units ("Performance Units") and designate the Participants to whom Performance Units are to be awarded and determine the number of Performance Units and the terms and conditions of each such Award. Performance Units shall entitle the Participant to a payment in cash upon the attainment of performance goals and other terms and conditions specified by the Committee. Notwithstanding the satisfaction of any performance goals, the amount to be paid under an Award of Performance Units may be adjusted on the basis of such further consideration as the Committee shall determine in its sole discretion. However, the Committee may not, in any event, increase the amount earned under Awards of Performance Units upon satisfaction of any performance goal by any Covered Employee, and the maximum amount earned by such Covered Employee in any calendar year may not exceed $500,000. The Committee, in its discretion, may substitute actual shares of Company Stock for the cash payment otherwise required to be made to a Participant pursuant to a Performance Unit. Section 11. Performance Criteria 11.1 Awards Subject to Performance Goals Awards of Restricted Stock, Stock Units, Performance Shares, Performance Units and other Awards made pursuant to the Plan may be made subject to the attainment of performance goals relating to one or more of the following business criteria within the meaning of Section 162(m) of the Code: profits (including, but not limited to, profit growth, net operating profit or economic profit); profit-related return ratios; return measures (including, but not limited to, return on assets, capital, equity or sales); cash flow (including, but not limited to, operating cash flow, free cash flow or cash flow return on capital); earnings (including, but not limited to, net earnings, earnings per share, or earnings before or after taxes); net sales growth; net income (before or after taxes, interest, depreciation and/or amortization); gross or operating margins; productivity ratios; share price (including, but not limited to, growth measures and total stockholder return); expense targets; margins; operating efficiency; customer satisfaction; and working capital targets ("Performance Criteria"). Performance Criteria may be stated in absolute terms or relative to comparison companies or indices to be achieved during a period of time. 11.2 Use and Calculation of Performance Criteria Any Performance Criteria may be used to measure the performance of the Company as a whole or any business unit of the Company. Any Performance Criteria may include or exclude Nonrecurring Items. Performance Criteria shall be calculated in accordance with the Company's financial statements or generally accepted accounting principles, or under a methodology established by the Committee prior to the issuance of an Award that is consistently applied and identified in the audited financial statements, including footnotes, or the Management's Discussion and Analysis section of the Company's annual report. The Committee may not in any event increase the amount of compensation payable to a Covered Employee upon the satisfaction of any Performance Criteria. Section 12. Other Stock or Cash-Based Awards In addition to the Awards described in Sections 7 through 10, and subject to the terms of the Plan, the Committee may grant other incentives payable in cash or in shares of Company Stock under the Plan as it determines to be in the best interests of the Company and subject to such other terms and conditions as it deems appropriate. Section 13. Withholding The Company may require the Participant to pay to the Company the amount of (a) any taxes that the Company is required by applicable federal, state, local or foreign law to withhold with respect to the grant, vesting or exercise of an Award ("tax withholding obligations") and (b) any amounts due from the Participant to the Company or to any Related Company ("other obligations"). The Company shall not be required to issue any shares of Company Stock or other consideration under the Plan until such tax withholding obligations and other obligations are satisfied. The Committee may permit or require a Participant to satisfy all or part of his or her tax withholding obligations and other obligations by (a) paying cash to the Company, (b) having the Company withhold an amount from any cash amounts otherwise due or to become due from the Company to the Participant, (c) having the Company withhold a number of shares of Company Stock that would otherwise be issued to the Participant (or become vested in the case of Restricted Stock) having a Fair Market Value equal to the tax withholding obligations and other obligations, or (d) surrendering a number of shares of Company Stock the Participant already owns having a Fair Market Value equal to the tax withholding obligations and other obligations. Section 14. Assignability No Award or interest in an Award may be sold, assigned, pledged (as collateral for a loan or as security for the performance of an obligation or for any other purpose) or transferred by the Participant or made subject to attachment or similar proceedings otherwise than by will or by the applicable laws of descent and distribution, except that to the extent permitted by the Committee, in its sole discretion, a Participant may designate one or more beneficiaries on a Company-approved form who may receive payment under an Award after the Participant's death. During a Participant's lifetime, an Award may be exercised only by the Participant. Notwithstanding the foregoing, with the approval of the Committee and in its sole discretion, an Award may be amended to permit the Participant to transfer Awards under this Plan to such persons as the Committee deems appropriate. Section 15. Adjustments In the event, at any time or from time to time, a stock dividend, stock split, spin-off, combination or exchange of shares, recapitalization, merger, consolidation, distribution to stockholders other than a normal cash dividend or other change in the Company's corporate or capital structure results in (a) the outstanding shares of Company Stock, or any securities exchanged therefore or received in their place, being exchanged for a different number or kind of securities of the Company or of any other company or (b) new, different or additional securities of the Company or of any other company being received by the holders of shares of Company Stock, then the Committee shall make proportional adjustments in (i) the maximum number and kind of securities available for issuance under the Plan; (ii) the maximum number and kind of securities issuable as Incentive Stock Options as set forth in Section 4.2 all in accordance with section 424 of the Code and the Treasury regulations issued thereunder; (iii) the maximum number and kind of securities that may be issued to an individual in any one calendar year as set forth in Section 4.3; (iv) the maximum number and kind of securities that may be made subject to the different types of Awards available under the Plan; and (v) the number and kind of securities that are subject to any outstanding Award and the per share price of such securities, without any change in the aggregate price to be paid therefor. The determination by the Committee as to the terms of any of the foregoing adjustments shall be conclusive and binding. Notwithstanding the foregoing, the issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, for cash or property, or for labor or services rendered, either upon direct sale or upon the exercise of rights or warrants to subscribe therefore, or upon conversion of shares or obligations of the Company convertible into such shares or other securities, shall not affect, and no adjustment by reason thereof shall be made with respect to, outstanding Awards. Section 16. Amendment and Termination 16.1 Amendment, Suspension or Termination of the Plan The Board or the Committee may amend, suspend or terminate the Plan or any portion of the Plan at any time and in such respects as it shall deem advisable; provided, however, that, to the extent required by applicable law, regulation or stock exchange rule, stockholder approval shall be required for any amendment to the Plan. 16.2 Term of the Plan Unless sooner terminated as provided herein, the Plan shall terminate ten years from the Effective Date. After the Plan is terminated, no future Awards may be granted, but Awards previously granted shall remain outstanding in accordance with their applicable terms and conditions and the Plan's terms and conditions. Notwithstanding the foregoing, no Incentive Stock Options may be granted more than ten years after the earlier of (a) the adoption of the Plan by the Board and (b) the Effective Date. 16.3 Consent of Participant The amendment, suspension or termination of the Plan or a portion thereof or the amendment of an outstanding Award shall not, without the Participant's consent, materially adversely affect any rights under any Award theretofore granted to the Participant under the Plan. Any change or adjustment to an outstanding Incentive Stock Option shall not, without the consent of the Participant, be made in a manner so as to constitute a "modification" within the meaning of section 424 of the Code and the Treasury regulations thereunder that would cause such Incentive Stock Option to fail to continue to qualify as an Incentive Stock Option. Specifically, the Committee may, with the consent of the person entitled to exercise any outstanding Option, amend an Option in any manner consistent with the provisions of this Plan that it may deem advisable. Notwithstanding the foregoing, any adjustments made pursuant to Section 15 shall not be subject to these restrictions. Section 17. General 17.1 No Individual Rights No individual or Participant shall have any claim to be granted any Award under the Plan, and the Company has no obligation for uniformity of treatment of Participants under the Plan. Furthermore, nothing in the Plan or any Award granted under the Plan shall be deemed to constitute an employment contract or confer or be deemed to confer on any Participant any right to continue in the employ of, or to continue any other relationship with, the Company or any Related Company or limit in any way the right of the Company or any Related Company to terminate a Participant's employment or other relationship at any time, with or without cause. 17.2 Issuance of Shares Notwithstanding any other provision of the Plan, the Company shall have no obligation to issue or deliver any shares of Company Stock under the Plan or make any other distribution of benefits under the Plan unless, in the opinion of the Company's counsel, such issuance, delivery or distribution would comply with all applicable laws (including, without limitation, the requirements of the Securities Act or the laws of any state or foreign jurisdiction) and the applicable requirements of any securities exchange or similar entity. The Company shall be under no obligation to any Participant to register for offering or resale or to qualify for exemption under the Securities Act, or to register or qualify under the laws of any state or foreign jurisdiction, any shares of Company Stock, security or interest in a security paid or issued under, or created by, the Plan, or to continue in effect any such registrations or qualifications if made. The Company may issue certificates for shares with such legends and subject to such restrictions on transfer and stop-transfer instructions as counsel for the Company deems necessary or desirable for compliance by the Company with federal, state and foreign securities laws. The Company may also require such other action or agreement by the Participants as may from time to time be necessary to comply with applicable securities laws. To the extent the Plan or any instrument evidencing an Award provides for issuance of stock certificates to reflect the issuance of shares of Company Stock, the issuance may be effected on a noncertificated basis, to the extent not prohibited by applicable law or the applicable rules of any stock exchange. 17.3 No Rights as a Stockholder Unless otherwise provided by the Committee or in the instrument evidencing the Award or in a written employment or services agreement, no Option or Award denominated in units shall entitle the Participant to any cash dividend, voting or other right of a stockholder unless and until the date of issuance under the Plan of the shares that are the subject of such Award. 17.4 Compliance With Laws and Regulations Notwithstanding anything in the Plan to the contrary, the Committee, in its sole discretion, may bifurcate the Plan so as to restrict, limit or condition the use of any provision of the Plan to Participants who are officers or directors subject to Section 16 of the Exchange Act without so restricting, limiting or conditioning the Plan with respect to other Participants. Additionally, in interpreting and applying the provisions of the Plan, any Option granted as an Incentive Stock Option pursuant to the Plan shall, to the extent permitted by law, be construed as an "incentive stock option" within the meaning of Section 422 of the Code. 17.5 No Trust or Fund The Plan is intended to constitute an "unfunded" plan. Nothing contained herein shall require the Company to segregate any monies or other property, or shares of Company Stock, or to create any trusts, or to make any special deposits for any immediate or deferred amounts payable to any Participant, and no Participant shall have any rights that are greater than those of a general unsecured creditor of the Company. 