UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 3, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 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 or organization)
9300 NORTH 75TH AVENUE, MINNEAPOLIS, MN 55428
(Address of principal executive offices)
Registrant's telephone number, including area code: (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 March 5, 1999, based on the closing sale price of the Common
Stock on such date as reported on the Nasdaq National Market, was $51,142,000.
On March 5, 1999, the Company had outstanding 6,019,698 shares of Common Stock,
par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Shareholders for the fiscal year
ended January 3, 1999 (the "Annual Report to Shareholders"), are incorporated by
reference into Part II. Portions of the registrant's definitive Proxy Statement
for the Annual Meeting of Shareholders to be held on April 29, 1999 (the "Proxy
Statement"), are incorporated by reference into Part III.
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TABLE OF CONTENTS
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PART I
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FORWARD-LOOKING STATEMENTS........................................................................................1
ITEM 1. BUSINESS............................................................................................1
General.............................................................................................1
Industry Overview...................................................................................1
Business Strategy...................................................................................2
Products............................................................................................3
Marketing and Distribution..........................................................................6
Research and Development............................................................................7
Manufacturing.......................................................................................8
Patents.............................................................................................8
Competition.........................................................................................8
Government Regulation...............................................................................9
Employees...........................................................................................9
ITEM 1A. IMPORTANT INFORMATION...............................................................................9
ITEM 2. PROPERTIES.........................................................................................13
ITEM 3. LEGAL PROCEEDINGS..................................................................................13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................13
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS............................................14
ITEM 6. SELECTED FINANCIAL DATA............................................................................14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..........................................................................14
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........................................14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................................14
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE................................................................14
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS...................................................................15
ITEM 11. EXECUTIVE COMPENSATION.............................................................................15
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.....................................................................................15
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................................................15
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K................................................................................16
SIGNATURES.......................................................................................................18
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PART I
FORWARD-LOOKING STATEMENTS
The information included or incorporated by reference in this Annual
Report on Form 10-K contains statements relating to future events or the future
financial performance of Recovery Engineering, Inc. (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. Certain statements in the Company's
press releases and oral statements made by or with the approval of the Company's
executive officers also constitute or will constitute "forward-looking
statements." 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, product demand, competitive products, and other
factors described herein. See "Important Information."
ITEM 1. BUSINESS
GENERAL
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, which accounted for
more than 87% of the Company's net sales in fiscal 1998, are offered in a
variety of configurations, including pitchers and dispensers which are filled
from the tap ("pour-through" systems) and faucet-mounted, countertop and
under-sink filter systems which are connected to the water lines ("in-line"
systems). Each PUR household water filter system incorporates a replaceable
filtration cartridge. PUR household products are distributed through
approximately 35,000 retail outlets in the United States and Canada, including
Costco, Wal-Mart, Sears, Target, Kmart, Macy's and Walgreens.
The Company was founded in 1986, and initially 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 entered the retail water filter market in late 1994.
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 customer 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.
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 parts of Asia, Africa and Latin America, does not have adequate sewage
or water treatment facilities, leaving tap water unfit for human consumption.
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HOUSEHOLD MARKET
The household market consists of tap water substitutes (primarily bottled
water) and drinking water treatment equipment (such as water filters, water
softeners and whole house systems). 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 and drinking water equipment. 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 reverse 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:
o 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(R)(Automatic Safety Monitor(TM)) monitoring
technology and higher performance filters such as the PUR
ULTIMATE faucet-mounted filter and the PUR PLUS pour-through
pitcher and dispenser.
o 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.
o 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 35,000 retail outlets. The Company continues to
seek additional retail outlets and distribution channels for
its household products.
o 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
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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 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.
o 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.
o 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. 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.
o In 1988, the Company introduced the world's first
hand-operated reverse osmosis desalinator.
o 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.
o In 1994, the Company introduced the first faucet-mounted water
filter capable of removing CRYPTOSPORIDIUM and GIARDIA
LAMBLIA.
o In 1994, the Company introduced the first faucet-mounted water
filter with a device that automatically monitors the useful
life of the filter cartridge.
o In 1996, the Company introduced the first gravity-fed,
pour-through pitcher with an automatic monitoring device.
o In 1997, the Company introduced the first faucet-mounted water
filter to remove mercury, particulates, atrazine and lindane.
o 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.
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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 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 82% of all household faucet-mounted water filtration
sales in the United States in 1998.
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 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 14% of all
water filtration pitcher sales in the United States in 1998.
The products comprising the PUR line of household water filters are as
follows:
POUR-THROUGH PRODUCTS:
o PUR Pitcher - Pitcher capacity: 1/2 gallon; filter capacity:
40 gallons (1-2 mos.)
o PUR PLUS Pitcher - Pitcher capacity: 1/2 gallon; filter
capacity: 40 gallons (1-2 mos.)
o PUR PLUS Dispenser - Dispenser capacity: 2 gallons; filter
capacity: 40 gallons (1-2 mos.)
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IN-LINE PRODUCTS:
o PUR FM (standard) - Faucet-mounted; filter capacity: 100
gallons (2-3 mos.)
o PUR FM PLUS - Faucet-mounted; filter capacity: 100 gallons
(2-3 mos.)
o PUR FM ULTIMATE - Faucet-mounted; filter capacity: 100 gallons
(2-3 mos.)
o PUR CT PLUS - Countertop; filter capacity: 200 gallons (4-6
mos.)
o PUR US PLUS - Under-sink; filter capacity: 200 gallons (4-6
mos.)
The number of months of estimated useful life of the filters is based on
Company surveys of consumer usage.
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 chemicals and 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(R)
disinfection 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
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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 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:
PORTABLE SYSTEMS:
o PUR Pioneer - Microfilter; special feature: disposable filter
o PUR Hiker - Microfilter; special feature: anti-clog filter
o PUR Voyageur - Purifier; special features: anti-clog filter with
iodinated resin
o PUR Scout - Purifier; special features: anti-clog filter with
iodinated resin and dirt shield
o PUR Explorer - Purifier; special features: double-action pump;
self-cleaning filter with iodinated resin
DESALINATORS:
o PUR Survivor-06 - Desalinator; special features: hand-operated, 6
gallons per day ("gpd")
o PUR Survivor-35 - Desalinator; special features: hand-operated, 35
gpd
o PUR PowerSurvivor-40E - Desalinator; special features: powered by
12-volt DC motor, 40 gpd
o PUR PowerSurvivor-80E - Desalinator; special features: powered by
12-volt DC motor, 80 gpd
o PUR PowerSurvivor-160E - Desalinator; special features: powered by
12-volt DC motor, 160 gpd
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.
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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 mass merchants, department stores,
drug stores, grocery stores, home center and hardware stores, warehouse clubs
and specialty retailers. The Company's household products are distributed in
approximately 35,000 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.
The Company's household products are distributed through the following
channels:
o Mass merchants (including Wal-Mart, Target, Kmart and Fred Meyer)
o Department stores (including Dayton's, Marshall Fields, Macy's,
Robinson-May, Dillard's, Bloomingdale's, JC Penney and Sears)
o Drug stores (including Walgreens, Eckerd Drug, Long's Drug, American
Stores, Rite-Aid and CVS)
o Grocery stores (including Albertson's, Kroger, Super Valu, Fleming,
Wegman's, Winn-Dixie and Publix)
o Home center and hardware stores (including Home Depot, Lowes,
Menards, Payless Cashways, Builders Square, Ace Hardware, True Value
Hardware, Hardware Hank, Servistar and Coast-to- Coast)
o Warehouse clubs (including Costco, Sam's Club and B.J.'s)
o Specialty retailers (including Bed, Bath & Beyond, Linens 'N Things,
Home Place, Lechters and QVC).
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 35 retailers including most
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.
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
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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 research and development were $2.0 million in 1996,
$3.1 million in 1997, and $4.2 million in fiscal 1998, representing 6.0%, 4.3%
and 5.5% 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. 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 13 United States utility patents and six
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 2001 to 2016. The Company has applied for
corresponding foreign patents where it deemed such applications necessary. The
Company has also applied for additional 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. (a subsidiary of U.S. Filter, 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.
8
<PAGE>
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 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 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 January 3, 1999, the Company had approximately 360 full-time employees,
of whom 31 were involved in research and development, 240 in engineering,
manufacturing, assembly and testing, 51 in sales, marketing, technical and
customer service, and 38 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.
ITEM 1A. IMPORTANT INFORMATION
Certain statements in this Annual Report on Form 10-K and in the Company's
press releases and oral statements made by or with the approval of the Company's
executive officers constitute or will constitute "forward-looking statements."
Forward-looking statements involve risks and uncertainties that could cause
actual results to differ materially from those suggested in the forward-looking
statement, including without limitation the effects of economic conditions,
product demand, competitive products and other risks detailed herein.
RECENT HISTORY OF OPERATING LOSSES
The Company has experienced a net loss in each of the last three years due
primarily to costs associated with entering the household market including,
among other things, costs of creating brand name awareness, developing broader
product line offerings, and establishing a wide distribution network for its
products. The net losses were incurred despite substantial increases in net
sales that resulted from the Company's entry into the household water filter
market. The Company intends to continue investing significant amounts in
development of additional extensions of its product lines, advertising and
promotional activities to support existing products and new product
introductions, and continued development of enhanced manufacturing processes and
expanded production capacity. Thus, the Company may continue to generate losses
even if revenues increase, and there can be no assurance that the Company will
become consistently profitable. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation."
CONTINUED ACCEPTANCE OF PRODUCTS
The Company's ability to continue to increase its sales and return to
consistent profitability will depend to a significant degree on the continued
successful retail sell-through of new and existing household drinking water
treatment products for consumer markets in the United States and other
countries. The success of the Company's products will depend in part on the
Company's continued ability to educate consumers about the
9
<PAGE>
advantages of such products over other means of addressing drinking water
concerns, including bottled water and alternative products for water filtration.
Additionally, there can be no assurance that the Company's household water
filtration products will continue to be successfully sold through the Company's
established network of retail outlets or that the Company will be able to
maintain its distribution network. The Company's performance will also depend on
consumers' willingness to continue using the Company's products and to buy
replacement filter cartridges. See "Business - Industry Overview - Household
Market" and "Business - Products - Household Water Filters."
