UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
OR
[ ] TRANSITION REPORT PURSAUNT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File Number: 333-118568
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NATIONAL PATENT DEVELOPMENT CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 13-4005439
- ------------------------------------ -------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
777 Westchester Avenue, White Plains, NY 10604
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip code)
(914) 249-9700
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 whether the registrant is an accelerated filer (as
defined in Rule 12(b)-2 of the Exchange Act). Yes No X
Indicate the number of shares outstanding of each of issuer's classes of common
stock as of November 10, 2006:
Common Stock 17,859,016 shares
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
Page No.
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations-
Three Months and Nine months Ended
September 30, 2006 and 2005 (Unaudited) 1
Condensed Consolidated Statements of Comprehensive Loss-
Three Months and Nine months Ended
September 30, 2006 and 2005 (Unaudited) 2
Condensed Consolidated Balance Sheets -
September 30, 2006 (Unaudited) and December 31, 2005 3
Condensed Consolidated Statements of Cash Flows -
Nine months Ended September 30, 2006
and 2005 (Unaudited) 4
Notes to Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosure about Market Risk 26
Item 4. Controls and Procedures 26
Part II. Other Information
Item 6. Exhibits 27
Signatures 28
4
PART I. FINANCIAL INFORMATION
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share data)
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Sales $30,125 $28,940 $92,491 $90,686
Cost of sales 25,090 24,992 76,369 76,087
------- ------- ------- -------
Gross margin 5,035 3,948 16,122 14,599
Selling, general and administrative
expenses (4,819) (5,091) (14,874) (15,873)
--------- --------- ---------- ----------
Operating profit (loss) 216 (1,143) 1,248 (1,274)
Interest expense (391) (396) (1,234) (1,223)
Investment and other income 101 27 178 298
------- ------- -------- --------
Income (loss) before income
taxes and minority interest (74) (1,512) 192 (2,199)
Income tax (expense) benefit ( 68) (478) (446) 107
--------- ---------- ---------- -------
Loss before minority interest (142) (1,034) ( 254) (2,092)
Minority interest (19) 249 (172) 92
---------- --------- ----------- ------
Net loss $ (161) $ (785) $ (426) $ (2,000)
========= ========= ========= ===========
Net loss per share
Basic and diluted $ (0.01) $ (0.04) $ (0.02) $ (0.11)
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
1
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(in thousands)
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Net loss $ (161) $ (785) $ (426) $ (2,000)
Other comprehensive income (loss),
before tax:
Net unrealized gain (loss) on
available-for-sale-securities (393) 116 3,930 679
Reclassification adjustment for
(gain) on securities sold included in
net loss (7) (159)
Net unrealized gain (loss) on interest rate
swap,
net of minority interest (95) 100 (29) 158
--------- -------- --------- --------
Comprehensive income (loss)
before tax (649) (576) 3,475 (1,322)
Income tax (expense) benefit
related to items of other
comprehensive income (loss) 37 (41) 11 (66)
------- --------- ----- -------
Comprehensive income (loss) $ (612) $ (617) $ 3,486 $ (1,388)
======= ======= ======= =========
See accompanying notes to consolidated financial statements.
2
NATIONAL PATENT DEVELOPMENT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
September 30, December 31,
2006 2005
---- ----
(unaudited)
Assets
Current assets
Cash and cash equivalents $ 4,885 $ 5,115
Accounts receivable, less allowance
for doubtful accounts of $539 and $480 15,674 12,083
Receivable from GP Strategies Corporation 537 1,142
Inventories 22,510 24,021
Prepaid expenses and other current assets 944 997
Property held for sale - 352
---------- ------
Total current assets 44,550 43,170
Marketable securities available for sale 386 477
Property, plant and equipment, net 2,914 3,085
Investment in Valera , including available
for sale securities of $4,771 in 2006 5,789 1,590
Other assets 3,316 3,360
--------- ---------
Total assets $56,955 $52,222
======= =======
Liabilities and stockholders' equity
Current liabilities
Current maturities of long-term debt $ 101 $ 291
Short term borrowings 18,820 20,764
Accounts payable and accrued expenses 12,817 9,566
-------- ------
Total current liabilities 31,738 30,621
Long-term debt less current maturities 1,030 1,106
Other liabilities 288 279
Interest rate collar, at market 20
Minority interest 1,889 1,727
Stockholders' equity
Common Stock 178 178
Additional paid-in capital 25,976 25,921
Accumulated deficit (8,188) (7,762)
Accumulated other comprehensive income 4,044 132
------------- --------
Total stockholders' equity 22,010 18,469
---------- --------
Total liabilities and stockholders' equity $56,955 $52,222
======= =======
See accompanying notes to consolidated financial statements.