17.6 Successors All obligations of the Company under the Plan with respect to Awards shall be binding on any successor to the Company, whether the existence of such successor is the result of a merger, consolidation, direct or indirect purchase of all or substantially all the business and/or assets of the Company, or otherwise. 17.7 Severability If any provision of the Plan or any Award is determined to be invalid, illegal or unenforceable in any jurisdiction, or as to any person, or would disqualify the Plan or any Award under any law deemed applicable by the Committee, such provision shall be construed or deemed amended to conform to applicable laws, or, if it cannot be so construed or deemed amended without, in the Committee's determination, materially altering the intent of the Plan or the Award, such provision shall be stricken as to such jurisdiction, person or Award, and the remainder of the Plan and any such Award shall remain in full force and effect. 17.8 Choice of Law The Plan, all Awards granted thereunder and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the laws of the United States, shall be governed by the laws of the State of Delaware without giving effect to principles of conflicts of law. Section 18. Effective Date The Plan shall become effective (the "Effective Date") immediately following stockholder approval of the Plan. EX-10 6 ex10-16.txt INVESTMENT RIGHTS AGREEMENT DATED MAY 30, 2003 Exhibit 10.16 HYDRO MED SCIENCES, INC. AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT May 30, 2003 TABLE OF CONTENTS PAGE SECTION 1 GENERAL..................................................1 1.1 Definitions..............................................1 SECTION 2 RESTRICTIONS ON TRANSFER; REGISTRATION...................3 2.1 Restrictions on Transfer.................................3 2.2 Demand Registration......................................5 2.3 Piggyback Registrations..................................6 2.4 Form S-2 and S-3 Registration............................7 2.5 Expenses of Registration.................................9 2.6 Obligations of the Company...............................9 2.7 Termination of Registration Rights......................11 2.8 Delay of Registration; Furnishing Information...........11 2.9 Indemnification.........................................11 2.10 Assignment of Registration Rights.......................13 2.11 Amendment of Registration Rights........................14 2.12 Limitation on Subsequent Registration Rights............14 2.13 "Market Stand-Off" Agreement............................14 2.14 Agreement to Furnish Information........................14 2.15 Rule 144 Reporting......................................14 SECTION 3 COVENANTS...............................................15 3.1 Basic Financial Information and Reporting...............15 3.2 Inspection Rights.......................................15 3.3 Confidentiality of Records..............................16 3.4 Reservation of Common Stock.............................16 3.5 Stock Vesting...........................................16 3.6 Special Relationships of Prospective Employees..........16 3.7 Directors' Liability and Indemnification................17 3.8 Reimbursement of Expenses...............................17 3.9 Qualified Small Business................................17 3.10 Election of Directors...................................17 3.11 Observer Rights.........................................17 3.12 Termination of Covenants................................18 SECTION 4 PREEMPTIVE RIGHTS.......................................18 4.1 Subsequent Offerings....................................18 4.2 Exercise of Preemptive Rights...........................18 4.3 Termination and Waiver of Preemptive Right..............19 4.4 Transfer of Preemptive Rights...........................19 4.5 Excluded Securities.....................................19 SECTION 5 MISCELLANEOUS...........................................20 5.1 Governing Law...........................................20 5.2 Survival................................................20 5.3 Successors and Assigns..................................20 5.4 Entire Agreement........................................20 5.5 Severability............................................20 5.6 Amendment and Waiver....................................20 5.7 Delays or Omissions.....................................21 5.8 Notices.................................................21 5.9 Attorneys' Fees.........................................21 5.10 Titles and Subtitles....................................21 5.11 Additional Investors....................................21 5.12 Counterparts............................................22 5.13 Joinder of Spouses......................................22 HYDRO MED SCIENCES, INC. AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT THIS AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT (this "Agreement") is entered into as of May 30, 2003, by and among HYDRO MED SCIENCES, INC., a Delaware corporation (the "Company"), the stockholders of the Company listed as "Common Stock Investors" on Exhibit A hereto (collectively, the "Common Stock Investors", and each individually, a "Common Stock Investor"), the investors listed as the "Series B Investors" on Exhibit A hereto (the "Series B Investors"), and the stockholders of the Company listed as "Series A Investors" on Exhibit A hereto (the "Series A Investors" and, together with the Common Stock Investors and the Series B Investors, the "Investors"). RECITALS The Series B Investors are purchasing shares of the Company's Series B Convertible Preferred Stock pursuant to that certain Stock Purchase Agreement (the "Purchase Agreement") of even date herewith (the "Financing"). The obligations in the Purchase Agreement are conditioned upon the execution and delivery of this Agreement. In connection with the consummation of the Financing, the parties desire to enter into this Agreement in order to grant registration, information rights and other rights to the Investors as set forth below. AGREEMENT In consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, intending to be legally bound hereby, the parties agree hereto as follows: 1. GENERAL. 1.1. Definitions. As used in this Agreement the following terms shall have the following respective meanings: "Board of Directors" means the Company's Board of Directors. "Certificate" means the Company's Restated Certificate of Incorporation, as filed with the Delaware Secretary of State on May 30, 2003. "Common Stock" means the Company's common stock, par value $.001 per share. "Equity Securities" means (i) any Common Stock, Preferred Stock, or other security of the Company, (ii) any security convertible, with or without consideration, into any Common Stock, Preferred Stock, or other security of the Company (including any option to purchase such a convertible security), (iii) any security carrying any warrant or right to subscribe to or purchase any Common Stock, Preferred Stock, or other security of the Company, or (iv) any such warrant or right. "Exchange Act" means the Securities Exchange Act of 1934, as amended. "Form S-2" means such form under the Securities Act as in effect on the date hereof or any successor or similar registration form under the Securities Act subsequently adopted by the SEC that permits inclusion or incorporation of certain information by reference to other documents filed by the Company with the SEC. "Form S-3" means such form under the Securities Act as in effect on the date hereof or any successor or similar registration form under the Securities Act subsequently adopted by the SEC, which permits inclusion or incorporation of substantial information by reference to other documents filed by the Company with the SEC. "GP Strategies" means GP Strategies Corporation, a Delaware corporation. "Holder" means any person owning of record Registrable Securities, or securities convertible into Registrable Securities that have not been sold to the public or any assignee of record of such Registrable Securities or securities in accordance with Section 2.10 hereof. "Preferred Stock" means the Company's preferred stock, par value $.001 per share. "Qualified Offering" a firm commitment underwritten public offering of the Company's Common Stock, pursuant to an effective registration statement under the Securities Act (i) at a public offering price per share, before deductions for underwriter discounts and commissions, of at least three (3) times the higher of the then-applicable conversion price of the Series B Convertible Preferred Stock or Series A Convertible Preferred Stock, and (ii) with aggregate proceeds to the Company of at least $25,000,000 before deductions for underwriter discounts and commissions and any and all expenses of such underwritten offering incurred by the Company. "Register," "registered," and "registration" refer to a registration effected by preparing and filing a registration statement in compliance with the Securities Act, and the declaration or ordering of effectiveness of such registration statement or document. "Registrable Securities" means (a) Common Stock of the Company issued or issuable upon conversion of the Shares, (b) for purposes of Section 2.3 and 2.4 only (and to the extent such provisions relate to Section 2.3 or 2.4, Sections 2.1, 2.5, 2.6, 2.7, 2.8, 2.9, 2.10, 2.11, 2.12, 2.13, 2.14, 2.15 or Section 5), Common Stock owned by GP Strategies, and (c) any Common Stock of the Company issued as (or issuable upon the conversion or exercise of any warrant, right or other security which is issued as) a dividend or other distribution with respect to, or in exchange for or in replacement of, such above-described securities. Notwithstanding the foregoing, Registrable Securities shall not include any securities sold by a person to the public either pursuant to a registration statement or Rule 144 or sold in a private transaction in which the transferor's rights under Section 2 of this Agreement are not assigned. "Registrable Securities then outstanding" shall be the number of shares determined by calculating the total number of shares of the Company's Common Stock that are Registrable Securities and either (a) are then issued and outstanding or (b) are issuable pursuant to then exercisable or convertible securities, excluding any Registrable Securities as to which the rights under Section 2 have terminated pursuant to Section 2.7. "Registration Expenses" mean all expenses incurred by the Company in complying with Sections 2.2, 2.3 and 2.4 hereof, including, without limitation, all registration and filing fees, printing expenses, fees and disbursements of counsel for the Company, reasonable fees and disbursements of a single special counsel for the Holders, blue sky fees and expenses and the expense of any special audits incident to or required by any such registration (but excluding the compensation of regular employees of the Company which shall be paid in any event by the Company). "SEC" or "Commission" means the Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. "Selling Expenses" mean all underwriting discounts and selling commissions applicable to the sale. "Series A Convertible Preferred Stock" means shares of the Company's Preferred Stock designated as Series A Convertible Preferred Stock, par value $.001 per share. "Series B Convertible Preferred Stock" means shares of the Company's Preferred Stock designated as Series B 10% Convertible Preferred Stock, par value $.001 per share. "Shares" mean (i) Series B Convertible Preferred Stock issued pursuant to the Purchase Agreement held by the Series B Investors hereto and their permitted assigns, (ii) Series A Convertible Preferred Stock held by the Series A Investors and their permitted assigns, and (iii) for purposes of Section 2.3 and 2.4 only (and to the extent such provisions relate to Section 2.3 or 2.4, Sections 2.1, 2.5, 2.6, 2.7, 2.8, 2.9, 2.10, 2.11, 2.12, 2.13 and 2.14 or Section 5), shares of Common Stock held by GP Strategies and its permitted assigns. "Special Registration Statement" means a registration statement relating to any employee benefit plan or with respect to any corporate reorganization or other transaction under Rule 145 of the Securities Act. 2. RESTRICTIONS ON TRANSFER; REGISTRATION. 