ARGAN INC — Proxy Solicitation & Information Statement 2003

Feb 20, 2003

PRE 14A 1 formpre14a05190_02282003.htm sec document SCHEDULE 14A Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Amendment No. ) Filed by the Registrant /X/ Filed by a party other than the Registrant / / Check the appropriate box: /X/ Preliminary proxy statement / / Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(e)(2)) / / Definitive proxy statement / / Definitive additional materials / / Soliciting material under Rule 14a-12 PUROFLOW INCORPORATED --------------------- (Name of Registrant as Specified in its Charter) (Name of Person(s) Filing Proxy Statement, if other than the Registrant) Payment of filing fee (Check the appropriate box): /X/ No fee required. / / Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11. (1) Title of each class of securities to which transaction applies: Not applicable -------------------------------------------------------------------------------- (2) Aggregate number of securities to which transaction applies: Not applicable -------------------------------------------------------------------------------- (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): Not applicable -------------------------------------------------------------------------------- (4) Proposed maximum aggregate value of transaction: -------------------------------------------------------------------------------- (5) Total fee paid: / / Fee paid previously with preliminary materials. / / Check box if any part of the fee is offset as provided by Exchange Act Rule 0-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the form or schedule and the date of its filing. (1) Amount Previously Paid: -------------------------------------------------------------------------------- (2) Form, Schedule or Registration Statement No.: -------------------------------------------------------------------------------- (3) Filing Party: -------------------------------------------------------------------------------- (4) Date Filed: -------------------------------------------------------------------------------- PUROFLOW INCORPORATED --------------------- __, 2003 To Our Stockholders: You are cordially invited to attend the Special Meeting of Stockholders of Puroflow Incorporated, to be held on _, 2003. Enclosed are the Secretary's notice of this meeting, a proxy statement, and a form of proxy. Please note that the meeting will be held at _ a.m., at _____. At the Special Meeting, you will be asked to consider and vote upon the following proposals described in the enclosed proxy statement: o To approve the issuance and sale by Puroflow, pursuant to a private placement, of between 1.3 million and 2.6 million of our non-registered shares of common stock at the price of $7.75 per share, as more fully described in the proxy materials. o To amend our 2001 Stock Option Plan, to increase the total number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000 shares. o To transact such other business as may properly come before the meeting and any adjournments thereof. AS DESCRIBED IN THE ENCLOSED MATERIALS, OUR BOARD OF DIRECTORS HAS APPROVED THE MATTERS INCLUDED IN THESE PROPOSALS AND BELIEVES THAT IT IS FAIR TO, AND IN THE BEST INTERESTS OF, US AND OUR STOCKHOLDERS. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH OF THE PROPOSALS. Regardless of whether you plan to attend the Special Meeting, your vote is important. I urge you to participate by promptly completing and returning the enclosed proxy card as soon as possible. You may revoke your proxy and vote in person if you decide to attend the Special Meeting. Sincerely, Puroflow Incorporated ---------------------- Michael H. Figoff President and Chief Executive Officer PUROFLOW INCORPORATED --------------------- Notice of Special Meeting of Stockholders _, 2003 -------------------------- TO OUR STOCKHOLDERS: NOTICE IS HEREBY GIVEN that the Special Meeting of Stockholders of Puroflow Incorporated (we, us, Puroflow or the Company), a Delaware corporation, will be held on , 2003 at a.m., at ____, for the following purposes: 1. To consider and vote upon a proposal to approve the issuance and sale by Puroflow, pursuant to a private placement, of between 1.3 million and 2.6 million of our non-registered shares of common stock at the price of $7.75 per share, as more fully described in the proxy materials; 2. To consider and vote on an amendment to our 2001 Stock Option Plan, to increase the total number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000 shares; and 3. To transact such other business as may properly come before the meeting and any adjournment(s) thereof. The foregoing items of business are more fully described in the Proxy Statement accompanying this Notice. Only Stockholders of record at the close of business on [_, 2003], are entitled to notice of and to vote at the Special Meeting and any adjournment(s) thereof. To assure your representation at the Special Meeting, you are urged to mark, sign, date, and return the enclosed proxy card as promptly as possible in the postage-prepaid envelope enclosed for that purpose. Any Stockholder attending the Special Meeting may vote in person even if such Stockholder returned a proxy card. By Order of the Board of Directors, ------------------------------ Sandy Yoshisato Corporate Secretary Sun Valley, California ______________ , 2003 PUROFLOW INCORPORATED --------------------- PROXY STATEMENT ---------------------- INFORMATION CONCERNING SOLICITATION AND VOTING General The enclosed proxy is solicited on behalf of the Board of Directors of Puroflow Incorporated (we, us, Puroflow or the Company) for use at the Special Meeting of Stockholders ("Special Meeting") to be held __, 2003, at _ a.m., or at any adjournment(s) thereof, for the purposes set forth herein and in the accompanying Notice of Special Meeting of Stockholders. The Special Meeting will be held at ____. These proxy solicitation materials were mailed on or about _, to all Stockholders entitled to vote at the Special Meeting. The cost of soliciting these proxies will be paid by the Company. The Company has retained the services of McKenzie Partners, Inc. to solicit proxies and distribute materials to brokerage houses, banks, custodians, and other institutional owners. The Company will pay McKenzie Partners, Inc. a fee of approximately $_______ for these services, plus expenses. In addition, the Company will reimburse brokerage firms and other persons representing beneficial owners of shares for their expenses in forwarding solicitation materials to such beneficial owners. The Company may conduct further solicitation personally, by telephone, or by facsimile through its officers, directors, and regular employees, none of whom will receive additional compensation for assisting with the solicitation. REVOCABILITY OF PROXIES Any proxy given pursuant to this solicitation may be revoked by the person giving it at any time before its use, by delivering to the Company, at its principal office at 10616 Lanark Street, Sun Valley, California 91352, (Attention: Sandy Yoshisato), a written notice of revocation or a duly executed proxy card bearing a later date, or by attending the Special Meeting and voting in person. VOTING AND SOLICITATION Only Stockholders of record at the close of business on [_________, 2003], are entitled to notice of and to vote at the Special Meeting. At the record date, ____________ shares of our Company's common stock, with a par value of $.15 per share, were issued and outstanding. Approval of the issuance of our common stock described in Proposal No. 1 and of the amendment to the 2001 Stock Option Plan described in Proposal No. 2 requires the affirmative vote of a majority of the total votes cast by holders of the outstanding shares of common stock present in person or represented by proxy at the Special Meeting and entitled to vote at the Special Meeting. Votes cast by proxy or in person at the Special Meeting will be tabulated by the inspector of elections. The inspector of elections will also determine whether or not a quorum is present. The required quorum is a majority of the shares issued and outstanding on the record date, represented either in person or by proxy. Votes that are cast for or against a proposal, abstentions, and broker non-votes are counted as present for the purpose of determining the presence of a quorum for the transaction of business. For purposes of determining the number of shares voting on a particular proposal, votes cast for or against a proposal and abstentions are counted as shares voting, whereas broker non-votes are not counted as shares voting. Accordingly, an abstention will have the same effect as a vote against the proposal, and broker non-votes will have no effect. Any proxy which is returned using the proxy card enclosed and which is not marked as to any proposal will be voted for (i) the issuance and sale of between 1.3 million and 2.6 million of our non-registered shares of common stock at the price of $7.75 per share, subject to the terms of a Private Placement Offering Memorandum, consisting of an Offering Summary, Purchase Questionnaire, Subscription Agreement and Registration Rights Agreement; and (ii) the amendment of the Company's 2001 Stock Option Plan, to increase the total number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000 shares. As described further below, our Board of Directors has approved the matters included in both of these proposals and believes that it is fair to, and in the best interests of, us and our Stockholders. The Board of Directors recommends a vote "for" each of these proposals. -2- PROPOSAL NO. 1 APPROVAL OF THE PRIVATE PLACEMENT INTRODUCTION We are asking you to approve the issuance and sale, through a private placement, of between 1.3 million and 2.6 million of our non-registered shares of common stock at the price of $7.75 per share, subject to the terms of a Private Placement Offering Memorandum (the "Private Placement"), consisting of an Offering Summary, Purchase Questionnaire, Subscription Agreement and Registration Rights Agreement. The following is a brief summary of some of the principal terms of the Private Placement. The description contained below in this proxy, especially the statements under the captions "Effects of the Private Placement on the Company" and "Terms of the Private Placement" should be reviewed carefully. REASONS FOR THE PRIVATE PLACEMENT The principal reasons for the Private Placement of non-registered shares of common stock are: o to provide us with additional working capital; and o to provide us with additional capital for acquisitions in growth oriented industries. We believe that obtaining additional capital is critical to our ability to continue to execute our business plan while simultaneously looking to make acquisitions in growth oriented industries. We believe that the best option for the Company is to obtain this additional financing through the Private Placement. BACKGROUND OF THE PRIVATE PLACEMENT On December 31, 2002, we executed a non-binding term sheet with the Bosselmann Group, Rainer Bosselmann, Haywood Miller and Arthur Trudel ("Term Sheet"), setting forth terms for the Private Placement. Rainer Bosselmann is a principal of the Bosselmann Group. Pursuant to the Term Sheet, the Bosselmann Group and/or its affiliates agreed to invest not less than $2 million in the Private Placement and the balance of the Private Placement would be from accredited investors (as defined in Rule 501(c) of Regulation D under the Securities Act of 1933, as amended). Additionally, pursuant to the Term Sheet, upon the closing of the Private Placement, Rainer Bosselmann would nominate (and the Board of Directors would appoint) three directors to serve on the Company's Board of Directors, in -3- addition to himself. Mr. Bosselman was appointed to the Company's Board of Directors upon the execution of the Term Sheet. The transactions contemplated by the Term Sheet were approved by our Board of Directors after careful review and analysis with input and guidance from our management and our financial advisors. Based on this analysis, our Board of Directors determined that the Term Sheet from the Bosselmann Group presented the best strategic option for the Company. In the course of reaching its decision to approve the Term Sheet and proceed with the Private Placement, the Board of Directors consulted our senior management and financial advisors, and reviewed a significant amount of information and considered a significant number of factors including, but not limited to, the size of the transaction and the identity of the potential investors and the impact of the transaction on our earnings per share. In view of the wide variety of the material factors considered in connection with the evaluation of the Private Placement and the complexity of these matters, our Board of Directors did not find it practicable to, and did not, quantify or otherwise attempt to assign any relative weight to the various factors considered. In addition, in considering the various factors, individual members of our Board of Directors may have given different weight to different factors. Among other terms of the Private Placement which are more fully described below under "Terms of the Private Placement," our Board of Directors will be changed if the Private Placement is approved and is consummated. Prior to the execution of the Term Sheet, our Board