DEVELOPMENT, PURCHASE AND LICENSE AGREEMENT FOR HYDROGEN SENSOR PRODUCTS AND RELATED SERVICES

This Development, Purchase and License Agreement (“Agreement”) is made by and between Nano-Proprietary, Inc. (“NPI”) and its wholly-owned subsidiary Applied Nanotech, Inc. (“ANI”) with offices located at 3006 Longhorn Blvd., Suite 107, Austin, Texas 78758, and Kelman, Ltd. (“Kelman”), a UK Limited Company with offices located at Lissue Industrial Estate East, Lissue Road, Lisburn, BT28 2RB N. Ireland UK (collectively “the parties”).

WHEREAS, ANI and NPI have developed certain hydrogen sensor technology as hereafter defined; and

WHEREAS, Kelman desires: (a) to purchase such hydrogen sensors developed by ANI to be used and incorporated in certain of Kelman’s products, and (b) to take a license from ANI and NPI for their hydrogen sensor technology for certain applications and under certain limitations as hereinafter defined; and

WHEREAS, the parties desire to accomplish the foregoing in certain phases and under certain time constraints and conditions set forth more specifically herein below.

NOW, THEREFORE, in consideration of the mutual agreements set forth herein, and other good and valuable consideration, the receipt and sufficiency is hereby acknowledged, the parties agree as follows:

1.1.       “Effective Date” means July 6, 2005.

1.2       “ANI Hydrogen Sensor” means a variable-range hydrogen sensor comprised of one or more fabricated palladium-silver nanowires and/or nanobumps on a suitable substrate with the performance defined in Appendix 1.

1.3       “Hydrogen Sensor Product” means any product, including but not limited to software, which incorporates the use of the ANI Hydrogen Sensor.

1.4       “Hydrogen Sensor Technology” means certain proprietary technology and know-how and improvements and enhancements developed, licensed, and/or owned by NPI and/or ANI related to the manufacture and use of Hydrogen Sensors, which includes, but is not limited to, the inventions disclosed in U.S. Patent Application Publication No. 2004 / 0070006A1, published April 15,

2004 under U.S. Patent Application No. 10 / 651,220 filed August 28, 2003 (the “Application”), and any other applications, continuations and foreign counterparts that may issue claiming in whole or in part the priority date of the Application, as well as all other confidential and proprietary information and know-how related to the design, manufacture and use of Hydrogen Sensors which has been provided or may be provided by NPI and/or ANI to Kelman over the course of their relationship.

1.6       “Technical Field” means any instrumentation using in whole or in part the ANI Hydrogen Sensor for the measurement of the content of hydrogen in insulated fluids for power transformers.

1.7       “Gross Selling Price” means at least the fair market value of the Hydrogen Sensor Products, that is, the selling price which would result from an unaffiliated end-user of the completed product in an arm’s length sale of a substantially identical product in the same country, in the same quantity and at the same time subject to the same royalty.

1.8       “Sales Price” means the Gross Selling Price for the Hydrogen Sensor Products, less accepted returns from customers, excise, sales or use taxes, customs duties and consular fees, and transportation and insurance costs.

1.9       “Entity” shall mean any natural person, legal entity, partnership, limited partnership, corporation and all other forms of organization or association, as well as any parent, subsidiary or affiliate of the same.

3.       Purchase of Sensors

Kelman shall purchase Hydrogen Sensors from ANI under the terms set forth herein. If, during the term of this agreement, Kelman determines that it wishes to manufacture the sensors itself, ANI will provide training and expertise at cost to assist Kelman in the set-up and an initial operation of a plant to manufacture the sensor for Kelman’s use. In this event, prior to the commencement of training, ANI and Kelman will develop a plan to minimize training costs and quantify the amount.

