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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended Commission file number 0-16416
OCTOBER 31, 1999
ELECTROPURE, INC.
(FORMERLY, HOH WATER TECHNOLOGY CORPORATION)
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0056212
(State or Other Jurisdiction (IRS Employer
of Incorporation or Organization) Identification No.)
23456 South Pointe Drive, Laguna Hills, California 92653
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 770-9347
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether any director, officer, beneficial owner of more
than 10 percent of any class of equity securities of the Registrant failed to
file any reports required by Section 16(a) of the Securities Exchange Act of
1934 on a timely basis during the most recent fiscal year. Yes [X] No [ ].
The aggregate market value of the voting stock held by non-affiliates of the
Registrant at December 27, 1999 was $1,908,227.
At December 27, 1999, 7,791,415 shares of the Registrant's stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
NONE
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PART I
ITEM 1. BUSINESS
BUSINESS
Electropure, Inc. ("Electropure" or the "Company" - formerly, HOH Water
Technology Corporation) was organized in 1979 to design, develop, manufacture
and market its series of patented electrodeionization ("EDI") water treatment
devices for commercial, residential, municipal, industrial and agricultural
applications. The original EDI was designed as a point-of-entry system to treat
the entire house or facility. However, lack of funds and high production costs
delayed development of this model. The Company subsequently developed a smaller
point-of-use model of the EDI technology aimed at the high purity water
treatment segment of the commercial and industrial water treatment markets. The
Company's current EDI product is marketed to original equipment manufacturers
("OEMs") as a specialized component for water treatment systems designed to
provide ultrapure water to market segments whose major customers include, but
are not limited to, semiconductor, pharmaceutical and power generation
companies, as well as laboratories and petrochemical companies.
The Company's current EDI design is able to desalt pre-treated (water filtered
and softened generally by reverse osmosis) tap water to a purity level exceeding
ten megohm-cm (roughly less than 0.2 parts per million ("ppm") of total
dissolved solids) at a rate of up to 10 gallons per minute on demand.
Modularized designs (connecting additional modules in parallel formations)
increase a system's capacity exponentially to service installations requiring up
to hundreds of gallons per minute. In addition to its cost-effective operation,
a major environmental and competitive benefit of the EDI technology is that it
does not require the addition of chemicals (acids and bases) for resin
regeneration. Most other competitive processes require the addition of these
elements.
The Company began sales of light commercial/industrial water and waste water
treatment equipment in May 1998. Included in the product line, which the Company
offers as its Hydro Components line of products, are high quality sanitary heat
exchangers, sample coolers for sterile steam and water, ion exchange filter
cartridges, and ion exchange membranes for electrodialysis, electrodeposition,
and electrochemical separations.
In February 1998, the Company acquired the rights to certain proprietary
membrane technology from Pennsylvania-based Hydro Components, Inc. See "Item 1 -
BUSINESS - Acquisition of Intellectual Properties - Ion Exchange Membrane
Technology." The Company began a research project utilizing the acquired
technology to develop ion permeable membranes for use with its EDI product and
has successfully developed membranes which will allow the Company to offer more
cost-sensitive models of its EDI product to a broader range of users for a wider
range of uses.
In October 1997, the Company acquired an exclusive license to certain patent and
intellectual property rights involving laser light scattering techniques to be
utilized in the detection and monitoring of toxicants in drinking water. This
acquisition provides the basis for Electropure's proposed development of near
"real-time" drinking water monitoring systems. This technology and the EDI
technology are not intended to be integrated into one product. See "Item 1 -
BUSINESS -
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Acquisition of Intellectual Property - Micro Imaging Technology" and "BUSINESS -
Micro Imaging Technologies Division." See also "Item 3 - LEGAL PROCEEDINGS."
ACQUISITION OF INTELLECTUAL PROPERTIES
EDI COMPONENTS
Effective August 5, 1997, the Company entered into a License Termination
Agreement with EDI Components ("EDI Components") terminating the July 1992
agreements which granted EDI Components a security interest in and exclusive
manufacturing and marketing rights to the Company's patented water purification
technology. Pursuant to the termination agreement, 362,500 shares of the
Company's Common Stock, with an agreed value by the parties of $2.00 per share,
were issued to the investors of EDI Components in amounts commensurate with
their capital investment in such entity. The Company has agreed to issue
Additional Shares upon the Common Stock of the Company first having a per share
value for thirty consecutive trading days equal to or in excess each of $3.00,
$4.00 and $5.50 per share (each a "Trigger Value"). The aggregate value of such
Additional Shares shall equal $675,006, $675,012 and $674,982, respectively, for
a total additional value of $2,025,000. If all of the Additional Shares are
issued pursuant to the License Termination Agreement, the investors of EDI
Components will have received a total of 878,979 shares of the Company's Common
Stock, with an aggregate value equal to $2,750,000. The fair market value of the
Company's restricted Common Stock was $0.3136 per share on August 14, 1997, the
date on which the 362,500 shares were issued to the investors of EDI Components.
The Company issued an additional 566,409 shares of Common Stock, at $0.375 per
share, upon conversion of $200,000 in indebtedness, plus $12,404 in related
interest, on notes payable assumed by the Company from EDI Components. An
additional $10,000 principal loan, plus $1,620 in accrued interest, was assumed
by the Company and was paid in September 1997 with the proceeds realized from
the sale of an additional 30,988 shares of Common Stock at $0.375 per share.
The License Termination Agreement provided for an extension, until October 1,
1997, on 95,400 warrants to purchase common stock granted to various investors
of EDI Components pursuant to the July 1992 license agreement. As of October 1,
1997, all of such warrants were exercised at $0.50 per share, including 44,000
warrants which had been assigned to William Farnam, a Director of the Company,
and 40,000 warrants held by Floyd Panning, President of EDI Components. Mr.
Panning also exercised 10,000 warrants to purchase Common Stock previously
issued to him in February 1993 at $0.50 per share as a bonus for services
rendered.
ION EXCHANGE MEMBRANE TECHNOLOGY
On February 17, 1998, the Company paid Hydro Components, Inc. ("HCI")
the sum of $200,000 under the terms of an Assignment Agreement to acquire the
rights to certain proprietary ion exchange membrane technology for use with its
EDI water treatment technology. Pursuant to the agreement, HCI, a
Pennsylvania-based supplier of light commercial water and wastewater treatment
products, is to provide the Company with the know-how and technical support to
develop extruded membranes with ion exchange materials. In April 1999, pursuant
to an Addendum to such agreement, HCI was granted a $65,000 bonus for the
successful development of such membrane technology which is now being
incorporated into a new EDI module.
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MICRO IMAGING TECHNOLOGY
On October 25, 1997, the Company issued 2,100,000 shares of its Common Stock,
valued at $447,146 by independent appraisal, to Wyatt Technology Corporation
("Wyatt") as consideration for the transfer by Wyatt of an exclusive worldwide
license to certain intellectual property related to drinking water monitoring
technology. The agreement encompassed exclusive patent rights, software,
technical support, manufacturing services and other know-how based on Wyatt's
proprietary multi-angle laser light scattering instrumentation and techniques to
detect and monitor the presence of toxicants (mutagens, carcinogens, and
metabolic toxins) in fluid. The Company refers to this technology as its "Micro
Imaging Technology." In May 1998, Wyatt privately sold 150,000 of the Company's
shares to pay federal and state income taxes on the transaction.
Pursuant to the transfer agreement, the Company's Micro Imaging Division
(formerly known as the Laserpure Division) focused its initial research efforts
on applying the Wyatt technology in developing the instrumentation and software
to detect, in near "real-time," particulate materials (parasites and other
organisms such as bacteria, viruses, spores, etc.) in drinking water. In May
1998, the initial research phase proved, in a laboratory environment, a
capability of the technology for identification and measurement of
Cryptosporidium and Giardia cysts. The Company has initiated further research
efforts based on these successful results.
The agreement provided that Wyatt provide technical support required for the
research program and in February 1999, the Company filed a lawsuit claiming
Wyatt breached such provision. The lawsuit was resolved by settlement in July
1999. See Item 3 - "Legal Proceedings."
THE MARKET FOR WATER PURIFICATION
Water is essential to life and potable water, that which is fit for human
consumption, is a necessity for which a market will always exist. Growing
population has increased demand for potable water just as the waste and
pollution created by the enlarging population has reduced nature's ability to
supply potable water. The United Nations focused attention on the world's water
problem in 1980 and allocated $300 billion to the development of solutions to
the problem. Beyond the need for water which is merely fit for human consumption
is the demand for "high purity" water which is usable for purposes other than
drinking, such as cleaning or industrial processing. Such water requires the
removal of contaminants which interfere with the intended use. In fact,
examination of municipal water use reveals that less than one percent is
actually used for human consumption. The remainder is used by industry,
irrigation, bathing, laundry, etc. Enhanced treatment of such water at the point
of use, therefore, is an economically viable solution for compliance with
stringent standards imposed by users of high purity water. The Environmental
Protection Agency ("EPA") has studied and is in favor of the point-of-use
approach, provided that treatment equipment meets its Generally Available
Technology (GAT) criteria. According to a 1996 report by Environmental Business
International, Inc., the San Diego-based market research and consulting firm,
the water/wastewater environmental services sector in the United States will
grow from its then annual level of $75 billion to $96 billion by the year 2000.
The report projects this growth on the basis of two expanding areas of the
business: the expansion in the use of outsourcing for industrial water and
wastewater treatment activities, and the trend toward privatization of municipal
treatment facilities. The three largest markets for ultrapure
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water, wherein the Company's EDI product finds it market, are power generation,
semiconductor and pharmaceutical industries. According to the Journal of
Ultrapure Water, the total capital to be spent for ultrapure water in the year
2000 is approximately $2.5 billion, with almost $2.2 billion being spent by
these three segments.
The market is currently growing at a steady annual rate and given the general
deterioration of the world's water supplies this growth is likely to continue
and expand as the cost of treatment falls. Advanced manufacturing technologies
and the tremendous expansion seen in electronics, pharmaceuticals and bio-tech
firms in the last decade alone, have been the precursors of an increased need
for high purity process water and for water purification equipment. The industry
is in a major growth cycle and there are about 40 major companies in the world
active in supplying goods and services with an estimated 13,500 customers in the
United States. Besides U.S. Patent No. 4,465,573, the Company holds patents for
the EDI technology in Austria, Belgium, France, Great Britain, Luxembourg,
Switzerland and the former West Germany.
CURRENT TECHNOLOGIES IN WATER PURIFICATION
Water purification is a relative term referring to removing selected, but not
all, of a limited number of contaminants depending on the expected use to be
made of the water. There are three general types of water purification
processes:
1. Physical processes which depend simply on physical properties of the
impurities, such as particle size, specific gravity and viscosity.
Examples of this type of process are reverse osmosis, distillation,
screening, sedimentation, filtration and gas transfer.
2. Chemical processes which depend on the chemical properties of an
impurity or utilize the chemical properties of added reagents.
Examples are ion exchange, electrodialysis, chlorination, coagulation
and precipitation.
3. Biological processes which utilize biochemical reactions to remove
soluble or colloidal organic impurities. Examples are biological
filtration and the activated sludge process.
THE EDI TECHNOLOGY
The need to satisfy the increasing demand for high purity water in a variety of
industries can now be achieved through the Company's patented
electrodeionization process. The EDI design combines two well-established water
desalination technologies -- electrodialysis and ion exchange deionization.
Through this technique, dissolved salts can be removed at low energy costs, and
without the need for chemical regeneration; the result is high quality water of
multi-megohm/cm resistivity which can be produced continuously at substantial
flow rates.
The EDI module has been proved to be an effective new electrodeionization
process and can be used for a broad range of process applications, including the
supply of high water quality for the food and beverage industry, for
microelectronics production, biomedical and laboratory use, pharmaceutical
compounders and for general industry. The advantages of having a dependable and
high quality water source which requires no chemical regeneration, coupled with
low operation and maintenance costs, makes the EDI process an attractive and
environmentally-safe alternative compared with other deionization processes.
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The Company has recently redesigned the EDI module, now called "XL by
Electropure", to improve integration into water treatment systems with all water
connections on the module face and all electrical connections on the rear of the
module. The EDI module is 9" wide and 22" high and ranges in depth from 6" to
14" for flow rates ranging from 1/4 gallons per minute (gpm) to 10 gpm,
respectively. The product has no moving parts and is capable of continuously
producing ultrapure water. The module is marketed to original equipment
manufacturers of water treatment equipment for incorporation into a water supply
system complete with pre-treatment components (such as reverse osmosis, filters,
softeners, etc.), power supply, and desired gauges and monitors. This system
would then be connected to the incoming water line, to a drain line and to an
electrical source. A singular module is designed to service the small industry
users. For higher flow rate requirements, the existing EDI module has been
successfully combined in parallel formations to provide multi-gallons per minute
of multi-megohm quality water. Larger systems, which produce 25 - 200 gpm, would
be marketed to medium scale users. The Company plans to design a higher capacity
version of the EDI module which will be intended to provide volumes of high
purity water at 15 gpm or more from a single module. The Company believes that
this model, if it can be developed, will become the primary product line for
desired high purity flow rates in the 25-200 gpm market segment.
XL-500 MODULE
[GRAPHIC]
(6 to 10 GPM Flow Rate)
The Company believes that the major advantage of the EDI technology over systems
utilizing ion exchange resins only is the efficient recharging of the resins
without the extensive use of caustic and acid chemicals which add excessive
contamination and cost to the system's waste water. The Company believes that
the primary advantage of the EDI technology over products using distillation and
reverse osmosis is its ability to utilize electrical and chemical properties of
the water molecule and of naturally occurring salts, instead of merely physical
properties, in separating water from the dissolved mineral ions. The EDI can
operate without booster pumps or holding tanks and the EDI module achieves a
high flow rate with relatively smaller sized and less expensive equipment.
EDI technology requires less maintenance than existing systems but requires more
stringent pretreatment of entry water. Maintenance is a major problem with
conventional electrodialysis and reverse osmosis units, particularly the
clogging of membranes. Thus, the advantages of the EDI technology system, as
compared to some conventional water treatment systems, include the following:
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- lower maintenance since nothing is consumed except small amounts of
electricity. If at all necessary, chemicals are added less
frequently than existing equipment.
- large flow rate relative to its size, as compared to conventional
systems that purport to treat the same flow rates.
The Company's belief as to the expected advantages of the EDI technology are
based upon its experience with prototypes, pilot production units, products sold
by its former licensee, EDI Components, and the approximately 150 EDI products
sold by the Company through October 31, 1999. The EDI technology incorporates a
number of design improvements to the original EDI patent. The Company intends to
conduct continued product development on the EDI technology, with an eye toward
improving the technology while reducing manufacturing costs, and allowing the
Company to expand its market reach.
Development of new technologies for manufacture, such as the EDI technology, is
frequently subject to unforeseen expenses, difficulties and complications and in
some cases such development cannot be accomplished. In the opinion of
management, the EDI technology has demonstrated positive attributes, but any
such attributes must be balanced against the lack of any substantial operating
experience, the existence of established companies in the water purification
field with greater financial resources, experience and developed products, and
unknown technological difficulties. Consequently, no assurances can be given as
to if and when the product discussed above will be successfully marketed and
sold.
Similar risks will apply to the use of any product which may be developed using
the technology acquired from Wyatt and the ion permeable membrane which has been
developed using the Hydro Components technology and is now being incorporated
into the EDI module.
THE HYDRO COMPONENTS LINE
The Company began offering for sale its Hydro Components line of products in May
1998. The Hydro Components line includes water and wastewater treatment products
for light commercial/industrial markets such as optical lens manufacturers;
sterile steam samplers for pharmaceutical and biotechnical firms; industrial
steam samplers for power plants, pulp and paper mills and refineries; high-flow
deionizers sold through catalog houses for humidification, rinse water, cooling
water and small laboratories. The Hydro Components line also offers
solvent-based coated membranes which are sold to OEM's of stabilizing equipment
for electrodeposition automotive and appliance painting.
MARKETING
The EDI module was developed for the ultrapure light industrial segment of the
water treatment market, i.e., pharmaceuticals, electronics, medical and research
laboratories. The Company sells these products through manufacturers of
commercial water treatment equipment in the United States and in foreign
countries. The Company has patents for its EDI technology in the following
foreign
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countries: Austria, Belgium, France, Great Britain, Luxembourg, Switzerland and
the former West Germany.
ULTRAPURE MARKET. The Company believes that a substantial market
currently exists for EDI technology in the commercial and light industrial
market sector where ultrapure water is a necessity in manufacturing and where
chemically pure water is demanded for laboratory uses. The electro-regeneration
feature of the EDI technology is considered a significant advantage over
existing demineralization technology. The existing EDI module will provide
ultrapure water at a rate of 1/2 to 10 gallons per minute (and higher volumes in
parallel formations), which is generally ample for the needs of the OEM's
marketing to these various end users. This model and the proposed larger scale
version of the EDI will access a water system capital equipment market segment
of $2.2 billion of which $200 million is immediately accessible.
The Company's marketing strategy is to identify and target independent operating
water equipment manufacturers where the EDI technology can either be
incorporated into or replace certain components in the water treatment systems
currently offered by such manufacturers. The Company has initiated its marketing
strategy both in the U.S. market and overseas, but has no current intentions of
entering into formal supply agreements with any such potential customers.
GOVERNMENT REGULATION
A California State Health and Safety Code (the "Code"), as amended through 1992,
provides that water treatment devices which are sold for residential use be
certified by the State Department of Health Services, or approved certification
facility, if claims are made that the device will remove or reduce a contaminant
for which a primary drinking water standard as defined in the Code has been
established. In addition, a California Business and Professions Code makes it
illegal to make any false claims in connection with the sale of any water
treatment product.
Other states have similar laws.
The Company believes that the EDI ultrapure technology, which is not intended
for drinking water applications, is not subject to the above regulations.
However, if the Company offers industrial applications of the EDI point-of-use
technology, i.e., hospitals, such products will require approval by
Underwriter's Laboratory or equivalent organization. The Company will seek all
necessary approvals or certifications.