of Directors had seven directors. Immediately following the execution of the Term Sheet, in accordance with its terms, on January 2, 2003, Mr. Bosselmann was appointed to the Company's Board of Directors as Vice Chairman of the Board of Directors (increasing the size of the Board of Directors to eight). If the Private Placement is not approved or is otherwise not consummated, he has agreed to resign from the Board of Directors and as Vice Chairman. Following the closing of the Private Placement, four of our current directors will resign and will be replaced by three new directors to be nominated by Mr. Bosselmann. See "Terms of the Private Placement - Board of Directors". Accordingly, Mr. Bosselmann and his designees will constitute a majority of the Board of Directors. Additionally, upon the execution of the Term Sheet, and pursuant to the terms of the Term Sheet, the Company granted to the Bosselmann Group warrants to purchase 180,000 shares of the Company common stock at $7.75 per share, and agreed to grant to certain Bosselmann Group advisors warrants to purchase 50,000 shares of the Company common stock at $7.75 per share. These warrants can only be exercised in the event that the Company Stockholders approve the Private Placement and it is consummated. In addition, upon consummation of the Private Placement, a fee of $210,000 will be paid to such advisors. See "Terms of the Private Placement". -4- EFFECTS OF THE PRIVATE PLACEMENT ON THE COMPANY As of [__________, 2003] we have __________ shares of common stock outstanding. After the Private Placement, holders of the non-registered common stock (the "Private Placement Common Stock") will hold shares representing between ____% and ____% of the total shares outstanding, on a fully diluted basis. We have agreed to file a registration statement to register such shares no later than 180 days following the closing of the Private Placement. The issuance of the Private Placement Common Stock will result in a significant dilution of your ownership interest in Puroflow. Upon the closing of the Private Placement, four (4) current members of the Board of Directors have agreed to resign, and Rainer Bosselmann will have the right to designate three (3) new members to the Board of Directors (as discussed below), who together with him will constitute the majority of the Board of Directors. Additionally, because the holders of the Private Placement Common Stock will own a majority of the outstanding shares of common stock of Puroflow, if they vote together, they will have significant influence in determining the outcome of any corporate transaction or other matter to be submitted to Stockholders for approval, including, without limitation, the election of directors and approval of mergers, consolidations and the sale of all or substantially all of our assets. Sales in the public market (pursuant to a registration) of the Private Placement Common Stock acquired could lower our stock price and impair our ability to raise funds in additional stock offerings. Future sales of a substantial number of shares of our common stock in the public market, or the perception that such sales could occur, could adversely affect the prevailing market price of our common stock and could make it more difficult for us to raise funds through a public offering of our equity securities. TERMS OF THE PRIVATE PLACEMENT GENERAL The Company is offering pursuant to a private placement a minimum of 1.3 million and a maximum of 2.6 million shares of non-registered common stock at a price of $7.75 per share, in order to raise between $10.075 million and $20.15 million to use as additional working capital and for acquisitions in growth oriented industries. The Private Placement Offering Memorandum consists of an Offering Summary, Purchaser Questionnaire, Subscription Agreement and Registration Rights Agreement. BOARD OF DIRECTORS In the event the Private Placement is approved and is consummated, Rainer Bosselmann will have the ability to appoint a majority of our Board of Directors. Prior to the execution of the Term Sheet, our Board of Directors consisted of seven directors. Immediately following the execution of the Term -5- Sheet in accordance with its terms, on January 2, 2003, Mr. Bosselmann was appointed to our Board of Directors as Vice Chairman of the Board of Directors. If the Private Placement is not approved or is otherwise not consummated he has agreed to resign as Vice Chairman. Following the closing of the Private Placement, the Board of Directors will be composed of seven directors. Four of our current directors, Warren Lichtenstein, Glen Kassan, Joshua Schechter and Robert Smith, have agreed to resign and will be replaced with three new directors to be nominated by Mr. Bosselmann. The three new directors are DeSoto Jordan, James Quinn and Daniel Levinson. These three directors will be appointed by the remaining members of the Board of Directors and our stockholders will not have an opportunity to vote on their election until the next succeeding election of directors following the closing of the Private Placement. APPOINTMENT OF OFFICES; COMPENSATION. Immediately following the execution of the Term Sheet in accordance with its terms, Haywood Miller and Arthur Trudel, both members of the Bosselmann Group, were appointed as corporate officers of the Company, each at the nominal annual salary of $1.00. Upon the consummation of the Private Placement, each of Messrs. Bosselmann, Miller and Trudel will become senior officers of the Company at an annual salary of $100,000 each. The Bosselmann Group has also been granted warrants to purchase 180,000 shares of the Company's common stock at $7.75 per share. These warrants are only exercisable in the event that the Private Placement is approved and is consummated. CONDITIONS TO CLOSING The closing of the Private Placement is conditioned upon the occurrence of the following events: (i) approval of the Private Placement by the Board of Directors of the Company and its stockholders; (ii) the receipt of a fairness option by an investment bank; (iii) compliance with applicable state securities regulation; and (iv) approval of an amendment to our 2001 Stock Option Plan to increase the total number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000 shares. The Board of Directors has approved the Private Placement and recommends that stockholders approve it. The Company has also received a fairness opinion from Imperial Capital as described below. We believe that the Private Placement complies with all applicable state securities regulations. Accordingly, the outstanding conditions to closing are the approval of the Private Placement by Stockholders (Proposal 1) and the approval of an amendment to the 2001 Stock Option Plan (Proposal 2). If Proposal 1 is approved but Proposal 2 is not, the Private Placement will not close unless the Private Placement investors waive that condition. FEES AND EXPENSES Upon the closing of the Private Placement, we will pay to certain investment advisors of the Bosselmann Group a cash payment of $210,000 and the Company has agreed to grant such advisors warrants to purchase 50,000 shares of -6- Company common stock at $7.75 per share. In addition we will reimburse the Bosselmann Group for reasonable fees and expenses of legal counsel incurred by the Bosselmann Group in connection with the Private Placement and all other reasonable out-of-pocket fees and expenses incurred by the Bosselmann Group in connection with the Private Placement. THE REGISTRATION RIGHTS AGREEMENT In connection with the Private Placement, we will enter into a Registration Rights Agreement with the purchasers of the Private Placement Common Stock. Pursuant to the terms of the Registration Rights Agreement, not later than 180 days after the closing of the Private Placement, the Company is required to file a shelf registration statement relating to the resale of the Private Placement Common Stock. Additionally, if the Company shall register for sale for cash any of its common stock, for its own account or for the account of others, other than certain registrations relating primarily to a registration solely for employee benefit plans or securities issued or issuable to employees or consultants, or any of their families, the Company shall promptly give notice to the holders of the Private Placement Common Stock, and shall include in such registration all of the Private Placement Common Stock whose holders notified the Company by a written request of their desire to be included in such a registration. USE OF PROCEEDS After expenses of the Private Placement which are currently estimated at $260,000, the net proceeds of the Private Placement are expected to be between $19.7 million and $9.8 million. We intend to use the net proceeds from the Private Placement for acquisitions in growth oriented industries and for working capital. OPINION OF PUROFLOW'S FINANCIAL ADVISOR FAIRNESS OPINION The Company's Board of Directors engaged Imperial Capital as a financial advisor to render its written opinion that the consideration to be received by the Company in the Private Placement was fair to the Company from a financial point of view. A copy of the opinion, which sets forth the assumptions made, matters considered and scope and limitations of the review undertaken and the procedures followed by Imperial Capital, is attached hereto as Appendix A and is incorporated by reference into this proxy statement. You are urged to read Imperial Capital's opinion carefully and in its entirety for assumptions made, matters considered and limits of the review by Imperial Capital. Imperial Capital's opinion, which was prepared at the request and for the information of the Board of Directors of the Company, addressed only the fairness from a financial point of view as of ____________, of the consideration to be received by the Company and did not address any other aspect of the Private Placement. Imperial Capital's opinion does not address the business -7- decision or the relative merits of the decision of the Board of Directors. Imperial Capital was not retained to nor did it advise the Company with respect to alternatives to the Private Placement. Consequently, no opinion was expressed whether any alternative transaction might have produced proceeds to the Company in an amount in excess of the consideration to be received by the Company from the Private Placement. Imperial Capital's opinion is not a recommendation to any of the Company's Stockholders as to how a Stockholder should vote with respect to Proposal No. 1. In rendering its opinion, Imperial Capital assumed, with the Company's consent, that the Company will comply with all material terms of the Private Placement. No limitations were placed on Imperial Capital by the Company with respect to the investigation made, the procedures followed or the factors considered in preparing and rendering its opinion. [Analysis to be included upon receipt of opinion.] Imperial Capital's opinion was based upon economic, monetary and market conditions existing on the date of the opinion. Imperial Capital expressed no opinion, nor should one be implied, as to the current fair market value of the Shares. Imperial Capital was retained by the Company's Board of Directors to evaluate the fairness from a financial point of view to the Company of the consideration to be received by the Company in the Private Placement and [has been paid] [will receive] a fee [of $_______] for its services, including rendering its opinion. The Company also agreed, under a separate agreement, to indemnify Imperial Capital, its affiliates and each of its directors, officers, agents and employees and each person, if any, controlling Imperial Capital or any of its affiliates against certain liabilities. Imperial Capital, in the ordinary course of its business, may actively trade the equity securities of the Company for its own account and for the accounts of customers and, accordingly, may at any time hold a long or short position in such securities. APPROVAL BY STOCKHOLDERS The Company is not required by law or by any regulation to obtain Stockholder approval for the issuance and sale of the Private Placement Common Stock. Due to the nature of the transaction, however, the Company has determined to seek the approval of its Stockholders. If Proposal No. 1 is not approved, then the Private Placement will not be consummated on the terms described herein. The Company has determined that approval by the affirmative vote of a majority of the total votes cast by holders of the outstanding shares of common stock present in person or represented by proxy at the Special Meeting and entitled to vote at the meeting will be required in order for the Company to proceed with the issuance and sale of the Private Placement Common Stock pursuant to the terms of the Private Placement. -8- The Company has been informed by Steel Partners II, L.P., who beneficially owns 175,840 shares, representing 35.6% of the Company's outstanding common stock, that they intend to vote in favor of Proposal No. 1. RECOMMENDATION OF THE BOARD OF DIRECTORS THE BOARD OF DIRECTORS HAS APPROVED THE MATTERS INCLUDED IN PROPOSAL NO. 1 AND BELIEVES THAT THEY ARE FAIR TO, AND IN THE BEST INTERESTS OF, US AND OUR STOCKHOLDERS. THE BOARD RECOMMENDS A VOTE "FOR" PROPOSAL NO. 1. -9- ADDITIONAL INFORMATION PROVIDED PURSUANT TO SECTION 14(f) OF THE SECURITIES EXCHANGE ACT OF 1934 