UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act
of 1934
For the fiscal year ended December 31, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange
Act of 1934
For the transition period from ____________ to _______________
Commission File Number 333-118568
NATIONAL PATENT DEVELOPMENT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 13-4005439
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(State of Incorporation) (I.R.S. Employer Identification No.)
777 Westchester Avenue, White Plains, NY 10604
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(Address of principal executive offices) (Zip Code)
(914) 249-9700
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Registrant's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K/x/.
Indicate by check mark whether the registrant is an accelerated filer. Yes No X
The aggregate market value of the outstanding shares of the Registrant's Common
Stock, par value $.01 per share held by non-affiliates as of December 31, 2004
was approximately $29,612,000.
The number of shares outstanding of each of the Registrant's Common Stock and
Class B Stock as of March 29, 2005:
Class Outstanding
Common Stock, par value $.01 per share 17,799,945 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 2005 Annual
Meeting of Stockholders are incorporated herein by reference into Part III
hereof.
Page
PART I
Item 1. Business 2
Item 2. Properties 17
Item 3. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 18
PART II
Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters 19
Item 6. Selected Financial Data 20
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 21
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33
Item 8. Financial Statements and Supplementary Data 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 73
Item 9A. Controls and Procedures 73
PART III
Item 10. Directors and Executive Officers of the Registrant * 73
Item 11. Executive Compensation * 73
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters* 73
Item 13. Certain Relationships and Related Transactions* 73
Item 14. Principal Accountant Fees and Services* 73
PART IV
Item 15. Exhibits and Financial Statement Schedules 74
Signatures 75
Exhibit Index 76
* To be incorporated by reference from the proxy statement for the Registrant's
2005 Annual Meeting of Shareholders.
Cautionary Statement Regarding Forward-Looking Statements
The forward-looking statements contained herein reflect National Patent
Development Corporation's management's current views with respect to future
events and financial performance. 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 "Factors Affecting Our Future Performance" 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.
PART I
Item 1: Business
General Development of Business
National Patent Development Corporation (the "Company", "we" or
"National Patent Development") was incorporated on March 10, 1998 as a
wholly-owned subsidiary of GP Strategies Corporation ("GP Strategies"). The
Company common stock is quoted on the OTC Bulletin Board and is traded under the
symbol NPDV.OB.
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. On July 30, 2004, GP Strategies contributed its
ownership interests in its optical plastics and home improvement distribution
businesses, as well as other non-core assets, to National Patent Development in
exchange for National Patent Development common stock. The separation of these
businesses was accomplished through a pro-rata distribution (the "Distribution"
or "spin-off") of 100% of the outstanding common stock of National Patent
Development to the stockholders of GP Strategies on the record date of November
18, 2004 for the Distribution. On November 24, 2004, holders of record received
one share of National Patent Development common stock for each share of GP
Strategies common stock or Class B capital stock owned.
The Company owns and operates 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. ("Five Star") and also owns certain other non-core assets, including an
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investment in a publicly held company, Millennium Cell; an approximately 17.7%
interest in a private company, Valera Pharmaceuticals; and certain real estate.
Company Information Available on the Internet
The Company's internet address is www.npdc.com. The Company makes
available free of charge through its internet site, its annual reports on Form
10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; and any
amendment to those reports filed or furnished pursuant to the Securities
Exchange Act of 1934, or the "Exchange Act," as soon as reasonably practicable
after such material is electronically filed with, or furnished to, the U.S.
Securities and Exchange Commission.
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. Polycarbonate
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.
MXL also produces custom molded and decorated products manufactured out of
acrylic. Additionally, MXL's Illinois 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 Illinois division, Woodland Mold and Tool, was acquired by MXL in
1987 as MXL's business grew to include in-house optical injection molding.
Illinois' capabilities range from the production of long-life tooling for
standard molding applications to the design, construction and repair and
polishing of sophisticated optical molds. In the fourth quarter 2004, MXL began
to explore the divestiture of its Illinois facility, as a result of a decline in
production volume for the Illinois division and taking into consideration MXL's
diminished real estate needs. MXL is in contract to sell the Illinois facility
and lease back 10,000 square feet of the facility. Management believes the
transaction will occur in 2005; however there can be no assurance that the
transaction will be completed in 2005 or that it will ever occur.
In 2003, MXL acquired certain of the precision custom optical
assemblies inventory, machinery and equipment of AOtec for $1,000,000 in notes
(the "AOtec Notes") and $100,000 in cash. 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. In 2004, MXL exercised an
option for an earlier termination without penalty of the Massachusetts facility
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lease. MXL vacated the premises and the lease terminated as of March 31, 2005.
MXL relocated the inventory, machinery and equipment purchased from AOtec and is
consolidating its injection molding and precision coating operations at its
Lancaster, PA facility. In addition, MXL is currently negotiating a reduction in
the amounts due under the AOtec Notes with maturity dates of August 5, 2004 and
2005, resulting from a dispute over the purchase price. According to the
contract of sale, the payments due pursuant to the AOtec Notes were subject to
an offset and withholding by MXL. The parties are attempting to resolve this
matter; however there is no guarantee that MXL will successfully negotiate the
reduction of the AOtec Notes. The AOtec Notes, which amount to $550,000 in the
aggregate following a repayment of $450,000 of the AOtec Notes in October 2003,
are included in short-term borrowings in the consolidated December 31, 2004
balance sheet.
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 coatings, anti-reflective coatings and/or 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 years ended
December 31, 2004, 2003 and 2002, based upon the customers' locations, are as
follows (in thousands):
Year Ended December 31,
--------------------------------------
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2004 2003 2002
---- ---- ----
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United States $5,662 $6,930 $8,264
Far East 1,288 1,230 1,266
Other 1,291 453 466
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Total $8,241 $8,613 $9,996
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MXL has been continuously and actively engaged in its optical plastics
business since 1968. Prior to the spin-off of National Patent Development, 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 built expressly for precision injection molding and
personnel with the technical expertise to run such facility.
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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 9001:2000 Registration. MXL's Pennsylvania and
Massachusetts facilities are ISO 9001:2000 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 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.
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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 on average a
minimum of 10 years of direct manufacturing experience in this
or related industries.
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 polycarbonate, 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.
MXL serves as the prime contractor for several major development
programs in industry and government for 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.
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
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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 Illinois operations use eight 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.
Manufacturing and Raw Materials
MXL's primary raw materials are plastic resin (principally
polycarbonate), acrylic, silicone hard coatings and HYDRON(R) anti-fog coating.
MXL is able to fulfill its requirements for plastic resin and acrylic through
arrangements with various distributors and is able to fulfill its requirements
for silicone hard coating from manufacturers. MXL manufactures its proprietary
HYDRON(R), which is applied as a fog resistant coating to its optical products.
Plastic resin is a petroleum based product, and as such, is subject to price
increases (up to 40% during the year ended December 31, 2004) along with
increases in crude oil prices, which have increased by over 50% during the year
ended December 31, 2004.
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 two customers comprised approximately 16% and 13%, respectively,
of its total sales in 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, is 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, 2004 was approximately
$1,627,000 ($1,703,000 as of December 31, 2003) and most of the orders are
expected to be completed during fiscal 2005.
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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, 2004, MXL employed approximately 78 persons,
including 46 at its Lancaster facility, 7 in its Illinois facility and 25 at its
new Massachusetts facility. Of the MXL employees, 64 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.
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, and as far south as North Carolina. This addition to the
sales force generates revenues of approximately $9 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.
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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, which was then 37.5% owned by GP Strategies, purchased its
business from GP Strategies in 1998 in exchange for cash and a $5,000,000
unsecured 8% note payable (the "Five Star Note"). In 2002 and 2003, GP
Strategies converted $1,000,000 principal amount of the Five Star Note into
4,272,727 shares of Five Star's common stock. In 2004, Five Star, through a
tender offer, repurchased approximately 2,628,000 shares of its common stock.
The conversion of the Five Star Note and the tender offer increased GPS'
ownership in the Company to approximately 64%. On July 30, 2004, GP Strategies
contributed its ownership interest in Five Star and the Five Star Note to the
Company.
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 are estimated to be $236 billion in 2004 and are
projected to grow at a 5.3% compound rate through 2008.
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.
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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
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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%.
11
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, Bestt 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% of its
sales in 2004. All 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, 2004.
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.
Other Assets
Valera Pharmaceuticals
We own 100% of the common stock and 2,068,966 shares of the Series B
convertible preferred stock of Valera Pharmaceuticals (formerly Hydro Med
12
Sciences, Inc.), which amounts to a 17.7% 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
histrelin, a synthetic nonapeptide agonist of luteinizing hormone-releasing
hormone (LHRH). LHRH agonists have become a mainstay in treating locally
advanced and metastatic prostate cancer. On October 13, 2004, Valera announced
that the FDA approved the marketing of Vantas(TM), the name for Valera's
long-acting LHRH implant for treating prostate cancer.
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. On July 30, 2004 GP Strategies
contributed its ownership interest in Valera to National Patent Development.
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.
National Patent Development is also subject to the Investors Rights Agreement.
Accordingly, while we own 100% of Valera's common stock, we do 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. We exercised such
option on October 28, 2004 at a price of $0.7685 per share, for an aggregate
exercise price of $1,590,000. On November 12, 2004, we entered into an agreement
to borrow approximately $1,022,000 from Bedford Oak Partners, which is
controlled by Harvey P. Eisen, a director of the Company, and approximately
$568,000 from Jerome I. Feldman, who is Chairman and Chief Executive Officer of
the Company, to exercise our option to purchase Series B Convertible Preferred
shares of Valera. The loans bear interest at 6% per annum, mature on October 31,
2009, and are secured by all shares of Valera owned by us, including the
purchased shares. The loans are required to be prepaid out of the proceeds
received from the sale of the purchased shares or from any additional capital
contribution received by us from GP Strategies out of proceeds received by GP
13
Strategies from its claims relating to the Learning Technologies acquisition.
Bedford Oak Partners and Jerome I. Feldman are entitled to receive 50% of any
profit received by us from the sale of the Valera purchased shares. On January
11, 2005, we prepaid the loans, including accrued interest of approximately
$16,000, to Bedford Oak Partners and Jerome I. Feldman out of such proceeds.
On August 16, 2004 Valera sold 11,600,000 shares of Series C
convertible preferred stock and received gross proceeds of $11.6 million. On
March 14, 2005 Valera registered with the Securities and Exchange Commission for
an initial public offering of up to approximately $75 million of common stock.
If the initial public offering is completed, all the convertible preferred stock
outstanding at the time of the offering, including accrued dividends, will
automatically convert into common stock. Assuming conversion of all of the
outstanding shares of Series A, Series B and Series C convertible preferred
stock and exercise of stock options held by employees of Valera at December 31,
2004, the Company would own approximately 17.7% of Valera. Such percentage will
be further reduced upon successful completion of the public offering.
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 held 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 of a receivable from GP Strategies 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 held
1,188,271 shares of common stock of Millennium Cell with a market value of
$2,769,000. At December 31, 2004, we held 964,771 shares of common stock of
Millennium Cell with a market value of $1,235,000.
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.
Factors Affecting Our Future Performance
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
14
Strategies will not be obligated to provide assistance or services to National
Patent Development after the spin-off, except as provided in an agreement by GP
Strategies to provide certain management services to 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 reduce our
net income and working capital.
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 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.
Risks Related to our Business
MXL's revenue and net income could decline as a result of a loss of business
from significant customers.
For the years ended December 31, 2004, 2003 and 2002, revenue from
MXL's three largest customers represented approximately 38%, 37%, and 52% 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 and failure to obtain raw materials
with cost efficiency and on a timely basis may cause a disruption in MXL's
operations.
MXL's primary raw material is plastic resin (principally
polycarbonate). In the past, MXL primarily relied on one supplier for its
primary raw material. Due to new entrants in the market to supply plastic resin,
MXL currently uses two primary 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
15
materials, and the failure of MXL to fulfill its raw material requirement could
disrupt its business and result in a decrease in net income.
In addition, plastic resin is a petroleum based product, and as such,
is subject to price increases (20% to 40% during the year ended December 31,
2004, depending on grade and type) along with increases in crude oil prices
(over 50% during the year ended December 31, 2004). There is no guarantee that
MXL will be able to fully recover from its customers its cost increases
associated with increases in the price of plastic resin.
