UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A-1
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 0-21232
RECOVERY ENGINEERING, INC.
(Name of small business issuer in its charter)
MINNESOTA 41-1557115
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
9300 NORTH 75TH AVENUE, MINNEAPOLIS, MN 55428
(Address of principal executive offices)
Registrant's telephone number: (612) 315-5500
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, $.01
PAR VALUE
(Title of class)
Indicate by checkmark 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 checkmark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 20, 1998, based on the closing sale price of the
Common Stock on such date as reported on the Nasdaq National Market, was
$94,621,000.
On February 20, 1998, the Company had outstanding 4,552,994 shares of Common
Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
<PAGE>
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. BUSINESS.............................................................1
General..............................................................1
Industry Overview....................................................1
Business Strategy....................................................3
Products.............................................................4
Marketing and Distribution...........................................8
Research and Development.............................................9
Manufacturing........................................................9
Patents.............................................................10
Competition.........................................................10
Government Regulation...............................................10
Employees...........................................................11
ITEM 2. PROPERTIES..........................................................11
ITEM 3. LEGAL PROCEEDINGS...................................................11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................11
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS.............12
ITEM 6. SELECTED FINANCIAL DATA.............................................13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...........................................14
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..........20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.........................20
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.................................20
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS....................................21
ITEM 11. EXECUTIVE COMPENSATION..............................................23
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT......................................................27
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS......................29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.....30
SIGNATURES..........................................................32
INDEX TO FINANCIAL STATEMENTS......................................F-1
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Recovery Engineering, Inc. (the "Company") designs, manufactures and
markets proprietary small-scale drinking water systems under the PUR(R) brand
name for the household, recreational and military markets. These products
include a line of self-monitoring water filters for household use, a rugged line
of portable drinking water systems for outdoor enthusiasts and international
travelers and a line of low-energy, reverse osmosis desalinators for offshore
marine, commercial life raft and military use. PUR household water filters are
offered in a variety of configurations, including pour-through pitchers and
dispensers and in-line faucet-mounted, countertop and under-sink filter systems.
Each PUR household water filter system incorporates a replaceable filtration
cartridge. PUR household water filter systems and replacement filter cartridges
accounted for more than 80% of the Company's net sales in 1997.
The Company's objective is to establish and maintain PUR as the leading
brand of consumer drinking water treatment equipment, using proprietary
technology, superior design and extensive advertising and promotional programs
to obtain a leading position in each market segment it enters. The Company
launched its first PUR water filters for the household market in late 1994, with
the intent of establishing a large installed base of PUR water filter systems to
support recurring sales of replacement filter cartridges. To date, the Company
has sold more than 2.5 million household water filter systems and has obtained a
significant share of this market. According to survey information from Intelect,
a third party market research firm, PUR is the number one brand of in-line water
filters and the second leading brand of all household water filters sold in the
United States. PUR household products currently are distributed through
approximately 26,000 retail outlets in the United States and Canada, compared
with approximately 15,000 retail outlets at the end of 1996. Major customers
include Wal-Mart, Sears, Target, Costco, Kmart, Macy's and Walgreens.
Since its formation in 1986, the Company has utilized its mechanical and
chemical engineering expertise to develop new water filtration and purification
products with superior performance characteristics to meet the identified needs
of consumers. PUR reverse osmosis desalinators, introduced in 1988, include
hand-operated models for life rafts which it believes are the only such products
available in the world, and motor-driven models powered by a 12-volt DC motor.
PUR portable systems drinking water products, launched in 1991, incorporate the
Company's proprietary Tritek(R) disinfection technology which eliminates
microorganisms from water in seconds, making it possible for individuals to
produce safe drinking water when traveling, backpacking or on wilderness trips.
The Company has established a leading position in each of these markets.
In 1994, the Company introduced a faucet-mounted water filter, the first
PUR product for the rapidly growing household water filter market. Since then,
the Company has expanded its household product lines to include a broad range of
products at a variety of price points. The Company's household water filters use
advanced filtration technologies to reduce a wide range of contaminants, such as
microbiological cysts, lead, pesticides, volatile organic compounds ("VOCs") and
other impurities, while improving water taste and odor. The Company currently
offers eight different types of pour-through and in-line water filters, as well
as replacement filter cartridges for such products. All PUR household products
incorporate the Company's proprietary technology, known as ASM(R) (Automatic
Safety Monitor(TM)), which measures the filter's usage and indicates its
remaining capacity. The Company believes that this visible indication of when to
replace the filter cartridge encourages consumers to purchase replacement
cartridges more frequently than they otherwise would. The Company anticipates
that the installed base of PUR water filter systems will continue to grow,
further promoting the sale of replacement filter cartridges, which on average
carry a higher margin than the Company's other products. Sales of replacement
filter cartridges are expected to comprise an increasing portion of the market
for household water filter products and provide a source of recurring revenues.
INDUSTRY OVERVIEW
During the last half of this century, reliable drinking water has largely
been taken for granted in the United States and other industrialized countries.
However, lead and other impurities can make water potentially unsafe or
unpleasant in taste and odor. In addition, much of the populated world,
including
1
<PAGE>
parts of Asia, Africa and Latin America, does not have adequate sewage or water
treatment facilities, leaving tap water unfit for human consumption.
HOUSEHOLD MARKET
The United States Environmental Protection Agency ("EPA") and other
organizations have identified a number of harmful contaminants that many
municipal water authorities do not remove from drinking water or that enter the
water supply after it has left the municipal water treatment facility.
* In 1993, the EPA identified microbiological cysts, in particular
CRYPTOSPORIDIUM, as contaminants likely to be found in over 55% of the
nation's surface waters and 17% of the nation's municipal water supplies.
There have been numerous instances of water-borne illness resulting from
such contaminants. For example, approximately 400,000 people became ill in
1993 by an outbreak of CRYPTOSPORIDIA in the municipal water supply for
Milwaukee, Wisconsin, despite the fact that water from the Milwaukee
water-treatment plants met all existing state and federal quality
standards.
* In 1994, the EPA reported on the effect of chlorine byproducts, such as
trihalomethane, in drinking water supplies. The presence of
trihalomethanes in drinking water is considered by the EPA to be a cancer
risk. In 1998, the California Department of Health Services released a
study which found that women who had a high exposure to trihalomethanes
from water consumption were more likely to have miscarriages.
* In 1993, CONSUMER REPORTS published a report on tests it conducted for
lead in household drinking water that found unacceptable lead
contamination, based on EPA standards, in Chicago, Boston, New York,
Washington, D.C. and San Francisco. Lead consumption is regarded as a
significant health hazard, particularly for children.
* In 1997, a study conducted by the Environmental Working Group found that
certain pesticides and herbicides have leached into underground aquifers
in areas with concentrated agricultural activities. The Environmental
Working Group reported that tap water testing in 1996 by authorities in
midwestern states found that 104 communities, with a total population of
3.3 million, were provided tap water contaminated with five or more cancer
causing weed killers.
A new contaminant selection regulation under the Safe Drinking Water Act
requires the EPA to publish a list of contaminants that may be found in water
supplies and to consider the need for regulations addressing such contaminants.
The EPA will require all municipalities to notify their customers once a year
whether any contaminants are found in levels higher than the acceptable limits
identified by the EPA. The Company believes that this requirement will promote
public awareness that water supplies may contain health contaminants that
municipalities are currently unable to remove and that water treatment in the
home at the point-of-use is an increasingly important option for homeowners.
The Company believes that increasing awareness and concern about water
quality has contributed significantly to a steady increase in the size of the
market in the United States for household tap water substitutes (primarily
bottled water) and drinking water equipment. The United States market for
bottled water is currently estimated to be over $3.0 billion annually, with
approximately 35% of United States households purchasing bottled water in
individual or bulk containers. However, bottled water is less convenient and
over time is more costly per gallon than water from a point-of-use treatment
system. The Company estimates that the overall annual market for household
drinking water systems, services and supplies (such as water filters, water
softeners and whole house systems) is more than $1.7 billion, with the Company's
current segments of this overall market representing approximately $400 million.
Despite heightened awareness of water quality and safety issues, the domestic
market penetration of household drinking water treatment systems is estimated by
the Company to be less than 25% of United States households.
OUTDOOR MARKETS
The outdoor market consists of reverse osmosis desalinators for offshore
marine and military applications, as well as portable water treatment systems
for recreational outdoor use. The Company estimates that the annual U.S. market
for such outdoor systems is approximately $30 million. The reverse
2
<PAGE>
osmosis desalinator segment includes large motorized systems for use aboard
larger vessels, as well as smaller systems which are hand-operated or powered by
12-volt DC motors for use aboard life rafts or as a back-up system on a boat or
ship. The recreational segment includes a variety of portable, hand-operated
water purifiers and microfilters which eliminate harmful microorganisms from
outdoor or other questionable water sources, such as tap water in developing
countries. These products are typically used by outdoor enthusiasts and
international travelers.
BUSINESS STRATEGY
The Company's objective is to establish and maintain PUR as the leading
brand of consumer drinking water treatment equipment and attain a leading
position in each of the market segments it enters. The Company's key strategies
to accomplish this objective are:
* DEVELOP PROPRIETARY TECHNOLOGY TO ADDRESS CONSUMER CONCERNS. The Company's
research and development efforts are focused on creating innovative and
technologically superior products that provide performance characteristics
exceeding those of competing products. Consumer research conducted by the
Company in 1993 and 1996 revealed that the performance of water filters
from other manufacturers failed to meet consumers' expectations because
(i) consumers were uncertain whether a filter had reached the end of its
useful life and (ii) such filters treated primarily the aesthetic
properties of drinking water and generally did not remove contaminants
related to health concerns. In response to these findings, the Company
developed the ASM monitoring technology and higher performance filters
such as the PUR ULTIMATE faucet-mounted filter and the PUR PLUS
pour-through pitcher and dispenser which were introduced in January 1998.
The Company believes that its research and development team gives it a
significant competitive advantage over others engaged in the design and
manufacture of consumer water filtration and purification equipment.
* OFFER A BROAD LINE OF SUPERIOR PRODUCTS WHICH CATER TO A WIDE CONSUMER
SEGMENT. The Company has established a leading position in its consumer
drinking water treatment categories by developing a broad range of
products with superior performance characteristics at a number of retail
price points. The Company's products are offered in a variety of
configurations with varying performance characteristics.
* ESTABLISH A BROAD DISTRIBUTION NETWORK. The Company's entry into the
household water filter market in 1994 required it to establish new
distribution channels for its products. Since then, the Company has
expanded its distribution network aggressively. The Company's broad
product line and range of price points and its ability to provide
retailers with differentiated product configurations has enabled PUR
products to be sold by a wide variety of retailers including department
stores, mass merchants, drug stores, grocery stores, hardware stores and
warehouse clubs. PUR household products are currently sold throughout the
United States and Canada through approximately 26,000 retail outlets, a
significant increase from approximately 15,000 retail outlets at the end
of 1996. The Company continues to seek additional retail outlets and
distribution channels for its household products. The Company also
distributes its household products to international markets through
Groupe-SEB, one of the world's leading suppliers of small household
appliances whose products are distributed in over 80 countries under the
brand names Rowenta and T-Fal.
* PROMOTE BRAND AWARENESS THROUGH EFFECTIVE MARKETING. The Company entered
the growing household water filter market with the belief that it could
capture a significant share of the market by quickly establishing its PUR
brand. The Company therefore invested and continues to invest significant
resources in advertising and promotional activities to increase awareness
of its products and build the PUR brand name. These activities include
providing its retailers with point-of-sale displays, cooperative
advertising programs, product flyers and in-store product demonstrations.
The Company also utilizes television commercials and infomercials which
air on a variety of national cable channels and local broadcast stations,
as well as print and radio advertisements. These efforts have enabled the
Company to establish PUR products as the number one brand of in-line water
filters and the number two brand of all household water filters sold in
the United States.
3
<PAGE>
* GENERATE RECURRING SALES OF REPLACEMENT FILTER CARTRIDGES. The Company has
pursued a strategy of building brand name recognition for PUR products and
developing an installed base of its products to promote recurring sales of
replacement cartridges. The Company anticipates that, as the installed
base of PUR water filter systems grows, an increasing portion of its net
sales will be derived from recurring sales of replacement cartridges,
which on average carry a higher margin than the Company's other products.
All PUR household products incorporate the Company's proprietary ASM
technology which measures the filter's usage and indicates its remaining
capacity. The Company believes that this visible indication of when to
replace the filter cartridge encourages consumers to purchase replacement
filters more frequently than they otherwise would.
* DEVELOP LOW-COST, HIGH-VOLUME FLEXIBLE MANUFACTURING PROCESSES. The
Company has invested heavily in automating the manufacturing and assembly
processes for its household water filters, including the development of
several proprietary, automated processes for manufacturing filter elements
used in certain of its products. These automated processes have enabled
the Company to improve its manufacturing efficiencies while enhancing its
ability to provide high volumes of differentiated products to respond to
retailers' needs. Many of these processes were implemented in 1997 and
have contributed to improved margins. The Company intends to continue
implementing processes to reduce the cost of manufacturing it products.
PRODUCTS
Since its formation in 1986, the Company has utilized its mechanical and
chemical engineering expertise to develop new water filtration and purification
products with superior performance characteristics to address the identified
concerns of consumers. The Company believes it is a leader in introducing new
technology to the markets its serves.
* In 1988, the Company introduced the world's first hand-operated reverse
osmosis desalinator.
* In 1991, the Company launched its line of PUR portable systems employing
the Company's proprietary Tritek(R) disinfection technology which enables
the elimination of microorganisms from water.
* In 1994, the Company introduced the first faucet-mounted water filter
capable of removing CRYPTOSPORIDIUM and GIARDIA LAMBLIA.
* In 1994, the Company introduced the first faucet-mounted water filter with
a device that automatically monitors the useful life of the filter
cartridge.
* In 1996, the Company introduced the first gravity-fed, pour-through
pitcher with an automatic monitoring device.
* In 1997, the Company introduced the first faucet-mounted water filter to
remove mercury, particulates, atrazine and lindane.
* In 1998, the Company introduced two new pour-through systems, the PUR PLUS
pitcher and the PUR PLUS dispenser, the first gravity-fed water filter
systems capable of removing microorganisms as small as CRYPTOSPORIDIUM and
GIARDIA LAMBLIA.
* In 1998, the Company introduced the PUR ULTIMATE faucet-mounted filter,
the first faucet-mounted system to remove VOCs, including trihalomethanes,
which have been linked to cancer.
The Company believes its track record of introducing leading edge
technology to the marketplace ahead of its competitors has enabled it to attain
the number one market share in the outdoor product and reverse osmosis market
segments in which it competes, as well as the number one market share in in-line
household water filter systems.
HOUSEHOLD WATER FILTERS
The Company believes it offers the broadest line of household water filters
widely available at retail. PUR household water filters are offered in a variety
of configurations, including pour-through
4
<PAGE>
pitchers and dispensers and in-line faucet-mounted, countertop and under-sink
filters. Each PUR household water filter system incorporates a replaceable
filter cartridge. Within each configuration, the Company offers different levels
of contaminant reduction capabilities and a range of price points. In addition,
the Company's flexible manufacturing processes allow it to make minor
modifications to its products to meet the preferences of retailers.
All PUR household water filters incorporate the Company's ASM technology
which measures the filter's usage and indicates its remaining capacity, enabling
consumers to anticipate the need to purchase a replacement filter cartridge. The
PUR in-line products also include a feature that automatically shuts off the
water flow when the filter cartridge needs changing. Replacement filter
cartridges are sold at suggested retail prices ranging from $7.99 to $29.99
which allow consumers to obtain filtered water at a small fraction of the cost
of bottled water.