PRODUCTION METHODS
EDI TECHNOLOGY - The EDI module is composed of various components. All
internal parts are made of engineered thermoplastics, except the membranes,
electrodes and electronics. The Company has previously purchased certain tooling
and molds required for component plastic parts and contracts for the production
of the plastic parts and electrodes for the EDI product. The membranes utilized
in the EDI product were purchased from outside sources until the Company
recently began manufacturing membranes based on the technology acquired from
Hydro Components. No assurances can be given that the membrane which the Company
has recently
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developed will prove to be efficient for long term use with the EDI product. All
final assembly is completed by the Company at its Laguna Hills, California
manufacturing facility. Production and assembly functions have been designed
with the flexibility to produce customized variations of the EDI for specialized
usage.
HYDRO COMPONENTS LINE - Except for the membranes offered by the Company,
the Hydro Components line of products consists of component parts purchased from
unaffiliated third party suppliers or sub-contractors and assembled by the
Company into the finished product. The membranes sold under the Hydro Components
line (which are not the ion permeable membranes utilized in the EDI product) are
specially treated by the Company and currently are fabricated by an outside
source.
WARRANTY
The Company offers a one year limited parts and labor warranty for the EDI
module and may, in the future, contract with others to provide warranty service.
However, it has not made any arrangements with any persons to provide such
service and it may not be able to locate competent persons to perform the
services at an acceptable price. The Company has not experienced significant
warranty returns to date; however, no assurances can be given that future
warranty expenses will not be significant.
Suppliers of components utilized in the Hydro Components line of products
provide certain limited parts and labor warranties which the Company passes on
to its customers. No additional warranties are offered by the Company at this
time.
SOURCES OF SUPPLY
The Company believes that material to build the products which it currently
offers are readily available from at least two sources and the Company currently
has two sources for all such material. The Company is not dependent upon any one
or more principal supplier.
PATENTS AND LICENSE AGREEMENT
Certain technology used by the EDI technology is covered by U.S. Patent No.
4,465,573, issued on August 14, 1984, to Harry M. O'Hare, Sr. Corresponding
patent applications have been filed in certain limited foreign countries. The
improvements in the EDI technology involve upgrades of various components,
including ion permeable membranes, manifolds (front and rear), and product water
and waste water compartments. Such improvements increase performance quality and
decrease production costs. The existence of patents for the EDI technology may
not provide any meaningful protection for the Company because of technological
changes, the decision of courts not to uphold all or part of a patent, or
because of the limited financial resources which may be available to the Company
to enforce its patent rights. The Company has recently filed a patent
application with regard to the ion permeable membrane technology acquired from
Hydro Components.
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The Company has not secured a registered trademark or trade name for the "EDI"
or "Micro Imaging Technologies."
Harry M. O'Hare, Sr., the inventor of the EDI technology, entered into a License
Agreement with the Company and HOH, Inc., dated October 30, 1986. The License
Agreement grants to the Company an exclusive worldwide license to manufacture,
use and sell the EDI technology and other water purification products covered by
the current patent and any improvements thereon or under corresponding foreign
patents for the life of such patents. Under the terms of the License Agreement,
the Company is obligated to pay to the individuals who have royalty rights in
the EDI technology, a royalty of approximately $42.00 for each EDI technology
system, which has a capacity of from six to twenty gallons per minute, sold or
placed in service by the Company and its licensees during the life of the
patent. Royalties of approximately $9.00 per such EDI technology are also
payable until a maximum of approximately $525,600 is paid at which time such
additional royalties will terminate. Royalties of approximately 2.05% of the net
sales price are also payable on EDI products of other flow rates. In May 1987,
Mr. O'Hare assigned all of his interest, including rights to future royalties,
in the patent covering certain parts of the EDI technology to the Company.
On January 21, 1988, the Company and Harry M. O'Hare, Sr. entered into an
Invention Assignment Agreement for certain payments wherein Mr. O'Hare assigned
to the Company his entire right, title and interest in and to an Improved
Compact Water Purification System and an Improved Compact Low Volume Water
Purification System, both of which are point-of-use products designed to remove
certain contaminants from solution on demand at flow rates under 1 gallon per
minute. In September 1988, an application for a U.S. patent was filed on the
Compact Low Volume Water Purification System and in October 1990, U.S. Patent
No. 4,964,970 was granted thereon and has since been abandoned. The Company's
point-of-use EDI technology incorporates claims covered in both the original
U.S. Patent No. 4,465,573 and the patent for the Improved Compact Low Volume
Water Purification System (Patent No. 4,964,970).
In July 1992, the Company granted an exclusive worldwide license to EDI
Components for the manufacture and sale of EDI products. Such license was
terminated in August 1997. See Item 1 "BUSINESS - Acquisition of Intellectual
Properties - EDI Components."
NON-EXCLUSIVE LICENSE AGREEMENTS
GLEGG WATER CONDITIONING, INC.
On July 1, 1994, the Company and its former licensee (EDI Components) granted
Canadian-based Glegg Water Conditioning, Inc. a non-exclusive license to use and
commercially exploit the EDI technology for an initial term of ten (10) years
for which Glegg paid the non-refundable sum of $50,000. The license provided
that Glegg pay a continuing royalty of 5% on the net sale price of all licensed
products having a total system design flow rate of 100 gallons per minute and
above and a 10% royalty on flow rates less than 100 gallons per minute.
In May 1997, the Company and its former licensee entered into an Amended and
Restated Technology Licence Agreement providing Glegg with a paid-up license for
a lump sum payment of
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$125,000 to EDI Components. The amended agreement provides Glegg the right to
sublicense its subsidiaries and affiliates as well as Asahi Glass Co., LTD, with
which Glegg has an on-going working relationship. The license provided to Glegg
relates to sales throughout the world.
In October 1999, GE Power Systems acquired 82% of Glegg Industries and had an
outstanding offer to purchase the remaining shares of Glegg which the Company
believes has been completed as of the date of this report.
POLYMETRICS
On May 3, 1995, the Company and its former licensee granted a non-exclusive EDI
license to Polymetrics of San Jose, California. The terms of such license, for
which Polymetrics paid the sum of $200,000, are similar to those contained in
the July 1994 Glegg agreement, with the exception that Polymetrics may sell the
licensed product to its end-user customers only. In 1996, Polymetrics was
acquired by U. S. Filter Corporation.
RESEARCH AND DEVELOPMENT
During fiscal 1999, the Company expended $650,897 primarily on its research
program to develop a drinking water monitoring system derived from the
technology acquired from Wyatt in October 1997. The Company concluded its Phase
1 research on this proposed technology and initiated phase two of its program in
1998. The Company expects to continue to incur additional research and
development costs on this Micro Imaging Technology project through product
development. See Item 6 - "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
The Company also conducted minimal research and development activities to
develop its ion permeable membrane with technology acquired from Hydro
Components in February 1998. The Company has successfully developed such
membrane and has recently begun incorporating it into the EDI product.
For a description of the technologies referenced above see headings entitled
"Micro Imaging Technologies" and "Ion Exchange Membrane Technology" under Item 1
- - "BUSINESS - Acquisition of Intellectual Properties."
MICRO IMAGING TECHNOLOGIES DIVISION
The technology transferred under the October 25, 1997 agreement with Wyatt
Technology Corporation has (at inception) two main areas for exploitation:
(1) Detection and early warning of dangerous particulate materials such as
parasites and other organisms, i.e., bacteria, viruses, spores, etc. If
the initial efforts are successful, future efforts will be directed to
include detection and early warning of asbestos fibers and similar
materials which pose a health hazard to the consumer.
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(2) Detection and early warning of dangerous soluble substances such as
mutagens, carcinogens and metabolic poisons.
The latter technology area had already been confirmed, although never
commercialized, during a study by Wyatt for the U. S. Army through a Small
Business Innovative Research program conducted approximately a decade ago. To
transform the latter area into a viable product line will require the
development of specialized instrumentation for the implementation of the methods
developed (and patented) under that program, market studies, and the
establishment of a marketing plan to target water consumer delivery agencies
(municipalities). Although this market may well represent a major opportunity
(on a worldwide basis) for future growth of the Company's consumer market
products, the currently available instrumentation and methods being developed by
the Company appears to provide a more immediate path to developing the parasite
detection concept for the technology. It is for this reason that the Company's
current research and development efforts have focused on, and have thus far
proven successful in a laboratory setting, for the detection and monitoring of
parasites, primarily Cryptosporidium and Giardia(1), in drinking water sources.
Since these parasites form cysts that have a protective shell, they are
particularly dangerous and difficult to remove as they are resistant to normal
treatment levels of chlorine.
The Center for Disease Control ("CDC") and the Environmental Protection Agency
("EPA") have developed a national "surveillance system" to monitor and track the
incidences of water borne diseases, including those associated with
Cryptosporidium and Giardia contamination. However, this system relies upon
standard water sample gathering and analysis and recognition of outbreaks after
they occur. The CDC documents an average of 15 to 20 waterborne outbreaks
throughout the country each year. Experts speculate, however, that the numbers
are much higher since illnesses caused by waterborne diseases are often mistaken
for the stomach flu or intestinal disorders. In 1997, the CDC reported 1,770(2)
cumulative Cryptosporidiosis cases in the U.S. alone. Cryptosporidiosis was
brought to national attention in 1993 in a Milwaukee incident, when over 400,000
people (more than half of the total population of the city) became ill, with
more than 4,000 hospitalized and 100 deaths. Particularly susceptible were
immunocompromised persons.
The current method for water quality sampling is labor intensive, expensive,
sporadic, time consuming, and results are untimely for corrective action. In the
monitoring for bacteria or parasite detection, for example, workers will collect
samples at distribution points, influent points or effluent points. These
samples will then be transported to laboratories that are equipped to provide
detection and identification of the contaminants in question. Samples are then
physically separated to allow for microscopic visual identification by trained
technicians. Standard turn-around time for information is one to two days,
although some tests can often be run in as little as a few hours. Expenses
increase dramatically if quick (few hour) turn-around is requested or required.
- ------------------
1 Cryptosporidium (Cryptosporidium parvum) and Giardia (Giardia lamblia)
are waterborne protozoan parasites which contaminate water sources such
as wells, rivers, streams, and lakes, generally through animal and fowl
fecal deposits.
2 CDC Morbidity and Mortality Weekly Report 46(47):1121, 1997 (week ending
November 22, 1997)
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<PAGE> 13
This method of "surveillance" is recognized as woefully inadequate by the water
industry. While it serves to provide incidence statistics, it is operationally
ineffective since problems are detected after product already has been
delivered. By the time positive detection is made, it is not possible to take
corrective action to prevent exposure. Corrective actions are limited to often
overblown solutions such as general boil orders or a total water system
shutdown. These actions serve to only limit the initial outbreaks, rather than
to prevent them.
A system that would provide for "real-time" contaminant detection and monitoring
could prevent or limit outbreaks, save lives and be less expensive. The
availability of this technology would clearly represent a leap forward in water
delivery and monitoring. The proposed system would monitor the laser light
scattering properties of each particle passing through the detector region and
software would examine the measurements and decide whether the particle was a
parasite.
Potential customers for the proposed water monitoring system would include local
water utilities, both private and municipal; state water utilities and water
quality and health agencies; Federal government agencies such as EPA, DoD, DoE,
CDC; wastewater treatment plants; ground water and well users; and potentially,
as the cost of the sensors and system decreases, homeowners.
The Company is also researching applications for its Micro Imaging technology in
the clinical laboratory and food processing areas, each of which would reap cost
and efficiency benefits similar to the proposed water monitoring device under
development by the Company. This technology has already demonstrated
identification of the bacteria E.coli, Listeria and Salmonella.
Based on a very preliminary evaluation of market needs and the size and number
of potential customers, the market size in the water monitoring market is
estimated to be greater than $20 million per year. Markets for a device which
will address the needs of clinical laboratories and food processing operations
are estimated to be in the range of $200 million and $55 million per year,
respectively. Detailed market validation has not been completed; however,
management believes that these estimates are conservative and that market
penetration of 10% is achievable within the first several years of introducing a
viable product. Concurrent with conducting its research program, the Company
will continue to conduct more comprehensive market studies for this proposed
technology. See Item 1 - "BUSINESS - Acquisition of Intellectual Property -
Micro Imaging Technology."
COMPETITION
The Company's EDI technology competes with only three principal competitors:
on-site regeneration, service deionization and electrodeionization. U.S. Filter
licensed electrodeionization technology from Millipore Corporation of New
Bedford, Mass. in 1989 and continues to work closely with its technical staff.
U.S. Filter(1) manufactures and markets electrodeionization systems for the high
purity industrial segment with capacities ranging from 20 liters/hours to 100
gallons/minute. Compared to the Company's point-of-use EDI technology, the U.S.
Filter (Ionpure, Inc.) equipment is more expensive, but still offers substantial
operating cost savings over service
- -----------------
1 Pursuant to a March, 1999 acquisition, U.S. Filter became a wholly owned
subsidiary of Vivendi, a French environmental service provider and leader in
water treatment and distribution services.
13
<PAGE> 14
deionization. Comparison tests have shown that the Company's EDI technology is
also more efficient than the Ionpure product, resulting in better performance
and a lower operating cost. Ionics, Inc., Glegg/Ecell Inc., and Christ, Ltd.
also manufacture and market electrodeionization technology.
The technology directly competitive with electrodeionization is service
deionization. The service deionization industry is composed of a few larger
companies such as Arrowhead Industrial Water, Polymetrics (acquired by U. S.
Filter), and Continental Water, as well as hundreds of smaller entities, some of
which are dealerships of Culligan (also recently acquired by U. S. Filter) and
other water conditioning companies. The EDI unit can reduce operating costs of
producing high purity water by up to 40% in comparison to service deionization.
The marketing challenge for the Company will be to convince water equipment
manufacturers to utilize the EDI technology rather than conventional ion
exchange resin deionization. With service deionization, the customer does not
have to purchase capital equipment as he does with EDI, so the service
deionization system can be upgraded or down-sized with no substantial cost to
the customer. The customer pays for the water on either a cost-per-gallon basis,
or a cost-per-regeneration basis. Regeneration is done at the service company's
facility so that the customer does not have to handle or dispose of chemical
waste.
Many companies in the water treatment market are established in the field,
including the well-known firms mentioned above and others. All of such companies
are larger and better financed than the Company, have established products and
an established customer base and can accordingly devote more resources to
research and development, production and marketing activities. In addition, it
is possible that the water purification industry may be the subject of
technological innovation or other factors which may attract additional
competition in the future. The Company believes, however, that the patents for
the EDI technology and its technical know-how may be significant in its ability
to compete.
The Company's ion permeable membrane technology is intended to reduce dependence
on outside suppliers for this component of the EDI product as well as to
significantly reduce the cost of such component. The cost reduction in the
membrane component of the EDI product has resulted in a substantial increase in
the cost competitiveness of the Company's product. See "Item 6 "Management's
Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources."
With regard to the Company's proposed Micro Imaging product, there are
established methods of testing currently employed by both public and private
agencies. However, these methods are labor intensive, expensive and time
consuming, and do not provide the near "real time" monitoring capabilities which
the Company's product, if it can be developed, would purport to offer.
EMPLOYEES
As of December 27, 1999, the Company employed fifteen full-time employees, of
which eight were engaged in marketing, development, production and design; four
in administrative, accounting and clerical functions; and three are engaged in
research and development of the Company's proposed Micro Imaging Technology
products(s) (see Item 1 - "BUSINESS - Micro Imaging Technologies Division"). To
implement its proposed business, the Company will have to hire additional
employees
14
<PAGE> 15
in 2000. However, the Company cannot predict with any certainty when it will
hire such personnel. The Company believes that its relationship with its
employees is good and it is not a party to any collective bargaining agreement.
The future success of the Company will be dependent upon its ability to attract
and retain qualified personnel.
ITEM 2. PROPERTIES
The Company currently leases, with an option to purchase, a 30,201 sq. ft.
facility in Laguna Hills, California and pays a gross (including taxes,
insurance and major repairs) lease payment of $16,480 per month. In March 1998,
the Company sub-leased approximately 10,000 sq. ft. of such facility to an
unaffiliated third party which utilizes such space to warehouse and distribute
heating and cooling parts and equipment. Under the terms of the two-year
agreement, the sub-lessee pays the Company $6,500 per month. Management believes
that its present facilities are adequate for all of its current operations, and
those contemplated for the foreseeable future.
On July 29, 1999, the Company exercised an option under the lease to purchase
the building for the sum of $2,300,000 and paid $15,000 as part of the purchase
price therefor. Under the lease, the Lessor has 18 months within which to
complete the sale. The Company will continue to pay rent as set forth in the
lease with applicable increases until the sale has been completed.
ITEM 3. LEGAL PROCEEDINGS
In June 1998, the Company entered into an agreement to settle a 1993 default
judgment rendered in the Los Angeles County Municipal Court against the Company
for unpaid credit card charges. The Company paid a total of $22,000 to
extinguish the debt accrued at $30,744, resulting in a gain on the settlement in
the sum of $8,744 for the fiscal year ended October 31, 1998.
In January 1998, the Company satisfied the principal and interest due on a
$12,000 promissory note issued to the Economic Development Bank for Puerto Rico
(the "Bank") under the terms of a settlement reached in May 1997 on a $3 million
default judgment rendered against the Company in June 1996. The settlement also
provided for the issuance by the Company of 100,000 shares of Common Stock and
100,000 five-year warrants to purchase Common Stock at $1.00 per share. The
lawsuit, which was brought by the Bank in February 1993 in the San Juan (Puerto
Rico) Superior Court, alleged that the Company, its bankrupt Puerto Rico
subsidiary (HOH International, Inc.), and the officers and directors of both,
breached their fiduciary duty in entering into a distribution agreement with
HOH/CNM2 Enterprises which ultimately led to the dissolution of the subsidiary.
With payment of the referenced promissory note, the Company has satisfied all of
its obligations under the settlement.
In July 1999, the Company entered into an agreement to settle the February 1999
lawsuit it brought against Wyatt Technology Corporation ("Wyatt Technology") for
breach of the October 1997 Technology Transfer Agreement by which Electropure
obtained a license to use and develop certain laser-based technology and patents
held by Wyatt Technology. The lawsuit, brought in the Orange County Superior
Court of California, Case No. 805529, alleged that Wyatt had failed and refused
to
15
<PAGE> 16
provide the technical support indicated under the original agreement in an
attempt to bring about a rescission of the license.