4.       Obligations to Purchase

A.       From July 1, 2005 until June 30, 2006 and for an “Extended Exclusivity Period” (as defined in Section 7.2.D. herein below), subject to earlier termination of this Agreement as provided herein, Kelman shall purchase Hydrogen Sensors solely from ANI for use in the Insulprobe product, and shall not purchase any product that detects hydrogen from any other source or supplier for this product. During such periods, ANI may not sell Hydrogen Sensors or license Hydrogen Sensor Technology to a company other than Kelman within the Technical Field.

B.       In the event: (a) Kelman chooses not to extend the exclusivity of this Agreement for a period of time beyond June 30, 2006 under Section 7.2.D.; then in such event Kelman may purchase or acquire from a source or supplier other than ANI a product that detects hydrogen so long as such product does not use or involve Hydrogen Sensor Technology or an ANI Hydrogen Sensor. In such event, ANI and NPI may sell Hydrogen Sensors to and/or license Hydrogen Sensor Technology to Entities other than Kelman whether inside or outside the Technical Field. At such points the license becomes non-exclusive as per Section 7.1.B.

5.         Price and Discounts

A.       Pricing for the Hydrogen Sensors will be as follows:

B.       The price break levels are calculated based upon the total number of units sold to Kelman per order and include all varieties of Hydrogen Sensors sold by ANI to Kelman.

C.       The parties agree that neither of them is required to take any action in the future with respect to any product other than the Hydrogen Sensors as is specifically required herein. However, in the event the parties agree in the future to develop, manufacture, sell or buy other products with, for, by or between one another, pricing will be negotiated at such time on terms of which the parties can mutually agree in writing

6.       Ordering, Delivery and Shipment

A.       All orders shall be in writing and specify: the number of Hydrogen Sensors to be purchased; the purchase price; the requested ship date; and if applicable, state the appropriate tax exemption certificate number. Any production order of Hydrogen Sensors shall be for an amount not less than ten (10) units.

B.       Shipments of Hydrogen Sensors purchased by Kelman pursuant to this Agreement shall be made F.O.B. Kelman’s place of business in Lisburn, N. Ireland, UK. Kelman shall take title to the Hydrogen Sensors at the F.O.B. point and all risks of loss and expenses in connection with the Hydrogen Sensors shall thereafter be the responsibility of Kelman.

C.       The Hydrogen Sensors shall be deemed accepted by Kelman upon its receipt of the Hydrogen Sensors either at its place of business in Lisburn, N. Ireland, UK, or at such earlier time that Kelman takes delivery of the Hydrogen Sensors at ANI’s place of business. Kelman shall have thirty (30) business days after receipt to inspect and test the Hydrogen Sensors. Kelman shall inspect these sensors using a testing system substantially equivalent to the system installed at ANI’s facilities using personnel trained to follow the testing procedures set forth by ANI. Any sensors not tested in the 30 day period will be deemed acceptable. If Kelman discovers any defect in any of the Hydrogen Sensors within such 30-day period, it shall notify ANI of such defect(s) in writing (by mail or fax) during such 30-day period. ANI will have the option of replacing any defective sensors or issuing Kelman a credit or refund for the purchase price of such defective Hydrogen Sensors. Kelman shall make such defective Hydrogen Sensors ready for shipment back to ANI at Kelman’s offices in Lisburn, UK. ANI shall bear the expense and risk of loss associated with the return of said defective Hydrogen Sensors.

D.       ANI shall deliver to Kelman an invoice for each order at such time that the Hydrogen Sensors covered by the order are shipped. Payment shall be made by Kelman within thirty (30) business days from the date of receipt of the invoice.

7.          License and Royalties

7.1       License

In connection solely with Kelman’s purchase of the ANI Hydrogen Sensor, ANI and NPI shall be deemed to have granted to Kelman a license as follows:

A.       NPI and ANI grant to Kelman a limited, exclusive , non-transferable license to the Hydrogen Sensor Technology solely for use in the Technical Field, solely to the extent set forth in this section 7.1, and solely for the time period July 1, 2005 to June 30, 2006, except as otherwise provided in Section 7.2.D. below.