2.1. Restrictions on Transfer. (a) Each Holder agrees not to make any disposition of all or any portion of the Shares or Registrable Securities unless and until: (i) There is then in effect a registration statement under the Securities Act covering such proposed disposition and such disposition is made in accordance with such registration statement; or (ii) (A) The transferee has agreed in writing to be bound by the terms of this Agreement, (B) such Holder shall have notified the Company of the proposed disposition and shall have furnished the Company with a detailed statement of the circumstances surrounding the proposed disposition, and (C) if reasonably requested by the Company, such Holder shall have furnished the Company with an opinion of counsel, reasonably satisfactory to the Company, that such disposition will not require registration of such shares under the Securities Act. It is agreed that the Company will not require opinions of counsel for transactions made pursuant to Rule 144 except in unusual circumstances. Notwithstanding the provisions of paragraphs (i) and (ii) above, no such registration statement, detailed statement or opinion of counsel shall be necessary for a transfer by a party hereto which is (A) a partnership to its partners or former partners in accordance with partnership interests, (B) a corporation to its shareholders in accordance with their interest in the corporation, (C) a limited liability company to its members or former members in accordance with their interest in the limited liability company, (D) to the party's family member or trust for the benefit of an individual party, (E) an entity which is controlled by, controls or is under common control with the transferor (an "Affiliate"), or (F) a Common Stock Investor to another Common Stock Investor or then current employees of the Company; provided that in each case the transferee will be subject to the terms of this Agreement to the same extent as if he, she or it were an original party hereunder. (b) Each certificate representing Shares or Registrable Securities shall (unless otherwise permitted by the provisions of the Agreement) be stamped or otherwise imprinted with a legend substantially similar to the following (in addition to any legend required under applicable state securities laws or under any other agreement): THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE STATE SECURITIES OR BLUE SKY LAWS OF ANY JURISDICTION. SUCH SHARES MAY NOT BE SOLD, OFFERED FOR SALE, PLEDGED OR TRANSFERRED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT AS TO THE SECURITIES UNDER SAID ACT AND SECURITIES LAWS OR AN OPINION OF COUNSEL SATISFACTORY TO THE CORPORATION THAT SUCH REGISTRATION IS NOT REQUIRED. COPIES OF THE AGREEMENTS COVERING THE PURCHASE OF THESE SHARES AND RESTRICTING THEIR TRANSFER MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF THE CORPORATION AT THE PRINCIPAL EXECUTIVE OFFICES OF THE CORPORATION. (c) If such Shares or Registrable Securities are proposed to be disposed of, the Company shall be obligated to reissue promptly certificates without the foregoing legend at the request of any holder thereof if the holder shall have obtained an opinion of counsel (which counsel may be counsel to the Company) reasonably acceptable to the Company to the effect that the securities may lawfully be so disposed of thereafter without registration, qualification, or legend. 2.2. Demand Registration. (a) Subject to the conditions of this Section 2.2, if the Company shall receive a written request from a Holder or Holders of at least 50% of the Registrable Securities then outstanding (the "Initiating Holders") that the Company file a registration statement under the Securities Act covering the registration of a majority of the Registrable Securities owned by such Initiating Holders, then the Company shall, within 30 days of receipt thereof, give written notice of such request to all Holders and, subject to the limitations of this Section 2.2, use its commercially reasonable efforts to file a registration statement under the Securities Act with the Commission covering all Registrable Securities that the Initiating Holders request to be registered. (b) If the Initiating Holders intend to distribute the Registrable Securities covered by their request by means of an underwriting, they shall so advise the Company as a part of their request made pursuant to this Section 2.2 and the Company shall include such information in the written notice referred to in Section 2.2(a), as applicable. In such event, the right of any Holder to include its Registrable Securities in such registration shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their securities through such underwriting shall enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company (which underwriter or underwriters shall be reasonably acceptable to a majority in interest of the Initiating Holders). Notwithstanding any other provision of this Section 2.2, if the underwriter advises the Company that marketing factors require a limitation of the number of securities to be underwritten (including Registrable Securities) then the Company shall so advise all Holders of Registrable Securities that would otherwise be underwritten pursuant hereto, and the number of shares that may be included in the underwriting shall be allocated first to the Holders who are holders of Series B Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) and Series A Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) on a pro rata basis based on the total number of Registrable Securities held by such Holders of Series B Convertible Preferred Stock and Series A Convertible Preferred Stock; provided, however, that the number of shares of Registrable Securities to be included in such underwriting and registration shall not be reduced unless all other securities of the Company are first entirely excluded from the underwriting and registration. Any Registrable Securities excluded or withdrawn from such underwriting shall be withdrawn from the registration. (c) The Company shall not be required to effect a registration pursuant to this Section 2.2: (1) prior to the earlier of (A) six months following a Qualified Offering, and (B) December 31, 2004; (2) after the Company has effected two (2) registrations pursuant to Section 2.2(a), and such registrations have been declared or ordered effective; (3) during the period starting with the date of filing of, and ending on the date 90 days following the effective date of, any registration statement (other than a Special Registration Statement) of the Company; (4) if within 30 days of receipt of a written request from Initiating Holders pursuant to Section 2.2(a), the Company gives notice to the Holders of the Company's intention to make a Qualified Offering within 90 days; (5) if the Company shall furnish to the Initiating Holders, a certificate signed by the Chairman of the Board of Directors stating that in the good faith judgment of the Board of Directors, it would be seriously detrimental to the Company and its stockholders for such registration statement to be effected at such time, in which event the Company shall have the right to defer such filing for a period of not more than 120 days after receipt of the request of the Initiating Holders; provided that such right to delay a request shall be exercised by the Company not more than once in any twelve-month period; or (6) if the Initiating Holders propose to dispose of shares of Registrable Securities that may be immediately registered on Form S-3 pursuant to a request made pursuant to Section 2.4 below. 2.3. Piggyback Registrations. The Company shall notify all Holders of Registrable Securities in writing at least 20 days prior to the filing of any registration statement under the Securities Act for purposes of a public offering of securities of the Company (including, but not limited to, registration statements relating to secondary offerings of securities of the Company, but excluding Special Registration Statements) and will afford each such Holder an opportunity to include in such registration statement all or part of such Registrable Securities held by such Holder. Each Holder desiring to include in any such registration statement all or any part of the Registrable Securities held by it shall, within 15 days after the above-described notice from the Company, so notify the Company in writing. Such notice shall state the intended method of disposition of the Registrable Securities by such Holder. If a Holder decides not to include all of its Registrable Securities in any registration statement thereafter filed by the Company, such Holder shall nevertheless continue to have the right to include any Registrable Securities in any subsequent registration statement or registration statements as may be filed by the Company with respect to offerings of its securities, all upon the terms and conditions set forth herein. (a) Underwriting. If the registration statement under which the Company gives notice under this Section 2.3 is for an underwritten offering, the Company shall so advise the Holders of Registrable Securities. In such event, the right of any such Holder to be included in a registration pursuant to this Section 2.3 shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their Registrable Securities through such underwriting shall enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company. Notwithstanding any other provision of the Agreement, if the underwriter determines in good faith that marketing factors require a limitation of the number of shares to be underwritten, the number of shares that may be included in the underwriting shall be allocated, first, to the Company; second, to the Holders who are holders of Series B Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) and Series A Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) on a pro rata basis based on the total number of Registrable Securities held by such Holders of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock; and third, to the Holders who are holders of Common Stock (issued otherwise than upon conversion of Series B Convertible Preferred Stock or Series A Convertible Preferred Stock) on a pro rata basis based on the total number of Registrable Securities held by such Holders; provided, however, that the number of shares of Registrable Securities to be included in such underwriting and registration shall not be reduced unless all other securities of the Company (other than securities being offered by the Company and Registrable Securities being offered by the Holders) are first entirely excluded from the underwriting and registration. If any Holder disapproves of the terms of any such underwriting, such Holder may elect to withdraw therefrom by written notice to the Company and the underwriter, delivered at least ten business days prior to the effective date of the registration statement. Any Registrable Securities excluded or withdrawn from such underwriting shall be excluded and withdrawn from the registration. For any Holder that is a partnership or corporation, the partners, retired partners, stockholders and Affiliates of such Holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing person shall be deemed to be a single "Holder," and any pro rata reduction with respect to such "Holder" shall be based upon the aggregate amount of shares of Registrable Securities owned by all entities and individuals included in such "Holder," as defined in this sentence. (b) Right to Terminate Registration. The Company shall have the right to terminate or withdraw any registration initiated by it under this Section 2.3 prior to the effectiveness of such registration whether or not any Holder has elected to include securities in such registration. The Registration Expenses of such withdrawn registration shall be borne by the Company in accordance with Section 2.5 hereof. 2.4. Form S-2 and S-3 Registration. In case the Company shall receive from a Holder or Holders of at least 50% of the Registrable Securities then outstanding a written request or requests that the Company effect a registration on Form S-2 or Form S-3 or any similar short-form registration statement and any related qualification or compliance with respect to all or a part of the Registrable Securities owned by such Holder or Holders, the Company will: (a) promptly give written notice of the proposed registration, and any related qualification or compliance, to all other Holders of Registrable Securities; and (b) as soon as practicable, use its best efforts to file such registration statement as may be so requested and as would permit or facilitate the sale and distribution of all or such portion of such Holder's Registrable Securities as are specified in such request, together with all or such portion of the Registrable Securities of any other Holder or Holders joining in such request as are specified in a written request given within 15 days after receipt of such written notice from the Company; provided, however, that the Company shall not be obligated to effect any such registration, qualification or compliance pursuant to this Section 2.4: (i) if Form S-2 or Form S-3, as the case may be, is not available for such offering by the Holders, or (ii) if the Company shall furnish to the Holders a certificate signed by the Chairman of the Board of Directors stating that in the good faith judgment of the Board of Directors, it would be seriously detrimental to the Company and its stockholders for such Form S-2 or Form S-3 registration to be effected at such time, in which event the Company shall have the right to defer the filing of the registration statement for a period of not more than 90 days after receipt of the request of the Holder or Holders under this Section 2.4; provided, that such right to delay a request shall be exercised by the Company not more than once in any twelve-month period, or (iii) in any particular jurisdiction in which the Company would be required to qualify to do business or to execute a general consent to service of process in effecting such registration, qualification or compliance, or (iv) if the Holders, together with the holders of any other securities of the Company entitled to inclusion in such Form S-2 or Form S-3 registration statement, propose to sell Registrable Securities and such other securities (if any) at an aggregate price to the public of less than $3,000,000; or (v) if the Company has filed a registration statement at the request of Holders under this Section 2.4 within the preceding six months. (c) Subject