3
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
Nine months Ended
September 30,
2006 2005
---- ----
Cash flows from operations:
Net loss $ (426) $ (2,000)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Depreciation and amortization 440 461
Minority interest 172 (91)
Expenses paid in common stock 55
Services provided by GP Strategies applied to repayment of receivable 666
Deferred income taxes 214
Net gain on marketable securities (159)
Loss on disposal of fixed assets 276
Changes in other operating items 1,128 (1,699)
------ -----------
Net cash provided by (used in) operations 2,249 (3,212)
----- -------
Cash flows from investing activities:
Additions to property, plant and equipment, net (269) (1,012)
Proceeds from sale of investments 1,351
Proceeds from sale of fixed assets _____ 1,514
----- -----
Net cash (used in) provided by investing activities (269) 1,853
----- -----
Cash flows from financing activities:
Distribution to GP Strategies (91)
Contribution from GP Strategies - 5,000
(Repayment of) proceeds from short-term borrowings (1,944) 3,188
Repayment of long-term debt (266) (3,026)
------- ---------
Net cash (used in) provided by financing activities ( 2,210) 5,071
--------- --------
Net (decrease) increase in cash and cash equivalents (230) 3,712
Cash and cash equivalents at beginning of period 5,115 2,087
---------- ----------
Cash and cash equivalents at end of period $4,885 $5,799
======== ========
See accompanying notes to the condensed consolidated financial statements.
4
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Basis of presentation and summary of significant accounting policies
Basis of presentation
The accompanying Condensed Consolidated Balance Sheet as of September 30, 2006
and the Condensed Consolidated Statements of Operations, Comprehensive Income
(Loss) and Cash Flows for the three months and nine months ended September 30,
2006 and 2005 have not been audited, but have been prepared in conformity with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. These financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the year
ended December 31, 2005 as presented in our Annual Report on Form 10-K. In the
opinion of management, this interim information includes all material
adjustments, which are of a normal and recurring nature, necessary for a fair
presentation. The results for the 2006 interim periods are not necessarily
indicative of results to be expected for the entire year.
Description of business. National Patent Development Corporation (the "Company"
or "National Patent Development "), through its wholly owned subsidiary, MXL
Industries, Inc. ("MXL"), manufactures 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. The Company's 64% owned subsidiary, Five
Star Products, Inc. ("Five Star"), is engaged in the wholesale distribution of
home decorating, hardware and finishing products. It serves over 3,500
independent retail dealers in twelve states in the Northeast. Products
distributed include paint sundry items, interior and exterior stains, brushes,
rollers, caulking compounds and hardware products
Revenue recognition. Revenue on product sales is recognized at the point in time
when the product has been shipped, title and risk of loss has been transferred
to the customer, and the following conditions are met: persuasive evidence of an
arrangement exists, the price is fixed and determinable, and collectibility of
the resulting receivable is reasonably assured. Allowances for estimated returns
and allowances are recognized when sales are recorded.
Shipping and handling costs. Shipping and handling costs are included as a part
of selling, general and administrative expense. These cost amounted to
$1,273,000, $1,356,000, $3,818,000 and $3,913,000, for the three months and nine
months ended September 30, 2006 and 2005, respectively.
Inventories. Inventories are valued at the lower of cost, using the first-in,
first-out method, or market.
5
Derivatives and hedging activities. The interest rate swap and interest rate
collar entered into by the Five Star in connection with its Loan and Security
Agreement (see Note 5) 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. During the quarter and nine
months ended September 30, 2006 the Company recognized a gain of $27,000 and
$11,000, respectively, as part of other income, for the changes in the fair
value of the interest rate collar. During the quarter and nine months ended
September 30, 2005 the Company recognized a loss of $14,000 and $4,000,
respectively, as part of other income, for the changes in the fair value of the
interest rate collar.
Recent accounting pronouncements. In July 2006, the Financial Accounting
Standards Board (FASB) released FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109" (FIN
48). FIN 48 clarifies the accounting and reporting for uncertainties in income
tax law. This Interpretation prescribes a comprehensive model for the financial
statement recognition, measurement, presentation and disclosure of uncertain tax
positions taken or expected to be taken in income tax returns. The Company will
adopt this Interpretation in the first quarter of 2007. The cumulative effects,
if any, of applying this Interpretation will be recorded as an adjustment to
retained earnings as of the beginning of the period of adoption. The Company has
commenced the process of evaluating the expected effect of FIN 48 on its
Consolidated Financial Statements and is currently not yet in a position to
determine such effects.
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans--an amendment of FASB Statements No. 87, 88, 106, and
132(R)," which requires employers to: (a) recognize in its statement of
financial position an asset for a plan's overfunded status or a liability for a
plan's underfunded status; (b) measure a plan's assets and its obligations that
determine its funded status as of the end of the employer's fiscal year; and (c)
recognize changes in the funded status of a defined benefit postretirement plan
in the year in which the changes occur. Those changes will be reported in
comprehensive income of a business entity. The requirement to recognize the
funded status of a benefit plan and the disclosure requirements are effective as
of the end of the fiscal year ending after December 15, 2006, for entities with
publicly traded equity securities. The requirement to measure plan assets and
6
benefit obligations as of the date of the employer's fiscal year-end statement
of financial position is effective for fiscal years ending after December 15,
2008. The Company has no defined benefit pension plans.
Also in September 2006, FASB issued SFAS No. 157, "Fair Value Measurements'"
which defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles and expands disclosures about fair
value measurements. This Statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007 and interim periods within
those fiscal years. Earlier application is encouraged provided that the
reporting entity has not yet issued financial statements for that fiscal year
including financial statements for an interim period within that fiscal year.