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
decrease our results of operations and working capital.
Risks Related to Our Stock
We have agreed to restrictions and adopted policies that could have possible
anti-takeover effects and reduce the value of our stock.
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.
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'
16
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.
Item 2. Properties
The following information describes the material physical properties
owned or leased by us and our subsidiaries. We lease approximately 10,000 square
feet of space for our White Plains, New York principal executive offices.
MXL owns 50,200 square feet of warehouse and office space in Lancaster,
PA and 55,000 square feet of warehouse and office space in Downer's Grove, IL,
both of which are subject to mortgages. Due to a decline in production volume
for the Illinois division and considering MXL's diminished real estate
requirements, MXL is in contract to sell the Illinois facility and lease back
10,000 square feet of the facility. In September 2003, MXL entered into a
three-year lease for a 55,000 square foot storage and manufacturing facility in
Southbridge, Massachusetts for its newly purchased equipment from AOtec. In
2004, MXL exercised an option for an earlier termination without penalty of the
Massachusetts facility lease. MXL vacated the premises and the lease terminated
as of March 31, 2005.
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 operating lease for the Connecticut facility
expires in February, 2007.
The facilities owned or leased by us are considered to be suitable and
adequate for their intended uses and are considered to be well maintained and in
good condition.
Item 3. Legal Proceedings
Claims Relating to Learning Technologies Acquisition
On July 30, 2004 GP Strategies agreed to make an additional capital
contribution to National Patent Development, in an amount equal to the first $5
million of any proceeds (net of litigation expenses and taxes incurred, if any),
and 50% of any proceeds (net of litigation expenses and taxes incurred, if any)
in excess of $15 million, received with respect to the claims described below.
GPS has received $13.7 million of net proceeds from such claims and, pursuant to
such agreement, in January 2005 GPS made a $5 million additional capital
contribution to National Patent Development
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's 1998
acquisition of Learning Technologies from the defendants for $24,300,000. GP
Strategies seeks actual damages in the amount of $117,900,000 plus interest,
17
punitive damages in an amount to be determined at trial, and costs. Such damages
are subject to reduction by the amount recovered in the arbitration.
The complaint, which is pending in the New York State Supreme Court,
alleges that the defendants fraudulently induced GP Strategies to acquire
Learning Technologies by concealing the poor performance of Learning
Technologies' United Kingdom operation. 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, but with leave to the other defendants to renew, as described below.
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 $17,600,000 plus interest, are concluded. In a decision dated May 9,
2003, the court granted the motion and stayed the fraud action pending the
outcome of the arbitration.
The arbitration hearings began on May 17, 2004 and concluded on May 24,
2004 before JAMS, a private dispute resolution firm. On September 10, 2004, the
arbitrator issued an interim award in which she found that the sellers of
Learning Technologies breached certain representations and warranties contained
in the acquisition agreement. In a final award dated November 29, 2004, the
arbitrator awarded GP Strategies $12,273,575 in damages and $6,016,109 in
interest. On December 30, 2004, EDS made a payment of $18,427,684, which
included $138,000 of accrued interest, to GP Strategies to satisfy its
obligation under the arbitration award. The arbitration settlement, net of legal
fees and expenses was held in escrow as of December 31, 2004. EDS subsequently
agreed that the arbitration award is final and binding and that it will take no
steps of any kind to vacate or otherwise challenge the award.
As a result of the conclusion of the arbitration, the state court has
lifted the stay of the fraud claim against EDS. GP Strategies is now proceeding
with the fraud claim against EDS. On February 14, 2005, EDS filed a new motion
for summary judgment dismissing GP Strategies' fraud claim. GP Strategies
responded to the motion by March 17, 2005 and the motion was argued by the
parties on April 4, 2005. The fraud action against MCI had been stayed as a
result of the bankruptcy of MCI. In February 2004, the Bankruptcy Court lifted
the stay so that the state court could rule on the merits of MCI's summary
judgment motion. MCI has stated that it intends to ask the Bankruptcy Court to
reinstate the stay.
MXL and Five Star are 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.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
18
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock, $.01 par value, is quoted on the OTC Bulletin Board.
The high and low market prices since regular trading began on November 26, 2004
were $2.50 and $1.50, respectively.
The number of shareholders of record of the Common Stock as of March 29, 2005
was 1,967 and the closing price on the OTC Bulletin Board on that date was
$2.75.
The Company has not declared or paid any cash dividends on its Common Stock in
2004. The Company currently intends to retain future earnings to finance the
growth and development of its business
Equity Compensation Plan information as of December 31, 2004:
2003 Incentive Stock
Plan category Plan
Equity compensation plans not approved by security holders:
(a) Number of securities to be issued upon exercise
of outstanding options (1) -
(b) Weighted average exercise price of outstanding options (1) -
(c) Number of securities remaining available for future issuance under
equity compensation plans (excluding securities reflected in row (a)) (2) -
Equity compensation plans approved by security holders:
(a) Number of securities to be issued upon exercise
of outstanding options (1) -
(b) Weighted average exercise price of outstanding options (1) -
(c) Number of securities remaining available for future issuance under
equity compensation plans (excluding securities reflected in row (a)) (2) 1,750,000
(1) Does not include warrants to purchase 1,423,887 shares issued and sold to
four Gabelli funds in conjunction with GP Strategies 6% Conditional
Subordinated Notes due 2008 at an exercise price of $3.57 per share.
(2) Does not include shares of Common Stock that may be issued to directors of the Company as director's fees.
For a description of the material terms of the Company's 2003 Incentive Stock
Plan, see Note 11 to the notes to the Consolidated Financial Statements.
Directors of the Company who are not employees of the Company or its
subsidiaries receive an annual fee of $5,000, payable quarterly. At the option
of each director up to one-half of the annual fee could be paid in Common Stock.
In addition, the directors receive $1,000 for each meeting of the Board of
Directors attended, and generally do not receive any additional compensation for
service on the committees of the Board of Directors. Employees of the Company or
its subsidiaries do not receive additional compensation for serving as
directors.
19
Item 6: Selected Consolidated Financial Data (in thousands, except per share
data):
The selected financial data presented below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and the notes thereto
included elsewhere in this report. 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.
- ----------------------------------------- --------------------------------------------------------------------
Consolidated Statement of
Operations Data (1) Year Ended December 31,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
- ----------------------------------------- --------------- -------------- ----------- ------------ ------------
Sales $ 110,223 $103,698 $9,996 $11,184 $10,998
Gross Margin 20,069 19,582 2,099 2,816 2,888
Interest expense 1,098 864 208 169 102
Income (loss) before income taxes and
minority interest (3,111) 383 292 764 (1,468)
Net income (loss) (4,529) (104) 147 369 (960)
Net income (loss)
per share:
Basic and diluted $ (.25) $ (.01) $ .01 $ .03 $ (.08)
Consolidated Balance Sheet Data (1) December 31,
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
- --------------------------------------- -------------- ------------ ------------ ----------- ------------
- --------------------------------------- -------------- ------------ ------------ ----------- ------------
Cash and cash equivalents $ 2,087 $ 602 $ 562 $ 536 $ 627
Short-term borrowings 18,784 16,960 - - -
Working capital 14,028 10,565 3,954 14,139 10,866
Total assets 60,474 53,638 29,870 30,836 29,441
Long-term debt 1,395 3,203 2,670 2,875 59
Stockholders' equity 19,760 17,236 25,451 26,025 26,580
(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. The
acquisition of a controlling financial interest was accounted for as a
purchase transaction.
As a result of an issuer tender offer by Five Star, approximately 2,628,000
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.
20
Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations:
Results of Operations
General Overview
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. On
July 30, 2004 GP Strategies transferred to National Patent Development its
optical plastics business through its wholly-owned subsidiary, MXL; the home
improvement distribution business through its partially owned subsidiary Five
Star; and certain other non-core assets. The separation of these businesses was
accomplished through a pro-rata distribution (the "Distribution" or "spin-off")
of 100% of the outstanding common stock of National Patent Development to the
stockholders of GP Strategies on the record date of November 18, 2004 for the
Distribution. On November 24, 2004, holders of record received one share of
National Patent Development common stock for each share of GP Strategies common
stock or Class B capital stock owned.
The Company operates in two segments: MXL, which was formerly called
the Optical Plastics segment, and Five Star, which was formerly called the Home
Improvement Distribution segment. The Company also owns certain other non-core
assets, including an investment in a publicly held company, Millennium Cell; an
approximately 17.7% interest in a private company, Valera Pharmaceuticals; and
certain real estate. 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 $1.6 million as of December 31, 2004. Some of MXL's
21
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.
22
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 National Retail Hardware Association predicts
average annual industry growth of approximately 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 not increased at the same rate, 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, and as far south as North
Carolina, which has generated additional annual revenues of approximately $9
million since 2000. 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.
Consolidated Results of Operations
Year Ended December 31, 2004 compared to Year Ended December 31, 2003
National Patent Development had losses before income taxes and minority
interest of $3,111,000 for the year ended December 31, 2004 as compared to
income before income taxes and minority interest of $383,000 for the year ended
December 31, 2003. The decrease in profitability of $3,494,000 is primarily
related to the following factors: (i) increased selling, general and
administrative expenses of $1,695,000, partly due to higher allocation of
expenses from GP Strategies, higher MXL selling, general and administrative
expenses (ii) a loss on the write-down of the Illinois facility of $872,000 and
(iii) a decrease in investment and other income of $1,180,000, primarily due to
an impairment loss due to a decline in market value considered other-than
23
temporary of $1,081,000 on the National Patent Development investment in
Millennium Cell stock, in addition to a net loss on sales of stock of Millennium
Cell. The decrease was partially offset by a higher gross margin of $487,000
which increased in proportion with the increase in Five Star revenue.
Sales. For the year ended December 31, 2004, sales increased by
$6,525,000 from $103,698,000 for the year ended December 31, 2003 to
$110,223,000, due to increased Five Star sales of $6,897,000. 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. Sales were
favorably affected by clement weather in the Northeast during the year ended
December 31, 2004, causing an increase in home improvement projects.
The decrease in MXL sales of $372,000 was a result of a decrease in
sales from the Illinois and Lancaster facilities, primarily a result of market
fluctuations on tool purchases, lower levels of purchases from several key
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 decreases were offset by increased sales from MXL's
Massachusetts facility, which was purchased in September 2003.
Gross margin. For the year ended December 31, 2004, gross margin
increased by $487,000, or 2%, from $19,582,000, or 18.9% of sales, for the year
ended December 31, 2003 to $20,069,000, or 18.2% of sales, due to an increase in
Five Star gross margin, offset by a decrease in MXL gross margin.
The increase of $1,671,000, or 9%, in Five Star gross margin dollars
from $17,719,000 for the year ended December 31, 2003 to $19,389,000 for the
year ended December 31, 2004 was the result of increased sales and increased
gross margin percentage, offset in part by higher costs on purchases for the
period. Five Star gross margin as a percentage of sales increased from 18.6 %
for the year ended December 31, 2003 to 19.0% for the year ended December 31,
2004, mainly due to a favorable shift in the product mix sold, offset by an
increase in warehousing costs. Five Star includes warehousing expenses as part
of cost of goods sold.
MXL gross margin of $680,000 or 8.3% of sales, for the year ended
December 31, 2004 declined by $1,183,000, or 63%, from gross margin of
$1,863,000, or 21.6% of sales, for the year ended December 31, 2003. The
decrease in gross margin dollars and percentage is due to the following factors:
(i) the Massachusetts facility, which MXL has exited as of March 31, 2005,
experienced higher levels of manufacturing overhead, (ii) the Illinois facility
incurred certain cost associated with write-downs of inventory and equipment,
and (iii) the Lancaster facility experienced an increase in raw material costs.
Selling, general and administrative. For the year ended December 31,
2004, selling, general and administrative expenses increased by $1,695,000, or
9%, from $18,274,000 for the year ended December 31, 2003 to $19,969,000
partially due to increased allocations of GP Strategies corporate selling,
general and administrative expenses of $906,000. Five Star's selling, general
and administrative expenses increased by $494,000 primarily due to increased
24
delivery expenses, salesmen commissions, medical expenses and legal and
professional fees. MXL's selling, general and administrative expenses increased
by $307,000 primarily due to increased salaries and employee benefits, as well
as rent associated with MXL's Massachusetts facility.
