UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 4, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission File Number 0-21232
------------------------------
RECOVERY ENGINEERING, INC.
(Exact name of registrant as specified in its charter)
Minnesota 41-1557115
--------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation organization)
9300 North 75th Avenue
Minneapolis, MN 55428
(Address of principal executive offices)
Registrant's telephone number, including area code: (612) 315-5500
- - --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
Common Stock, $.01 Par Value - 6,004,860 shares as of October 22, 1998
----------------------------------------------------------------------
================================================================================
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<PAGE>
RECOVERY ENGINEERING, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements (Unaudited):
Balance Sheets
October 4, 1998 and December 31, 1997............................. 3
Statements of Operations
Three and nine-month periods ended October 4, 1998 and
September 30, 1997................................................ 4
Statements of Cash Flows
Nine-month periods ended October 4, 1998 and September 30, 1997... 5
Notes to Financial Statements..................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 12
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 13
Item 2. Changes in Securities and Use of Proceeds......................... 13
Item 3. Defaults upon Senior Securities................................... 13
Item 4. Submission of Matters to a Vote of Security Holders............... 13
Item 5. Other Information................................................. 13
Item 6. Exhibits and Reports on Form 8-K.................................. 13
Signatures........................................................ 14
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<PAGE>
RECOVERY ENGINEERING, INC.
BALANCE SHEETS
(In thousands, except share data)
October 4, December 31,
1998 1997
---- ----
ASSETS Unaudited)
Current assets:
Cash and cash equivalents ...................... $ 13,802 $ 261
Accounts receivable (net of allowance of
$377 for 1998 and $314 for 1997) ............... 20,483 16,236
Inventory ...................................... 9,328 7,594
Prepaid marketing .............................. 3,441 500
Other current assets ........................... 680 1,022
-------- --------
Total Current Assets ....................... 47,734 25,613
Property and equipment:
Tooling ........................................ 9,342 7,307
Equipment and fixtures ......................... 14,406 11,200
-------- --------
23,748 18,507
Less accumulated depreciation .................. 6,699 4,771
-------- --------
17,049 13,736
Deferred income taxes .............................. 1,512 1,512
Patents (net of accumulated amortization) .......... 729 732
Other assets ....................................... 372 676
-------- --------
Total assets ............................... $ 67,396 $ 42,269
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Bank line of credit ............................ $ -- $ 7,161
Accounts payable ............................... 5,799 8,336
Accrued facility relocation costs .............. 167 217
Accrued marketing expenses ..................... 1,148 1,781
Accrued co-op advertising ...................... 2,905 2,138
Other accrued expenses ......................... 2,957 3,405
-------- --------
Total current liabilities .................. 12,976 23,038
Long-term debt ..................................... 15,000 15,000
Shareholders' equity:
Common stock, $.01 par value:
Authorized shares -- 100,000,000
Issued and outstanding shares:
1998 - 6,004,000 and 1997 - 4,548,000 ...... 60 45
Additional paid-in capital ..................... 59,940 21,364
Note receivable from sale of stock ............. (498) (498)
Retained earnings (deficit) .................... (20,082) (16,680)
-------- --------
Total shareholders' equity ................. 39,420 4,231
-------- --------
Total liabilities and shareholders' equity ..... $ 67,396 $ 42,269
======== ========
See accompanying notes
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<PAGE>
RECOVERY ENGINEERING, INC.