The settlement with Wyatt Technology provided that each party has the right to
utilize the licensed technology as developed through Phase I of the Company's
research program which proved, in principle, that the instrument under
development can perform instantaneous microbe identification by measuring the
light scattered by particles as they pass through a laser beam. The settlement
also provided for the return by Wyatt Technology of 1.95 million of the 2.1
million common shares it received from the Company under the original license
agreement. Warrants to purchase 10,000 shares of Common Stock at $1.38 per share
issued to Clifford Wyatt, an officer of Wyatt Technology, were also cancelled
pursuant to the settlement. Mr. Clifford Wyatt resigned as a Director of the
Company in April 1999.
In August 1999, a Cross Complaint for breach of contract, misrepresentation and
negligence was filed against the Company and other unaffiliated defendants by
Douglas B. Platt d/b/a East-West Technic Group ("Platt"), the defendant in a Los
Angeles Superior Court action, Case No. GC 023410, brought by Starr Surgical
Company, Inc. The cross-complaint charges Electropure with breach of contract,
misrepresentation and negligence in connection with the sale to Platt of an EDI
module subsequently provided by Platt to Starr Surgical. The cross-complaint
seeks unspecified damages. The Company intends to vigorously defend this matter.
The Company and its counsel believe that it will prevail on the merits if this
matter should go to trial.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Shareholders of the Company was held on June 26, 1999
at the Company's offices located at 23456 South Pointe Drive, Laguna Hills,
California 92653 at 10:00 A.M. pursuant to notice to the shareholders. The
following matters were submitted to the vote of shareholders:
Proposal 1. The election of five directors to hold office until the Annual
Meeting of the Shareholders at which time their term expires or
until their successors have been duly elected. The following
named persons received the number of votes set opposite their
respective names for election to the Board of Directors:
<TABLE>
<CAPTION>
DIRECTORS VOTES FOR VOTES AGAINST
<S> <C> <C>
William F. Farnam 8,405,510 123,704
Randall P. Frank 8,409,741 123,909
Randolph S. Heidmann 8,414,532 123,554
Arthur Lipper III 8,414,532 123,554
Floyd H. Panning 8,414,532 123,554
</TABLE>
Proposal 2. A proposal to adopt the Company's 1999 Stock Option Plan.
Proposal 3. A proposal to approve an Agreement with Harry O'Hare.
16
<PAGE> 17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS MATTERS.
The Company's Common Stock is currently quoted in the OTC Electronic Bulletin
Board market as a "penny stock" under the symbol "ELTP." The following table
sets forth the high and low bid prices for the Company's Common Stock, as
reported on the Bulletin Board or "pink sheets," for the quarters that the
securities were traded. The quotations reflect inter-dealer prices, without
retail mark-up or mark-down or commissions and may not represent actual
transactions.
<TABLE>
<CAPTION>
COMMON STOCK
BID PRICES
-------------
HIGH LOW
----- -----
<S> <C> <C>
FISCAL 1998 First Quarter 2-1/8 1/2
Second Quarter 3-3/4 7/8
Third Quarter 3 1-3/8
Fourth Quarter 1-3/4 13/16
FISCAL 1999 First Quarter 1-1/2 1/2
Second Quarter 1-6/16 1
Third Quarter 1-3/16 1/2
Fourth Quarter 13/16 11/16
FISCAL 2000 First Quarter (through December 27, 1999) 13/16 3/8
</TABLE>
The market for the Company's securities is sporadic and quoted prices may not
represent the true value of such securities.
As of December 27, 1999, the Company had approximately 760 holders of record of
its Common Stock.
On January 15, 1999, the Company issued 1,000,000 shares of its Series B
Convertible Preferred Stock ("Series B") out of the 1,000,000 shares of
authorized Preferred Stock, $1.00 par value. Series B provides for a $1.00 per
share liquidation preference over the Common Stock, Class B Common Stock and
Redeemable Convertible Preferred Stock and each share of Series B entitles the
holder thereof to four (4) votes per share and is to vote as a class along with
holders of the Common Stock, Class B Common Stock and Redeemable Convertible
Preferred Stock. The shares of Series B are convertible, in whole or in part,
into Common Stock on a share for share basis at any time at the option of the
holder, Mr. Anthony M. Frank. Each share of Series B is automatically
convertible into one share of Common Stock upon five days' written notice from
the Company if either of the following events shall occur:
(1) The Company shall make a public offering of any of its securities
under the terms of an Underwriting Agreement with a securities
dealer or underwriter; or
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<PAGE> 18
(2) The Company's securities shall be admitted for listing on a
national securities exchange market system or the NASDAQ System
where its Common Stock may then be traded.
Between April 22, 1999 and July 29, 1999, the Company issued 1,020,000 shares of
Common Stock and 510,000 three-year warrants to purchase Common Stock in a
private placement offering of securities and received $1,020,000 in net
proceeds. The warrants, which are exercisable at $2.00 per share, are redeemable
by the Company for $0.05 each if the Company's Common Stock shall equal or
exceed $4.00 for thirty consecutive trading days.
In May 1999, the Company authorized the issuance of 100,000 shares of Common
Stock, with a fair market value of $100,000, as a retainer against which fees
and expenses for new patent-related work are to be charged by its patent
lawfirm.
On September 21, 1999, the Company issued 2,500 shares of Common Stock on the
exercise of 2,500 options at $0.50 per share.
In December 1998, the Company granted 50,000 five-year warrants to purchase
Common Stock for $1.00 per share to a consultant for services rendered. Such
warrants vest over a two-year period commencing on the date of grant.
In March 1999, the Company granted 175,000 warrants to purchase Common Stock to
a consultant in partial consideration of services to be rendered. Such warrants,
exercisable at $1.00 per share, vest over a five-year period commencing one year
from the date of grant
In September 1999, the Company granted a total of 18,600 warrants to purchase
Common Stock at $1.00 per share to two firms which provided design services in
the design and fabrication of molds for its new EDI module. The warrants expire
on September 1, 2002.
Between November 18, 1998 and October 6, 1999, the Company granted a total of
940,000 options to purchase Common Stock to employees, consultants and Board
members pursuant to the 1999 Stock Option Plan and outside of the Plan as
follows:
In August 1999, 10,000 options were granted to each of the Five Directors of the
Company with a ten-year term at $0.9375 per share. Such options were granted as
an annual stipend for services rendered to the Board.
In August 1999, the Company granted 10,000 options to purchase Common Stock at
$0.9375 per share for consulting services. The options are exercisable in 5,000
annual increments commencing on the date of grant and expire on August 13, 2009.
Also in August 1999, the Company entered into a five-month agreement for
administrative and accounting services for which it paid $3,500 per month and
also granted 100,000 warrants to purchase Common Stock at $0.625 per share. The
options vest in 20,000 annual increments commencing on February 1, 2000 and will
expire on February 1, 2005.
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<PAGE> 19
Between November 18, 1998 and October 6, 1999, the Company granted 780,000
options to purchase Common Stock to employees of the Company at prices ranging
from $.90 to $1.0625 per share. The options vest in varying annual increments
and expire through October, 2005.
In December 1999, the Company granted a total of 165,000 additional options to
three employees to purchase Common Stock at $0.59375 per share. Such options
vest in varying annual increments and expire on January 1, 2005.
All of these securities issuances were in private direct transactions, exempt
under Section 4(2) of the Securities Act of 1933 or Regulation D promulgated
thereunder.
The Company has not paid any dividends on its Common Stock since its
incorporation. Electropure anticipates that, in the foreseeable future,
earnings, if any, will be retained for use in the business or for other
corporate purposes and it is not anticipated that cash dividends will be paid.
Payment of dividends is at the discretion of the Board of Directors and may be
limited by future loan agreements or California law. Under California law, if a
corporation does not have retained earnings, it may pay dividends provided that
after giving effect thereto, (a) the sum of the assets of the corporation
(exclusive of good will, capitalized research and development expenses or
deferred charges) would be at least equal to one and one-quarter times its
liabilities (not including deferred taxes, deferred income and other deferred
credits) and (b) the current assets of the corporation would be at least equal
to the current liabilities or, if the average of the earnings of the corporation
before taxes on income and for interest expense for the two preceding fiscal
years was less than the average of interest expense of the corporation for such
fiscal years, the current assets would be at least equal to one and one-quarter
times its current liabilities.
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<PAGE> 20
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FISCAL YEARS ENDED OCTOBER 31, 1998 AND 1999
Sales decreased for the fiscal year ended October 31, 1999 by $109,948 as
compared to fiscal 1998 primarily due to several factors: (a) the current
economic downturn in Japan and Europe accounted for an approximate 10% reduction
in sales; (b) the Company lowered its selling price to be more cost competitive
during the latter part of fiscal 1999 and; (c) marketing efforts to sell the
Company's EDI products were reduced during the latter part of the fiscal year as
design changes for such products were being completed. The Company anticipates
EDI sales to recover and increase in fiscal year 2000 since the EDI design
modifications have been completed and marketing activities have been increased.
Research and development expenses for fiscal 1999 increased by $205,787 compared
to fiscal 1998 due an increase in salaries and pursuant to the allocation of
overhead expenses to the program which the Company initiated in December 1997 to
develop the Micro Imaging Technology acquired from Wyatt Technology Corporation
in late October 1997. In addition, approximately $60,000 was expended on
research and development of the Company's ion permeable membranes and a power
supply being developed by Mr. Heidmann for the EDI product, as compared to no
such development activities during fiscal 1998.
General and administrative expenses for fiscal 1999 increased compared to fiscal
1998 by $305,071, the primary component of which resulted from increased
expenses relating to outside consultants, legal and accounting fees, and
pursuant to the issuance of a $67,127 bonus to Hydro Components upon the
successful development of the Company's new EDI membranes. In addition, during
fiscal 1999, the Company realized $78,000 in income on the sub-lease of
approximately 10,000 square feet of the facility which it currently occupies.
The Company will continue to sub-lease such premises until it requires the use
of the area involved.
Interest income and expense activity is reflected as a net figure and represents
a decrease of $408,706 in interest expense for the fiscal year ended 1999 as
compared to the prior year. Interest income for fiscal 1999, in the sum of
$14,252, arose from short-term investments. The primary component of interest
expense in fiscal 1998 was a $400,175 expense realized pursuant to the issuance
of convertible debt of $400,000 in loans by a principal shareholder.
The Company realized a net loss of $1,958,644 for fiscal 1999, representing an
increase of $451,701 from the prior year level. The increase was primarily due,
as noted above, to a reduction in sales, the bonus issued to Hydro Components
and increases in salaries, consulting fees, legal and accounting expenses.
LIQUIDITY AND CAPITAL RESOURCES
At October 31, 1999, the Company had net working capital (total current assets
less total current liabilities) of $199,456, representing a decrease of $$85,501
from the prior year end. The Company
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<PAGE> 21
accrued $168,755 pursuant to the prepayment by a customer for EDI products to be
delivered at a later date. All of such products are expected to be delivered and
the sales revenue recorded in the first quarter of fiscal 2000.
The Company funded its working capital and other cash needs during fiscal 1998
from the sale of securities. The Company received net proceeds of $550,000
pursuant to a private placement offering whereby the Company issued 278,363
shares of Common Stock and 137,500 three-year warrants to purchase Common Stock.
Of such common shares, 3,363 shares were issued as a commission to one
individual. The Company received an additional $155,928 on the exercise of
warrants to purchase Common Stock pursuant to a private offering by the Company
to temporarily reduce, to $1.00, the exercise prices of such warrants originally
granted at prices ranging from $2.00 to $15.00. The Company also received notes
in the amount of $6,000 and $29,750 on the exercise of 12,000 and 25,000
warrants during fiscal 1998.
During fiscal 1999, the Company funded its working capital requirements and
received $1,020,000 from the private placement issuance of 1,020,000 shares of
Common Stock and 510,000 three-year warrants to purchase Common Stock at $2.00
per share. The Company received an additional $1,250 in cash upon the exercise
of 2,500 options to purchase Common Stock.
On January 15, 1999, the Company received $1 million in net proceeds upon the
sale to Anthony M. Frank of one million shares of Series B Convertible Preferred
Shares. See Item 5 for a description of the Series B Convertible Preferred
Stock. See also Item 12 - "Certain Relationships and Related Transactions - Mr.
Anthony Frank."
The Company began selling its EDI products during the latter part of fiscal 1997
and initiated sales of its Hydro Components line of products in May 1998. The
Company experienced a small gross profit of $69,623 and $16,016 on sales of its
Hydro Components products in fiscal years 1998 and 1999, respectively. Sales of
the Company's EDI products were adversely effected by economic factors in Europe
and Japan and sales efforts were reduced during the latter part of fiscal year
1999, however, and the Company experienced a loss of $218,837 in fiscal 1999 as
compared to a gross profit of $31,525 for the prior year period. The Company
curtailed its marketing activity on the EDI product while modifications could be
effected to the EDI design and the ion permeable membrane derived from the Hydro
Components acquisition could be developed. Sales of the EDI product are expected
to increase in fiscal 2000 since the new EDI module design has been completed
and now incorporates the more cost-effective ion permeable membranes developed
by the Company.
PLAN OF OPERATION
In the opinion of management, available funds will satisfy the Company's working
capital requirements through January, 2000. The Company intends to fund its
working capital requirements by focusing on selling its EDI products and
currently has orders filled or pending for over 80 EDI products since November
1, 1999. Although a substantial portion of such sales will be applied to the
$168,755 currently held on deposit from one customer, the Company has quoted
over $375,000 in potential sales as of the date of this report and has
confidence that marketing efforts currently in progress will increase sales
revenues in the short term. In addition, the Company seeks to establish
21
<PAGE> 22
strategic alliances with potential joint venture partners for specific products
under development or now being produced by the Company. The Company has had
preliminary discussions with potential strategic partners regarding its EDI
product, membrane technology, and with regard to its Micro Imaging Technology.
The Company's management believes that, if necessary, the Company will be able
to raise additional working capital by the private sale of its securities.
No assurances can be given that currently available funds will satisfy the
working capital needs of the Company for the period estimated, or that the
Company can obtain additional working capital through the sale of Common Stock
or other securities, the issuance of indebtedness or otherwise or on terms
acceptable to the Company. Further, no assurances can be given that any such
equity financing will not result in a further substantial dilution to the
existing shareholders or will be on terms satisfactory to the Company.
The Company will be required to raise substantial amounts of new financing, in
the form of additional equity investments, loan financing, or from strategic
partnerships, to carry out its business objectives. There can be no assurance
that the Company will be able to obtain such additional financing on terms that
are acceptable to the Company and at the time required by the Company, or at
all. Further, any such financing may cause dilution of the interests of the
current shareholders in the Company. If the Company is unable to obtain such
additional equity or loan financing, the Company's financial condition and
results of operations will be materially adversely affected. Moreover, the
Company's estimates of its cash requirements to carry out its current business
objectives are based upon certain assumptions, including certain assumptions as
to the Company's revenues, net income (loss) and other factors, and there can be
no assurance that such assumptions will prove to be accurate or that unbudgeted
costs will not be incurred. Future events, including the problems, delays,
expenses and difficulties frequently encountered by similarly situated
companies, as well as changes in economic, regulatory or competitive conditions,
may lead to cost increases that could have a material adverse effect on the
Company and its plans. If the Company is not successful in obtaining loans or
equity financing for future developments, it is unlikely that the Company will
have sufficient cash to continue to conduct operations, particularly research
and development programs, as currently planned. The Company believes that in
order to raise needed capital, it may be required to issue debt or equity
securities that are significantly lower than the current market price of the
Company's Common Stock.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 13 (a)
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
CHANGE IN CERTIFYING ACCOUNTANTS
On June 16, 1998, due to a need for expanded accounting requirements and
location of accountants, the Board of Directors approved the recommendation of
management to (i) engage Kelly & Company as the independent auditors for
Electropure, Inc. and (ii) dismiss Alex Chaplan & Associates as such independent
accountants.
22
<PAGE> 23
For the Company's fiscal years ended October 31, 1996 and 1997, the financial
statements were subject to going concern qualifications and an uncertainty as to
the outcome of certain litigation and claims, but were not otherwise qualified
or modified as to audit scope, or accounting principles by Alex N. Chaplan &
Associates. During the two fiscal years ended October 31, 1996 and 1997, and
since October 31, 1997, there were not any disagreements with Alex N. Chaplan &
Associates on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of Alex N. Chaplan & Associates, would have
caused it to make a reference to the subject matter of the disagreements in
connection with its report, nor were there any "reportable events" as defined in
Item 304(a)(1)(v) of Regulation S-K. During the two fiscal years ended October
31, 1996 and 1997, and between October 31, 1997 and June 16, 1998, Registrant
did not consult with Kelly & Company on the application of accounting principles
to a specified transaction, or the type of audit opinion that might be rendered
on the Registrant's financial statements or any disagreements (as defined in
Item 304(a)(1)(iv) of Regulation S-K) or a reportable event (as defined above).
23
<PAGE> 24
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of Electropure, Inc. are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---------------------- --- ------------------------
<S> <C> <C>
William F. Farnam * 78 Director (Chairman)
Randall P. Frank * 37 Director
Randolph S. Heidmann * 48 Director
Arthur Lipper III * 68 Director
Floyd H. Panning * 71 Director, President and
Chief Executive Officer
Catherine Patterson 47 Chief Financial Officer
and Secretary
</TABLE>
* All Directors currently serve as members of the Company's Audit
Committee, with Mr. Lipper as the Chairman of such Committee.
WILLIAM F. FARNAM, 78, was named to the Board of Directors on August 5, 1997.
Mr. Farnam spent 1967 through 1968 as General Manager on construction of The
Forum (Los Angeles) for sports entrepreneur Jack Kent Cooke. He served the City
of Inglewood, California for 20 (cumulative) years, as Public Works Director and
City Engineer and went on to become the Assistant City Manager there from 1980
to 1982. Between 1983 and 1984, he served as Project Engineer for the Park Place
Associates Poker Casino in Southern California. He provided engineering
consulting services for various municipalities from 1985 through 1990 when he
retired. Mr. Farnam is a Registered Professional Civil Engineer in the State of
California and received a Bachelor of Science Degree in Electrical Engineering
from the University of Southern California and is a Management Studies Graduate
from the University of California at Los Angeles.
RANDALL P. FRANK, 37, joined the Board of Directors on October 25, 1997. Mr.
Frank, is the son of Anthony M. Frank, who is the former Postmaster General of
the United States and is a substantial shareholder in the Company. Between 1992
and 1995, he worked in sales and marketing for Sonnet Systems, a Northern
California firm which offers computerized currency exchange services. Randall
Frank has been engaged since 1995 as an insurance underwriter with Five Star
Managers, LLC in San Francisco, California, an insurance firm whose primary
business is underwriting trustees for union and corporate employee benefit
plans. Mr. Frank received a B.A. degree from the University
24
<PAGE> 25
of California at Berkeley and a Masters degree in International Management from
the American Graduate School of International Management ("Thunderbird").