Loss on write-down of the Illinois facility. In the fourth quarter
2004, MXL began to explore the divestiture of its Illinois facility as a result
of a decline in production volume for the Illinois division and taking into
consideration MXL's diminished real estate needs. In accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets, assets held for
sale are reported at the lower of the carrying amount or fair value, less costs
to sell. The Company recognized a charge of $872,000 to record the Illinois
facility assets at fair value of $1,595,000, based upon the expected net
proceeds from the sale of the Illinois facility.
Investment (loss) and other income, net. National Patent Development
incurred investment and other losses of $1,241,000 for the year ended December
31, 2004 mainly due an impairment loss due to a decline in market value
considered other-than temporary of $1,081,000 on National Patent Development
investment in Millennium Cell stock, as well as to a net loss of $131,000 on
sales of Millennium and HEB stock, as compared to other loss of $61,000 for the
year ended December 31, 2003, mainly due to a net loss on sales of Millennium
and HEB stock.
Income taxes. National Patent Development had an effective tax rate of
31.6% and 46% for the year ended December 31, 2004 and December 31, 2003,
respectively. The rate was primarily due to operating losses of MXL unable to be
utilized on a stand-alone basis in 2004, 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
25
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.
26
Liquidity and Capital Resources
At December 31, 2004, National Patent Development had cash and cash
equivalents totaling $2,087,000, 964,771 shares of common stock of Millennium
Cell with a market value of $1,235,000 and a receivable from GP Strategies of
$5,000,000, which was collected in January 2005. 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 year ended December 31, 2004, National Patent Development's
working capital increased by $3,463,000 to $14,028,000 from $10,565,000 as of
December 31, 2003. The working capital increase was primarily a result of
capital contributions from GP Strategies; offset by a net loss for the period,
additions to property, plant and equipment, and repayment of long term debt.
The increase in cash and cash equivalents of $1,485,000 for the year
ended December 31, 2004 resulted from net cash used in operations of $641,000;
cash used in investing activities of $1,542,000, consisting of additions to
property, plant and equipment of $458,000, acquisition of minority interest in
Five Star Products pursuant to the tender offer of $657,000 and additions to
investments of $1,590,000, offset by proceeds on sale of investments of
$1,013,000 and cash repayment of the receivable from GPS of $150,000; and cash
provided by financing activities of $3,668,000, consisting of capital
contributions from GPS of $1,951,000, proceeds of borrowings of $3,139,000,
offset by repayments of long-term debt of $414,000 and distributions to GP
Strategies of $1,008,000.
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 December 31, 2004, $1,305,000 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 December 31, 2004, $1,155,000 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. As of December 31, 2004, the mortgage has been
classified separately in the balance sheet as a current liability, as a result
of the classification of the Illinois property as held for sale.
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
27
$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. MXL is currently negotiating a
reduction in the amounts due under the AOtec Notes with maturity dates of August
5, 2004 and 2005, resulting from a dispute over the purchase price. According to
the contract of sale, the payments due pursuant to the AOtec Notes were subject
to an offset and withholding by MXL. The parties are attempting to resolve this
matter; however there is no guarantee that MXL will successfully negotiate the
reduction of the AOtec notes. The AOtec Notes, which amount to $550,000 in the
aggregate following a repayment of $450,000 of the AOtec Notes in October 2003,
are included in short-term borrowings in the consolidated December 31, 2004
balance sheet.
On June 20, 2003, Five Star obtained a Loan and Security Agreement (the
"Loan Agreement") with Bank of America (formerly Fleet Capital Corporation) (the
"Lender"). The Loan Agreement has a five-year term, with a maturity date of June
30, 2008. The Loan Agreement, as amended on May 28, 2004, provides for a
$28,000,000 revolving credit facility, which allows Five Star 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 Loan Agreement
consist of LIBOR plus a credit spread of 2% (4.28% at December 31, 2004) for
borrowings not to exceed $15,000,000 and the prime rate (5.25% at December 31,
2004) 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 December 31, 2004, approximately
$18,234,000 was outstanding under the Loan Agreement and approximately $434,000
was available to be borrowed.
In March 2005, Five Star amended the Loan Agreement to allow it to
increase the maximum amount that can be borrowed under the revolving credit
facility to $30,000,000 through June 30, 2005; reverting back to a maximum of
$28,000,000 on July 1, 2005.
In connection with the Loan Agreement, Five Star also entered into a
derivative transaction with the Lender on June 20, 2003. The derivative
transaction is an interest rate swap and 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 the Lender on notional principal of $12,000,000. In
return, the Lender will pay to Five Star 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%.
On June 17, 2004, Five Star has also entered into a derivative interest
rate collar transaction during the period from July 1, 2004 through June 30,
2008 on notional principal of $12,000,000. The transaction consists of an
interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender will
pay to Five Star the difference between LIBOR and 2.25%, on the same notional
principal amount. The transaction also consists of an interest rate cap of
5.75%, whereas if LIBOR is above 5.75%, Five Star will pay to the Lender the
difference between LIBOR and 5.75%, on the same notional principal amount.
As of December 31, 2003 MXL provided security for General Physics'
Financing and Security Agreement. The Financing and Security Agreement provides
28
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 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 GP Strategies' common stock. The aggregate
purchase price for the Notes and GP Warrants was $7,500,000. GP Strategies
agreed to allocate to National Patent Development $1,875,000 of the $7,500,000
received for the Notes and Warrants (the "Gabelli Allocation"). National Patent
Development received the funds pursuant to the Gabelli Allocation prior to the
spin-off.
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 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
Notes, GP Strategies has agreed to indemnify MXL for loss of the value of the
Property.
The Note and Warrant Purchase Agreement provided that, on completion of
the spin-off, National Patent Development would issue warrants ("National Patent
Development Warrants") to the holders of the GP Warrants. The National Patent
Development Warrants 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. An aggregate
of 1,423,887 National Patent Development Warrants were issued to the holders of
the GP Warrants on December 4, 2004, 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 is
$3.57, which represents 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 are
exercisable at any time 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 GP Strategies to the holders of the GP Warrants.
29
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. 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.
On March 1, 2005, MXL obtained a Line of Credit Loan (the "MXL Line")
from M&T Bank with a one year term, maturing on March 1, 2006. The MXL Line
provides for a $1,000,000 revolving credit facility, which is secured by MXL's
eligible accounts receivable, inventory and a secondary claim on the Lancaster,
PA property. The interest rates under the MXL Line consist of LIBOR plus a
credit spread of 3% or the prime rate plus a credit spread of 0.25%. The MXL
Line is subject to an unused commitment fee of 0.25% of the average daily unused
balance of the line payable quarterly. National Patent Development has
guaranteed the MXL Line.
Contractual Obligations and Commitments
The following table summarizes operating lease commitments and
employment agreements as of December 31, 2004 (in thousands):
Payments due in
2005 2006-2007 2008-2009 After 2009 Total
---- --------- --------- ---------- -----
Operating lease commitments 2,267 2,955 340 - 5,562
Employment agreements 938 150 - - 1,088
------- -------- ----------- ------- -------
Total $ 3,205 $ 3,105 $340 $ - $6,650
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 2 to the Consolidated Financial
Statements, includes further discussion of our significant accounting policies.
30
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 2.6% and 6.3% at December 31,
2004 and December 31, 2003, 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 December 31, 2004, National Patent Development holds undeveloped
land in Pawling, New York with a carrying amount of approximately $2.5 million
and in East Killingly, Connecticut with a carrying amount of approximately $0.4
million, which management believes is less than its fair value, less cost of
sale.
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 stockholders'
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 an impairment
loss of $1,081,000 in 2004 on its marketable security investment in Millennium
Cell. Management determined the loss to be other than a temporary decline.
On October 8, 2003 National Patent Development acquired additional
shares of Five Star, bringing its ownership to 54%. Five Star is consolidated
31
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 and 2,068,966 shares of the Series B convertible
preferred stock (a17.7% ownership interest, assuming conversion of Valera
outstanding preferred stock and exercise of stock options held by employees of
Valera) 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's Series B convertible preferred stock under the cost
method.
Recent accounting pronouncements
During December 2004, the Financial Accounting Standards Board ("FASB")
issued a new standard entitled Statement of Financial Accounting Standards
("SFAS") 123R, Share-Based Payment, which would revise SFAS No. 123, Accounting
for Stock Based Compensation, and amend SFAS No. 95, Statement of Cash Flows.
Among other items, the new standard would require the expensing, in the
financial statements, of stock options issued by the Company. The new standard
will be effective July 1, 2005, for calendar year companies. The Company is
currently evaluating the method of adoption of SFAS No. 123R, including the
valuation methods and assumptions that underlie the valuation of the awards. As
permitted under SFAS No. 123 the Company currently accounts for share-based
payments to employees using Accounting Principles Board ("APB") Opinion No. 25
intrinsic value method, and as such, recognizes no compensation cost for
employee stock options. Accordingly the adoption of SFAS No. 123R fair value
method could have a significant impact on the Company's results of operations,
although it will have no impact on the Company's overall financial position. The
impact of adoption of SFAS No. 123R cannot be predicted at this time, because it
will depend on levels of share-based payments in the future. However had the
Company adopted SFAS No. 123R in prior periods, the impact of that statement
would have approximated the impact of SFAS No. 123 as described in the
disclosure of pro forma net income and earnings per share shown in Note 2 under
"Stock based compensation"
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment to ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research
Bulleting No. 43, to clarify that abnormal amounts of idle facility expense,
freight, handling costs and wasted material (spoilage) should be recognized as
current period charges. In addition, FAS 151 requires that allocation of fixed
production overhead to inventory be based on the normal capacity of the
production facilities. The Company is required to adopt FAS 151 beginning
January 1, 2006. The Company is currently assessing the impact that FAS 151 will
have on its results of operations, financial position or cash flows.
32
Item 7a: 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.
As of December 31, 2004, the Company had approximately $7.5 million of
variable rate borrowings. The Company estimates that for every 1% fluctuation in
general interest rates, assuming debt levels at December 31, 2004, interest
expense would vary by $75,000.
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 Five Star's exposure to fluctuations in LIBOR. Changes in
the fair value of the interest rate swap are recognized in 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 the Lender on notional principal of $12,000,000.
In return, the Lender will pay to Five Star 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%.
On June 17, 2004, Five Star has also entered into a derivative interest
rate collar transaction during the period from July 1, 2004 through June 30,
2008 on notional principal of $12,000,000. The transaction consists of an
interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender will
pay to Five Star the difference between LIBOR and 2.25%, on the same notional
principal amount. The transaction also consists of an interest rate cap of
5.75%, whereas if LIBOR is above 5.75%, Five Star will pay to the Lender the
difference between LIBOR and 5.75%, on the same notional principal amount.
33
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
National Patent Development Corporation
Page
Report of Independent Registered Public Accounting Firm 35
Consolidated Statements of Operations - Years ended December 31,
2004, 2003 and 2002 36
Consolidated Statements of Comprehensive Income (Loss) - Years
ended December 31, 2004, 2003 and 2002 36
Consolidated Balance Sheets - December 31, 2004 and 2003 37
Consolidated Statements of Cash Flows - Years ended December 31,
2004, 2003 and 2002 38
Consolidated Statements of Changes in Stockholders' Equity - Years
ended December 31, 2004, 2003 and 2002 40
Notes to Consolidated Financial Statements 42
34
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders 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, 2004
and 2003 and the related consolidated statements of operations, comprehensive
loss, cash flows and stockholders' equity for each of the years in the three
year period ended December 31, 2004. 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 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, 2004 and 2003, and
the consolidated results of their operations and their cash flows for each of
the years in the three year period ended December 31, 2004, in conformity with
accounting principles generally accepted in the Unites States of America.