STATEMENTS OF OPERATIONS
(Unaudited - in thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended Nine months ended
Oct. 4, 1998 Sept. 30, 1997 Oct. 4, 1998 Sept. 30, 1997
------------ -------------- ------------ --------------
<S> <C> <C> <C> <C>
Net sales ........................... $ 18,505 $ 22,371 $ 57,454 $ 48,180
Cost of products sold ............... 9,551 11,790 29,210 26,443
-------- -------- -------- --------
Gross profit ........................ 8,954 10,581 28,244 21,737
Operating expenses:
Selling, general and administrative 10,979 9,777 27,701 22,390
Research and development .......... 1,050 797 3,150 2,255
-------- -------- -------- --------
12,029 10,574 30,851 24,645
-------- -------- -------- --------
Income (loss) from operations ....... (3,075) 7 (2,607) (2,908)
Other income (expense):
Interest income and other ......... 232 -- 439 68
Interest expense and other ........ (300) (455) (1,234) (998)
-------- -------- -------- --------
(68) (455) (795) (930)
-------- -------- -------- --------
Loss before income taxes ............ (3,143) (448) (3,402) (3,838)
Income tax expense .................. (40) -- -- --
-------- -------- -------- --------
Net loss ............................ $ (3,183) $ (448) $ (3,402) $ (3,838)
======== ======== ======== ========
Net loss per share - basic and
diluted ........................... $ (.53) $ (.10) $ (.64) $ (.87)
======== ======== ======== ========
Weighted average shares - basic and
diluted ........................... 5,959 4,540 5,346 4,434
</TABLE>
See accompanying notes.
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<PAGE>
RECOVERY ENGINEERING, INC.
STATEMENTS OF CASH FLOWS
(Unaudited - in thousands)
<TABLE>
<CAPTION>
Nine months ended
October 4, 1998 September 30, 1997
--------------- ------------------
<S> <C> <C>
Operating activities
Net loss ........................................ $ (3,402) $ (3,838)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization ................... 2,027 1,461
Changes in operating assets and liabilities:
Accounts receivable ........................... (4,247) (8,928)
Inventory ..................................... (1,734) (3,287)
Prepaid marketing ............................. (2,941) (21)
Other assets .................................. 646 21
Accounts payable .............................. (2,537) (860)
Accrued expenses .............................. (364) 3,588
-------- --------
Net cash used in operating activities ........... (12,552) (11,864)
Investing activities
Purchase of property and equipment .............. (5,241) (4,305)
Sale of marketable securities ................... -- 1,542
Purchase of patents ............................. (96) (76)
-------- --------
Net cash used in investing activities ........... (5,337) (2,839)
Financing activities
Net proceeds (repayments) - bank line of credit . (7,161) 8,182
Issuance of common stock ........................ 38,591 661
-------- --------
Net cash provided by financing activities ....... 31,430 8,843
-------- --------
Increase (decrease) in cash and cash equivalents ... 13,541 (5,860)
Cash and cash equivalents at beginning of period ... 261 5,988
-------- --------
Cash and cash equivalents at end of period ......... $ 13,802 $ 128
======== ========
</TABLE>
See accompanying notes
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<PAGE>
RECOVERY ENGINEERING, INC.
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
October 4, 1998
Note A -- Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
and the instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the ninety-one and two
hundred seventy-seven day periods ended October 4, 1998 are not necessarily
indicative of the results that may be expected for the fiscal year ending
January 3, 1999, or any other period. For further information, refer to the
financial statements and footnotes thereto for the year ended December 31, 1997
included in the Company's latest annual report on Form 10-K.
The Company's fiscal year ends on the Sunday closest to December 31 (January 3,
1999) and each quarter ends on the last Sunday of a thirteen-week period. As a
result, the first quarters ended April 5, 1998, and March 31, 1997, included 95
and 90 days, respectively, while the quarters ended July 5, 1998, October 4,
1998, June 30, 1997, and September 30, 1997, included 91 days. In the Company's
opinion, this difference in days does not materially affect the comparability of
the financial results of the periods presented.
Note B -- Inventory
The components of inventory consist of the following:
October 4, December 31,
1998 1997
---- ----
Raw materials $5,509,000 $5,456,000
Work in process 35,000 157,000
Finished products 3,784,000 1,981,000
----------- ---------
$9,328,000 $7,594,000
========== ==========
Note C -- Net Loss Per Share
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.
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Note D -- Accounting Statements
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 did not have a material impact
on the Company's financial statements.
Note E -- Public Offering
The Company completed a public offering of Common Stock on April 28, 1998
netting approximately $33,200,000 from the sale of 1,190,000 shares. The Common
Stock was priced at $30.00 per share. All of the shares were sold by the
Company. On May 18, 1998, the underwriters purchased an additional 178,500
shares of Common Stock pursuant to the exercise of their overallotment option,
which resulted in additional net proceeds to the Company of approximately
$5,000,000.