PUR faucet-mounted water filters, introduced to the market in 1994, were
the first household water filters offered by the Company. These compact units
are approximately five inches high and incorporate a proprietary carbon block
filter developed by the Company. The filter cartridges for these units have a
useful life of about two to three months based on the Company's surveys of
consumer usage. The Company introduced its PUR countertop water filter systems
in 1996 and its PUR under-sink water filter system in 1997, with filter
cartridges having a useful life of four to six months. Each of these products is
approximately nine inches high and offers greater contaminant reduction and
longer filter life than the faucet-mounted units. The filter cartridge for the
countertop and under-sink units employ the same proprietary carbon block
technology as the faucet-mounted units. The Company estimates, based on survey
information from Intelect, that its line of faucet-mounted PUR water filters
accounted for approximately 75% of all household faucet-mounted water filtration
sales in the United States in 1997.
The initial PUR pour-through product, introduced to the market in January
1996, is a water pitcher which holds approximately a half-gallon of filtered
water. In 1998, the Company introduced its PUR PLUS pitcher and PUR PLUS
dispenser, which are the only gravity-fed water filters capable of filtering
microorganisms as small as CRYPTOSPORIDIUM and GIARDIA LAMBLIA. The Company
expects to begin shipping the PUR PLUS pour-through products to retailers toward
the end of the first quarter of 1998. The PUR pour-through products incorporate
a proprietary three-stage filtration cartridge, developed and manufactured by
the Company, which employs activated carbon, ion exchange resin and a
microfilter and has a useful life of approximately one to two months based on
the Company's surveys of consumer usage. The Company estimates, based on survey
information from Intelect, that its line of PUR pour-through products accounted
for approximately 8% of all water filtration pitcher sales in the United States
in 1997.
5
<PAGE>
The products comprising the PUR line of household water filters are as
follows:
<TABLE>
<CAPTION>
SUGGESTED RETAIL PRICE
------------------------
ASM
FILTER LIFE NSF CERTIFICATION OF FILTER FILTER REPLACEMENT
PRODUCT/CONFIGURATION INDICATOR CONTAMINANT REDUCTION CAPABILITY (1)(2) CAPACITY (3) SYSTEM (4) CARTRIDGE
- --------------------- ----------- --------------------------------------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C>
POUR-THROUGH PRODUCTS:
PUR Pitcher X * Chlorine, Taste/Odor, Zinc, 40 gal. $ 24.99 $ 7.99
(1|M/2 gallon capacity) Particulate, Lead, Copper 1-2 mos.
PUR PLUS Pitcher X * Chlorine, Taste/Odor, Zinc, 40 gal. $ 39.99 $ 12.99
(1|M/2 gallon capacity) Particulate, Lead, Copper 1-2 mos.
* Cysts (CRYPTOSPORIDIUM, GIARDIA),
Asbestos, Turbidity
PUR PLUS Dispenser X * Chlorine, Taste/Odor, Zinc, 40 gal. $ 49.99 $ 12.99
(2 gallon capacity) Particulate, Lead, Copper 1-2 mos.
* Cysts (CRYPTOSPORIDIUM, GIARDIA),
Asbestos, Turbidity
IN-LINE PRODUCTS:
PUR FM (standard) X * Chlorine, Taste/Odor, Particulate, 100 gal. $ 39.99 $ 14.99
(faucet-mounted) Cysts (CRYPTOSPORIDIUM, GIARDIA), 2-3 mos.
Lead
PUR FM PLUS X * Chlorine, Taste/Odor, Particulate, 100 gal. $ 49.99 $ 19.99
(faucet-mounted) Cysts (CRYPTOSPORIDIUM, GIARDIA), 2-3 mos.
Lead
* Asbestos, Mercury, Lindane,
Atrazine
PUR FM ULTIMATE X * Chlorine, Taste/Odor, Particulate, 100 gal. $ 59.99 $ 21.99
(faucet-mounted) Cysts (CRYPTOSPORIDIUM, GIARDIA), 2-3 mos.
Lead
* Asbestos, Mercury, Lindane,
Atrazine
* VOCs
PUR CT PLUS X * Chlorine, Taste/Odor, Particulate, 200 gal. $ 79.99 $ 29.99
(countertop) Cysts (CRYPTOSPORIDIUM, GIARDIA), 4-6 mos.
Lead
* Asbestos, Mercury, Lindane,
Atrazine
* Turbidity
PUR US PLUS X * Chlorine, Taste/Odor, Particulate, 200 gal. $ 119.99 $ 29.99
(under-sink) Cysts (CRYPTOSPORIDIUM, GIARDIA), 4-6 mos.
Lead
* Asbestos, Mercury, Lindane,
Atrazine
</TABLE>
- ------------------
(1) The National Sanitation Foundation ("NSF") is a nationally recognized
not-for-profit agency which, at the request of state drinking water
administrators and the EPA, has developed consensus standards for the
certification of water filters. NSF certification indicates that a product
has passed a series of stringent independent tests.
(2) NSF certification of the PUR PLUS dispenser and PUR FM ULTIMATE
faucet-mounted products is pending.
(3) Estimated useful life (months) based on Company surveys of consumer usage.
(4) A filter system includes the base unit and one filtration cartridge.
6
<PAGE>
OUTDOOR PRODUCTS
The Company believes that it offers the broadest line of small-scale
drinking water systems for recreational and offshore marine use. The Company's
outdoor products include a rugged line of portable drinking water systems for
outdoor enthusiasts and international travelers and a line of low-energy,
reverse osmosis desalinators for offshore marine, commercial life raft and
military use.
Various methods have historically been used to disinfect fresh water,
including chlorine gas, iodine, silver nitrate, hydrogen peroxide and boiling.
These methods involve a significant amount of time to be effective and,
therefore, are not convenient or practical for use on a consistent basis to
produce drinking water. In addition, chemical disinfectants are relatively
ineffective against cyst forms of various parasites, including GIARDIA LAMBLIA,
and leave residual concentrations in water, which may render the water
unpalatable. Although filtration is also commonly used to treat contaminated
water and is an effective means of removing larger microorganisms like protozoa
and bacteria, filtration is not a practical means of removing viruses.
PUR fresh water purifiers incorporate the Company's proprietary Tritek
technology, which combines microfiltration and an iodinated resin matrix to
produce safe drinking water in seconds. The microfilter is used to remove
sediment and the largest and most chemically resistant microorganisms. Smaller
microorganisms, like bacteria and viruses, are killed upon contact with the
iodinated resin. The result is a process that takes advantage of the positive
attributes of microfiltration and iodinated resin, without suffering the
drawbacks of each approach when used alone. Each of the PUR fresh water
purifiers is registered with the EPA, which has established minimum performance
guidelines for microbiological water purifiers. See "Business -- Government
Regulation."
The Company offers a range of PUR water purifiers and microfilters for use
by backpackers, campers and other outdoor enthusiasts. The PUR Voyageur(TM) is a
compact water purifier which produces approximately 1.0 liter of water per
minute. The Voyageur incorporates the Company's proprietary Anti-Clog Filter
Technology ("AFT") which extends the life of the filter, eliminating the need
for the user to clean or maintain it. The PUR Scout(R) also incorporates the AFT
filter technology and produces approximately 0.5 liter of water per minute. The
PUR Explorer(R) has a double-action pump which enables one person to produce
over 1.5 liters of water per minute. The Explorer includes a self-cleaning
mechanism, permitting the filter to be cleaned conveniently without disassembly.
The Company's microfilter products include the PUR Pioneer(R), an entry level
product which features a disposable microfilter designed to filter up to 20
gallons, and the PUR Hiker(R), which incorporates the Company's AFT filter
technology and is designed to filter up to 100 gallons.
The Company also offers a line of PUR reverse osmosis desalinators for
converting seawater to potable water when sources of energy are either
unavailable or in limited supply. These products are used primarily in offshore
marine, commercial life raft and military applications. Reverse osmosis
desalination, which has been in use in large-scale systems for over 20 years,
occurs when feed water with dissolved solids (such as salt) is forced against a
semipermeable membrane at high pressure, typically 800 pounds per square inch.
The membrane acts as a barrier to contaminants such as salts, viruses and
bacteria, separating them from the pure water that passes through the membrane.
In a conventional reverse osmosis system, approximately 10% of the seawater
forced against the membrane passes through as pure water. The remaining
high-pressure waste brine stream is discharged. This process requires a large
amount of energy, making it impractical for small-scale applications. In 1988,
the Company introduced the world's first hand-operated reverse osmosis
desalinator, a compact unit incorporating a patented high-pressure energy
recovery pump that is designed to recover and effectively use energy that is
wasted in a conventional reverse osmosis system. The pump recycles the
high-pressure waste brine stream, redirecting it to the backside of the pump's
piston, providing a power assist to the pumping operation. By thus recovering
energy contained in the high-pressure waste brine stream, the Company's energy
recovery pump reduces the external power needed to operate a desalinator by
approximately 90%, and makes possible a small-scale low-energy desalinator.
The PUR Survivor(R) models are hand-operated desalinators, designed
primarily for emergency life raft use. The Survivor-35, the first desalinator
built by the Company, was designed for use by the United States Navy in
25-person life rafts and is also available in commercial versions. The
Survivor-06, the
7
<PAGE>
smallest reverse osmosis desalinator manufactured in the world, can produce a
pint of fresh water in less than 30 minutes. It is recommended for 4-to
12-person life rafts and individual survival kits. The Company is not aware of
any other hand-operated desalinators on the market. The PUR PowerSurvivor models
are driven by a 12-volt DC motor with power supplied by a boat's battery.
The products comprising the PUR line of outdoor products are as follows:
<TABLE>
<CAPTION>
SUGGESTED
PRODUCT TYPE SPECIAL FEATURES RETAIL PRICE
- ------------------------ ------------- ------------------------------------------ -------------
<S> <C> <C> <C>
PORTABLE SYSTEMS:
PUR Pioneer Microfilter Disposable filter $ 34.95
PUR Hiker Microfilter Anti-clog filter $ 59.95
PUR Voyageur Purifier Anti-clog filter with iodinated resin $ 74.95
PUR Scout Purifier Anti-clog filter with iodinated resin $ 89.95
and dirt shield
PUR Explorer Purifier Double-action pump; self-cleaning filter $ 129.95
with iodinated resin
DESALINATORS:
PUR Survivor-06 Desalinator Hand-operated, 6 gallons per day ("gpd") $ 585.00
PUR Survivor-35 Desalinator Hand-operated, 35 gpd $ 1,550.00
PUR PowerSurvivor-40E Desalinator Powered by 12-volt DC motor, 40 gpd $ 2,220.00
PUR PowerSurvivor-80E Desalinator Powered by 12-volt DC motor, 80 gpd $ 3,540.00
PUR PowerSurvivor-160E Desalinator Powered by 12-volt DC motor, 160 gpd $ 3,770.00
</TABLE>
MARKETING AND DISTRIBUTION
The Company entered the growing household water filter market with the
belief that it could capture a significant share of the market by quickly
establishing its PUR brand name. The Company therefore invested and continues to
invest significant resources in advertising and promotional activities to create
awareness of its products and recognition of the PUR brand name. These
activities include providing its retailers with point-of-sale displays,
cooperative advertising programs, product flyers and in-store product
demonstrations. The Company also utilizes television commercials which air on a
variety of national cable channels and local broadcast stations, as well as
print and radio advertisements. These efforts have enabled the Company to
establish PUR products as the number one brand of in-line water filters and the
second leading brand of all household water filters sold in the United States.
In February 1998, the Company began airing a one-half hour infomercial featuring
the PUR PLUS pitcher. This infomercial is designed to generate both direct and
retail sales and further educate consumers about the advantages of the PUR PLUS
pitcher relative to the leading pitcher brand.
The Company's entry into the household water filter market in 1994 required
it to establish new distribution channels for its products. Since then, the
Company has expanded its distribution network aggressively, and currently sells
its household water filters in the United States and Canada through a wide
variety of mass retail channels, including department stores, mass merchants,
drug stores, grocery stores, hardware stores, and warehouse clubs. The Company's
household products are distributed in approximately 26,000 stores in the United
States and Canada. The accounts are serviced by a network of more than 30
independent manufacturers' representative agencies. The Company continues to
seek additional retail outlets and distribution channels for its household
products.
8
<PAGE>
The Company's household products are distributed through the following
channels:
<TABLE>
<CAPTION>
APPROXIMATE
DISTRIBUTION CHANNEL NO. OF STORES (1) REPRESENTATIVE RETAILERS
- ---------------------- ------------------- -----------------------------------------------------
<S> <C> <C>
Mass merchants 6,400 Wal-Mart; Target; Kmart
Department stores 2,100 Dayton's; Marshall Fields; Macy's; Robinson-May;
Dillard's; Bloomingdale's; JC Penney; Sears
Drug stores 7,800 Walgreens; Eckerd Drug; Long's Drug; Osco
Grocery stores 3,400 Albertson's; Kroger; Super Valu; Fleming; Wegman's
Home center and 4,500 Home Depot; Lowes; Menards; Payless Cashways;
hardware stores Builders Square; Ace Hardware; True Value Hardware;
Hardware Hank; Servistar; Coast-to-Coast
Warehouse clubs 700 Costco; Sam's Club; B.J.'s
Specialty retailers 1,100 Bed, Bath & Beyond; Linens 'N Things; Home Place;
Lechters; QVC
</TABLE>
- ------------------
(1) Represents the Company's estimate of the number of outlets at which one or
more of the Company's household products are sold, including but not limited
to the representative retailers named in the table.
As part of its continuing efforts to enhance communications with its
customers, the Company utilizes electronic data interchange with its customers
to generate electronic purchase orders and invoices. The Company also receives
point-of-sale information through this system from 25 retailers including seven
of the Company's top 10 customers. This information allows the Company to track
and monitor consumer sales of its products and anticipate orders from its
principal customers.
In 1996, the Company established an international distribution agreement
with Groupe-SEB, one of the world's leading suppliers of small household
appliances whose products are distributed in over 80 countries under the brand
names Rowenta and T-Fal. Under the distribution agreement, Groupe-SEB has the
exclusive right to distribute PUR household water filters in all countries
outside of North America and Japan. The agreement gives the Company immediate
access to worldwide markets with minimal investment in sales and marketing
activities. The agreement has an initial term expiring on December 31, 1998, and
is automatically renewed for successive one-year terms unless notice of
non-renewal is given by either party at least six months prior to the renewal
date. The agreement may be terminated by the Company upon 30 days written notice
if Groupe-SEB does not purchase specified quantities of products.
The Company's portable drinking water systems are offered to outdoor
enthusiasts and international travelers through more than 1,550 outdoor and
travel stores and more than a dozen mail order catalogs. A network of
approximately 20 independent manufacturers' representatives services these
accounts. The Company's reverse osmosis desalinators can be purchased from more
than 450 marine dealers and service centers on the Atlantic, Pacific and Gulf
coasts and from several marine catalogs. Internal sales and service personnel
manage these accounts directly. The Company also sells directly to the United
States armed forces. Sales to foreign military forces and consumers are made
through approximately 30 distributors located in Europe, Asia and the Middle
East. To create awareness for its products, the Company advertises in consumer
and trade publications, participates in consumer and trade shows, and publishes
periodic newsletters to its retailers.
RESEARCH AND DEVELOPMENT
The Company believes that its research and development team gives it a
significant competitive advantage over others engaged in the design and
manufacture of consumer water filtration and purification equipment. Through the
efforts of its research and development team, the Company develops products
which incorporate proprietary technology to offer performance superior to
comparably priced products sold by competitors. The Company utilizes customer
surveys, focus groups, home user studies and field testing of its products to
assess consumer needs and preferences. Research and development efforts are then
focused on products where technological innovation can create a meaningful
difference between the Company's products and competing products. The Company's
research and development team includes an advanced manufacturing design group
which works to coordinate the transition of new products from the research and
development stage through the manufacturing process and ultimately to a
successful product launch. The Company's expenditures for
9
<PAGE>
research and development were $3.1 million in 1997 and $2.0 million in each of
1996 and 1995, representing 4.3%, 6.0% and 8.8% of sales, respectively.
MANUFACTURING
Since entering the household water filter market in 1994, the Company has
invested heavily in developing and implementing automated assembly and
manufacturing processes. Since 1994, the Company's annual production volume has
risen from approximately 140,000 units and cartridges to approximately 5.4
million in 1997. During this period, the Company has also implemented management
processes and information systems which it believes can accommodate significant
additional growth.