EISNER LLP
New York, New York
March 22, 2005
35
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
2004 2003 2002
----------------------------------------------------- ---------------- --------------- ---------------
Sales $110,223 $103,698 $ 9,996
Cost of sales 90,154 84,116 7,897
----------------------------------------------------- ---------------- --------------- ---------------
Gross margin 20,069 19,582 2,099
----------------------------------------------------- ---------------- --------------- ---------------
Selling, general and administrative expenses (19,969) (18,274) (2,047)
Loss on write-down of Illinois property (872) - -
Income related to equity investee - - 439
----------------------------------------------------- ---------------- --------------- ---------------
Operating profit (loss) (772) 1,308 491
----------------------------------------------------- ---------------- --------------- ---------------
Interest expense (1,098) (864) (208)
Investment and other income (loss) (1,241) (61) 9
----------------------------------------------------- ---------------- --------------- ---------------
Income (loss) before income taxes (3,111) 383 292
and minority interest
----------------------------------------------------- ---------------- --------------- ---------------
Income tax expense 982 176 145
----------------------------------------------------- ---------------- --------------- ---------------
Income (loss) before minority interest (4,093) 207 147
----------------------------------------------------- ---------------- --------------- ---------------
Minority interest (436) (311)
----------------------------------------------------- ---------------- --------------- ---------------
Net income (loss) (4,529) $ (104) $ 147
----------------------------------------------------- ---------------- --------------- ---------------
Net income (loss) per share
Basic and diluted $ (.25) $ (.01) $ .01
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
Year Ended December 31,
2004 2003 2002
------------------------------------------------------------ --------------- -------------- -------------
------------------------------------------------------------ --------------- -------------- -------------
Net income (loss) $ (4,529) $ (104) $ 147
Other comprehensive income (loss), before tax:
Net unrealized loss on available-for-sale-securities
(1,067) (902) (833)
Reclassification adjustment for loss on securities sold
included in net loss 173 - -
Reclassification adjustment for impairment loss on
securities included in net loss 1,081 - -
Net unrealized gain on interest rate swap, net of minority
interest 31 43
------------------------------------------------------------ --------------- -------------- -------------
------------------------------------------------------------ --------------- -------------- -------------
Comprehensive loss before tax (4,311) (963) (686)
------------------------------------------------------------ --------------- -------------- -------------
------------------------------------------------------------ --------------- -------------- -------------
Income tax benefit (expense) related to items of other
comprehensive loss (19) 116 325
------------------------------------------------------------ --------------- -------------- -------------
------------------------------------------------------------ --------------- -------------- -------------
Comprehensive loss $(4,330) $(847) $ (361)
------------------------------------------------------------ --------------- -------------- -------------
See accompanying notes to consolidated financial statements.
36
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
2004 2003
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Assets
Current assets
Cash and cash equivalents $ 2,087 $ 602
Accounts and other receivables, less allowance
for doubtful accounts of $306 and $739 11,410 11,082
Inventories 30,698 28,300
Receivable from GP Strategies Corporation 5,000 709
Deferred tax asset 172 80
Prepaid expenses and other current assets 358 845
Property held for sale 1,595
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Total current assets 51,320 41,618
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Marketable securities available for sale 1,416 2,981
Investment in Valera 1,590 -
Property, plant and equipment, net 2,876 5,725
Goodwill 182 182
Other assets 3,090 3,132
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Total assets $60,474 $53,638
- --------------------------------------------------------------------------- ------------------ ------------------
Liabilities and stockholders' equity
Current liabilities
Current maturities of long-term debt $ 1,967 $ 389
Short term borrowings 18,784 16,960
Accounts payable and accrued expenses 15,386 13,704
Mortgage collateralized by property held for sale 1,155
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Total current liabilities 37,292 31,053
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Long-term debt less current maturities 1,395 3,203
Deferred tax liability 239 102
Interest rate collar, at market 19 -
Minority interest 1,769 2,044
Stockholders' equity
Preferred stock, par value $0.01 per share
authorized 10,000,000 shares; issued none - -
Common stock, par value $0.01 per share
authorized 30,000,000 shares; issued 17,798,585 shares 178 178
Additional paid-in capital 24,761 17,946
Accumulated deficit (4,843) (353)
Accumulated other comprehensive loss (336) (535)
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
Total stockholders' equity 19,760 17,236
- --------------------------------------------------------------------------- ------------------ ------------------
- --------------------------------------------------------------------------- ------------------ ------------------
$60,474 $53,638
- --------------------------------------------------------------------------- ------------------ ------------------
See accompanying notes to consolidated financial statements.
37
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year ended December 31,
2004 2003 2002
------------------------------------------------------------------- ------------- ------------- -------------
------------------------------------------------------------------- ------------- ------------- -------------
Cash flows from operations:
Net income (loss) $(4,529) $(104) $147
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 726 593 510
Minority Interest 436 48 -
Income related to equity investee, prior to acquiring a
controlling financial interest - (256) (55)
Net loss on marketable securities 131 36 -
Impairment charge on securities 1,081
Loss on write-off of equipment 83 - -
Loss on write-down of Illinois property 872 - -
Deferred income taxes 53 (296) 77
Allocation of expenses and taxes from GP Strategies 1,470 1,150 593
Changes in other operating items:
Accounts and other receivables (328) 4,730 (293)
Inventories (2,398) (6,348) 354
Prepaid expenses and other assets 80 225 (69)
Accounts payable and accrued expenses 1,682 2,917 147
------------------------------------------------------------------- ------------- ------------- -------------
Net cash provided by (used in) operations (641) 2,695 $1,411
------------------------------------------------------------------- ------------- ------------- -------------
Cash flows from investing activities:
Additions to property, plant and equipment, net (458) (525) $(368)
Proceeds from sales of fixed assets - 203 -
Proceeds from sale of investments 1,013 521 -
Advances to GP Strategies (882) (1,310) (400)
Repayment of receivable from GP Strategies 1,032 - -
Additions to investments (1,590) - -
Payments for acquisition of AOtec assets, net of
cash ($6) acquired in Five Star acquisition - (544) -
Acquisition of minority interest in Five Star Products pursuant
to the tender offer (657) - -
Repayment of note from Five Star Products - 1,000 -
Recovery of investment in Five Star Products - 475 33
------------------------------------------------------------------- ------------- ------------- -------------
Net cash used in investing activities (1,542) (180) $(735)
------------------------------------------------------------------- ------------- ------------- -------------
See accompanying notes to consolidated financial statements.
38
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year ended December 31,
2004 2003 2002
------------------------------------------------------------------- ------------- -------------- ------------
------------------------------------------------------------------- ------------- -------------- ------------
Cash flows from financing activities:
Distributions to GP Strategies (1,008) (1,985) (360)
Contribution from GP Strategies 1,951 - -
Proceeds from issuance of long-term debt 1,590 700 -
Proceeds from (repayment of)
short-term borrowings 1,549 (932) -
Repayment of long-term debt (414) (258) (290)
------------------------------------------------------------------- ------------- -------------- ------------
------------------------------------------------------------------- ------------- -------------- ------------
Net cash (used in) provided by financing activities 3,668 (2,475) (650)
------------------------------------------------------------------- ------------- -------------- ------------
------------------------------------------------------------------- ------------- -------------- ------------
Net increase in cash and cash equivalents 1,485 40 26
Cash and cash equivalents at beginning of period 602 562 536
------------------------------------------------------------------- ------------- -------------- ------------
Cash and cash equivalents at end of period $2,087 $602 $562
------------------------------------------------------------------- ------------- -------------- ------------
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 1,190 $ 398 $ 208
Income taxes 524 201 2
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
Non-cash financing activities:
Capital contribution receivable from GP Strategies 5,000
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.
39
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(in thousands)
Accumulated
Common Additional Retained other Total
Stock paid-in earnings comprehensive stockholders'
$(.01 Par) capital (deficit) income (loss) equity
- ----------------------------------------------- ------------- ------------------- ------------- ------------------- ----------------
Balance at December 31, 2001 $178 $18,432 $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 $178 $18,387 $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 $178 $17,946 $(353) $(535) $17,236
- ----------------------------------------------- ------------- ------------------- ------------- ------------------- ----------------
(a) Principally represents net income (loss) attributable to non-core assets not
operated as separate entities.
See accompanying notes to consolidated financial statements.
40
(Continued)
NATIONAL PATENT DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(in thousands)
Accumulated
Common Additional other Total
Stock paid-in Accumulated comprehensive stockholders'
$(.01 Par) capital deficit income (loss) equity
- -------------------------------------------- ---------------- ---------------- ------------------ ------------------- --------------
Balance at December 31, 2003 $178 $17,946 $(353) $(535) $17,236
- -------------------------------------------- ---------------- ---------------- ------------------ ------------------- --------------
Net unrealized loss on available
for sale securities (1,067) (1,067)
Reclassification adjustment for
loss on securities sold included
in net loss, net of tax 173 173
Net unrealized gain on interest
rate swap, net of tax
and minority interest 12 12
Reclassification adjustment for
impairment loss on securities
included in net loss 1,081 1,081
Net loss (4,529) (4,529)
Allocation of expenses
from GP Strategies 911 911
Reclassification (a) (39) 39 -
Distributions to GP Strategies (1,008) (1,008)
Contributions from GP Strategies 6,951 6,951
- -------------------------------------------- ---------------- ---------------- ------------------ ------------------- --------------
Balance at December 31, 2004 $178 $24,761 $(4,843) $(336) $19,760
- -------------------------------------------- ---------------- ---------------- ------------------ ------------------- --------------
(a) Principally represents net income (loss) attributable to non-core assets not
operated as separate entities.
See accompanying notes to consolidated financial statements.
41
NATIONAL PATENT DEVELOPMENT CORPORATION
Notes to Consolidated Financial Statements
1. The Company and basis of presentation
National Patent Development Corporation ("National Patent Development" or the
"Company") was incorporated on March 10, 1998 as a wholly-owned subsidiary of GP
Strategies Corporation ("GPS" or "GP Strategies"). In July 2002, the Board of
Directors of GPS approved a spin-off of certain of its non-core assets into
National Patent Development and a pro-rata distribution (the "Distribution" or
"spin-off") of 100% of the outstanding common stock of National Patent
Development to the stockholders of GPS. On March 21, 2003, the Internal Revenue
Service issued a favorable tax ruling which would enable the Distribution to be
tax-free.
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
17,769,919 shares of common stock:
1. 100% of the outstanding common stock of MXL Industries, Inc. ("MXL").
2. 9,133,417 common shares of Five Star Products, Inc. ("Five Star") (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 (see Note 2).
8. 100% of the common stock of Chestnut Hill Reservoir Company whose sole
asset is certain undeveloped property located in East Killingly,
Connecticut (see Note 2).
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, in 2004 GPS made a capital contribution to National
Patent Development, which in turn transferred to MXL, $1,875,000 in cash,
representing an allocation of the proceeds received by GPS when it issued and
sold to four Gabelli funds $7,500,000 aggregate principal amount of 6%
42
Conditional Subordinated Notes due 2008 (see Note 16(b)). On July 30, 2004 GPS
also agreed to make an additional capital contribution to National Patent
Development out of certain proceeds of pending litigation and arbitration claims
(see Note 15).
As a result of the contribution, the Company owns and operates the optical
plastics business through its wholly-owned subsidiary, MXL, the home improvement
distribution business through its partially owned subsidiary Five Star and also
owns certain other non-core assets. GP Strategies continues to own and operate
its wholly-owned subsidiary, General Physics Corporation, and retains a 58%
interest in GSE Systems Inc. The separation of these businesses was accomplished
through the Distribution on November 24, 2004 of 17,798,585 common shares of
National Patent Development, representing 100% of the outstanding common stock
of National Patent Development to the stockholders of GPS on the record date of
November 18, 2004 on the basis of one share of National Patent Development
common stock for each share of GP Strategies common stock or Class B capital
stock owned. The shares distributed reflect 28,666 additional common shares
issued by National Patent Development to GPS in connection with the exchange
based on an increase in outstanding common stock of GPS between the date of the
exchange and the record date.
The contribution of assets from GPS to the Company represents a transfer of
assets between entities under common control and accordingly has been accounted
for at the carryover basis to GPS of the transferred assets as if the transfer
occurred at the beginning of the periods presented. Accordingly, the
accompanying consolidated financial statements present the historical results of
operations, cash flows, assets, liabilities and changes in stockholders' equity
of MXL combined with the non-core assets and their effect on results of
operations and cash flows for 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, 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. 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 December 31, 2004 and December 31, 2003 reflected in the
43
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.
The Company owns 100% of the common stock and 2,068,966 shares of Series B
convertible preferred stock of Valera Pharmaceuticals, Inc. ("Valera") (which
amounts to a 17.7% 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.