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<PAGE>
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Three and Nine-Month Periods ended October 4, 1998)
RESULTS OF OPERATIONS:
Net sales increased 19.2 percent to $57,454,000 for the nine-month period ended
October 4, 1998 from $48,180,000 for the same period the prior year. This growth
is due to increased sales of the Company's existing PUR household water
filtration products and the continued rollout of new products introduced at the
International Housewares Show in January. New products shipped this year include
the PUR PLUS Pitcher, the PUR PLUS Dispenser and the PUR ULTIMATE faucet mount
water filter. The PUR PLUS Pitcher and PUR PLUS Dispenser incorporate a
breakthrough filter technology recently developed by the Company. With this
technology, PUR has created the first pour-through water filters certified to
remove dangerous microorganisms such as cryptosporidium and giardia from
drinking water. The PUR ULTIMATE faucet mount water filter incorporates further
advancements of the Company's carbon matrix filtration technology. With these
advancements, the PUR ULTIMATE water filter can remove volatile organic
chemicals (VOCs), such as trihalomethanes, which are a by-product of chlorine
and organic matter. Net sales decreased 17.3 percent to $18,505,000 for the
three-month period ended October 4, 1998 from $22,371,000 for the same period
last year. Retail sell-through of the Company's household water filters
increased 90 percent this quarter compared to the third quarter last year at the
top ten customer accounts from which the Company receives point-of-sale data.
Despite the increase in retail sell-through, net sales declined for two primary
reasons. First, initial stocking orders to new accounts were over $6,000,000
less this quarter than in third quarter last year. Second, during this quarter
existing retail accounts reduced their net inventories by an estimated
$1,500,000, whereas during the third quarter last year, existing accounts
increased their net inventories by an estimated $4,000,000, resulting in a sales
differential of approximately $5,500,000. For reasons discussed in the following
paragraph, the Company has decided to temporarily stop shipping the PUR ULTIMATE
faucet mount water filter which could adversely affect net sales for the fourth
quarter of 1998. The Company continued to expand its distribution base during
the three-month period ended October 4, 1998, including the addition of CVS
Drug, a 4,500 location drug store chain. PUR household water filter systems and
replacement filters are now available at over 35,000 retail outlets nationwide.
Gross margins increased to 48.4 percent and 49.2 percent for the three and
nine-month periods ended October 4, 1998, respectively, compared to 47.3 percent
and 45.1 percent for the comparable periods ended September 30, 1997. The
increase in gross margin for the quarter compared to the same period last year
reflects continued product cost reduction activities as well as the
implementation of automated manufacturing and assembly processes. The increase
was achieved despite lower than forecast production yields for the Company's two
new filtration processes and lower revenue to offset fixed expenses. The lower
than forecast production yields are mainly due to difficulties producing the
filter assembly for its PUR ULTIMATE faucet mount product due to
inconsistent raw materials. With the increased demand for the product in the
fourth quarter, a decline in production yields during the end of the third
quarter, and a desire to avoid placing its retail accounts' fourth quarter
business at
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risk, the Company decided to stop shipping the PUR ULTIMATE temporarily until it
can more consistently and reliably be delivered to the market. The Company has
offered to substitute other faucet mount products to meet current PUR ULTIMATE
demand. The increase in gross margins for the nine-month period ended October 4,
1998 compared to the same period last year 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,
including replacement filter cartridges, as a percentage of total sales.
Selling, general and administrative expenses increased to $10,979,000 (59.3
percent of net sales) and $27,701,000 (48.2 percent of net sales) for the three
and nine-month periods ended October 4, 1998 from $9,777,000 (43.7 percent of
net sales) and $22,390,000 (46.5 percent of net sales) for the three and
nine-month periods ended September 30, 1997. The increase in selling, general
and administrative expenses was attributable primarily to advertising and
promotional expenses related to the continued rollout and expansion of the
Company's line of household water filters. Selling expenses are expected to be
above 1997 levels throughout the remainder of the year to support the continued
rollout of the household drinking water systems and product line extensions.