AND RULE 14f-1 THEREUNDER This information is being furnished in connection with the designation by Rainer Bosselmann (a principal of the Bosselmann Group), pursuant to the closing of the Private Placement, of persons to be elected to the Company's Board of Directors other than at a meeting of the Company's Stockholders. Pursuant to the closing of the Private Placement, Mr. Bosselmann shall be entitled to designate three (3) members to the Company's Board of Directors (in addition to himself) to replace four current members of the Board of Directors who have agreed to resign. Following such appointment and resignations, the Board of Directors will have seven members and shall consist of Mr. Bosselmann, his three nominees, and three current members of the Board of Directors. The Company has also agreed to use its best efforts to effect the resignations of the four directors so as to enable Mr. Bosselmann's designees to be appointed to the Board of Directors. The Company has agreed to take all action necessary to effect any such election. This proxy statement shall constitute the information required by Section 14(f) of the Exchange Act and Rule 14f-1 promulgated thereunder. DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 12,000,000 shares of common stock, $.15 par value, and 500,000 shares of preferred stock, $.10 par value. COMMON STOCK As of the record date, [__________, 2003,] there were __________ shares of common stock outstanding held of record by ___ Stockholders. Holders of common stock are entitled to one vote per share on all matters to be voted upon by the Stockholders. Subject to preferences that may be applicable to the holders of outstanding shares of preferred stock, if any, the holders of common stock are entitled to receive such lawful dividends as may be declared by the Board of Directors. In the event of liquidation, dissolution or winding up of the Company, and subject to the rights of the holders of outstanding shares of preferred stock, if any, the holders of shares of common stock shall be entitled to receive pro rata all of the remaining assets of the Company available for distribution to its Stockholders. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable. PREFERRED STOCK As of [__________, 2003,] there were no shares of preferred stock issued or outstanding. -10- The Board of Directors has the authority, without further action by the Stockholders, to issue the authorized shares of preferred stock in one or more series and to fix the rights, preferences and privileges thereof, including voting rights, terms of redemption, redemption prices, liquidation preferences, number of shares constituting any series or the designation of such series. Although it presently has no intention to do so, the Board of Directors, without Stockholder approval, could issue preferred stock with voting and conversion rights which could adversely affect the voting power of the holders of common stock. REGISTRATION RIGHTS In connection with the Private Placement, we will enter into a Registration Rights Agreement with the purchasers of the Private Placement Common Stock. Pursuant to the terms of the Registration Rights Agreement, not later than 180 days after the closing of the Private Placement, the Company shall file a shelf registration statement relating to the resale of the Private Placement Common Stock. Additionally, if the Company shall register for sale for cash any of its common stock, for its own account or for the account of others, other than certain registrations relating primarily to a registration solely to employee benefit plans or securities issued or issuable to employees or consultants, or any of their families, the Company shall promptly give notice to the holders of the Private Placement Common Stock, and shall include in such registration, all of the Private Placement Common Stock, whose holders notified the Company by a written request of their desire to be included in such a registration. DELAWARE LAW AND CERTAIN CHARTER PROVISIONS The Company is subject to the provisions of Section 203 of the Delaware General Company Law. In general, the statute prohibits a publicly-held Delaware corporation from engaging in a "business combination" with an "interested" stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder, unless either (i) prior to the date at which the person becomes an interested stockholder, the Board of Directors approves such transaction or business combination, (ii) the stockholder acquires more than 85% of the outstanding voting stock of the corporation (excluding shares held by directors who are officers or held in certain employee stock plans) upon consummation of such transaction, or (iii) the business combination is approved by the Board of Directors and by two-thirds of the outstanding voting stock of the corporation (excluding shares held by the interested stockholder) at a meeting of stockholders (and not by written consent). A "business combination" includes a merger, asset sale or other transaction resulting in a financial benefit to such interested stockholder. For purposes of Section 203, an "interested" stockholder is a person who, together with affiliates and associates, owns (or within three years prior, did own) 15% or more of the corporation's voting stock. The Company's Certificate of Incorporation, as amended, allows the Board of Directors to issue preferred stock in one or more series with such voting rights and other provisions as the Board of Directors may determine. In addition, the Company's stock option plans provide for full or partial -11- acceleration of vesting of options granted under such plans in the event of certain transactions which result in a change in control of the Company. These provisions may be deemed to have a potential anti-takeover effect and may delay or prevent a change of control of the Company. INFORMATION WITH RESPECT TO BOSSELMANN GROUP'S BOARD DESIGNEES CERTAIN ARRANGEMENTS CONCERNING THE ELECTION OF DIRECTORS As described under the caption "Terms of the Private Placement - Board of Directors" section of this proxy statement, upon the consummation of the Private Placement, Rainer Bosselmann shall have the right to designate three (3) persons, in addition to himself, whom the Company has agreed to nominate and use its best efforts to cause to be elected to the Board of Directors. Mr. Bosselmann has stated that he intends to designate DeSoto Jordan, James Quinn and Daniel Levinson (together, the "Private Placement Directors") to be directors of the Company following the closing of the Private Placement, who, together with Mr. Bosselmann, who was elected to the Board of Directors upon the execution of the Term Sheet, constitute the four (4) designees of Mr. Bosselmann. The names and certain biographical information concerning the three designees with respect to the Private Placement are as follows: DeSoto Jordan has been Chairman of Afton Holdings, LLC, a private equity firm, since 2000. Mr. Jordan was the Director of Arguss Communications, Inc. (formerly known as Arguss Holdings, Inc.)("Arguss") from 1999 through 2002. Mr. Jordan was co-founder of Perot Systems Corporation and served as an officer from 1988 to 1999. James Quinn served as Director of Arguss from 1999 through 2002. Mr. Quinn is currently Vice President and Director of Allen & Company, an investment banking firm, since 1982. Since 1982, Mr. Quinn has served in various capacities at Allen & Company, including head of the Corporate Syndicate Department and Chief Financial Officer. Daniel Levinson is founder and managing partner of Main Street Resources, a niche sponsor of private equity transactions, since 1997. From 1988 to 1997, Mr. Levinson was one of the principals of Holding Capital Group. Mr. Levinson was also Director of Arguss. None of Mr. Bosselmann's designees, other than Mr. Bosselmann, currently is a director of or holds any position with the Company. The Company has been advised by Mr. Bosselmann that, other than himself, to the best of his knowledge, none of Mr. Bosselmann's designees or any of their associates beneficially owns any equity securities of the Company, or rights to acquire any equity securities of the Company, or has been involved in any transactions with the Company or any of its directors, executive officers or affiliates which are required to be disclosed pursuant to the rules and regulations of the Securities and Exchange Commission (the "Commission"). -12- INFORMATION WITH RESPECT TO THE COMPANY'S BOARD OF DIRECTORS AND EXECUTIVE OFFICERS All members of the Company's Board of Directors hold office until the next annual meeting of Stockholders or until their successors are elected and have qualified. Officers serve at the discretion of the Board of Directors. The current directors of the Company are as follows: NAME AGE POSITION ---- --- -------- Michael H. Figoff 59 Director, CEO and President Travis Bradford 31 Chairman of the Board Rainer Bosselmann 59 Vice Chairman of the Board Warren G. Lichtenstein 37 Director Glen Kassan 58 Director Dr. Tracy Kent Pugmire 71 Director Josh Schechter 29 Director Robert A. Smith 61 Director Michael H. Figoff has served as President and Chief Executive Officer and Director of the Company since May 1995. Mr. Figoff joined the Company in 1988 and has previously served as its Executive Vice President and Director of Marketing. Prior to joining the Company, Mr. Figoff served in various capacities with Lockheed Martin, Textron, Fairchild and Ferranti International. Mr. Figoff received his B.S. degree in Business Administration from Woodbury University in 1973. Travis Bradford has been a Director of the Company since February 1, 2001 and Chairman of the Board of Directors since August 28, 2001. Mr. Bradford has been a strategic and operational consultant for over 10 years. He has served as a Vice President of Steel Partners, Ltd., a management and advisory company, since March 2002. Steel Partners, Ltd. has provided management services to Steel Partners II, L.P. ("Steel") and other affiliates of Steel since March 2002. He has served as a Vice President of Steel Partners Services, Ltd., a management and advisory company from June 1999 to March 2002. Steel Partners Services, Ltd. provided management services to Steel and other affiliates of Steel until March 2002, when Steel Partners, Ltd. acquired the rights to provide certain management services from Steel Partners Services, Ltd. From March 1997 to May 1999, he was a member of Holding Capital Group, LLC, an equity investment group. -13- Mr. Bradford received his B.B.A. in Finance from Georgia State University in 1992, and his M.B.A. in Finance and Management from Stern School of Business at New York University in 1996. He also attended the Ph.D. program at the University of Chicago studying finance and economics. Warren G. Lichtenstein has served as a Director of the Company since September 16, 1999. Mr. Lichtenstein has served as the Chairman of the Board, Secretary and the Managing Member of Steel Partners, L.L.C., the general partner of Steel Partners II, L.P., since January 1, 1996. Prior to such time, Mr. Lichtenstein was the Chairman and a director of Steel Partners, Ltd., the general partner of Steel Partners Associates, L.P., which was the general partner of Steel, from 1993 until prior to January 1, 1996. Mr. Lichtenstein was the acquisition/risk arbitrage analyst at Ballantrae Partners, L.P., a private investment partnership formed to invest in risk arbitrage, special situations and undervalued companies, from 1988 to 1990. Mr. Lichtenstein has served as a director of WebFinancial Corporation, a consumer and commercial lender, since 1996 and as its President and Chief Executive Officer since December 1997. He served as a director and the Chief Executive Officer of Gateway Industries, Inc., a provider of database development and Web site design and development services, since 1994 and as the Chairman of the Board since 1995. Mr. Lichtenstein has served as a Director and the President and Chief Executive Officer of Steel Partners, Ltd. since June 1999 and as its Secretary and Treasurer since May 2001. He has also served as Chairman of the Board of Directors of Caribbean Fertilizer Group Ltd., a private company engaged in the production of agricultural products in Puerto Rico and Jamaica, since June 2000. Mr. Lichtenstein is a Director of SL Industries, Inc., a manufacturer and marketer of Power and Data Quality systems and equipment for industrial, medical, aerospace and consumer applications. Mr. Lichtenstein has served as Chairman of the Board and as Chief Executive Officer of SL Industries, Inc. since January 24, 2002 and February 4, 2002, respectively. Mr. Lichtenstein is also a Director of the following publicly held companies: TAB Products Co., a document management company; Tandycrafts, Inc., a manufacturer of picture frames and framed art; ECC International Corp., a manufacturer and marketer of computer-controlled simulators for training personnel to perform maintenance and operator procedures on military weapons; and United Industrial Corporation, a designer and producer of defense, training, transportation and energy systems. Glen Kassan has been a Director of the Company since August 28, 2001. Mr. Kassan has served as Executive Vice President of Steel Partners, Ltd., a management and advisory company, since March 2002. Steel Partners, Ltd. has provided management services to Steel