RELIANCE ON PROPRIETARY TECHNOLOGY
The Company's ability to compete depends in part on its proprietary
technology, which it seeks to protect with patents and trademarks. The Company
is the owner of numerous United States utility patents, United States design
patents, and United States registered trademarks related to its desalinator,
recreational, and household water filtration products. Additionally, the Company
has applied for several patents related to its new and existing household water
filtration products and recreational products. The Company has also applied for
and received various corresponding foreign patents where it deemed such
applications necessary. The laws of certain foreign countries do not protect the
Company's intellectual property rights to the same extent as do the laws of the
United States. The Company intends to vigorously defend and protect its patents
and other proprietary technology against infringement or misappropriation by
others. There can be no assurance, however, that steps taken by the Company will
prevent misappropriation of its technology, that any patents from pending patent
applications or from any future patent application will be issued, that the
scope of any patent protection will provide competitive advantages to the
Company or preclude competitors from developing products similar to the
Company's products, that any of the Company's patents will be held valid if
subsequently challenged, or that others will not claim rights in or ownership of
the patents and other proprietary rights held by the Company. In addition, there
can be no assurance that third parties will not assert infringement claims with
respect to the Company's current or future products or that any such claims will
not require the Company to enter into license arrangements or result in
litigation, regardless of the merits of such claims. No assurance can be given
that any necessary licenses could be obtained on commercially reasonable terms,
or at all. Litigation or regulatory proceedings may also be necessary to enforce
patent or other intellectual property rights of the Company or to determine the
scope and validity of other parties' proprietary rights. Such litigation could
be expensive and time consuming and could have a material adverse effect on the
Company's business, financial condition or results of operations regardless of
the outcome of such litigation. See "Business - Patents."
PATENT LITIGATION
The Company has been involved in litigation from time to time with respect
to certain aspects of its technology and may become involved in similar
litigation in the future. The costs associated with such litigation and
potential adverse decisions resulting from such litigation could have a material
adverse effect on the Company's business, prospects and financial condition. See
"Legal Proceedings"
TECHNOLOGICAL CHANGE AND PRODUCT OBSOLESCENCE
The water treatment markets in which the Company competes are subject to
technological changes, and the Company's business strategy is based to a
substantial extent on the Company's ability to offer technologically superior
products. The ability of the Company to compete successfully will depend in part
on its ability to continue to respond effectively to technological changes,
enhance its technology and develop and market new products and new applications
for its existing technology. Although the Company expends a significant portion
of its revenues on research and development and product enhancement efforts,
there can be no assurance that the Company can successfully develop and bring
any new products to the market in a timely manner, that such products will be
commercially successful, or that competitors' technologies or services will not
render the Company's products or services non-competitive or obsolete. The
Company relies on product effectiveness certifications from the National
Sanitation Foundation ("NSF"), a nationally recognized not-for-profit agency for
the certification of water filters, to support its claims to consumers.
10
<PAGE>
There can be no assurance that NSF will certify each of the claims the Company
may submit from time-to-time with respect to the performance of its products.
Furthermore, the failure to receive, or a delay in receiving, the anticipated
certification could impair the Company's ability to market such products. See
"Business - Products" and "Business - Research and Development."
MANAGEMENT OF GROWTH
During the last three years, as a result of significant increases in sales
of the Company's household water filter systems, the Company was not able at all
times to adjust its production capacity quickly enough to keep pace with the
demand for its products. In addition, the Company's shipments of one of its
products were interrupted because of inconsistent raw materials. To manage
further growth successfully, the Company will be required to continue improving
its operations, management and financial systems and controls and expand its
facilities and its employee workforce. Any future growth can be expected to
place significant additional responsibilities on the Company's management,
operations, employees and resources. There can be no assurance the Company will
be able to maintain or accelerate its current growth, effectively manage its
expanding operations or achieve planned growth on a timely or profitable basis.
To the extent that the Company is unable to manage its growth efficiently and
effectively, the Company's business, financial condition and results of
operations could be materially adversely affected. Furthermore, in pursuing its
growth strategy, the Company may need to incur additional debt or issue
additional equity securities, resulting in increased financial leverage or
potential dilution to holders of Common Stock. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Business -
Business Strategy."
COMPETITION
The Company encounters and expects to continue to encounter intense
competition in the sale of its products. The Company believes that the principal
competitive factors affecting the market for its products include product
features, product performance and reputation, price and service. The Company's
competitors include companies with established reputations in the consumer,
household water filtration and purification field and substantially greater
financial, technical, marketing and other resources than the Company. As a
result, such companies may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements or to devote greater resources
to the promotion and sale of their products than the Company. Competition could
increase if new companies enter the market or if existing competitors expand
their product lines or intensify efforts within existing product lines. The
Company also indirectly competes on the retail consumer level with suppliers of
prepackaged bottled water and bulk water dispensing systems. There can be no
assurance that the Company's current products, products under development or
ability to discover new technologies will be sufficient to enable it to compete
effectively. See "Business Competition."
PRODUCT LIABILITY
The Company could be liable for personal injuries allegedly caused by a
defect in one of the Company's products. While to date the Company has not
experienced any such claims, there can be no assurance that such claims will not
be made in the future. The Company currently carries product liability insurance
covering its products with policy limits of $2.0 million in the aggregate and
$1.0 million per occurrence. The Company also maintains umbrella coverage over
this amount to $15.0 million. It cannot be predicted, however, whether such
insurance is sufficient to adequately cover the Company's product liability
risk. Lack of sufficient insurance could expose the Company to substantial
damages in connection with product liability claims or product recalls. In
addition, the costs related to defending any claim, and/or the negative
publicity resulting from any liability action could have a material adverse
effect on the Company's sales and profitability.
11
<PAGE>
CUSTOMER CONCENTRATION
Sales of PUR household water filtration products to the Company's five
largest customers accounted for more than 51% of the Company's net sales in
1998, with Wal-Mart (16.8%) and Sam's Club (10.5%) each representing more than
10% of net sales. A reduction, delay or cancellation of orders from one or more
of these customers, or the loss of one or more of such customers, could have a
material adverse effect on the Company's operating results. See "Business -
Marketing and Distribution."
SEASONALITY; QUARTERLY FLUCTUATIONS; POSSIBLE VOLATILITY OF STOCK PRICE
Management believes that the Company's business is to some extent
seasonal, with its highest sales levels occurring during the fourth quarter,
although its recent sales growth and interruptions of shipments of certain
products due to inconsistent raw materials may have masked seasonal patterns.
Results for any quarter are not necessarily indicative of the results that the
Company may achieve for any subsequent quarter or a full fiscal year. Quarterly
results may fluctuate as a result of the timing of merchandise shipments, timing
of expenditures for product development and other factors. There can be no
assurance that results in future periods will not fluctuate on a quarterly
basis. In addition, the market price for the Common Stock may be highly volatile
depending on various factors, including the general economy, stock market
conditions, the establishment or loss of major customer relationships,
technological innovations, new product introductions by the Company or its
competitors, and fluctuations in the Company's operating results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
POTENTIAL ADVERSE EFFECT OF STOCK OPTIONS, WARRANTS AND CONVERTIBLE SECURITIES
A substantial number of shares of Common Stock are issuable upon the
exercise of outstanding stock options and warrants or the conversion of the
Company's 5% Convertible Notes which expire in 2003 and are payable in annual
installments beginning in August 2001 (the "Convertible Notes"). When issued,
such shares may become available for sale in the public market. Sales of
substantial amounts of such shares in the public market could adversely affect
the market price of the Common Stock.
EFFECTS OF CERTAIN ANTI-TAKEOVER PROVISIONS
The Company has adopted a Shareholder Rights Plan and is subject to
certain anti-takeover provisions of the Minnesota Business Corporation Act. In
addition, the Company proposes to amend its Articles of Incorporation to create
a classified Board of Directors. This proposal will be presented to the
shareholders of the Company for their approval at the Annual Meeting to be held
on April 29, 1999. Such anti-takeover provisions could have the effect of
discouraging a takeover proposal or tender offer not approved by management and
the Board of Directors of the Company. Accordingly, shareholders may be denied
the opportunity to participate in a transaction which offers a premium to the
prevailing market price of the Common Stock. Furthermore, the Company's Board of
Directors is authorized, without further action by the holders of Common Stock,
to establish various series of Preferred Stock from time to time and to
determine the rights, preferences and restrictions of any wholly unissued
series, including, among other matters, dividend, liquidation and voting rights.
Thus, the Board of Directors may, without shareholder approval, issue shares of
a class or series of Preferred Stock with voting and conversion rights which
could adversely affect the voting power of the holders of the Common Stock and
could have the effect of delaying, deferring or preventing a change in control
of the Company. The creation and issuance of shares of such a class or series of
Preferred Stock could also adversely affect the market price of the Common
Stock.
12
<PAGE>
ITEM 2. PROPERTIES
The Company is headquartered in a leased facility of 188,000 square feet
at 9300 North 75th Avenue, Minneapolis, Minnesota 55428, pursuant to a lease
which expires in May 2008. The Company believes this 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 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 the remainder of the facility is
currently vacant. The original lease remains in effect and the Company may 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 were named as
defendants in a civil proceeding initiated in January 1997 by Brita U.S.A., a
subsidiary of Clorox Company, which asserted that the defendants infringed one
of Brita's patents relating to pitcher products. On March 3, 1999, summary
judgment was entered in the United States District Court for the Northern
District of Illinois, dismissing all claims against the Company and the other
defendants. Brita has the right to appeal the decision within 30 days from the
date the decision was entered. If the decision is appealed, the Company intends
to defend vigorously its right to market and sell its products. 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 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 was also a defendant in a civil proceeding initiated in April
1997 by UltraPure Systems, Inc., a subsidiary of Culligan Water Technologies,
Inc., which asserted that the Company infringed an UltraPure patent on a
faucet-mounted filter system. All claims against the Company were dismissed in
an order of summary judgment entered in the United States District Court for
Minnesota. A subsequent agreement between the Company and UltraPure Systems,
Inc. dismissed the entire case with prejudice and without opportunity for
appeal.
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 January 3, 1999.