RANDOLPH S. HEIDMANN, 48, was employed by the Company between September 1990 and
November 1991 as an electronics instrumentation design engineer to continue
development work on innovative electronic components which the Company planned
to engineer into its product line. He was named to the Company's Board of
Directors in September 1991. Prior to joining the Company, he spent nine years
with Teledyne Electronics where he was responsible for data acquisition
subsystems design for telemetry products. He has participated in the development
of a variety of consumer electronics products and custom production test
equipment. Between 1991 and June 1999, Mr. Heidmann served as an electrical
engineer for Photonic Detectors, Inc. in Simi Valley, California. Currently, Mr.
Heidmann provides independent electrical engineering consulting services. He
holds a BS degree in Physics from the University of California at Davis.
ARTHUR LIPPER III, 68, has provided financial and management consulting services
to the Company since May 1998 and was elected to the Company's Board of
Directors in June 1999. Mr. Lipper is an internationally known investment
banker, financier and management consultant. He is Chairman of British Far East
Holdings Ltd. and President of Communications Management Associates, privately
owned companies which provide and arrange financing and offer financial and
management advisory services. Mr. Lipper has been affiliated with the
international financial community since 1954 and currently serves as an officer,
director or advisor to a number of publicly traded and privately owned companies
including, among others, Lion Brothers, an embroidered emblem manufacturer with
facilities in the United States and China; MeterNet, providing set top box
Internet access to television sets, Cargo4less.com, an internet marketed
international freight forwarding service matching customer bids and service
offerings; and Cavion.Com which services the electronic communications and
processing needs of credit unions.
Mr. Lipper is the author of numerous financial and investment-related books and
publications and has served as the Chairman, Publisher and Editor-In-Chief of
Venture Magazine. He is a member of the Financial Analysts Society of San Diego,
the San Diego Press Club, and the University of California, San Diego (UCSD)
Faculty Club. He has been a Trustee of the Kenan Institute of Private Enterprise
of the Kenan-Flagler Business School at the University of North Carolina. Mr.
Lipper has also served as a Director of the National Schools Committee for
Economic Education and has served as Chairman of the New York & Foreign
Securities Corporation (co-founder) and the Arthur Lipper Corporation and
international subsidiaries, both New York Stock Exchange member firms. Mr.
Lipper's stock and commodity exchange memberships have included the New York
Stock Exchange, American, Midwest, Pacific Coast, Detroit, Boston, Philadelphia,
Bangkok, NY Comex and NY Futures Exchange.
FLOYD H. PANNING, 71, joined the Board of Directors and was engaged by the
Company as President and Chief Executive Officer in August 1997. Mr. Panning
came out of retirement in April 1992 to establish EDI Components and form a
license relationship with the Company to manufacture and market the EDI
technology. He has been the president of EDI Components since 1992. Prior to
forming EDI Components, Mr. Panning had founded two million-dollar businesses
which were sold in 1982. In 1972, he founded Formatron, Inc., a manufacturer of
rotational molded plastic products
25
<PAGE> 26
such as plating and chemical storage tanks, and many other polyethylene and
polypropylene containers. In 1963, he acquired Mills Engineering Co., a
manufacturer of high quality aluminum products. As owner/operator he expanded
the firm from a limited local sales organization by establishing major national
and international accounts with Fortune 100 companies and major municipalities.
CATHERINE PATTERSON, 47, became Secretary of the Company in May 1989, was
Assistant Secretary from May 1986 to May 1988, held the position of Treasurer
from August 1984 to February 1986, and was a director for a short time in 1984.
In June 1990, she became Chief Financial Officer of the Company. From 1971 until
joining the Company in 1981, she was a legal secretary for various Michigan law
offices, including General Motors Corporation, where she dealt closely with
various corporate sectors and counsels throughout the United States and Puerto
Rico and portions of Canada and South America.
Directors serve until the next Annual Meeting of Shareholders when their
successors are elected and qualified. Mr. Panning has a right to nominate one
director of the Company. See Item 4 -"Submission of Matters to a Vote of
Security Holders" and Item 10 - "Executive Compensation Employment Agreement."
Officers, subject to any employment agreements, serve at the pleasure of the
Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
As of the date of this report, all current directors, officers and beneficial
owners of more than 10 percent of any class of equity securities of the Company
have filed all reports required by Section 16(a) of the Securities Exchange Act
of 1934. The following table provides information regarding any of such reports
which were filed on a delinquent basis:
<TABLE>
<CAPTION>
NAME OF TYPE OF NO. OF TRANSACTIONS
REPORTING PERSON REPORT FILED LATE REPORTED LATE
----------------------- ----------------------------------- -------------------
<S> <C> <C>
William F. Farnam Form 4 - Statement of Changes in
Beneficial Ownership 2
Anthony M. Frank Form 4 - Statement of Changes in
Beneficial Ownership 2
Randall P. Frank Form 4 - Statement of Changes in
Beneficial Ownership 2
Randolph S. Heidmann Form 4 - Statement of Changes in
Beneficial Ownership 2
Arthur Lipper III Form 4 - Statement of Changes in
Beneficial Ownership 1
Floyd H. Panning Form 4 - Statement of Changes in
Beneficial Ownership 2
Catherine Patterson Form 4 - Statement of Changes in
Beneficial Ownership 1
Clifford D. Wyatt (1) Form 3 - Initial Statement of
Beneficial Ownership 1
</TABLE>
(1) Clifford D. Wyatt resigned from the Company's Board of Directors on April
14, 1999.
26
<PAGE> 27
ITEM 10. EXECUTIVE COMPENSATION
In November 1999, the Board of Directors established a Compensation and Benefits
Committee to oversee compensation and benefits, i.e., option and warrant grants,
to the Company's employees and service providers. The following Directors
currently serve on such Committee: William F.
Farnam (Chairman), Randall P. Frank and Arthur Lipper III.
The Company had no executive officer whose annual compensation was more than
$100,000 per year for the fiscal years ended October 31, 1999 and 1998. Floyd
Panning, who joined the Company as Chief Executive Officer in August 1997, is
being compensated at the rate set forth in his Employment Agreement with the
Company that is described below under "Executive Compensation Employment
Agreement."
The following table sets forth summary information regarding compensation paid
by the Company for the years ended October 31, 1999 and 1998 to the chief
executive officer of the Company.
<TABLE>
<CAPTION>
OTHER ANNUAL
NAME AND COMPENSATION AWARDS
PRINCIPAL POSITION YEAR SALARY ($) ($) (1) OPTIONS (#)
------------------ ---- ---------- ------------- -----------
<S> <C> <C> <C> <C>
FLOYD H. PANNING
President and 1999 $97,751 -
Chief Executive
Officer 1998 87,346 - 250,000 (2)
</TABLE>
(1) The Company is not required to report the value of personal benefits unless
the aggregate dollar value for 1998 was at least 10 percent of the executive
officer's salary and bonus or $50,000.
(2) In March 1998, the Company granted Mr. Panning 250,000 options to purchase
Common Stock at an exercise price of $1.125 per share. The options, which expire
in March, 2008, vest in increments of 50,000 over a five-year period commencing
on the grant date.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Compensation of executive officers is determined by the Board of Directors. The
Board of Directors negotiated Mr. Floyd Panning's Employment Agreement, whereby
he became President and Chief Executive Officer of the Company, in connection
with the License Termination Agreement with EDI Components and Mr. Panning
assuming such positions with the Company.
EMPLOYMENT AGREEMENT
On August 14, 1997, the Company entered into a five-year Employment Agreement
(effective August 5, 1997) with Floyd Panning whereby he became the Company's
President and Chief Executive Officer. Mr. Panning has the unilateral option to
extend such employment for a period of
27
<PAGE> 28
two (2) years. The Agreement provides Mr. Panning with five weeks' vacation, the
use of a Company car and cellular telephone and participation in any benefit
programs offered by the Company (none at this time). Pursuant to the terms of
the Employment Agreement, Mr. Panning was granted 125,000 warrants to purchase
Common Stock at $0.28125 per share. Such warrants are exercisable in increments
of 25,000 annually commencing with the date of the agreement. The Employment
Agreement also provides for the following:
(a) A base monthly salary of $6,500 increasing to $8,000 per month once
the Company has realized a minimum of $1 million in financing. Each
year thereafter, the base salary shall automatically increase by an
amount equal to five (5%) percent. Mr. Panning's base salary was
$8,400 per month as of April 1999.
(b) Upon realizing the above minimum financing, the Company has agreed to
reimburse Mr. Panning for certain wages deferred while he was
employed at EDI Components (a total of $63,700 was deferred). A
$25,000 promissory note issued by Mr. Panning, in consideration for
his exercise of 50,000 warrants to purchase Common Stock at $0.50 per
share, will be satisfied (including accrued interest) with such
deferred wages, net of normal federal, state and local income and
payroll taxes. Mr. Panning agreed to waive any remaining balance of
deferred wages after payment of such promissory note.
(c) Mr. Panning has the right to nominate, subject to shareholder
approval, one person to the Company's Board of Directors during the
term of his employment. In the meantime, Mr. Panning has been named
to the Company's Board of Directors as his nominee.
(d) Mr. Panning may, without cause, terminate his employment and retain
the right to the following percentage of his base monthly salary:
<TABLE>
<CAPTION>
YEAR OF PERCENT
TERMINATION OF SALARY
----------- ---------
<S> <C>
1 60%
2 70%
3 80%
4 90%
5 100%
6 0%
7 0%
</TABLE>
(e) Any termination of employment by the Company shall immediately vest
all 125,000 warrants granted to Mr. Panning under the employment
agreement. In addition, termination by the Company of Mr. Panning's
employment without cause, shall automatically accelerate the issuance
of Additional Shares due EDI's investors under the License
Termination Agreement at the then fair market value; provided,
however, Mr. Panning's successor has not been approved by simple
majority vote of such EDI Components' investors (excluding Mr.
Panning).
28
<PAGE> 29
COMPENSATION OF DIRECTORS
In August 1997, the Company authorized an annual issuance of 10,000 ten-year
warrants to purchase Common Stock to each Director for service to the Company at
a 25% discount to the fair market value of the Common Stock as of the date of
grant. In August 1998, 10,000 warrants to purchase Common Stock were issued to
each of the then five (5) Directors of the Company (including Clifford Wyatt who
resigned from the Board and surrendered such warrants in April 1999) at an
exercise price of $1.375 per share.
In August 1999, pursuant to the above resolution, the Company issued 10,000
ten-year warrants to purchase Common Stock to each of the Company's five
Directors at an exercise price of $0.9375 per share.
STOCK OPTION PLAN
The Company has adopted a 1999 Stock Option Plan (the "Plan"). Under the Plan,
incentive and non-qualified stock options for 1 million shares of Common Stock.
Incentive stock options may be issued to any employee of the Company; are
exercisable in installments as determined by the Board of Directors or the
Compensation and Benefits Committee; and may be granted for not more than ten
years (five years in the case of any employee who owns or is considered to own
more than 10% of the Common Stock). Incentive stock options may not be
exercisable for less than 100% of the fair market value of the Common Stock on
the date of grant (110% of fair market value in the case of a more than 10%
shareholder). Non-qualified stock options may be granted to employees,
directors, consultants and advisor of the Company. Non-qualified stock options
may not be granted for more than ten years, are exercisable in installments as
determined by the Board or Compensation and Benefits Committee, and may not be
exercisable for less than 100% of the fair market value of the Common Stock on
the date of grant.
All options are non-transferable except by will or the laws of descent and
distribution and terminate six months after death or termination of employment
due to permanent disability and three months after employment terminates for any
other reason.
Since November 1, 1998, the Company has granted options for its Common Stock to
the following current officers and directors pursuant to the Plan and outside of
the Plan as follows:
<TABLE>
<CAPTION>
Number of Exercise Net
Shares Subject Price Options Realized Value
NAME to Options Per Share Exercised (1)
- ----------------------------- -------------- --------- --------- --------------
<S> <C> <C> <C> <C>
Communications Management (2) 10,000 $0.9375 - -
William F. Farnam 10,000 $0.9375 - -
Randall P. Frank 10,000 $0.9375 - -
Randolph S. Heidmann 10,000 $0.9375 - -
Floyd H. Panning 10,000 $0.9375 - -
</TABLE>
29
<PAGE> 30
(1) The market price of the Common Stock on the date an option was exercised
less the exercise price.
(2) Arthur Lipper III is an executive officer of Communications Management.
Mr. Lipper disclaims beneficial ownership of the options and has no
control over the disposition or the voting control, if any, of the
options.
30
<PAGE> 31
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
PRINCIPAL SHAREHOLDERS
The following table sets forth information as of December 27, 1999 with respect
to the Common Stock, Class B Common Stock, Series B Preferred Stock and
Convertible Preferred Stock owned by the only persons known by the Company to
own beneficially 5% or more of any such classes of stock, by each director and
by all directors and officers as a group.
<TABLE>
<CAPTION>
COMMON CLASS B SERIES B CONVERTIBLE % OF
STOCK % OF COMMON % OF PREFERRED % OF PREFERRED % OF VOTING
NAME (1)(2) CLASS STOCK CLASS STOCK(3) CLASS STOCK(4) CLASS POWER (5)
- -------------------------- --------- ------ ------- ----- --------- ----- ----------- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
William F. Farnam 126,918 1.1% -- -- -- -- -- -- *
Anthony M. Frank
320 Meadowood Court
Pleasant Hill, CA 94523 3,829,742 32.2% -- -- 1,000,000 100% -- -- 40.8%
Randall P. Frank 413,898 3.5% -- -- -- -- -- -- 2.2%
Randolph S. Heidmann 30,000 * -- -- -- -- -- -- *
Arthur Lipper III(6) -- -- -- -- -- -- -- -- --
Harry M. O'Hare, Sr
2035 Huntington Dr. #1
S. Pasadena, CA 91030 2,500 * 83,983 100% -- -- 931,629 35.8% 8.4%
Floyd H. Panning
23456 South Pointe Drive
Laguna Hills, CA 92653 836,792 7.0% -- -- -- -- 7,500 * 4.4%
Catherine Patterson 210,112 1.8% -- -- -- -- 2,906 * 1.1%
All officers and directors
as a group (6 persons) 1,617,720 13.6% -- -- -- -- 10,406 * 8.5%
</TABLE>
- ------------------
* Less than 1%
** Includes address of five percent or more shareholders of
any class.
(1) Excludes 83,983 shares of Common Stock issuable upon conversion of Class
B Common Stock, which carry eight (8) votes per share. If such shares of
Common Stock were included, Mr. O'Hare and all officers and directors,
as a group would own 86,483 shares (1.0%) and 1,617,720 shares (13.5%)
of Common Stock, respectively.
(2) Includes currently exercisable warrants or options to purchase an
aggregate of 4,111,934 shares of Common Stock.
(3) The Series B Convertible Preferred Stock is convertible into Common
Stock, on a share-for-share basis, at the option of the holder or
automatically if (a) the Company makes a public
31
<PAGE> 32
offering of its securities, or (2) if the Company's securities are
listed on NASDAQ or a national securities exchange market system.
(4) The Convertible Preferred Stock was convertible into Common Stock only
if certain earnings or market prices of the Common Stock were achieved
prior to October 31, 1990. Such earnings and market prices were not
achieved and commencing January 31, 1991, the Company was required to
redeem such shares at $0.01 per share. The Company intends to redeem the
Convertible Preferred Stock during fiscal 2000.
(5) Reflects the voting rights of the Common Stock and Convertible Preferred
Stock, each of which carries one (1) vote per share; Class B Common
Stock, which carries eight (8) votes per share; and Series B Convertible
Preferred Stock, which carries four (4) votes per share.
(6) Excludes warrants to purchase 175,000 shares of Common Stock at $1.06
per share, expiring on May 14, 2006 and 10,000 options to purchase
Common Stock at $0.9375 per share, expiring on August 13, 2009, all of
which are beneficially owned by Communications Management Associates for
which Arthur Lipper III disclaims beneficial ownership. Arthur Lipper
III is an executive officer of Communications Management and has no
control over the disposition or the voting control, if any, of the
securities.
In order to comply with conditions imposed by the Commissioner of Corporations
of the State of California (the "Commissioner"), in connection with the public
offering of Units in June 1987, Harry M. O'Hare, Sr. and Sandra O'Hare (Mr.
O'Hare's former late wife) agreed that until such conditions are lifted by order
of the Commissioner, all the shares of Class B Common Stock and Convertible
Preferred Stock held by them (except for 107,848 shares of Convertible Preferred
Stock issued in July 1988 to Harry M. O'Hare, Sr.) and any Common Stock received
upon conversion of the Class B Common Stock and Convertible Preferred Stock,
will be subject to the following conditions (which shall be referenced in a
legend on the certificates for such shares):
(1) such shares will not participate in dividends, other than stock
dividends;
(2) such shares will not participate in any distribution of assets in the
event of liquidation; and
(3) such shares may not be transferred without prior written consent of the
Commissioner except for transfer pursuant to order or process of any
court.
The issuance of an order lifting such conditions is in the sole discretion of
the Commissioner. However, under the Commissioner's Rules, such an order will
generally be issued when the Company has demonstrated a satisfactory earnings
record, as defined in such Rules, and the Company understands that in practice
such an order will also be issued in the event of a merger, consolidation, or
liquidation in which the holders of the Common Stock have received a
satisfactory return on such shares.
In October 1998, the Company agreed to seek the approval of its shareholders (at
the next annual meeting of shareholders) to enter into an agreement with Mr.
O'Hare and two of his creditors which would support a petition to the
Commissioner for removal of the above restrictions. If such petition
32
<PAGE> 33
is approved, the agreement provides for the transfer of all Electropure, Inc.
securities held by Mr. O'Hare's to such creditors, including the Company, in
exchange for certain monthly cash payments and extinguishment of debt owed by
Mr. O'Hare. The Company's shareholders approved such agreement at the Annual
Meeting of Shareholders held on June 26, 1999.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
MR. WILLIAM FARNAM
On October 8, 1998, Mr. Farnam exercised 1,250 and 1,668 warrants to purchase
Common Stock which had been assigned to him by the original holder of such
warrants on October 2, 1998. Pursuant to a private placement offering authorized
by the Company in September 1998, the original exercise price of such warrants
($9.00 and $15.00, respectively) had been reduced to $1.00 per share.