The company is assessing SFAS No. 157 and has not determined yet the impact that
the adoption of SFAS No. 157 will have on its result of operations or financial
position.
2. Stock based compensation
The Company and Five Star have stock-based compensation plans for employees and
non-employee members of the Board of Directors. The plans provide for
discretionary grants of stock options, restricted stock shares, and other
stock-based awards. The plans are administered by the Compensation Committee of
the Board of Directors, consisting of non-employee directors. Effective January
1, 2006, the Company and Five Star adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment", ("SFAS 123R"),
utilizing the modified prospective method whereby prior periods will not be
restated for comparability. SFAS 123R requires recognition of stock-based
compensation expense in the statement of operations over the vesting period
based on the fair value of the award at the grant date. Previously, the Company
used the intrinsic value method under Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25"), as amended by related
interpretations of the FASB. Under APB 25, no compensation cost was recognized
for stock options because the quoted market price of the stock at the grant date
was equal to the amount per share the employee had to pay to acquire the stock
after fulfilling the vesting period. SFAS 123R supersedes APB 25 as well as
Statement of Financial Accounting Standard 123 "Accounting for Stock-Based
Compensation", which permitted pro forma footnote disclosures to report the
difference between the fair value method and the intrinsic value method. As of
September 30, 2006, no awards have been granted under the Company's plan. In
addition, during the nine months ended September 30, 2006, Five Star did not
grant any stock options or any other stock-based awards under its plan, and
therefore the adoption of this pronouncement did not have any effect on the
Company's consolidated results of operations for the three and nine month
periods ended September 30, 2006.
At September 30, 2006, Five Star had 1,100,000 options outstanding of which
1,070,000 were exercisable under its stock option plan with an aggregate
weighted average price of $0.14 per share and a contractual remaining life of
0.3 years. The aggregate intrinsic value of the options outstanding at September
30, 2006 was $40,000. During the nine months ended September 30, 2006, there
were no option exercises, forfeitures or expirations.
7
The following table provides the pro forma effect on net earnings as if the
fair-value-based measurement method had been applied to all stock-based
compensation for the three months and nine months ended September 30, 2005 (in
thousands, except per share amounts):
Three Months Ended Nine months Ended
September 30, September 30,
2005 2005
---- ----
Net loss - As reported $ (785) $ (2,000)
Compensation expense, net of tax
Five Star stock options (2) (5)
------- -------
Pro forma net loss (787) $ (2,005)
Basic and diluted loss per share
As reported $ (.04) $ (.11)
Pro forma net loss per share $ (.04) $ (.11)
3. Per share data
Basic and diluted loss per share for the three months and nine months ended
September 30, 2006 and 2005 is based upon the actual number of National Patent
Development shares outstanding during the periods. Outstanding warrants to
acquire 1,423,887 common shares issued in December 2004 were not included in the
2006 and 2005 diluted computation, as their effect would be anti-dilutive. In
addition, the diluted computation was not effected by Five Star's outstanding
options.
Loss per share for the three months and nine months ended September 30, 2006 and
2005 are as follows (in thousands, except per share amounts):
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Basic and Diluted EPS
Net loss $ (161) $ (785) $ (426) $ (2,000)
Weighted average shares
outstanding, basic and diluted 17,848 17,810 17,836 17,804
Basic and diluted loss per share $ (.01) $ (.04) $ (.02) $ (.11)
8
4. Long-term debt
Long-term debt
Long-term debt is comprised of the following (in thousands):
September 30, December 31,
2006 2005
------- -------
MXL Pennsylvania Mortgage (a) $1,130 $1,205
Other debt 186
Capital lease obligations 1 6
--------- --------
1,131 1,397
Less current maturities (101) (291)
--------- ------
$1,030 $1,106
(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 GP Strategies.
5. Short term borrowings
Five Star short-term borrowings
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 August 1, 2005, provides for a
$35,000,000 revolving credit facility, which allows Five Star to borrow based
upon a formula of up to 65% of eligible inventory and 85% of eligible accounts
receivable, as defined therein. The interest rates under the Loan Agreement
consist of LIBOR plus a credit spread of 1.5% (7.57% at September 30, 2006) for
borrowings not to exceed $15,000,000 and the prime rate (8.25% at September 30,
2006) 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 September 30, 2006 and December 31,
2005, approximately $17,870,000 and $19,764,000 was outstanding under the Loan
Agreement and approximately $6,286,000 and $1,451,000 was available to be
borrowed, respectively. Substantially all of Five Star's assets are pledged as
collateral for these borrowings. Under the Loan Agreement Five Star is subject
to covenants requiring minimum net worth, limitations on losses, if any, and
minimum or maximum values for certain financial ratios. As of September 30,
2006, Five Star was in compliance with all required covenants.
9
In connection with the Loan Agreement, Five Star also entered into a derivative
transaction with the Lender. 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
fair value of the interest rate swap amounted to $351,000 and 395,000 at
September 30, 2006 and December 31, 2005, respectively, and is included in other
assets in the accompanying balance sheets.