13
<PAGE>
PART II
ITEM 5. MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Common stock market and dividend information on page 20 of the Annual
Report to Shareholders is incorporated herein by reference in response to this
item.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data on page 20 of the Annual Report to Shareholders is
incorporated herein by reference in response to this item.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations on pages 7 through 12 of the Annual Report to Shareholders is
incorporated herein by reference in response to this item.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are not currently subject to market risks
for interest rates, foreign currency rates, commodity prices or other market
price risks of a material nature.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The report of independent auditors and financial statements included on
pages 13 through 20 of the Annual Report to Shareholders are incorporated herein
by reference in response to this item.
The quarterly financial information on page 20 of the Annual Report to
Shareholders is incorporated herein by reference in response to this item.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
14
<PAGE>
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS
The information contained on pages 8 through 11 of the Proxy Statement
with respect to directors and executive officers of the Company is hereby
incorporated by reference in response to this item.
The information contained on pages 14 and 15 of the Proxy Statement with
respect to compliance with Section 16(a) of the Exchange Act is hereby
incorporated by reference in response to this item.
ITEM 11. EXECUTIVE COMPENSATION
The information contained on pages 11 through 14 of the Proxy Statement
with respect to executive compensation is hereby incorporated by reference in
response to this item.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information contained on pages 18 through 20 of the Proxy Statement
with respect to security ownership of certain beneficial owners and management
is hereby incorporated by reference in response to this item.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information contained on page 15 of the Proxy Statement with respect
to certain relationships and related transactions is hereby incorporated by
reference in response to this item.
15
<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.
included in the Annual Report to Shareholders, are incorporated by
reference in Item 8:
Balance Sheets as of December 31, 1997 and January 3, 1999
Statements of Operations for the Years ended December 31, 1996 and
1997, and January 3, 1999
Statements of Cash Flows for the Years ended December 31, 1996 and
1997, and January 3, 1999
Statement of Changes in Shareholders' Equity for the Years
ended December 31, 1996 and 1997, and January 3, 1999
Notes to Financial Statements
2. FINANCIAL STATEMENT SCHEDULES.
The following schedule supporting financial statements for the three
years ended January 3,1999 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 Financing Agreement dated March 31, 1997 between Recovery
Engineering, Inc. and U.S. Bank National Association, f/k/a
First Bank National Association
10.6.1 First Amendment to Financing Agreement dated March 16, 1998,
between Recovery Engineering, Inc. and U.S. Bank National
Association, f/k/a First Bank National Association
10.6.2 Waiver Letter dated November 16, 1998, from U.S. Bank National
Association
10.7 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")
16
<PAGE>
10.8 Registration Rights Agreement dated July 19, 1996 by and among
Recovery Engineering, Inc. and GS Group
10.9* Executive Restriction Agreement dated July 19, 1996 by and
among Recovery Engineering, Inc., GS Group and Brian F.
Sullivan
10.10* Executive Severance Pay Agreement dated March 24, 1997 between
Recovery Engineering, Inc. and Charles F. Karpinske
10.11* Change-in-Control Severance Pay Agreement dated November 2,
1998 between Recovery Engineering, Inc. and Brian F. Sullivan
10.12* Change-in-Control Severance Pay Agreement dated November 2,
1998 between Recovery Engineering, Inc. and Richard D. Hembree
10.13* Change-in-Control Severance Pay Agreement dated November 2,
1998 between Recovery Engineering, Inc. and Jeffrey T. Dekko
10.14* Change-in-Control Severance Pay Agreement dated November 2,
1998 between Recovery Engineering, Inc. and Barry B. Van
Lerberghe
10.15* Change-in-Control Severance Pay Agreement dated November 2,
1998 between Recovery Engineering, Inc. and Daniel B. Seebart
10.16* Change-in-Control Severance Pay Agreement dated February 8,
1999 between Recovery Engineering, Inc. and Reed A. Watson
10.17 Lease Agreement dated November 8, 1996 between Ryan Companies
US, Inc. and Recovery Engineering, Inc.
10.17.1 First Amendment to Lease dated December 20, 1996, between Ryan
Companies US, Inc. and Recovery Engineering, Inc.
10.17.2 Second Amendment to Lease dated May 1, 1997, between Ryan
Recovery, LLC and Recovery Engineering, Inc.
10.17.3 Third Amendment to Lease dated December 22, 1997, between Ryan
Recovery, LLC and Recovery Engineering, Inc.
13.1 Annual Report to Shareholders for the fiscal year ended
January 3, 1999
21.1 Subsidiary of Recovery Engineering, Inc.
23.1 Consent of Independent Auditors
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
January 3, 1999.
17
<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 report to be signed on
its behalf by the undersigned, thereunto duly authorized.
RECOVERY ENGINEERING, INC.
Date: March 31, 1999 By /s/ Brian F. Sullivan
-------------------------------------------
Brian F. Sullivan
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------- ----- ----
<S> <C> <C>
/s/ Brian F. Sullivan Chairman, Chief Executive Officer March 31, 1999
- -------------------------------------------- and Director (Principal Executive
Brian F. Sullivan Officer)
/s/ Charles F. Karpinske Vice President and Chief Financial March 31, 1999
- -------------------------------------------- Officer (Principal Financial and
Charles F. Karpinske Accounting Officer)
/s/ Robert Gheewalla Director March 31, 1999
- --------------------------------------------
Robert Gheewalla
/s/ John E. Gherty Director March 31, 1999
- --------------------------------------------
John E. Gherty
/s/ Sanjay H. Patel Director March 31, 1999
- --------------------------------------------
Sanjay H. Patel
/s/ William D. Thompson Director March 31, 1999
- --------------------------------------------
William D. Thompson
/s/ William F. Wanner, Jr. Director March 31, 1999
- --------------------------------------------
William F. Wanner, Jr.
/s/ Richard J. Zeckhauser Director March 31, 1999
- --------------------------------------------
Richard J. Zeckhauser
</TABLE>
18
<PAGE>
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
RECOVERY ENGINEERING, INC.
(in thousands)
<TABLE>
<CAPTION>
ADDITIONS
--------------------------
BALANCE AT CHARGED TO
BEGINNING COSTS AND CHARGED TO BALANCE AT END
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS OF PERIOD
- ----------- --------- -------- -------------- ---------- ---------------
<S> <C> <C> <C> <C>
YEAR ENDED JANUARY 3, 1999
Reserves & allowances deducted from
asset accounts:
Allowance for uncollectible accounts $314 $ 52 $ 58 (1) $308
Reserve for inventory obsolescence $418 $587 $318 (2) $687
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
</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 Proxy
Engineering, Inc. 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, Filed as Exhibit 4.1 to the Company's Form
1996 between Recovery Engineering, Inc. 8-A Registration Statement dated February
and Norwest Bank Minnesota, National 20, 1996 (File No. 0-21232) and incorporated
Association, as Rights Agent herein by reference
4.1.1 Amendment No. 1 dated as of February 3, Filed as Exhibit 4.1.1 to the Company's
1998 to Rights Agreement between Annual Report on Form 10-K for the year
Recovery Engineering, Inc. and Norwest ended December 31, 1997 (File No. 0-21232)
Bank Minnesota, National Association, and incorporated herein by reference
as Rights Agent
10.1 * Recovery Engineering, Inc. 1986 Stock Filed as Exhibit 10.6 to the Company's
Option 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 Filed as Exhibit 99.1 to the Company's
Option 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, Filed as Exhibit 10.5 to the Company's
1996, between Thermotech and Recovery Annual Report on Form 10-K for the year
Engineering, Inc. ended December 31, 1997 (File No. 0-21232)
and incorporated herein by reference.
<PAGE>
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
- --- ----------- ----------------
10.6 Financing Agreement dated March 31, Filed as Exhibit 99.1 to the Company's
1997 between Recovery Engineering, Inc. Quarterly Report on Form 10-Q for the
and U.S. Bank National Association, f/k/a quarter ended June 30, 1997 (File No.
First Bank National Association 0-21232) and incorporated herein by
reference
10.6.1 First Amendment to Financing Filed as Exhibit 10.7.1 to the Company's
Agreement dated March 16, 1998 Registration Statement on Form S-3 (No.
between Recovery Engineering, Inc. and 333-46833) and incorporated herein by
U.S. Bank National Association, f/k/a reference
First Bank National Association
10.6.2 Waiver Letter dated November 16, 1998, Filed electronically herewith
from U.S. Bank National Association
10.7 Securities Purchase Agreement dated Filed as Exhibit 4.1 to the Company's Report
July 19, 1996 by and among Recovery on Form 8-K dated July 19, 1996 (File No.
Engineering, Inc. and investment 0-21232) and incorporated herein by
partnerships affiliated with The Goldman reference
Sachs Group, L.P. ("GS Group")
10.8 Registration Rights Agreement dated Filed as Exhibit 99.1 to the Company's
July 19, 1996 by and among Recovery Report on Form 8-K dated July 19, 1996 (File
Engineering, Inc. and GS Group No. 0-21232) and incorporated herein by
reference
10.9 * Executive Restriction Agreement dated Filed as Exhibit 99.2 to the Company's
July 19, 1996 by and among Recovery Report on Form 8-K dated July 19, 1996 File
Engineering, Inc., GS Group and Brian F. No. 0-21232) and incorporated herein by
Sullivan reference
10.10 * Executive Severance Pay Agreement Filed as Exhibit 99.2 to the Company's
dated March 24, 1997 between Recovery Quarterly Report on Form 10-Q for the
Engineering, Inc. and Charles F. Quarter ended June 30, 1997 (File No.
Karpinske 0-21232) and incorporated herein by
reference
10.11 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated November 2, 1998 between Recovery
Engineering, Inc. and Brian F. Sullivan
10.12 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated November 2, 1998 between Recovery
Engineering, Inc. and Richard D.