The Company currently assembles all of the filter elements used in its
household products. The manufacturing and assembly processes of some of its
filter units and most of its filter cartridges is automated. The assembly,
testing, quality control and packaging of the Company's products are conducted
by the Company's employees at its facilities in Minneapolis, Minnesota.
The principal raw materials utilized in the Company's manufacturing
operations are engineered thermoplastics, stainless steel and filtration media.
The Company relies on third party machine shops and injection molders to
manufacture components to the Company's specifications. The Company has
consolidated its supply relationships to two or three vendors for each component
to promote quality control. The Company has identified additional potential
suppliers for most of its components, and believes that alternate sources of
supply would be readily available to the Company if its relationships with
current suppliers were interrupted. The interruption of any of these supply
relationships could have a material adverse effect on the Company's results of
operations.
PATENTS
The Company is the owner of 12 United States utility patents and five
United States design patents related to its reverse osmosis desalinators,
portable drinking water systems and household drinking water systems. These
patents expire at various dates from 1998 to 2013. The Company has applied for
corresponding foreign patents where it deemed such applications necessary. The
Company has also applied for 11 other patents in the United States with respect
to its household drinking water products and for corresponding foreign patents.
The protection offered by these patents and the ability to obtain protection
with respect to new technology are important to the Company's future
performance.
COMPETITION
The Company competes with a number of companies in the manufacture and
marketing of household water filtration and purification systems. The most
significant competitors in this market currently are Brita U.S.A. (a subsidiary
of Clorox Company), Teledyne Waterpik (a subsidiary of Allegheny Teledyne,
Inc.), Culligan Water Technologies, Inc., Rubbermaid Inc. and Signature Brands
Inc. As this market develops, the Company may experience increased competition
from public water utilities, appliance manufacturers and consumer electronics
companies. In addition, the Company competes indirectly with suppliers of
bottled water.
The Company is not aware of any other company which manufactures
hand-operated desalinators. The Company competes with several other companies in
the manufacture and sale of small-scale motorized reverse osmosis desalinators.
These companies include Sea Recovery Corp. and Village Marine Tec. The Company
also competes with several companies in the manufacture of water filters and
purifiers for personal and recreational uses. These companies include Katadyn
U.S.A., Inc., Mountain Safety Research Corporation (a subsidiary of Recreational
Equipment, Inc.), and Cascade Designs, Inc.
The Company competes in the sale of drinking water systems on the basis of
product features, product performance and reputation, price and service.
GOVERNMENT REGULATION
The manufacture, marketing, advertising and distribution of water
purification devices containing active ingredients, such as iodine, is regulated
by the EPA. The EPA generally requires registration of the
10
<PAGE>
manufacturer, the active ingredients and the applicable device and its packaging
prior to sale of the product. Registration entails obtaining scientific data as
to the efficacy and toxicity of the device and its active ingredients. The PUR
Explorer, Scout and Voyageur, all of which contain iodinated resin, have been
registered by the EPA as "microbiological water purifiers."
In 1987, the EPA issued a protocol (the "1987 Protocol"), applicable to
manufacturers of microbiological water purification devices, for the testing and
certification of such devices, including those offered by the Company. The 1987
Protocol requires that to be registered as a "microbiological water purifier," a
device must remove, kill or inactivate all types of disease-causing
microorganisms from the water, including bacteria, viruses and protozoan cysts,
so as to render the processed water safe for drinking. The 1987 Protocol does
not require the removal of all traces of iodine from the treated water. Because
small amounts of iodine may be present in water treated by the Company's
antimicrobial water purifiers, the Company, in its labeling, advises persons
with thyroid problems and pregnant women to consult their doctors before use of
such products. Management believes the Company's water purification products
satisfy all the 1987 Protocol requirements.
In addition to EPA regulation, some states require registration of
household water filtration and purification products. The Company believes that
its current household products, and any future household products it develops,
comply and will comply with state regulations applicable to such products. There
can be no assurance, however, that such state registration requirements will not
result in delays in introduction of these products in certain markets.
The Company is also subject to regulation with respect to the handling and
disposal of the elemental iodine used in manufacturing resins. The Company
believes it is in compliance with applicable rules, and that it has properly
disposed of such material. There can be no assurance that more restrictive and
costly requirements will not be imposed in the future.
EMPLOYEES
At December 31, 1997, the Company had approximately 345 full-time
employees, of whom 33 were involved in research and development, 229 in
manufacturing, assembly and testing, 47 in sales, marketing, technical and
customer service, and 36 in administration. None of the Company's employees is
represented by a labor union or is covered by a collective bargaining agreement.
The Company has not experienced any work stoppages and believes that its
employee relations are excellent.
11
<PAGE>
ITEM 2. PROPERTIES
The Company is headquartered in a leased facility of 101,000 square feet
at 9300 North 75th Avenue, Minneapolis, Minnesota 55428. The Company initiated
construction on an 87,000 square foot expansion of this facility in 1997, and
expects to take occupancy of such expansion in May 1998, at which time the
expiration date of the lease for the entire facility will be extended from April
2007 to the date that is ten years from the date of occupancy. The Company
believes this expanded facility will provide sufficient space to support the
Company's anticipated requirements for the near-term, and that additional or
alternate facilities would be available on terms acceptable to the Company if
the Company's operations were to require additional space. The Company also
leases a warehouse facility of 19,000 square feet in Brooklyn Park, Minnesota
pursuant to a one year lease that expires on July 31, 1998.
The Company was formerly headquartered in a leased facility of 52,000
square feet in St. Louis Park, Minnesota pursuant to a seven-year lease which
expires on December 31, 2000. The Company has obtained a replacement tenant for
26,000 square feet of that facility and is seeking tenants for the remainder of
the facility. The original lease remains in effect and the Company will have
continuing financial obligations under such lease to the extent the facility is
not occupied by another tenant or the tenant does not assume or perform the
Company's obligations under the original lease.
The Company owns manufacturing and engineering equipment, located at its
facilities in Minneapolis, used in its assembly operations and research and
development efforts. Such equipment is available from a variety of sources, and
the Company believes that it currently owns or can readily acquire equipment
required for its current and anticipated levels of operations.
ITEM 3. LEGAL PROCEEDINGS
The Company and several other water filtration companies are defendants in
a civil proceeding initiated in January 1997 by Brita U.S.A., a subsidiary of
Clorox Company, which asserts that the defendants have infringed one of Brita's
patents relating to pitcher products. Brita's lawsuit, now pending in the United
States District Court for the Northern District of Illinois, seeks injunctive
relief and unspecified monetary damages. This litigation is still in the initial
stages. The Company was aware of Brita's patent prior to developing the PUR
pitcher design and believes that it does not infringe Brita's patent. The
Company intends to defend vigorously its right to market and sell these
products. The design of the PUR PLUS pitcher, dispenser and related filter
cartridge differs in material respects from the design of the pitcher products
that are the subject of this litigation.
The Company is also a defendant in a civil proceeding initiated in April
1997 by UltraPure Systems, Inc., a subsidiary of Culligan Water Technologies,
Inc., which asserts that the Company has infringed an UltraPure patent on a
faucet-mounted filter system. UltraPure's lawsuit, now pending in the United
States District Court for the District of Minnesota, seeks injunctive relief and
unspecified monetary damages. The Company believes it does not infringe
UltraPure's patent and intends to defend vigorously its right to market and sell
these products.
The Company from time to time is involved in various other legal
proceedings arising in the normal course of business, none of which is expected
to result in any material loss to the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
quarter ended December 31, 1997.
12
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been quoted on the Nasdaq National Market
under the symbol "REIN" since March 1993. The following table sets forth, for
the periods indicated, the range of high and low prices for the Company's Common
Stock as reported on the Nasdaq National Market.
HIGH LOW
1996:
First Quarter............................... $15.75 $ 8.25
Second Quarter.............................. 17.50 10.25
Third Quarter............................... 14.75 11.50
Fourth Quarter.............................. 12.38 6.50
1997:
First Quarter............................... $ 8.75 $ 6.75
Second Quarter.............................. 16.50 6.25
Third Quarter............................... 30.50 15.00
Fourth Quarter.............................. 31.50 23.00
As of February 20, 1998, there were 175 shareholders of record and
approximately 2,200 beneficial owners of the Company's Common Stock.
13
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The statement of operations data for the years ended December 31, 1995,
1996 and 1997, and the balance sheet data at December 31, 1996 and 1997, are
derived from the Company's financial statements included elsewhere in this
Report, which have been audited by Ernst & Young LLP, independent auditors.
The statement of operations data for the years ended December 31, 1993 and 1994
and the balance sheet data at December 31, 1993, 1994 and 1995 are derived from
audited financial statements not included herein. The selected financial data
set forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the financial
statements and the notes thereto included elsewhere in this Report.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- --------- --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net sales ............................... $ 10,292 $ 16,671 $ 22,921 $ 33,277 $ 71,243
Cost of products sold ................... 4,988 7,897 13,959 20,756 37,417
-------- -------- --------- --------- -----------
Gross profit ............................ 5,304 8,774 8,962 12,521 33,826
Operating expenses:
Selling, general and administrative .... 2,446 5,240 14,692 21,803 32,815
Research and development ............... 801 1,064 2,021 2,007 3,082
Facility relocation costs .............. -- -- -- 973 --
-------- -------- --------- --------- -----------
3,247 6,304 16,713 24,783 35,897
-------- -------- --------- --------- -----------
Income (loss) from operations ........... 2,057 2,470 (7,751) (12,262) (2,071)
Other income (expense):
Interest income ........................ 167 508 551 220 43
Interest expense ....................... (22) (52) (126) (457) (1,427)
-------- -------- --------- --------- -----------
Income (loss) before income taxes ....... 2,202 2,926 (7,326) (12,499) (3,455)
Income tax expense (benefit) ............ 705 907 (2,564) -- --
-------- -------- --------- --------- -----------
Net income (loss) ....................... $ 1,497 $ 2,019 $ (4,762) $ (12,499) $ (3,455)
======== ======== ========= ========= ===========
Net income (loss) per share (basic) (1) . $ 0.53 $ 0.57 $ (1.12) $ (2.90) $ (0.77)
======== ======== ========= ========= ===========
Weighted average shares (basic) ......... 2,843 3,531 4,239 4,307 4,471
Net income (loss) per share (diluted) (1) $ 0.45 $ 0.50 $ (1.12) $ (2.90) $ (0.77)
======== ======== ========= ========= ===========
Weighted average shares (diluted) ....... 3,321 4,029 4,239 4,307 4,471
OPERATING DATA:
Estimated number of retail outlets at end
of period (2) .......................... 1,200 2,200 9,900 16,900 28,000
Number of replacement cartridges shipped
during year ............................ 4,500 51,000 186,000 716,000 3,135,000
BALANCE SHEET DATA (at end of period):
Working capital ......................... $ 7,458 $ 14,754 $ 10,051 $ 9,743 $ 2,144
Total assets ............................ 10,025 25,054 23,622 33,257 42,700
Long-term debt .......................... -- -- -- 15,000 15,000
Shareholders' equity .................... 8,667 22,895 19,430 7,131 4,231
</TABLE>
- ------------------
(1) All earnings per share amounts for all periods have been presented and,
where appropriate, restated to conform to FASB Statement 128 requirements.
(2) Represents the Company's estimate of the number of outlets at which one or
more of the Company's household and outdoor products were sold. The
approximate numbers of retail outlets at which the Company's household
products were sold at the end of such periods were none in 1993, 1,000 in
1994, 8,000 in 1995, 15,000 in 1996 and 26,000 in 1997.
14
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EXCEPT FOR HISTORICAL INFORMATION CONTAINED IN THIS REPORT, THE MATTERS
DISCUSSED HEREIN CONTAIN FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
SUGGESTED IN THE FORWARD-LOOKING STATEMENTS, INCLUDING WITHOUT LIMITATION THE
EFFECTS OF ECONOMIC CONDITIONS, PRODUCT DEMAND, COMPETITIVE PRODUCTS AND OTHER
RISKS DETAILED HEREIN.
OVERVIEW
The Company designs, manufactures and markets proprietary small-scale
drinking water systems under the PUR(R) brand name for the household,
recreational and military markets. These products include a line of
self-monitoring water filters for household use, a rugged line of portable
drinking water systems for outdoor enthusiasts and international travelers and a
line of low-energy, reverse osmosis desalinators for offshore marine, commercial
life raft and military use, including the world's only hand-operated
desalinators. PUR household water filter systems and replacement filter
cartridges, which together accounted for more than 80% of the Company's net
sales in 1997, are distributed through approximately 26,000 retail outlets in
the United States and Canada, including Wal-Mart, Sears, Target, Costco, Kmart,
Macy's and Walgreens.
Since its formation in 1986, the Company has utilized its mechanical and
chemical engineering expertise to develop new water filtration and purification
products that provide solutions to a variety of problems that have historically
prevented the adequate treatment of drinking water in a number of settings.
Initially, the Company developed a line of reverse osmosis desalinators for the
United States Navy and other military and offshore marine users. The Company
subsequently developed a line of PUR antimicrobial water purifiers and
microfilters for use by outdoor enthusiasts and international travelers. The
Company has a leading position in each of these markets.
The Company entered the retail water filter market in late 1994 with the
intent of establishing PUR as the leading brand of household water filters.
Recognizing that a significant portion of revenues in the household market would
be derived from recurring sales of replacement cartridges, the Company pursued a
strategy of building brand name recognition for PUR products and developing an
installed base of its products to promote recurring sales of replacement
cartridges. To implement this strategy, the Company invested significant
resources to develop advanced filtration and monitoring technologies, launch a
broad range of products at a variety of price points, expand distribution of its
products, and provide high levels of consumer and trade advertising support. The
Company has also developed and implemented automated manufacturing and assembly
processes for its household products, which enables it to manufacture nearly all
of the filter elements for such products, reducing the Company's costs and
enhancing its ability to respond to retailers' needs. The Company currently
offers eight different types of household water filters at suggested retail
prices ranging from $24.99 to $119.99, as well as replacement cartridges for
each product at suggested retail prices ranging from $7.99 to $29.99, and has a
distribution network of approximately 26,000 retail outlets. This strategy of
investing heavily to build the PUR brand name and establish a large installed
base, coupled with the resulting rapid growth in production and sales, led to
reduced profit margins and net losses in each of the last three years. The
Company believes it is now well positioned to benefit from these investments, as
evidenced by the Company's results of operations for the fourth quarter of 1997,
in which it had net sales of $23.1 million, a gross margin of 52.4%, and its
first quarterly profit since the first quarter of 1995.
The Company's net sales increased from $10.3 million in 1993 to $71.2
million in 1997. The increase in net sales was primarily the result of the
Company's successful entry in late 1994 into the household water filter market.
Future increases in net sales are also expected to be derived principally from
the sale of household water filter systems and replacement cartridges. Sales of
the Company's household water filter systems have increased with (i) the
introduction of additional products for this market, (ii) an increase in the
number of retail outlets at which the Company's household products are sold,
(iii) an increase in the number of units sold at existing outlets, and (iv) the
overall growth in the market for household water filter systems. The Company
believes that its aggressive campaign to build brand name recognition for PUR
products has contributed significantly to the increase in net sales. Net sales
have also increased as a result of the sale of replacement filter cartridges to
the growing installed base of
15
<PAGE>
owners of PUR water filter systems. The sale of replacement cartridges is
expected to constitute an increasing portion of the net sales in future periods
as the size of the installed base continues to increase. Revenues from the sale
of outdoor systems to consumers have also increased, but at a significantly
lower rate than revenues from the sale of household water filters.