On June 17, 2004, Five Star also entered into a derivative interest rate collar
transaction for 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%, whereby 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%, whereby 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.
MXL short-term borrowings
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, which has been extended to
June 30, 2007 on the same terms. 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. At
September 30, 2006, $950,000 was outstanding under the MXL Line and $50,000 was
available to be borrowed. The MXL Line contains certain financial covenants,
most significant being a cash flow coverage ratio of 1.25 to 1.00, which is
calculated annually at December 31.
6. Inventories
Inventories are comprised of the following (in thousands):
September 30, 2006 December 31, 2005
------------------ -----------------
Raw materials $ 394 $ 386
Work in process 161 113
Finished goods 21,955 23,522
------- --------
$22,510 $24,021
======= =======
10
7. 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
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's 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 the Company 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 9 (a)).
On August 16, 2004, Valera sold 11,600,000 shares of Series C convertible
preferred stock and received gross proceeds of $11.6 million. As of December 31,
2005, the Company owned 10,000,000 shares of Valera common stock and 2,068,966
shares of Valera series B convertible preferred 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, 2005, the Company would own approximately 18% of Valera. On
February 7, 2006 Valera completed an initial public offering of 3,862,500 shares
of common stock at $9.00 per share. All the convertible preferred stock
11
outstanding at the time of the offering, including accrued dividends,
automatically converted into common stock. In addition, Valera effected a 1 for
6 reverse split of common stock. Subsequent to the public offering after giving
effect to the conversion of the Series B preferred stock and the reverse split
the Company owned 2,070,670 shares of Valera common stock or approximately 14%
of the outstanding shares of common stock. The Company entered into a lock-up
agreement with the underwriters of the public offering which restricted the
Company from selling or otherwise disposing of its shares of Valera common stock
until August 16, 2006.
On October 17, 2003, MXL received from GP Strategies in partial payment of a
note receivable the common shares of Valera and recorded such shares at zero
representing their carrying amount to GP Strategies. 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%. In addition, at December 31, 2005 Valera's board of
directors consisted 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 no longer accounts for its investment in Valera by the equity method.
As a result thereof, as of December 31, 2005 the investment in Valera's Series B
convertible preferred stock is being accounted for at cost.
As a result of the initial public offering, the Company's investment in Valera's
common stock became a marketable security and accordingly, the investment, to
the extent of shares available to be sold within a year at any balance sheet
date under Rule 144 or an effective registration statement, has been classified
as available for sale securities and measured at fair value with the adjustment
to fair value and changes therein to be retained by the Company recorded in
other comprehensive income. The remainder of the investment is considered
restricted and will continue to be carried at cost. In addition, if it is
determined that the Company is no longer an affiliate, the shares would become
freely tradable after the initial six month lock-up period. The Valera shares
available for sale over the next 12 months at September 30, 2006 totaled 744,277
and resulted in an unrealized gain of $4,019,000 being included in accumulated
other comprehensive income as of such date. Two related parties, Bedford Oak
Partners and Mr. Jerome I. Feldman, are entitled to receive 50% of any profit
received from the sale, on a pro-rata basis, of 404,004 shares of Valera common
stock in excess of $3.94 per share (see Note 9(a)). The unrealized profit on
Valera shares available for sale at September 30, 2006 which would be payable to
the related parties upon sale totaled $179,000, which is included in Accounts
payable and accrued expenses on the September 30, 2006 balance sheet.
12
8. Business segments
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, distributes paint sundry items, interior and exterior
stains, brushes, rollers, caulking compounds and hardware products on a regional
basis.
The following tables set forth the sales and operating income (loss) of each of
the Company's operating segments (in thousands):
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Sales
Five Star $27,666 $26,899 $85,556 $84,717
MXL 2,459 2,041 6,935 5,969
--------- --------- --------- ---------
$30,125 $28,940 $92,491 $90,686
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Segment operating income
(loss)
Five Star $ 518 $ (722) $ 2,229 $ 937
MXL 119 83 324 (623)
--------- -------- ------- ---------
$ 637 $ (639) $ 2,553 $ 314
A reconciliation of the segment operating income (loss) to income (loss) before
income tax (expense) benefit and minority interests in the condensed
consolidated statements of operations is shown below (in thousands):
13
Three Months Ended Nine months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Segment operating income (loss) $637 $(639) $2,553 $314
Corporate and other general and
administrative expenses (421) (504) (1,305) (1,588)
Interest expense (391) (396) (1,234) (1,223)
Investment and other income 101 27 178 298
--- ------- ---------- ----------
Income (loss) before income tax
expense and minority interests $(74) $(1,512) $ 192 $ (2,199)
9. Related party transactions
(a) 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 bore interest at 6% per annum, were scheduled to mature on
October 31, 2009, and were secured by all shares of Valera owned by the Company,
including the purchased shares. Bedford Oak Partners and Jerome I. Feldman are
entitled to receive 50% of any profit received by the Company from the sale on a
pro-rata basis of the Valera purchased shares. 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 the proceeds from the claims
relating to the Learning Technologies acquisition.