MR. ANTHONY FRANK
On January 26, 1998, Mr. Frank loaned the Company, at 10% annual interest, the
sum of $200,000 and on January 29, 1998, he converted such loan into 206,186
shares of the Company's Common Stock at $0.97 per share. Conversion of such debt
to equity resulted in an expense to the Company as of October 31, 1999 in the
sum of $7,217. On February 4, 1998, Mr. Frank loaned the Company an additional
$200,000 under a two-year note which also carried the right to convert the
principal and interest accrued thereon into Common Stock at a 25% discount to
the fair market value. On March 25, 1998, Mr. Frank converted the additional
$200,000 loan, together with $2,630 in accrued interest, into 136,473 shares of
Common Stock. Under the loan agreements with Mr. Frank, fair market value is
determined as the mean of the bid and asked prices of the Common Stock for the
thirty (30) consecutive trading days prior to the conversion date.
On January 15, 1999, Mr. Frank purchased 1,000,000 shares of the Company's
Series B Convertible Preferred Stock, $1 par value, and paid therefor the sum of
$1 million. Each share of Series B Stock carried four (4) votes per share and is
convertible into Common Stock, on a share-for-share basis, at any time at Mr.
Frank's option. Such Series B shares are also automatically convertible,
however, if either of the following events occur:
(1) Electropure shall make a public offering of any of its securities
under the terms of an Underwriting Agreement with a securities
dealer or underwriter; or
(2) Electropure's securities shall be admitted for listing on a
national securities exchange market system or the NASDAQ System
where its Common Stock may then be traded.
In July 1999, Mr. Frank purchased 900,000 shares of the Company's Common Stock
and 450,000 three-year warrants to purchase Common Stock in a private placement
offering and paid the sum of $900,000. The warrants are exercisable at $2.00 per
share and are redeemable by the Company for
33
<PAGE> 34
$0.05 each if the Common Stock shall equal or exceed $4.00 per share for thirty
consecutive trading days.
On December 13, 1999, Mr. Frank and the Company executed a two-year convertible
term note by which Mr. Frank has agreed to loan the Company $200,000 at the rate
of 10% annual interest. Pursuant to the note, Mr. Frank has the option to
convert the principal and any interest accrued on such loan into the Company's
securities or securities of any subsidiary which the Company may form with
regard to its Micro Imaging Technologies Division. The terms of any such
conversion are to be mutually agreed upon between the parties.
MR. RANDALL FRANK
On September 21, 1998, Mr. Frank exercised 1,250 and 1,112 warrants to purchase
Common Stock at $1.00 per share pursuant to the Company's private placement
offering to temporarily reduce the exercise price (originally $9,00 and $15.00,
respectively) of such warrants.
MR. RANDOLPH S. HEIDMANN
Between August 1998 and October 31, 1999, the Company paid Mr. Heidmann a total
of $42,000 pursuant to an arrangement to develop certain proprietary technology
relating to a new design of a power supply which may be used with the Company's
EDI water treatment product. The parties intend to negotiate an agreement
whereby the Company will acquire the rights to said technology once a prototype
has been developed. Funds paid to Mr. Heidmann under this arrangement will be
credited toward the acquisition price to be negotiated. Since November 1, 1999,
an additional $9,500 has been paid to Mr. Heidmann pursuant to this arrangement.
MR. ARTHUR LIPPER III
In May 1998, the Company entered into a three-year agreement with Communications
Management Associates for financial and management consulting services at the
rate of $2,500 per month. Mr. Lipper is the president of Communications
Management and is the primary contact for the Company under the consulting
arrangement. Concurrent with the commencement of the agreement, the Company
granted Communications Management 25,000 warrants to purchase Common Stock and
50,000 warrants each year thereafter for a period of three years. The warrants
are exercisable at $1.06 per share and expire on May 13, 2006.
MR. PANNING
On March 25, 1998, Mr. Panning was granted 250,000 ten-year warrants to purchase
Common Stock at $1.125 per share. Such warrants are exercisable in annual
increments of 50,000, commencing on the grant date, to vest over a five-year
period; provided, however, that Mr. Panning is employed by the Company on the
exercise date.
34
<PAGE> 35
MISCELLANEOUS
The Company's Board of Directors has adopted a policy that no transaction
between the Company and any officer, director, employee or members of their
family shall be entered into without the full disclosure of such transaction to
and the approval of such transaction by the non-interested members of the Board
of Directors. Furthermore, no agreements will be entered into regarding
royalties, distributorships, supply agreements, sales agreements, the borrowing
of money or the sale or granting of securities or options or the leasing or
buying of property by the Company (exclusive of routine supply or sales
agreements not exceeding $25,000), or any other type of contract over three
months or $50,000 without the approval of the Board of Directors.
35
<PAGE> 36
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
1. Financial Statements
Independent Auditor's Report
Balance Sheets as of October 31, 1999 and 1998
Statements of Operations for the years ended October 31, 1999
and 1998
Statements of Shareholders' Equity for the years ended October
31, 1999 and 1998
Statements of Cash Flows for the years ended October 31, 1999
and 1998
Notes to Financial Statements
2. Financial Statement Schedules.
No financial statement schedules have been included because they
are not applicable or not required under Regulation S-X.
(b) Reports on Form 8-K
None
(c) Exhibits
3.1 Articles of Incorporation of the Registrant, as amended. ***
3.2 By-Laws of the Registrant, as amended. *
10.19 Form of Indemnity Agreement with each current Officer and
Director. **
10.47.8 License Termination Agreement with EDI Components dated August
14, 1997 (effective 08/05/97). ******
10.47.9 Employment Agreement with Floyd H. Panning dated August 14, 1997
(effective 08/05/97). ******
36
<PAGE> 37
10.48 Technology License Agreement with Glegg Water Conditioning, Inc.
dated July 2, 1994. ****
10.48.1 Amended and Restated Technology Licence Agreement with Glegg
Water Conditioning, Inc. dated May 22, 1997. *****
10.51 Settlement Agreement with Economic Development Bank for Puerto
Rico dated May 16, 1997. *****
10.52 Technology Transfer Agreement with Wyatt Technology Corporation
dated October 25, 1997. *******
10.53 Assignment Agreement with Hydro Components, Inc. dated February
17, 1998.********
27. Financial Data Schedule.
- -------------
* Previously filed on December 15, 1986 in connection with Registration
Statement of Registrant on Form S-1, File No. 33-10669.
** Incorporated by reference to Exhibit "B" to Registrant's Definitive
Proxy Statement, dated April 20, 1988, for the Annual Meeting held May
18, 1988, as filed on May 4, 1988.
*** Previously filed on February 28, 1989 in connection with Registrant's
Form 10-K for the fiscal year ended October 31, 1988.
**** Previously filed on October 11, 1995 in connection with Registrant's
Form 10-KSB for the fiscal year ended October 31, 1994.
***** Previously filed on July 16, 1997 in connection with Registrant's Form
10-KSB for the fiscal year ended October 31, 1996.
****** Previously filed on September 11, 1997 in connection with Registrant's
Form 10-QSB for the fiscal quarter ended July 31, 1997.
******* Previously filed on November 14, 1997 in connection with Schedule 13-D
filed by Wyatt Technology Corporation.
******** Previously filed on March 5, 1998 in connection with Registrant's Form
10-QSB for the fiscal quarter ended January 31, 1998.
37
<PAGE> 38
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto.
Dated: December 27, 1999
ELECTROPURE, INC.
BY /S/ CATHERINE PATTERSON
---------------------------------------
CATHERINE PATTERSON
Chief Financial Officer
Pursuant to the requirements of the Securities Act of 1934, as amended, this
Report has been signed below by the following persons in the capacities and on
the dates indicated.
SIGNATURES
/S/ WILLIAM F. FARNAM Director December 27, 1999
- --------------------------
WILLIAM F. FARNAM
Director
- --------------------------
RANDALL P. FRANK
Director
- --------------------------
RANDOLPH S. HEIDMANN
/S/ ARTHUR LIPPER III Director December 27, 1999
- --------------------------
ARTHUR LIPPER III
/S/ FLOYD H. PANNING Chief Executive Officer December 27, 1999
- -------------------------- and Director
FLOYD H. PANNING
Chief Financial
/S/ CATHERINE PATTERSON Officer (Principal December 27, 1999
- -------------------------- Financial and
CATHERINE PATTERSON Accounting Officer)
38
<PAGE> 39
ELECTROPURE, INC.
INDEX TO THE FINANCIAL STATEMENTS
AS OF OCTOBER 31, 1999 AND 1998 AND
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
Financial Statements of Electropure, Inc.:
Report of Independent Auditors ...............................................1
Balance Sheets, October 31, 1999 and 1998............................2
Statements of Operations For Each of the Two Years in the
Period Ended October 31, 1999......................................4
Statements of Shareholders' Equity For Each of the Two Years
in the Period Ended October 31, 1999...............................5
Statements of Cash Flows For Each of the Two Years in the
Period Ended October 31, 1999......................................7
Notes to the Financial Statements............................................10
<PAGE> 40
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Electropure, Inc.
We have audited the accompanying balance sheets of Electropure, Inc. as of
October 31, 1999 and 1998, and the related statements of operations,
shareholders' equity and cash flows for each of the two years in the period
ended October 31, 1999. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Electropure, Inc. as of October
31, 1999 and 1998, and the results of its operations and its cash flows for each
of the two years in the period ended October 31, 1999, in conformity with
generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2, the Company
has suffered recurring losses from operations, has negative cash flow from
operations and an accumulated deficit. In addition, the Company has relied
primarily on the sale of its securities and borrowings to provide the cash
needed for operations. These conditions raise substantial doubt about its
ability to continue as a going concern. Management's plan in regard to these
matters is discussed in Note 2. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Kelly & Company
Newport Beach, California
December 23, 1999
<PAGE> 41
ELECTROPURE, INC.
BALANCE SHEETS
OCTOBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
ASSETS
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Current assets:
Cash and equivalents $ 204,328 $ 57,440
Trade accounts receivable 97,745 161,225
Note receivable, related party -- 3,500
Note receivable, individual -- 67,127
Inventories 204,888 320,532
Prepaid legal fees 92,500 --
Other prepaid expenses 12,007 24,505
---------- ----------
Total current assets 611,468 634,329
Property and equipment, net 566,872 134,045
Acquired technology, net of accumulated amortization 131,945 528,192
Building purchase option 105,000 90,000
---------- ----------
TOTAL ASSETS $1,415,285 $1,386,566
========== ==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
<PAGE> 42
ELECTROPURE, INC.
BALANCE SHEETS
OCTOBER 31, 1999 AND 1998
- --------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Current liabilities:
Trade accounts payable $ 86,544 $ 126,843
Current portion of obligations under capital leases 9,465 --
Note payable to officer 7,632 6,216
Customer deposit 168,755 100,000
Accrued payroll 87,986 79,345
Other accrued liabilities 51,630 36,968
------------ ------------
Total current liabilities 412,012 349,372
Obligations under capital leases, net of current portion 1,298 --
Note payable to officer, net of current portion 4,683 12,315
------------ ------------
TOTAL LIABILITIES 417,993 361,687
------------ ------------
Commitments and contingencies
Redeemable preferred stock; $.01 par value; 2,600,000
shares authorized, issued and outstanding 26,000 26,000
Shareholders' equity:
Series B convertible preferred stock; $1.00 par
value; 1,000,000 and no shares authorized,
issued and outstanding (Notes 2 and 25) 1,000,000 --
Common stock; $.01 par value; 20,000,000 shares
authorized; 7,791,425 and 8,618,925 shares
issued and outstanding 77,914 86,189
Class B common stock; $.01 par value; 83,983 shares
authorized, issued and outstanding 840 840
Additional paid-in capital 20,971,537 20,032,205
Accumulated deficit (21,018,249) (19,059,605)
Notes receivable on common stock (60,750) (60,750)
------------ ------------
TOTAL SHAREHOLDERS' EQUITY 971,292 998,879
------------ ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,415,285 $ 1,386,566
============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE> 43
ELECTROPURE, INC.
STATEMENTS OF OPERATIONS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Net sales $ 695,565 $ 805,513
Cost of sales 898,386 704,365
----------- -----------
Gross profit (loss) (202,821) 101,148
----------- -----------
Operating costs and expenses:
Research and development 650,897 445,110
Salaries 364,697 263,953
Consulting 243,392 142,919
Other operating expenses 512,793 407,939
----------- -----------
Total operating expenses 1,771,779 1,259,921
----------- -----------
Loss from operations (1,974,600) (1,158,773)
----------- -----------
Other income (expense):
Interest income 14,252 7,556
Other income 3,920 22,449
Interest expense (1,416) (403,426)
----------- -----------
Other income (expense), net 16,756 (373,421)
----------- -----------
Loss before provision for income taxes and
extraordinary item (1,957,844) (1,532,194)
Provision for income tax (800) (800)
Extraordinary gain -- 26,051
----------- -----------
NET LOSS $(1,958,644) $(1,506,943)
=========== ===========
NET LOSS PER SHARE, BASIC AND DILUTED $ (0.23) $ (0.19)
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE> 44
ELECTROPURE, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
<TABLE>
<CAPTION>
Series B Class B Series B Class B
Convertible Common Common Convertible Common Common
Preferred Shares Shares Shares Preferred Stock Stock Stock
---------------- ------ ------- --------------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, OCTOBER 31, 1997, AS RESTATED -- 7,734,293 83,983 -- $77,343 $840
Common shares issued for convertible debt
to a related party -- 342,659 -- -- 3,427 --
Common shares issued on the exercise of
warrants with beneficial conversion features -- 155,928 -- -- 1,559 --
Paid-in capital arising from beneficial
conversion features on convertible debt issued -- -- -- -- -- --
Common shares issued on exercise of warrants -- 25,000 -- -- 250 --
Common shares issued on exercise of options -- 12,000 -- -- 120 --
Common shares and warrants issued in a
private placement offering -- 278,363 -- -- 2,784 --
Common shares issued for an option to
purchase real estate -- 60,000 -- -- 600 --
Common shares issued for real estate broker
commission -- 6,579 -- -- 66 --
Common shares issued for consulting and
public relations services -- 4,103 -- -- 40 --
Payment of note receivable arising from
an earlier issuance of common stock -- -- -- -- -- --
Warrants granted on common stock to
employees and consultants for services -- -- -- -- -- --
Net loss -- -- -- -- -- --
-- --------- ------ -- ------- ----
BALANCE, OCTOBER 31, 1998 -- 8,618,925 83,983 -- $86,189 $840
-- --------- ------ -- ------- ----
<CAPTION>
Additional
Paid-in Accumulated Note Receivable
Capital Deficit Common Stock Total
---------- ------------ --------------- -----------
<S> <C> <C> <C> <C>
BALANCE, OCTOBER 31, 1997, AS RESTATED $18,244,073 $(17,552,662) $(50,000) $ 719,594
Common shares issued for convertible debt
to a related party 406,420 -- -- 409,847
Common shares issued on the exercise of
warrants with beneficial conversion features 154,369 -- -- 155,928
Paid-in capital arising from beneficial
conversion features on convertible debt issued 400,175 -- -- 400,175
Common shares issued on exercise of warrants 29,500 -- (29,750) --
Common shares issued on exercise of options 5,880 -- (6,000) --
Common shares and warrants issued in a
private placement offering 547,216 -- -- 550,000
Common shares issued for an option to
purchase real estate 89,400 -- -- 90,000
Common shares issued for real estate broker
commission 9,934 -- -- 10,000
Common shares issued for consulting and
public relations services 7,460 -- -- 7,500
Payment of note receivable arising from
an earlier issuance of common stock -- -- 25,000 25,000
Warrants granted on common stock to
employees and consultants for services 137,778 -- -- 137,778
Net loss -- (1,506,943) -- (1,506,943)
----------- ------------ -------- -----------
BALANCE, OCTOBER 31, 1998 $20,032,205 $(19,059,605) $(60,750) $ 998,879
----------- ------------ -------- -----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE> 45
ELECTROPURE, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
<TABLE>
<CAPTION>
Series B Class B Series B Class B
Convertible Common Common Convertible Common Common
Preferred Shares Shares Shares Preferred Stock Stock Stock
---------------- ---------- ------- --------------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, OCTOBER 31, 1998 -- 8,618,925 83,983 -- $ 86,189 $840
Common shares issued upon exercise
of options -- 2,500 -- -- 25 --
Common shares and warrants issued
in private placement -- 1,020,000 -- -- 10,200 --
Common shares issued as prepaid legal fees -- 100,000 -- -- 1,000 --
Common shares cancelled pursuant
to a settlement -- (1,950,000) -- -- (19,500) --
Class B convertible preferred shares
issued in private placement to
a related party 1,000,000 -- -- $1,000,000 -- --
Options and warrants granted to
employees and consultants for services -- -- -- -- -- --
Net loss -- -- -- -- -- --
--------- ---------- ------ ---------- -------- ----
BALANCE, OCTOBER 31, 1999 1,000,000 7,791,425 83,983 $1,000,000 $ 77,914 $840
========= ========== ====== ========== ======== ====
<CAPTION>
Additional
Paid-in Accumulated Note Receivable
Capital Deficit Common Stock Total
------------ ------------ --------------- -----------
<S> <C> <C> <C> <C>
BALANCE, OCTOBER 31, 1998 $ 20,032,205 $(19,059,605) $(60,750) $ 998,879
Common shares issued upon exercise
of options 1,225 -- -- 1,250
Common shares and warrants issued
in private placement 1,009,800 -- -- 1,020,000
Common shares issued as prepaid legal fees 99,000 -- -- 100,000
Common shares cancelled pursuant
to a settlement (273,000) -- -- (292,500)
Class B convertible preferred shares
issued in private placement to
a related party -- -- -- 1,000,000
Options and warrants granted to
employees and consultants for services 102,307 -- -- 102,307
Net loss -- (1,958,644) -- (1,958,644)
------------ ------------ -------- -----------
BALANCE, OCTOBER 31, 1999 $ 20,971,537 $(21,018,249) $(60,750) $ 971,292
============ ============ ======== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE> 46
ELECTROPURE, INC.