Cost of products sold is significantly affected by (i) costs of raw
materials, such as engineered thermoplastics, stainless steel and filtration
media, most of which are purchased from third party vendors, (ii) costs of
assembly, testing, quality control and packaging, which are performed by the
Company, and (iii) the mix of products sold. During 1995, 1996 and the first
half of 1997, gross margins were adversely affected by costs related to entering
the household water filter market, including investments made by the Company in
designing and implementing automated manufacturing and assembly processes for
PUR household water filters, together with the cost of conducting manual
assembly operations pending the installation of such automated processes. During
this period, the Company also took steps to reduce its material costs, including
development of a process to produce internally nearly all of its own filter
elements for its household products at significantly lower cost than purchasing
them from third party vendors. Following implementation of enhanced
manufacturing processes, the Company's household products generally carry a
higher gross margin than its other products, with replacement cartridges on
average carrying the highest gross margin of products within the household
category. The sale of household water filters and, in particular, the sale of
replacement cartridges is expected to constitute an increasing portion of net
sales in future periods.
Selling, general and administrative expenses include advertising and
promotional expenses. To implement its strategy of building brand name
recognition for PUR products and developing an installed base of its products to
promote the sale of replacement filter cartridges, the Company has invested
heavily in advertising and promotional programs. Advertising and promotional
activities in 1995 and 1996 were designed to create an initial awareness of the
Company's products, establish recognition of the PUR brand name and build an
installed base supporting recurring sales of replacement cartridges. In 1997,
such expenses were incurred in connection with the introduction and promotion of
several new products for the household market. The Company expects that, as a
percentage of net sales, its advertising and promotional expenses in 1998 will
be essentially unchanged from 1997 as it continues to expand its position in the
household market, and will decline as a percentage of net sales in subsequent
years. However, the Company expects that advertising and promotional expenses
related to the introduction of new products may, from time to time, result in an
increase in such expenses as a percentage of net sales on a quarterly basis,
including in the first quarter of 1998.
The Company intends to continue expanding its distribution network and seek
additional distribution channels to solidify its position in the growing
household water filter market. While such activities would be undertaken to
increase net sales and net income, they could affect the Company's gross profit
or selling, general and administrative expenses as a percentage of net sales.
For example, the sale of the PUR PLUS pitcher through infomercials, which
commenced in February 1998, is expected to result in different levels of gross
profit and selling, general and administrative expenses as a percentage of net
sales than the sale of the PUR products through retail outlets. The impact of
such differences will depend on the extent to which the Company determines to
use such distribution channels and the relative volumes of sales in the
respective channels.
The Company's results of operations on a quarterly basis are subject to
fluctuation due to the seasonal nature of sales for its household products, with
highest sales levels occurring during the fourth quarter, and the periodic
introduction of new products. The Company believes that these seasonal patterns
may have been masked by its recent sales growth and by the mix of sales of
outdoor systems and household systems. The Company's results of operations are
also affected by the timing of the introduction of new products, product
enhancements and related advertising and promotional expenses. Product
development expenses are incurred and advertising and promotional efforts
typically are commenced prior to the initial shipments of new products and
product enhancements. As a result, product development expenses and advertising
and promotional expenses are incurred in periods before any revenues are
recognized from the sale of new products and enhancements, and therefore, gross
margins are relatively lower and operating expenses are relatively higher during
such periods. For example, the Company expects that its gross margin and results
of operations in the first quarter of 1998
16
<PAGE>
will be adversely affected by its recent introduction of the PUR PLUS pitcher,
PUR PLUS dispenser and PUR ULTIMATE faucet-mounted products. Accordingly, the
Company expects that its gross margin for the first quarter of 1998 will be
similar to that in the third quarter of 1997. The Company also anticipates that
variations in its quarterly results of operations will occur from time to time
in future periods.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain items
from the Company's statements of operations, expressed as a percentage of net
sales.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1993 1994 1995 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net sales .......................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of products sold .............. 48.5 47.4 60.9 62.4 52.5
----- ----- ----- ----- -----
Gross profit ....................... 51.5 52.6 39.1 37.6 47.5
Operating expenses:
Selling, general and administrative 23.8 31.4 64.1 65.5 46.1
Research and development .......... 7.8 6.4 8.8 6.0 4.3
Facility relocation ............... -- -- -- 2.9 --
----- ----- ----- ----- -----
31.6 37.8 72.9 74.4 50.4
----- ----- ----- ----- -----
Income (loss) from operations ...... 19.9 14.8 (33.8) (36.8) (2.9)
Other income (expense):
Interest income ................... 1.6 3.0 2.4 0.7 0.1
Interest expense .................. (0.2) (0.3) (0.6) (1.4) (2.0)
----- ----- ----- ----- -----
Income (loss) before income taxes .. 21.3 17.5 (32.0) (37.5) (4.8)
Income tax expense (benefit) ....... 6.8 5.4 (11.2) -- --
----- ----- ----- ----- -----
Net income (loss) .................. 14.5% 12.1% (20.8)% (37.5)% (4.8)%
===== ===== ===== ===== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Net sales increased 114.1% to $71.2 million in 1997 from $33.3 million in
1996. This $37.9 million increase in net sales was attributable primarily to an
increase of $38.4 million in sales of the Company's PUR household water filter
products, offset by a decrease of $1.5 million in sales of reverse osmosis
desalinators to military customers. Sales of household products, including OEM
water filters, increased 173.5% to $60.5 million in 1997 from $22.1 million in
1996, reflecting increased sales of filter systems and replacement cartridges,
and the introduction of the PUR PLUS faucet-mounted filter and the PUR
under-sink models. Revenues from the sale of outdoor systems to consumers also
increased, but at a significantly lower rate than revenues from the sale of
household water filters. Sales of OEM water filters to Braun AG were
discontinued upon expiration of the Company's contract with Braun AG in December
1997. The expiration of this contract is not expected to have a material adverse
effect on the Company's operations. Price increases did not have a significant
impact on net sales for 1997.
Gross profit as a percentage of net sales increased to 47.5% in 1997 from
37.6% in 1996. The increase in gross profit as a percentage of net sales in 1997
was due to the implementation of automated manufacturing and assembly processes,
reductions in costs of materials, and an increase in sales of higher margin
household products and replacement filter cartridges as a percentage of net
sales.
Selling, general and administrative expenses increased to $32.8 million in
1997 from $21.8 million in 1996, representing 46.1% and 65.5% of net sales,
respectively. The increase in selling, general and administrative expenses was
attributable primarily to advertising and promotional expenses related to the
continued roll-out and expansion of the Company's line of household water
filters. Advertising costs increased to $14.6 million in 1997 from $9.5 million
in 1996, and accounted for 46.0% of the increase in selling, general and
administrative expenses in 1997 relative to 1996. Due to continued investment in
17
<PAGE>
marketing and advertising expenditures relating to new product introductions,
the Company believes that selling, general and administrative expenses will
remain flat as a percentage of net sales in 1998.
Research and development expenses increased to $3.1 million in 1997 from
$2.0 million in 1996, representing 4.3% and 6.0% of net sales, respectively. The
Company expects that research and development expenses will continue to increase
in 1998 as it develops new technology and product line extensions.
Interest income decreased to $43,000 in 1997 from $220,000 in 1996 due to
decreased balances of cash, cash equivalents and marketable securities. Interest
expense increased to $1.4 million in 1997 from $457,000 in 1996 due to interest
on the Company's line of credit, which was established in 1997, and a full year
of interest on the Company's long-term debt in 1997 compared with six months of
interest in 1996.
The Company's effective tax rate for 1997 and 1996 was 0%. The Company
recorded a valuation allowance for the tax benefit related to the net operating
losses for 1997 and 1996. The Company had net operating tax loss carryforwards
of $23.7 million at December 31, 1997.
YEAR ENDED DECEMBER 31, 1996 COMPARED WITH YEAR ENDED DECEMBER 31, 1995
Net sales increased 45.2% to $33.3 million in 1996 from $22.9 million in
1995. This $10.4 million increase in net sales was attributable primarily to
increased sales of the Company's PUR household water filter products, including
the countertop and pitcher models which were introduced in 1996, as well as a
full year's sales of OEM water filters to Braun AG. Sales of household products,
including OEM water filters, increased 163.7% to $22.1 million in 1996 from $8.4
million in 1995. This increase was partially offset by a decline in sales of
reverse osmosis desalinators due to lower military sales. Price increases did
not have a significant impact on net sales for 1996 and 1995.
Gross profit as a percentage of sales decreased to 37.6% in 1996 from 39.1%
in 1995. The decrease in gross profit as a percentage of sales in 1996 was
primarily the result of costs associated with entering the household water
filter market, including investments made by the Company in automating its
manufacturing and assembly processes and the cost of conducting manual assembly
operations pending the installation of such automated processes, as well as the
full year impact of OEM filter sales, which had relatively lower profit margins.
Selling, general and administrative expenses increased to $21.8 million in
1996 from $14.7 million in 1995, representing 65.5% and 64.1% of net sales,
respectively. The increase in selling, general and administrative expenses
related primarily to the continued roll-out and expansion of the household water
systems in 1996. Advertising costs increased to $9.5 million in 1996 from $6.4
million in 1995, and accounted for 44.6% of the increase in selling, general and
administrative expenses in 1996 relative to 1995.
Research and development expenses were $2.0 million in each of 1996 and
1995, representing 6.0% and 8.8% of net sales, respectively.
Interest income decreased to $220,000 in 1996 from $551,000 in 1995, due to
decreased balances of cash, cash equivalents and marketable securities. Interest
expense increased to $457,000 in 1996 from $126,000 in 1995 due to interest on
long-term debt issued by the Company in July 1996.
The Company's effective tax rate for 1996 was 0%, compared with 35.0% in
1995. The Company recorded a valuation allowance for the tax benefit related to
the 1996 net operating loss.
SELECTED QUARTERLY FINANCIAL DATA
The following table sets forth certain unaudited quarterly financial data
of the Company for each quarter in calendar year 1996 and 1997. The quarterly
data are derived from the Company's unaudited financial statements not otherwise
contained in this Prospectus. The Company believes that such unaudited
statements include all adjustments (consisting solely of normal recurring
adjustments) necessary for a fair presentation of such quarterly information.
The operating results for any quarter are not necessarily indicative of the
results of the full year or any future quarter.
18
<PAGE>
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1996
---------------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Net sales ........................ $ 6,440 $ 6,598 $ 11,001 $ 9,238
Gross profit ..................... 2,454 2,522 4,239 3,306
Gross profit margin .............. 38.1% 38.2% 38.5% 35.8%
Net income (loss) ................ (1,921) (1,722) (2,916) (5,940)
Net income (loss) per common share
(Basic and Diluted) ............. $ (0.45) $ (0.40) $ (0.67) $ (1.37)
</TABLE>
<TABLE>
<CAPTION>
1997
---------------------------------------------------------------------
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Net sales ........................ $ 10,347 $ 15,462 $ 22,371 $ 23,063
Gross profit ..................... 4,155 7,001 10,581 12,089
Gross profit margin .............. 40.2% 45.3% 47.3% 52.4%
Net income (loss) ................ (1,898) (1,492) (448) 383
Net income (loss) per common share
(Basic and Diluted) ............. $ (0.44) $ (0.33) $ (0.10) $ 0.08
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operations was $8.6 million in 1997, $5.7 million in 1996, and
$8.1 million in 1995. The reduction in cash flow from operations in 1997
resulted primarily from the net loss and increases in inventories and accounts
receivable. Cash used in operations in 1996 was primarily the result of the net
loss and an increase in accounts receivable. In 1995, the reduction in cash flow
from operations resulted primarily from the net loss and increased inventory
levels. In 1997 and 1996, the decrease in cash flow was partially offset by
increases in accounts payable and accrued liabilities.
Capital expenditures were $6.3 million in 1997 compared with $4.1 million
in 1996 and $4.6 million in 1995. The Company anticipates that capital
expenditures in 1998, principally associated with new product introductions and
an increase in production capacity, will total approximately $8.6 million.
In the past three years the Company has funded its cash requirements
principally with proceeds from the sale of securities and borrowings under
credit facilities with a bank. In June 1994, the Company received net proceeds
of approximately $12.0 million from a public offering of Common Stock. In July
1996, the Company issued $15.0 million of Convertible Notes to GS Group. The
Convertible Notes bear interest at an annual rate of five percent, payable
quarterly, and are due in July 2003. GS Group has the right to convert the
principal amount of the Convertible Notes to Common Stock at any time prior to
maturity at a conversion price of $14.85 per share.
The Company had $7.2 million outstanding under its bank credit facility at
December 31, 1997, compared with no bank borrowings at December 31, 1996. The
credit facility, established in March 1997 and amended in March 1998, provides
for total borrowings of up to $25.0 million, secured by equipment, inventory,
receivables, and intangibles. The credit facility consists of a $15.0 million
discretionary working capital line of credit, limited to eligible receivables
and inventory, which bears interest at the bank's reference rate plus 0.75%, and
a $10.0 million equipment loan which bears interest at the bank's reference rate
plus 1.25%. Borrowings under the equipment loan are made in increments of $2.0
million and are payable over a 48-month period commencing the first full month
following each separate advance. Other borrowings under the credit facility are
due on demand. Pursuant to the Company's agreement with GS Group, borrowings
under the bank credit facility were limited to $10.0 million in 1997 and are
limited to $12.5 million in 1998. However, the Company received waivers from GS
Group allowing it to borrow up to $14.0 million under the credit facility during
the fourth quarter of 1997 and up to $16.0 million in 1998.
Management believes that anticipated cash flows from operations, funds
available through its bank credit facility and the net proceeds from this
offering will provide sufficient capital resources for current operations and
planned product introductions through 1999. The Board of Directors currently
intends to retain all earnings for expansion of the Company's business.
19
<PAGE>
The Company had recorded $1.6 million of net deferred tax assets at
December 31, 1997 resulting from net operating loss carryforwards and the tax
effects of temporary differences between tax bases and financial statement
carrying amounts of existing assets and liabilities. Realization of the future
tax benefits related to the net deferred tax assets is dependent on many
factors, including the Company's ability to generate taxable income within the
net operating loss carryforward period. Management believes that, at a minimum,
it is more likely than not that future taxable income over the next three years
will be sufficient to realize the recorded asset.
At December 31, 1997, the Company had net operating tax loss carryforwards
available to offset future taxable income of approximately $23.7 million. The
net operating loss carryforwards expire as follows: $5.0 million in year 2010,
$11.5 million in 2011 and $7.2 million in 2012, and may be subject to
limitations under Section 382 of the Internal Revenue Code due to changes in
equity ownership of the Company.
ACCOUNTING STATEMENTS
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
No. 128, EARNINGS PER SHARE. Statement 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to Statement 128
requirements.
In 1997, the FASB issued Statements No. 130, REPORTING COMPREHENSIVE
INCOME, and No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, effective for fiscal years beginning after December 15, 1997. The
adoption by the Company of these Statements in January 1998 is not expected to
have a material impact on the Company's financial statements.
YEAR 2000 ISSUES
Many existing computer programs use only two digits to identify a year in
the date field, with the result that data referring to the year 2000 and
subsequent years may be misinterpreted by these programs. If present in the
computer applications of the Company or its suppliers and customers and not
corrected, this problem could cause computer applications to fail or to create
erroneous results and could cause a disruption in operations and have a
short-term adverse effect on the Company's business and results of operations.
The Company has evaluated its principal computer systems and has determined that
they are substantially Year 2000 compliant. The Company has initiated
discussions with its key suppliers and customers to determine whether they have
any Year 2000 issues. The Company has not incurred any material expenses to date
in connection with this evaluation and does not anticipate material expenses in
the future, depending on the status of its suppliers and customers with respect
to this issue.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements are included in a separate section of
this Report, beginning at page F-1.