Accordingly, the Company accounts for its investment in Valera under the cost
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 to 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 consisted of the common stock of Hemispherx Biopharma, Inc.,
were included in other current assets at December 31, 2003. National Patent
Development fully disposed of its trading securities in the year ended December
31, 2004.
Inventories. Inventories are valued at the lower of cost or market, using the
first-in, first-out method.
44
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.
Reclassifications. Certain prior year amounts in the financial statements and
notes thereto have been reclassified to conform to 2004 classifications.
Shipping and handling costs. Shipping and handling costs, which are included as
a part of selling, general and administrative expense, amounted to $4,840,000,
$4,514,000 and $82,000 for the years ended December 31, 2004, 2003 and 2002,
respectively.
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 in Pawling, New York with a carrying value
of $2.5 million and in East Killingly, Connecticut with a carrying value of $0.4
million, which are included in other assets in the Consolidated Balance Sheets
(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. Derivative instruments
are carried at fair value representing the amount the Company would receive or
pay to terminate the derivative.
45
Derivatives and hedging activities. The interest rate swap and interest rate
collar entered into by the Five Star in connection with its loan agreement (see
Note 9) 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. Changes in the fair value of the interest rate
collar are recognized in earnings. Such change from June 17, 2004, the date the
interest rate collar was entered into, through December 31, 2004 amount to
approximately $19,000, which has been charged to earnings during the year ended
December 31, 2004.
Recent Accounting Pronouncements. During December 2004, the Financial Accounting
Standards Board ("FASB") issued a new standard entitled Statement of Financial
Accounting Standards ("SFAS") 123R, Share-Based Payment, which would revise SFAS
No. 123, Accounting for Stock Based Compensation, and amend SFAS No. 95,
Statement of Cash Flows. Among other items, the new standard would require the
expensing, in the financial statements, of stock options issued by the Company.
The new standard will be effective July 1, 2005, for calendar year companies.
The Company is currently evaluating the method of adoption of SFAS No. 123R,
including the valuation methods and assumptions that underlie the valuation of
the awards. As permitted under SFAS No. 123 the Company currently accounts for
share-based payments to employees using Accounting Principles Board ("APB")
Opinion No. 25 intrinsic value method, and as such, recognizes no compensation
cost for employee stock options. Accordingly the adoption of SFAS No. 123R's
fair value method could have a significant impact on the Company's results of
operations, although it will have no impact on the Company's overall financial
position. The impact of adoption of SFAS No. 123R cannot be predicted at this
time, because it will depend on levels of share-based payments in the future.
However had the Company adopted SFAS No. 123R in prior periods, the impact of
that statement would have approximated the impact of SFAS No. 123 as described
in the disclosure of pro forma net income and earnings per share shown below
under "Stock based compensation"
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment to
ARB No. 43, Chapter 4 (FAS 151). FAS 151 amends Accounting Research Bulleting
No. 43, to clarify that abnormal amounts of idle facility expense, freight,
handling costs and wasted material (spoilage) should be recognized as current
period charges. In addition, FAS 151 requires that allocation of fixed
production overhead to inventory be based on the normal capacity of the
production facilities. The Company is required to adopt FAS 151 beginning
January 1, 2006. The Company is currently assessing the impact that FAS 151 will
have on its results of operations, financial position or cash flows.
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 be granted under its own plan as well as 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
46
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.
As of December 31, 2004, no options have been granted under the Company's plan.
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 loss and loss per share disclosures as if compensation expense was
recorded based on the fair value of options granted under the Five Star plan
(see Note 11) have been presented in accordance with the provisions of SFAS No.
123, is as follows for the years December 31, 2004 and 2003 (in thousands,
except per share amounts):
Year ended December 31,
2004 2003
------------------------------------------------------------ ------------------------ ---------------------
Net loss - As reported $(4,529) $(104)
Compensation expense, net of tax
Five Star stock options (7) (1) (10) (1)
------------------------- ---------------------------------- ------------------------ ---------------------
Pro forma net loss $(4,536) $ (114)
Basic and diluted loss per share
As reported $(.25) $ (.01)
Pro forma $(.25) $ (.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.
Per share data. Basic and diluted income (loss) per share is based upon the
17,798,585 common shares of National Patent Development issued in 2004 and
distributed in the spin-off described in Note 1, which are treated as
outstanding for all periods presented.
Outstanding warrants to acquire 1,423,887 common shares issued in December 2004
(see Note 16 (b) were not included in the 2004 diluted computation as their
effect would be anti-dilutive.
47
Income (loss) per share for the years ended December 31, 2004, 2003 and 2002 is
as follows (in thousands, except per share amounts):
Year ended December 31,
2003 2003 2002
-------------------------------------------- -------------- ------------- ----------
Basic and Diluted EPS
Net income (loss) $(4,529) $(104) $147
Weighted average shares
outstanding, basic and diluted 17,798 17,798 17,798
Basic and diluted income (loss) per share $(.25) $(.01) $.01
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 10).
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.
48
Accumulated other comprehensive loss. The components of accumulated other
comprehensive loss are as follows (in thousands):
December 31,
2004 2003
--------------------------------------------------------- ---------------------- -------------------
--------------------------------------------------------- ---------------------- -------------------
Net unrealized loss on
available-for-sale-securities $ (375) $ (567)
Net unrealized gain on interest rate swap 67 46
--------------------------------------------------------- ---------------------- -------------------
--------------------------------------------------------- ---------------------- -------------------
Accumulated other comprehensive
loss before tax (308) (521)
--------------------------------------------------------- ---------------------- -------------------
--------------------------------------------------------- ---------------------- -------------------
Accumulated income tax expense
related to items of other comprehensive loss (28) (14)
--------------------------------------------------------- ---------------------- -------------------
--------------------------------------------------------- ---------------------- -------------------
Accumulated other comprehensive
loss, net of tax $ (336) $ (535)
3. Inventories
Inventories are comprised of the following (in thousands):
December 31,
2004 2003
----------------------------- ------------------- ------------------
Raw materials 753 921
Work in process 277 383
Finished goods 29,668 26,996
----------------------------- ------------------- ------------------
----------------------------- ------------------- ------------------
$30,698 $28,300
4. Investment in Valera Pharmaceuticals, Inc. ("Valera")
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 histrelin, a
synthetic nonapeptide agonist of luteinizing hormone-releasing hormone (LHRH).
LHRH agonists have become a mainstay in treating locally advanced and metastatic
prostate cancer. On October 13, 2004, Valera announced that the FDA approved the
marketing of Vantas(TM), the name for Valera's long-acting LHRH implant for
treating prostate cancer. 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
49
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 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, who
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.
The Company exercised such option on October 28, 2004 at a price of $0.7685 per
share, for an aggregate exercise price of $1,590,000. On November 12, 2004 the
Company obtained the funds necessary to pay the exercise price (see Note 14(d)).
On August 16, 2004 Valera sold 11,600,000 shares of Series C convertible
preferred stock and received gross proceeds of $11.6 million. On March 14, 2005
Valera registered with the Securities and Exchange Commission for an initial
public offering of up to approximately $75 million of common stock.
The Series A preferred stock, Series B preferred stock and Series C preferred
stock, 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 A, B and C preferred stock accrue cumulative dividends at the rate of 6%,
10% and 6%, respectively, of the 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. If the initial public
offering is completed under the terms presently anticipated, all the convertible
preferred stock outstanding at the time of the offering, including accrued
dividends, will automatically convert into common stock. Assuming conversion of
all of the outstanding shares of Series A, Series B and Series C convertible
preferred stock and exercise of stock options held by employees of Valera at
December 31, 2004, the Company would own approximately 17.7% of Valera. Such
percentage will be further reduced upon successful completion of the public
offering.
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 was accounting for
its investment in Valera under the equity method. However as the Company had not
guaranteed obligations of Valera and had not otherwise committed to provide
further support for Valera, it had discontinued recognizing additional losses of
Valera.
As described above, the Company's investment in voting stock of Valera has
declined below 20% and is anticipated to decrease further upon completion of
Valera's initial public offering. In addition, at December 31, 2004 Valera's
50
board of directors consists of nine directors only one of which has been
designated by the Company. Accordingly the Company believes that it no longer
has the ability to exercise significant influence over operating and financial
policies of Valera and will no longer account for its investment in Valera by
the equity method. As a result thereof, the investment in Valera's Series B
convertible preferred stock is being accounted for at cost.
5. Marketable securities
Marketable securities, which are carried at market value, were comprised of the
following (in thousands):
Available-for-sale securities
December 31,
2004 2003
--------------------------------------------- ------------- ------------
Millennium Cell Inc. $1,235 $2,769
Avenue Entertainment Group, Inc. 181 212
-------- --------
$1,416 $2,981
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, Company held 293,271 shares of Millennium with a
market value of $698,000 and $1,531,000, respectively, and unrealized gains of
$341,000 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 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. During the year ended December 31, 2004, the Company sold 223,500
shares of Millennium shares received in October 2003 for $609,000 and recognized
a loss of $173,000, which is included in Investment and other income (loss). At
December 31, 2004, the Company held 964,771 shares of common stock of Millennium
with a market value of $1,235,000, representing approximately a 3% ownership
interest, and an unrealized loss of $499,000 reflecting further unrealized
losses during the year ended December 31, 2004, after recognition of an
impairment loss described below.
At December 31, 2003 the Company believed that the reduction in market value of
Millennium correlated with the general trend of the market for emerging
technology companies and reflected the volatility of Millennium's stock price.
The Company had 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
51
time sufficient for a forecasted recovery of fair value, the Company did not
consider its investment in Millennium to be other-than-temporarily impaired.
However, at June 30, 2004, based on the increase in the severity and duration of
the impairment and the absence of sufficient evidence to support a recovery of
fair value within a reasonable period of time, the Company considered the
investment in the 671,500 remaining shares acquired in October 2003 to be
other-than-temporarily impaired and accordingly has recorded an impairment loss
of $1,081,000 related to such shares in Investment and other income (loss) in
the year ended December 31, 2004.
As of March 22, 2005, the market value of the 964,771 shares of Millennium
common stock was approximately $2,007,000, representing a recovery of the
unrealized loss at December 31, 2004.
Avenue Entertainment Group, Inc ("Avenue")
The Company owns 1,067,900 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. As of
December 31, 2004 and 2003 the market value of Avenue approximated $181,000 and
$212,000, respectively, resulting in an unrealized gain of $124,000 and
$154,000, 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 at December 31, 2003 were classified as trading
securities. 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. For the year
ended December 31, 2004 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
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 cash and 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
52
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.
Pursuant to the provisions of the Subordination Agreement, in 2003 Five Star
made principal payments on the Five Star Note to GP Strategies in the amounts of
$1,000,000 prior to the exchange referred to below and $200,000 after such
exchange. 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 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 transferred the Five Star Note with an outstanding
balance of $2,800,000 to National Patent Development (see Note 1); accordingly
the Five Star Note has been eliminated from the consolidated balance sheet as of
December 31, 2004 and December 31, 2003 as an intercompany balance.
The Company accounted for its investment in Five Star using the equity method
prior to obtaining a controlling financial interest. In 2003 and 2002, the
Company received $475,000 and $33,000, respectively, representing a recovery of
a portion of its investment in Five Star.
Information relating to the Company's investment in Five Star for the year ended
December 31, 2002 is as follows (in thousands):
2002
Interest income on note (1) $ 384
Equity interest in net income (2) $ 55
(1) Included in income related to equity investee.
53
(2) Net of depreciation of property, plant and equipment (attributable to
excess of the carrying value of investment in Five Star over underlying
equity in its net assets) of $107,000. Effective January 1, 2002, upon
adoption of FASB Statement No. 142, amortization of goodwill ceased
(see Note 8).
Condensed financial information for Five Star for the year ended December 31,
2002 is as follows (in thousands):
2002
----
Sales $94,074
Gross profit 16,613
Net income 391
As described above, 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 is a separate segment of the Company, formerly
called the 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
- ------------------------------------------------------------ -------------
54
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 would 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.
Effective as of such date, approximately 2,627,790 shares of common stock were
tendered and acquired by Five Star at a cost of $657,000. The effect of the
tender offer increased 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 December 31, 2004.