STATEMENTS OF CASH FLOWS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(1,958,644) $(1,506,943)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 43,080 11,937
Amortization 103,747 117,484
Provision for (recovery on) uncollectible accounts 560 (7,278)
Issuance of warrants for services 102,307 137,778
Interest expense arising from issuance of
convertible debt -- 400,175
Services provided in payment of note receivable -
related party 70,627 69,627
Issuance of common stock for services -- 17,500
Extraordinary gain on settlement of debt -- (26,051)
(Increase) decrease in assets:
Trade accounts receivable 62,920 (145,965)
Accounts receivable - related party -- 19,500
Prepaid legal and other expenses 19,998 (19,606)
Inventories 115,644 (216,239)
Building purchase - option (15,000) --
Increase (decrease) in liabilities:
Trade accounts payable (40,299) 70,668
Customer deposit 68,755 100,000
Accrued payroll and other liabilities 23,303 70,884
----------- -----------
CASH USED IN OPERATING ACTIVITIES (1,403,002) (906,529)
----------- -----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
7
<PAGE> 47
ELECTROPURE, INC.
STATEMENTS OF CASH FLOWS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Cash flows used in investing activities:
Purchase of property and equipment $ (471,360) $ (117,670)
Purchase of acquired technology -- (200,000)
Increase in notes receivable, related parties -- (203,500)
----------- -----------
CASH USED IN INVESTING ACTIVITIES (471,360) (521,170)
----------- -----------
Cash flows provided by (used in) financing activities:
Principal payments on notes payable -- (13,469)
Proceeds from the issuance of notes payable to a
related party -- 400,000
Payments on notes receivable for common stock -- 25,000
Proceeds from exercise of warrants 1,250 155,928
Proceeds from issuance of stock - private
placement 1,020,000 550,000
Proceeds from issuance of preferred stock
to a related party 1,000,000 --
----------- -----------
CASH PROVIDED BY FINANCING ACTIVITIES 2,021,250 1,117,459
----------- -----------
NET INCREASE (DECREASE) IN CASH 146,888 (310,240)
CASH AT BEGINNING OF PERIOD 57,440 367,680
----------- -----------
CASH AT END OF PERIOD $ 204,328 $ 57,440
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
8
<PAGE> 48
ELECTROPURE, INC.
STATEMENTS OF CASH FLOWS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
Supplemental Disclosure of Cash Flow Information
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Interest paid $ 2,543 $ 3,251
Income taxes paid $ 1,600 $ 800
Supplemental Schedule of Non-Cash Investing and Financing Activities
Acquisition of assets in non-cash transactions:
Assets acquired -- $ 200,108
Accounts receivable, related party satisfied -- $ (19,306)
Notes receivable satisfied -- $ (70,802)
Issuance of note payable to officer -- $ (20,000)
Issuance of common stock -- $ (90,000)
Litigation settlement:
Return and cancellation of common stock $ 292,500 --
Surrender of acquired technology $(292,500) --
Issuance of common stock for prepaid legal fees:
Prepaid legal fees $ 100,000 --
Issuance of common stock $(100,000) --
Issuance of common stock for note receivable:
Notes receivable received -- $ 35,750
Issuance of common stock -- $ (35,750)
Convertible debt retired by issuance of common stock:
Reduction of liabilities -- $ 409,847
Issuance of common stock -- $(409,847)
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE> 49
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
1. DESCRIPTION OF BUSINESS
-----------------------
Electropure, Inc. (the "Company") manufactures and markets
electrodeionization ("EDI") water treatment devices for commercial and
industrial high purity water applications. The Company holds an exclusive
patent on its EDI product and markets it to original equipment
manufacturers as a specialized component for water treatment systems,
whose major customers include semiconductor, pharmaceutical and cosmetic
companies, as well as laboratories and petrochemical companies. The
Company's Hydro Components ("HC") products are sanitary heat exchangers,
sample coolers for sterile steam and water, based on ion exchange membrane
technology for electrodialysis, electrodeposition, and electrochemical
separations. The Company's Micro Imaging ("MI") technology is in the
development phase, which, when completed, will provide a product that will
enable real time identification of contamination in water.
2. MANAGEMENT'S PLAN (UNAUDITED)
-----------------------------
The Company incurred net losses of $1,958,644 and $1,506,943 in fiscal
years October 31, 1999 and 1998, respectively, and at October 31, 1999 had
an accumulated deficit of $21,018,249 and is in default under the
redemption provisions of its redeemable preferred stock (Note 24). Despite
negative cash flows from operations of $1,403,002 and $906,529 in the
years ended October 31, 1999 and 1998, respectively, the Company has been
able to secure additional operating capital through private equity funding
sources, a significant portion of which is from an individual who is a
related party and the largest shareholder. No assurances can be given that
the Company can or will continue to obtain sufficient working capital
through the sale of the Company's securities, borrowing, or through the
sale of products that will generate sufficient revenues in the future to
sustain ongoing operations. The Company's ability to continue as a going
concern will be reliant upon its ability to gain access to equity and debt
capital or achieve profitable operations. The Company believes, however,
that the current market interest in its products is strong and will
enhance its ability to generate the funds necessary through equity and
debt capital and the sale of its products to meet its needs.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
Revenue Recognition
Revenues on the sale of the Company's products are recognized when the
products are shipped.
10
<PAGE> 50
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
-----------------------------------------------------
Cash and Cash Equivalents
The Company invests portions of its excess cash in highly liquid
investments. Cash and equivalents include time deposits and commercial
paper with original maturities of three months or less. The Company has no
requirements for compensating balances. The Company maintains cash
balances in accounts which exceeded the federally insured limits by
$166,684 and $0 at October 31, 1999 and 1998, respectively; however, the
Company has not experienced any losses in such accounts.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts
receivable. Exposure to losses on accounts receivable is principally
dependent on the individual customer's financial condition, as credit
sales are not collateralized. The Company monitors its exposure to credit
losses and reserves for those accounts receivable that it deems to be not
collectible.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined
on a standard cost basis, which approximates the first in - first out
method of valuation. The Company's management monitors inventories for
excess and obsolete items and makes necessary valuation corrections when
such adjustments are required.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the
straight-line method over the expected useful lives noted below.
Expenditures for normal maintenance and repairs are charged to operations.
The cost and related accumulated depreciation of assets are removed from
the accounts upon retirement or other disposition, and the resulting
profit or loss is reflected in the Statement of Operations. Renewals and
betterments that materially extend the life of the assets are capitalized.
Estimated Useful
Lives
----------------
Machinery and equipment 5 years
Automobiles 5 years
Furniture and fixtures 5 years
Leasehold improvements 3 years
11
<PAGE> 51
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
-----------------------------------------------------
Intangible Assets
Intangible assets represent the cost of intellectual properties described
as acquired patented technology and unpatented process technology that are
amortized on a straight-line method over the shorter of the estimated
useful life of the technology or the remaining term of the patent.
Impairment of Long-Lived Assets
The Company annually evaluates its long-lived assets, including
identifiable intangible assets for potential impairment. When
circumstances indicate that the carrying amount of an asset is not
recoverable, as demonstrated by the projected undiscounted cash flows, an
impairment loss is recognized. The Company's management has determined
that there was no such impairment present at October 31, 1999 and 1998.
Debt Issued with Stock Purchase Warrants
Proceeds from debt issued were allocated between the debt and the warrants
based on their relative fair values. The value ascribed to the warrants,
based on the Black-Scholes Option Pricing Model, is amortized to interest
expense over the term of the related debt using the effective interest
method.
Induced Conversion of Debt
The Company in certain instances will grant or modify conversion
privileges of debt to equity after its issuance. These grants or
modifications take the form of new or reduced conversion prices of the
debt into the Company's common stock available to the applicable debt
holders. When the debt is converted into equity, the Company recognizes,
as debt conversion expense, the excess of the fair value of the common
stock issued at that time over the fair value of the common stock that
would be issuable under the original terms.
Income Taxes
The Company accounts for income taxes under the liability method. Under
the liability method, deferred income taxes are determined based on
differences between the financial reporting and tax bases of assets and
liabilities. They are measured using the enacted tax rates and laws that
will be in effect when the differences are expected to reverse. The
Company is required to adjust its deferred tax liabilities in the period
when tax rates or the provisions of the income tax laws change. Valuation
allowances are established to reduce deferred tax assets to the amounts
expected to be realized.
12
<PAGE> 52
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
-----------------------------------------------------
Stock Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting
for Stock-Based Compensation ("SFAS No. 123"), established accounting and
disclosure requirements using a fair value based method of accounting for
stock-based employee compensation plans. As permitted by SFAS No. 123, the
Company will continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Board Opinion
("APB") No. 25, Accounting for Stock Issued to Employees ("APB No. 25").
Compensation cost for stock options, if any, will be measured as the
excess of the quoted market price of the Company's stock at the date of
grant over the amount an employee must pay to acquire the stock.
Compensation cost is amortized over the requisite vesting periods.
Product Warranty Cost
Provision for estimated warranty cost is recorded at the time of sale and
periodically adjusted to reflect actual experience.
Research and Development
Research and development expenditures are charged to expense as they are
incurred. The Company's research and development activities include
ongoing work on various uses of the micro imaging multi-angle laser light
scattering technology. Additionally, efforts are continuing on development
of improved production processes and cost reduction techniques for the ion
permeable membranes for their application in the EDI products. Contract
research and development expenditures are expensed as incurred.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual amounts could differ from those
estimates.
Financial Statement Classification
Certain amounts presented within the 1998 financial statements have been
reclassified in order to conform to the 1999 financial statement
presentation.
13
<PAGE> 53
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
4. NOTE RECEIVABLE, INDIVIDUAL
---------------------------
In February 1998, the Company received a note receivable from an
individual with a fixed annual interest rate of 8%. During the year ended
October 31, 1999, the unpaid balance of the note plus the accrued interest
was offset against a vendor contract incentive bonus earned by the same
individual (Notes 11 and 26).
5. INVENTORIES
-----------
At October 31, 1999 and 1998, inventories consisted of the following:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Raw materials $125,292 $320,532
Finished goods 79,596 --
-------- --------
INVENTORIES $204,888 $320,532
======== ========
</TABLE>
6. PROPERTY AND EQUIPMENT
----------------------
At October 31, 1999 and 1998, property and equipment consisted of the
following:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Machinery and equipment $424,999 $ --
Automobiles 39,797 23,000
Furniture and fixtures 111,018 94,711
Leasehold improvements 45,954 28,443
-------- --------
621,768 146,154
Less: accumulated depreciation (54,896) (12,109)
-------- --------
TOTAL PROPERTY AND EQUIPMENT, NET $566,872 $134,045
======== ========
</TABLE>
Depreciation expense for the years ended October 31, 1999 and 1998 was
$43,080 and $11,937, respectively.
14
<PAGE> 54
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
7. ACQUIRED TECHNOLOGY
-------------------
At October 31, 1999 and 1998, intangible assets consisted of the
following:
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Micro imaging multi-angle laser light scattering
instrumentation (Note 26) -- $ 447,146
Ion exchange membrane technology (Note 26) $ 200,000 200,000
--------- ---------
Total acquired technology 200,000 647,146
Less: accumulated amortization (68,055) (118,954)
--------- ---------
TOTAL ACQUIRED TECHNOLOGY, NET $ 131,945 $ 528,192
========= =========
</TABLE>
Amortization expense for the years ended October 31, 1999 and 1998 was
$103,747 and $117,484, respectively.
The Company currently holds a patent on certain electrodeionization water
treatment technology. This patent was issued in 1984 and will expire in
2001.
8. CAPITAL LEASE OBLIGATIONS
-------------------------
The Company acquired machinery and equipment under the provisions of two
long-term leases during the year ended October 31, 1999. For financial
reporting purposes, minimum lease payments relating to the equipment have
been capitalized. One of the leases expires in 2000, and one expires in
2001. The leased property under capital leases as of October 31, 1999, has
a cost of $17,594, accumulated amortization of $1,787, and a net book
value of $15,807. Amortization of the leased property is included in
depreciation expense.
The future minimum lease payments under capital leases and the net present
value of the future minimum lease payments at October 31, 1999 are as
follows:
<TABLE>
<S> <C>
2000 $ 10,347
2001 1,394
--------
Total minimum lease payments 11,741
Less: amount representing interest (978)
--------
Present value of net minimum lease payments 10,763
Less: current maturities (9,465)
--------
LONG-TERM CAPITAL LEASE OBLIGATION $ 1,298
========
</TABLE>
15
<PAGE> 55
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
9. NOTE PAYABLE TO AN OFFICER
--------------------------
At October 31, 1999 and 1998, a note payable to an officer consisted of
the following:
<TABLE>
<CAPTION>
1999 1998
-------- -------
<S> <C> <C>
Note payable to officer, collateralized by an
automobile, with interest at 9% per annum,
payable in monthly installments of $636 through
July 15, 2001 $ 12,315 18,531
Less: current portion (7,632) (6,216)
-------- -------
LONG TERM PORTION OF NOTE PAYABLE TO AN OFFICER $ 4,683 12,315
======== =======
</TABLE>
Maturities of notes payable to an officer as of October 31, 1999 are as
follows:
2000 $7,632
2001 $4,683
10. INCOME TAXES
------------
At October 31, 1999 and 1998, the components of the provision for income
taxes are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Current tax expense:
Federal -- --
State $800 $800
---- ----
800 800
---- ----
Deferred tax expense (benefit):
Federal -- --
State -- --
---- ----
-- --
---- ----
TOTAL PROVISION $800 $800
==== ====
</TABLE>
16
<PAGE> 56
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
10. INCOME TAXES, CONTINUED
-----------------------
Significant components of the Company's deferred income tax assets and
liabilities at October 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforward $ 5,527,023 $ 4,536,592
Allowance for doubtful accounts -- 9,902
Amortization 19,635 35,989
Other 4,473 1,026
Accrued expenses 38,536 6,553
----------- -----------
Total deferred income tax asset 5,589,667 4,590,062
Valuation allowance (5,589,667) (4,590,062)
----------- -----------
NET DEFERRED INCOME TAX ASSET -- --
=========== ===========
</TABLE>
The Company, based upon its history of losses and management's assessment
of when operations are anticipated to generate taxable income, has
concluded that it is more likely than not that none of the net deferred
income tax assets will be realized through future taxable earnings and has
established a valuation allowance for them.
Reconciliation of the effective income tax rate to the U.S. statutory
income tax rate is as follows:
<TABLE>
<CAPTION>
1999 1998
------ ------
<S> <C> <C>
Tax expense at U.S. statutory income tax rate (34.0)% (34.0)%
State tax provision 0.1 0.1
Increase in the valuation allowance 34.0 34.0
----- -----
EFFECTIVE INCOME TAX RATE 0.1% 0.1%
===== =====
</TABLE>
The Company has federal and state net operating loss carryforwards of
$14,579,267 and $6,448,779, respectively. The federal and state net
operating loss carryforwards will begin to expire in 2000 and will
continue to lapse through 2019.
17
<PAGE> 57
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
11. COMMITMENTS
-----------
Facilities Lease Agreement
The Company entered into a three year lease agreement that began on
February 1, 1998 for its facility located in Laguna Hills, California.
Monthly lease payments were $16,000 through January 1999, $16,480 through
January 2000 and $16,974 through January 2001. The Company has an option
to extend the lease for two additional three year terms. In March 1998,
the Company entered into a two year sub-lease agreement for a portion of
the facility to a third party at the rate of $6,500 per month.
Future minimum facilities lease payments and facilities sublease rental
income as of October 31, 1999, are as follows:
<TABLE>
<CAPTION>
Minimum Minimum
Lease Sublease
Payments Rental Income
-------- -------------
<S> <C> <C>
2000 $202,206 $26,000
2001 50,922 --
-------- -------
TOTAL $253,128 $26,000
======== =======
</TABLE>
Rent expense was $196,320 and $151,956 for the years ended October 31,
1999 and 1998, respectively. Sublease rental income was $78,000 and 58,500
for the years ended October 31, 1999 and 1998, respectively. The sublease
rental income has been treated as a reduction of the rent expense on the
Statement of Operations.
Building Purchase Escrow
As part of the original facilities lease agreement, the Company issued
60,000 shares of its common stock for an option to purchase the Laguna
Hills building at any time prior to January 31, 2001 for $2,300,000. The
value of the facility purchase option for which the shares were issued was
$90,000.
In July 1999, the Company notified the lessor of its intent to exercise
its purchase option by opening an escrow with a $15,000 deposit. The
purchase option provides the Company with 18 months within which to close
the escrow and complete the sale. The Company will continue to make lease
payments as prescribed by the lease agreement until the sale transaction
is completed. If the sales transaction is not completed, the terms of the
lease agreement remain in effect. To date, financing for the building
purchase has not been obtained.
18
<PAGE> 58
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
11. COMMITMENTS, CONTINUED
----------------------
Consulting Agreement
In May 1998, the Company entered into a three year agreement for financial
consulting services for which it pays $2,500 per month and granted
warrants to purchase 175,000 shares of common stock (Note 16).
Agreement with Harry O'Hare
In October 1998, the Company entered into an agreement with Mr. Harry
O'Hare, a significant shareholder and founder of the Company. In June
1999, the shareholders approved the agreement at the annual shareholders'
meeting. The agreement provides for the Company to pay into a special bank
account, controlled by Mr. O'Hare's wife, $1,000 per month for ten years
and to issue to her a warrant to purchase 10,000 shares of the Company's
common stock at $.50 per share with a ten year term. Also, the Company
will cancel $9,105 owed by Mr. O'Hare to the Company, for which 2,500 of
his shares of the Company's common stock is pledged as collateral.
In exchange, the Company is to receive from Mr. O'Hare all of his 931,629
shares of redeemable preferred stock, 31,205 shares of his Class B common
stock, and all the 2,500 shares of his common stock pledged for payment of
the $9,105 he owes the Company. Mr. O'Hare will transfer 52,678 of his
remaining Class B common stock (52,778 shares) to others in satisfaction
of claims against him. Mr. O'Hare will also waive any claims he may have
to any royalties for technology the Company now owns, and he will not seek
any modification of this agreement.
The agreement also provides for the full mutual release of any and all
claims between the Company and Mr. O'Hare.