Research and development expense increased to $1,050,000 and $3,150,000 for the
three and nine-month periods ended October 4, 1998, compared to $797,000 and
$2,255,000 for the three and nine-month periods ended September 30, 1997,
reflecting the Company's commitment towards developing new products and
technology. Development of product line extensions and other new products will
require continued emphasis and spending on research and development.
Other expenses were $68,000 and $795,000 for the three and nine-month periods
ended October 4, 1998 compared to $455,000 and $930,000 for the three and
nine-month periods ended September 30, 1997. The decrease in other expenses for
the quarter compared to the third quarter of 1997 is due to higher interest
income for the quarter because of the increased balance of cash and cash
equivalents as a result of the Company's public offering which was completed
April 28, 1998, as well as the proceeds from the overallotment option completed
May 18, 1998. The decrease is also due to lower interest expense on the
Company's line of credit established in March 1997 and paid off in April 1998.
The decrease in other expense for the nine-month period ended October 4, 1998
compared to the same period in 1997 is mostly due to higher interest income as a
result of the higher cash and cash equivalents balances generated by the public
offering and overallotment option offset somewhat by higher interest expense on
the Company's line of credit which was established in March 1997 and repaid by
the Company subsequent to the public offering in April 1998.
The Company's effective income tax rate was zero percent for the three and
nine-month periods ended October 4, 1998 and September 30, 1997. The Company has
a $1,512,000 net deferred tax asset primarily related to net operating loss
carryforwards. The Company has recorded a valuation allowance for the majority
of its deferred tax asset due to the uncertainty of future realization.
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LIQUIDITY AND CAPITAL RESOURCES:
Cash used in operations was $12,552,000 for the nine-month period ended October
4, 1998, compared to cash used in operations of $11,864,000 for the nine month
period ended September 30, 1997. Cash was used in both periods to fund
operations and increase the level of inventories, prepaid marketing, and
receivables, as well as reduce the level of accounts payable. Cash was used to
reduce the level of accrued expenses for the nine-month period ended October 4,
1998 while cash was provided by the increase in accrued expenses for the same
period in the prior year.
Capital expenditures were $5,241,000 for the nine-month period ended October 4,
1998, compared to $4,305,000 for the nine-month period ended September 30, 1997.
The capital expenditures were primarily to purchase tooling and manufacturing
equipment for both periods. The Company anticipates continued expenditures for
tooling and manufacturing equipment purchases associated with new product
introductions and an increase in overall production capacity.
The Company had no bank debt at October 4, 1998, as compared to $7,161,000
outstanding under its bank credit facility at December 31, 1997. This credit
facility, established in March 1997 and amended in March 1998, provides for
total borrowings of up to $25,000,000, secured by equipment, inventory,
receivables and intangibles. The credit facility consists of $15,000,000
discretionary working capital line of credit, limited to eligible receivables
and inventory, which bears interest at the bank's reference rate plus 0.75
percent, and a $10,000,000 equipment loan which bears interest at the bank's
reference rate plus 1.25 percent. Borrowings under the equipment loan are made
in increments of $2,000,000 and, unless payment is demanded sooner, 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 $10,000,000 in 1997 and are limited to $12,500,000 in
1998.
The Company completed a public offering of Common Stock on April 28, 1998
netting approximately $33,200,000 from the sale of 1,190,000 shares. The Common
Stock was priced at $30.00 per share. All of the shares were sold by the
Company. On May 18, 1998, the underwriters purchased an additional 178,500
shares of Common Stock pursuant to the exercise of their overallotment option,
which resulted in additional net proceeds to the Company of approximately
$5,000,000.
Management believes that anticipated cash flows from operations, funds available
through its bank credit facility and the net proceeds from its public offering
of Common Stock will provide sufficient capital resources for current operations
and planned product introductions through 1999.
The Company has not paid cash dividends. The Board of Directors currently
intends to retain all earnings for expansion of the Company's business.