to the foregoing, the Company shall file a Form S-2 or Form S-3 registration statement, as the case may be, covering the Registrable Securities and other securities so requested to be registered as soon as practicable after receipt of the request or requests of the Holders. Registrations effected pursuant to this Section 2.4 shall not be counted as demands for registration or registrations effected pursuant to Sections 2.2 or 2.3, respectively. (d) If the registration statement under which the Company gives notice under this Section 2.4 is for an underwritten offering, the Company shall so advise the Holders of Registrable Securities. In such event, the right of any such Holder to be included in a registration pursuant to this Section 2.4 shall be conditioned upon such Holder's participation in such underwriting and the inclusion of such Holder's Registrable Securities in the underwriting to the extent provided herein. All Holders proposing to distribute their Registrable Securities through such underwriting shall enter into an underwriting agreement in customary form with the underwriter or underwriters selected for such underwriting by the Company. Notwithstanding any other provision of this Agreement, if the underwriter determines in good faith that marketing factors require a limitation of the number of shares to be underwritten, the number of shares that may be included in the underwriting shall be allocated, first, to the Holders who are holders of Series B Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) and Series A Convertible Preferred Stock (or shares of Common Stock issued upon conversion thereof) on a pro rata basis based on the total number of Registrable Securities held by such Holders of Series A Convertible Preferred Stock and Series B Convertible Preferred Stock; and second, to the Holders who are holders of Common Stock issued other than upon conversion of the Series B Convertible Preferred Stock or Series A Convertible Preferred Stock on a pro rata basis based on the total number of Registrable Securities held by such Holders; provided, however, that the number of shares of Registrable Securities to be included in such underwriting and registration shall not be reduced unless all other securities of the Company (other than securities being offered by the Company and Registrable Securities being offered by the Holders) are first entirely excluded from the underwriting and registration. If any Holder disapproves of the terms of any such underwriting, such Holder may elect to withdraw therefrom by written notice to the Company and the underwriter, delivered at least ten (10) business days prior to the effective date of the registration statement. Any Registrable Securities excluded or withdrawn from such underwriting shall be excluded and withdrawn from the registration. For any Holder which is a partnership or corporation, the partners, retired partners, stockholders and Affiliates of such Holder, or the estates and family members of any such partners and retired partners and any trusts for the benefit of any of the foregoing person shall be deemed to be a single "Holder," and any pro rata reduction with respect to such "Holder" shall be based upon the aggregate amount of shares of Registrable Securities owned by all entities and individuals included in such "Holder," as defined in this sentence. 2.5. Expenses of Registration. Except as specifically provided herein, all Registration Expenses incurred in connection with any registration, qualification or compliance pursuant to Section 2.2 or any registration under Section 2.3 or Section 2.4 herein shall be borne by the Company; provided, however, that the Company shall not be required to pay any Registration Expenses incurred in connection with any registration, qualification or compliance proceedings begun pursuant to a request under Section 2.2 if such request is subsequently withdrawn by the Holders of a majority of the Registrable Securities to be included in such registration, qualification or compliance (in which case all participating Holders shall bear all such Registration Expenses). All Selling Expenses incurred in connection with any registrations hereunder, shall be borne by the holders of the securities so registered pro rata on the basis of the number of shares so registered and sold. 2.6. Obligations of the Company. Whenever required to effect the registration of any Registrable Securities, the Company shall, as expeditiously as reasonably possible: (a) Prepare and file with the SEC a registration statement with respect to such Registrable Securities and use all reasonable efforts to cause such registration statement to become effective, and, upon the request of the Holders of a majority of the Registrable Securities registered thereunder, keep such registration statement effective (i) in the case of any registration under Section 2.2, for up to 180 days or, if earlier, until the Holder or Holders have completed the distribution related thereto and (ii) in the case of any registration under Section 2.4, indefinitely or, if earlier, until the Holder or Holders have completed the distribution related thereto. (b) Prepare and file with the SEC such amendments and supplements to such registration statement and the prospectus used in connection with such registration statement as may be necessary to comply with the provisions of the Securities Act with respect to the disposition of all securities covered by such registration statement for the period set forth in paragraph (a) above. (c) Furnish to the Holders such number of copies of a prospectus, including a preliminary prospectus, in conformity with the requirements of the Securities Act, and such other documents as they may reasonably request in order to facilitate the disposition of Registrable Securities owned by them. (d) Use its reasonable efforts to register and qualify the securities covered by such registration statement under such other securities or Blue Sky laws of such jurisdictions as shall be reasonably requested by the Holders; provided that the Company shall not be required in connection therewith or as a condition thereto to qualify to do business or to file a general consent to service of process in any such states or jurisdictions. (e) In the event of any underwritten public offering, enter into and perform its obligations under an underwriting agreement, in usual and customary form, with the managing underwriter(s) of such offering. Each Holder participating in such underwriting shall also enter into and perform its obligations under such an agreement. (f) Notify each Holder of Registrable Securities covered by such registration statement at any time when a prospectus relating thereto is required to be delivered under the Securities Act of the happening of any event as a result of which the prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. The Company will use reasonable efforts to amend or supplement such prospectus in order to cause such prospectus not to include any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading in the light of the circumstances then existing. (g) Use its reasonable efforts to furnish, on the date that such Registrable Securities are delivered to the underwriters for sale, if such securities are being sold through underwriters, (i) an opinion, dated as of such date, of the counsel representing the Company for the purposes of such registration, in form and substance as is customarily given to underwriters in an underwritten public offering, addressed to the underwriters, if any, and (ii) a letter dated as of such date, from the independent certified public accountants of the Company, in form and substance as is customarily given by independent certified public accountants to underwriters in an underwritten public offering addressed to the underwriters. (h) Use reasonable efforts to cause all such Registrable Securities to be listed on each securities exchange on which similar securities issued by the Company are then listed and to be qualified for trading on each system on which securities issued by the Company are from time to time qualified. (i) Use its reasonable efforts to provide a transfer agent and registrar for all such Registrable Securities not later than the effective date of such registration statement and thereafter maintain such transfer agent and registrar. (j) Use its reasonable efforts to provide a CUSIP number for all Registrable Securities, not later than the effective date of the applicable registration statement. 2.7. Termination of Registration Rights. All registration rights granted under Sections 2.2, 2.3, and 2.4 shall terminate and be of no further force and effect with respect to any Holder when all Registrable Securities held by and issuable to such Holder (and its Affiliates, partners, former partners, members and former members) may be sold under Rule 144 during any 90-day period. 2.8. Delay of Registration; Furnishing Information. (a) No Holder shall have any right to obtain or seek an injunction restraining or otherwise delaying any such registration as the result of any controversy that might arise with respect to the interpretation or implementation of this Section 2. (b) It shall be a condition precedent to the obligations of the Company to take any action pursuant to Section 2.2, 2.3, or 2.4 that the selling Holders shall furnish to the Company such information regarding themselves, the Registrable Securities held by them and the intended method of disposition of such securities as shall be required to effect the registration of their Registrable Securities. 2.9. Indemnification. In the event any Registrable Securities are included in a registration statement under Section 2.2, 2.3, or 2.4: (a) To the extent permitted by law, the Company will indemnify and hold harmless each Holder, the partners, members, officers and directors of each Holder, any underwriter (as defined in the Securities Act) for such Holder and each person, if any, who controls such Holder or underwriter within the meaning of the Securities Act or the Exchange Act, against any losses, claims, damages or liabilities (joint or several) to which they may become subject under the Securities Act, the Exchange Act or other federal or state law, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon any of the following statements, omissions or violations (collectively a "Violation") by the Company: (i) any untrue statement or alleged untrue statement of a material fact contained in such registration statement, including any preliminary prospectus or final prospectus contained therein or any amendments or supplements thereto, (ii) the omission or alleged omission to state therein a material fact required to be stated therein, or necessary to make the statements therein not misleading, or (iii) any violation or alleged violation by the Company of the Securities Act, the Exchange Act, any state securities law or any rule or regulation promulgated under the Securities Act, the Exchange Act or any state securities law in connection with the offering covered by such registration statement; and the Company will pay as incurred to each such Holder, partner, officer, director, underwriter or controlling person for any legal or other expenses reasonably incurred by them in connection with investigating or defending any such loss, claim, damage, liability or action; provided however, that the indemnity agreement contained in this Section 2.9(a) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Company, which consent shall not be unreasonably withheld, nor shall the Company be liable in any such case for any such loss, claim, damage, liability or action to the extent that it arises out of or is based upon a Violation which occurs in reliance upon and in conformity with written information furnished expressly for use in connection with such registration by such Holder, or by any partner, member, officer, director, underwriter or controlling person of such Holder; and provided, further, that such indemnity shall not apply with respect to any untrue statement or alleged untrue statement or omission or alleged omission in any preliminary or final prospectus if the prospectus (as amended or supplemented), as provided to the person claiming indemnification prior to the time the Company made the sale to the person making the claim of a Violation, did not contain such statement or alleged statement or omission or alleged omission. (b) To the extent permitted by law, each Holder will, if Registrable Securities held by such Holder are included in the securities as to which such registration qualifications or compliance is being effected, indemnify and hold harmless the Company, each of its directors, its officers and each person, if any, who controls the Company within the meaning of the Securities Act or the Exchange Act, any underwriter and any other Holder selling securities under such registration statement or any of such other Holder's partners, directors or officers or any person who controls such Holder, against any losses, claims, damages or liabilities (joint or several) to which the Company or any such director, officer, controlling person, underwriter or other such Holder, or partner, director, officer or controlling person of such other Holder may become subject under the Securities Act, the Exchange Act or other federal or state law, insofar as such losses, claims, damages or liabilities (or actions in respect thereto) arise out of or are based upon any Violation, in