7. Property, plant and equipment
Property, plant and equipment consist of the following (in thousands):
December 31,
2004 2003
-------------------------------------------------------- ------------------ -------------------
Land $ 90 $ 915
Buildings and improvements 2,383 4,228
Machinery and equipment 7,910 7,755
Furniture and fixtures 1,294 1,071
------------------ -------------------
------------------ -------------------
11,677 13,969
------------------ -------------------
------------------ -------------------
Accumulated depreciation and amortization (8,801) (8,244)
------------------ -------------------
------------------ -------------------
$ 2,876 $ 5,725
Depreciation and amortization expense for the years ended December 31, 2004,
2003 and 2002 amounted was $726,000, $593,000 and $510,000, respectively.
In the fourth quarter 2004, management decided to sell MXL's Illinois facility
as a result of a decline in production volume for the Illinois division and
taking into consideration MXL's diminished real estate needs. On March 16, 2005,
MXL entered into a contract to sell the Illinois facility for $1,750,000, and
lease back a portion of the facility. Management believes the transaction will
55
close in 2005. Accordingly, the carrying value of the land and building has been
written down by $872,000 to $1,595,000, representing its estimated fair value
less costs to sell.
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,
2004, 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 Company's carrying amount of goodwill was $182,000 as of
December 31, 2004 and 2003.
9. Long-term debt and short term borrowings
Long-term debt is comprised of the following (in thousands):
December 31,
2004 2003
---------------------------------------------------------- -------------- ------------
MXL Pennsylvania Mortgage (a) $1,305 $1,405
MXL Illinois Mortgage (b) - 1,185
AOtec Debt and Notes (c) 421 922
Valera stock acquisition debt (see Note 14(d)) 1,590 -
Capital lease obligations 46 80
---------------------------------------------------------- -------------- ------------
---------------------------------------------------------- -------------- ------------
3,362 3,592
Less current maturities (1,967) (389)
---------------------------------------------------------- -------------- ------------
---------------------------------------------------------- -------------- ------------
$1,395 $3,203
(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. As of
December 31, 2004, the mortgage has been classified separately in the balance
56
sheet as a current liability, as a result of the classification of the Illinois
property as held for sale.
(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 Notes
amounting to $550,000 and $275,000 as of December 31, 2004 and 2003,
respectively, are classified as short term borrowings on the Company's
Consolidated Balance Sheets and are not included in the table above. MXL is
currently negotiating a reduction in the amounts due under the AOtec Notes with
maturity dates of August 5, 2004 and 2005, resulting from a dispute over the
purchase price. According to the contract of sale, the payments due pursuant to
the AOtec Notes were subject to an offset and withholding by MXL. The parties
are attempting to resolve this matter; however there is no guarantee that MXL
will successfully negotiate the reduction of the AOtec Notes.
Aggregate annual maturities of long-term debt at December 31, 2004 are as
follows (in thousands):
2005 $ 1,967
2006 289
2007 101
2008 100
2009 100
Thereafter 805
--------------------------------
Total $3,362
Short-term borrowings
Five Star
In 2003, Five Star obtained a Loan and Security Agreement (the "Loan Agreement")
with Bank of America Business Capital (formerly Fleet Capital Corporation) (the
"Lender"). The Loan Agreement has a five-year term, with a maturity date of June
30, 2008. The Loan Agreement, as amended on May 28, 2004 provides for a
$28,000,000 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 of 2% (4.28% at December 31, 2004) for borrowings not
to exceed $15,000,000 and the prime rate (5.25% at December 31, 2004) for
borrowings in excess of the above-mentioned LIBOR-based borrowings. The credit
57
spreads can be reduced in the event that Five Star achieves and maintains
certain performance benchmarks. At December 31, 2004 and 2003, approximately
$18,234,000 and $16,685,000 was outstanding under the Loan Agreement and
approximately $434,000 and $480,000 was available to be borrowed, respectively.
Substantially all of Five Star's assets (with a carrying amount of $40,277,000
at December 31, 2004) 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. As of December 31, 2004 Five Star was in compliance
with all required covenants.
In March 2005, Five Star amended the Loan Agreement to allow it to increase the
maximum amount that can be borrowed under the revolving credit facility to
$30,000,000 through June 30, 2005; reverting back to a maximum of $28,000,000 on
July 1, 2005.
In connection with the Loan Agreement, Five Star also entered into a derivative
transaction with the Lender 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 the Lender on notional principal of $12,000,000. In return, the Lender
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, 2004 and 2003, the interest rate swap had a fair value of $105,000 and
$122,000, respectively, which is included in other assets in the accompanying
balance sheets. On June 17, 2004, Five Star has also entered into a derivative
interest rate collar transaction during the period from July 1, 2004 through
June 30, 2008 on notional principal of $12,000,000. The transaction consists of
an interest rate floor of 2.25%, whereas if LIBOR is below 2.25%, the Lender
will pay to Five Star the difference between LIBOR and 2.25%, on the same
notional principal amount. The transaction also consists of an interest rate cap
of 5.75%, whereas if LIBOR is above 5.75%, Five Star will pay to the Lender the
difference between LIBOR and 5.75%, on the same notional principal amount. The
interest rate collar is shown as a non-current liability in the Company's
Consolidated Balance Sheet as of December 31, 2004.
MXL
On March 1, 2005, MXL obtained a Line of Credit Loan (the "MXL Line") from M&T
Bank with a one year term, maturing on March 1, 2006. The MXL Line provides for
a $1,000,000 revolving credit facility, which is secured by MXL's eligible
accounts receivable, inventory and a secondary claim on the Lancaster, PA
property. The interest rates under the MXL Line consist of LIBOR plus a credit
spread of 3% or the prime rate plus a credit spread of 0.25%. The MXL Line is
subject to an unused commitment fee of 0.25% of the average daily unused balance
of the line payable quarterly. National Patent Development has guaranteed the
MXL Line.
58
10. Income taxes
Commencing November 24, 2004, the date of the spin-off, the Company will file a
consolidated federal income tax return with its subsidiaries, except for Five
Star which is less than 80% owned and files its own separate consolidated
federal income tax return. Prior to the spin-off, 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 for the periods prior
to the spin-off 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 did not own 80% of its common stock, Five Star filed its own separate
consolidated federal income tax return, as well as separate state and local
income tax returns.
Prior to the spin-off National Patent Development and GPS entered into a Tax
Sharing Agreement. The Tax Sharing Agreement, which was effective as of January
1, 2004, provides for tax sharing payments between National Patent Development
and GPS for the period prior to the spin-off, so that National Patent
Development is generally responsible for tax expense attributable to its lines
of business and entities comprising it, and GPS is generally responsible for the
tax expense attributable to its lines of business and entities comprising it.
From January 1, 2004 through November 24, 2004, the date of the spin-off, no
amounts were charged to National Patent Development under the Tax Sharing
Agreement, as no tax expense was incurred by National Patent Development for
this period. Prior to the tax sharing agreement being in effect, no amounts were
charged or credited to MXL as if it filed its own separate federal income tax
return. In addition, no amount was credited to MXL for utilization by GPS of
MXL's 2004 loss for the period prior to the spin-off. Accordingly, the expense
(benefit) for current federal income taxes (exclusive of amounts pertaining to
Five Star for 2004 and 2003) for such periods and current state and local income
taxes related to the results of non-core assets has been accounted for as an
adjustment to stockholders' equity.
The components of income tax expense (benefit) are as follows (in thousands):
Year Ended December 31,
2004 2003 2002
-------------------------------- -------------- ------------- -------------
Current
Federal $703 $359 $57
State and local 226 113 11
-------------------------------- -------------- ------------- -------------
-------------------------------- -------------- ------------- -------------
Total current 929 472 68
-------------------------------- -------------- ------------- -------------
-------------------------------- -------------- ------------- -------------
Deferred
Federal 53 (246) 64
State and local - (53) 13
-------------------------------- -------------- ------------- -------------
-------------------------------- -------------- ------------- -------------
Total deferred 53 (296) 77
-------------------------------- -------------- ------------- -------------
-------------------------------- -------------- ------------- -------------
Total income tax expense $982 $176 $145
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
stockholders' equity.
59
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:
Year Ended December 31,
2004 2003 2002
------------------------------------------------------------------------- ------------- ------------ -------------
Federal income tax rate (35.0)% 35.0% 35.0%
State and local taxes, net of federal benefit 4.7 7.0 5.2
Non-deductible expenses 0.4 9.3 7.6
Impairment and realized losses for investment in marketable securities
for which no benefit has been provided 15.2 3.4 -
Loss on write-down of Illinois property for which no benefit has been
provided 10.9 - -
Net operating loss of MXL for period prior to spin-off unable to be
utilized on a stand-alone basis for which no benefit has been provided 15.1 - -
Net operating loss of the Company for period subsequent to spin-off for
which no benefit has been provided 24.6 - -
Other (4.3) (8.7) 1.9
------------------------------------------------------------------------- ------------- ------------ -------------
------------------------------------------------------------------------- ------------- ------------ -------------
Effective tax rate expense (benefit) 31.6% 46.0% 49.7%
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:
December 31,
2004 2003
----------------------------------------------- ------------- -----------
Deferred tax assets:
Property and equipment $ 425 $ 176
Allowance for doubtful accounts 98 78
Accrued liabilities 42 45
Marketable securities 491 187
Other investments 2,256 2,256
Net operating loss carryforward 1,801 -
Interest rate collar 8 -
Inventory 122 47
Capital loss carryforward 65 14
----------------------------------------------- ------------- -----------
Deferred tax assets 5,308 2,803
----------------------------------------------- ------------- -----------
Deferred tax liabilities:
Interest rate swap 44 51
----------------------------------------------- ------------- -----------
Deferred tax liabilities 44 51
----------------------------------------------- ------------- -----------
----------------------------------------------- ------------- -----------
Net deferred tax assets 5,264 2,752
----------------------------------------------- ------------- -----------
----------------------------------------------- ------------- -----------
Less valuation allowance (5,331) (2,774)
----------------------------------------------- ------------- -----------
Net deferred tax liabilities $ (67) $ (22)
----------------------------------------------- ------------- -----------
60
As of December 31, 2004 National Patent Development has a net operating loss
carryforward of $4,618,000, representing a loss incurred subsequent to the
spin-off and losses incurred by MXL prior to the spin-off, which expire from
2017 to 2024. In addition, National Patent Development has a capital loss
carryforward of $166,000, which expires in 2009.
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 entered 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 agreed 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.
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 entered
into a tax sharing agreement with GP Strategies (which was 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.
61
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, 2002, 2003 and 2004 are as
follows:
Number Number Weighted Average
Price Range Of Options Of Options Exercise Years
Per share Outstanding Exercisable Price Remaining
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
December 31, 2001 $ 9.98 1,250 1,250 $ 9.98 1 year
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
Expired $ 9.98 (1,250) $ 9.98
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
- ------------------------------------------ ------------------ ---------------- --------------- --------------- ---------------
December 31, 2002, 2003 and 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 are available for grant to employees, directors and outside service
providers. The plan permits 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. As of December 31, 2004, no awards have been granted
under the plan.
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
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.
62
Activity relating to stock options granted by Five Star commencing at the date
the Company acquired a controlling financial interest follows:
Number of Weighted Average
Options Outstanding Shares Exercise Price
-------------------------------------------------------------- ------------------- ------------------------
October 8, 2003 2,930,000 $.16
-------------------------------------------------------------- ------------------- ------------------------
Granted - -
Exercised - -
Terminated (1,400,000) .13
-------------------------------------------------------------- ------------------- ------------------------
December 31, 2003 1,530,000 .19
-------------------------------------------------------------- ------------------- ------------------------
Granted - -
Exercised - -
Terminated (430,000) .30
-------------------------------------------------------------- ------------------- ------------------------
December 31, 2004 1,100,000 $.14
-------------------------------------------------------------- ------------------- ------------------------
-------------------------------------------------------------- ------------------- ------------------------
Options Exercisable at December 31, 2004 770,000 $.14
-------------------------------------------------------------- ------------------- ------------------------
The following table summarizes information about the Five Star Plan's options at
December 31, 2004:
Weighted Weighted
Average Average
Exercise Number Years Number Years
Price Outstanding Remaining Exercisable Remaining
-------------- --------------------- --------------- -------------------- ----------------
-------------- --------------------- --------------- -------------------- ----------------
$.14 900,000 2.0 630,000 1.9
.15 50,000 2.3 50,000 2.3
.16 150,000 2.6 90,000 2.6
-------------- --------------------- --------------- -------------------- ----------------
-------------- --------------------- --------------- -------------------- ----------------
1,100,000 2.1 770,000 2.0
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
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 $123,000 and $125,000 for the years ended December 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
several noncancellable leases for machinery and equipment. Such leases expire at
various dates with, in some cases, options to extend their terms.