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YEAR 2000 ISSUES
The Company understands the Year 2000 ("Y2K") issue to be the result of computer
programs using a two-digit format, as opposed to four digits, to indicate the
year. Such computer systems would be unable to interpret dates beyond the year
1999, which could cause a system failure or other computer errors, leading to
disruptions in operations either through internal failures or through the effect
of failures which might happen externally, and which could have a material
adverse effect on the Company's financial position.
In 1998, the Company developed a three-phase program for Y2K information systems
readiness. The intent of Phase I is to identify those systems with which the
Company has exposure to Y2K issues and assess the ability to make them Y2K
ready. The intent of Phase II is to implement corrective actions to remedy
issues discovered in Phase I. The intent of Phase III is to test all remedial
corrective actions taken and, if necessary, complete a contingency plan.
The Company has identified three major areas determined to be critical for
successful Y2K readiness: (1) financial and informational system applications,
(2) manufacturing automation and (3) third-party relationships.
The Company, in accordance with Phase I of the program, has completed an
internal review of all systems and contacted all software suppliers to determine
major areas of exposure to Y2K issues. In the financial and information system
area, a number of applications have been identified as Y2K ready due to their
recent implementation. These include the Company's core financial and reporting
systems. In the manufacturing area, the Company is in the process of identifying
areas of exposure. In the third-party area, the Company continues its assessment
of its major third parties. Many of these parties state that they intend to be
Y2K ready by 2000. The Company intends to complete Phases II and III by mid
1999.
The Company has yet to determine what costs will be incurred in connection with
its Y2K readiness initiatives, but estimates that such costs will not be
material to the company.
FORWARD-LOOKING STATEMENTS
This report (as well as press releases, other written statements and oral
statements made or to be made by the Company) contains statements relating to
future events or the future financial performance of the Company which are
forward-looking statements within the meaning of the safe harbor provisions of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Forward-looking statements involve
risks and uncertainties that could significantly affect anticipated results in
the future and, accordingly, actual results may differ materially from those
described in the forward-looking statements. These risks and uncertainties
include, but are not limited to, the effects of economic conditions, continued
customer acceptance of products, the Company's reliance on proprietary
technology, pending patent litigation, product obsolescence, the Company's
ability to manage growth, risks associated with international operations,
competition, product liability, and other factors described from time to time in
the Company's filings with the Securities and Exchange Commission, including the
Company's Annual Report on Form 10-K and certain registration statements of the
Company.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
The Company's Board of Directors has authorized up to $2,500,000 for
the repurchase of the Company's common stock. The authorization
includes open market purchases, block transactions, and privately
negotiated purchases. Repurchases will be at such prices and at such
times as management of the Company approves from time to time. As of
October 4, 1998, the Company had approximately six million shares of
common stock outstanding.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Not applicable.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the
quarter covered by this Form 10-Q.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Recovery Engineering, Inc.
----------------------------------------------
(Registrant)
Dated: November 17, 1998. /s/Brian F. Sullivan
----------------------------------------------
Brian F. Sullivan
President, Chief Executive Officer
and Director
(principal executive officer)
Dated: November 17, 1998. /s/Charles F. Karpinske
----------------------------------------------
Charles F. Karpinske
Chief Financial Officer
(principal financial and accounting officer)
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<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-03-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> OCT-04-1998
<CASH> 13,802
<SECURITIES> 0
<RECEIVABLES> 20,483
<ALLOWANCES> 377
<INVENTORY> 9,328
<CURRENT-ASSETS> 47,734
<PP&E> 23,748
<DEPRECIATION> 6,699
<TOTAL-ASSETS> 67,396
<CURRENT-LIABILITIES> 12,976
<BONDS> 0
0
0
<COMMON> 60
<OTHER-SE> 39,360
<TOTAL-LIABILITY-AND-EQUITY> 67,396
<SALES> 57,454
<TOTAL-REVENUES> 57,454
<CGS> 29,210
<TOTAL-COSTS> 60,061
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 124
<INTEREST-EXPENSE> 795
<INCOME-PRETAX> (3,402)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,402)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,402)
<EPS-PRIMARY> (0.64)
<EPS-DILUTED> (0.64)
</TABLE>
