Washington, D.C. 20549
FORM 10-KSB
(MARK ONE)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 (fee required)
For the fiscal year ended December 31, 1996
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[ ] TRANSITION REPORT UNDER SECTION 13 OR A5(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (no fee required)
Commission file number 0-23544
EROX CORPORATION
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(Name of small business issuer in its charter)
California 94-3107202
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(State or other jurisdiction of (I.R.S. employee
incorporation or organization) Identification No.)
4034 Clipper Court, Fremont, California 94538
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(Address of principal executive offices) (Zip code)
Issuer's telephone number: (510) 226-6874
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Securities registered under Section 12(b) of the Exchange Act:
None
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(Title of class)
Check whether the Issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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
[ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [ X ]
State issuer's revenues for its most recent fiscal year. $20,323,028
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State the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was sold,
or the average bid and asked price of such stock, as of a specified date within
the past 60 days. (See definition of affiliate in rule 12b-2 of the Exchange
Act.) $31,090,474 (1)
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(1) Excludes 1,743,573 shares held by directors, officers and shareholders whose
ownership exceeds 5% of the outstanding shares at March 1, 1997 based on a
closing bid price on that day of $3.66 per share. Exclusion of such shares
should not be construed as indicating that the holders thereof possess the
power, direct or indirect, to direct the management or policies of the
registrant or that such person is controlled by or under common control with the
registrant.
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date. 10,238,238
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [ X ]
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated by reference into
Part III of this Form 10-KSB Report: the Proxy Statement for the Registrant's
1997 Annual Meeting of Shareholders (the "Proxy Statement").
<PAGE>
Item 1. Description of Business
Introduction
This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Except for the historical
information contained in this discussion of the business and the discussion and
analysis of financial condition and results of operations, the matters discussed
herein are forward looking statements. These forward looking statements include
but are not limited to the Company's plans for sales growth and expansion into
new channels of trade, expectations of gross margin, expenses, new product
introduction, and the Company's liquidity and capital needs. These matters
involve risks and uncertainties that could cause actual results to differ
materially from the statements made. In addition to the risks and uncertainties
described in "Risk Factors", below, these risks and uncertainties may include
consumer trends, business cycles, scientific developments, changes in
governmental policy and regulation, currency fluctuations, economic trends in
the United States and inflation. These and other factors may cause actual
results to differ materially from those anticipated in forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof.
The Company, a California corporation, was founded in 1989 to develop
and market innovative fine fragrances and other fragranced consumer products
containing human pheromones as a component. The Company believes that human
pheromone research funded by the Company presents an opportunity to create and
market a new category of pheromone-based fragrances and related products.
Pheromones are chemical substances known to stimulate species-specific
biological responses in animals. For seven years, scientists and advisors
engaged by EROX have studied the functions and characteristics of human
pheromones. EROX believes this research has resulted in findings that have
disproved earlier theories that humans do not perceive and respond to
pheromones. Specifically, the Company has focused on:
o Identification, isolation and synthetic production of naturally
occurring human pheromones;
o Demonstration of the presence of the vomeronasal organ ("VNO") in the
nasal passages of humans; and
o Elucidation of its structure, function, and response to human
pheromones.
The human pheromones included as a component of and as a fixative for
the Company's fragrance products have been manufactured for the Company by
Pherin Corporation. The manufacturing process for human pheromones begins with
hydrocarbon compounds commonly available from chemical supply houses, and
involves the use of a synthetic chemistry process performed for the Company by
Pherin at its laboratories in Salt Lake City, Utah. All the steps in the
manufacturing process are standard chemical laboratory procedures; the
manufacturing process for pheromones is similar to methods by which other
naturally occurring substances (such as amino acids) are synthetically produced.
The EROX Technology
Pheromones. People have long known that insects and animals communicate
with one another through subtle, biochemical cues recognized and understood by
other members of the same species. These biochemical signals warn of danger,
indicate the presence of food, mark territorial boundaries and display sexual
maturation or readiness. The biochemical messengers that deliver these
communications are pheromones.