Hembree
10.13 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated November 2, 1998 between Recovery
Engineering, Inc. and Jeffrey T. Dekko
<PAGE>
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
- --- ----------- ----------------
10.14 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated November 2, 1998 between Recovery
Engineering, Inc. and Barry B. Van
Lerberghe
10.15 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated November 2, 1998 between Recovery
Engineering, Inc. and Daniel B. Seebart
10.16 * Change-in-Control Severance Pay Agreement Filed electronically herewith
dated February 8, 1999 between Recovery
Engineering, Inc. and Reed A. Watson
10.17 Lease Agreement dated November 8, Filed as Exhibit 10.20 to the Company's
1996 between Ryan Companies US, Inc. Annual Report on Form 10-K for the year
and Recovery Engineering, Inc. ended December 31, 1996 (File No. 0-21232)
and incorporated herein by reference
10.17.1 First Amendment to Lease dated Filed as Exhibit 10.12.1 to the Company's
December 20, 1996, between Ryan Annual Report on Form 10-K for the year
Companies US, Inc. and Recovery ended December 31, 1997 (File No. 0-21232)
Engineering, Inc. and incorporated herein by reference.
10.17.2 Second Amendment to Lease dated Filed as Exhibit 10.12.2 to the Company's
May 1, 1997, between Ryan Recovery, Annual Report on Form 10-K for the year
LLC and Recovery Engineering, Inc. ended December 31, 1997 (File No. 0-21232)
and incorporated herein by reference
10.17.3 Third Amendment to Lease dated Filed as Exhibit 10.12.3 to the Company's
December 22, 1997, between Ryan Annual Report on Form 10-K for the year
Recovery, LLC and Recovery ended December 31, 1997 (File No. 0-21232)
Engineering, Inc. and incorporated herein by reference
13.1 Annual Report to Shareholders for the Filed electronically herewith
fiscal year ended January 3, 1999
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)
and incorporated herein by reference
23.1 Consent of Independent Auditors Filed electronically herewith
27.1 Financial Data Schedule Filed electronically herewith
</TABLE>
- -------------
* Management Contracts
USbancorp.
November 16, 1998
Recovery Engineering, Inc.
9300 North 75th Avenue
Brooklyn Park, MN 55428
ATTENTION: James Moe
Re: Loan to Recovery Engineering, Inc.
Dear Mr. Moe:
Reference is made to that certain Financing Agreement dated as of March
31, 1997 between Recovery Engineering, Inc. (the "Borrower") and U.S. Bank
National Association, formerly known as First Bank National Association, (the
"Lender") as amended by that First Amendment to Financing Agreement dated as of
March 16, 1998 (as so amended the "Financing Agreement"). Capitalized terms used
herein and not defined shall have the meaning assigned to them in the Financing
Agreement.
Pursuant to the provisions of the Financing Agreement, the Borrower is
required to have Cumulative Net Profit at the amounts and on the dates set forth
in Section 2.3(c) of the Financing Agreement. In the event that Borrower fails
to have Cumulative Net Profit in the amounts and by the dates set forth in
Section 2.3(c) of the Financing Agreement, then all Advances are due and payable
pursuant to Section 2.4 of the Financing Agreement. The Borrower has informed
the Lender that it failed to achieve Cumulative Net Profit for fiscal year end
1998 as of September 30, 1998 at the level set forth in Section 2.3(c)(ii) of
the Financing Agreement.
The Borrower has requested that the Lender waive, and the Lender hereby
waives, the requirement that all Advances are due and payable due to the
Borrower's failure to achieve Cumulative Net Profit for the fiscal year end 1998
as of September 30, 1998 at the level set forth in Section 2.3(c)(ii) of the
Financing Agreement.
<PAGE>
Recovery Engineering, Inc.
November 16,1998
Page 2
This waiver is expressly limited to the express terms described hereof
and shall not extend to any other failure to achieve Cumulative Net Profit under
Section 2.3 of the Financing Agreement causing all Advances to be and payable
under Section 2.4, to any event of default under the Security Agreement or to
any other period. This waiver shall not be deemed a course performance upon
which the Borrower may rely with respect to any failure to achieve Cumulative
Net Income, any default or event of default under the Security Agreement, or
request for a waiver and the Borrower hereby waives any such claim.
U.S. Bank National Association
By /s/ Lee Anderson
Its Analyst/Lender
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 2nd day of November, 1998, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Brian
F. Sullivan (the "Executive").
RECITALS
A. The Executive is the President and Chief Executive Officer of the
Company as of the date of this Agreement, and has been an employee of the
Company since March 1986.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
-1-
<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to three times the Executive's average annual compensation (as defined
below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 36 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
-2-
<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
-3-
<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
-4-
<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
-5-
<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ WILLIAM F. WANNER, JR.
----------------------------------
William F. Wanner, Jr.
Director
EXECUTIVE:
/s/ BRIAN F. SULLIVAN
------------------------------------
Brian F. Sullivan
-6-
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 2nd day of November, 1998, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Richard
D. Hembree (the "Executive").
RECITALS
A. The Executive is the Vice President - Engineering of the Company as
of the date of this Agreement, and has been an employee of the Company since
1987.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
-1-
<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to two times the Executive's average annual compensation (as defined
below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 24 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
-2-
<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
-3-
<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
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<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
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<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ BRIAN F. SULLIVAN
------------------------------------------
Brian F. Sullivan
President and Chief Executive Officer
EXECUTIVE:
/s/ RICHARD D. HEMBREE
--------------------------------------------
Richard D. Hembree
-6-
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 2nd day of November, 1998, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Jeffrey
T. Dekko (the "Executive").
RECITALS
A. The Executive is the Vice President - Marketing of the Company as of
the date of this Agreement, and has been an employee of the Company since
October 1994.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
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<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to the Executive's average annual compensation (as defined below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 12 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
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<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
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<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
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<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
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<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ BRIAN F. SULLIVAN
----------------------------------------
Brian F. Sullivan
President and Chief Executive Officer
EXECUTIVE:
/s/ JEFFREY T. DEKKO
------------------------------------------
Jeffrey T. Dekko
-6-
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 2nd day of November, 1998, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Barry
B. Van Lerberghe (the "Executive").
RECITALS
A. The Executive is the Vice President - Sales of the Company as of the
date of this Agreement, and has been an employee of the Company since July 1995.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
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<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to the Executive's average annual compensation (as defined below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 12 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
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<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
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<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
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<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
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<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ BRIAN F. SULLIVAN
-----------------------------------------
Brian F. Sullivan
President and Chief Executive Officer
EXECUTIVE:
/s/ BARRY B. VAN LERBERGHE
-------------------------------------------
Barry B. Van Lerberghe
-6-
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 2nd day of November, 1998, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Daniel
B. Seebart (the "Executive").
RECITALS
A. The Executive is the Vice President - Manufacturing of the Company
as of the date of this Agreement, and has been an employee of the Company since
October 1998.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
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<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to the Executive's average annual compensation (as defined below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 12 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
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<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
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<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
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<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
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<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ BRIAN F. SULLIVAN
----------------------------------------
Brian F. Sullivan
President and Chief Executive Officer
EXECUTIVE:
/s/ DANIEL B. SEEBART
------------------------------------------
Daniel B. Seebart
-6-
CHANGE-IN-CONTROL SEVERANCE PAY AGREEMENT
THIS AGREEMENT is made this 8th day of February, 1999, by and between
Recovery Engineering, Inc., a Minnesota corporation, (the "Company") and Reed A.
Watson (the "Executive").
RECITALS
A. The Executive has been named President and Chief Operating Officer
of the Company, effective as of the date of this Agreement.
B. The Board of Directors of the Company desires to retain the
Executive in the employ of the Company.
C. The Board of Director believes that it is essential to preserve and
maintain the stability and continuity of management of the Company by providing
the Executive with economic and other security from the uncertainty of risks
inherent in a potential or threatened takeover of the Company which might
jeopardize the Executive's employment.
NOW THEREFORE, in consideration of the foregoing and of the mutual
promises of the parties hereto, the Company and the Executive agree as follows:
1. Eligibility for Severance Pay. The Executive shall be eligible to
receive severance pay, in the amounts and at the times described in paragraph 3,
if:
(a) the Executive's employment with the Company and all of its
subsidiaries (if any) is terminated within 24 months after there has
been a "change in control," as such term is hereinafter defined; and
(b) the Executive's termination of employment was not:
(i) on account of the Executive's death;
(ii) on account of a physical or mental
condition that entitles the Executive to benefits under any
long-term disability plan maintained by the Company or any of
its subsidiaries, as then in effect;
(iii) for conduct involving serious willful
misconduct (such as commission by the Executive of a felony or
a common law fraud against the Company) which is detrimental
in a significant way to the business of the Company or any or
its subsidiaries; or
(iv) on account of the Executive's voluntary
resignation; provided, that a resignation shall not be
considered to be voluntary for the purposes of this Agreement
if it occurs under the circumstances described in paragraph
11(a), or if,
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<PAGE>
subsequent to the change in control, there has been: (1) a
reduction in the Executive's compensation; or (2) a change in
the place in which the Executive is required to perform his or
her duties, if the new place is more than 25 miles from his or
her previous place of employment.
2. Change in Control. For the purposes of this Agreement, a "change in
control" shall be deemed to have occurred if:
(a) the shareholders of the Company shall adopt a resolution
providing for its dissolution or liquidation, or for a merger,
consolidation, or other corporate reorganization of the Company under
circumstances in which the Company will not be the surviving party; or
(b) any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934) (other than the Company
or any of its subsidiaries or any employee benefit plan of the Company
or any of its subsidiaries) becomes a beneficial owner, directly or
indirectly, of securities of the Company representing 25% or more of
the voting power of all of the Company's then outstanding securities;
or
(c) during any period of two consecutive years, individuals
who at the beginning of such period constituted the Board of Directors
of the Company ceased for any reason to constitute at least a majority
thereof (unless the nomination of each new director was approved by a
vote of at least two thirds of the directors then still in office who
were directors at the beginning of such period); or
(d) the Board of Directors of the Company shall approve the
sale of all, or substantially all, of the business or assets of the
Company.
3. Amount and Payment of Severance Pay. The Executive shall receive:
(a) a lump sum cash payment, no later than 30 days after the
date on which the Executive's employment terminates, in an amount equal
to the Executive's average annual compensation (as defined below);
(b) continuation of coverage under the Company's group
medical, group life, and group long-term disability plans, if any, and
under any individual policy or policies of life insurance maintained by
the Company, with the same rate of employer contributions as for active
employees, until the earlier to occur of:
(i) the expiration of 12 months from the
date on which the Executive's employment terminates; or
(ii) the date on which the Executive obtains
comparable coverage provided by a new employer.