Quarterly Results of Operations Information is included in Management's
Discussion and Analysis of Financial Condition and Results of Operations (Item
7) in this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
20
<PAGE>
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH COMPANY
- ------------------------------------ ----- -------------------------------------------
<S> <C> <C>
Brian F. Sullivan ............... 36 President, Chief Executive Officer
and Director
Jeffrey T. Dekko ................ 31 Vice President -- Marketing
Richard D. Hembree .............. 45 Vice President -- Engineering
Charles F. Karpinske ............ 43 Vice President and Chief Financial Officer
Sally S. Mainquist .............. 42 Vice President -- Manufacturing
Barry B. Van Lerberghe .......... 36 Vice President -- Sales
Robert R. Gheewalla ............. 30 Director
John E. Gherty .................. 54 Director
Sanjay H. Patel ................. 37 Director
William D. Thompson ............. 76 Director
William F. Wanner, Jr. .......... 55 Director
Ronald W. Weber ................. 69 Director
Richard J. Zeckhauser ........... 57 Director
</TABLE>
BRIAN F. SULLIVAN has been the President and Chief Executive Officer and a
director of the Company since its inception in 1986, and also served as Chief
Financial Officer of the Company from 1986 to 1994. Mr. Sullivan has established
and directed the implementation of the Company's strategic direction since its
inception. He has led the Company from the development stage through its initial
contracts with the United States armed forces, the introduction of reverse
osmosis desalinators and portable drinking water systems, and the development
and introduction of the Company's household drinking water systems. Mr. Sullivan
is named as an inventor on four United States patents held by the Company. Mr.
Sullivan is also a director of North Central Life Insurance Company.
JEFFREY T. DEKKO has served as Vice President -- Marketing of the Company
since July 1995. Mr. Dekko served as Vice President of Recreational Products
for the Company from October 1994 to July 1995. Mr. Dekko directs the Company's
marketing efforts in the consumer household water products category. From 1988
to October 1994, Mr. Dekko was marketing manager for General Mills, Inc.
RICHARD D. HEMBREE has served as chief engineer of the Company since 1986
and Vice President -- Engineering since 1987. Mr. Hembree has been principally
responsible for the development of new technologies incorporated into the
Company's products. Mr. Hembree is named as an inventor on eight United States
patents held by the Company. From 1983 to 1986, Mr. Hembree was a senior design
engineer at Seagold Industries Corporation, a manufacturer of desalinators,
where he designed several energy recovery pumps and was engaged in the design
and development of manual desalinators and hydraulic energy recovery devices.
CHARLES F. KARPINSKE has served as the Company's Vice President and Chief
Financial Officer since February 1996. Prior to joining the Company, Mr.
Karpinske served as Vice President of Operations and Chief Financial Officer of
Goretek Data Systems, a software development company, from April 1995 to
February 1996. From August 1993 to March 1995, Mr. Karpinske was the Chief
Operating Officer and Chief Financial Officer for Decision Data, a manufacturer
and distributor of computer equipment. From October 1986 to July 1993, Mr.
Karpinske worked for Apertus Technologies (formerly Lee Data), a manufacturer
and distributor of computer equipment, serving in a number of financial
positions including Chief Financial Officer, Vice President of Finance and
Administration and Corporate Controller.
SALLY S. MAINQUIST has served as Vice President -- Manufacturing of the
Company since March 1994. Ms. Mainquist directs the Company's manufacturing
operations and is responsible for establishing automated manufacturing processes
for the Company's household drinking water systems. From 1982 to February 1994,
Ms. Mainquist served in various positions with Graco Inc., a manufacturer of
fluid handling equipment, most recently as a factory operations manager.
21
<PAGE>
BARRY B. VAN LERBERGHE has served as Vice President -- Sales of the Company
since July 1995. Prior to joining the Company, Mr. Van Lerberghe was Western
Regional Manager for Sunbeam Household Products from 1992 to 1995, and District
Sales Manager for Polaroid Corporation from 1988 to 1992.
ROBERT GHEEWALLA has been a director of the Company since February 1998.
Mr. Gheewalla has been an Associate in the Principal Investment Area of
Goldman, Sachs & Co. since 1994. From 1989 to 1994, he worked in the Global
Finance Department of Goldman, Sachs & Co. Mr. Gheewalla also serves on the
Advisory Committees or Boards of Directors of Marcus Cable Co., L.P. and North
American Railnet, Inc.
JOHN E. GHERTY has been a director of the Company since 1988. Mr. Gherty
has been President and Chief Executive Officer of Land O' Lakes, Inc., a food
and agricultural company, since 1989 and prior thereto was Group Vice President
and Chief Administrative Officer of Land O' Lakes, Inc. Mr. Gherty is also a
director of CF Industries, Inc., the National Parenting Association, the
National Council of Farmer Cooperatives and the Minnesota Business Partnership.
SANJAY H. PATEL has been a director of the Company since July 1996. Mr.
Patel is expected to join Greenwich Street Capital Partners as a managing
director in April 1998. Mr. Patel was a Managing Director in the Principal
Investment Area of Goldman, Sachs & Co. from 1996 to January 1998, and worked
in the Leveraged Buyout Group of Goldman, Sachs & Co. from 1987 to 1996. Mr.
Patel is also a director of Stirling Cooke Brown Holdings Limited.
WILLIAM D. THOMPSON has been a director of the Company since December
1995. Mr. Thompson served as Executive Vice President of the New York City
advertising firm of Young & Rubicam, Inc. until his retirement in 1989. During
37 years of service for Young & Rubicam, Mr. Thompson oversaw accounts for
numerous companies, including General Foods, Merrill Lynch, General Electric,
Warner-Lambert, Bristol-Meyers Squibb, and Johnson & Johnson.
WILLIAM F. WANNER, JR. has been a director of the Company since its
inception in 1986. Mr. Wanner served as Chairman of the Board of the Company
from 1986 to 1994. Since 1973, Mr. Wanner has been the Chief Executive Officer
and principal shareholder of Wanner Engineering, Inc. and its affiliated
companies, which design, produce and market a range of high pressure pumps and
controls.
RONALD W. WEBER has been a director of the Company since 1993. Mr. Weber
has been President and Chief Executive Officer of Normark Corporation, a
distributor of fishing and sporting equipment, since 1959. Mr. Weber is also a
director of Rapala Oy, a manufacturer of fishing and sporting equipment.
RICHARD J. ZECKHAUSER has been a director of the Company since 1987. Dr.
Zeckhauser has been a professor of political economy at the John F. Kennedy
School of Government at Harvard University since 1968. Dr. Zeckhauser was a
co-founder of Niederhoffer, Cross and Zeckhauser, a New York-based investment
firm specializing in mergers and acquisitions and money management.
Directors of the Company are elected annually to serve until the next
annual meeting of shareholders. GS Group has the right to nominate one person to
serve on the Company's Board of Directors, and the Company has agreed to use its
best efforts to secure the election of such nominee to the Board of Directors.
Mr. Gheewalla serves as a director of the Company pursuant to such arrangements.
See "Item 13. Certain Relationships and Related Transactions."
22
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following Summary Compensation Table sets forth certain information
regarding compensation of the Chief Executive Officer and each of the other
executive officers of the Company for the years ended December 31, 1997, 1996
and 1995.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL ------------------
COMPENSATION AWARDS
---------------------------- ------------------ OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS(1) OPTIONS COMPENSATION(2)
- --------------------------- -------- ------------ ------------ ------------------ ----------------
<S> <C> <C> <C> <C> <C>
Brian F. Sullivan 1997 $205,000 $150,000 -- $3,200
(President and Chief Executive 1996 150,000 -- 250,000 shares --
Officer) 1995 150,000 -- 121,500 shares --
Jeffrey T. Dekko (3) 1997 $110,000 $60,345 12,000 shares $2,575
(Vice President - Marketing) 1996 88,500 -- 14,000 shares 1,312
1995 82,000 -- 11,000 shares --
Richard D. Hembree 1997 $112,000 $49,164 10,000 shares $2,382
(Vice President - Engineering) 1996 99,900 -- -- 1,996
1995 82,000 -- 45,000 shares --
Charles F. Karpinske (4) 1997 $140,000 $64,280 40,000 shares $3,023
(Vice President and Chief 1996 112,500 -- 25,000 shares --
Financial Officer) 1995 N/A N/A N/A N/A
Sally S. Mainquist 1997 $107,000 $47,304 10,000 shares $2,191
(Vice President - 1996 99,000 -- 20,000 shares 1,974
Manufacturing) 1995 82,000 -- -- --
Barry B. Van Lerberghe (5) 1997 $110,000 $57,020 12,000 shares $2,491
(Vice President - Sales) 1996 96,300 -- 13,000 shares 2,140
1995 41,885 -- 12,000 shares 39,440(6)
</TABLE>
- -----------------
(1) The executive officers of the Company are eligible to earn annual cash
bonuses tied to the level of achievement of annual performance targets.
(2) Represents the Company's matching contribution under its 401(k) Retirement
Savings Plan, unless otherwise indicated.
(3) Mr. Dekko and Mr. Van Lerberghe became executive officers of the Company in
April 1997.
(4) Mr. Karpinske's employment with the Company commenced in February 1996.
(5) Mr. Van Lerberghe's employment with the Company commenced in July 1995.
(6) Represents relocation costs in connection with the hiring of Mr. Van
Lerberghe.
AGREEMENTS WITH EXECUTIVES
The Company, certain investment partnerships affiliated with The Goldman
Sachs Group, L.P. ("GS Group"), and Brian F. Sullivan entered into an Executive
Restriction Agreement, dated July 19, 1996, in connection with the Company's
sale of Convertible Notes to the GS Group. See "Certain Transactions."
The Company and Charles F. Karpinske entered into an Executive Severance
Pay Agreement, dated March 24, 1997, which provides that if Mr. Karpinske's
employment with the Company is terminated within 24 months following a "change
in control" of the Company, other than termination for cause, voluntary
termination by Mr. Karpinske, or termination on account of death or disability,
the Company will pay to Mr. Karpinske an amount equal to two times his average
annual compensation, including bonus, for the three-year period ending in the
year in which his employment terminates, will provide continued coverage under
the Company's insurance programs, and will pay him an amount equal to the
difference between the aggregate fair market value of shares subject to stock
options which are forfeited or become unexercisable as a result of his
termination of employment,
23
<PAGE>
and the aggregate exercise price of such options. For these purposes, a "change
in control" means (i) the dissolution or liquidation of the Company, or a
merger, consolidation or other corporate reorganization in which the Company is
not the surviving party; (ii) the sale of all or substantially all of the
business or assets of the Company; (iii) the acquisition by any person of
securities representing more than 25% of the voting power of the Company's
outstanding securities; or (iv) individuals who constitute the Board of
Directors at the beginning of any two-year period ceasing to constitute at least
a majority of the Board of Directors, unless each new director is approved by a
two-thirds vote of the directors then in office who were directors at the
beginning of such period.
RETIREMENT SAVINGS PLAN
The Company maintains a profit sharing and savings plan (the "401(k)
Plan") under Section 401(k) of the Internal Revenue Code of 1986, as amended
(the "Code"), which allows employees to contribute up to 15% of their pre-tax
income to the 401(k) Plan. The 401(k) Plan includes a discretionary matching
contribution by the Company and provides that the Company may make an additional
discretionary contribution out of profits at the end of any year. The Company
made discretionary matching contributions of $98,000, $61,000 and $34,000 for
1997, 1996 and 1995, respectively. No additional discretionary contributions
were made by the Company for 1997, 1996 or 1995.
STOCK OPTIONS
Since its inception, the Company has utilized stock and stock options to
provide incentives and rewards to its employees and directors. The Recovery
Engineering, Inc. 1986 Stock Option Plan (the "1986 Option Plan") permits the
granting of awards to directors and employees of the Company in the form of
stock options. Stock options granted under the 1986 Option Plan may be
"incentive stock options" meeting the requirements of Section 422 of the Code or
non-qualified options which do not meet the requirements of Section 422. At
December 31, 1997, options for an aggregate of 21,650 shares were outstanding
under the 1986 Plan. The outstanding options are presently exercisable with
respect to 15,950 shares. No additional options may be granted under the 1986
Plan.
The Recovery Engineering, Inc. 1994 Stock Option and Incentive Plan (the
"1994 Plan") permits the granting of awards to employees, consultants and other
service providers in the form of incentive stock options, non-qualified stock
options and grants of restricted stock. At December 31, 1997, options for an
aggregate of 875,300 shares were outstanding under the 1994 Plan, and 154,015
shares were available for grant. The outstanding stock options are presently
exercisable with respect to 278,676 shares. Awards may be granted under the 1994
Plan through January 31, 2004. The 1994 Plan may be terminated earlier by the
Board of Directors in its sole discretion.
The 1986 Option Plan and the 1994 Plan are administered by the
Compensation Committee of the Board of Directors. These Plans give broad powers
to the Committee to administer and interpret the plans, including the authority
to select the individuals to be granted awards and to prescribe the particular
form and conditions of each award granted. Awards are granted on the basis of
various factors, including the individual's capacity for contributing to the
successful performance of the Company, the nature of the operations for which
the individual is responsible, and the period for which the individual has
served or will have served the Company at the vesting of the award.
24
<PAGE>
The following table sets forth certain information regarding stock options
granted to the executive officers named in the Summary Compensation Table during
the Company's 1997 fiscal year.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
----------------------------------------------------- ANNUAL RATES OF STOCK
PERCENT OF TOTAL PRICE APPRECIATION FOR
OPTIONS GRANTED EXERCISE OPTION TERM (1)
OPTIONS TO EMPLOYEES PRICE EXPIRATION -----------------------
NAME GRANTED(#) IN FISCAL YEAR (S/Sh) DATE 5% ($) 10% ($)
- ---- ---------- ----------------- --------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Brian F. Sullivan............ -- -- -- -- -- --
Jeffrey T. Dekko............. 12,000(2) 4.8% $7.00 02/02/2007 $52,827 $133,874
Richard D. Hembree........... 10,000(2) 4.0% $7.00 02/02/2007 $44,023 $111,562
Charles F. Karpinske......... 40,000(2) 16.0% $7.00 02/02/2007 $176,090 $446,248
Sally S. Mainquist........... 10,000(2) 4.0% $7.00 02/02/2007 $44,023 $111,562
Barry B. Van Lerberghe....... 12,000(2) 4.8% $7.00 02/02/2007 $52,827 $133,874
</TABLE>
- ----------------
(1) Represents the potential net realizable value of each grant of options
assuming that the market price of the underlying common stock appreciates
in value from its fair market value on the date of grant to the end of the
option term at the indicated annual rates.
(2) Each option was granted on February 2, 1997 and vests with respect to 25%
of the option shares on the first, second, third and fourth anniversaries
of the grant date.
The following table sets forth certain information regarding the number
and value of unexercised stock options held by the executive officer named in
the Summary Compensation Table as of the end of the Company's fiscal year ended
December 31, 1997.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT YEAR-END(#) AT YEAR-END($)(1)
ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE / UNEXERCISABLE EXERCISABLE / UNEXERCISABLE
- ---- ------------ ----------- --------------------------- ---------------------------
<S> <C> <C> <C> <C>
Brian F. Sullivan........ 199,000 $771,125(2) 121,500 / 250,000 $1,275,750 / $2,625,000
Jeffrey T. Dekko......... -- -- 14,750 / 22,250 $231,313 / $380,438
Richard D. Hembree....... -- -- 41,250 / 18,750 $612,188 / $291,563
Charles F. Karpinske..... -- -- 22,500 / 42,500 $371,875 / $721,875
Sally S. Mainquist....... 200 $3,075(3) 19,800 / 17,500 $291,500 / $275,000
Barry B. Van Lerberghe... -- -- 12,250 / 24,750 $194,875 / $413,625
</TABLE>
- ----------------
(1) Based on the difference between the December 31, 1997 closing price of
$24.50 per share as reported on the Nasdaq National Market and the exercise
price of the options.
(2) Based on the difference between the closing price of $6.375 per share on
April 21, 1997, the date of exercise, as reported on the Nasdaq National
Market and the exercise price of the options.
(3) Based on the difference between the closing price of $25.50 per share on
November 13, 1997, the date of exercise, as reported on the Nasdaq National
Market and the exercise price of the option.