and other affiliates of Steel since March 2002. Mr. Kassan served as Executive Vice President of Steel Partners Services, Ltd., a management and advisory company, from June 2001 through March 2002 and Vice President from October 1999 through May 2001. Steel Partners Services, Ltd. provided management services to Steel and other affiliates of Steel until March 2002, when Steel Partners, Ltd. acquired the rights to provide certain management services from Steel Partners Services, Ltd. He has also served as Vice President, Chief Financial Officer and Secretary of WebFinancial Corporation, a commercial and consumer lender, since June 2000. Mr. Kassan has served as Vice Chairman of the Board of Directors of Caribbean Fertilizer Group Ltd., a private company engaged in the production of agricultural products in -14- Puerto Rico and Jamaica, since June 2000. Mr. Kassan is a Director and has served as President of SL Industries, Inc., a manufacturer and marketer of Power and Data Quality systems and equipment for industrial, medical, aerospace and consumer applications, since January 2002 and February 2002, respectively. From 1997 to 1998, Mr. Kassan served as Chairman and Chief Executive Officer of Long Term Care Services, Inc., a privately owned healthcare services company which Mr. Kassan co-founded in 1994 and initially served as Vice Chairman and Chief Financial Officer. Mr. Kassan is currently a Director of Tandycrafts, Inc., a manufacturer of picture frames and framed art, United Industrial Corporation, a designer and producer of defense, training, transportation and energy systems and the Chairman of the Board of US Diagnostic Inc., an operator of outpatient diagnostic imaging. Dr. Tracy Kent Pugmire has served as a Director of the Company since June 1991. Since April 1992, Dr. Pugmire has served as an independent technical consultant. Dr. Pugmire currently provides consulting services to Spincraft, a Division of Standex International, and is involved with the design and fabrication of the X-33 and X-34 rocket vehicles. Previously, Dr. Pugmire was Executive Vice President of ARDE Inc. and worked as a Program Manager for several companies including TRW Space Systems Division, Technion Inc., AVCO Missile and Space Systems (now a division of Textron), General Electric Space Sciences Laboratory, and Boeing Propulsion and Mechanical Systems Department. Josh Schechter has been a Director of the Company since August 28, 2001. Mr. Schechter has served as an Associate of Steel Partners, Ltd., a management and advisory company since March 2002. Steel Partners, Ltd. has provided management services to Steel and other affiliates of Steel since March 2002. He has served as an Associate of Steel Partners Services, Ltd., a management and advisory company, from July 2001 to March 2002. Steel Partners Services, Ltd. provided management services to Steel and other affiliates of Steel until March 2002, when Steel Partners, Ltd. acquired the rights to provide certain management services from Steel Partners Services, Ltd. From March 1998 to June 2001, Mr. Schechter was an Associate in the corporate finance group at Imperial Capital, LLC, an investment banking firm. From August 1997 to February 1998, he was a Senior Analyst at Leifer Capital, Inc., an investment banking firm. From January 1996 to June 1997, Mr. Schechter was a Tax Consultant with Ernst & Young LLP. Mr. Schechter received his B.B.A. and M.A. in Professional Accounting from the University of Texas at Austin in 1995. Robert A. Smith has served as a Director of the Company since July 1994. Mr. Smith had been President of Microsource Incorporated, a subsidiary of Giga-tronics, from October 1998 until May 2001. Previously, Mr. Smith served as President of the Industrial Products Group of Haskel International Inc. from February 1995 to January 1998; President and Chief Executive Officer of Industrial Tools Inc. from January 1994 to February 1995; President of Engineered Filtration Company from October 1992 to January 1994; President of Puroflow Corporation, a wholly-owned subsidiary of the Company, from February 1991 to October 1992; and President of RTS Systems Incorporated from May 1988 to -15- February 1991, when the company was acquired by Telex Communications, Inc. Mr. Smith served as President of Purolator Technologies Inc. from 1980 to 1988 and served as the General Manager of the Filter Division of HR Textron Inc. from 1964 to 1980. Rainer H. Bosselmann has been a Director and Vice Chairman of the Board since January 2, 2003. Mr. Bosselmann was Chairman of the Board, Chief Executive Officer and a Director of Arguss from 1966 through 2002 and President of Arguss from May 1997 through 2002. Since 1996, Mr. Bosselmann served as a principal with Holding Capital Group, Inc., a firm engaged in mid-market acquisitions and investments. From 1991 through 1995, Mr. Bosselmann served as the President of Jupiter National, Inc. ("Jupiter National"), a business development company listed on the American Stock Exchange. BOARD MEETINGS AND ATTENDANCE During the fiscal year ended January 31, 2003, the Company's Board of Directors held three meetings and acted by unanimous written consent three times. Each director attended the Board meeting and committee meetings, to the extent they were a member of such committee, held during the fiscal year ended January 31, 2003. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has a standing Audit Committee and Compensation Committee, which did not meet during the fiscal year ended January 31, 2003. The Audit and Compensation Committees do not meet on a regular basis, but only as circumstance require. The Compensation Committee recommends to the Board of Directors compensation of the Company's executive officers and other key personnel, reviews new or existing compensation programs and periodically reviews management perquisites and other benefits. The current members of the Compensation Committee are Mr. Smith and Dr. Pugmire. The Audit Committee's principal functions are to recommend to the Board of Directors the firm of independent auditors to serve the Company each fiscal year and to review the plan and results of the audit by the independent accountants. The current members of the Audit Committee are Mr. Smith and Dr. Pugmire. In accordance with NASDAQ rule 4200(a)(15), the Company believes that both Mr. Smith and Dr. Pugmire are independent directors. The members of the Audit and Compensation Committees are appointed by the Board of Directors. The Company does not currently have a nominating committee. Nominations to the Board of Directors are made by the entire Board. An Audit Committee charter is in the process of being prepared. -16- OTHER EXECUTIVE OFFICERS The other current executive officers of the Company are as follows: NAME AGE POSITION ---- --- -------- Wayne Conner 55 Vice President of Engineering Dale Livingston 64 Vice President of Operations Craig Montesanti 43 Vice President of Finance Wayne Conner has over 30 years of filtration experience and has been the Vice President of Engineering of the Company since July 1997. From 1990 to 1994, Mr. Conner served as Senior Project Engineer - New Product Development for the Hydraulic Filter Division of Parker Hannifin Corporation. Mr. Conner also served in various capacities with Purolator Technologies Inc. Mr. Conner received his B.S. degree in Mechanical Engineering from Wayne State University in 1971. Dale Livingston has been the Vice President of Operations of the Company since February 1998. From August 1995 until February 1998, Mr. Livingston served as Director of Operations of the Company, and from October 1989 until August 1995, he served as Production Manager of the Company. Mr. Livingston previously served in various capacities with Parker Hannifin Corporation, Hydraulic Research/Textron, Talley Corporation, The Marquardt Company and Teleflex Control Systems. Craig Montesanti has been the Vice President of Finance of the Company since November 2001. Prior to joining the Company, Mr. Montesanti was the Director of Finance for Aspen Marketing Group, a large privately held organization. Mr. Montesanti was also Director of Finance and Administration for VitalCom Inc. (GE Medical Group) and Trikon Technologies Inc. - both publicly traded manufacturing organizations. Mr. Montesanti also served in various capacities with Ioptex Research Inc. and General Electric Co. Mr. Montesanti received his B.S. degree in Business Management from California State Polytechnic University, Pomona in 1982 and his M.B.A. degree in Finance and Management from Pepperdine University in 1993. -17- COMPENSATION OF EXECUTIVE OFFICERS The following summary compensation table sets forth the aggregate compensation paid to or earned by the President and Chief Executive Officer of the Company and the four most highly compensated executive officers of the Company (other than the President and Chief Executive Officer) whose total annual salaries and bonuses exceeded $100,000 for the year ended January 31, 2003 (the "Named Executive Officers"). Annual Compensation Long Term Compensation ---------------------- Awards Payouts Fiscal Year Ended Other Annual Securities January, Compensation Underlying All Other Name And Principal Position 31 Salary($) Bonus($) ($)(1) Options(#) Comp.($) ---------------------------------------------------------------------------------------------------------------------- Michael H. Figoff 2003 165,000 -- 29,990 2,000 -- Chief Executive Officer and 2002 165,000 -- 28,657 -- -- President 2001 165,000 -- 27,101 -- -- Wayne Conner 2003 118,130 -- 8,769 2,000 -- Vice President of Engineering 2002 113,990 -- 8,215 -- -- 2001 106,391 -- 7,813 -- -- Dale Livingston 2003 114,304 -- 7,205 2,000 -- Vice President of Operations 2002 108,544 -- 6,828 -- -- 2001 102,400 -- 6,554 -- -- Craig Montesanti 2003 120,625 -- 11,769 2,000 -- Vice President of Finance 2002 31,150(2) -- 2,804 -- -- 2001 -- -- -- -- -- -------------------- (1) Represents Company-reimbursed automobile expenses of such executive and life and disability insurance premiums paid by the Company. (2) Mr. Montesanti has been employed by the Company since November 5, 2001. OPTION MATTERS Option grants for the fiscal year ended January 31, 2003. The following table provides certain information regarding individual grants of stock options made during the fiscal year ended January 31, 2003, to each of the Named Executive Officers. While the Commission-mandated column headings refer to -18- stock appreciation rights ("SARS"), the Company has not awarded any SARS to its Named Executive Officers. Individual grants Number of securities Percent of total underlying options/SARs granted option/SARs granted to employees in fiscal Exercise of base price Name (#) year ($/Sh) Expiration Date (a) (b) (c) (d) (e) Michael H. Figoff 2,000 20.0% 5.70 04/04/2012 Wayne Conner 2,000 20.0% 5.70 04/04/2012 Dale Livingston 2,000 20.0% 5.70 04/04/2012 Craig Montesanti 2,000 20.0% 5.70 04/04/2012 Aggregate Option Exercises in Last Fiscal Year. The following table provides certain information regarding stock option ownership and exercises by the Named Executive Officers, as well as the number and assumed value of exercisable and unexercisable options held by those persons during the fiscal year ended January 31, 2003. No options were exercised by any of the Named Executive Officers during the fiscal year ended January 31, 2003. Number of Securities Underlying Unexercised Value of Unexercised In- Options/SARs At FY-End The-Money Options/SARs Shares Acquired (#) At FY-End ($) Name On Exercise (#) Value Realized ($) Exercisable/Unexercisable Exercisable/Unexercisable (a) (b) (c) (d) (e) -------------------------------------------------------------------------------------------------------------------------- Michael H. Figoff 0 / 2,000 0 / 3,600 Wayne Conner 0 / 2,000 0 / 3,600 Dale Livingston 0 / 2,000 0 / 3,600 Craig Montesanti 0 / 2,000 0 / 3,600 SENIOR EXECUTIVE BONUS PLAN The Compensation Committee developed and approved a senior executive bonus plan on April 4, 2002. The senior executive bonus plan has specific performance targets. Bonuses are to be paid under the bonus plan only if performance goals that were set at the beginning of the fiscal year are achieved by the end of the fiscal year. Accordingly, the actual bonuses paid will vary depending on actual performance. In general, the performance goals set at the beginning of the fiscal year were linked to factors such as annual revenue, earnings before interest, taxes, depreciation and amortization (EBITDA) and equity. No bonuses were granted for the fiscal year ended January 31, 2003. -19- DESCRIPTION OF THE 2001 STOCK OPTION PLAN In August 2001, the Board of Directors adopted and the Stockholders approved the 2001 Stock Option Plan. The 2001 Stock Option Plan was authorized to issue options to purchase a maximum of 33,333 shares of common stock. The maximum number of shares may be adjusted in certain events, such as a stock split, reorganization or recapitalization. Employees (including officers and directors who are employees) of the Company or its subsidiaries are eligible to receive incentive stock options. In the event incentive stock options are granted, the aggregate fair market value of the common stock issuable under such options for each optionee during any calendar year cannot exceed $100,000. This limit does not apply to non-qualified options. To the