b) Certain of the Company's executive officers are also executive officers of GP
Strategies and will remain on GP Strategies' payroll. The executive officers do
not receive any salary from the Company; however, they provide the Company with
management services under a management agreement between GP Strategies and the
Company. Services under the agreement relate to corporate federal and state
income taxes, corporate legal services, corporate secretarial administrative
support, and executive management consulting. The term of the agreement extends
for three years from the date of the spin-off, or through November 24, 2007, and
may be terminated by either the Company or GP Strategies on or after July 30,
2006 with 180 days prior written notice. Prior to July 1, 2005 GP Strategies
charged the Company a management fee to cover an allocable portion of the
compensation of these officers, based on the time they spent providing services
to the Company, in addition to an allocable portion of certain other corporate
expenses. Such fees amounted to $656,000 for the six months ended June 30, 2005.
Effective July 1, 2005, GP Strategies and the Company amended the above
management agreement. Pursuant to the amendment, the Company will pay GP
Strategies an annual fee of not less than $970,000 as compensation for these
14
services, payable in equal monthly installments. The Company incurred a fee of
$221,000 and $653,000 for the three and nine months ended September 30, 2006,
respectively, and $230,000 for the period July 1, 2005 through September 30,
2005, including approximately 80% of the cost of the compensation and benefits
required to be provided by GP Strategies to Jerome Feldman, who serves as the
Company's Chief Executive Officer. Such fee shall be increased by 80% of any
increase of the cost of the compensation and benefits required to be provided by
GP Strategies to Mr. Feldman; in addition, the Company shall remain liable for
paying to GP Strategies 80% of the cost of the compensation and benefits
required to be provided by GP Strategies to Mr. Feldman if the management
agreement expires, is terminated, or is otherwise not extended through May 31,
2007. The Company also occupies a portion of corporate office space leased by GP
Strategies. The Company compensates GP Strategies approximately an additional
$205,000 annually for use of this space. GP Strategies' lease extends through
December 31, 2006.
15
NATIONAL PATENT DEVELOPMENT CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General Overview
The Company operates in two segments: MXL and Five Star. The Company also owns
certain other non-core assets, including investments in 2 publicly held
companies, Millennium Cell and Valera Pharmaceuticals; and certain real estate.
The Company monitors Millennium Cell for progress in the commercialization of
Millennium Cell's emerging technology and monitors Valera Pharmaceuticals for
progress in the sales efforts related to their product.
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 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. Some of MXL's
consumer based products are considered to be at the high-end of their respective
markets. As a result, sales of MXL's products may decline together with a
decline in discretionary consumer spending; therefore a key performance
indicator that the Company's management uses to manage the business is the level
of discretionary spending in key markets, specifically the United States and
Japan. Other key performance measures used by the Company's management to run
the business include:
o consumer confidence indices in key markets,
o sales levels of complementary items in the recreational vehicle market,
such as motorcycles, RV's and snowmobiles,
o levels of defense spending, and
o new OSHA safety standards.
16
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. 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.
Five Star Overview
Five Star is a publicly held company that is a leading distributor in the United
States of home decorating, hardware, and finishing products. Five Star offers
products from leading manufacturers in the home improvement industry and
distributes those products to retail dealers, which include lumber yards, "do-it
yourself" centers, hardware stores and paint stores. Five Star has grown to be
one of the largest independent distributors in the Northeast United Stated by
providing a complete line of competitively priced products, timely delivery and
attractive pricing and financing terms to its customers.
The following key factors affect Five Star's financial and operation
performance:
o its ability to negotiate the lowest prices from its suppliers,
o its ability to increase revenue by obtaining new customers, while
maintaining a level fixed cost structure by utilizing its existing
warehouses,
o the housing market in general,
o consumers' confidence in the economy,
o consumers' willingness to invest in their homes, and
o weather conditions that are conducive to home improvement projects.
The following key performance measures are utilized by the Company's management
to run Five Star's business:
o new U.S. housing starts,
o sales of existing homes,
o sales of high margin products to its customers,
o purchases from each vendor, and
o performance benchmarks used by Home Depot and Lowe's, such as number of
stores and square footage, as well as financial benchmarks.
Five Star operates in the Home Improvement market, which has grown in recent
years and for which the Home Improvement Research Institute predicts average
annual industry growth of nearly 5% for the next several years. Nonetheless,
Five Star faces intense competition from large national distributors, smaller
regional distributors, and manufacturers that bypass the distributor and sell
directly to the retail outlet. The principal means of competition for Five Star
are its strategically placed distribution centers and its extensive inventory of
quality, name-brand products. In addition, Five Star's customers face stiff
17
competition from Home Depot and Lowe's, which purchase directly from
manufacturers. As a result of such competition, while the Home Improvement
market has expanded significantly in recent years, Five Star's revenue has
increased only incrementally, and such revenue would have declined if Five Star
had not entered into new geographic sales territories as described below. In
spite of this, the independent retailers that are Five Star's customers remain a
viable alternative to Home Depot and Lowe's, due to the shopping preferences of
and the retailer's geographic convenience for some consumers.
Five Star has also established a presence in the Mid-Atlantic States, servicing
customers as far south as North Carolina. 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.