Fragrances and Pheromones. Animal pheromones are well-known in the
fragrance industry. Natural and synthetic equivalents of mammalian pheromones
such as musk, civet and castoreum are found in many perfumes today. However,
since pheromonal cues can trigger a response only by members of the same
species, these animal pheromones have no specific effect on humans; instead,
they act only as fixatives or carriers for the fragrance or as a component of
the scent.
A scent binds to smell receptors in the nose and stimulates a specific
region of the brain resulting in the sensation of smell. A pheromone binds to
separate receptors which are physically and functionally distinct from smell
receptors. These pheromone receptors stimulate a region of the brain different
from that stimulated by smell receptors. Since it is widely believed that
traditional perfumes allure and intrigue the senses, an alliance between fine
fragrances and
<PAGE>
pheromones seems quite natural. For a perfume to create a true pheromonal effect
in humans, however, it must contain human pheromones. Thus, a fragrance
containing human pheromones may provide more allure than a traditional
fragrance.
Scientists have observed that in higher species the influence of
pheromones grows increasingly more subtle and complex. Not surprisingly,
reactions to pheromones are the most subtle in human beings. While humans appear
to have definite responses to pheromones, the research sponsored by EROX
suggests that the highly developed human brain filters and masks those
reactions. Rather than producing an isolated effect, as in lower level species,
human pheromones act in concert with other sensory cues provided by odor, sight,
taste, sound and touch to provide a cumulative influence.
As a result of its sponsored research, the Company believes evidence
has been developed that indicates that humans respond to human pheromones. EROX
has also found that its human pheromones are sexually dimorphic: that is, some
are more active in females while others show a higher level of activity in
males. During the studies of human pheromones conducted by the Company, certain
human subjects volunteered descriptions of their feelings. Women frequently
described feeling comfortable or at ease, while a number of male subjects
described a feeling of confidence and self-assurance. The Company continues to
explore these naturally occurring substances in a variety of tests to increase
its knowledge and understanding of their range of influence on human emotions
and their application as components of fine fragrance products.
The Vomeronasal Organ. Over the course of their work on human
pheromones, scientists working on behalf of EROX believe they have made a
further, important discovery concerning the VNO.
The VNO consists of two tiny sensory organs -- one in each nasal
passage. The VNO had been identified earlier in animal species, from reptiles to
mammals, and has been known for some time to be a receptor for pheromones in
animals. In humans, however, the VNO was assumed to be a non-functioning,
vestigial remnant, rarely even present in modern-day men and women.
EROX believes that research conducted on its behalf has invalidated
that assumption; not only is the VNO present in all normal adults, it appears to
be an active, functional receptor for human pheromones. This has allowed
scientists engaged on behalf of EROX to track the activity of human pheromones
by measuring the changes in the neuroelectric potential of the VNO's receptor
cells caused by pheromones. To measure these changes in humans, a proprietary
noninvasive method is utilized to measure the electrical response of the VNO in
a way similar to how electrical responses of the heart are recorded by an
electrocardiogram.
The EROX Products
Products. The Company is currently marketing two fragrances, REALM(R)
Women and REALM(R) Men. In 1995 the Company introduced an eau de parfum
concentration of its women's fragrance and bath and body products for men and
women which include a body lotion for women, an aftershave balm for men and bath
and shower gels for both men and women. Also in 1995, the Company made available
several "value sets". These sets include combinations of the Company's signature
fragrance and reduced size versions of the bath and body products. As a special
Holiday promotion, the Company produced a set which included a full size
fragrance and a watch which used the EROX "sixth sense" graphic as a watch face.
In 1996, the Company introduced a body talc, a body cream and a unique
refillable, dripless roll-on applicator containing Realm eau de toilette for
women and an antiperspirant/deodorant product for men. In addition, development
work was completed on a new fragrance for women called inner REALM(TM). The
fragrance was developed by Ann Gottlieb and contains a pheromone component other
than the combined pheromone components in REALM Women and REALM Men.