each case to the extent (and only to the extent) that such Violation occurs in reliance upon and in conformity with written information furnished by such Holder in writing expressly for use in connection with such registration; and each such Holder will pay as incurred any legal or other expenses reasonably incurred by the Company or any such director, officer, controlling person, underwriter or other Holder, or partner, officer, director or controlling person of such other Holder in connection with investigating or defending any such loss, claim, damage, liability or action if it is judicially determined that there was such a Violation; provided, however, that the indemnity agreement contained in this Section 2.9(b) shall not apply to amounts paid in settlement of any such loss, claim, damage, liability or action if such settlement is effected without the consent of the Holder, which consent shall not be unreasonably withheld; provided further, that in no event shall any indemnity under this Section 2.9 exceed the net proceeds from the offering received by such Holder. (c) Promptly after receipt by an indemnified party under this Section 2.9 of notice of the commencement of any action (including any governmental action), such indemnified party will, if a claim in respect thereof is to be made against any indemnifying party under this Section 2.9, deliver to the indemnifying party a written notice of the commencement thereof and the indemnifying party shall have the right to participate in, and, to the extent the indemnifying party so desires, jointly with any other indemnifying party similarly noticed, to assume the defense thereof with counsel mutually satisfactory to the parties; provided, however, that an indemnified party shall have the right to retain its own counsel, with the fees and expenses to be paid by the indemnifying party, if representation of such indemnified party by the counsel retained by the indemnifying party would be inappropriate due to actual or potential differing interests between such indemnified party and any other party represented by such counsel in such proceeding. The failure to deliver written notice to the indemnifying party within a reasonable time of the commencement of any such action, if materially prejudicial to its ability to defend such action, shall relieve such indemnifying party of any liability to the indemnified party under this Section 2.9, but the omission so to deliver written notice to the indemnifying party will not relieve it of any liability that it may have to any indemnified party otherwise than under this Section 2.9. (d) If the indemnification provided for in this Section 2.9 is held by a court of competent jurisdiction to be unavailable to an indemnified party with respect to any losses, claims, damages or liabilities referred to herein, the indemnifying party, in lieu of indemnifying such indemnified party thereunder, shall to the extent permitted by applicable law contribute to the amount paid or payable by such indemnified party as a result of such loss, claim, damage or liability in such proportion as is appropriate to reflect the relative fault of the indemnifying party on the one hand and of the indemnified party on the other in connection with the Violation(s) that resulted in such loss, claim, damage or liability, as well as any other relevant equitable considerations. The relative fault of the indemnifying party and of the indemnified party shall be determined by a court of law by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission to state a material fact relates to information supplied by the indemnifying party or by the indemnified party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission; provided, that in no event shall any contribution by a Holder hereunder exceed the net proceeds from the offering received by such Holder. (e) The obligations of the Company and Holders under this Section 2.9 shall survive completion of any offering of Registrable Securities in a registration statement and the termination of this Agreement. No Indemnifying Party, in the defense of any such claim or litigation, shall, except with the consent of each Indemnified Party, consent to entry of any judgment or enter into any settlement which does not include as an unconditional term thereof the giving by the claimant or plaintiff to such Indemnified Party of a release from all liability in respect to such claim or litigation. 2.10. Assignment of Registration Rights. (a) The rights to cause the Company to register Registrable Securities pursuant to this Section 2 may be assigned by a Holder to a transferee or assignee of Registrable Securities which (i) is a subsidiary, parent, Affiliate, general partner, limited partner, retired partner, member, retired member or shareholder of a Holder, (ii) is a Holder's family member or trust for the benefit of an individual Holder or (iii) acquires at least 100,000 shares of such Holder's Registrable Securities (as adjusted for any stock dividend, combination, splits, reorganization, and the like); provided, however, (A) the transferor shall, within ten (10) days after such transfer, furnish to the Company written notice of the name and address of such transferee or assignee and the securities with respect to which such registration rights are being assigned and (B) such transferee shall agree to be subject to all restrictions set forth in this Agreement. (b) Notwithstanding anything to the contrary contained in this Section 2.10, no assignment under Section 2.10(a) shall be valid if the transferee of the Registrable Securities of a Holder is determined in good faith by the Board of Directors to be a direct competitor of the Company. 2.11. Amendment of Registration Rights. Any provision of this Section 2 may be amended and the observance thereof may be waived (either generally or in a particular instance and either retroactively or prospectively), only with the written consent of the Company and the Holders of at least a majority of the Registrable Securities then outstanding. Any amendment or waiver effected in accordance with this Section 2.11 shall be binding upon each Holder and the Company. By acceptance of any benefits under this Section 2, Holders of Registrable Securities hereby agree to be bound by the provisions hereunder. 2.12. Limitation on Subsequent Registration Rights. Other than as provided in Section 5.11, after the date of this Agreement, the Company shall not, without the prior written consent of the Holders of at least a majority of the Registrable Securities then outstanding, enter into any agreement with any holder or prospective holder of any securities of the Company that would grant such holder registration rights pari passu or senior to those granted to the Holders hereunder. 2.13. "Market Stand-Off" Agreement. Each Holder hereby agrees that such Holder shall not sell, transfer, make any short sale of, grant any option for the purchase of, or enter into any hedging or similar transaction with the same economic effect as a sale of, any Common Stock (or other securities) of the Company held by such Holder (other than those included in the registration) for a period specified by the representative of the underwriters of Common Stock (or other securities) of the Company not to exceed 180 days following the effective date of a registration statement of the Company filed under the Securities Act; provided that such agreement shall apply only to the Company's initial Qualified Offering. 2.14. Agreement to Furnish Information. Each Holder agrees to execute and deliver such other agreements as may be reasonably requested by the Company or the underwriter which are consistent with the foregoing or which are necessary to give further effect thereto. In addition, if requested by the Company or the representative of the underwriters of Common Stock (or other securities) of the Company, each Holder shall provide, within ten (10) days of such request, such information as may be required by the Company or such representative in connection with the completion of any public offering of the Company's securities pursuant to a registration statement filed under the Securities Act. 2.15. Rule 144 Reporting. With a view to making available to the Holders the benefits of certain rules and regulations of the SEC which may permit the sale of the Registrable Securities to the public without registration, the Company agrees to use its best efforts to: (a) Make and keep public information available, as those terms are understood and defined in SEC Rule 144 or any similar or analogous rule promulgated under the Securities Act, at all times after the effective date of the first registration filed by the Company for an offering of its securities to the general public; (b) File with the SEC, in a timely manner, all reports and other documents required of the Company under the Exchange Act; and (c) So long as a Holder owns any Registrable Securities, furnish to such Holder forthwith upon request: a written statement by the Company as to its compliance with the reporting requirements of said Rule 144 of the Securities Act, and of the Exchange Act (at any time after it has become subject to such reporting requirements); a copy of the most recent annual or quarterly report of the Company; and such other reports and documents as a Holder may reasonably request in availing itself of any rule or regulation of the SEC allowing it to sell any such securities without registration. 3. COVENANTS. 3.1. Basic Financial Information and Reporting. (a) The Company will maintain true books and records of account in which full and correct entries will be made of all its business transactions pursuant to a system of accounting established and administered in accordance with generally accepted accounting principles consistently applied, and will set aside on its books all such proper accruals and reserves as shall be required under generally accepted accounting principles consistently applied. (b) As long as shares of Series B Convertible Preferred Stock, Series A Convertible Preferred Stock, and/or Registrable Securities issued therefor are outstanding, the Company shall deliver or provide to each Series B Investor and Series A Investor (so long as such Investor continues to hold 10% of the Shares originally purchased by said Series B Investor or Series A Investor and/or Registrable Securities issued therefor) of each respective class, and as long as GP Strategies holds at least 10% of the outstanding Common Stock, the Company shall deliver and provide to GP Strategies: (i) Within 90 days after the end of each fiscal year of the Company, a balance sheet of the Company, as at the end of such fiscal year, and a statement of income and a statement of cash flows of the Company, for such year, all prepared in accordance with generally accepted accounting principles consistently applied and setting forth in each case in comparative form the figures for the previous fiscal year, all in reasonable detail. Such financial statements shall be accompanied by a report and opinion thereon by independent public accountants of national standing selected by the Board of Directors; and (ii) (A) At least 30 days prior to the beginning of each fiscal year, an annual budget and operating plans for such fiscal year (and as soon as available, any subsequent revisions thereto); and (B) within 20 days after the end of each quarter, a balance sheet of the Company as of the end of each such quarter, and a statement of income and a statement of cash flows of the Company for such quarter and for the current fiscal year to date, prepared in accordance with generally accepted accounting principles consistently applied, with the exception that no notes need be attached to such statements and year-end audit adjustments may not have been made. 3.2. Inspection Rights. As long as Series B Convertible Preferred Stock and Series A Convertible Preferred Stock, and/or Registrable Securities issued therefor are outstanding, each Series B Investor and Series A Investor (so long as such Investor continues to hold 10% of the Shares originally purchased by said Investor and/or Registrable Securities issued therefor), and as long as GP Strategies holds at least 10% of the outstanding Common Stock, GP Strategies, after giving reasonable advance notice to the Company, shall have the right during normal business hours to visit and inspect any of the properties of the Company or any of its subsidiaries, and to discuss the affairs, finances and accounts of the Company or any of its subsidiaries with its officers, and to review such information as is reasonably requested all at such reasonable times and as often as may be reasonably requested; provided, however, that the Company shall not be obligated under this Section 3.2 with respect to a direct competitor of the Company or with respect to information which the Board of Directors determines in good faith is confidential and should not, therefore, be disclosed. 