63
As of December 31, 2004, minimum rentals under long-term operating leases are as
follows (in thousands):
Real Machinery &
property equipment Total
-------------------- ------------------ ------------------ --------------
2005 $ 1,829 $ 438 $ 2,267
2006 1,779 374 2,153
2007 436 366 802
2008 - 302 302
2009 - 38 38
Thereafter - - -
-------------------- ------------------ ------------------ --------------
-------------------- ------------------ ------------------ --------------
Total $4,044 $1,518 $5,562
-------------------- ------------------ ------------------ --------------
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 $3,147,000, $3,037,000, and $81,000 for the years
ended December 31, 2004, 2003 and 2002, 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 MXL Segment, formerly called the Optical Plastics Segment, 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 Five Star Segment, formerly called the Home Improvement Distribution
Segment, 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.
64
The following tables set forth the sales and operating profit attributable to
each line of business (in thousands):
Year Ended December 31,
2004 2003 2002
-------------------------------------------- ---------------- ---------------- --------------
Sales
MXL $ 8,241 $ 8,613 $9,996
Five Star 101,982 95,085 -
-------------------------------------------- ---------------- ---------------- --------------
$110,223 $103,698 $9,996
-------------------------------------------- ---------------- ---------------- --------------
Operating profit (loss)
MXL $ (2,593) $ (280) $ 180
Five Star 3,244 2,068 439(a)
Corporate and other (1,423) (480) (128)
-------------------------------------------- ---------------- ---------------- --------------
$ (772) $ 1,308 $ 491
-------------------------------------------- ---------------- ---------------- --------------
(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):
December 31,
2004 2003
------------------------------------------------- -------------- --------------
Total assets
MXL $13,621 $14,261
Five Star 40,277 36,622
Corporate and other 6,576 2,755
------------------------------------------------- -------------- --------------
$60,474 $53,638
------------------------------------------------- -------------- --------------
Year Ended December 31,
2004 2003 2002
------------------------------------------------- ------------ ---------------- ------------
Additions to property,
plant, and equipment
MXL $ 183 $ 1,135 (a) $368
Five Star 275 159 -
------------------------------------------------- ------------ ---------------- ------------
$458 $1,294 $368
------------------------------------------------- ------------ ---------------- ------------
Depreciation and amortization
MXL $ 616 $ 565 $510
Five Star 110 28
------------------------------------------------- ------------ ---------------- ------------
$ 726 $ 593 $510
------------------------------------------------- ------------ ---------------- ------------
65
(a) Includes property, plant and equipment acquired from AOtec.
For the years ended December 31, 2004 and 2003, no customer accounted for 10% or
more of the Company's sales. The Company's major customers of the MXL Segment
accounted for the following percentage of total sales for the year ended
December 31, 2002:
2002
--------------------- --- ---------------
--------------------- --- ---------------
A 23%
B 21%
C 8%
--------------------- --- ---------------
--------------------- --- ---------------
Total 52%
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):
Year Ended December 31,
2004 2003 2002
------------------------------ ------------- ------------- --------------
------------------------------ ------------- ------------- --------------
United States $107,644 $102,015 $8,264
Far East 1,288 1,230 1,266
Other 1,291 453 466
------------------------------ ------------- ------------- --------------
------------------------------ ------------- ------------- --------------
$110,223 $103,698 $9,996
All assets of the Company are in the United States.
14. Related party transactions
(a) GPS provided certain administrative services to National Patent Development,
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 $911,000, $680,000 and
$321,000 being recorded in selling, general and administrative expenses in the
accompanying consolidated statements of operations for the years ended December
31, 2004, 2003 and 2002, 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 in additional
paid-in capital. 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.
GPS also provided 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 2005. The management fee increased to $25,000 per
month effective October 1, 2004. In addition Five Star agreed to reimburse GPS
for $16,666 per month for Mr. Feldman's (GPS' Chief Executive Officer) service
66
to the Company effective October 1, 2004. Prior to the Distribution, GPS
transferred 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 $132,000 and $100,000 for the years ended December 31, 2004
and 2003, respectively. At December 31, 2003 fees due to GPS, which are included
in accounts payable and accrued expenses, amounted to $257,000.
GPS and National Patent Development have entered into contracts described below
that will govern certain relationships between them. GPS and National Patent
Development 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.
Certain of National Patent Development's executive officers are also executive
officers of GPS and will remain on GPS's payroll. 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 GPS and National Patent Development. GPS charges 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. Such fee amounted to $107,000 for the period
subsequent to the spin-off through December 31, 2004.
In connection with the spin-off, National Patent Development entered into a
separate management agreement with GPS pursuant to which National Patent
Development will provide certain general corporate services to GPS. Under this
management agreement, National Patent Development will charge GPS a management
fee to cover an allocable portion of the compensation of its employees, based on
the time they spend providing services to GPS, in addition to an allocable
portion of corporate overhead related to services performed for GPS and its
subsidiaries. Such fee amounted to $17,000 for the period subsequent to the
spin-off through December 31, 2004.
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 both GPS and National Patent Development, upon six months prior
written notice.
National Patent Development was included in GPS's consolidated income tax group
and National Patent Development's tax liability was included in the consolidated
federal income tax liability of GPS until the time of the spin-off. The Tax
Sharing Agreement provides for tax sharing payments between GPS 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 GPS will be generally
responsible for the taxes attributable to its lines of business and the entities
comprising it.
GPS and National Patent Development agreed that taxes related to intercompany
transactions that are triggered by the National Patent Development spin-off will
be generally allocated to GPS. GPS and National Patent Development agreed that
67
joint non-income tax liabilities will generally be allocated between GPS 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 GPS.
Under the distribution agreement that governed the spin-off of National Patent
Development from GPS, GPS 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. 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.
(b) The receivable from GPS, which, except for the balance due at December 31,
2004, arose principally from cash advances by MXL, is non-interest bearing.
Transactions affecting the receivable, together with the average balances,
follow (in thousands):
Year Ended December 31,
------------- -- -------------- -- --------------
2004 2003 2002
------------- -------------- --------------
Balance at beginning of period $ 709 $10,116 $10,162
Management fee and
other charges from GPS (1) (559) (717) (446)
Repayments (1,032) (10,000)
Advances 882 1,310 400
Contribution receivable from GPS 5,000
----------------------------------------------- ------------- -- -------------- -- --------------
Balance at end of period $ 5,000 $ 709 $ 10,116
----------------------------------------------- ------------- -- -------------- -- --------------
Average balance $ 897 $ 7,734 $ 10,096
(1) Includes a management fee paid to GPS by MXL of $140,000 for the year ended
December 31, 2004 and $240,000 for each of the fiscal years ended December 31,
2003 and 2002, 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. 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
stockholders' equity.
The receivable from GPS was zero following the spin-off. In December 2004 GPS
received certain proceeds of litigation and arbitration claims, out of which it
had agreed on July 30, 2004 to make an additional capital contribution to
National Patent Development (see Note 15). GPS made the capital contribution to
National Patent Development in January 2005 to settle the receivable.
68
(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.
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.
(d) On November 12, 2004, the Company entered into an agreement to borrow
approximately $1,022,000 from Bedford Oak Partners, which is controlled by
Harvey P. Eisen, a director of the Company, and approximately $568,000 from
Jerome I. Feldman, who is Chairman and Chief Executive Officer of the Company,
to exercise the option to purchase Series B Convertible Preferred shares of
Valera. The loans bear interest at 6% per annum, mature on October 31, 2009, and
are secured by all shares of Valera owned by the Company, including the
purchased shares. The loans are required to be prepaid out of the proceeds
received from the sale of the purchased shares or from any additional capital
contribution received by the Company from GP Strategies out of proceeds received
by GP Strategies from its claims relating to the Learning Technologies
acquisition (see Note 15). Bedford Oak Partners and Jerome I. Feldman are
entitled to receive 50% of any profit received by the Company from the sale of
the Valera purchased shares.
In connection with the Spin-off, GP Strategies agreed to make an additional
capital contribution to the Company in an amount equal to the first $5 million
of any proceeds (net of litigation expenses and taxes incurred, if any), and 50%
of any proceeds (net of litigation expenses and taxes incurred, if any) in
excess of $15 million, received by GP Strategies from its claims relating to the
Learning Technologies acquisition. Pursuant to such agreement, GP Strategies
made a $5 million additional capital contribution to the Company on January 6,
2005. On January 11, 2005, the Company prepaid the loans, including accrued
interest of approximately $16,000, to Bedford Oak Partners and Jerome I. Feldman
out of such proceeds.
(e) Jerome I. Feldman, the Company's Chairman and Chief Executive Officer is
also Chairman and Chief Executive Officer of GPS. Scott N. Greenberg, the
Company's director and Chief Financial Officer is the President and the Chief
Financial Officer of GPS. Andrea D. Kantor, the Company's Vice President and
General Counsel, is the Vice President and General Counsel of GPS. Harvey P.
Eisen, a director of the Company, is also a director of GPS.
69
15. Litigation
On July 30, 2004, GPS agreed to make an additional capital contribution to
National Patent Development, in an amount equal to the first $5 million of any
proceeds (net of litigation expenses and taxes incurred, if any), and 50% of any
proceeds (net of litigation expenses and taxes incurred, if any) in excess of
$15 million, received with respect to the claims described below. GPS has
received $13.7 million of net proceeds from such claims and, pursuant to such
agreement, in January 2005 GPS made a $5 million additional capital contribution
to National Patent Development.
On January 3, 2001, GPS 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 GPS's 1998 acquisition of Learning
Technologies from the defendants for $24,300,000. GPS seeks actual damages in
the amount of $117,900,000 plus interest, punitive damages in an amount to be
determined at trial, and costs. Such damages are subject to reduction by the
amount recovered in the arbitration.
The complaint, which is pending in the New York State Supreme Court, alleges
that the defendants fraudulently induced GPS to acquire Learning Technologies by
concealing the poor performance of Learning Technologies' United Kingdom
operation. 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, but with
leave to the other defendants to renew, as described below.
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 $17,600,000 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.
The arbitration hearings began on May 17, 2004 and concluded on May 24, 2004
before JAMS, a private dispute resolution firm. On September 10, 2004, the
arbitrator issued an interim award in which she found that the sellers of
Learning Technologies breached certain representations and warranties contained
in the acquisition agreement. In a final award dated November 29, 2004, the
arbitrator awarded GPS $12,273,575 in damages and $6,016,109 in interest. On
December 30, 2004, EDS made a payment of $18,427,684, which included $138,000 of
accrued interest, to GPS to satisfy its obligation under the arbitration award.
The arbitration settlement, net of legal fees and expenses was held in escrow as
of December 31, 2004. EDS subsequently agreed that the arbitration award is
final and binding and that it will take no steps of any kind to vacate or
otherwise challenge the award.
70
As a result of the conclusion of the arbitration, the state court has lifted the
stay of the fraud claim against EDS. GPS is now proceeding with the fraud claim
against EDS. On February 14, 2005, EDS filed a new motion for summary judgment
dismissing GPS's fraud claim. GPS responded to the motion by March 17, 2005 and
the motion was argued by the parties on April 4, 2005. The fraud action against
MCI had been stayed as a result of the bankruptcy of MCI. In February 2004, the
Bankruptcy Court lifted the stay so that the state court could rule on the
merits of MCI's summary judgment motion. MCI has stated that it intends to ask
the Bankruptcy Court to reinstate the stay.
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 $1,875,000 of the
$7,500,000 received for the Notes and Warrants. National Patent Development
received the funds prior to the spin-off.
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.
71
The Note and Warrant Purchase Agreement provided that, on completion of the
spin-off, National Patent Development would issue warrants ("National Patent
Development Warrants") to the holders of the GP Warrants. The National Patent
Development Warrants 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. An aggregate
of 1,423,887 National Patent Development Warrants were issued to the holders of
the GP Warrants on December 4, 2004, 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 is $3.57, which
represents 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 are exercisable at any
time through August 2008. The National Patent Development Warrants have
anti-dilution provisions similar to those of the GP Warrants. National Patent
Development provided the holders of the National Patent Development Warrants
with registration rights similar to those provided by GPS to the holders of the
GP Warrant.