Research. Scientists working on behalf of EROX have identified and
synthesized several naturally occurring human pheromones of interest. One
combination of pheromones shows a measurable response in women and another a
comparable response in men. EROX has also developed the capability to
manufacture commercial quantities of these naturally occurring substances. EROX
intends to continue basic pheromone research as applied to fragrances and
ancillary products. Since its inception through December 31, 1996, the Company
has incurred $3,265,277 in research and development related expenses.
Markets and Competition
The Competitive Environment. The Company's fragrance products are
intended to contain what the Company believes is a unique component: human
pheromones. Consequently, EROX believes it will be able to differentiate its
products from traditional fragrances. If such differentiation is successful, the
Company's fragrances initially should have
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little direct competition in the marketplace, since the Company believes no
other fragrance products containing human pheromones are currently marketed in
the United States.
Marketing Strategy. While new product launches in the fragrance
industry frequently require considerable expenditures for promotional programs
which attempt to establish product differentiation based upon imagery alone,
EROX sought to develop a program in 1993, which was amended and augmented since
that time, which followed a different approach -- one that relied on the human
pheromone component in its fragrances for product differentiation. This
marketing program was intended to:
o develop both pre- and post-launch promotional programs, blending public
relations and advertising to educate the trade and the consumer;
o transition into a more traditional program using promotional materials
that suggest the enhanced sensuality the wearer of the EROX fragrance
may experience;
o produce fragrances and ancillary products that are packaged in fine
quality materials;
o implement a fragrance product launch that initially used direct
marketing, which is a nontraditional distribution method for
fragrances, to attempt to ensure quality and clarity of the EROX
message; thereafter, expanded into more conventional channels
(department and specialty stores) based upon a series of predetermined
criteria (e.g. location, image, promotional support); and
o price the EROX fragrances at the high end of the fragrance market, to
communicate the importance of their human pheromone component and
differentiate the Company's products from traditional fragrance
products.
Promotional Activities. During 1993, the Company developed two
fragrances, REALM Women and REALM Men, each presented in 50 Ml. and 5 Ml. sizes.
As an introduction to planned roll-out of its fragrances in up-scale department
and specialty stores, the Company began marketing its fragrances in the last
four months of 1994 by airing a new one half hour infomercial. Test broadcasting
commenced in August, 1994 and, as a result of favorable consumer response,
television airings were increased during the last four months of the year.
In addition, the Company developed a print advertising campaign,
changed its secondary packaging (cartons, carton inserts, and the like) and
attempted to reflect the theme "Awaken your Sixth Sense" in both the infomercial
and print advertising.
The infomercial was continued for the first six months of 1995, and the
Company began to roll-out its fragrance products to a select group of upscale
retailers. This retail launch was supported with 30 second advertising spots
airing during "drive time" on local radio stations. These spots contained brief
testimonial messages and invitations to consumers to purchase REALM at retailers
in their area. The Company also began a full-scale education program aimed at
educating the retailers of the scientific differentiation of its REALM products.
This education process has included trainings attended by the local retail
employees and hosted by the EROX sales force and Pherin research scientists. The
Company feels these training sessions have been instrumental in providing the
retailer's sales associates with the information to communicate the pheromone
story to the retail customer.
A considerable amount of interest has been generated from local
television news stations. When the Company launches a new retailer or division
of a retailer, local television stations are provided with a short video new
release which contains product and scientific information. A majority of local
television markets has provided news stories on the local REALM launches during
their evening news broadcasts.
Distribution. Direct response, telemarketing and direct mail order
continued to be a part of the Company's direct marketing efforts during 1995.