extent that an incentive stock option exceeds the $100,000 threshold, the excess will be treated as a non-qualified option. The Company will receive no monetary consideration for the grant of options under the 2001 Stock Option Plan. In the case of an incentive stock option, the exercise price cannot be less than the fair market value (as defined in the 2001 Stock Option Plan) of the common stock on the date the option is granted. If the optionee is a Stockholder who beneficially owns 10% or more of the outstanding common stock, the exercise price of incentive stock options may not be less than 110% of the fair market value of the common stock. The term of an option cannot exceed ten years; provided, however, that the term of options granted to owners of 10% or more of the outstanding shares of common stock cannot exceed five years. The 2001 Stock Option Plan will terminate automatically and no options may be granted after July 19, 2011 (the "Termination Date"); provided, however, that the 2001 Stock Option Plan may be terminated by the Board of Directors at any time prior to the Termination Date. Termination of the 2001 Stock Option Plan will not affect options that were granted prior to the Termination Date. As of January 31, 2003, there were 10,000 options granted under the 2001 Stock Option Plan. DESCRIPTION OF THE 1991 STOCK OPTION PLAN In 1991, the Board of Directors adopted and the Stockholders approved the 1991 Stock Option Plan (the "1991 Option Plan"). Under the 1991 Stock Option Plan, the maximum number of shares of common stock that may be subject to options may not exceed an aggregate of 33,333 shares. The maximum number of shares may be adjusted in certain events, such as a stock split, reorganization or recapitalization. Employees (including officers and directors who are employees) of the Company or its subsidiaries are eligible to receive incentive stock options, but may receive non-qualified options. Options may also be granted to other persons, provided that such options shall be non-qualified options. In the event of incentive options, the aggregate fair market value of the common stock with respect to which such options become first exercisable by the holder during any calendar year cannot exceed $100,000. This limit does not -20- apply to non-qualified options. To the extent an option that otherwise would be an incentive option exceeds this $100,000 threshold, it will be treated as a non-qualified option. This plan was terminated upon consummation of the 2001 Stock Option Plan. As of January 31, 2003, there were options for 8,333 shares of common stock outstanding of which options for 8,131 shares of common stock are exercisable. EMPLOYMENT AND SEVERANCE AGREEMENTS On March 1, 1993, the Company entered into an employment agreement with Michael Figoff pursuant to which Mr. Figoff agreed to serve as the Executive Vice President of the Company for a term of five years at an annual base salary of $95,000. Effective February 14, 1994, Mr. Figoff's annual base salary was increased to $104,500. Mr. Figoff was appointed President of the Company in February 1995, and was appointed President and Chief Executive Officer in May 1995. In April 1997, Mr. Figoff's annual base salary was increased to $165,000. On June 9, 1998, the Company extended Mr. Figoff's employment agreement for a term of five years at an annual base salary of $165,000. In January 2003, the Company extended Mr. Figoff's employment agreement for a term of one year. DIRECTOR COMPENSATION Each outside director of the Company receives a $2,500 annual fee, plus $300 for each formal meeting attended. Directors are also reimbursed for reasonable expenses actually incurred in connection with attending each formal meeting of the Board of Directors or any committee thereof. The Company's outside directors are currently Messrs. Bradford, Lichtenstein, Kassan, Schechter, Bosselmann, Smith and Dr. Pugmire. There is a Management Agreement between Steel Partners, Ltd. (an affiliate of Steel Partners II, L.P., which beneficially owns approximately 35.6% of the Company's common stock, and of which Warren Lichtenstein (a member of the Company's Board of Directors) is the managing member of the general partner) and the Company relating to the provision of certain management advisory and consulting services. Pursuant to the terms of such agreement, Messrs. Bradford, Lichtenstein, Kassan and Schechter waived their Board of Directors fees. ACCELERATION OF OUTSTANDING OPTIONS Pursuant to the terms of the Company's 2001 Stock Option Plan, the vesting with respect to all issued and outstanding options to purchase common stock of the Company will accelerate and become fully exercisable upon a "change in control." SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Exchange Act requires the Company's directors and executive officers and persons who beneficially own more than 10% of the Company's common stock (collectively, the "Reporting Persons") to file with the -21- Commission (and, if such security is listed on a national securities exchange, with such exchange), various reports as to ownership of such common stock. Such Reporting Persons are required by Commission regulations to furnish the Company with copies of all Section 16(a) reports they file. Based solely upon a review of copies of Section 16(a) reports and representations received by the Company from Reporting Persons, and without conducting any independent investigations of its own, the Company believes that no Reporting Person failed to timely file Forms 3, 4, and 5 with the Commission during the fiscal year ended January 31, 2003, other than Rainer Bosselmann who failed to timely file a Form 4, with respect to the purchase of Company common stock by his wife on January 3, 2003 and January 6, 2003. Mr. Bosselmann did file a Form 4 with respect to these transactions on January 9, 2003. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reuben M. Siwek, the former Chairman of the Board of Directors of the Company, renders legal services to the Company. The Company incurred expenses of approximately $1,750 and $53,636 during the fiscal years ended January 31, 2003 and 2002, for legal services rendered by Mr. Siwek. Rainer Bosselmann, the Vice Chairman of the Board of Directors, is a principal of the Bosselmann Group, which in connection with the Private Placement will purchase at least $2 million of the Private Placement Common Stock at $7.75 per share. Additionally, for services provided in connection with the Private Placement, the Bosselmann Group has been issued warrants to purchase 180,000 shares of the Company common stock at $7.75 per share. These warrants can only be exercised in the event that the Company Stockholders approve the Private Placement and the Private Placement is consummated. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information as of January 31, 2003 regarding the beneficial ownership of common stock by (A) each person known by the Company to own beneficially more than five percent of the common stock, (B) each director and each of the Private Placement Directors of the Company, (C) each of the "Named Executive Officers" (as defined in "Executive Compensation - Summary Compensation Table"), and (D) all executive officers, directors and director nominees of the Company as a group. Unless otherwise indicated, the address of each person named in the table below is c/o Puroflow Incorporated, 10616 Lanark Street, Sun Valley, California 91352. -22- Number of Shares Percentage Name Beneficially Owned(1) Beneficially Owned(1) -------------------------------------------------------------------------------------------- Steel Partners II, L.P. 175,840(2) [35.6%] Warren G. Lichtenstein 175,840(2) [35.6%] David S. Nagelberg 30,623(3) [6.2%] Michael H. Figoff 14,331(4)(9) [2.9%] Robert A. Smith 366(5) * Dale Livingston 2,025(6)(9) * Dr. Tracy Kent Pugmire 1,400 * Wayne Conner 2,531(7)(9) * Travis Bradford -(2) * Glen Kassan -(2) * Joshua Schechter -(2) * Rainer Bosselmann 23,850(8) [4.8%] DeSoto Jordon - * James Quinn - * Daniel Levinson - * Craig Montesanti 666(9) * All directors and executive officers as a group (ten persons (excluding the Private Placement Directors)) 251,632 [50.9%] ------------------------ * Less than 1 % (1) As used in this table, a beneficial owner of a security includes any person who, directly or indirectly, through contract, arrangement, understanding, relationship or otherwise has or shares (i) the power to vote, or direct the voting of, such security or (ii) investment power which includes the power to dispose, or to direct the disposition of, such security. In addition, a person is deemed to be the beneficial owner of a security if that person has the right to acquire beneficial ownership of such security within 60 days of the date shown above. (2) Based upon a Form 4, filed with the Commission by Steel Partners II, L.P. and its affiliates. Mr. Lichtenstein is deemed to beneficially own all of the shares held by Steel Partners II, L.P. The business address of Steel Partners and Messrs. Lichtenstein, Bradford, Kassan and Schechter is 150 East 52nd Street, 21st Floor, New York, New York 10020. (3) Based upon a Schedule 13G filed with the Commission by Mr. Nagelberg. Includes 6,617 shares owned by The Nagelberg Family Trust over which Mr. Nagelberg and his spouse, as trustees, share voting and dispositive power. The business address of Mr. Nagelberg is c/o M.H. Meyerson & Co., Inc., P.O. Box 2142, Rancho Santa Fe, California 92067-2142. -23- (4) Includes (a) options to purchase 3,667 shares of common stock, all of which are fully vested, and (b) 533 shares of common stock owned by Mr. Figoff's spouse. Mr. Figoff disclaims beneficial ownership of the shares owned by his spouse. (5) Includes 366 shares of common stock owned jointly by Mr. Smith and his spouse. (6) Includes options to purchase 933 shares of common stock, all of which are fully vested. (7) Includes options to purchase 1,519 shares of common stock, all of which are fully vested. (8) Does not include the warrants granted to the Bosselmann Group (Rainer Bosselmann is a principal of the Bosselmann Group) to purchase 180,000 shares of the Company common stock at the price of $7.75 per share. These warrants can only be exercised in the event that the Company Stockholders approve the Private Placement and the Private Placement is consummated. (9) Includes options to purchase 666 shares of common stock, all of which shall vest on April 4, 2003. -24- PROPOSAL NO. 2 APPROVAL OF THE AMENDMENT TO THE 2001 STOCK OPTION PLAN INTRODUCTION We are asking you to approve an amendment to our 2001 Stock Option Plan, to increase the total number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000 shares (the "Option Plan Amendment"). As of the Record Date, 33,333 shares were reserved for issuance under the 2001 Stock Option Plan, of which 23,333 options were available for grant and 10,000 options were issued and outstanding. Since the Option Plan Amendment is a condition to the consummation of the Private Placement, the Board of Directors believes it is in the Company's and its Stockholders' best interests to approve the Option Plan Amendment. Pursuant to the Option Plan Amendment, the Company would be able to utilize the increase in the number of options available to make acquisitions. The following is a brief summary of the 2001 Stock Option Plan. The description contained below in this proxy should be reviewed carefully. The Summary is qualified by reference to the 2001 Stock Option Plan, which is attached hereto as Appendix B. DESCRIPTION OF THE 2001 STOCK OPTION PLAN In August 2001, the Board of Directors adopted and the Stockholders approved the 2001 Stock Option Plan. The 2001 Stock Option Plan was authorized to issue options to purchase a maximum of 33,333 shares of common stock. The maximum number of shares may be adjusted in certain events, such as a stock split, reorganization or recapitalization. Employees (including officers and Directors who are employees) of the Company or its subsidiaries are eligible to receive incentive stock options. In the event incentive stock options are granted, the aggregate fair market value of the common stock issuable under such options for each optionee during any calendar year cannot exceed $100,000. This limit does not apply to non-qualified options. To the extent that an incentive stock option exceeds the $100,000 threshold, the excess will be treated as a non-qualified option. The Company will receive no monetary consideration for the grant of options under the 2001 Stock Option Plan. In the case of an incentive stock option, the exercise price cannot be less than the fair market value (as defined in the 2001 Stock Option Plan) of the common stock on the date the option is granted. If the optionee is a Stockholder who beneficially owns 10% or more of the outstanding common stock, the exercise price of incentive stock options may not be less than 110% of the fair market value of the common stock. The term of -25 an option cannot exceed ten years; provided, however, that the term of options granted to owners of 10% or more of the outstanding shares of common stock cannot exceed five years. The 2001 Stock Option Plan will terminate automatically and no options may be granted after July 19, 2011 (the "Termination Date"); provided, however, that the 2001 Stock Option Plan may be terminated by the Board of Directors at any