3.3. Confidentiality of Records. Each Investor agrees to use, and to use its reasonable commercial efforts to insure that its authorized representatives use, the same degree of care as such Investor uses to protect its own confidential information to keep confidential any information furnished to it which the Company identifies as being confidential or proprietary (so long as such information is not in the public domain), except that such Investor may disclose such proprietary or confidential information to any partner, Affiliate, subsidiary or parent of such Investor for the purpose of evaluating its investment in the Company as long as such partner, subsidiary or parent is advised of and agrees to abide by the confidentiality provisions of this Section 3.3. Notwithstanding the foregoing, each Investor (and each employee, representative, or other agent of such Investor) may disclose to any and all persons, without limitations of any kind, the tax treatment and tax structure of the transactions contemplated by this Agreement and all materials of any kind (including opinions or other tax analysis) that are provided to such Investor relating to such tax treatment and tax structure. 3.4. Reservation of Common Stock. The Company will at all times reserve and keep available, solely for issuance and delivery upon the conversion of the Shares, all Common Stock issuable from time to time upon such conversion. 3.5. Stock Vesting. Except as otherwise provided by the Board of Directors, all stock options and other stock equivalents issued by the Company after the date of this Agreement to employees, directors, consultants and other service providers of the Company shall be subject to vesting as follows: (a) 25% of such stock shall vest at the end of the first year following the date of issuance, and (b) 75% of such stock shall vest on a monthly basis over the remaining three years. With respect to any shares of stock purchased by any such person, except as otherwise provided by the Board of Directors, the Company will enter into an agreement in connection with each such issuance of stock to an employee, director or consultant of the Company that provides that upon the termination of the employment or service of such employee, director or consultant, with or without cause with respect to any unvested shares or options owned or held by an employee, director or consultant of the Company, such unvested shares or options shall be forfeited to the Company or its assignee. 3.6. Special Relationships of Prospective Employees. The Company shall not hire or contract for the services, directly or indirectly, whether as an employee, independent contractor, consultant or in any other capacity, of any person who is a spouse, sibling, parent, child, or other family member of a current officer, director, employee, independent contractor or consultant to the Company without the unanimous consent of the Board of Directors of the Company. 3.7. Directors' Liability and Indemnification. The Company's Certificate of Incorporation and Bylaws shall provide (a) for elimination of the liability of directors to the maximum extent permitted by law and (b) for indemnification of directors for acts on behalf of the Company to the maximum extent permitted by law. 3.8. Reimbursement of Expenses. The Company shall reimburse each nonemployee member of the Board of Directors for all reasonable and customary actual expenses incurred in connection with their service as a member of the Board of Directors, including without limitation all actual travel and lodging expenses incurred in connection with the attendance by any such member at a meeting of the Board of Directors or any committee thereof. 3.9. Qualified Small Business. The Company will use its best efforts to comply with the reporting and recordkeeping requirements of Section 1202 of the Internal Revenue Code of 1986, as amended, any regulations promulgated thereunder and any similar state laws and regulations, and agrees not to repurchase any stock of the Company if such repurchase would cause the Shares not to so qualify as "Qualified Small Business Stock." 3.10. Election of Directors. (a) In any election of directors of the Company, the Investors shall vote at any regular meeting or special meeting of stockholders of the Company (or by written consent) such number of shares of voting capital stock then owned by them (or as to which they then have voting power) as may be necessary to elect the following individuals to the Board of Directors: (i) One director designated by the Corporate Opportunities Fund, L.P., who shall initially be James C. Gale; (ii) One director designated by Wheatley MedTech Partners L.P.; (iii) One director designated by GP Strategies; (iv) One director designated by SMH Hydro Med II, LLC; (v) Two directors who have relevant industry experience and are not employees of the Company or GP Strategies, nominated by mutual agreement of the Investors (the "Outside Directors"); and (vi) The President or Chief Executive Officer of the Company. (b) Any director nominated pursuant to Section 3.10(a)(i), (ii), (iii) or (iv) may be removed by, and shall not be removed except by, Corporate Opportunities Fund, L.P., Wheatley MedTech Partners L.P., GP Strategies, and SMH Hydro Med II, LLC, respectively. 3.11. Observer Rights. As long as SMH Hydro Med LLC or Paladin Labs, Inc., respectively, hold any Shares, the Company shall, if such Investors do not otherwise have a representative on the Board of Directors, invite a representative of each such Investor to attend all meetings of its Board of Directors and the committees of the Board of Directors in a nonvoting observer capacity and, in this respect, shall give such representative copies of all notices, minutes, consents, and other materials that it provides to its directors; provided, however, that such representative shall agree to hold in confidence and trust and to act in a fiduciary manner with respect to all information so provided; and, provided further, that the Company reserves the right to withhold any information and to exclude such representative from any meeting or portion thereof if access to such information or attendance at such meeting could adversely affect the attorney-client privilege between the Company and its counsel. 3.12. Termination of Covenants. All covenants of the Company contained in Section 3 of this Agreement shall expire and terminate as to each Investor upon the earlier of (a) the effective date of the registration statement pertaining to the initial Qualified Offering, or (b) upon (i) the acquisition of the Company by another entity by means of any transaction or series of related transactions, including, without limitation, any reorganization, merger or consolidation but, excluding any merger effected exclusively for the purpose of changing the domicile of the Company or (ii) a sale of all or substantially all of the assets of the Company (a "Change in Control"); provided that in the event that the Company's stockholders of record as constituted immediately prior to any such transaction (on a fully diluted basis) will, immediately after such transaction (by virtue of securities issued as consideration for the Company's acquisition or sale or otherwise), hold at least 50% of the voting power of the surviving or acquiring entity, such transaction shall not be deemed to constitute a Change in Control. 4. PREEMPTIVE RIGHTS. 4.1. Subsequent Offerings. In the event the Company issues and sells Equity Securities (as defined below) other than the Equity Securities excluded by Section 4.5 hereof, each Investor shall have a preemptive right to purchase such number of shares of Equity Securities necessary for such Investor to maintain its percentage ownership position in the Company on an as converted basis. Each Investor's preemptive share is equal to the ratio of (a) the number of shares of the Company's Common Stock (including all shares of Common Stock issued or issuable upon conversion of the Series B Convertible Preferred Stock or Series A Convertible Preferred Stock) of which such Investor is deemed to be a holder immediately prior to the issuance of such Equity Securities to (b) the total number of shares of the Company's outstanding Common Stock (including all shares of Common Stock issued or issuable upon conversion of the Series B Convertible Preferred Stock, Series A Convertible Preferred Stock, or other security of the Company or upon the exercise of any outstanding warrants, options, or rights to subscribe to or purchase any Common Stock, Preferred Stock, or other security) immediately prior to the issuance of the Equity Securities. 4.2. Exercise of Preemptive Rights. If the Company issues any Equity Securities, it shall give each Investor written notice of such issuance, describing the Equity Securities and the price and the terms and conditions upon which the Company issued the same and shall provide each Investor with access to any information regarding such offering and the Company, provided to the purchasers of Equity Securities. Each Investor shall have 45 days from the giving of such notice to exercise its preemptive right to purchase Equity Securities for the price and upon the terms and conditions specified in the notice by giving written notice to the Company and stating therein the quantity of Equity Securities to be purchased. Notwithstanding the foregoing, the Company shall not be required to offer or sell such Equity Securities to any Investor who would cause the Company to be in violation of applicable federal securities laws by virtue of such offer or sale. 4.3. Termination and Waiver of Preemptive Rights. The preemptive rights established by this Section 4 shall terminate following the Company's initial Qualified Offering. 4.4. Transfer of Preemptive Rights. The preemptive rights of each Investor under this Section 4 may be transferred to the same parties, subject to the same restrictions, as any transfer of registration rights pursuant to Section 2.10. 4.5. Excluded Securities. The preemptive rights established by this Section 4 shall have no application to any of the following Equity Securities: (a) Up to 5,500,000 shares (as may be adjusted for any stock dividend, combinations, splits, recapitalizations and the like) of Common Stock (and/or options, warrants or other Common Stock purchase rights issued pursuant to such options, warrants or other rights) issued or to be issued after the date hereof to employees, officers or directors of, or consultants or advisors to the Company or any subsidiary, pursuant to stock purchase or stock option plans or other arrangements that are approved by the Board of Directors; (b) Up to 6,896,552 shares (as may be adjusted for any stock dividend, combinations, splits, recapitalizations and the like) of Series B Convertible Preferred Stock issued or to be issued after the date hereof to GP Strategies; (c) capital stock of the Company issued pursuant to any rights or agreements outstanding as of the date of this Agreement, options and warrants outstanding as of the date of this Agreement, and capital stock issued pursuant to or upon the exercise of any such rights or agreements granted after the date of this Agreement; provided that in the case of rights or agreements granted after the date of this Agreement, such rights or agreements were approved by the Board of Directors, including representatives designated by Sanders Morris Harris and Wheatley MedTech Partners L.P.; (d) shares of Common Stock issued in connection with any stock split, dividend, combination, distribution, or recapitalization; (e) shares of Common Stock issued in connection with any merger, consolidation, acquisition, or similar business combination approved by the Board of Directors; (f) shares of Common Stock issued upon conversion of the Shares; (g) any Equity Securities issued pursuant to any equipment leasing or loan arrangement, or debt financing from a bank or similar financial or lending institution approved by the Board of Directors; and (h) any Equity Securities issued in connection with strategic transactions involving the Company and other entities, including (i) joint ventures, manufacturing, marketing or distribution arrangements or (ii) technology transfer or development arrangements; provided that such strategic transactions and the issuance of shares therein, has been approved by the Board of Directors. 5. MISCELLANEOUS. 5.1. Governing Law. This Agreement shall be governed by and construed under the laws of the State of Delaware, without regard to principals of conflict of laws. 5.2. Survival. The representations, warranties, covenants, and agreements made herein shall survive any investigation made by any Holder and the closing of the transactions contemplated hereby. All statements as to factual matters contained in any certificate or other instrument delivered by or on behalf of the Company pursuant hereto in connection with the transactions contemplated hereby shall be deemed to be representations and warranties by the Company hereunder solely as of the date of such certificate or instrument. 5.3. Successors and Assigns. Except as otherwise expressly provided herein, the provisions hereof shall inure to the benefit of, and be binding upon, the successors, assigns, heirs, executors, and administrators of the parties hereto and shall inure to the benefit of and be enforceable by each person who shall be a holder of Registrable Securities from time to time; provided, however, that prior to the receipt by the Company of adequate written notice of the transfer of any Registrable Securities in accordance with this Agreement, such notice to specify the full name and address of the transferee, the Company may deem and treat the person listed as the holder of such shares in its records as the absolute owner and holder of such shares for all purposes, including the payment of dividends or any redemption price. 