However, the Company experienced an anticipated decrease in the
sales-to-advertising ratio generated from telemarketing efforts as the
infomercial approached the end of its natural life span. Industry experience has
been that infomercials have a life span of nine months to one year; at which
time, the sales-to-advertising ratio may no longer generate acceptable revenue.
The Company initiated retail distribution in 1994 with a holiday season
launch in I. Magnin Inc.'s twelve specialty-department stores in the Western
United States and their Holiday catalogue. Although the I. Magnin stores were
<PAGE>
closed prior to Christmas as part of the consolidation of stores by its new
parent, Federated Department Stores, the Company was pleased that the REALM
products supplied to I. Magnin sold out in all of the stores.
Inserts containing scent strips for REALM Women and REALM Men
fragrances were included in Neiman Marcus mail order catalogues and in
Bloomingdales by Mail during the first quarter of 1995. Retail roll-out
commenced with selected Bloomingdale's stores at the end of the first quarter of
1995, and the Company opened 7 additional retail accounts in the United States
during the remainder of 1995. At the end of 1995, Realm fragrances were being
sold through the Rich's/Lazarus and Bloomingdale's divisions of Federated
Department Stores, all divisions of Dillard Department Stores, ZCMI, and
Jacobson's. In addition, product was shipped to Macy's East, Jordan Marsh and
Dayton Hudson/Marshall Fields for launch in January 1996. The Company's products
were introduced in the remaining divisions of Federated Department Stores in
1996 including Burdine's, the Bon Marche and Macy's West, selected May Company
units (including Lord & Taylor, Famous Barr, Kaufman's and Robinson May stores),
the more upscale divisions of Dayton Hudson/Marshall Fields, Carson Pirie Scott,
Mercantile Group, Proffitts and selected regional upscale department store
chains. The Company intends to continue to expand its retail presence slightly
by pursuing a small number of additional up-scale retail outlets during 1997.
The Company believes that there are additional opportunities to increase its
consumer base in the department stores in which REALM products are currently
sold rather than attempt to expand its department store base by adding chains or
stores that generally feature lower priced merchandise. inner REALM will be
introduced in the same class of trade commencing in April 1997. Full roll-out to
all customers currently selling classic REALM products is planned to be
completed by the end of 1997.
The Company signed a Distribution Agreement for the sale and marketing
of its REALM products in Italy in 1995. Under the terms of the Distribution
Agreement, the distributor guaranteed the Company a minimum level of sales for
each of the next three years in order to retain exclusivity. The Company intends
to continue to expand its distribution efforts in Europe, and to facilitate this
process, the Company has opened a branch of its US corporation in France. In
1996, the Company signed an Agency Agreement for distribution of its products in
selected Middle East markets including Saudi Arabia and the Gulf States. The
Company is also interested in expanding the presence of its REALM products to
other distributor markets outside the United States. In 1996, the Company sought
to expand distribution in this geographical area by signing an Agency Agreement
covering the distribution of its products on an in-market basis in several
countries of Latin and South America.
In 1995, the Company entered into an agreement with a duty free
distributor for the sale of its REALM fragrances in the Caribbean and Latin and
South America. This agreement gave the Company initial access to the duty free
market. In 1996, the Company entered into an agreement with an additional duty
free distributor for the sale of its REALM products in selected North American
(primarily, the US borders with Canada and Mexico) duty free operations. The
Company is very conscious of the fact that numerous brands of prestige
fragrances have suffered immeasurable harm due to diversion by gray marketers.
While realizing that certain levels of such diversion are inevitable, the
Company hopes to curtail the risk of its REALM products being diverted back into
the US by gray market discounters by selecting duty free partners who purchase
realistic quantities for sale in the regions they service. Such partnership
agreements are subject to cancellation if significant diversion occurs.