Operating Highlights
Three months ended September 30, 2006 compared to the three months ended
September 30, 2005
For the three months ended September 30, 2006, the Company had a loss before
income tax expense and minority interest of $74,000 compared to a loss before
income tax expense and minority interest of $1,512,000 for the three months
ended September 30, 2005. The reduced loss is primarily a result of
significantly improved operating profits at Five Star, which increased by
$1,240,000, as well as marginally increased profitability at MXL. In addition,
the Company had reduced general and administrative expenses at the corporate
level by $83,000 and increased investment and other income by $74,000.
Sales
Three months
ended September 30,
2006 2005
---- ----
Five Star $27,666,000 $26,899,000
MXL 2,459,000 2,041,000
------------- -------------
$30,125,000 $28,940,000
The increase in Five Star sales of $767,000 or 3% was primarily the result of
increased prices and reduced sales discounts offered to existing customers.
The increase in MXL sales of $418,000 was a result of increased sales volume and
prices from existing customers resulting from a concerted effort to expand sales
opportunities with existing customers.
18
Gross margin
Three months ended
September 30,
--------------- --------- ----------------- ----------
2006 % 2005 %
-------- - -------- -
Five Star $4,459,000 16.1 $3,429,000 12.7
MXL 576,000 23.4 519,000 25.4
------------ ------ ------------ ------
$5,035,000 13.1 $3,948,000 13.6
---------- ---- ---------- ----
Five Star's gross margin of $4,459,000, or 16.1% of net sales, for the quarter
ended September 30, 2006 increased by $1,030,000 when compared to $3,429,000, or
12.7% of net sales, for the quarter ended September 30, 2005. The increase in
gross margin and gross margin percentage for the quarter ended September 30,
2006 was a result of increased sales during the three months ended September 30,
2006 as well as the following factors which occurred in the quarter ended
September 30, 2005; (i) an unfavorable shift in the product mix sold, (ii) lower
prices due to competition, (iii) an increase in pricing by vendors, and some
resistance to price increases by customers, (iv) reduced promotional discounts
from vendors as a result of Five Star's decision to reduce inventory levels.
MXL's gross margin of $576,000, or 23.4% of sales, for the quarter ended
September 30, 2006 increased by $57,000 when compared to gross profit of
$519,000, or 25.4% of sales, for the quarter ended September 30, 2005, as a
result of increased sales, partially offset by reduced gross margin percentage
due to increased production and facility related costs.
Selling, general, and administrative expenses
For the three months ended September 30, 2006, selling, general and
administrative expenses decreased by $272,000 from $5,091,000 for the three
months ended September 30, 2005 to $4,819,000 for the three months ended
September 30, 2006. The decrease in selling, general and administrative expenses
was primarily attributable to the following; (i) reduced general and
administrative expenses of $83,000 at the Company corporate level and (ii)
reduced selling, general and administrative expenses at Five Star of $209,000
primarily attributable to an overall effort to reduce selling, general and
administrative expenses,
Investment and other income, net
National Patent Development recognized net investment and other income of
$101,000 for the three months ended September 30, 2006, compared to $27,000 for
the three months ended September 30, 2005. Investment and other income, net
includes interest income, investment income, and recognition of a gain or loss
for the change in the fair value of the Five Star's interest rate collar. The
increase of $74,000 is primarily attributable to the change in the fair value of
Five Star's interest rate collar as well as increased interest income.
19
Income taxes
For the three months ended September 30, 2006 and 2005, although the Company had
a consolidated pre-tax loss for the periods, the Company recorded an income tax
expense of $68,000 and $478,000, respectively, due to recording income tax
expense on the income of Five Star, a 64% owned subsidiary, which is not
included in the Company's consolidated return and not recording income tax
benefit for the losses of National Patent and MXL.
Nine months ended September 30, 2006 compared to the nine months ended September
30, 2005
For the nine months ended September 30, 2006, the Company had income before
income tax expense and minority interest of $192,000 compared to a loss before
income tax expense and minority interest of $2,199,000 for the nine months ended
September 30, 2005. The change to pre-tax income is primarily a result of the
following; (i) increased operating income of $1,292,000 at Five Star and
$947,000 at MXL, (ii) reduced corporate and other general and administrative
expenses of $283,000 and (iii) reduced Investment and other income of $120,000.
Sales
Nine months
ended September 30,
2006 2005
---- ----
Five Star $85,556,000 $84,717,000
MXL 6,935,000 5,969,000
------------- -------------
$92,491,000 $90,686,000
The increase in Five Star sales of $839,000 was primarily the result of
increased prices passed on to Five Star's customers as well as reduced sales
discounts.
The increase in MXL sales of $966,000 was primarily a result of increased sales
volume and increase in prices to existing customers resulting from a concerted
effort to expand sales opportunities with existing customers.