time prior to the Termination Date. Termination of the 2001 Stock Option Plan will not affect options that were granted prior to the Termination Date. As of January 31, 2003, there were 10,000 options granted under the 2001 Stock Option Plan. No options to purchase shares of common stock were exercised by any of the Named Executive Officers during the fiscal year ended January 31, 2003. The Named Executive Officers received grants of stock options in the fiscal year ended January 31, 2003 as listed in the table below. During the fiscal year ended January 31, 2003, options to purchase shares of common stock have been granted pursuant to the 2001 Stock Option Plan to (i) the Named Executive Officers and (ii) Non-Executive Officer Employees as set forth below. Name And Position Dollar Value ($) Number Of Units ----------------- ---------------- --------------- Michael H. Figoff 2,000 Chief Executive Officer and President Wayne Conner 2,000 Vice President of Engineering Dale Livingston 2,000 Vice President of Operations Craig Montesanti 2,000 Vice President of Finance Named Executive Officers 8,000(1) Non-Executive Director Group Non-Executive Officer Employee Group 2,000(2) -26- ------------------------ (1) The number of units for the Named Executive Officers represents the aggregate number of units for Messrs. Figoff, Conner, Livingston and Montesanti. (2) Options granted to Sandy Yoshisato. If approved, the Option Plan Amendment would increase the total number of shares of common stock reserved for issuance under the 2001 Stock Option Plan to 250,000 shares. ADMINISTRATION The 2001 Stock Option Plan is administered by the Stock Option Committee (the "Committee"). The Committee selects the optionees who will be granted options to purchase shares of common stock under the 2001 Stock Option Plan and, subject to the provisions of the 2001 Stock Option Plan, determines the terms and conditions and number of shares of common stock subject to each such option. The Committee also makes any other determinations necessary or advisable for the administration of the 2001 Stock Option Plan. The determinations by the Committee are final and conclusive. The options granted to the Company's Chief Executive Officer or to any of the Company's other four most highly compensated officers that are intended to qualify as performance based compensation under Section 162(m) of the United States Internal Revenue Code of 1986, as amended (the "Code") may only be granted by a stock option committee comprised of two or more directors who are "Non-Employee Directors" (as such term is defined in Rule 16b-3 of the Securities and Exchange Act of 1934, as amended) and "Outside Directors" (as such term is defined in Rule 162(m) of the Code). Options granted under the 2001 Stock Option Plan shall vest and become exercisable at such times as shall be determined by the Committee. OPTIONS Upon the grant of an option to purchase shares of common stock under the 2001 Stock Option Plan, the Committee will fix the number of shares of the Company's common stock that the optionee may purchase upon exercise of such option and the price at which the shares may be purchased, subject to the terms of the 2001 Stock Option Plan. Payment of the exercise price for shares of common stock subject to options may be made with cash, check or such other instrument as may be acceptable to the Company. Full payment for shares of common stock exercised must be made at the time of exercise. FEDERAL INCOME TAX CONSEQUENCES INCENTIVE STOCK OPTIONS. Incentive stock options granted under the 2001 Stock Option Plan are intended to be "incentive stock options" as defined by Section 422 of the Code. Under present law, the grantee of an incentive stock option will not realize taxable income upon the grant or the exercise of the incentive stock option and the Company will not receive an income tax deduction at either such time. If the grantee does not sell the shares acquired upon -27- exercise of an incentive stock option within either (i) two years after the grant of the incentive stock option or (ii) one year after the date of exercise of the incentive stock option, the gain upon a subsequent sale of the shares will be taxed as long-term capital gain. If the grantee, within either of the above periods, disposes of the shares acquired upon exercise of the incentive stock option, the grantee will recognize as ordinary income an amount equal to the lesser of (i) the gain realized by the grantee upon such disposition or (ii) the difference between the exercise price and the fair market value of the shares on the date of exercise. In such event, the Company would be entitled to a corresponding income tax deduction equal to the amount recognized as ordinary income by the grantee. The gain in excess of such amount recognized by the grantee as ordinary income would be taxed as a long-term capital gain or short-term capital gain (subject to the holding period requirements for long-term or short-term capital gain treatment). Pursuant to the Code, Incentive Stock options will not be permitted to be granted under the 2001 Stock Option Plan following July 19, 2011. Unless the shares subject to an incentive stock option are subject to a risk of forfeiture at the time the option is exercised, the exercise of the incentive stock option will result in the excess of the stock's fair market value on the date of exercise over the exercise price being included in the optionee's alternative minimum taxable income ("AMTI"). If the shares are subject to a risk of forfeiture and are nontransferable, the excess described above will be included in AMTI when the risk of forfeiture lapses or the shares become transferable, whichever occurs sooner. Liability for the alternative minimum tax is complex and depends upon an individual's overall tax situation. Before exercising an incentive stock option, a grantee should discuss the possible application of the alternative minimum tax with his tax advisor in order to determine the tax's impact. NON-QUALIFIED STOCK OPTIONS. Upon exercise of a non-qualified stock option granted under the 2001 Stock Option Plan, the grantee will recognize ordinary income in an amount equal to the excess of the fair market value of the shares received over the exercise price of such shares. That amount increases the grantee's basis in the stock acquired pursuant to the exercise of the non-qualified option. Upon a subsequent sale of the stock, the grantee will incur short-term or long-term gain or loss depending upon his holding period for the shares and upon the shares' subsequent appreciation or depreciation in the value. The Company will be allowed a federal income tax deduction for the amount recognized as ordinary income by the grantee upon the grantee's exercise of the option. SUMMARY OF TAX CONSEQUENCES. The foregoing outline is no more than a summary of the federal income tax provisions relating to the grant and exercise of options and stock appreciation rights under the 2001 Stock Option Plan and the sale of shares acquired under the 2001 Stock Option Plan. Individual circumstances may vary these results. The federal income tax laws and regulations are constantly being amended, and each participant should rely upon his own tax counsel for advice concerning the federal income tax provisions applicable to the 2001 Stock Option Plan. -28- REQUIRED APPROVAL BY STOCKHOLDER Approval of the Option Plan Amendment described in this Proposal No. 2 requires the affirmative vote of a majority of the total votes cast by holders of the outstanding shares of common stock present in person or represented by proxy at the Special Meeting and entitled to vote at the meeting. The Company has been informed by Steel Partners II, L.P., who beneficially owns 175,840 shares, representing 35.6% of the Company's outstanding common stock, that they intend to vote in favor of Proposal No. 2. If the Option Plan Amendment is approved by the Stockholders (Proposal 2), but the issuance of the Private Placement Common Stock in the Private Placement (Proposal 1) is not approved by the Stockholders, the Option Plan Amendment will not be implemented and no increase to the number of shares of common stock reserved for issuance under the 2001 Stock Option Plan will result. RECOMMENDATION OF THE BOARD OF DIRECTORS THE BOARD OF DIRECTORS HAS APPROVED THE MATTERS INCLUDED IN PROPOSAL NO. 2 AND BELIEVES THAT THEY ARE FAIR TO, AND IN THE BEST INTERESTS OF, US AND OUR STOCKHOLDERS. THE BOARD RECOMMENDS A VOTE "FOR" PROPOSAL NO. 2. -29- OTHER MATTERS The Company knows of no other matters to be submitted to Stockholders at the meeting. If any other matters properly come before the meeting, it is the intention of the persons named in the enclosed proxy card to vote the shares they represent as the Board of Directors may recommend. THE BOARD OF DIRECTORS PUROFLOW INCORPORATED ______________, 2003 -30- PUROFLOW INCORPORATED PROXY FOR SPECIAL MEETING OF STOCKHOLDERS THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS The undersigned hereby appoints ____________________, or any of them, proxies and attorneys-in-fact, with full power of substitution to each, on behalf and in the name of the undersigned (i) to attend the Special Meeting of Stockholders of Puroflow Incorporated (the "Company"), to be held on _______________, at ___ a.m., local time, at ________, and any postponement or adjournment thereof, and (ii) to vote on all matters set forth in the Notice and the Proxy Statement on the reverse side. The undersigned hereby revokes any proxy or proxies heretofore given and acknowledges receipt of a copy of the Notice of Special Meeting and Proxy Statement, both dated January , 2003. THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE SPECIFIC DIRECTIONS HEREIN GIVEN. IN THE ABSENCE OF SUCH INDICATION, THIS PROXY WILL BE VOTED FOR PROPOSAL NO. 1, FOR PROPOSAL NO. 2, AND IN THE DISCRETION OF THE PROXY HOLDER ON ANY OTHER MATTERS THAT MAY PROPERLY COME BEFORE THE MEETING OR ANY POSTPONEMENT OR ADJOURNMENT OF THE MEETING. SEE REVERSE CONTINUED AND TO BE SIGNED ON REVERSE SEE REVERSE SIDE SIDE SIDE PROPOSAL NO. 1: ISSUANCE AND SALE OF NON-REGISTERED COMMON STOCK The approval of the issuance and sale by the Company, pursuant to a private placement, of between 1.3 million and 2.6 million of the Company's non-registered shares of common stock at the price of $7.75 per share as more fully described in the proxy materials. FOR ( ) AGAINST ( ) ABSTAIN ( ) PROPOSAL NO. 2: ADOPTION OF AMENDMENT TO THE 2001 STOCK OPTION PLAN The adoption of an amendment to the Company's 2001 Stock Option Plan to increase the number of shares of common stock reserved for issuance under the Stock Option Plan to 250,000. FOR ( ) AGAINST ( ) ABSTAIN ( ) -31- The undersigned acknowledges receipt of a Notice and Proxy Statement regarding the foregoing matters. Dated: -------------------------- -------------------------------- Signature of Stockholder -------------------------------- PLEASE PRINT NAME Dated: -------------------------- -------------------------------- Signature of Stockholder -------------------------------- PLEASE PRINT NAME I plan to attend the meeting: Yes ___ No ___ STOCKHOLDERS SHOULD SIGN THIS PROXY PROMPTLY AND RETURN IT IN THE ENCLOSED ENVELOPE. PLEASE RETURN BOTH PAGES OF THIS PROXY. Sign exactly as your name(s) appears on the stock certificate(s). A corporation is requested to sign its name by its President or other authorized officer, with the office held designated. Executors, administrators, trustees, etc., are requested to so indicate when signing. If a stock certificate is registered in two names or held as joint tenants or as community property, both interested persons should sign. -32- APPENDIX A [FAIRNESS OPINION] -33- APPENDIX B PUROFLOW INCORPORATED 2001 STOCK OPTION PLAN 1. PURPOSE OF THE PLAN. This 2001 Stock Option Plan (the "Plan") is intended as an incentive, to retain in the employ of and as directors, officers, consultants and advisors to PUROFLOW INCORPORATED, a Delaware corporation (the "Company") and any Subsidiary of the Company, within the meaning of Section 424(f) of the United States Internal Revenue Code of 1986, as amended (the "Code"), persons of training, experience and ability, to attract new employees, directors, officers, consultants and advisors whose services are considered valuable, to encourage the sense of proprietorship and to stimulate the active interest of such persons in the development and financial success of the Company and its Subsidiaries. It is further intended that certain options granted pursuant to the Plan shall constitute incentive stock options within the meaning of Section 422 of the Code (the "Incentive Options") while certain other options granted pursuant to the Plan shall be nonqualified stock options (the "Nonqualified Options"). Incentive Options and Nonqualified Options are hereinafter referred to collectively as "Options." The Company intends that the Plan meet the requirements of Rule 16b-3 ("Rule 16b-3") promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act") and that transactions of the type specified in subparagraphs (c) to (f) inclusive of Rule 16b-3 by officers and directors of the Company pursuant to the Plan will be exempt from the operation of Section 16(b) of the Exchange Act. Further, the Plan is intended to satisfy the performance-based compensation exception to the limitation on the Company's tax deductions imposed by Section 162(m) of the Code with respect to those Options for which qualification for such exception is intended. In all cases, the terms, provisions, conditions and limitations of the Plan shall be construed and interpreted consistent with the Company's intent as stated in this Section 1. 