Mr. Sullivan's options that are not currently exercisable will become
exercisable in 2005 and may become exercisable earlier if certain sales and
income objectives established by the Compensation Committee are achieved by the
Company. In addition, the options will become exercisable if Mr. Sullivan's
employment with the Company is terminated by reason of his death or disability,
or within 24 months following a "change in
25
<PAGE>
control" of the Company. For these purposes, a "change in control" means (i) the
dissolution or liquidation of the Company, or a merger, consolidation or other
corporate reorganization in which the Company is not the surviving party; (ii)
the acquisition by any person, other than Wanner Engineering, Inc., of
securities representing more than 50% of the voting power of the Company's
outstanding securities; or (iii) individuals who constitute the Board of
Directors at the beginning of any two-year period ceasing to constitute at least
a majority of the Board of Directors, unless each new director is approved by a
two-thirds vote of the directors then in office who were directors at the
beginning of such period.
DIRECTOR STOCK OPTION PLAN
The Company's 1993 Director Stock Option Plan (the "Director Option Plan")
was adopted by the Board of Directors in 1993 and approved by the shareholders
of the Company in 1994. The Director Option Plan provides for the automatic
granting of an option for shares of common stock to each non-employee director
of the Company on the date of his or her initial election or appointment as a
director, and additional options on the date of each annual meeting of
shareholders at which the director is reelected by the shareholders. The number
of shares covered by such options was 1,000 shares per grant through 1996, and
4,000 shares per grant for 1997 and subsequent years. The exercise price of
options granted under the Director Option Plan is equal to 85% of the fair
market value of the Common stock on the date of grant. A total of 100,000 shares
of the Company's common stock has been reserved for issuance pursuant to options
granted under the Director Option Plan. At December 31, 1997, options for an
aggregate of 49,000 shares were outstanding under the Director Option Plan, and
51,000 shares were available for grant. All of the outstanding options are
presently exercisable.
EMPLOYEE STOCK PURCHASE PLAN
In 1994, the Company's 1994 Stock Purchase Plan was adopted by the Board
of Directors and approved by the shareholders of the Company. The Stock Purchase
Plan permits eligible employees to make voluntary contributions through payroll
deductions, to be used to purchase stock from the Company on a monthly basis at
a price equal to 85% of the fair market value of a share of common stock on the
purchase date. An aggregate of 100,000 shares has been reserved for issuance
under the Stock Purchase Plan. The number of shares that an employee may
purchase under the Stock Purchase Plan may not exceed 500 shares during any
calendar year, and the aggregate purchase price of shares purchased by any
employee under the Stock Purchase Plan may not exceed $10,000 during any
calendar year. The Company issued 9,501 shares, 6,874 shares and 5,312 shares
under the Stock Purchase Plan in 1997, 1996 and 1995, respectively.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS
Decisions and recommendations regarding compensation paid to the Company's
executive officers in 1997 were made by a Compensation Committee consisting of
John E. Gherty and William F. Wanner, Jr., each of whom is a non-employee
director of the Company. Brian F. Sullivan, the only executive officer of the
Company who serves on the Board of Directors, abstains from voting on
compensation matters affecting his compensation.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The Company's directors, executive officers and any persons holding more
than 10% of the outstanding Common Stock of the Company are required to file
with the Securities and Exchange Commission reports concerning their initial
ownership of Common Stock and any subsequent changes in such ownership. The
Company believes that during 1997 the filing requirements were satisfied on a
timely basis by all such persons, except as follows: Initial reports of
beneficial ownership by Mr. Dekko and Mr. Van Lerberghe were not timely filed;
and one transaction by Mr. Hembree and one transaction by Mr. Thompson were not
reported on a timely basis. In making this disclosure, the Company has relied
solely on written representations of its directors, officers and beneficial
owners of more than 10% of the Common Stock and copies of the reports they have
filed with the Securities and Exchange Commission and furnished to the Company.
26
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of December 31, 1997,
regarding the beneficial ownership of shares of Common Stock of the Company by
each director and executive officer of the Company, by all directors and
executive officers of the Company as a group, and by each shareholder known by
the Company to own beneficially more than five percent (5%) of the outstanding
shares of the Company's Common Stock. Unless otherwise noted, each person or
group identified possesses sole voting and investment power with respect to such
shares.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED(1) OUTSTANDING SHARES(2)
- ------------------------------------ --------------------- ---------------------
<S> <C> <C>
Certain investment funds affiliated with
The Goldman Sachs Group, L.P. (3).................. 1,015,101 18.2%
85 Broad Street
New York, NY 10004
Investment Advisers, Inc. (4)........................ 620,300 13.6%
3700 First Bank Place
Minneapolis, MN 55440
Wanner Engineering, Inc. (5)......................... 596,100 13.1%
1204 Chestnut Avenue
Minneapolis, MN 55403
US Trust Company of New York (6)..................... 370,036 8.1%
114 West 47th Street
New York, NY 10036
Nevis Capital Management, Inc. (7)................... 311,300 6.8%
1119 St. Paul Street
Baltimore, MD 21202
DIRECTORS AND EXECUTIVE OFFICERS:
Brian F. Sullivan (8) (9)............................ 530,000 11.3%
Jeffrey T. Dekko (8)................................. 15,263 *
Richard D. Hembree (8)............................... 72,150 1.6%
Charles F. Karpinske (8)............................. 22,500 *
Sally S. Mainquist (8)............................... 20,615 *
Barry B. Van Lerberghe (8)........................... 16,050 *
Robert R. Gheewalla (10)............................. -- *
John E. Gherty (8)(11)............................... 56,451 1.2%
Sanjay H. Patel (8)(12).............................. 5,700 *
William D. Thompson (8).............................. 21,000 *
William F. Wanner, Jr. (8)(13)....................... 660,150 14.5%
Ronald W. Weber (8).................................. 28,000 *
Richard J. Zeckhauser (8)(14)........................ 92,500 2.0%
All directors and executive officers as a group
(13 persons, including those named above) (8)...... 1,540,379 31.9%
</TABLE>
- ----------------------
* Less than one percent.
(1) Each person has sole voting and sole power with respect to all outstanding
shares, except as noted.
(2) Based on 4,548,249 shares outstanding at December 31, 1997. Such amount
does not include 2,094,051 shares of Common Stock issuable upon exercise of
stock options and warrants or conversion of Convertible Notes outstanding
27
<PAGE>
at December 31, 1997. Each figure showing the percentage of outstanding
shares owned beneficially has been calculated by treating as outstanding
and owned the shares which could be purchased by the indicated person(s)
within 60 days upon the exercise of existing stock options or the
conversion of the Convertible Notes.
(3) Reflects information included on a Schedule 13D, dated October 1, 1997,
filed with the Securities and Exchange Commission by certain investment
partnerships, of which affiliates of The Goldman Sachs Group, L.P. ("GS
Group") are the general partner, managing general partner, managing partner
or investment manager. Includes (i) 1,010,101 shares which may be acquired
upon the conversion of Convertible Notes owned by the investment
partnerships, and (ii) 5,000 shares subject to options held for the benefit
of the GS Group by Mr. Patel (see Notes 8 and 12). Includes Convertible
Notes held of record by GS Capital Partners II, L.P., currently convertible
into 633,766 shares, Convertible Notes held of record by GS Capital
Partners II Offshore, L.P., currently convertible into 251,948 shares,
Convertible Notes held of record by Stone Street Fund 1996, L.P., currently
convertible into 60,191 shares, Convertible Notes held of record by Bridge
Street Fund 1996, L.P. , currently convertible into 40,819 shares, and
Convertible Notes held of record by Goldman, Sachs & Co. Verwaltungs GmbH,
currently convertible into 23,377 shares. Does not include up to 367,309
aggregate shares of Common Stock in respect of certain reset rights held by
the investment partnerships. GS Group disclaims beneficial ownership of the
shares owned by such investment partnerships to the extent attributable to
partnership interests therein held by persons other than GS Group and its
affiliates. Each of such investment partnerships shares voting and
investment power with certain of its respective affiliates.
(4) Reflects information as of December 31, 1997, based on a Schedule 13G,
dated January 30, 1998, filed by such company with the Securities and
Exchange Commission, which indicates that the shareholder has sole voting
power and sole dispositive power with respect to 464,500 shares and shared
voting power and shared dispositive power with respect to 155,800 shares.
(5) Mr. Wanner, a director of the Company, is a director, officer and principal
shareholder of Wanner Engineering, Inc. Such shares are also included in
the shares beneficially owned by Mr. Wanner.
(6) Reflects information as of December 31, 1997, based on a Schedule 13G,
dated February 6, 1998, filed by such company with the Securities and
Exchange Commission, which indicates that the shareholder has shared voting
power and shared dispositive power with respect to said shares.
(7) Reflects information as of December 31, 1996, based on a Schedule 13G,
dated February 12, 1997, filed by such company with the Securities and
Exchange Commission, which indicates that the shareholder has sole voting
power and sole dispositive power with respect to said shares.
(8) Includes shares which could be purchased within 60 days upon the exercise
of stock options as follows: Mr. Sullivan, 121,500 shares; Mr. Dekko,
14,750 shares; Mr. Hembree, 41,250 shares; Mr. Karpinske, 22,500 shares;
Ms. Mainquist, 19,800 shares, Mr. Van Lerberghe, 12,250 shares; Mr. Gherty,
9,000 shares; Mr. Patel, 5,000 shares; Mr. Thompson, 6,000 shares; Mr.
Wanner, 10,000 shares; Mr. Weber, 8,000 shares; Dr. Zeckhauser, 8,500
shares; and all directors and executive officers as a group, 278,550
shares.
(9) Mr. Sullivan's address is 9300 North 75th Avenue, Minneapolis, MN 55428.
(10) Does not include securities that may be deemed to be beneficially owned by
GS Group (see Note 3). Mr. Gheewalla, a director of the Company, is an
associate of Goldman, Sachs & Co., the investment manager for certain of
the investment partnerships. Mr. Gheewalla disclaims beneficial ownership
of such securities.
(11) Includes 10,701 shares held by Mr. Gherty as custodian for his minor
children.
(12) Includes 5,000 shares subject to options held for the benefit of GS Group
with which Mr. Patel was previously associated. Mr. Patel disclaims
beneficial ownership of such securities.
(13) Includes 2,200 shares held by Mr. Wanner as trustee for members of his
family and 596,100 shares owned by Wanner Engineering, Inc., of which Mr.
Wanner is a director, officer and principal shareholder.
(14) Includes 25,000 shares owned by Dr. Zeckhauser's wife. Dr. Zeckhauser,
having no voting or dispositive powers with respect to such shares,
disclaims beneficial ownership of such shares.
28
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On July 19, 1996, the Company entered into a Securities Purchase Agreement
with five investment partnerships affiliated with GS Group, L.P. ("GS Group"),
pursuant to which the Company issued to GS Group $15 million principal amount of
its 5% Convertible Notes Due 2003 (the "Convertible Notes"). The Convertible
Notes are convertible into shares of the Company's common stock at a conversion
price of $14.85 per share, subject to customary anti-dilution provisions. The
Convertible Notes may be converted to common stock at any time at the option of
GS Group or, if certain conditions are satisfied, after January 18, 2000 by the
Company. The Convertible Notes bear interest at the rate of 5% per annum,
payable quarterly on March 31, June 30, September 30, and December 31 in each
year, commencing September 30, 1996, until the principal of the Convertible
Notes becomes due and payable. The principal amount of the Convertible Notes is
due and payable on July 18, 2003. The Convertible Notes may be prepaid in whole
or in part at any time by the Company, without penalty, provided that if less
than the entire indebtedness evidenced by the Convertible Notes is to be prepaid
by the Company, it must offer to repay the Convertible Notes pro rata from each
holder thereof.
Under the Securities Purchase Agreement, for so long as at least 25% of
the initial amount of Convertible Notes remain outstanding and GS Group holds at
least a majority of the outstanding Convertible Notes, at each meeting for the
election of directors of the Company, the Company is to use its best efforts to
cause to be elected to, and maintained as a member of, the Company's Board of
Directors, one person designated by GS Group. The representative is to be a
member of the Company's executive and finance committees, if any, or any other
committee performing substantially similar functions and, upon request by the
representative, any other committee of the Board of Directors. The Company has
also agreed that if, at any time, GS Group does not have a representative on the
Company's Board of Directors, GS Group will be entitled to have an observer
present at all meetings of the Company's Board. Robert R. Gheewalla currently
serves as a director of the Company as the designee of GS Group.
In connection with the sale of the Convertible Notes, the Company, GS
Group and Brian F. Sullivan entered into an Executive Restriction Agreement,
dated July 19, 1996. The Executive Restriction Agreement prohibits, subject to
certain exceptions, Mr. Sullivan's sale of common stock of the Company until
July 19, 1998. After that date, Mr. Sullivan may not sell or otherwise transfer
in any transaction more than 25% of the common stock (including shares subject
to stock options) which he held as of July 19, 1996 unless the holders of the
Convertible Notes are allowed to participate in such sale on a pro rata basis.
Under the Executive Restriction Agreement, Mr. Sullivan also has agreed to
refrain from competing with the Company for three years after (i) his employment
with the Company is terminated for cause or (ii) he resigns from the Company
other than for good reason (as defined in the Executive Restriction Agreement).
In April 1997, Brian F. Sullivan exercised stock options for an aggregate
of 199,000 shares of Common Stock, and paid the exercise price of the options by
delivering to the Company a Promissory Note in the principal amount of $497,500.
The Note bears interest at the rate of 9.25% per annum, and matures on June 30,
1999.
29
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) THE FOLLOWING DOCUMENTS ARE FILED AS PART OF THE REPORT:
1. FINANCIAL STATEMENTS.
The following financial statements of Recovery Engineering, Inc. are
included as a separate section of this Report, beginning at page F-1:
Report of Independent Auditors
Balance sheets as of December 31, 1996 and 1997
Statements of Operations for the Years ended December 31, 1995, 1996
and 1997
Statements of Cash Flows for the Years ended December 31, 1995, 1996
and 1997
Statement of Changes in Shareholders' Equity for the Years ended
December 31, 1995, 1996 and 1997
Notes to Financial Statements
2. FINANCIAL STATEMENT SCHEDULES.
The following schedule supporting financial statements for the three
years ended December 31, 1997 is filed herewith:
Schedule II - Valuation and Qualifying Accounts.
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable and therefore
have been omitted.
3. LISTING OF EXHIBITS.
EXHIBIT
NO. DESCRIPTION
3.1 Articles of Incorporation of Recovery Engineering, Inc.
3.2 Bylaws of Recovery Engineering, Inc.
4.1 Rights Agreement dated as of January 30, 1996 between
Recovery Engineering, Inc. and Norwest Bank Minnesota,
National Association, as Rights Agent
4.1.1 Amendment No. 1 dated as of February 3, 1998 to Rights
Agreement between Recovery Engineering, Inc. and Norwest
Bank Minnesota, National Association, as Rights Agent
10.1 * Recovery Engineering, Inc. 1986 Stock Option Plan, as
amended
10.2 * Recovery Engineering, Inc. 1993 Director Stock Option Plan
10.3 * Recovery Engineering, Inc. 1994 Stock Purchase Plan
10.4 * Recovery Engineering, Inc. 1994 Stock Option and Incentive
Plan
10.5 Supplier Agreement dated November 25, 1996, between
Thermotech and Recovery Engineering, Inc.
10.6 Form of Distributor Agreement
10.7 Financing Agreement dated March 31, 1997 between Recovery
Engineering, Inc. and First Bank National Association
10.7.1 First Amendment to Financing Agreement dated March 16,
1998 between Recovery Engineering, Inc. and First Bank
National Association
10.8 Securities Purchase Agreement dated July 19, 1996 by and
among Recovery Engineering, Inc. and investment partnerships
affiliated with The Goldman Sachs Group, L.P. ("GS Group")
10.9 Registration Rights Agreement dated July 19, 1996 by and
among Recovery Engineering, Inc. and GS Group
10.10 * Executive Restriction Agreement dated July 19, 1996 by and
among Recovery Engineering, Inc., GS Group and Brian F.