5.4. Entire Agreement. This Agreement, the Exhibits and Schedules hereto, the Purchase Agreement and the other documents delivered pursuant thereto constitute the full and entire understanding and agreement between the parties with regard to the subjects hereof and no party shall be liable or bound to any other in any manner by any representations, warranties, covenants and agreements except as specifically set forth herein and therein. This Agreement replaces and supercedes the Investor Rights Agreement dated December 27, 2001 by and among the Company, the Common Investors, and the Series A Investors. 5.5. Severability. In the event one or more of the provisions of this Agreement should, for any reason, be held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect any other provisions of this Agreement, and this Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been contained herein. 5.6. Amendment and Waiver. (a) Except as otherwise expressly provided, this Agreement may be amended or modified only upon the written consent of the Company and the Holders of at least a majority of the Registrable Securities. (b) Except as otherwise expressly provided, the obligations of the Company and the rights of the Holders under this Agreement may be waived only with the written consent of the Holders of at least a majority of the Registrable Securities. (c) Notwithstanding the foregoing, this Agreement may be amended with only the written consent of the Company to include additional purchasers of Series B Convertible Preferred Stock as "Series B Investors," "Holders," and parties hereto. (d) For the purposes of determining the number of Holder or Investors entitled to vote or exercise any rights hereunder, the Company shall be entitled to rely solely on the list of record holders of its stock as maintained by or on behalf of the Company. 5.7. Delays or Omissions. It is agreed that no delay or omission to exercise any right, power, or remedy accruing to any Holder, upon any breach, default or noncompliance of the Company under this Agreement shall impair any such right, power, or remedy, nor shall it be construed to be a waiver of any such breach, default or noncompliance, or any acquiescence therein, or of any similar breach, default or noncompliance thereafter occurring. It is further agreed that any waiver, permit, consent, or approval of any kind or character on any Holder's part of any breach, default or noncompliance under the Agreement or any waiver on such Holder's part of any provisions or conditions of this Agreement must be in writing and shall be effective only to the extent specifically set forth in such writing. All remedies, either under this Agreement, by law, or otherwise afforded to Holders, shall be cumulative and not alternative. 5.8. Notices. All notices required or permitted hereunder shall be in writing and shall be deemed effectively given: (a) upon personal delivery to the party to be notified, (b) when sent by confirmed electronic mail or facsimile if sent during normal business hours of the recipient; if not, then on the next business day, (c) five days after having been sent by registered or certified mail, return receipt requested, postage prepaid, or (d) one day after deposit with a nationally recognized overnight courier, specifying next day delivery, with written verification of receipt. All communications shall be sent to the party to be notified at the address as set forth on the signature pages hereof or Exhibit A hereto or at such other address as such party may designate by ten days advance written notice to the other parties hereto. 5.9. Attorneys' Fees. In the event that any suit or action is instituted to enforce any provision in this Agreement, the prevailing party in such dispute shall be entitled to recover from the losing party all reasonable fees, costs and expenses of enforcing any right of such prevailing party under or with respect to this Agreement, including without limitation, such reasonable fees and expenses of attorneys and accountants, which shall include, without limitation, all fees, costs and expenses of appeals. 5.10. Titles and Subtitles. The titles of the sections and subsections of this Agreement are for convenience of reference only and are not to be considered in construing this Agreement. 5.11. Additional Investors. Notwithstanding anything to the contrary contained herein, if the Company shall issue additional shares of its Preferred Stock pursuant to the Purchase Agreement, any purchaser of such shares of Preferred Stock may become a party to this Agreement by executing and delivering an additional counterpart signature page to this Agreement and shall be deemed an "Investor" hereunder. 5.12. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one instrument. 5.13. Joinder of Spouses. The undersigned spouses of each Investor, if applicable, join in the execution and delivery of this Agreement for the express purpose of binding any interest he or she may have in the Shares or Common Stock. [THIS SPACE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, the parties hereto have executed this AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT as of the date set forth in the first paragraph hereof. COMPANY: SERIES B INVESTORS: HYDRO MED SCIENCES, INC. SMH HYDRO MED II LLC By: By: ------- Name: David S. Tierney Name: James C. Gale Title: President Title: Manager CORPORATE OPPORTUNITIES FUND, L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager CORPORATE OPPORTUNITIES FUND (INSTITUTIONAL),L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager LIFE SCIENCES OPPORTUNITIES FUND, L.P. By: SMH Life Sciences Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager WHEATLEY MEDTECH PARTNERS L.P. By: Wheatley MedTech Partners LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY PARTNERS III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY ASSOCIATES III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY FOREIGN PARTNERS III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ PALADIN LABS INC. By:_________________________________ Name:____________________________ Title: ____________________________ FALCON SEABOARD HOLDINGS, L.P. By:_________________________________ Name:____________________________ Title: _____________________________ SERIES A INVESTORS: SMH HYDRO MED LLC By: Name: James C. Gale Title: Manager CORPORATE OPPORTUNITIES FUND, L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager CORPORATE OPPORTUNITIES FUND (INSTITUTIONAL), L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager WHEATLEY MEDTECH PARTNERS L.P. By: Wheatley MedTech Partners LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ COMMON STOCK INVESTORS: GP STRATEGIES CORPORATION By:_________________________________ Name:____________________________ Title:_____________________________ EXHIBIT A COMMON STOCK INVESTORS GP Strategies Corporation 9 West 57th Street New York, New York 10019 SERIES B INVESTORS As of May 30, 2003 SMH Hydro Med II LLC 600 Travis, Suite 3100 Houston, Texas 77002 Attention: John Malanga Corporate Opportunities Fund, L.P. Corporate Opportunities Fund (Institutional), L.P. Life Sciences Opportunities Fund, L.P. c/o SMM Corporate Management LLC 126 East 56 Street New York, New York 10022 Attention: James C. Gale Wheatley MedTech Partners L.P. 80 Cuttermill Road, Suite 311 Great Neck, New York 11021 With a copy to: Wheatley Partners 825 Third Avenue, 32nd Floor New York, New York 10022 Attn: David R. Dantzker, M.D./ Lawrence Wagenburg Wheatley Partners III, L.P. Wheatley Associates III, L.P. Wheatley Foreign Partners, III, L.P. 80 Cuttermill Road, Suite 311 Great Neck, New York 11021 With a copy to: Wheatley Partners 825 Third Avenue, 32nd Floor New York, New York 10022 Attn: David R. Dantzker, M.D./ Barry K. Fingerhut Paladin Labs, Inc. 6111 Royalmount Avenue Suite 102 Montreal, Quebec H4P 2T4 Attention: Samira Sakhia Falcon Seaboard Holdings, L.P. 109 N. Post Oak Lane Houston, Texas 77024 GP Strategies Corporation 9 West 57th Street New York, New York 10019 Attention: Andrea Kantor Series A Investors SMH Hydro Med LLC 600 Travis, Suite 3100 Houston, Texas 77002 Attention: John Malanga Corporate Opportunities Fund, L.P. Corporate Opportunities Fund (Institutional), L.P. c/o SMM Corporate Management LLC 126 East 56 Street New York, New York 10022 Attention: James C. Gale Wheatley MedTech Partners L.P. 80 Cuttermill Road, Suite 311 Great Neck, New York 11021 With a copy to: Wheatley Partners 825 Third Avenue, 32nd Floor New York, New York 10022 Attn: David R. Dantzker, M.D./ Lawrence Wagenburg EX-10 7 ex10-17.txt VALERIA STOCK PURCHASE OPTION AGREEMENT Exhibit 10.17 VALERA PHARMACEUTICALS, INC. series B convertible preferred stock Stock PURCHASE Option AGREEMENT This Stock Purchase Option Agreement (this "Agreement") is made and entered into as of June __, 2004, by and among Pequot Scout Fund, L.P. ("Scout"), Pequot Navigator Fund, L.P. ("Navigator"), GP Strategies Corporation, a Delaware corporation ("GP Strategies"), National Patent Development Corporation, a Delaware corporation ("NPDC"), Valera Pharmaceuticals, Inc. (f/k/a Hydro Med Sciences Inc.), a Delaware corporation (the "Company"), and each of the persons and entities listed on Exhibit A hereto (collectively with Scout and Navigator, the "Stockholders"). RECITALS The Stockholders are the holders of all of the outstanding shares of preferred stock (the "Preferred Stock") of the Company, and GP Strategies is the holder of all of the outstanding shares of common stock (the "Common Stock") of the Company. NPDC is currently a wholly-owned subsidiary of GP Strategies, which GP Strategies contemplates spinning off to the stockholders of GP Strategies. GP Strategies had an option to purchase shares of Series B-1 Convertible Preferred Stock from the Company, which GP Strategies assigned to Scout and Navigator (the "Assignment"). The Company and Scout and Navigator have agreed to amend the option to be an option to purchase shares of Series B Convertible Preferred Stock (the "Option Amendment"). Scout and Navigator exercised such option and have today purchased from the Company (the "Initial Purchase") a total of 3,448,276 shares (the "Shares") of Series B Convertible Preferred Stock of the Company, and Scout and Navigator have agreed to grant an option to purchase a portion of the Shares to NPDC, and if NPDC does not exercise such option in full, to the Stockholders, on the terms and conditions set forth herein. AGREEMENT In consideration of the foregoing recitals and the mutual promises, representations, warranties and covenants hereinafter set forth and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, intending to be legally bound hereby, the parties hereto agree as follows: 1. OPTION TO PURCHASE. 1.1 Subject to the terms and conditions hereof, NPDC shall have the option to purchase from Scout up to 1,329,596 Shares and from Navigator 739,370 Shares (the "Option Shares") at a purchase price of (a) $0.725 per Option Share during the period commencing on the date hereof and ending on July 28, 2004, (b) $0.7395 per Option Share during the period commencing on July 29, 2004 and ending on August 28, 2004, (c) $0.754 per Option Share during the period commencing on August 29, 2004 and ending on September 28, 2004, and (d) $0.7685 per Option Share during the period commencing on September 29, 2004 and ending on October 28, 2004. To exercise the option, NPDC must give notice (the "NPDC Notice") to Scout and Navigator on or before October 28, 2004 stating the number of Option Shares with respect to which the option is being exercised. 1.2 Promptly after October 28, 2004, Scout and Navigator shall give notice (the "Pequot Notice") to the Stockholders stating whether the option was exercised by NPDC and, if it was, stating the number of Option Shares with respect to which the option was exercised. If NPDC did not exercise the option in full, each Stockholder shall have the option to purchase some or all of the Option Shares not purchased by NPDC (the "Remaining Shares") at a purchase price of $0.7685 per Remaining Share. Each Stockholder desiring to exercise its option to purchase some or all of the Remaining Shares must, within the 20-day period (the "Stockholder Option Period") commencing on the date the Pequot Notice is given, give written notice to Scout and Navigator of such Stockholder's election to purchase Remaining Shares, and the number of Remaining Shares that such Stockholder desires to purchase. If the total number of Remaining Shares specified in the elections of the Stockholders exceeds the number of Remaining Shares, then (unless the electing Stockholders otherwise agree in writing) each Stockholder electing to purchase will have the right to purchase that number of Remaining Shares that is obtained by multiplying the number of Remaining Shares by a fraction (A) the numerator of which will be the number of shares of Preferred Stock then held by such Stockholder and (B) the denominator of which will be the sum of the total number of shares of Preferred Stock then held by all Stockholders electing to purchase Remaining Shares. 2. CLOSINGS, DELIVERY AND PAYMENT. 2.1 Closing. The closing of the purchase by NPDC of Option Shares pursuant to Section 1.1 shall take place at 9:00 a.m. on the third business day after the date the NPDC Notice is given, at 380 Lexington Ave., New York, New York, or at such other time or place as GP Strategies and Scout and Navigator may mutually agree. The closing of the purchase by the Stockholders of Remaining Shares pursuant to Section 1.2 shall take place at 9:00 a.m. on the third business day after the end of the Stockholder Option Period, at 380 Lexington Ave., New York, New York, or at such other time or place as the Stockholders and Scout and Navigator may mutually agree. Each such closing is referred to herein as a "Closing." 