2. Administration of the Plan. The Board of Directors of the Company (the "Board") shall appoint and maintain as administrator of the Plan a Committee (the "Committee") consisting of two or more directors who are "Non-Employee Directors" (as such term is defined in Rule 16b-3) and "Outside Directors" (as such term is defined in Section 162(m) of the Code), which shall serve at the pleasure of the Board. The Committee, subject to Sections 3 and 5 hereof, shall have full power and authority to designate recipients of Options, to determine the terms and -34- conditions of respective Option agreements (which need not be identical) and to interpret the provisions and supervise the administration of the Plan. The Committee shall have the authority, without limitation, to designate which Options granted under the Plan shall be Incentive Options and which shall be Nonqualified Options. To the extent any Option does not qualify as an Incentive Option, it shall constitute a separate Nonqualified Option. Subject to the provisions of the Plan, the Committee shall interpret the Plan and all Options granted under the Plan, shall make such rules as it deems necessary for the proper administration of the Plan, shall make all other determinations necessary or advisable for the administration of the Plan and shall correct any defects or supply any omission or reconcile any inconsistency in the Plan or in any Options granted under the Plan in the manner and to the extent that the Committee deems desirable to carry into effect the Plan or any Options. The act or determination of a majority of the Committee shall be the act or determination of the Committee and any decision reduced to writing and signed by all of the members of the Committee shall be fully effective as if it had been made by a majority at a meeting duly held. Subject to the provisions of the Plan, any action taken or determination made by the Committee pursuant to this and the other Sections of the Plan shall be conclusive on all parties. In the event that for any reason the Committee is unable to act or if the Committee at the time of any grant, award or other acquisition under the Plan of Options or Stock as hereinafter defined does not consist of two or more Non-Employee Directors, or if there shall be no such Committee, then the Plan shall be administered by the Board, and references herein to the Committee (except in the proviso to this sentence) shall be deemed to be references to the Board, and any such grant, award or other acquisition may be approved or ratified in any other manner contemplated by subparagraph (d) of Rule 16b-3; provided, however, that options granted to the Company's Chief Executive Officer or to any of the Company's other four most highly compensated officers that are intended to qualify as performance-based compensation under Section 162(m) of the Code may only be granted by the Committee. 3. Designation of Optionees. The persons eligible for participation in the Plan as recipients of Options (the "Optionees") shall include employees, officers and directors of, and consultants and advisors to, the Company or any Subsidiary; provided that Incentive Options may only be granted to employees of the Company and the Subsidiaries. In selecting Optionees, and in determining the number of shares to be covered by each Option granted to Optionees, the Committee may consider the office or position held by the Optionee or the Optionee's relationship to the Company, the Optionee's degree of responsibility for and contribution to the growth and success of the Company or any Subsidiary, the Optionee's length of service, age, promotions, potential and any other factors that the Committee may consider relevant. An Optionee who has been granted an Option hereunder may be granted an additional Option or Options, if the Committee shall so determine. -35- 4. STOCK RESERVED FOR THE PLAN. Subject to adjustment as provided in Section 7 hereof, a total of 33,333 shares of the Company's Common Stock, $.01 par value per share (the "Stock"), shall be subject to the Plan. The maximum number of shares of Stock that may be subject to options granted under the Plan to any individual in any calendar year shall not exceed 13,333, and the method of counting such shares shall conform to any requirements applicable to performance-based compensation under Section 162(m) of the Code. The shares of Stock subject to the Plan shall consist of unissued shares, treasury shares or previously issued shares held by any Subsidiary of the Company, and such amount of shares of Stock shall be and is hereby reserved for such purpose. Any of such shares of Stock that may remain unsold and that are not subject to outstanding Options at the termination of the Plan shall cease to be reserved for the purposes of the Plan, but until termination of the Plan the Company shall at all times reserve a sufficient number of shares of Stock to meet the requirements of the Plan. Should any Option expire or be canceled prior to its exercise in full or should the number of shares of Stock to be delivered upon the exercise in full of an Option be reduced for any reason, the shares of Stock theretofore subject to such Option may be subject to future Options under the Plan, except where such reissuance is inconsistent with the provisions of Section 162(m) of the Code. 5. TERMS AND CONDITIONS OF OPTIONS. Options granted under the Plan shall be subject to the following conditions and shall contain such additional terms and conditions, not inconsistent with the terms of the Plan, as the Committee shall deem desirable: (a) OPTION PRICE. The purchase price of each share of Stock purchasable under an Incentive Option shall be determined by the Committee at the time of grant, but shall not be less than 100% of the Fair Market Value (as defined below) of such share of Stock on the date the Option is granted; provided, however, that with respect to an Optionee who, at the time such Incentive Option is granted, owns (within the meaning of Section 424(d) of the Code) more than 10% of the total combined voting power of all classes of stock of the Company or of any Subsidiary, the purchase price per share of Stock shall be at least 110% of the Fair Market Value per share of Stock on the date of grant. The purchase price of each share of Stock purchasable under a Nonqualified Option shall not be less than 80% of the Fair Market Value of such share of Stock on the date the Option is granted; provided, however, that if an option granted to the Company's Chief Executive Officer or to any of the Company's other four most highly compensated officers is intended to qualify as performance-based compensation under Section 162(m) of the Code, the exercise price of such Option shall not be less than 100% of the Fair Market Value (as such term is defined below) of such share of Stock on the date the Option is granted. The exercise price for each Option shall be subject to adjustment as provided in Section 7 below. "Fair Market Value" means the closing price of publicly traded shares of Stock on the principal securities exchange on which shares of Stock are listed (if the shares of Stock are so listed), or on the -36- NASDAQ Stock Market (if the shares of Stock are regularly quoted on the NASDAQ Stock Market), or, if not so listed or regularly quoted, the mean between the closing bid and asked prices of publicly traded shares of Stock in the over-the-counter market, or, if such bid and asked prices shall not be available, as reported by any nationally recognized quotation service selected by the Company, or as determined by the Committee in a manner consistent with the provisions of the Code. Anything in this Section 5(a) to the contrary notwithstanding, in no event shall the purchase price of a share of Stock be less than the minimum price permitted under the rules and policies of any national securities exchange on which the shares of Stock are listed. (b) Option Term. The term of each Option shall be fixed by the Committee, but no Option shall be exercisable more than ten years after the date such Option is granted and in the case of an Incentive Option granted to an Optionee who, at the time such Incentive Option is granted, owns (within the meaning of Section 424(d) of the Code) more than 10% of the total combined voting power of all classes of stock of the Company or of any Subsidiary, no such Incentive Option shall be exercisable more than five years after the date such Incentive Option is granted. (c) Exercisability. Subject to Section 5(j) hereof, Options shall be exercisable at such time or times and subject to such terms and conditions as shall be determined by the Committee. Upon the occurrence of a "Change in Control" (as hereinafter defined), the Committee may accelerate the vesting and exercisability of outstanding Options, in whole or in part, as determined by the Committee in its sole discretion. In its sole discretion, the Committee may also determine that, upon the occurrence of a Change in Control, each outstanding Option shall terminate within a specified number of days after notice to the Optionee thereunder, and each such Optionee shall receive, with respect to each share of Company Stock subject to such Option, an amount equal to the excess of the Fair Market Value of such shares immediately prior to such Change in Control over the exercise price per share of such Option; such amount shall be payable in cash, in one or more kinds of property (including the property, if any, payable in the transaction) or a combination thereof, as the Committee shall determine in its sole discretion. For purposes of the Plan, a Change in Control shall be deemed to have occurred if: (i) a tender offer (or series of related offers) shall be made and consummated for the ownership of 50% or more of the outstanding voting securities of the Company, unless as a result of such tender offer more than 50% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the shareholders of the Company (as of the time immediately prior to the commencement of such offer), any employee benefit plan of the Company or its Subsidiaries, and their affiliates; (ii) the Company shall be merged or consolidated with another corporation, unless as a result of such merger or consolidation more than 50% of -37- the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the shareholders of the Company (as of the time immediately prior to such transaction), any employee benefit plan of the Company or its Subsidiaries, and their affiliates; (iii) the Company shall sell substantially all of its assets to another corporation that is not wholly owned by the Company, unless as a result of such sale more than 50% of such assets shall be owned in the aggregate by the shareholders of the Company (as of the time immediately prior to such transaction), any employee benefit plan of the Company or its Subsidiaries and their affiliates; or (iv) a Person (as defined below) shall acquire 50% or more of the outstanding voting securities of the Company (whether directly, indirectly, beneficially or of record), unless as a result of such acquisition more than 50% of the outstanding voting securities of the surviving or resulting corporation shall be owned in the aggregate by the shareholders of the Company (as of the time immediately prior to the first acquisition of such securities by such Person), any employee benefit plan of the Company or its Subsidiaries, and their affiliates. For purposes of this Section 5(c), ownership of voting securities shall take into account and shall include ownership as determined by applying the provisions of Rule 13d-3(d)(I)(i) (as in effect on the date hereof) under the Exchange Act. In addition, for such purposes, "Person" shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof; however, a Person shall not include (A) the Company or any of its Subsidiaries; (B) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its Subsidiaries; (C) an underwriter temporarily holding securities pursuant to an offering of such securities; or (D) a corporation owned, directly or indirectly, by the shareholders of the Company in substantially the same proportion as their ownership of stock of the Company. (d) METHOD OF EXERCISE. Options to the extent then exercisable may be exercised in whole or in part at any time during the option period, by giving written notice to the Company specifying the number of shares of Stock to be purchased, accompanied by payment in full of the purchase price, in cash, or by check or such other instrument as may be acceptable to the Committee. As determined by the Committee, in its sole discretion, at or after grant, payment in full or in part may be made at the election of the Optionee (i) in the form of Stock owned by the Optionee (based on the Fair Market Value of the Stock on the trading day before the Option is exercised) which is not the subject of any pledge or security interest, (ii) in the form of shares of Stock withheld by the Company from the shares of Stock otherwise to be received with such withheld shares of Stock having a Fair Market Value on the date of exercise equal to the exercise price