Sullivan
10.11 * Executive Severance Pay Agreement dated March 24, 1997
between Recovery Engineering, Inc. and Charles F. Karpinske
30
<PAGE>
10.12 Lease Agreement dated November 8, 1996 between Ryan
Companies US, Inc. and Recovery Engineering, Inc.
10.12.1 First Amendment to Lease dated December 20, 1996, between
Ryan Companies US, Inc. and Recovery Engineering, Inc.
10.12.2 Second Amendment to Lease dated May 1, 1997, between Ryan
Recovery, LLC and Recovery Engineering, Inc.
10.12.3 Third Amendment to Lease dated December 22, 1997, between
Ryan Recovery, LLC and Recovery Engineering, Inc.
21.1 Subsidiary of Recovery Engineering, Inc.
23.1 Consent of Ernst & Young LLP
27.1 Financial Data Schedule
- -------------
* Management Contracts
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1997.
31
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized.
RECOVERY ENGINEERING, INC.
Date: April 2, 1998 By /s/ Brian F. Sullivan
--------------------------------------
Brian F. Sullivan
Chairman and Chief Executive Officer
32
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Auditors ............................................... F-2
Balance Sheets as of December 31, 1996 and 1997 .............................. F-3
Statements of Operations for the Years Ended December 31, 1995, 1996 and 1997 F-4
Statements of Cash Flows for the Years Ended December 31, 1995, 1996 and 1997 F-5
Statements of Changes in Shareholders' Equity for the Years Ended
December 31, 1995, 1996 and 1997 ............................................ F-6
Notes to Financial Statements ................................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Recovery Engineering, Inc.
We have audited the accompanying balance sheets of Recovery Engineering,
Inc. as of December 31, 1996 and 1997, and the related statements of operations,
changes in shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. Our audit also included the financial
statement schedule listed in the index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule 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 statement presentation. 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 Recovery Engineering, Inc.
at December 31, 1996 and 1997, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
Ernst & Young LLP
Minneapolis, Minnesota
January 30, 1998
F-2
<PAGE>
RECOVERY ENGINEERING, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................ $ 5,988 $ 261
Marketable securities ................................ 1,542 --
Accounts receivable (net of allowance of $212 for 1996
and $314 for 1997) .................................. 8,109 16,236
Inventory ............................................ 4,926 7,594
Other current assets ................................. 304 1,522
--------- ---------
Total current assets .................................. 20,869 25,613
Property and equipment:
Tooling .............................................. 6,057 9,815
Equipment and fixtures ............................... 6,569 9,123
--------- ---------
12,626 18,938
Less accumulated depreciation ........................ 3,003 4,771
--------- ---------
9,623 14,167
Deferred income taxes ................................. 1,512 1,512
Patents (net of accumulated amortization) ............. 766 732
Other assets .......................................... 487 676
--------- ---------
Total assets .......................................... $ 33,257 $ 42,700
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank line of credit .................................. $ -- $ 7,161
Accounts payable ..................................... 6,483 8,336
Accrued facility relocation costs .................... 608 217
Accrued marketing expenses ........................... 861 1,781
Accrued coop advertising ............................. 1,050 2,138
Other accrued expenses ............................... 2,124 3,836
--------- ---------
Total current liabilities ............................. 11,126 23,469
Long term debt ........................................ 15,000 15,000
Commitments
Shareholders' equity:
Common stock, $.01 par value:
Authorized shares -- 100,000,000
Issued and outstanding shares 1996 -- 4,325,710 and
1997 -- 4,548,249 ................................. 43 45
Additional paid-in capital ........................... 20,313 21,364
Note receivable from sale of stock ................... -- (498)
Retained earnings (deficit) .......................... (13,225) (16,680)
--------- ---------
Total shareholders' equity ............................ 7,131 4,231
--------- ---------
Total liabilities and shareholders' equity ............ $ 33,257 $ 42,700
========= =========
</TABLE>
See accompanying notes
F-3
<PAGE>
RECOVERY ENGINEERING, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net sales ....................................... $ 22,921 $ 33,277 $ 71,243
Cost of products sold ........................... 13,959 20,756 37,417
-------- --------- --------
Gross profit .................................... 8,962 12,521 33,826
Operating expenses:
Selling, general and administrative ............ 14,692 21,803 32,815
Research and development ....................... 2,021 2,007 3,082
Facility relocation costs ...................... -- 973 --
-------- --------- --------
16,713 24,783 35,897
-------- --------- --------
Loss from operations ............................ (7,751) (12,262) (2,071)
Other income (expense):
Interest income ................................ 551 220 43
Interest expense ............................... (126) (457) (1,427)
-------- --------- --------
Loss before income taxes ........................ (7,326) (12,499) (3,455)
Income tax benefit .............................. (2,564) -- --
-------- --------- --------
Net loss ........................................ $ (4,762) $ (12,499) $ (3,455)
======== ========= ========
Net loss per share -- basic and diluted ......... $ (1.12) $ (2.90) $ (0.77)
======== ========= ========
Weighted average shares ......................... 4,239 4,307 4,471
======== ========= ========
</TABLE>
See accompanying notes
F-4
<PAGE>
RECOVERY ENGINEERING, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1995 1996 1997
------------ ------------- ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss .................................................... $ (4,762) $ (12,499) $ (3,455)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .............................. 852 1,396 1,883
Write off of leasehold improvements ........................ -- 365 --
Deferred income taxes ...................................... (1,775) -- --
Changes in operating assets and liabilities:
Accounts receivable ..................................... (207) (3,913) (8,127)
Inventory ............................................... (3,554) 1,247 (2,668)
Refundable income taxes ................................. (975) 1,177 --
Other current assets .................................... 69 80 (1,218)
Other assets ............................................ -- (487) (189)
Accounts payable ........................................ 1,489 3,571 1,853
Accrued expenses ........................................ 807 3,363 3,329
-------- --------- ---------
Net cash used in operating activities ....................... (8,056) (5,700) (8,592)
INVESTING ACTIVITIES
Purchase of marketable securities ........................... (2,511) (12,185) --
Sale of marketable securities ............................... 4,963 11,665 1,542
Purchase of investments ..................................... (614) -- --
Sale of investments ......................................... 5,116 -- --
Purchase of property and equipment .......................... (4,601) (4,117) (6,312)
Purchase of patents ......................................... (216) (166) (81)
-------- --------- ---------
Net cash (used in) provided by investing activities ......... 2,137 (4,803) (4,851)
FINANCING ACTIVITIES
Gross borrowings -- bank line of credit ..................... -- -- 52,181
Gross repayments -- bank line of credit ..................... -- -- (45,020)
Issuance of warrants ........................................ -- -- 328
Proceeds from issuance of long-term debt .................... -- 15,000 --
Note receivable from sale of stock .......................... -- -- (498)
Exercise of stock options and warrants ...................... 1,342 334 725
Common stock acquired ....................................... (45) (134) --
-------- --------- ---------
Net cash provided by financing activities ................... 1,297 15,200 7,716
-------- --------- ---------
Increase (decrease) in cash and cash equivalents ............ (4,622) 4,697 (5,727)
Cash and cash equivalents at beginning of year .............. 5,913 1,291 5,988
-------- --------- ---------
Cash and cash equivalents at end of year .................... $ 1,291 $ 5,988 $ 261
======== ========= =========
</TABLE>
See accompanying notes
F-5
<PAGE>
RECOVERY ENGINEERING, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK RETAINED
---------------------- ADDITIONAL NOTE EARNINGS
SHARES AMOUNT PAID-IN CAPITAL RECEIVABLE (DEFICIT) TOTAL
------------- -------- ----------------- ----------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1994 ...................... 4,002,414 $ 40 $18,819 $ -- $ 4,036 $ 22,895
Stock options and warrants
exercised ............................ 251,525 2 1,270 -- -- 1,272
Employee stock purchase plan .......... 5,312 -- 70 -- -- 70
Common stock acquired ................. (2,528) -- (45) -- -- (45)
Net loss for year ..................... -- -- -- -- (4,762) (4,762)
--------- ---- ------- ------ --------- ---------
December 31, 1995 ...................... 4,256,723 42 20,114 -- (726) 19,430
Stock options and warrants
exercised ............................ 71,375 1 272 -- -- 273
Employee stock purchase plan .......... 6,874 -- 61 -- -- 61
Common stock acquired ................. (9,262) -- (134) -- -- (134)
Net loss for year ..................... -- -- -- -- (12,499) (12,499)
--------- ---- ------- ------ --------- ---------
December 31, 1996 ...................... 4,325,710 43 20,313 -- (13,225) 7,131
Stock options and warrants
exercised ............................ 213,038 2 605 -- -- 607
Employee stock purchase plan .......... 9,501 -- 118 -- -- 118
Issuance of warrants .................. -- -- 328 -- -- 328
Note receivable from sale of stock .... -- -- -- (498) -- (498)
Net loss for year ..................... -- -- -- -- (3,455) (3,455)
--------- ---- ------- ------ --------- ---------
December 31, 1997 ...................... 4,548,249 $ 45 $21,364 $ (498) $ (16,680) $ 4,231
========= ==== ======= ====== ========= =========
</TABLE>
See accompanying notes
F-6
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1. BUSINESS ACTIVITY
Recovery Engineering, Inc., (the Company) manufactures and markets low
energy desalinators, antimicrobial water purifiers and microfilters, and
residential water filters sold primarily to retailers under the PUR brand name
for residential, marine, military and recreational use in the United States and
foreign markets.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Marketable securities and investments are classified as available for sale
and consist primarily of commercial paper, US Treasury Notes and municipal
bonds. At December 31, 1997, the Company had no marketable securities. At
December 31, 1996, the market value of marketable securities and investments
approximates cost.
Sales are recorded upon shipment of product. The Company performs periodic
credit evaluation of its customers' financial condition and generally does not
require collateral. The Company requires irrevocable letters of credit on sales
to certain foreign customers. Receivables generally are due within 30 days.
Credit losses relating to customers consistently have been within management's
expectations.
Inventories are stated at the lower of cost or market determined by the
first-in, first-out (FIFO) method. Inventory cost elements consist of raw
materials, purchased parts, direct labor and applied manufacturing overhead.
The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in
accounting for its stock options. Under APB 25, when the exercise price of stock
options equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION ("Statement 123"). The Company adopted the disclosure only
provisions of Statement 123. Accordingly, the Company has made pro forma
disclosures of what net loss and loss per share would have been had the
provisions of Statement 123 been applied to the Company's stock options.
Property and equipment are stated at cost. The Company depreciates these
assets over their estimated useful lives ranging from three to ten years.
Depreciation expense was $767,000, $1,294,000 and $1,768,000 for the years ended
1995, 1996, and 1997, respectively.
Patents are stated at cost and are amortized on a straight-line basis
ranging from three to fifteen years. The carrying value of a patent will be
reviewed if the facts and circumstances suggest that it may be impaired. If this
review indicates that patent cost will not be recoverable, the Company's
carrying value of the patents will be reduced to the estimated fair value.
Deferred financing costs which are included in other assets are being
amortized over a five year period.
The Company records losses on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
Advertising costs are charged to operations in the year incurred.
Advertising costs charged to operations were $6,372,000, $9,541,000 and
$14,602,000 for the years ended December 31, 1995, 1996, and 1997, respectively.
Income taxes are accounted for under the liability method. Deferred income
taxes are provided for temporary differences between the financial reporting and
tax basis of assets and liabilities.
F-7
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from the estimates.
In 1997, the Financial Accounting Standards Board (FASB) issued Statement
No. 128, EARNINGS PER SHARE. Statement 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts for all periods have been
presented, and where appropriate, restated to conform to Statement 128
requirements.
In 1997, the FASB issued Statements No. 130, REPORTING COMPREHENSIVE
INCOME, and No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, effective for fiscal years beginning after December 15, 1997. The
adoption by the Company of these Statements in January 1998 is not expected to
have a material impact on the Company's financial statements
NOTE 3. INVENTORIES
Inventories consist of the following:
DECEMBER 31
-----------------------------
1996 1997
------------- -------------
Finished goods ........... $1,704,000 $1,981,000
Work in progress ......... 95,000 157,000
Raw materials ............ 3,127,000 5,456,000
---------- ----------
$4,926,000 $7,594,000
========== ==========
NOTE 4. RELATED PARTY NOTE RECEIVABLE
At December 31, 1997 the Company had a note receivable of approximately
$498,000 due from its president and CEO. The note bears interest at 9.25%.
Principal and interest are due and payable in one installment on June 30, 1999.
The proceeds of the note were used to exercise stock options which were nearing
their expiration date.
NOTE 5. DEBT
Long-term debt consists of a $15.0 million convertible loan with certain
investment partnerships affiliated with The Goldman Sachs Group, L.P. ("GS
Group") which bears interest at 5% per annum and expires in 2003. Interest on
the loan is paid quarterly. GS Group may convert the outstanding balance of the
loan into shares of Common Stock at a conversion price of $14.85 per share at
any time during the life of the loan. If not converted, the loan is payable in
annual installments starting August 2001. The estimated fair value of the
convertible loan, based on the Company's incremental borrowing rate for similar
liabilities, approximates its carrying value.
The Company had no bank debt at December 31, 1996, compared with $7.2
million at December 31, 1997. In March 1997, the Company obtained a $14.0
million credit facility secured by equipment, inventory, receivables, and
intangibles. The credit facility consists of a $10.0 million discretionary
working capital line-of-credit, limited to eligible receivables and inventory,
which bears interest at the bank reference rate plus 1.25%, and a $4.0 million
equipment loan which bears interest at the bank reference rate plus 2.50%. The
principal amount of the equipment loan is payable over a 42-month period
commencing October 1998, unless demand is made sooner. Other borrowings under
the credit facility are due on demand. The Company's weighted average interest
rate on the bank debt for 1997 was 10.2%. Borrowings under this agreement are
limited to $10.0 million in 1997 and $12.5 million in 1998
F-8
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 5. DEBT (CONTINUED)
by provisions in the convertible loan agreement. The Company received a waiver
allowing it to make full use of the $14.0 million credit facility for the fourth
quarter of 1997. In connection with the acquisition of the credit facility, the
Company issued warrants to the bank for the purchase of 80,000 shares of Common
Stock at $7.00 per share. The warrants cannot be exercised until October 8, 1998
and expire six years from the effective date of the credit facility. The Company
has estimated the value of the warrants to be $328,000, which has been included
in additional paid-in capital and is being amortized over the estimated life of
the credit facility.
NOTE 6. STOCK OPTIONS AND WARRANTS
The Company has various incentive and non-qualified stock option plans
which it uses as an incentive for directors, officers, and other employees,
consultants and technical advisors. Options are granted at fair market values
determined on the date of grant and vesting normally occurs over a four year
period. The Company adopted the 1993 Director Stock Option Plan, a non-qualified
stock option plan, to provide non-employee directors with an automatic annual
stock option grant at 85% of fair market value on the date of grant.