As the National Patent Development Warrants relate to a capital contribution by
GPS, their issuance has been accounted for as an offsetting charge and credit to
additional paid-in capital for $883,000, representing the estimated fair value
of the warrants.
17. Accounts payable and accrued expenses
Accounts payable and accrued expenses are comprised of the following at December
31, 2004 and 2003 (in thousands):
December 31,
2004 2003
------------------------------------ ------------ ------------
------------------------------------ ------------ ------------
Accounts payable $12,193 $11,983
Accrued expenses 1,634 1,152
Due to GPS - 257
Other 1,559 312
------------------------------------ ------------ ------------
------------------------------------ ------------ ------------
$15,386 $13,704
72
NATIONAL PATENT DEVELOPMENT CORPORATION
Notes to Consolidated Financial Statements
73
18. 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):
Additions
Balance at Additional Charged to
Beginning of Allowance Costs & Balance at
Period Acquired (a) Expenses Deductions (b) End of Period
- ------------------------------------------ ----------------- ---------------- ---------------- --------------- --------------
Year ended December 31, 2004:
Allowance for doubtful accounts 739 - 253 (686) 306
- ------------------------------------------ ----------------- ---------------- ---------------- --------------- --------------
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
- ------------------------------------------ ----------------- ---------------- ---------------- --------------- --------------
(a) Represents the allowance for doubtful accounts of Five Star at date of
consolidation.
(b) Write-off of uncollectible accounts, net of recoveries.
19. Selected Quarterly Financial Data
(Unaudited) (in thousands, except per share data)
- -------------------------------------- -----------------------------------------------------------------------
Three months ended
March 31, June 30, September 30, December. 31,
2004 2004 2004 2004
- -------------------------------------- -------------- ---------------- -------------------- ------------------
Sales $29,121 $29,604 $28,738 $22,760
Gross margin 4,765 5,405 4,955 4,944
- -------------------------------------- -------------- ---------------- -------------------- ------------------
Net loss $ (297) $ (1,366) $ (548) $ (2,318)
- -------------------------------------- -------------- ---------------- -------------------- ------------------
Net loss per share:
Basic and Diluted $ (.01) $ (.08) $ (.03) $ (.13)
----------- ------------ ---------- ----------
- -------------------------------------- ----------------------------------------------------------------------
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) $ (35) $ 50 $ (71)
- -------------------------------------- -------------- --------------- ------------------- -------------------
Net income (loss) per share:
Basic and Diluted $ .00 $ .00 $ .00 $ (.01)
--------- ---------- -------- ----------
73
80
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
ITEM 9A. Controls and Procedures
"Disclosure controls and procedures" are the controls and other
procedures of an issuer that are designed to ensure that information required to
be disclosed by the issuer in the reports filed or submitted by it under the
Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms. These controls and
procedures are designed to ensure that information required to be disclosed by
an issuer in its Exchange Act reports is accumulated and communicated to the
issuer's management, including its principal executive and financial officers,
as appropriate, to allow timely decisions regarding required disclosure.
Under the supervision and with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, the Company carried out an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to the Exchange Act Rule 13a-15(e).
Based upon the evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures are
effective as of the end of the period covered by this report.
During the year ended December 31, 2004, there were no changes in the
Company's internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the internal control
over financial reporting.
PART III
The Company has adopted a Code of Ethics for directors, officers, and
employees of the Company and its subsidiaries, including but not limited to the
principal executive officer, the principal financial officer, the principal
accounting officer or controller, or persons performing similar functions for
the Company and its subsidiaries. The Code of Ethics and Conduct of Business
Policy is available on the Company's website at www.npdc.com. A copy of this
Code of Business Conduct and Ethics is also incorporated by reference into this
report as Exhibit 14.1. If the Company makes any substantive amendment to the
Code of Ethics or grants any waiver from a provision of the Code of Ethics for
its executive officers or directors, the Company will disclose the nature of
such amendment or waiver on its website at www.npdc.com. The Company will also
provide a copy of such Code of Ethics and Code of Business Policy to any person
upon written request made to the Company's Secretary in writing to the following
address: National Patent Development Corporation, Attn: Secretary, 777
Westchester Avenue, White Plains, NY 10604, with a copy to National Patent
Development Corporation, General Counsel at the same address.
All other information required by Items 10, 11, 12, 13 and 14 of Part III of
this Annual Report on Form 10-K is incorporated herein by reference to the
information under the captions "Directors and Executive Officers of the
Registrant", "Executive Compensation", "Security Ownership of Certain Beneficial
74
Owners and Management and Related Stockholder Matters", "Certain Relationships
and Related Transactions" and "Principal Accountant Fees and Services" in the
Proxy Statement for the Company's 2005 Annual Meeting of Shareholders.
PART IV
Item 15: Exhibits and Financial Statement Schedules
(a)(1) The following financial statements are included in Part II, Item 8.
Financial Statements and Supplementary Data:
Financial Statements of National Patent Development Corporation and
Subsidiaries:
Page
Report of Independent Registered Public Accounting Firm 35
Consolidated Statements of Operations - Years ended December
31, 2004, 2003 and 2002 36
Consolidated Statements of Comprehensive Income (Loss) -
Years ended December 31, 2004, 2003 and 2002 36
Consolidated Balance Sheets - December 31, 2004 and 2003 37
Consolidated Statements of Cash Flows - Years ended December
31, 2004, 2003 and 2002 38
Consolidated Statements of Changes in Stockholders' Equity -
Years ended December 31, 2004, 2003 and 2002 40
Notes to Consolidated Financial Statements 42
(a)(2) Schedules have been omitted because they are not required or are not
applicable, or the required information has been
included in the financial statements or the notes thereto.
(a)(3) See accompanying Index to Exhibits
75
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
NATIONAL PATENT DEVELOPMENT CORPORATION
Dated: April 14, 2005 Jerome I. Feldman
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signatures Title
Date: April 14, 2005 Jerome I. Feldman
Chairman and Chief Executive Officer
(Principal Executive Officer)
Date: April 14, 2005 Scott N. Greenberg
Chief Financial Officer and Director
(Principal Financial and Accounting Officer)
Date: April 14, 2005 Harvey P. Eisen
Director
Date: April 14, 2005 Roald Hoffmann
Director
Date: April 14, 2005 Ellen Havdala
Director
Date: April 14, 2005 Thomas C. Kinnear
Director
Date: April 14, 2005 Talton R. Embry
Director
76
EXHIBIT INDEX
Number Description
2.1 Form of Distribution Agreement between GP Strategies
Corporation and the Registrant. Incorporated herein by
reference to Exhibit 2.1 of the Registrant's Form S-1,
Registration No. 333-118568.
3.1 Form of Amended and Restated Certificate of Incorporation of
National Patent Development Corporation. Incorporated herein
by reference to Exhibit 3.1 of the Registrant's Form S-1,
Registration No. 333-118568.
3.2 Amended and Restated Bylaws of National Patent Development
Corporation. Incorporated herein by reference to Exhibit 3.2
of the Registrant's Form S-1, Registration No. 333-118568.
4.1 Form of certificate representing shares of common stock, par
value $0.01 per share, of National Patent Development
Corporation. Incorporated herein by reference to Exhibit 4.1
of the Registrant's Form S-1, Registration No. 333-118568.
4.2 Form of National Patent Development Corporation Warrant
Certificate dated August 14, 2003. 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. Incorporated herein by
reference to Exhibit 10.1 of the Registrant's Form S-1,
Registration No. 333-118568.
10.2 Form of Management Agreement between the Registrant and GP
Strategies Corporation. Incorporated herein by reference to
Exhibit 10.2 of the Registrant's Form S-1, Registration No.
333-118568.
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. Incorporated herein by
reference to Exhibit 10.2 of the Registrant's Form S-1,
Registration No. 333-118568.
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.
77
10.6 Registration Rights Agreement dated August 14, 2003 between
the Registrant and Gabelli Funds, LLC. Incorporated herein by
reference to Exhibit 10.06 to GP Strategies' Form 10-Q for
the quarter ended June 30, 2003.
10.7 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.
10.8 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.
10.9 National Patent Development Corporation 2003 Incentive Stock
Plan. Incorporated herein by reference to Exhibit 10.8 of the
Registrant's Form S-1, Registration No. 333-118568.
10.10 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.
10.11 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.
10.12 First Modification Agreement dated as of May 28, 2004 by and
between Five Star Group, Inc. as borrower and Fleet Capital
Corporation, as Lender. Incorporated herein by reference to
Exhibit 10.11 of Five Star Products, Inc. Form 10-K for the
year ended December 31, 2004.
10.13 Second Modification Agreement dated as of March 22, 2005 by
and between Five Star Group, Inc. as borrower and Fleet
Capital Corporation, as Lender. Incorporated herein by
reference to Exhibit 10.12 of Five Star Products, Inc. Form
10-K for the year ended December 31, 2004.
10.14 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.
10.15 Amended Note in the amount of $2,800,000 dated December 19,
2003, between the Five Star Products, Inc. and GP Strategies
Corporation. Incorporated herein by reference to Exhibit
10.11 of Five Star Products, Inc. Form 10-K for the year
ended December 31, 2003.
78
10.16 Agreement dated as of January 22, 2004, between Five Star
Products, Inc. and GP Strategies Corporation. Incorporated
herein by reference to Exhibit 99(d) of Five Star Products,
Inc. Schedule TO filed on February 6, 2004.
10.17 Tax Sharing Agreement dated as of February 1, 2004 between
Five Star Products, Inc. and GP Strategies Corporation.
Incorporated herein by reference to Exhibit 10.19 of Five
Star Products, Inc. Form 10-K for the year ended December 31,
2003.
10.18 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.
10.19 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.
10.20 Credit Agreement dated March 8, 2001 by and between Allfirst
Bank and MXL Industries, Inc. Incorporated herein by
reference to Exhibit 10.14 of the Registrant's Form S-1,
Registration No. 333-118568.
10.21 Mortgage, Security Agreement, Assignment of Leases and Rents
and Fixture Filing dated June 26, 2001 by MXL Industries,
Inc. to LaSalle Bank National Association. Incorporated
herein by reference to Exhibit 10.15 of the Registrant's Form
S-1, Registration No. 333-118568.
10.22 Credit Agreement dated March 1, 2005 by and between M&T Bank
and MXL Industries, Inc. *
10.23 Continuing Guaranty Agreement dated March 1, 2005 by the
Registrant for the benefit of M&T Bank. *
10.24 Amended and Restated Investor Rights Agreement dated as of
May 30, 2003 by and among Hydro Med Sciences and certain
Institutional Investors. Incorporated herein by reference to
Exhibit 10.34 of GP Strategies' Form 10-K for the year ended
December 31, 2003.
10.25 Amended and Restated Investor Right of First Refusal and
Co-Sale Agreement dated as of May 30, 2003 by and among Hydro
Med Sciences, Inc. and certain Institutional Investors.
Incorporated herein by reference to Exhibit 10.35 of the GP
Strategies' Form 10-K for the year ended December 31, 2003.
10.26 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. Incorporated herein by
reference to Exhibit 10.17 of the Registrant's Form S-1,
Registration No. 333-118568.
10.27 Note Purchase Agreement dated as of November 12, 2004 by and
between the Registrant, Bedford Oak Partners L.P. and Jerome
Feldman. *
79
10.28 The Registrant's 6% Secured Note due 2009 dated as of
November 12, 2004. *
10.29 Consulting and Severance Agreement dated as of July 1, 2004
between MXL Industries, Inc. and Steve Cliff *
10.30 Consulting and Severance Agreement dated as of September 20,
2004 between MXL Industries, Inc. and Frank Yohe *
14.1 Code of Ethics Policy. *
18 Not Applicable
19 Not Applicable
20 Not Applicable
21.1 Subsidiaries of the Registrant *
23.1 Not Applicable
28 Not Applicable
31.1 Certification of Chief Executive Officer *
31.2 Certification of Chief Financial Officer *
32.1 Certification Pursuant to 18 U.S.C. Section 1350 *
* Filed herewith
80