In connection with a public offering made by the Company in 1987, the
California Commissioner of Corporations (the "Commissioner") imposed
transfer and other restrictions on Mr. O'Hare's Class B common stock and
redeemable preferred stock. Even though the agreement was executed by the
parties and approved by the shareholders, the closing, and therefore the
effectiveness of this agreement, is subject to approval from the
Commissioner for the transfer of the shares as described above. The
Company and Mr. O'Hare agreed to jointly prepare an application to obtain
authorization from the Commissioner to transfer the shares, and in October
1999 the application was filed. There is no assurance such authorization
will be obtained.
19
<PAGE> 59
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
11. COMMITMENTS, CONTINUED
----------------------
Agreement with Harry O'Hare, Continued
During the year ended October 31, 1999, the Company made advances of the
monthly payments contemplated under the agreement totaling $12,000 to the
special bank account controlled by Mr. O'Hare's wife.
12. GAIN ON THE EXTINGUISHMENT OF DEBTS
-----------------------------------
Lapse in Statutory Collection Period
In the year ended October 31, 1998, the Company received a legal
determination that applicable state statutes with regard to enforcement of
the collectability of a $17,308 note payable due from the Company had
lapsed. Accordingly, the resulting gain on the lapsing of the
enforceability of the debt has been recognized as an extraordinary item.
There is no income tax effect on this extraordinary item.
Settlement of Judgment
In the year ended October 31, 1998, the Company settled a $30,744
liability it recognized as an account payable resulting from a 1993
default judgment rendered against the Company for unpaid corporate credit
card charges. The Company paid a total of $22,000 to satisfy the judgment.
The resulting gain on settlement of $8,744 has been recognized as an
extraordinary item. There is no income tax effect on this extraordinary
item.
13. ROYALTIES
---------
In 1986, the former owner of the EDI patents and an original officer of
the Company, entered into agreements to pay two separate royalties of $42
and $9 to a group of individuals for each EDI water purification unit sold
by the Company or any sublicensees. The royalty at $42 per unit continues
until the last patent related to these products expires. The last patent
expires in August 2001. The second royalty at $9 per unit is payable until
a maximum of $525,600 has been paid.
The Company sold 68 and 81 EDI water purification units in fiscal years
1999 and 1998, respectively. No units affected by these royalty agreements
were sold prior to fiscal year 1997. The amounts due under the $42 per
unit royalty totaled $6,249 and $3,402 in fiscal years 1999 and 1998,
respectively. Under the $9 per unit royalty the amounts totaled $1,341 and
$729 in fiscal years 1999 and 1998, respectively. These royalties have
been accrued and have not been paid.
20
<PAGE> 60
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
14. LICENSED TECHNOLOGY AGREEMENTS
------------------------------
Nonexclusive licenses for the worldwide use of the EDI technology were
issued to Glegg Water Consulting, Inc. ("Glegg") and to Polymetrics, Inc.
("Polymetrics"). The license granted to Glegg is a paid up license with no
continuing royalty requirements. The license provides Glegg the right to
sublicense the technology to its subsidiaries and affiliates and to a
Japanese entity. The license granted to Polymetrics has continuing royalty
requirements with royalty fee percentages of five (5) percent of net sales
of "greater than 100 gallon per minute ("gpm")" systems and ten (10)
percent of the "less than 100 gpm" systems. Polymetrics has not sold any
units subject to the license since inception of the agreement.
15. CONTINGENCIES
-------------
Litigation
In August 1999, the Company was named as a cross defendant in a cross
complaint by Douglas B. Platt doing business as East-West Technic Group
("Platt") arising from a lawsuit brought by Staar Surgical Company, Inc.
("Staar") against East-West Technic Group, Douglas B. Platt, and Does 1
through 100. The cross complaint alleges breach of contract, breach of
implied duty of good faith and fair dealing, misrepresentation, negligence
and common counts. More specifically, Platt claims that in December 1997,
the Company and Platt entered into a written agreement wherein the Company
agreed to supply, service, and support an electrodeionization module to be
part of a system installed by Platt for Staar. Platt claims that the
Company knew the details and specifications of the systems and
participated in its design, but failed to provide a module that could be
operated as part of the system.
As a result, Platt seeks to recover damages he suffered under the
contract. The amount of such damages has not yet been determined.
The Company believes the lawsuit is without merit and intends to
vigorously defend itself. While it is not practical to estimate a range of
possible loss, if any, for the Company's litigation of this matter, a loss
could have a material adverse effect on the Company's results of
operations, liquidity and financial position.
Concentrations of Risk
One customer represents 35% and 67% of the Company's sales of its HC
products for the years ended October 31, 1999 and 1998, respectively, and
at October 31, 1999 accounts receivable included $11,800 due from this
customer, which represents 12% of trade accounts receivable.
21
<PAGE> 61
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
15. CONTINGENCIES, CONTINUED
------------------------
Concentrations of Risk, Continued
During the years ended October 31, 1999 and 1998, two customers accounted
for 48% and 10% and 23% and 10% of EDI product sales, respectively. At
October 31, 1999 and 1998, no amounts were due from either of these
customers.
Management believes the trade accounts receivable are fully collectible,
and therefore no provision has been recorded for uncollectable trade
accounts receivable at the years ended October 31, 1999 and 1998.
16. STOCK OPTIONS AND WARRANTS
--------------------------
In May 1999, the Company adopted the Electropure, Inc. 1999 stock option
plan (the "plan"), for officers, directors, employees, consultants, and
advisors of the Company. The plan authorizes the granting of options on up
to 1,000,000 shares of common stock. The exercise price per share on
options granted may not be less than the fair market value per share of
the Company's common stock at the date of grant. The exercise price per
share of options granted to anyone who owns more than 10% of the voting
power of all classes of the Company's common stock is a minimum of 110% of
the fair market value per share at the date of grant. The options exercise
price may be paid in cash or its equivalent including cashless exercises
as determined and approved by the plan administrator. The plan provides
two types of options: (i) Incentive Stock Options and (ii) Non-Qualified
Stock Options. In fiscal year 1999, the Company granted options to
purchase 455,000 shares of its common stock under this plan. The term of
each stock option granted is fixed by the plan administrator and shall not
exceed 10 years, except that for those who own 10% of the voting power of
the Company the term of the option may be no more than 5 years. The
vesting period is determined by the administrator at or after the date of
grant.
From time-to-time prior to the adoption of the plan, the Company has
granted warrants to officers, key employees, consultants, advisors and
vendors to attract and retain personnel, provide for performance
incentives, and promote the success of the Company by providing warrant
holders the opportunity to acquire an equity interest. Only non-employees
have been granted warrants outside the stock option plan since its
adoption.
22
<PAGE> 62
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
16. STOCK OPTIONS AND WARRANTS, CONTINUED
-------------------------------------
Issued to Employees
The following table summarizes information about options granted to
employees. Unless otherwise noted, options vest on an annual pro rata
basis over various periods of time and are exercisable, upon proper
notice, in whole or in part at any time upon vesting. Generally, unvested
options terminate when an employee leaves the Company. The options granted
have contractual lives ranging from 3 to 10 years.
The weighted average fair value of the options granted during the years
ended October 31, 1999 and 1998 were $.94 and $1.31, respectively.
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Options Price
--------- --------
<S> <C> <C>
BALANCE AT OCTOBER 31, 1997 518,478 $0.57
Granted 1,265,000 1.05
Exercised (12,000) 0.50
Canceled (4,978) 2.80
--------- -----
OUTSTANDING AT OCTOBER 31, 1998 1,766,500 0.91
Granted 890,000 0.96
Exercised (2,500) 0.50
Repriced (25,000) 1.78
Canceled (500,000) 0.86
--------- -----
OUTSTANDING AT OCTOBER 31, 1999 2,129,000 $0.93
========= =====
</TABLE>
The Company continues to account for stock-based compensation to employees
using the intrinsic value method prescribed in APB No. 25 whereby no
compensation cost is recognized for options granted at or above fair
market value. Had compensation expense for options awards been determined
based upon fair values at the grant dates in accordance with SFAS No. 123,
the Company's pro forma net loss and net loss per share would have been
the amounts indicated in the following schedule. For purposes of pro forma
disclosures, the estimated fair value of the options is amortized over
their vesting periods. The pro forma effects of applying SFAS No. 123 are
not indicative of future results because this statement does not apply to
awards granted prior to fiscal year 1997.
23
<PAGE> 63
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
16. STOCK OPTIONS AND WARRANTS, CONTINUED
-------------------------------------
Issued to Employees, Continued
<TABLE>
<CAPTION>
October 31
---------------------------------
1999 1998
----------- -----------
<S> <C> <C>
Net loss:
As reported $(1,958,644) $(1,506,943)
Pro forma $(2,382,137) $(1,811,487)
Loss per share:
As reported $ (0.23) $ (0.19)
Pro forma $ (0.28) $ (0.20)
</TABLE>
For purposes of the above pro forma calculation, the fair value of options
granted by the Company during the years ended October 31, 1999 and 1998,
is estimated using the Black-Scholes Option Pricing Model with the
weighted average assumptions listed below:
<TABLE>
<CAPTION>
1999 1998
----- -----
<S> <C> <C>
Risk-free interest rate 5.51% 4.99%
Expected dividend yield 0 0
Expected stock price volatility 2.042 2.125
Expected life in years 10 10
</TABLE>
Summary information about the Company's options outstanding at October 31,
1999:
<TABLE>
<CAPTION>
Weighted
Average Weighted Weighted
Range of Options Remaining Average Options Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices October 31, 1999 Life Price October 31, 1999 Price
-------------- ---------------- ----------- -------- ---------------- --------
<S> <C> <C> <C> <C> <C>
$.28 - $.58 164,000 7.3 $0.32 114,000 $0.33
$.58 - $.88 455,000 4.9 $0.76 100,000 $0.79
$.88 - $1.78 1,510,000 6.0 $1.07 321,000 $1.10
--------- -------
2,129,000 535,000
========= =======
</TABLE>
24
<PAGE> 64
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
16. STOCK OPTIONS AND WARRANTS, CONTINUED
-------------------------------------
Issued to Non-Employees
The Company accounts for stock-based compensation awards to non-employees
based upon fair values at the grant dates in accordance with SFAS No. 123.
The consideration received for the issuance of stock purchase warrants is
based on the fair value of the warrants or of the goods or services
received for the warrants issued, whichever is more reliably measurable.
When the value of the services is based on the fair value of the warrants,
the value is calculated using the Black-Scholes Option Pricing Model. The
fair value of the options or warrants is amortized over the period the
Company received the goods or services.
In this connection, during the years ended October 31, 1999 and 1998 the
Company granted warrants as follows:
Issued to Directors for Services
In August 1998, the Board of Directors granted to each of four
Directors of the Company 10,000 warrants, each with a ten year term
to purchase common stock at $1.375 per share. The issuance of these
warrants for services resulted in an aggregate expense of $6,000 in
fiscal year 1998.
In August 1999, the Board of Directors granted to each of four
Directors of the Company 10,000 warrants, each with a ten year term
to purchase common stock at $1.375 per share. The issuance of these
warrants for services resulted in aggregate expense of $3,000 in
fiscal year 1999.
Issued for Consulting Services
In March 1998, the Company granted 20,000 warrants at $1.125 per
share for consulting services. The warrants expire on March 31,
2002. The fair value of the services provided was $2,000 and is
recorded as a consulting expense in fiscal year 1998.
In May 1998, as part of a financial consulting contract, the Company
granted warrants to purchase 175,000 shares of common stock at an
exercise price of $1.06 per share. The warrants issued have a term
of five years. The value of the warrants issued in conjunction with
this agreement is $90,000 and is being recognized as a consulting
expense ratably over its life.
25
<PAGE> 65
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
16. STOCK OPTIONS AND WARRANTS, CONTINUED
-------------------------------------
Issued to Non-Employees, Continued
Issued for Consulting Services, Continued
-----------------------------------------
During the year ended October 31, 1999, the Company granted a total
of 303,600 warrants to purchase common stock to various individuals
for consulting services. The warrants have exercise prices ranging
from $.94 to $1.00, and have contractual lives ranging from 5 to 10
years. The fair value of the consulting services received was
$94,700 and is being charged to expense over the life of the
consulting arrangements. Consulting expense of $28,380 relating to
these services was recognized for the year ended October 31, 1999.
The following table summarizes the information relating to warrants
granted to non-employees as of October 31, 1999 and 1998 and changes
during the years then ended:
<TABLE>
<CAPTION>
Weighted
Average
Warrants Exercise
Outstanding Price
----------- --------
<S> <C> <C>
BALANCE AT OCTOBER 31, 1997 991,362 $ 2.60
Granted 382,500 1.80
Exercised (180,928) 0.44
Canceled (51,600) 0.07
--------- ------
OUTSTANDING AT OCTOBER 31, 1998 1,141,334 2.35
Granted 853,600 1.59
Exercised -- --
Canceled (12,000) 0.01
--------- ------
OUTSTANDING AT OCTOBER 31, 1999 1,982,934 $ 2.03
========= ======
</TABLE>
The values of the consideration received were based on the values of the
warrants, which granted were estimated using the Black-Scholes Option
Pricing Model with the following weighted average assumptions for grants
made in 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Risk-free interest rate 5.51% 4.99%
Expected dividend yield 0 0
Expected stock price volatility 2.042 2.125
Expected life in years 10 10
</TABLE>
26
<PAGE> 66
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
16. STOCK OPTIONS AND WARRANTS, CONTINUED
-------------------------------------
Issued to Non-Employees, Continued
Summary information about the Company's warrants outstanding at October
31, 1999 is as follows:
<TABLE>
<CAPTION>
Weighted
Average Weighted Weighted
Range of Warrants Remaining Average Warrants Average
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices October 31, 1999 Life in Years Price October 31, 1999 Price
-------- ---------------- ------------- -------- ---------------- --------
<S> <C> <C> <C> <C> <C>
$.10 - $.50 48,210 4.89 $ 0.28 48,210 $ 0.28
$.50 - $1.00 473,600 5.26 $ 0.98 238,600 $ 0.97
$1.00 - $1.50 322,500 5.61 $ 1.16 222,500 $ 1.20
$1.50 - $3.00 1,071,250 1.95 $ 2.14 1,071,250 $ 2.14
$3.00 - $10.00 22,376 1.50 $ 9.00 22,376 $ 9.00
$10.00 - $15.00 44,998 1.50 $15.00 44,998 $15.00
--------- ---------
1,982,934 1,647,934
========= =========
</TABLE>
Private Placement Offerings
During the year ended October 31, 1998, the Company issued 137,500
detachable warrants as part of a private placement offering. The warrants
have a three year term to purchase common stock at $3.00 per share. These
warrants were valued at $1.97 and resulted in an offsetting increase and
decrease to additional paid-in capital. The warrants are redeemable by the
Company at $.05 per warrant if the price of the common stock equals or
exceeds $4.00 per share for 30 consecutive business days.
During the year ended October 31, 1999, the Company issued 510,000
detachable warrants as part of a private placement offering. The warrants
have a three year term to purchase common stock at $2.00 per share. These
warrants were valued at $.90 and resulted in an offsetting increase and
decrease to additional paid-in capital. The warrants are redeemable by the
Company at $.05 per warrant if the price of the common stock equals or
exceeds $4.00 per share for 30 consecutive business days.
Issuances by the Company of warrants from all sources at exercise prices
below fair market value at the date of grant resulted in an expense to the
Company of $102,307 and $116,920 for the years ended October 31, 1999 and
1998, respectively.
27
<PAGE> 67
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
17. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
------------------------------------------------------
The estimated fair value amounts of all financial instruments on the
Company's October 31, 1999 and 1998 balance sheets have been determined by
using available market information and appropriate valuation
methodologies. Fair value is described as the amount at which the
instrument could be exchanged in a current transaction between informed
willing parties, other than in a forced liquidation. However, considerable
judgment is necessarily required in interpreting market data to develop
the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts that the Company could
realize in a current market exchange. The use of different market
assumptions and/or estimation methodologies may have a material effect on
the estimated fair value amounts. The Company does not have any off
balance sheet financial instruments.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial statements:
Cash and equivalents, trade accounts receivable, notes receivable,
inventories, prepaid expenses, trade accounts payable, current
portion of notes payable and capital leases, and certain other
current liability amounts are reported in the balance sheet at
approximate fair value due to the short term maturities of these
instruments.
The fair value of non-current notes payable is estimated by
determining the net present value of future payments. The carrying
amount on the balance sheet approximates the fair value as the
interest rates approximate current market rates.
18. RELATED PARTY TRANSACTIONS
--------------------------
Note Receivable
In August 1998, the Company acquired a note receivable for $3,500 from a
director resulting from cash advances. The note was unsecured and had an
annual interest rate of 5.58%, which became due in October 1998. The note
became delinquent but was eventually satisfied by offsetting it against
consulting fees due to the same individual for services during the year
ended October 31, 1999.
28
<PAGE> 68
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
18. RELATED PARTY TRANSACTIONS
--------------------------
Purchase of a Vehicle
During the year ended October 31, 1998, the Company purchased an
automobile from an officer for $23,000. The Company paid $3,000 in cash
and issued a note payable collateralized by the automobile for the
balance. In the year ended October 31, 1999, the Company exchanged the
automobile for another automobile. The Company paid $7,797 in cash and
issued a note payable for $16,008.
19. LOSS PER COMMON SHARE
In accordance with the disclosure requirements of SFAS No. 128, Earnings
per Share, a reconciliation of the numerator and denominator of the basic
and diluted loss per share calculation and the computations of net loss
per common share for the years ended October 31, 1999 and 1998 are as
follows.
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Net loss available to common shareholders:
Loss before extraordinary gain $(1,958,644) $(1,532,994)
Extraordinary gain -- 26,051
----------- -----------
Net loss available to common shareholders $(1,958,644) $(1,506,943)
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 8,404,713 8,240,951
=========== ===========
Basic and diluted loss per common share:
Loss before extraordinary gain $ (0.23) $ (0.19)
Extraordinary gain -- --
----------- -----------
NET LOSS $ (0.23) $ (0.19)
=========== ===========
</TABLE>
The following securities and contingently issuable shares are excluded in
the calculation of diluted shares outstanding as their effects would be
antidilutive for the years ended October 31, 1999 and 1998 as follows:
<TABLE>
<CAPTION>
1999 1998
--------- ---------
<S> <C> <C>
Stock options and warrants 4,111,934 2,607,834
Convertible preferred stock 1,000,000 --
</TABLE>
29
<PAGE> 69
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
20. SHARE TRANSACTIONS
------------------
Common Shares Issued for Debt with a Beneficial Conversion Feature
During the year ended October 31, 1998, the Company borrowed $400,000 from
a related party who is the largest shareholder. The terms of the notes
provided for conversion into shares of the Company's common stock at any
time after their issuance. The intrinsic value of the beneficial
conversion features was determined, and additional paid-in capital and
interest expense of $400,000 was recognized. The Company issued 342,659
shares of common stock to the major shareholder of the Company at fair
market value of $672,897 in connection with the conversion of convertible
notes payable and accrued interest totaling $409,847.