of the Option, or (iii) by a combination of the foregoing, provided that the combined value of all cash and cash equivalents and the Fair Market Value of any shares surrendered to the Company is at least equal to such -38- exercise price and except with respect to (ii) above, such method of payment will not cause a disqualifying disposition of all or a portion of the Stock received upon exercise of an Incentive Option. An Optionee shall have the right to dividends and other rights of a stockholder with respect to shares of Stock purchased upon exercise of an Option at such time as the Optionee has given written notice of exercise and has paid in full for such shares and (ii) has satisfied such conditions that may be imposed by the Company with respect to the withholding of taxes. (e) NON-TRANSFERABILITY OF OPTIONS. Options are not transferable and may be exercised solely by the Optionee during his lifetime or after his death by the person or persons entitled thereto under his will or the laws of descent and distribution. The Committee, in its sole discretion, may permit a transfer of a Nonqualified Option to (i) a trust for the benefit of the Optionee or (ii) a member of the Optionee's immediate family (or a trust for his or her benefit). Any attempt to transfer, assign, pledge or otherwise dispose of, or to subject to execution, attachment or similar process, any Option contrary to the provisions hereof shall be void and ineffective and shall give no right to the purported transferee. (f) TERMINATION BY DEATH. Unless otherwise determined by the Committee, if any Optionee's employment with or service to the Company or any Subsidiary terminates by reason of death, the Option may thereafter be exercised, to the extent then exercisable (or on such accelerated basis as the Committee shall determine at or after grant), by the legal representative of the estate or by the legatee of the Optionee under the will of the Optionee, for a period of one year after the date of such death or until the expiration of the stated term of such Option as provided under the Plan, whichever period is shorter. (g) TERMINATION BY REASON OF DISABILITY. Unless otherwise determined by the Committee, if any Optionee's employment with or service to the Company or any Subsidiary terminates by reason of total and permanent disability, any Option held by such Optionee may thereafter be exercised, to the extent it was exercisable at the time of termination due to Disability (or on such accelerated basis as the Committee shall determine at or after grant), but may not be exercised after 60 days after the date of such termination of employment or service or the expiration of the stated term of such Option, whichever period is shorter; provided, however, that, if the Optionee dies within such 60-day period, any unexercised Option held by such Optionee shall thereafter be exercisable to the extent to which it was exercisable at the time of death for a period of one year after the date of such death or for the stated term of such Option, whichever period is shorter. (h) TERMINATION BY REASON OF RETIREMENT. Unless otherwise determined by the Committee, if any Optionee's employment with or service to the Company or any Subsidiary terminates by reason of Normal or Early Retirement (as such terms are defined below), any Option held by such Optionee may thereafter be exercised to the extent it was exercisable at the time of such Retirement (or on such accelerated basis as the Committee shall determine at or after grant), but may not be exercised after 60 days after the date of such termination of employment -39- or service or the expiration of the stated term of such Option, whichever period is shorter; provided, however, that, if the Optionee dies within such 60-day period, any unexercised Option held by such Optionee shall thereafter be exercisable, to the extent to which it was exercisable at the time of death, for a period of one year after the date of such death or for the stated term of such Option, whichever period is shorter. For purposes of this paragraph (h) "Normal Retirement" shall mean retirement from active employment with or service to the Company or any Subsidiary on or after the normal retirement date specified in the applicable Company or Subsidiary pension plan or if no such pension plan, age 65, and "Early Retirement" shall mean retirement from active employment with or service to the Company or any Subsidiary pursuant to the early retirement provisions of the applicable Company or Subsidiary pension plan or if no such pension plan, age 55. (i) OTHER TERMINATION. Unless otherwise determined by the Committee, if any Optionee's employment with or service to the Company or any Subsidiary terminates for any reason other than death, Disability or Normal or Early Retirement, the Option shall thereupon terminate, except that the portion of any Option that was exercisable on the date of such termination of employment or service may be exercised for the lesser of 30 days after the date of termination or the balance of such Option's term if the Optionee's employment or service with the Company or any Subsidiary is terminated by the Company or such Subsidiary without cause (the determination as to whether termination was for cause to be made by the Committee). The transfer of an Optionee from the employ of or service to the Company to the employ of or service to a Subsidiary, or vice versa, or from one Subsidiary to another, shall not be deemed to constitute a termination of employment or service for purposes of the Plan. (j) LIMIT ON VALUE OF INCENTIVE OPTION. The aggregate Fair Market Value, determined as of the date the Incentive Option is granted, of Stock for which Incentive Options are exercisable for the first time by any Optionee during any calendar year under the Plan (and/or any other stock option plans of the Company or any Subsidiary) shall not exceed $100,000. (k) INCENTIVE OPTION SHARES. A grant of an Incentive Option under this Plan shall provide that (a) the Optionee shall be required as a condition of the exercise to furnish to the Company any payroll (employment) tax required to be withheld, and (b)if the Optionee makes a disposition, within the meaning of Section 424(c) of the Code and regulations promulgated thereunder, of any share or shares of Stock issued to him upon exercise of an Incentive Option granted under the Plan within the two-year period commencing on the day after the date of the grant of such Incentive Option or within a one-year period commencing on the day after the date of transfer of the share or shares to him pursuant to the exercise of such Incentive Option, he shall, within 10 days after such disposition, notify the Company thereof and immediately deliver to the Company any amount of United States federal, state and local income tax withholding required by law. 6. TERM OF PLAN. No Option shall be granted pursuant to the Plan on or after July 19, 2011, but Options theretofore granted may extend beyond that date. -40- 7. CAPITAL CHANGE OF THE COMPANY. In the event of any merger, reorganization, consolidation, recapitalization, stock dividend, or other change in corporate structure affecting the Stock, the Committee shall make an appropriate and equitable adjustment in the number and kind of shares reserved for issuance under the Plan and in the number and option price of shares subject to outstanding Options granted under the Plan, to the end that after such event each Optionee's proportionate interest shall be maintained as immediately before the occurrence of such event. The Committee shall, to the extent feasible, make such other adjustments as may be required under the tax laws so that any Incentive Options previously granted shall not be deemed modified within the meaning of Section 424(h) of the Code. 8. PURCHASE FOR INVESTMENT. Unless the Options and shares covered by the Plan have been registered under the Securities Act of 1933, as amended (the "Securities Act"), or the Company has determined that such registration is unnecessary, each person exercising an Option under the Plan may be required by the Company to give a representation in writing that he is acquiring the shares for his own account for investment and not with a view to, or for sale in connection with, the distribution of any part thereof. 9. TAXES. The Company may make such provisions as it may deem appropriate, consistent with applicable law, in connection with any Options granted under the Plan with respect to the withholding of any taxes (including income or employment taxes) or any other tax matters. 10. EFFECTIVE DATE OF PLAN. The Plan shall be effective on July 19, 2001, provided however that the Plan shall subsequently be approved by majority vote of the Company's stockholders not later than July 18, 2002. 11. AMENDMENT AND TERMINATION. The Board may amend, suspend, or terminate the Plan, except that no amendment shall be made that would impair the rights of any Optionee under any Option theretofore granted without the Optionee's consent, and except that no amendment shall be made which, without the approval of the stockholders of the Company would: -41- (a) materially increase the number of shares that may be issued under the Plan, except as is provided in Section 7; (b) materially increase the benefits accruing to the Optionees under the Plan; (c) materially modify the requirements as to eligibility for participation in the Plan; (d) decrease the exercise price of an Incentive Option to less than 100% of the Fair Market Value per share of Stock on the date of grant thereof or the exercise price of a Nonqualified Option to less than 80% of the Fair Market Value per share of Stock on the date of grant thereof; or (e) extend the term of any Option beyond that provided for in Section 5(b). The Committee may amend the terms of any Option theretofore granted, prospectively or retroactively, but no such amendment shall impair the rights of any Optionee without the Optionee's consent. The Committee may also substitute new Options for previously granted Options, including options granted under other plans applicable to the participant and previously granted Options having higher option prices, upon such terms as the Committee may deem appropriate. 12. GOVERNMENT REGULATIONS. The Plan, and the grant and exercise of Options hereunder, and the obligation of the Company to sell and deliver shares under such Options, shall be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies, national securities exchanges and interdealer quotation systems as may be required. 13. GENERAL PROVISIONS. (a) CERTIFICATES. All certificates for shares of Stock delivered under the Plan shall be subject to such stop transfer orders and other restrictions as the Committee may deem advisable under the rules, regulations and other requirements of the Commission, or other securities commission having jurisdiction, any applicable Federal or state securities law, any stock exchange or interdealer quotation system upon which the Stock is then listed or traded and the Committee may cause a legend or legends to be placed on any such certificates to make appropriate reference to such restrictions. (b) EMPLOYMENT MATTERS. The adoption of the Plan shall not confer upon any Optionee of the Company or any Subsidiary any right to continued employment or, in the case of an Optionee who is a director, continued service as a director, with the Company or a Subsidiary, as the case may be, nor shall -42- it interfere in any way with the right of the Company or any Subsidiary to terminate the employment of any of its employees, the service of any of its directors or the retention of any of its consultants or advisors at any time. (c) LIMITATION OF LIABILITY. No member of the Board or the Committee, or any officer or employee of the Company acting on behalf of the Board or the Committee, shall be personally liable for any action, determination or interpretation taken or made in good faith with respect to the Plan, and all members of the Board or the Committee and each and any officer or employee of the Company acting on their behalf shall, to the extent permitted by law, be fully indemnified and protected by the Company in respect of any such action, determination or interpretation. (d) REGISTRATION OF STOCK. Notwithstanding any other provision in the Plan, no Option may be exercised unless and until the Stock to be issued upon the exercise thereof has been registered under the Securities Act and applicable state securities laws, or are, in the opinion of counsel to the Company, exempt from such registration in the United States. The Company shall not be under any obligation to register under applicable federal or state securities laws any Stock to be issued upon the exercise of an Option granted hereunder in order to permit the exercise of an Option and the issuance and sale of the Stock subject to such Option, although the Company may in its sole discretion register such Stock at such time as the Company shall determine. If the Company chooses to comply with such an exemption from registration, the Stock issued under the Plan may, at the direction of the Committee, bear an appropriate restrictive legend restricting the transfer or pledge of the Stock represented thereby, and the Committee may also give appropriate stop transfer instructions with respect to such Stock to the Company's transfer agent. PUROFLOW INCORPORATED July 19, 2001 -43-