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<PAGE>
(c) a lump sum cash payment, payable no later than 30 days
after the date on which the Executive's employment terminates, in an
amount equal to the sum of:
(i) the amount by which the fair market
value of that number of shares of stock subject to any stock
option which is forfeited or which otherwise becomes
non-exercisable by the Executive by reason of the termination
of his or her employment (determined as of the date of such
termination) exceeds the option price for such shares;
(ii) such additional amounts (or the fair
market value of such additional property) in excess of the
amount determined pursuant to subparagraph (i) that would have
been paid or distributed to the Executive upon the exercise of
any such forfeited stock options, had such options been
exercisable, and exercised, by the Executive as of the date
his or her employment terminated;
(iii) an amount equal to the fair market
value of any shares of restricted stock forfeited by the
Executive by reason of the termination of his or her
employment, determined as of the date of such termination; and
(iv) an amount equal to the amount that the
Executive would have received if any stock appreciation right
which is forfeited or which otherwise becomes non-exercisable
by the Executive by reason of the termination of his or her
employment had been exercisable, and exercised, by the
Executive as of the date of such termination.
It is understood and agreed that this payment is to occur only to the
extent the Executive is not entitled to exercise his or her options or
stock appreciate rights, or to retain his or her restricted stock,
after the termination of his or her employment under the provisions of
the Executive's stock option, restricted stock, or stock appreciation
rights agreements.
For purposes of this paragraph 3, the term "average annual compensation" shall
mean the average rate of annual salary payable to the Executive for the calendar
year in which the Executive's employment terminates and for the two immediately
preceding calendar years, plus the average annual bonus or incentive payments
awarded to the Executive for the same three calendar years; provided, that if
bonus or incentive compensation awards have not been determined for the calendar
year in which the Executive's employment terminates prior to the date of such
termination, such average shall be determined using the bonuses or incentive
payments awarded to the Executive for the three calendar years immediately
preceding the year in which the Executive's employment terminates; and provided
further, that if the Executive has not been employed by the Company for two full
calendar years preceding the year in which the Executive's employment
terminates, "average annual compensation" shall be based on the Executive's
average annual rate of salary plus the average annual bonus or incentive
payments determined as described above, for the entire period of the Executive's
employment. The Executive's average annual compensation shall be determined
prior to any reduction for deferred compensation, "401(k)" plan contributions,
and similar items, and any reduction in the Executive's rate of salary occurring
within 24 months after a change in control shall be disregarded. In addition,
the insurance coverage provided under this paragraph shall be
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<PAGE>
governed by the insurance coverage provided to such the Executive immediately
prior to any reduction in such coverage occurring within 24 months after any
change in control.
4. Limitations. If any part of the amounts to be paid to or for the
benefit of the Executive pursuant to this Agreement constitute "parachute
payments" within the meaning of section 280G of the Internal Revenue Code of
1986, as from time to time amended (the "Code"), such amounts shall be reduced
as provided below so that the aggregate present value of the amounts payable
pursuant to this Agreement which constitute such parachute payments will be
equal to 299% of the Executive's "annualized includible compensation for the
base period," as such term is defined in section 280G(d)(1) of the Code. Such
reductions shall be made in the benefits provided pursuant to subparagraph 3(b),
in the inverse order of their anticipated payment, before any reductions are
made in the amounts payable pursuant to subparagraphs 3(a) or 3(c). For the
purpose of this subparagraph, present value shall be determined in accordance
with section 1274(b)(2) of the Code.
5. No Funding of Severance Pay. Nothing herein contained shall require
or be deemed to require the Company or a subsidiary to segregate, earmark, or
otherwise set aside any funds or other assets to provide for any payments
required to be made hereunder, and the rights of the terminating Executive to
severance pay hereunder shall be solely those of a general, unsecured creditor
of the Company. However, the Company may, in its discretion, deposit cash or
property, or both, equal in value to all or a portion of the amounts anticipated
to be payable hereunder for the Executive into a trust, the assets of which are
to be distributed at such times as determined by the trustee of such trust;
provided, that such assets shall be subject at all times to the rights of the
Company's general creditors.
6. Death. In the event of the Executive's death, any amount or benefit
payable or distributable to the Executive pursuant to paragraph 3(a) or
paragraph 3(c) shall be paid to the beneficiary designated by the Executive for
such purpose in the last written instrument, if any, received by the Boards of
Directors of the Company prior to the Executive's death, or, if no beneficiary
has been designated, to the Executive's estate.
7. Rights in the Event of Dispute. If a claim or dispute arises
concerning the rights of the Executive or a beneficiary to benefits under this
Agreement, regardless of the party by whom such claim or dispute is initiated,
the Company shall, upon presentation of appropriate vouchers, pay all legal
expenses, including reasonable attorneys' fees, court costs, and ordinary and
necessary out-of-pocket costs of attorneys, billed to and payable by the
Executive or by anyone claiming under or through the Executive (such person
being hereinafter referred to as the Executive's "claimant"), in connection with
the bringing, prosecuting, defending, litigating, negotiating, or settling such
claim or dispute; provided, that:
(a) the Executive or the Executive's claimant shall repay to
the Company any such expenses theretofore paid or advanced by the
Company if and to the extent that the party disputing the Executive's
rights obtains a judgment in its favor from a court of competent
jurisdiction, which judgment has become final, whether because the time
to appeal from such judgment has expired with no appeal taken or
otherwise, and it is determined that such expenses were not incurred by
the Executive or the Executive's claimant while acting in good faith;
and provided further, that
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<PAGE>
(b) in the case of any claim or dispute initiated by the
Executive or the Executive's claimant, such claim shall be made, or
notice of such dispute given, with specific reference to the provisions
of this Agreement, to the Board of Directors of the Company within one
year after the occurrence of the event giving rise to such claim or
dispute.
8. Amendment. This Agreement may not be amended or modified except by a
written instrument signed by both parties as of a date contemporaneous herewith
or subsequent hereto.
9. No Obligation to Mitigate Damages. In the event the Executive
becomes eligible to receive benefits hereunder the Executive shall have no
obligation to seek other employment in an effort to mitigate damages. To the
extent the Executive shall accept other employment after the termination of his
or her employment, the compensation and benefits received from such employment
shall not reduce any compensation and benefits due under this Agreement, except
as provided in paragraph 3(b).
10. Other Benefits. The benefits provided under this Agreement shall,
except to the extent otherwise specifically provided herein, be in addition to,
and not in derogation or diminution of, any benefits that the Executive or the
Executive's beneficiary may be entitled to receive under any other plan or
program now or hereafter maintained by the Company or by any of its
subsidiaries.
11. Successors.
(a) The Company will require any successor (whether direct or
indirect, by purchase, merger, consolidation, or otherwise) to all or
substantially all of the business and/or assets of the Company, to
expressly assume and agree to perform the Company's obligations under
this Agreement in the same manner and to the same extent that the
Company would be required to perform them if no such succession had
taken place unless, in the opinion of legal counsel mutually acceptable
to the Company and the Executive, such obligations have been assumed by
the successor as a matter of law. Failure of the Company to obtain such
agreement prior to the effectiveness of any such succession (unless the
foregoing opinion is rendered to the Executive) shall entitle the
Executive to terminate his or her employment and to receive the
payments provided for in paragraph 3 above. As used in this Agreement,
"Company" shall mean the Company, as presently constituted, and any
successor to its business and/or assets which executes and delivers the
agreement provided for in this paragraph 11 or which otherwise becomes
bound by all the terms and provisions of this Agreement as a matter of
law.
(b) The Executive's rights under this Agreement shall inure to
the benefit of, and shall be enforceable by, the Executive's legal
representative or other successors in interest, but shall not otherwise
be assignable or transferable.
12. Notices. Any notices referred to herein shall be in writing and
shall be sufficient if delivered in person or sent by U.S. registered or
certified mail to the Executive at his or her address on file with the Company
(or to such other address as the Executive shall specify by notice), or to the
Company at 9300 75th Avenue North, Minneapolis, Minnesota 55428, Attn: Board of
Directors.
-5-
<PAGE>
13. Waiver. Any waiver of any breach of any of the provisions of this
Agreement shall not operate as a waiver of any other breach of such provisions
or any other provisions, nor shall any failure to enforce any provision of this
Agreement operate as a waiver of any party's right to enforce such provision or
any other provision.
14. Severability. If any provision of this Agreement or the application
thereof is held invalid or unenforceable by a court of competent jurisdiction,
the invalidity or unenforceability thereof shall not affect any other provisions
or applications of this Agreement which can be given effect without the invalid
or unenforceable provision or application.
15. Governing Law. The validity, interpretation, construction, and
performance of this Agreement shall be governed by the laws of the State of
Minnesota, except to the extent superseded by applicable federal law.
16. Headings. The headings and paragraph designations of this Agreement
are included solely for convenience of reference and shall in no event be
construed to affect or modify any provisions of this Agreement.
17. Gender and Number. In this Agreement where the context admits,
words in any gender shall include the other genders, words in the plural shall
include the singular, and words in the singular shall include the plural.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY: RECOVERY ENGINEERING, INC.
By /s/ BRIAN F. SULLIVAN
----------------------------------------
Brian F. Sullivan
Chairman and Chief Executive Officer
EXECUTIVE:
/s/ REED A. WATSON
------------------------------------------
Reed A. Watson
-6-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company designs, manufactures and markets proprietary small-scale
drinking water systems under the P-UR 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. P-UR household products, which accounted for more than 87% of the
Company's net sales in 1998, are distributed through approximately 35,000 retail
outlets in the United States and Canada, including Costco, Wal-Mart, Sears,
Target, Kmart, Macy's and Walgreens.
The Company was founded in 1986, and initially 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 P-UR antimicrobial
water purifiers and microfilters for use by outdoor enthusiasts and
international travelers.
The Company has a dominant position in each of these markets.
The Company entered the retail water filter market in late 1994.
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 P-UR 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's net sales increased from $10,292,000 in 1993 to $76,965,000
in 1998. The increase in net sales was primarily the result of the Company's
successful entry 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 to consumers through retail
outlets. The Company believes that its aggressive campaign to build brand name
recognition for P-UR 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 owners of P-UR 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.