Common Shares Issued for Warrants Exercised with a Beneficial Conversion
Feature
During the year ended October 31, 1998, the Company offered to reduce the
exercise price to $1.00 per share on any warrants with original exercise
prices greater than $2.00 per share. As a result of this beneficial
conversion feature, warrants were exercised for the purchase of 155,928
shares of common stock for $155,928.
Common Shares Issued for Options and Warrants Exercised
During the year ended October 31, 1998, warrants were exercised resulting
in the purchase of 25,000 shares of common stock for $29,750. A note
receivable of $29,750 was acquired in payment for the shares issued.
The note receivable is recorded as a reduction of shareholders' equity.
During the year ended October 31, 1998, options were exercised to purchase
12,000 shares of common stock for $6,000. A note receivable for $6,000 was
acquired in payment of the shares issued. The note receivable is recorded
as a reduction of shareholders' equity.
During the year ended October 31, 1999, warrants were exercised resulting
in the purchase of 2,500 shares of common stock for $1,250.
Private Placement Offering - Common Stock
In April 1998, a private placement offering resulted in the issuance of
275,000 shares of common stock and 137,500 detachable warrants to purchase
common stock at an exercise price of $3.00 per share, and the Company
received net proceeds of $550,000. In connection with this private
placement offering, the Company issued 3,363 shares of common stock as a
finder's fee valued at $7,500, which was treated as a reduction of the
proceeds from the private placement offering.
30
<PAGE> 70
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
20. SHARE TRANSACTIONS, CONTINUED
-----------------------------
Private Placement Offering - Common Stock, Continued
During the year ended October 31, 1999, a private placement offering
resulted in the issuance of 1,020,000 shares of common stock and 510,000
detachable warrants to purchase common stock at $2.00 per share, and the
Company received net proceeds of $1,020,000.
Common Shares Issued in Consideration of an Option to Purchase Real Estate
During the year ended October 31, 1998, the Company issued 60,000 shares
of common stock with a fair market value of $90,000 at the date of issue
to the lessors of the Company's new facility in exchange for a three year
option to purchase the building. The $90,000 value attributable to the
option to purchase the building has been recorded as a building purchase
option.
Common Shares Issued for Services
In the year ended October 31, 1998, the Company issued 6,579 shares of
common stock to the real estate broker who negotiated the lease on the
Company's current facility in satisfaction of a $10,000 commission. The
value of the services involved in the transaction has been expensed and
added to common stock and additional paid-in capital.
In the year ended October 31, 1998, the Company issued 4,103 shares of
common stock, valued at $7,500, to a consulting firm in partial payment
for public relations services to be rendered. The value of the services
involved in the transaction has been expensed and added to common stock
and additional paid-in capital.
Prepaid Legal Services
In May 1999, the Company issued to a law firm involved with its patent
work, 100,000 shares of common stock with a fair value of $100,000 as a
retainer against which fees and expenses incurred will be paid. The value
of the services to be received in this transaction has been recorded as
prepaid legal services and added to common stock and additional paid-in
capital.
Settlement
In July 1999, pursuant to the terms of a settlement, the Company cancelled
1,950,000 shares of common stock previously held by Wyatt Technology
Corporation (Note 26).
31
<PAGE> 71
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
20. SHARE TRANSACTIONS, CONTINUED
-----------------------------
Private Placement Offering - Preferred Shares
In January 1999, the Company sold 1,000,000 shares of its Series B
convertible preferred stock to a related party who is the largest
shareholder of the Company in a private transaction for $1,000,000. The
Series B convertible preferred stock is convertible into 1,000,000 shares
of the Company's common stock in whole or in part at any time by its
holder. The Series B convertible preferred stock is automatically
convertible on the same basis if either of two events occur: a) the
Company makes a public offering of any of its securities, or b) the
Company's securities are admitted for listing on a national securities
exchange market system. In the event the number of shares of the Company's
common stock is increased or decreased as a result of a stock split, stock
dividend, reverse stock split, or otherwise, the number of shares of
common stock into which each share of Series B convertible preferred stock
may be converted shall concurrently be proportionately increased or
decreased. The Series B convertible preferred stock has no rights for
participation in any new or additional issuances of any Company equity
instruments.
Each share of Series B convertible preferred stock is entitled to four
votes on all matters, including the election of directors and shall vote
as a single class along with the common stock, Class B common stock and
redeemable preferred stock.
In any liquidation or dissolution of the Company, the holders of the
Series B convertible preferred stock will be entitled to a liquidation
preference of $1 per share.
21. NOTES RECEIVABLE FOR ISSUANCE OF COMMON STOCK
---------------------------------------------
On various dates during the years ended October 31, 1998 and 1997, the
Company allowed certain individuals, who were current or former officers
and directors, to purchase shares and to exercise options or warrants held
by them in exchange for notes receivable at fixed interest rates ranging
from 5.49% to 5.63%. As of October 31, 1999 and 1998, the notes receivable
related to the issuance of common stock are reflected as a reduction in
equity and are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
------- -------
<S> <C> <C>
Note receivable from an officer and director
of the Company for the issuance of 50,000
shares of common stock in August 1997, with
interest at 5.49% per annum, due in July
2002. The note receivable is collateralized
by the shares issued resulting from the
exercise of warrants. $25,000 $25,000
</TABLE>
32
<PAGE> 72
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
21. NOTES RECEIVABLE FOR ISSUANCE OF COMMON STOCK, CONTINUED
--------------------------------------------------------
<TABLE>
<S> <C> <C>
Note receivable from a former director of the
Company for the issuance of 12,000 shares of
common stock in July 1998, with interest at
5.51% per annum. The note receivable is
collateralized by the shares issued resulting
from the exercise of warrants and is due 90
days after their registration. $ 6,000 $ 6,000
Note receivable from a former director of the
Company for the issuance of 25,000 shares of
common stock in July 1998, with interest at
5.63% per annum. The note receivable is
collateralized by the shares issued resulting
from the exercise of warrants and is due 90
days after their registration. 29,750 29,750
------- -------
TOTAL $60,750 $60,750
======= =======
</TABLE>
22. EQUITY RIGHTS AND PREFERENCES
-----------------------------
Voting Rights
Each share of the Company's common stock is entitled to one vote per
share, and the Class B common stock of the Company is entitled to eight
votes per share. The holders of the outstanding redeemable preferred stock
of the Company are entitled to one vote per share. Each share of Series B
convertible preferred stock is entitled to four votes per share.
Liquidation Preferences
In the event of liquidation or dissolution of the Company, the holders of
the common stock, Class B common stock and redeemable preferred stock,
subject to the rights of the holders of the Series B convertible preferred
stock, shall be entitled to receive an equal amount per share, provided,
however, in no instance shall a share of redeemable preferred stock
receive more than $0.01 per share and in no instance shall each share of
Class B common stock receive an amount greater than 80% of the amount each
share of common stock receives, subject to the restrictions imposed by the
Commissioner as described in Note 23.
33
<PAGE> 73
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
23. CLASS B COMMON STOCK
--------------------
The Class B common stock is entitled to non-stock dividends and
liquidation payments equal to 80% of those paid to the common stock. All
of the Class B common stock is held by one individual (a significant
shareholder and the founder of the Company) and may not be transferred or
assigned. These shares automatically convert on a share for share basis
into common stock upon the death of the current owner. However, in
connection with an order imposed by the Commissioner, all shares held by
this individual will not participate in dividends, other than for stock in
distribution of assets in the event of liquidation and may not be
transferred without prior consent of the Commissioner or pursuant to a
court order.
24. REDEEMABLE PREFERRED STOCK
--------------------------
The redeemable preferred stock was issued in 1987 to the then holders of
the common and Class B common stock had a redemption date in 1991. The
redeemable preferred stock has not been redeemed due to a lack of "legally
available funds." These shares must be redeemed by the Company as soon as
possible for $0.01 per share at any time the Company has the "legally
available funds" for the redemption. There was a conversion feature to
this redeemable preferred stock, which, with the passing of time, has
lapsed. The Company believes the definition of "legally available funds"
to be the amount under California law from which dividends could be paid
by a corporation that does not have retained earnings. In general,
California law provides that to the extent a corporation's assets,
excluding intangible and deferred assets, are at least equal to 1.25 times
its liabilities, excluding deferred taxes, deferred income, and deferred
credits, a corporation may pay dividends. Under this definition, the
Company had "legally available funds" as of October 31, 1999 and 1998. As
a result, the Company is in default under the redemption provisions of the
redeemable preferred stock. The impact of this default on the Company's
financial position is uncertain.
The redeemable preferred stock is not assignable or transferable, except
upon death or upon approval of a majority of the members of the Board of
Directors not holding such shares and are not entitled to receive any
dividends. In the event of liquidation, dissolution, or winding up of the
Company, each share is entitled to share ratably in all assets available
for distribution equal to that of a share of common stock up to a maximum
of $.01 per share.
25. SERIES B CONVERTIBLE PREFERRED STOCK
------------------------------------
Each share of Series B convertible preferred stock is entitled to four
votes on all matters, including the election of directors and shall vote
as a single class along with the common stock, Class B common stock, and
redeemable preferred stock.
In any liquidation or dissolution of the Company, the holders of the
Series B convertible preferred stock will be entitled to a liquidation
preference of $1 per share.
34
<PAGE> 74
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
26. ACQUISITION AND DISPOSITION OF TECHNOLOGY
-----------------------------------------
Micro Imaging Technology
In October 1997, the Company completed a technology transfer agreement
(the "Agreement") for the acquisition of certain intellectual property
described in seven patents from Wyatt Technology Corporation ("Wyatt").
The intellectual property acquired relates to clean water monitoring
through the utilization of multi-angle laser light scattering
instrumentation, which the Company refers to as its "micro imaging
technology." The cost of the intellectual property acquired was 2,100,000
shares of the Company's common stock valued at $447,146. As part of the
Agreement, Wyatt was to manufacture and sell at prices including a
reasonable profit all components involving the intellectual property that
the Company requires for a period of three years.
During year ended October 31, 1999, disagreements arose between the
Company and Wyatt regarding the performance of each under the terms of the
Agreement. In February 1999, the Company filed a lawsuit claiming Wyatt
breached the terms of the Agreement. Wyatt filed a counter suit claiming
the Company breached the Agreement. In July 1999, the Company and Wyatt
entered into a settlement agreement whereby the Company and Wyatt each
retain the right to commercially exploit the technology that was the
subject of the Agreement, including that which was developed during "Phase
I" (as defined) of the Agreement (the "Retained Rights"). The Company's
Retained Rights are limited to use in detection of harmful substances in
drinking water and may not be transferred or assigned except to resellers
and end users of products developed by the Company from such Retained
Rights.
As consideration for the settlement, the Company delivered to Wyatt items
obtained from Wyatt during the term of the agreement and copies of the
technology, consisting of certain papers and software, developed by the
Company through April 1998.
Wyatt in turn, delivered all remaining shares it held of the Company's
common stock, which it received for entering into the Agreement, and all
stock purchase warrants received by Clifford Wyatt for services as a
member of the Company's Board of Directors. The settlement has been
recorded at $292,500, the fair value at the settlement date of the
1,950,000 shares returned.
The Company believes there is no remaining value in the Retained Rights.
Since the fair value of the shares received in the settlement is equal to
the net book value of the related intangible assets at the settlement
date, no gain or loss has been recognized as a result of the settlement.
35
<PAGE> 75
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
26. ACQUISITION AND DISPOSITION OF TECHNOLOGY, CONTINUED
----------------------------------------------------
Ion Exchange Membrane Technology
In February 1998 the Company acquired the HC ion exchange membrane process
technology for $200,000. The process technology is comprised of certain
production processes, intellectual properties, and know-how. None of the
acquired intangible assets are protected by patent, copyright or
trademark.
27. BUSINESS SEGMENTS
-----------------
The Company has three reportable segments: water purification ("EDI"),
hydro components ("HC"), and clean water monitoring (Micro Imaging ["MI"])
(a start up segment). The water purification segment produces water
treatment modules for sale to manufacturers. The hydro component segment
sells water and wastewater treatment products to the light
commercial/industrial markets. The clean water monitoring segment is
developing technology that is anticipated will enable real time
identification of contamination in water.
The Company's reportable segments are strategic business units that offer
different products, are managed separately, and require different
technology and marketing strategies. The accounting policies of the
segments are those described in the summary of significant accounting
policies. The Company evaluates performance based on results from
operations before income taxes not including nonrecurring gains and
losses.
Business Segment Information:
-----------------------------
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Revenue
EDI $ 278,943 $ 372,742
HC 416,622 432,771
MI -- --
----------- -----------
TOTAL REVENUE $ 695,565 $ 805,513
=========== ===========
Operating Loss
EDI $ (642,835) $ 7,883
HC (239,768) 93,265
MI (650,897) (445,110)
Corporate (437,180) (792,362)
----------- -----------
TOTAL OPERATING LOSS $(1,970,680) $(1,136,324)
=========== ===========
</TABLE>
36
<PAGE> 76
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
27. BUSINESS SEGMENTS, CONTINUED
----------------------------
Business Segment Information, Continued:
----------------------------------------
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Depreciation and Amortization
EDI $ 1,418 $ 8,952
HC 40,717 31,040
MI 65,425 89,429
Corporate 39,271 --
---------- ----------
TOTAL DEPRECIATION AND AMORTIZATION $ 146,831 $ 129,421
========== ==========
Identifiable Assets
EDI $ 426,103 $ 292,806
HC 634,154 522,734
MI 122,374 356,247
All others 232,654 214,779
---------- ----------
TOTAL IDENTIFIABLE ASSETS $1,415,285 $1,386,566
========== ==========
Expenditures for Long Lived Assets
EDI $ 122,258 $ 86,227
HC 292,368 200,000
MI 10,373 --
Corporate 17,809 --
---------- ----------
TOTAL EXPENDITURES FOR
LONG LIVED ASSETS $ 442,808 $ 286,227
========== ==========
Geographic Information:
Revenues
United States $ 502,228 $ 506,996
Japan 132,490 183,117
Ireland 28,668 83,600
Other foreign countries 32,179 31,800
---------- ----------
TOTAL REVENUES $ 695,565 $ 805,513
========== ==========
</TABLE>
37
<PAGE> 77
ELECTROPURE, INC.
NOTES TO FINANCIAL STATEMENTS
FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
- --------------------------------------------------------------------------------
28. SUBSEQUENT EVENT
----------------
Financial Arrangement with a Related Party
In December 1999, the Company entered into a financing arrangement with
the principal shareholder. The terms of the agreement are for the
principal shareholder to lend the Company $200,000 and receive in return
from the Company an unsecured convertible note with a term of two years
and an annual interest rate of 10%. The conversion terms and the number of
warrants have not as of yet been described and then approved by the
Company's Board of Directors. The $200,000 note payable has been issued,
and $100,000 of the proceeds therefrom have been received. The remainder
of the proceeds is anticipated by the Company in January 2000.
38
<PAGE> 78
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibits
no. Description
-------- -----------
<S> <C>
3.1 Articles of Incorporation of the Registrant, as amended. ***
3.2 By-Laws of the Registrant, as amended. *
10.19 Form of Indemnity Agreement with each current Officer and
Director. **
10.47.8 License Termination Agreement with EDI Components dated August
14, 1997 (effective 08/05/97). ******
10.47.9 Employment Agreement with Floyd H. Panning dated August 14, 1997
(effective 08/05/97). ******
10.48 Technology License Agreement with Glegg Water Conditioning, Inc.
dated July 2, 1994. ****
10.48.1 Amended and Restated Technology Licence Agreement with Glegg
Water Conditioning, Inc. dated May 22, 1997. *****
10.51 Settlement Agreement with Economic Development Bank for Puerto
Rico dated May 16, 1997. *****
10.52 Technology Transfer Agreement with Wyatt Technology Corporation
dated October 25, 1997. *******
10.53 Assignment Agreement with Hydro Components, Inc. dated February
17, 1998.********
27. Financial Data Schedule.
- -------------
* Previously filed on December 15, 1986 in connection with Registration
Statement of Registrant on Form S-1, File No. 33-10669.
** Incorporated by reference to Exhibit "B" to Registrant's Definitive
Proxy Statement, dated April 20, 1988, for the Annual Meeting held May
18, 1988, as filed on May 4, 1988.
*** Previously filed on February 28, 1989 in connection with Registrant's
Form 10-K for the fiscal year ended October 31, 1988.
**** Previously filed on October 11, 1995 in connection with Registrant's
Form 10-KSB for the fiscal year ended October 31, 1994.
***** Previously filed on July 16, 1997 in connection with Registrant's Form
10-KSB for the fiscal year ended October 31, 1996.
****** Previously filed on September 11, 1997 in connection with Registrant's
Form 10-QSB for the fiscal quarter ended July 31, 1997.
******* Previously filed on November 14, 1997 in connection with Schedule 13-D
filed by Wyatt Technology Corporation.
******** Previously filed on March 5, 1998 in connection with Registrant's Form
10-QSB for the fiscal quarter ended January 31, 1998.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-START> NOV-01-1998
<PERIOD-END> OCT-31-1999
<CASH> 204,328
<SECURITIES> 0
<RECEIVABLES> 97,745
<ALLOWANCES> 0
<INVENTORY> 204,888
<CURRENT-ASSETS> 611,468
<PP&E> 621,768
<DEPRECIATION> 54,896
<TOTAL-ASSETS> 1,415,285
<CURRENT-LIABILITIES> 412,012
<BONDS> 0
0
1,026,000
<COMMON> 77,914
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 1,415,285
<SALES> 695,565
<TOTAL-REVENUES> 695,565
<CGS> 898,386
<TOTAL-COSTS> 1,767,859
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (12,836)
<INCOME-PRETAX> (1,967,844)
<INCOME-TAX> (800)
<INCOME-CONTINUING> (1,958,644)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,958,644)
<EPS-BASIC> (0.23)
<EPS-DILUTED> (0.23)
</TABLE>