Gross margin
Nine months ended
September 30,
-----------------------------------------------------
-------------- --------- ----------------- ----------
2005 % 2005 %
------- - -------- -
Five Star $14,319,000 16.7 $13,437,000 15.9
MXL 1,803,000 26.0 1,162,000 19.5
----------- ------ ------------- ------
$16,122,000 17.4 $14,599,000 16.1
----------- ---- ----------- ----
Five Star's gross margin of $14,319,000, or 16.7% of net sales, for the nine
months ended September 30, 2006 increased by $882,000 when compared to
20
$13,437,000, or 15.9% of net sales, for the nine months ended September 30,
2005. The increased gross margin amount was the result of an increased gross
margin percentage, as well as increased sales volume. The increased gross margin
percentage for the nine months ended September 30, 2006 was primarily the result
of Five Star's ability to effectively pass price increases on to its customers
in 2006.
MXL's gross margin of $1,803,000 or 26% of sales, for the nine months ended
September 30, 2006 increased by $641,000 when compared to gross margin of
$1,162,000, or 19.5% of sales, for the nine months ended September 30, 2005,
mainly due to the following; (i) increased margins in all product lines due to
increased pricing, (ii) improved product mix, (iii) reduced costs due to exiting
the Massachusetts facility and the consolidation of all MXL's injection molding
and precision coating operations at its Lancaster PA facility, and (iv)
increased sales.
Selling, general, and administrative expenses
For the nine months ended September 30, 2006, selling, general and
administrative expenses decreased by $999,000 from $15,873,000 for the nine
months ended September 30, 2005 to $14,874,000 for the nine months ended
September 30, 2006 due to the following; (i) reduced general and administrative
expenses of $283,000 at the Company's corporate level, (ii) reduced selling,
general and administrative expenses at Five Star of $410,000, attributable to a
$175,000 recovery of bad debts written-off in prior years and reduced selling
and delivery expenses (iii) reduced selling, general and administrative expenses
of $330,000 at MXL, primarily due to reduced facility costs related to closing
of the Massachusetts facility in 2005, as well as increased operating
efficiencies. In addition, for the nine months ended September 30, 2005 the
Company incurred a loss of $140,000, based upon the final proceeds from the sale
of the Illinois facility, net of commissions, taxes and other closing costs.
This loss is included as part of selling, general and administrative expenses on
the consolidated statement of operation for the period.
Investment and other income, net.
National Patent Development recognized investment and other income of $178,000
for the nine months ended September 30, 2006 as compared to $298,000 the nine
months ended September 30, 2005. The reduced Investment and other income is
mainly due to the following; (i) a gain on sale of Millennium Cell, Inc. common
stock of $192,000 during the nine months ended September 30, 2005, (ii) a loss
on the sale of Avenue Entertainment Group, Inc common stock of $33,000 during
the nine months ended September 30, 2005, (iii) increased interest income for
the nine months ended September 30, 2006.
Income taxes
For the nine months ended September 30, 2006 and 2005, the Company recorded an
income tax expense of $446,000 and an income tax benefit of $107,000,
respectively, which represents the Company's applicable federal, state and local
tax expense and benefit for the periods. The provision for income taxes differs
from the tax computed at the federal statutory income tax rate due to (i)
recording income tax expense on the income of Five Star, a 64% owned subsidiary,
which is not included in the Company's consolidated return and (ii) not
recording income tax benefit for the losses of the Company and MXL.
21
Liquidity and capital resources
At September 30, 2006, the Company had cash and cash equivalents of $4,885,000.
The Company believes that cash anticipated to be generated from operations and
borrowing availability under existing credit agreements will be sufficient to
fund the Company's working capital requirements for at least the next twelve
months.
For the nine months ended September 30, 2006, the Company's working capital
increased by $263,000 to $12,812,000 from $12,549,000 as of December 31, 2005.
The working capital increase was primarily a result of increased accounts
receivable, partially offset by increased accounts payable and accrued expenses.
The decrease in cash and cash equivalents of $230,000 for the nine months ended
September 30, 2006 resulted from the following: (i) net cash provided by
operations of $2,249,000, due primarily to a net loss of $426,000, an increase
in accounts receivable of $3,652,000, partially offset by an increase in
accounts payable and accrued expenses of $3,071,000 and reduced inventory of
$1,511,000; (ii) net cash used in investing activities of $269,000 consisting of
additions to property, plant and equipment, ; and (iii) net cash used in
financing activities of $2,210,000, consisting of repayments of short term
borrowings of $1,944,000 and repayments of long-term debt of $266,000.