Patents and Other Intellectual Property
In December 1993 and January 1994, the Company received two United
States patents for non-therapeutic compositions of fragrances and human
pheromones for use as components in perfumes and personal care products and
consumer and industrial products such as clothing, air fresheners and paper
products. European patents regarding these compositions have been filed and are
pending. In 1995, patents were granted in Taiwan. EROX is also the exclusive
licensee for non-therapeutic uses of pheromones in perfumes and consumer
products under a royalty-free world-wide perpetual license to five United States
patent applications covering pheromone technology owned by Pherin Corporation.
This technology is also the subject of foreign patent applications. The Company
also relies on trade secrets protection for confidential and proprietary
information.
Regulation
Unless the FDA extends its regulatory authority, regulation by
governmental authorities in the United States and other countries is not
expected to be a significant consideration in the sale of the Company's
fragrance products and in its ongoing research and development activities. Under
current regulations, the market introduction of the majority of non-medicated
cosmetics products does not require prior formal registration or approval by the
FDA, although this could change in the future. The cosmetic industry has
established self-regulating procedures and most companies perform their own
toxicity and consumer tests. Voluntary filings related to manufacturing
facilities are made with the FDA. The Cosmetics
<PAGE>
Division of the FDA, however, does monitor closely problems of safety,
adulteration and labeling. In addition, if the FDA should determine that claims
made by the Company for its fragrances involve the cure, mitigation or treatment
of disease, the FDA could take regulatory action against the Company and its
products.
In addition, the United States Federal Trade Commission ("FTC")
monitors product claims made in television commercials and print advertising to
ensure that any claim can be substantiated. If the FTC believes that any
advertising claim made by the Company with regard to the effect or benefit of
its products is not substantiated by adequate data or research and the Company
cannot support such claim, the FTC could also take regulatory action against the
Company and its products.
Employees
At March 1, 1997, the Company had twenty nine full-time employees. In
addition, the Company retains consultants to provide advice in the areas of
sales and marketing, public relations, product safety testing, regulatory
compliance, MIS and product development and advertising. The Company also has
access to scientific and professional consultants, who are retained directly by
Pherin Corporation, and who undertake projects for the Company by virtue of the
Company's agreement with Pherin. None of the Company's employees is represented
by a labor union. The Company considers its relations with its employees and
consultants to be good.
Manufacturing
The Company is dependent on third parties to manufacture its fragrance
products. The Company has selected two essential oil companies, which provide
fragrance products to the industry generally, to supply such compounds to EROX
in accordance with proprietary formulas developed for the Company. The Company
has agreements in place with suppliers for its fragrances and has been supplied
with commercial quantities of the Company's products for sale to consumers.
While the Company is responsible for blending the human pheromones with these
fragrances, final bottling and packaging of the fragrance and ancillary product
lines are performed by independent manufacturers. These manufacturers selected
by EROX have extensive experience in blending, filling and packaging fragrance,
cosmetic and related products, and have the capacity to satisfy the Company's
manufacturing needs, at least for the foreseeable future. The Company believes
that such manufacturing services are widely available to the fragrance industry
at competitive prices and has identified additional contract manufacturing
companies. In addition, commercial scale production has taken place for the
Company's fragrance bottles and other components as well as tubes for the
Company's ancillary products.
The Company and Pherin are parties to an agreement under which Pherin
will supply EROX with its reasonable requirements of human pheromones and will
make available to EROX the basic manufacturing technology. At any time after
January 31, 1996, rather than supply human pheromones to EROX, Pherin may
instead elect to provide to the Company all manufacturing technology in its
possession that it has not previously supplied to EROX. Because only small
quantities of human pheromones, which can be produced in a laboratory
environment, are required for its fragrance and ancillary products, the Company
believes that the cost of establishing its own human pheromone manufacturing
facility would not be material.
Risk Factors
The Company's future results may be affected to a greater or lesser
degree by the following factors among others:
Competition: The prestige fragrance market is volatile and extremely
competitive. Consumer preferences and demands can shift dramatically reflecting
changes in fashion and current fads. There are numerous fragrance products which
are better known than the products marketed by the Company. There are also many
companies which have substantially greater resources than EROX and which have
the ability to invest heavily in new product development and introduction. The
Company can expect that its competitors will attempt to compete with the Company
through the introduction of new products and promotion of existing products.