2.2 Delivery at Closing. At each Closing, subject to the terms and conditions hereof, Scout and Navigator will deliver to each purchaser a certificate representing the purchased Option Shares registered in the name of the purchaser, against payment by the purchaser to Scout and Navigator of the purchase price by wire transfer of immediately available funds. 3. REPRESENTATIONS AND WARRANTIES OF GP STRATEGIES, NPDC, AND THE STOCKHOLDERS. Each of GP Strategies (as to Section 3.1 only), NPDC, and each Stockholder hereby represents and warrants to Scout and Navigator (as to itself only) as follows: 3.1 Requisite Power and Authority. It has all necessary power and authority to execute and deliver this Agreement and to carry out its provisions. All action on its part required for the lawful execution and delivery of this Agreement has been or will be effectively taken prior to the relevant Closing. This Agreement is its valid and binding obligation, enforceable against it in accordance with its terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting enforcement of creditors' rights and (b) as limited by general principles of equity that restrict the availability of equitable remedies. 3.2 Investment Representations. It understands that none of the Option Shares or the shares of Common Stock issuable upon conversion of the Option Shares (the "Conversion Shares") has been registered under the Securities Act of 1933, as amended (the "Securities Act"). It also understands that the Option Shares are being offered and sold pursuant to an exemption from registration contained in the Securities Act based in part upon its representations contained in this Agreement. It hereby represents and warrants as follows: (a) Economic Risk. It has substantial experience in evaluating and investing in private placement transactions of securities in companies similar to the Company so that it is capable of evaluating the merits and risks of its investment in the Company and has the capacity to protect its own interests. If it elects to exercise its option to purchase Option Shares, it must bear the economic risk of this investment indefinitely unless the Option Shares (or the Conversion Shares) are registered pursuant to the Securities Act, or an exemption from registration is available. It understands that the Company has no present intention of registering the Option Shares, the Conversion Shares, or any shares of its Common Stock. It also understands that there is no assurance that any exemption from registration under the Securities Act will be available and that, even if available, such exemption may not allow it to transfer all or any portion of the Option Shares or the Conversion Shares under the circumstances, in the amounts or at the times it might propose. (b) Acquisition for Own Account. If it elects to exercise its option to purchase Option Shares, it is acquiring the Option Shares and the Conversion Shares for its own account for investment only, and not with a view towards their distribution. (c) It Can Protect Its Interest. It represents that by reason of its, or of its management's, business or financial experience, it has the capacity to protect its own interests in connection with the transactions contemplated in this Agreement. Further, it is aware of no publication of any advertisement in connection with the transactions contemplated in the Agreement. (d) Accredited Investor. It represents that it is an "accredited investor" within the meaning of Regulation D under the Securities Act. (e) Company Information. It has received and read all information it has deemed necessary or appropriate for purposes of considering its investment hereunder. (f) Rule 144. If it elects to exercise its option to purchase Option Shares, it acknowledges and agrees that the Option Shares, and, if issued, the Conversion Shares must be held indefinitely unless they are subsequently registered under the Securities Act or an exemption from such registration is available. It has been advised or is aware of the provisions of Rule 144 promulgated under the Securities Act as in effect from time to time, which permits limited resale of shares purchased in a private placement subject to the satisfaction of certain conditions, including, among other things: the availability of certain current public information about the Company, the resale occurring following the required holding period under Rule 144 and the number of shares being sold during any three-month period not exceeding specified limitations. 3.3 Transfer Restrictions. If it elects to exercise its option to purchase Option Shares, it acknowledges and agrees that the Option Shares and, if issued, the Conversion Shares are subject to restrictions on transfer as set forth in the Amended and Restated Investor Rights Agreement, dated May 30, 2003, among the Company and its stockholders (the "Investor Rights Agreement"), and the Amended and Restated Right of First Refusal and Co-Sale Agreement, dated May 30, 2003, among the Company and its stockholders (the "Right of First Refusal and Co-Sale Agreement"). 4. REPRESENTATIONS AND WARRANTIES OF SCOUT AND NAVIGATOR. Scout and Navigator hereby represents and warrants to GP Strategies, NPDC, and the Stockholders as follows: 4.1 Requisite Power and Authority. Scout and Navigator have all necessary power and authority to execute and deliver this Agreement and to carry out its provisions. All action on its part required for the lawful execution and delivery of this Agreement has been or will be effectively taken prior to the Closing. This Agreement is the valid and binding obligation of Scout and Navigator, enforceable against it in accordance with its terms, except (a) as limited by applicable bankruptcy, insolvency, reorganization, moratorium or other laws of general application affecting enforcement of creditors' rights and (b) as limited by general principles of equity that restrict the availability of equitable remedies. 4.2 Title. Scout and Navigator beneficially own and have the unrestricted right (other than as such right may be restricted by the Securities Act, the Amended and Restated Investor Rights Agreement, and the Amended and Restated Right of First Refusal and Co-Sale Agreement) to transfer the Option Shares pursuant to this Agreement and, upon purchase of the Option Shares pursuant to this Agreement, the purchaser will have good title to the purchased Option Shares, free and clear of all liens, security interests, pledges, stockholder agreements, voting trusts, claims, charges and other encumbrances, other than the Investor Rights Agreement and the Right of First Refusal and Co-Sale Agreement. 5. CONSENT. 5.1 Consent. Each of the parties hereto hereby (other than NPDC) consents to the Assignment, the Option Amendment and the Initial Purchase and the transactions contemplated hereby and waives any rights it may have with respect thereto under the Investor Rights Agreement, the Right of First Refusal and Co-Sale Agreement, or otherwise. 6. MISCELLANEOUS. 6.1 Governing Law. This Agreement shall be governed in all respects by the laws of the State of New York, without reference to principles of conflict of laws. 6.2 Survival. The representations, warranties, covenants and agreements made herein shall survive any investigation made by any party and the closing of the transactions contemplated hereby. 6.3 Entire Agreement. This Agreement and the other documents delivered pursuant hereto constitute the full and entire understanding and agreement between the parties with regard to the subjects hereof and no party shall be liable or bound to any other in any manner by any representations, warranties, covenants and agreements except as specifically set forth herein and therein. 6.4 Severability. In case any provision of the Agreement shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. 6.5 Notices. All notices required or permitted hereunder shall be in writing and shall be deemed effectively given: (a) upon personal delivery to the party to be notified, (b) when sent by confirmed electronic mail or facsimile if sent during normal business hours of the recipient, if not, then on the next business day, (c) five days after having been sent by registered or certified mail, return receipt requested, postage prepaid, or (d) one day after deposit with a nationally recognized overnight courier, specifying next day delivery, with written verification of receipt. All communications shall be sent to the address of the party set forth opposite its signature below or such other address as either party may request by notifying the other party in writing. 6.6 Titles and Subtitles. The titles of the sections and subsections of the Agreement are for convenience of reference only and are not to be considered in construing this Agreement. 6.7 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be an original, but all of which together shall constitute one instrument. 6.8 Adjustments. The numbers of shares and purchase price set forth herein shall be equitably adjusted for stock splits, stock dividends, recapitalizations, and similar transactions. 6.9 Pronouns. All pronouns contained herein, and any variations thereof, shall be deemed to refer to the masculine, feminine or neutral, singular or plural, as to the identity of the parties hereto may require. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK] IN WITNESS WHEREOF, the parties hereto have executed the STOCK PURCHASE OPTION AGREEMENT as of the date set forth in the first paragraph hereof. VALERA PHARMACEUTICALS, INC. By: Name: David S. Tierney Title: President Address: 8 Clarke Drive Cranbury, New Jersey Fax: (609) 409-1650 Attn: President PEQUOT SCOUT FUND, L.P. PEQUOT NAVIGATOR ONSHORE FUND, L.P. By: Pequot Capital Management, Inc. By: Pequot Capital Management, Inc. as Investment Manager as Investment Manager By: ________________________________ By: ________________________________ Name: Lawrence Cutler Name: Lawrence Cutler Title: Principal Title: Principal Address: Address: Pequot Capital Management, Inc. Pequot Capital Management, Inc. 500 Nyala Farm Road 500 Nyala Farm Road Westport, CT 06880 Westport, CT 06880 Attention: Amber Tencic/Aryeh Davis Attention: Amber Tencic/Aryeh Davis GP STRATEGIES CORPORATION NATIONAL PATENT DEVELOPMENT CORP. By: _______________________________ By: ________________________________ Name:__________________________ Name:___________________________ Title:_________________________ Title:__________________________ Address: Address: 777 Westchester Avenue 777 Westchester Avenue 4th Floor 4th Floor White Plains, NY 10604 White Plains, NY 10604 Fax: (914) 249 9745 Fax: (914) 249 9745 SMH HYDRO MED LLC By: Name: James C. Gale Title: Manager SMH HYDRO MED LLC By: Name: James C. Gale Title: Manager SMH HYDRO MED II LLC By: Name: James C. Gale Title: Manager CORPORATE OPPORTUNITIES FUND, L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager CORPORATE OPPORTUNITIES FUND (INSTITUTIONAL), L.P. By: SMM Corporate Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager LIFE SCIENCES OPPORTUNITIES FUND, L.P. By: SMH Life Sciences Management, LLC, General Partner By: ________________________________ Name: James C. Gale Title: Manager WHEATLEY MEDTECH PARTNERS L.P. By: Wheatley MedTech Partners LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY PARTNERS III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY ASSOCIATES III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ WHEATLEY FOREIGN PARTNERS III, L.P. By: Wheatley Partners III, LLC, General Partner By: ________________________________ Name:__________________________ Title:___________________________ FALCON SEABOARD HOLDINGS, L.P. By:_________________________________ Name:____________________________ Title: _____________________________ PALADIN LABS, INC. By: ________________________________ Name:__________________________ Title:___________________________ : NJTC VENTURE FUND SBIC, L.P. By:_________________________________ Name:____________________________ Title: _____________________________ EXHIBIT A STOCKHOLDERS SMH Hydro Med LLC 600 Travis, Suite 3100 Houston, Texas 77002 Attention: John Malanga SMH Hydro Med II LLC 600 Travis, Suite 3100 Houston, Texas 77002 Attention: John Malanga Corporate Opportunities Fund, L.P. Corporate Opportunities Fund (Institutional), L.P. Life Sciences Opportunities Fund, L.P. c/o SMM Corporate Management LLC 126 East 56 Street New York, New York 10022 Attention: James C. Gale Wheatley MedTech Partners L.P. 80 Cuttermill Road, Suite 311 Great Neck, New York 11021 With a copy to: Wheatley Partners 825 Third Avenue, 32nd Floor New York, New York 10022 Attn: David R. Dantzker, M.D./ Lawrence Wagenburg Wheatley Partners III, L.P. Wheatley Associates III, L.P. Wheatley Foreign Partners, III, L.P. 80 Cuttermill Road, Suite 311 Great Neck, New York 11021 With a copy to: Wheatley Partners 825 Third Avenue, 32nd Floor New York, New York 10022 Attn: David R. Dantzker, M.D./ Barry K. Fingerhut Paladin Labs, Inc. 6111 Royalmount Avenue Suite 102 Montreal, Quebec H4P 2T4 Attention: Samira Sakhia Falcon Seaboard Holdings, L.P. 109 N. Post Oak Lane Houston, Texas 77024 NJTC Venture Fund SBIC, L.P. 1001 Briggs Road, Suite 280 Mt. Laurel, New Jersey 08054 -----END PRIVACY-ENHANCED MESSAGE-----