B.       NPI and ANI grant to Kelman a limited, non-exclusive , non-transferable license to the Hydrogen Sensor Technology solely for use in the Technical Field, solely to the extent set forth in this section 7.1, and solely for the time period from July 1, 2005 until this Agreement is terminated, except as otherwise provided in Sections 4 and 7.2.D. below.

C.       The license granted herein gives Kelman the right to (1) make, have made, use and sell Hydrogen Sensor Products to Kelman’s end-user customers in the normal course of business for use in the Technical Field; and (2) convey to, with respect to any Hydrogen Sensor Product sold, leased or otherwise disposed of by Kelman for use in the Technical Field, rights to use and re-sell such Hydrogen Sensor Product in the Technical Field as sold, leased or otherwise disposed of by Kelman.

D.       Kelman shall not have any rights under this license to make, have made, use, lease, sell, or export Hydrogen Sensor Products for any application outside of the Technical Field.

E.       Kelman shall have no right to sell Hydrogen Sensors to any Entity, and Kelman shall have no right to make, use, sell, lease, export, or otherwise use Hydrogen Sensors or Hydrogen Sensor Technology except as Kelman is permitted to so use Hydrogen Sensors and Hydrogen Sensor Technology in connection with Hydrogen Sensor Products as authorized in this Agreement.

F.       Kelman acknowledges that the Hydrogen Sensor Technology is proprietary to ANI and that, except for the rights and licenses expressly granted hereunder, ANI retains all right, title, and interest therein.

G.       Kelman agrees that this Agreement does not grant any right or license, under any other intellectual property of ANI or otherwise, except as expressly provided herein, and no other right or license is to be implied by or inferred from any provision of this Agreement or the conduct of the parties hereunder.

H.       The parties acknowledge that any know-how, trade secrets, patents, copyrights, or other intellectual property rights developed by Kelman without any participation by ANI pertaining to the Hydrogen Sensor Technology shall belong solely to and remain the property of Kelman. The parties acknowledge that any know-how, trade secrets, patents, copyrights, or other intellectual property rights developed by ANI without any participation by Kelman pertaining to the Hydrogen Sensor Technology shall belong solely to and remain the property of ANI. Any know-how, trade secrets, patents, copyrights, or other intellectual property rights developed jointly by the parties shall be jointly owned by Kelman and ANI.

I.       All licenses granted herein shall continue until this Agreement is terminated as provided herein.

For each and every Hydrogen Sensor Product sold or otherwise disposed of by Kelman to the extent permitted herein, Kelman shall pay to ANI the following royalty:

A.       Ten percent (10%) royalty on the Sales Price for each and every Hydrogen Sensor Product sold or otherwise disposed of by Kelman, with the exception of Hydrogen sensors used for initial in-house testing and beta field trials. Sensors to be used for initial in-house testing and beta field trials shall be identified at the time of order by Kelman. If sensors from this order remain after completion of such in-house testing or beta field trials, and such sensors are used in products, royalties shall be due on these sensors in accordance with the terms of the agreement. This ten percent (10%) royalty shall in no way be reduced, offset, or otherwise affected by the payment required pursuant to Section 5; that is, the amounts paid by Kelman to ANI for Kelman’s purchase of Hydrogen Sensors from ANI. Nor shall the purchase price in Section 5 in any way be reduced, offset, or otherwise affected by the ten percent (10%) royalty in this section; and

B.      From July 1, 2005 to June 30, 2006, Kelman shall pay royalties as follows:

At the end of each calendar quarter, Kelman shall pay royalties due on all products shipped by Kelman during the calendar quarter. Such payment is due within 30 days of the end of the calendar quarter, however Kelman shall notify ANI within 10 days of the end of each month, the amount of royalty due for that month that will be paid at the end of the quarter.

D.       K