Selling, general and administrative expenses include advertising and
promotional expenses. To implement its strategy of building brand name
recognition for P-UR 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. In 1998, such expenses were
incurred in connection with the introduction and promotion of new products for
the household market. The Company intends to continue strategically expanding
its distribution network and seek additional distribution channels to solidify
its position in the household water filter market.
7
<PAGE>
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, DECEMBER 31, JANUARY 3,
1996 1997 1999
--------------------------------------------------------------
<S> <C> <C> <C>
Net sales......................................... 100.0% 100.0% 100.0%
Cost of products sold............................. 62.4 52.5 52.3
--------------------------------------------------------------
Gross profit...................................... 37.6 47.5 47.7
Operating expenses:
Selling, general and administrative............. 65.5 46.1 54.1
Research and development........................ 6.0 4.3 5.5
Facility relocation costs....................... 2.9 -- --
Equipment disposal costs........................ -- -- 0.7
--------------------------------------------------------------
74.4 50.4 60.3
--------------------------------------------------------------
Loss from operations.............................. (36.8) (2.9) (12.6)
Other income (expense):
Interest income and other....................... 0.7 0.1 0.8
Interest expense and other..................... (1.4) (2.0) (2.0)
--------------------------------------------------------------
Loss before income taxes.......................... (37.5) (4.8) (13.8)
Income tax expense (benefit)...................... -- -- --
--------------------------------------------------------------
Net loss.......................................... (37.5)% (4.8)% (13.8)%
==============================================================
</TABLE>
YEAR ENDED JANUARY 3, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1997
Net sales increased 8.0% to $76,965,000 in 1998 from $71,243,000 in 1997.
This $5,722,000 increase in net sales was attributable primarily to an increase
of $6,720,000 in sales of the Company's P-UR household water filter products,
offset by a decrease of $1,675,000 in sales of reverse osmosis desalinators to
military customers. Sales of household products increased 11.1% to $67,204,000
in 1998 from $60,484,000 in 1997. This was due to increased sales of the
Company's existing P-UR household water filtration products and the rollout of
new products introduced at the International Housewares Show in January 1998,
including the P-UR Plus pour-through products and the P-UR Ultimate faucet-mount
water filter. Sales of filter systems decreased slightly in 1998 compared to
1997 while the sale of replacement cartridges increased over that same period.
Retail sell-through of the Company's household water filters to consumers
increased approximately 90% from 1997 to 1998. Despite this large increase in
consumer sell-through, sales of household products only increased 11.1% from
1997 to 1998 due to the large amount of initial stocking orders to new accounts
in 1997. In 1997, the Company significantly expanded the number of its retail
outlets and 45% of the Company's household system sales were to stock retailers'
shelves. That expansion was largely completed in 1997, with some incremental
additions through the second quarter of 1998. In 1998, only approximately 10% of
the Company's household system sales were for retailer inventories, which is
approximately $18,000,000 less than in 1997. The increase in the revenue from
the sale of household water filters was also offset by a decrease of $2,834,000
in sales of OEM water filters to Braun AG, which were discontinued upon
termination of the Company's contract with Braun AG in December 1997. Revenues
from the sale of outdoor systems to consumers increased, but at a lower rate
than revenues from the sale of household water filters. Price increases did not
have a significant impact on net sales for 1998.
8
<PAGE>
Gross profit as a percentage of net sales increased to 47.7% in 1998 from
47.5% in 1997. The increase in gross profit as a percentage of net sales in 1998
was mainly due to the implementation of automated manufacturing and assembly
processes, reductions in cost of materials, and an increase in sales of higher
margin household products and replacement filter cartridges as a percentage of
net sales. The gross profit percentage also increased due to a higher volume of
sales over which to spread fixed costs. These increases were partially offset by
costs related to the introduction of the P-UR Plus pitcher, the P-UR Plus
dispenser and the P-UR Ultimate faucet-mount water filter.
Selling, general and administrative expenses increased to $41,657,000 in
1998 from $32,815,000 in 1997, representing 54.1% and 46.1% of net sales,
respectively. 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. Advertising costs increased to $20,405,000 in 1998 from $14,602,000 in
1997, and accounted for 65.6% of the increase in selling, general and
administrative expenses in 1998 relative to 1997. Although the Company expects
to continue its investment in marketing and advertising expenditures, the
Company believes that selling, general and administrative expenses will, as a
percentage of net sales, decrease in 1999.
Research and development expenses increased to $4,186,000 in 1998 compared
to $3,082,000 in 1997, representing 5.5% and 4.3% of net sales, respectively.
The Company expects that research and development expenses will continue to
increase in 1999 as it continues to develop new technology and product line
extensions.
Interest income and other income increased to $598,000 in 1998 from $43,000
in 1997 due to increased balances 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 over-allotment option completed May 18, 1998. Interest expense
and other expense increased to $1,536,000 in 1998 from $1,427,000 in 1997. The
increase in interest expense and other expense is mainly due to 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 for 1998 and 1997 was 0%. The
Company recorded a valuation allowance for the tax benefit related to the net
operating losses for 1998 and 1997. The Company had net operating tax loss
carryforwards of $34,023,000 at January 3, 1999.
YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996
Net sales increased 114.1% to $71,243,000 in 1997 from $33,277,000 in 1996.
This $37,966,000 increase in net sales was attributable primarily to an increase
of $38,378,000 in sales of the Company's P-UR household water filter products,
offset by a decrease of $1,540,000 in sales of reverse osmosis desalinators to
military customers. Sales of household products, including OEM water filters,
increased 173.6% to $60,484,000 in 1997 from $22,106,000 in 1996, reflecting
increased sales of filter systems and replacement cartridges, and the
introduction of the P-UR Plus faucet-mounted filter and the P-UR 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. 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.
9
<PAGE>
Selling, general and administrative expenses increased to $32,815,000 in
1997 from $21,803,000 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 rollout and expansion of the Company's line of household water
filters. Advertising costs increased to $14,602,000 in 1997 from $9,541,000 in
1996, and accounted for 46.0% of the increase in selling, general and
administrative expenses in 1997 relative to 1996.
Research and development expenses increased to $3,082,000 in 1997 from
$2,007,000 in 1996, representing 4.3% and 6.0% of net sales, respectively.
Interest income and other 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 and other expense increased to $1,427,000 in 1997
from $457,000 in 1996 due mainly 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 income 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.
LIQUIDITY AND CAPITAL RESOURCES
Cash used in operations was $11,431,000 in 1998, $9,023,000 in 1997, and
$5,700,000 in 1996. The reduction in cash flow from operations in 1998 resulted
primarily from the net loss, an increase in inventories, and decreases in
accounts payable and accrued expenses. These factors were offset by a reduction
in accounts receivable in 1998. Cash used in operations in 1997 was primarily
the result of the net loss and an increase in inventories and accounts
receivable. In 1996, the reduction in cash flow from operations resulted
primarily from the net loss and an increase in accounts receivable. In 1997 and
1996, the decrease in cash flow was partially offset by increases in accounts
payable and accrued liabilities.
Capital expenditures were $6,167,000 in 1998 compared with $5,881,000 in
1997 and $4,117,000 in 1996. The capital expenditures in 1998 were primarily to
purchase tooling and manufacturing equipment. The Company anticipates continued
expenditures for tooling and manufacturing equipment purchases associated with
product development and an increase in overall production capacity. The Company
anticipates that these expenditures will total approximately $4,000,000 in 1999.
In July 1996, the Company issued $15.0 million of Convertible Notes to
certain investment partnerships affiliated with The Goldman Sachs Group, L.P.
("GS Group") which bear interest at 5% per annum and expire 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 borrowings outstanding under its bank credit facility at
January 3, 1999, compared with $7,161,000 at December 31, 1997. This credit
facility, established in March 1997 and amended in March 1998, provides for
total borrowings up to $15,000,000 secured by equipment, inventory, receivables,
and intangibles. The credit facility is a 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. Borrowings are due on demand.
Pursuant to the Company's agreement with GS Group, borrowings are limited to
$12,500,000 in 1998 and 1999.
10
<PAGE>
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 over-allotment 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 the sale of
securities will provide sufficient capital resources for current operations,
expansion of plant capacity and product development through 2000. The Board of
Directors currently intends to retain all earnings for expansion of the
Company's business.
The Company had recorded $1,575,000 of net deferred tax assets at January
3, 1999 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 January 3, 1999, the Company had net operating tax loss carryforwards
available to offset future taxable income of approximately $34,023,000 million.
The net operating loss carryforwards expire as follows: $4,986,000 million in
year 2010, $11,493,000 million in 2011, $7,185,000 million in 2012, and
$10,359,000 million in 2018, 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 1998, the FASB issued Statements No. 132 Employers' Disclosures about
Pensions and Other Postretirement Benefits, and No. 133 Accounting for
Derivative Instruments and Hedging Activities. Statement No. 132 is effective
for fiscal years beginning after December 15, 1997 and Statement No. 133 is
effective for fiscal years beginning after June 15, 1999. The adoption by the
Company of these statements in January 1998 and January 1999, respectively, did
not and is not expected to have a material impact on the Company's financial
statements.
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 was 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 was 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 information system applications, (2)
manufacturing automation and (3) third-party relationships.
11
<PAGE>
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, and no material issues were discovered. These include the
Company's core financial and reporting systems. In the manufacturing area, the
Company has completed its review and did not find any material issues. 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 has recently completed Phase II of the program and intends to
complete Phase III by mid 1999.
The Company is in the process of determining what total costs will be
incurred in connection with its Y2K readiness initiatives. Expenses incurred to
date are not material and future expenses estimated by the Company are not
expected to be material. The Company will fund all Y2K readiness expenses
through operating cash flows.
Management of the Company believes it has an effective program in place to
resolve Y2K issues in a timely manner. As noted above, the Company has not yet
completed all necessary phases of its Y2K readiness program. In the event that
the Company does not complete any additional phases or is exposed to Y2K
problems beyond its reasonable control, the Company may be unable to take
customer orders, manufacture and ship products, invoice customers or collect
payments, and may be generally subject to litigation or disruptions in the
economy which could materially adversely affect the Company. The amount of
potential liability or lost revenue that might result from such events cannot be
reasonably estimated at this time.
FORWARD-LOOKING STATEMENTS
This report (as well as press releases, other public documents, 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.