Shares available and options outstanding are as follows:
<TABLE>
<CAPTION>
WEIGHTED
PLAN DIRECTOR AVERAGE
OPTIONS PLAN NON-PLAN PLAN EXERCISE
AVAILABLE FOR OPTIONS OPTIONS OPTIONS PRICE
GRANT OUTSTANDING OUTSTANDING OUTSTANDING PER SHARE
--------------- ------------- ------------- ------------- ----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994. ......... 280,611 610,425 500 10,000 $ 4.32
Additional shares reserved ........... 350,000 -- -- -- --
Granted .............................. (306,475) 306,475 -- 8,000 13.86
Exercised ............................ -- (251,525) -- -- 2.30
Canceled ............................. 14,125 (14,125) -- -- 12.90
-------- -------- --- ------ -------
Balance at December 31, 1995 .......... 338,261 651,250 500 18,000 8.97
Granted .............................. (410,850) 410,850 -- 7,000 12.04
Exercised ............................ -- (71,375) -- -- 3.75
Canceled ............................. 95,700 (95,700) -- -- 11.27
-------- -------- --- ------ -------
Balance at December 31, 1996. ......... 23,111 895,025 500 25,000 9.77
Additional shares reserved ........... 350,000 -- -- -- --
Granted .............................. (249,825) 249,825 -- 24,000 13.59
Exercised ............................ -- (212,925) -- -- 2.86
Canceled ............................. 34,975 (34,975) -- -- 10.52
-------- -------- --- ------ -------
Balance at December 31, 1997 .......... 158,261 896,950 500 49,000 $ 12.49
======== ======== === ====== =======
</TABLE>
The weighted average fair value of options granted in 1995, 1996 and 1997
was $6.77, $6.35 and $8.52, per share, respectively. The exercise price of
options outstanding at December 31, 1997 ranged from $2.50 to $29.19 per share
as summarized in the following table:
F-9
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 6. STOCK OPTIONS AND WARRANTS (CONTINUED)
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE WEIGHTED AVERAGE
RANGE OF EXERCISE OUTSTANDING AT REMAINING NUMBER EXERCISABLE EXERCISE PRICE PER
PRICES 12/31/97 CONTRACTUAL LIFE AT 12/31/97 SHARE
- ------------------- ---------------- ------------------ -------------------- -------------------
<S> <C> <C> <C> <C>
$ 2.50 - $10.00 256,000 10 years 65,438 $ 7.26
$10.01 - $12.00 180,150 8 years 84,388 $ 10.22
$12.01 - $14.00 397,400 9 years 143,375 $ 13.92
$14.01 - $29.19 112,900 10 years 1,425 $ 22.92
- ------------------- ------- ------------------ ------- -------
$ 2.50 - $29.19 946,450 9 years 294,626 $ 12.49
=================== ======= ================== ======= =======
</TABLE>
The number of stock options exercisable at December 31, 1995 and 1996 were
391,025 and 403,350, respectively, at a weighted average price of $7.30 and
$7.68, respectively.
The Company has elected to follow Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided under FASB
Statement No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123"),
requires use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, when the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions for 1995, 1996 and 1997, respectively; risk-free interest rate of
6%; volatility factor of the expected market price of the Company's Common Stock
of .55 and a weighted-average expected life of the options of 6 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option's vesting period. The Company's
pro forma information is as follows:
<TABLE>
<CAPTION>
1995 1996 1997
---------------- ----------------- ----------------
<S> <C> <C> <C>
Pro forma net loss ........................... $ (5,024,000) $ (13,102,000) $ (4,254,000)
Pro forma net loss per common share .......... $ (1.19) $ (3.05) $ (0.95)
</TABLE>
These pro forma amounts may not be indicative of future years' amounts
since the statement provides for a phase in of option values beginning with
those granted in 1995.
The Company has warrants outstanding for the purchase of 57,500 shares of
Common Stock at $8.40 per share, which expire in 1998.
The Company has an Employee Stock Purchase Plan with 100,000 shares
reserved for issuance under the plan. During 1995, 1996 and 1997, 5,312, 6,874
and 9,501 shares were issued under the plan at prices ranging from $5.84 to
$25.73. Approximately 75,000 shares remain reserved for future issuance.
F-10
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7. INCOME TAXES
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1996 1997
--------------- ---------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward ................... $ 5,590,000 $ 8,070,000
Tax benefit of nonqualified stock options ......... 530,000 449,000
Warranty reserve .................................. 130,000 296,000
Inventory obsolescence ............................ 81,000 150,000
Bad debt reserve .................................. 76,000 130,000
Facility relocation costs ......................... 350,000 78,000
Accrued expenses .................................. 165,000 74,000
Other ............................................. 34,000 29,000
------------ ------------
Total deferred tax assets .......................... 6,956,000 9,276,000
Deferred tax liabilities:
Tax depreciation in excess of financial reporting
depreciation ..................................... 769,000 1,670,000
Tax amortization of patents in excess of financial
reporting amortization ........................... 116,000 108,000
------------ ------------
Total deferred tax liabilities ..................... 885,000 1,778,000
6,071,000 7,498,000
Valuation allowance ................................ (4,496,000) (5,923,000)
------------ ------------
Net deferred tax assets ............................ $ 1,575,000 $ 1,575,000
============ ============
</TABLE>
Realization of the future tax benefits related to the net deferred tax
assets is dependent on many factors, including the Company's ability to generate
taxable income within the net operating loss carryforward period. Management
believes that, at a minimum, it is more likely than not that future taxable
income will be sufficient to realize the recorded asset.
Significant components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------
1995 1996 1997
---------------- ------ -------
<S> <C> <C> <C>
Current:
Federal ............... $ (1,256,000) $ -- $ --
State ................. -- -- --
------------ ---- ----
Total current ......... (1,256,000) -- --
------------ ---- ----
Deferred:
Federal ............... (1,158,000) -- --
State ................. (150,000) -- --
------------ ---- ----
Total deferred ......... (1,308,000) -- --
------------ ---- ----
$ (2,564,000) $ -- $ --
------------ ---- ----
</TABLE>
The Company has net operating loss carryforwards of $23,664,000 available
to offset future taxable income, of which $4,986,000 expires in 2010,
$11,493,000 expires in 2011 and $7,185,000 expires in 2012. Cash paid for income
taxes amounted to $31,000, $0, and $0 in 1995, 1996, and 1997, respectively.
F-11
<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1997
NOTE 7. INCOME TAXES (CONTINUED)
A reconciliation of the statutory federal income tax rate of 34% to the
Company's effective income tax rate is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1995 1996 1997
---------------- ---------------- ----------------
<S> <C> <C> <C>
Income taxes (benefit) at statutory rate (34%). ......... $ (2,491,000) $ (4,249,000) $ (1,175,000)
State tax net of federal benefit ........................ (100,000) (255,000) (69,000)
Effect of tax rate changes on NOL carryback ............. 171,000 -- --
Valuation allowance ..................................... -- 4,496,000 1,427,000
Other ................................................... (144,000) 8,000 (183,000)
------------ ------------ ------------
Provision (benefit) for income taxes .................... $ (2,564,000) $ -- $ --
------------ ------------ ------------
Effective rate .......................................... 35% --% --%
------------ ------------- -------------
</TABLE>
NOTE 8. RETIREMENT SALARY SAVINGS PLAN
The Company has a defined contribution 401(k) plan that covers all
full-time employees who have six months of vested service. Employees are allowed
to contribute up to 15% of their pre-tax income to the plan. Employee salary
deferrals are matched by the Company at a rate of 100% of the first 1% of salary
deferred and 25% of the next 4% of salary deferred. The Company contributions to
this plan for each of the years ended December 31, 1995, 1996, and 1997 were
$34,000, $61,000, and $98,000, respectively.
NOTE 9. SALES AND SEGMENT INFORMATION
The Company, operating in a single business segment, designs, manufactures
and markets water purification products. The Company's manufacturing and
distribution operations are located within the United States. Export sales for
1995, 1996, and 1997 amounted to $2.6 million, $3.9 million, and $6.3 million,
respectively. During 1995, one customer accounted for approximately 22% of the
total net sales. During 1996, no one customer accounted for more than 10% of the
total net sales. During 1997, two customers accounted for approximately 12.8%
and 10.1%, respectively, of the total net sales.
NOTE 10. COMMITMENTS
The Company has noncancelable operating lease agreements for its facilities
in Minneapolis, Minnesota extending through April 2008. Under the terms of the
lease agreements, the Company is responsible for base rent and all operating
costs associated with the building. Total rent expense was $393,000, $469,000
and $695,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
Future minimum rental lease commitments are as follows: 1998 -- $837,000; 1999
- -- $717,000; 2000 -- $738,000; 2001 -- $613,000; 2002 -- $682,000; thereafter --
$3,698,000.
In the fourth quarter of 1997, management entered into an agreement to
expand the Company's facility. The Company entered into a noncancelable
operating lease agreement for an expansion to its facility in Brooklyn Park,
Minnesota extending through April 2008. Under the terms of the lease agreement,
the Company will be responsible for base rent and all operating costs associated
with the addition. Future minimum rental lease commitments are as follows: 1998
- -- $408,000; 1999 -- $544,000; 2000 -- $544,000; 2001 -- $544,000; 2002 --
$605,000; thereafter -- $3,281,000.
The Company incurred expenses of $973,000 for the year ended December 31,
1996, primarily related to the writedown of certain fixed assets, buildout
costs, future lease payments on the original lease, and real estate commissions
associated with the relocation to its new facility.
F-12
<PAGE>
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
RECOVERY ENGINEERING, INC.
<TABLE>
<CAPTION>
(in thousands)
Additions
------------------------------
Balance at Charged to
Beginning of Costs and Charged to Other Balance at End
Description Period Expenses Accounts Deductions of Period
- ----------- ------ -------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1997
Reserves & allowances deducted from
asset accounts:
Allowance for uncollectible accounts $212 $148 $46(1) $314
Reserve for inventory obsolescence $226 $471 $279(2) $418
YEAR ENDED DECEMBER 31, 1996
Reserves & allowances deducted from
asset accounts:
Allowance for uncollectible accounts $ 57 $315 $160(1) $212
Reserve for inventory obsolescence $112 $430 $316(2) $226
YEAR ENDED DECEMBER 31, 1995
Reserves & allowances deducted from
asset accounts:
Allowance for uncollectible accounts $32 $119 $94(1) $57
Reserve for inventory obsolescence $-- $112 $-- $112
</TABLE>
- ---------------------------
(1) Uncollectible accounts written off, net of recoveries.
(2) Inventory written off
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
- --- ----------- ----------------
<S> <C> <C>
3.1 Articles of Incorporation of Recovery Filed as Appendix 1 to the Company's
Engineering, Inc. Proxy Statement dated March 27, 1996 (File
No. 0-21232) and incorporated herein by
reference
3.2 Bylaws of Recovery Engineering, Inc. Filed as Appendix 2 to the Company's
Proxy Statement dated March 27, 1996 (File
No. 0-21232) and incorporated herein by
reference
4.1 Rights Agreement dated as of January 30, 1996 Filed as Exhibit 4.1 to the Company's Form
between Recovery Engineering, Inc. and 8-A Registration Statement dated February
Norwest Bank Minnesota, National 20, 1996 (File No. 0-21232) and
Association, as Rights Agent incorporated herein by reference
4.1.1 Amendment No. 1 dated as of February 3, 1998 Filed as Exhibit 4.1.1 to the Company's Annual
to Rights Agreement between Recovery Report on Form 10-K for the year ended
Engineering, Inc. and Norwest Bank December 31, 1997 (File No. 0-21232)
Minnesota, National Association, as Rights incorporated herein by reference
Agent
10.1 * Recovery Engineering, Inc. 1986 Stock Option Filed as Exhibit 10.6 to the Company's
Plan, as amended Registration Statement on Form SB-2 (No.
33-57826C) and incorporated herein by
reference
10.2 * Recovery Engineering, Inc. 1993 Director Filed as Exhibit 10.7 to the Company's
Stock Option Plan Annual Report on Form 10-K for the year
ended December 31, 1993 (File No. 0-
21232) and incorporated herein by reference
10.3 * Recovery Engineering, Inc. 1994 Stock Filed as Exhibit 10.8 to the Company's
Purchase Plan Annual Report on Form 10-K for the year
ended December 31, 1993 (File No. 0-
21232) and incorporated herein by reference
10.4 * Recovery Engineering, Inc. 1994 Stock Option Filed as Exhibit 99.1 to the Company's
and Incentive Plan, as amended Registration Statement on Form S-8 (No.
333-41621) and incorporated herein by
reference
10.5 Supplier Agreement dated November 25, 1996, Filed as Exhibit 10.5 to the Company's Annual
between Thermotech and Recovery Report on Form 10-K for the year ended
Engineering, Inc. December 31, 1997 (File No. 0-21232)
incorporated herein by reference.
10.6 Form of Distributor Agreement Filed as Exhibit 10.3 to the Company's
Registration Statement on Form SB-2 (No.
33-57826C) and incorporated herein by
reference
F-14
<PAGE>
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
- --- ----------- ----------------
10.7 Financing Agreement dated March 31, 1997 Filed as Exhibit 99.1 to the Company's
between Recovery Engineering, Inc. and First Quarterly Report on Form 10-Q for the
Bank National Association quarter ended June 30, 1997 (File No. 0-
21232) and incorporated herein by reference
10.7.1 First Amendment to Financing Agreement dated Filed as Exhibit 10.7.1 to the Company's
March 16, 1998 between Recovery Engineering, Registration Statement on Form S-3
Inc. and First Bank National Association (No. 333-46833) and incorporated herein by
reference
10.8 Securities Purchase Agreement dated July 19, Filed as Exhibit 4.1 to the Company's
1996 by and among Recovery Engineering, Inc. Report on Form 8-K dated July 19, 1996
and investment partnerships affiliated with The (File No. 0-21232) and incorporated herein
Goldman Sachs Group, L.P. ("GS Group") by reference
10.9 Registration Rights Agreement dated July 19, Filed as Exhibit 99.1 to the Company's
1996 by and among Recovery Engineering, Inc. Report on Form 8-K dated July 19, 1996
and GS Group (File No. 0-21232) and incorporated herein
by reference
10.10 * Executive Restriction Agreement dated July 19, Filed as Exhibit 99.2 to the Company's
1996 by and among Recovery Engineering, Report on Form 8-K dated July 19, 1996
Inc., GS Group and Brian F. Sullivan (File No. 0-21232) and incorporated herein
by reference
10.11 * Executive Severance Pay Agreement dated Filed as Exhibit 99.2 to the Company's
March 24, 1997 between Recovery Quarterly Report on Form 10-Q for the
Engineering, Inc. and Charles F. Karpinske quarter ended June 30, 1997 (File No. 0-
21232) and incorporated herein by reference
10.12 Lease Agreement dated November 8, 1996 Filed as Exhibit 10.20 to the Company's
between Ryan Companies US, Inc. and Annual Report on Form 10-K for the year
Recovery Engineering, Inc. ended December 31, 1996 (File No. 0-
21232) and incorporated herein by reference
10.12.1 First Amendment to Lease dated December 20, Filed as Exhibit 10.12.1 to the Company's Annual
1996, between Ryan Companies US, Inc. and Report on Form 10-K for the year ended
Recovery Engineering, Inc. December 31, 1997 (File No. 0-21232)
incorporated herein by reference.
10.12.2 Second Amendment to Lease dated May 1, Filed as Exhibit 10.12.2 to the Company's Annual
1997, between Ryan Recovery, LLC and Report on Form 10-K for the year ended
Recovery Engineering, Inc. December 31, 1997 (File No. 0-21232)
incorporated herein by reference
10.12.3 Third Amendment to Lease dated December Filed as Exhibit 10.12.3 to the Company's Annual
22, 1997, between Ryan Recovery, LLC and Report on Form 10-K for the year ended
Recovery Engineering, Inc. December 31, 1997 (File No. 0-21232)
incorporated herein by reference
21.1 Subsidiary of Recovery Engineering, Inc. Filed as Exhibit 21.1 to the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-21232)
incorporated herein by reference
23.1 Consent of Ernst & Young LLP Filed electronically herewith
27.1 Financial Data Schedule Filed as Exhibit 27.1 to the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997 (File No. 0-21232)
incorporated herein by reference
</TABLE>
- ---------------
* Management Contracts
F-15
EXHIBIT 23.1
Consent of Ernst & Young LLP
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-63214) pertaining to the 1986 Stock Option Plan, in the Registration
Statement (Form S-8 No. 33-76088) pertaining to the 1993 Director Stock Option
Plan, in the Registration Statement (Form S-8 No. 33-75882) pertaining to the
1994 Stock Purchase Plan, in the Registration Statements (Forms S-8 No. 33-76544
and No. 333-41621) pertaining to the 1994 Stock Option and Incentive Plan, and
in the Registration Statement (Form S-8 No. 333-41619) pertaining to the Salary
Savings Plan of Recovery Engineering, Inc. of our report dated January 30, 1998,
with respect to the financial statements and schedule of Recovery Engineering,
Inc. included in this amended Annual Report (Form 10-K) of Recovery Engineering,
Inc.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
April 2, 1998