In 2003, Five Star entered into 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 in August 1, 2005
provides for a $35,000,000 revolving credit facility, which allows Five Star to
borrow based upon a formula of up to 65% of eligible inventory and 85% of
eligible accounts receivable, as defined therein. The interest rates under the
Loan Agreement consist of LIBOR plus a credit spread of 1.5% (7.57% at September
30, 2006) for borrowings not to exceed $15,000,000 and the prime rate (8.25% at
September 30, 2006) 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 September 30, 2006 and
December 31, 2005, approximately $17,870,000 and $19,764,000 was outstanding
under the Loan Agreement and approximately $6,286,000 and $1,451,000 was
available to be borrowed, respectively. Substantially all of Five Star's assets
are pledged as collateral for these borrowings. Under the Loan Agreement Five
Star is subject to covenants requiring minimum net worth, limitations on losses,
if any, and minimum or maximum values for certain financial ratios. As of
September 30, 2006 Five Star was in compliance with all required covenants. The
following table sets forth the significant debt covenants at September 30, 2006:
22
Covenant Required Calculated
- -------- -------- ----------
Minimum tangible net worth $6,000,000 $7,846,000
Debt to tangible net worth < 6 2.28
Fixed charge coverage >1.1 1.68
Quarterly income No loss in consecutive quarters $278,000 -first quarter income
$148,000- second quarter income
$51,000- third quarter income
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, which has been extended to
June 30, 2007 on the same terms. 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. The Company has guaranteed the MXL Line. At September 30,
2006, $950,000 was outstanding under the MXL Line and $50,000 was available to
be borrowed. The MXL Line contains certain financial covenants, most significant
being a cash flow coverage ratio of 1.25 to 1.00, which is calculated annually
at December 31.
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.
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.
23
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 3.3% and 3.9% at September 30, 2006 and
December 31, 2005, 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 September 30, 2006, 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
The Company'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.
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.
24
Income taxes
To arrive at our income tax provision and other tax balances, significant
judgment is required. In the ordinary course of our business, there are many
transactions and calculations where the ultimate tax outcome is uncertain. Some
of these uncertainties arise as a consequence of the treatment of capital
assets, financing transactions and multistate taxation of operations. Although
we believe that our estimates are reasonable, no assurance can be given that the
final tax outcome of these matters will not be different than that which is
reflected in our historical tax provisions and accruals. Such differences could
have a material impact on our income tax provision, other tax accounts and net
income in the period in which such determination is made.
The Company records a valuation allowance against deferred income tax assets
when management believes it is more likely than not that some portion or all of
the deferred income tax assets will not be realized. Management considers
factors such as reversal of deferred income tax liabilities, projected future
taxable income, tax planning strategies, changes in tax law and other factors. A
change to these factors could impact the estimated valuation allowance and
income tax expense.
Under SFAS No. 109, "Accounting for Income Taxes," deferred tax assets and
liabilities are determined based on differences between the financial reporting
and tax basis of assets and liabilities, and are measured using enacted tax
rates and laws that will be in effect when the differences are expected to
reverse. SFAS No. 109 provides for the recognition of deferred tax assets if
realization of such assets is more likely than not. Based on the weight of
available evidence, we have provided a valuation allowance against certain
deferred tax assets. The valuation allowance was based on the historical
earnings patterns within individual tax jurisdictions that make it uncertain
that we will have sufficient income in the appropriate jurisdictions to realize
the full value of the assets. We will continue to evaluate the realizability of
the deferred tax assets on a quarterly basis.
Forward-looking statements
The forward-looking statements contained herein reflect National Patent
Development's management's current views with respect to future events and
financial performance. These forward-looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those in the forward-looking statements, all of which are difficult to
predict and many of which are beyond the control of National Patent Development,
including, but not limited to the risks and uncertainties detailed in National
Patent Development's periodic reports and registration statements filed with the
Securities and Exchange Commission.
25
Item 3. Quantitative and Qualitative Disclosure About Market Risk
We have no material changes to the disclosure on this matter made in our
report on Form 10-K for the fiscal year ended December 31, 2005.
Item 4. Controls and Procedures
a. Evaluation of disclosure controls and procedures. The Company's Chief
Executive Officer and Chief Financial Officer have reviewed and
evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 240.13a-14(c) and
15d-14(c)) as of a date within ninety days before the filing date of
this quarterly report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer have concluded that the Company's
current disclosure controls and procedures are effective as of the
evaluation date, providing them with material timely information
relating to the Company required to be disclosed in the reports the
Company files or submits under the Exchange Act. The Chief Executive
Officer and Chief Financial Officer have also concluded that the
Company's current disclosure controls and procedures are designed, and
are effective as of the evaluation date, to give reasonable assurance
that the information required to be disclosed by the Company in the
reports that it files under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules
and forms of the Securities and Exchange Commission.
b. Changes in internal controls. There have been no significant changes
in the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
evaluation.
26
PART II. OTHER INFORMATION
Item 6. Exhibits
a. Exhibits
31.1 Certification of Chief Executive Officer of the
Company dated November 14, 2006 pursuant to
Securities and Exchange Act Rule
13d-14(a)/15(d-14(a), as adopted pursuant to Section
302 and 404 of the Sarbanes-Oxley Act of 2002.*
31.2 Certification of Chief Financial Officer of the
Company dated November 14, 2006 pursuant to
Securities and Exchange Act Rule
13d-14(a)/15(d-14(a), as adopted pursuant to Section
302 and 404 of the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Chief Executive Officer and
Chief Financial Officer of the Company dated November
14, 2006 pursuant to 18 U.S.C. Section 1350 as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.*
________
*Filed herewith
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed in its behalf by the
undersigned thereunto duly authorized.
NATIONAL PATENT DEVELOPMENT CORPORATION
DATE: November 14, 2006 Jerome I. Feldman
Chairman of the Board and
Chief Executive Officer
DATE: November 14, 2006 Scott N. Greenberg
Chief Financial Officer
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