12
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JANUARY 3,
(In thousands, except share data) 1997 1999
---------------------------------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
Cash and cash equivalents............................................... $ 261 $ 14,000
Accounts receivable (net of allowance of $314 for 1997
and $308 for 1998)..................................................... 16,236 15,389
Inventory............................................................... 7,594 10,661
Other current assets.................................................... 1,522 620
---------------------------------------
Total current assets...................................................... 25,613 40,670
Property and equipment:
Tooling................................................................. 7,307 9,547
Equipment and fixtures.................................................. 11,200 14,109
---------------------------------------
18,507 23,656
Less accumulated depreciation........................................... 4,771 7,004
---------------------------------------
13,736 16,652
---------------------------------------
Deferred income taxes..................................................... 1,512 1,512
Patents (net of accumulated amortization of $1,039 for 1997
and $1,172 for 1998)..................................................... 732 729
Other assets.............................................................. 676 313
---------------------------------------
Total assets.............................................................. $ 42,269 $ 59,876
=======================================
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Bank line of credit..................................................... $ 7,161 $ --
Accounts payable........................................................ 8,336 5,740
Accrued marketing expenses.............................................. 1,781 1,003
Accrued co-op advertising............................................... 2,138 2,994
Other accrued expenses.................................................. 3,622 2,868
---------------------------------------
Total current liabilities................................................. 23,038 12,605
Long-term debt............................................................ 15,000 15,000
Commitments
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value:
Authorized shares - 100,000,000
Issued and outstanding shares
1997 - 4,548,249 and 1998 - 6,012,281................................ 45 60
Additional paid-in capital.............................................. 21,364 59,977
Note receivable from sale of stock...................................... (498) (498)
Retained earnings (deficit)............................................. (16,680) (27,268)
---------------------------------------
Total shareholders' equity................................................ 4,231 32,271
---------------------------------------
Total liabilities and shareholders' equity................................ $ 42,269 $ 59,876
=======================================
</TABLE>
SEE ACCOMPANYING NOTES
13
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED
---------------------------------------------------
DECEMBER 31, DECEMBER 31, JANUARY 3,
(In thousands, except per share data) 1996 1997 1999
---------------------------------------------------
<S> <C> <C> <C>
Net sales.................................................. $ 33,277 $ 71,243 $ 76,965
Cost of products sold...................................... 20,756 37,417 40,218
---------------------------------------------------
Gross profit............................................... 12,521 33,826 36,747
Operating expenses:
Selling, general and administrative...................... 21,803 32,815 41,657
Research and development................................. 2,007 3,082 4,186
Facility relocation costs................................ 973 -- --
Equipment disposal costs................................. -- -- 554
---------------------------------------------------
24,783 35,897 46,397
---------------------------------------------------
Loss from operations....................................... (12,262) (2,071) (9,650)
Other income (expense):
Interest income and other................................ 220 43 598
Interest expense and other............................... (457) (1,427) (1,536)
---------------------------------------------------
Loss before income taxes................................... (12,499) (3,455) (10,588)
Income tax expense (benefit)............................... -- -- --
---------------------------------------------------
Net loss................................................... $(12,499) $ (3,455) $ (10,588)
===================================================
Net loss per share - basic and diluted..................... $ (2.90) $ (0.77) $ (1.92)
===================================================
Weighted average shares - basic and diluted................ 4,307 4,471 5,510
===================================================
</TABLE>
SEE ACCOMPANYING NOTES
14
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED
----------------------------------------------------
DECEMBER 31, DECEMBER 31, JANUARY 3,
(In thousands) 1996 1997 1999
----------------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss................................................... $(12,499) $ (3,455) $ (10,588)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization.......................... 1,396 1,883 2,830
Write off of leasehold improvements.................... 365 -- --
Loss on disposal of property and
equipment............................................. -- -- 554
Changes in operating assets
and liabilities:
Accounts receivable.................................. (3,913) (8,127) 847
Inventory............................................ 1,247 (2,668) (3,067)
Refundable income taxes.............................. 1,177 -- --
Other current assets................................. 80 (1,218) 902
Other assets......................................... (487) (189) 363
Accounts payable..................................... 3,571 1,853 (2,596)
Accrued expenses..................................... 3,363 2,898 (676)
----------------------------------------------------
Net cash used in operating activities...................... (5,700) (9,023) (11,431)
INVESTING ACTIVITIES
Purchase of marketable securities.......................... (12,185) -- (2,000)
Sale of marketable securities.............................. 11,665 1,542 2,000
Purchase of property and equipment......................... (4,117) (5,881) (6,167)
Purchase of patents........................................ (166) (81) (130)
----------------------------------------------------
Net cash used in investing activities...................... (4,803) (4,420) (6,297)
FINANCING ACTIVITIES
Gross borrowings - bank line of credit..................... -- 52,181 25,054
Gross repayments - bank line of credit..................... -- ( 45,020) (32,215)
Issuance of warrants....................................... -- 328 --
Proceeds from issuance of stock............................ -- -- 38,236
Proceeds from issuance of long-term debt................... 15,000 -- --
Exercise of stock options and warrants..................... 334 725 1,250
Common stock acquired...................................... (134) -- (858)
Note receivable from sale of stock......................... -- (498) --
----------------------------------------------------
Net cash provided by financing activities.................. 15,200 7,716 31,467
----------------------------------------------------
Increase (decrease) in cash
and cash equivalents...................................... 4,697 (5,727) 13,739
Cash and cash equivalents at
beginning of year......................................... 1,291 5,988 261
----------------------------------------------------
Cash and cash equivalents at
end of year............................................... $ 5,988 $ 261 $ 14,000
====================================================
</TABLE>
SEE ACCOMPANYING NOTES
15
<PAGE>
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
------------ ADDITIONAL RETAINED
PAID-IN NOTE EARNINGS
(In thousands, except share data) SHARES AMOUNT CAPITAL RECEIVABLE (DEFICIT) TOTAL
--------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
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
Common stock issued for cash
in public offering.............................. 1,368,500 14 38,222 -- -- 38,236
Stock options and warrants exercised.............. 111,235 1 995 -- -- 996
Employee stock purchase plan...................... 21,520 -- 254 -- -- 254
Common stock acquired............................. (37,223) -- (858) -- -- (858)
Net loss for year................................. -- -- -- -- (10,588) (10,588)
--------------------------------------------------------------
January 3, 1999..................................... 6,012,281 $60 $59,977 $(498) $(27,268)$32,271
==============================================================
</TABLE>
SEE ACCOMPANYING NOTES
NOTES TO FINANCIAL STATEMENTS
JANUARY 3, 1999
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 P-UR 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. Cash equivalents are
classified as available for sale and consist primarily of commercial paper, U.S.
Treasury Notes, and municipal bonds. The carrying value of the cash equivalents
approximates fair value on the reporting dates.
In 1998 the Company changed its fiscal year end to the Sunday closest to
December31, which is January 3, 1999. Each quarter ends on the last Sunday
of a thirteen-week period. As a result, the fiscal year ended January 3, 1999
included 368 days while the fiscal year ended December 31, 1997 included 365
days. This difference in days does not materially affect the comparability of
the financial results of the periods presented.
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 to 60
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.
16
<PAGE>
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 on a straight-line basis over their estimated useful lives ranging from
three to ten years. Depreciation expense was $1,294,000, $1,768,000 and
$2,697,000 for 1996, 1997 and fiscal 1998, 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 the patent cost will not be recoverable, the Company's
carrying value of the patent 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 using the straight-line amortization method.
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. In
fiscal year 1998, the Company recorded a net loss on disposal of machinery and
equipment of $554,000 equal to the net book value of the equipment. The assets
had a gross book value of approximately $1,018,000. These assets were no longer
useful because of product enhancements and the elimination of a step in the
production process.
Advertising costs are charged to operations in the year incurred.
Advertising costs charged to operations were $9,541,000, $14,602,000 and
$20,405,000 for 1996, 1997, and fiscal 1998, 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.
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 the 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 did not have a
material impact on the Company's financial statements. In 1998, the FASB issued
Statements No. 132 EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS, and No. 133 ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES. Statement No. 132 is effective for fiscal years beginning
after December 15, 1997, and Statement No. 133 is effective for fiscal years
beginning after June 15, 1999. The adoption by the Company of these statements
in January 1998 and January 1999, respectively, did not and is not expected to
have a material impact on the Company's financial statements.
NOTE 3
INVENTORIES
Inventories consist of the following:
DECEMBER 31, JANUARY 3,
1997 1999
---------------------------
Finished goods.......... $1,981,000 $ 4,378,000
Work in progress........ 157,000 258,000
Raw materials........... 5,456,000 6,025,000
---------------------------
$7,594,000 $10,661,000
===========================
NOTE 4
RELATED PARTY NOTE RECEIVABLE
At January 3, 1999 and December 31, 1997 the Company had a note receivable
of approximately $498,000 due from its Chairman and CEO. The note bears interest
at 9.25%. Principal and interest are due and payable in one installment on June
30, 2001. 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 $15,000,000 convertible loan 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 borrowings outstanding under its bank credit facility at
January 3, 1999, compared with $7,161,000 at December 31, 1997. This credit
facility, established in March 1997 and amended in March 1998, provides for
total borrowings up to $15,000,000 secured by equipment, inventory, receivables
and intangibles. The credit facility is a discretionary working capital line of
credit, limited to eligible receivables and inventory, which
17
<PAGE>
bears interest at the bank's reference rate plus 0.75 percent. The weighted
average interest rate on amounts outstanding on December 31, 1997 was 10.2%.
Borrowings are due on demand. Pursuant to the Company's agreement with GS Group,
borrowings are limited to $12,500,000 in 1998 and 1999. 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
were exercisable as of September 1998 and expire six years from the effective
date of the credit facility. The Company 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. Amortization expense
on the warrants was $150,000 in 1998.
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, 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 -- -- 10.52
---------------------------------------------------------------------
Balance at
December 31, 1997 ........................... 158,261 896,950 500 49,000 12.49
Granted .................................... (199,552) 199,552 -- 28,000 13.23
Exercised .................................. -- (37,735) -- (16,000) 9.71
Canceled ................................... 76,995 (76,995) -- -- 15.60
---------------------------------------------------------------------
Balance at
January 3, 1999 ............................. 35,704 981,772 500 61,000 $ 11.00
=====================================================================
</TABLE>
The weighted average fair value of options granted in 1996, 1997 and fiscal
1998 was $6.35, $8.52 and $6.18, per share, respectively. The exercise price of
options outstanding at January 3, 1999 ranged from $2.50 to $29.37 per share as
summarized in the following table:
NUMBER WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
RANGE OF EXERCISE OUTSTANDING REMAINING EXERCISABLE EXERCISE
PRICES AT 1/3/99 CONTRACTUAL LIFE AT 1/3/99 PRICE PER SHARE
- --------------------------------------------------------------------------------
$ 2.50 - $10.00 514,772 9 years 168,403 $ 6.94
$10.01 - $14.00 452,300 8 years 185,300 $13.40
$14.01 - $29.37 76,200 10 years 29,250 $24.13
- --------------------------------------------------------------------------------
$ 2.50 - $29.37 1,043,272 9 years 382,953 $11.00
================================================================================
The number of stock options exercisable at December 31, 1996 and 1997 were
403,350 and 294,626, respectively, at a weighted average price of $7.68 and
$12.49, 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. The weighted average assumption for
risk-free interest rate was 6% for 1996 and 1997 and 5% for fiscal 1998. The
volatility factor of the expected market price of the Company's common stock was
.57 and the weighted-average expected life of the option is 6 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that 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:
FISCAL
1996 1997 1998
-----------------------------------------------------------
Pro forma net loss...$ (13,102,000) $(4,254,000) $(11,296,000)
Pro forma net loss per
common share........$ (3.05) $ (.95) $ (2.05)
18
<PAGE>
These pro forma amounts may not be indicative of future years' amounts
since the statement does not apply to awards granted prior to 1995.
The Company has an Employee Stock Purchase Plan with 100,000 shares
reserved for issuance under the plan. During 1996, 1997 and fiscal 1998, 6,874,
9,501 and 21,520 shares were issued under the plan at prices ranging from $5.45
to $30.95. Approximately 54,000 shares remain reserved for future issuance.
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:
DECEMBER 31, JANUARY 3,
1997 1999
----------------------------
Deferred tax assets:
Net operating loss carryforward $ 8,070,000 $ 11,592,000
Tax benefit of nonqualified
stock options ............... 449,000 657,000
Research and development and
other credits ............... 500,000 684,000
Warranty reserve .............. 296,000 341,000
Inventory obsolescence ........ 150,000 247,000
Bad debt reserve .............. 130,000 111,000
Accrued expenses and other .... 181,000 125,000
----------------------------
Total deferred tax assets ....... 9,776,000 13,757,000
Deferred tax liabilities:
Tax depreciation in excess of
financial reporting
depreciation ................ 1,670,000 1,479,000
Tax amortization of patents in
excess of financial reporting
amortization ................ 108,000 91,000
----------------------------
Total deferred tax liabilities 1,778,000 1,570,000
----------------------------
Net deferred tax .............. 7,998,000 12,187,000
Valuation allowance ........... (6,423,000) (10,612,000)
----------------------------
Deferred tax assets ........... $ 1,575,000 $ 1,575,000
============================
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.
The Company has net operating loss carryforwards of $34,023,000 available
to offset future taxable income, of which $4,986,000 expires in 2010,
$11,493,000 expires in 2011, $7,185,000 expires in 2012, and $10,359,000 expires
in 2018. No cash was paid for income taxes in 1996, 1997, and fiscal 1998.
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, DECEMBER 31, JANUARY 3,
1996 1997 1999
-------------------------------------------------
<S> <C> <C> <C>
Income taxes (benefit) at
statutory rate (34%) ............... $(4,249,000) $(1,175,000) $(3,600,000)
State tax net of federal benefit .... (255,000) (69,000) (212,000)
Valuation allowance.................. 4,496,000 1,927,000 4,189,000
Tax credits.......................... -- (500,000) (184,000)
Non-deductible expenses ............. 8,000 (183,000) (193,000)
-------------------------------------------------
Provision (benefit) for
income taxes........................ $ -- $ -- $ --
-------------------------------------------------
Effective rate....................... --% --% --%
=================================================
</TABLE>
NOTE 8
RETIREMENT SALARY SAVINGS PLAN
The Company has a defined contribution 401(k) plan that covers all
full-time employees who have completed six consecutive months of service and are
age 21 or older. 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, 1996, December 31, 1997, and January 3, 1999 were $61,000, $98,000,
and $170,000, 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
1996, 1997, and fiscal 1998 amounted to $3,924,000, $6,269,000, and $3,079,000,
respectively. 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. During fiscal 1998, two
customers accounted for approximately 16.8% and 10.5%, 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. At the end of the lease
term, the Company has the option to renew the term of the lease. 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 $469,000,
$700,000 and $1,341,000 for the years ended December 31, 1996, December 31, 1997
and January 3, 1999, respectively. Future minimum rental lease commitments are
as follows:
1999 -$1,303,000; 2000 - $1,282,000;
2001 -$1,157,000; 2002 - $1,288,000;
2003 -$1,330,000; thereafter - $5,649,000.
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.
19
<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, 1997 and January 3, 1999, and the related statements of
operations, changes in shareholders' equity and cash flows for each of the three
years in the period ended January 3, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial 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, 1997 and January 3, 1999, and the results of its operations and
its cash flows for each of the three years in the period ended January 3, 1999,
in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Minneapolis, Minnesota
January 26, 1999
COMMON STOCK
Recovery Engineering, Inc. common stock is listed on the NASDAQ National
Market under the symbol: REIN. The following table details, for the periods
indicated, the high and low closing sale prices for the Company's stock as
reported by NASDAQ:
1997 1998
HIGH LOW HIGH LOW
- -----------------------------------------------
1st Quarter.... $ 8.75 $ 6.88 $30.50 $23.25
2nd Quarter.... 16.50 6.38 34.75 19.50
3rd Quarter.... 29.00 16.00 20.13 8.19
4th Quarter.... 31.25 24.25 8.75 6.25
As of March 5, 1999, there were 205 shareholders
of record for the company common stock and approximately 2,100 other beneficial
owners whose stock is held in street name at brokerage houses. Recovery
Engineering has not paid any cash dividends on its common stock and does not
anticipate paying any cash dividends in the foreseeable future.
QUARTERLY FINANCIAL INFORMATION
(UNAUDITED - IN THOUSANDS, EXCEPT PER SHARE DATA)
1997 QUARTER ENDED
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
--------------------------------------------------
Sales ...................... $ 10,347 $ 15,462 $ 22,371 $ 23,063
Gross profit ............... 4,155 7,001 10,581 12,089
Net income (loss) .......... (1,898) (1,492) (448) 383
Net income (loss) per common
share - basic and diluted (.44) (.33) (.10) .08
1998 QUARTER ENDED
APRIL 5 JULY 5 OCTOBER 4 JANUARY 3
1998 1998 1998 1999
--------------------------------------------------
Sales ...................... $ 17,225 $ 21,724 $ 18,505 $ 19,511
Gross profit ............... 8,192 11,098 8,954 8,503
Net income (loss) .......... (1,039) 820 (3,183) (7,186)
Net income (loss) per common
share - basic ............ (.23) .15 (.53) (1.20)
Net income (loss) per common
share - diluted .......... (.23) .14 (.53) (1.20)
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED
(IN THOUSANDS, EXCEPT PER SHARE DATA) DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, JANUARY 3,
OPERATIONS DATA: 1994 1995 1996 1997 1999
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales............... $16,671 $22,921 $ 33,277 $71,243 $ 76,965
Gross profit............ 8,774 8,962 12,521 33,826 36,747
Pretax income (loss).... 2,926 (7,326) (12,499) (3,455) (10,588)
Income taxes (benefit).. 907 (2,564) -- -- --
Net income (loss)....... $ 2,019 $(4,762) $(12,499) $(3,455) (10,588)
Net income (loss) per
common share - basic... $ .57 $ (1.12) $ (2.90) $ (.77) $ (1.92)
Weighted average
shares - basic......... 3,531 4,239 4,307 4,471 5,510
Net income (loss) per
common share - diluted. $ .50 $ (1.12) $ (2.90) $ (.77) $ (1.92)
Weighted average
shares - diluted....... 4,029 4,239 4,307 4,471 5,510
</TABLE>
All earnings per share amounts, when appropriate, have been restated to
conform to Financial Accoun ting Standards Board Statement No. 128.
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, JANUARY 3,
BALANCE SHEET DATA: 1994 1995 1996 1997 1999
------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets............ $25,054 $23,622 $33,257 $42,269 $59,876
Working capital......... 14,754 10,051 9,743 2,575 28,065
Long-term debt.......... -- -- 15,000 15,000 15,000
Shareholders' equity.... 22,895 19,430 7,131 4,231 32,271
</TABLE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Recovery Engineering, Inc. of our report dated January 26, 1999, included in
the 1998 Annual Report to Shareholders of Recovery Engineering, Inc.
Our audits also included the financial statement schedule of Recovery
Engineering, Inc. listed in Item 14(a). This schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion based on
our audits. In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
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 26, 1999,
with respect to the financial statements and schedule of Recovery Engineering,
Inc. included in this Annual Report (Form 10-K) of Recovery Engineering, Inc.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 30, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JAN-03-1999
<PERIOD-START> JAN-01-1998
<PERIOD-END> JAN-03-1999
<CASH> 14,000
<SECURITIES> 0
<RECEIVABLES> 15,389
<ALLOWANCES> 308
<INVENTORY> 10,661
<CURRENT-ASSETS> 40,670
<PP&E> 23,656
<DEPRECIATION> 7,004
<TOTAL-ASSETS> 59,876
<CURRENT-LIABILITIES> 12,605
<BONDS> 15,000
0
0
<COMMON> 60
<OTHER-SE> 32,211
<TOTAL-LIABILITY-AND-EQUITY> 59,876
<SALES> 76,965
<TOTAL-REVENUES> 76,965
<CGS> 40,218
<TOTAL-COSTS> 86,615
<OTHER-EXPENSES> (598)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,536
<INCOME-PRETAX> (10,588)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,588)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,588)
<EPS-PRIMARY> (1.92)
<EPS-DILUTED> (1.92)
</TABLE>