In addition, the product life cycle of fragrances is shortening.
Traditional fragrance companies now introduce a new fragrance every one to two
years compared to every four to five years as in the past. This increase in
competing fragrances makes it difficult for any one fragrance to hold the
consumer's attention on a long term basis. Although the Company believes the
inclusion of human pheromones as a component clearly differentiates its
products, other fragrances are competing for space with the Company's products
at both the store level and in print and media advertising.
<PAGE>
Marketing: The failure to establish and maintain the necessary sales or
distribution channels could have a material adverse effect on the Company's
business. Although the Company believes its marketing strategy is the most cost
effective way to introduce its products, there can be no assurance that
broader-scale retail launches will be successful. The Company cannot guarantee
that retail outlets or catalogues will continue to carry the EROX products. If
the current strategy is unsuccessful, marketing of the Company's products would
require a new strategy and may require a significantly more expensive sales
effort for which the Company may not have sufficient funds.
Retail environment: Continued consolidation in the retail trade has led
to the emergence of four major retail players who control the major share of the
market. Federated Department Stores, The May Company, Dayton Hudson/Marshall
Fields and Dillard Department Stores now comprise the majority of US upper end
department stores. This consolidation could lead to price and promotional
pressure and increased credit risk for the Company.
Seasonality: Sales in the fragrance industry are generally seasonal,
with generally higher sales in the second half of the calendar year as a result
of increased demand for fragrance products in anticipation of and during the
Christmas holiday season. The anticipated seasonality of the Company's sales
could cause a significant variation in its quarterly operating results.
Patent protection: There can be no assurance that any patent or patent
application owned or controlled by the Company will continue to provide
commercially significant protection of the Company's technology or ensure that
the Company may not be determined to infringe valid patents of others. No
assurance can be given that others will not independently develop substantially
equivalent proprietary information or otherwise gain access to the Company's
trade secrets or that the Company can meaningfully protect its technology,
proprietary information or trade secrets.
Attraction and retention of key employees: The success of the Company's
future operations depends in large part on the Company's ability to recruit and
retain key employees and consultants with research, product development and
marketing experience, as well as other professionals who are in considerable
demand. There can be no assurance that the Company will be successful in
retaining or recruiting such key personnel.
Dependence on third parties for manufacturing: The Company does not
have facilities to manufacture its products and relies on Pherin to manufacture
its pheromones and third parties to supply components and to blend, fill and
package its fragrance products. The Company believes that such manufacturing
services are the most effective method of producing its products. Contract
fillers are used by the majority of the fragrance industry, and the Company has
no current plans to set up its own filling facilities. However, as with any
business that is not vertically integrated, the Company is unable to obtain or
retain fragrance suppliers, component manufacturers or third party manufacturing
on acceptable terms, it may not be able to obtain commercial quantities of its
products, which would adversely affect results.
Item 2. Description of Property
The Company presently occupies approximately 8,780 square feet of
office and warehousing space for its headquarters in Fremont, California,
pursuant to a lease which expires on October 31, 1998, and which is cancelable
by the Company after July 31, 1997 on 90 days written notice and by paying a
$15,000 cancellation fee which may be waived under certain circumstances. The
annual base rent will be approximately $75,336 and $62,780 for the 12 months
ended December 31, 1997 and 1998, respectively. Total rent expense may be
increased by the Company's proportional share of any escalation related to
taxes, common area charges and outside maintenance incurred by the complex in
which the facility is located. During the year ended December 31, 1996, the
Company incurred $88,776 in rent expense and related charges for this facility.
Item 3. Legal Proceedings
On February 3, 1997, a purported class action lawsuit was filed against
the Company in the Superior Court of Contra Costa County, California. The suit
alleges that the Company's packaging is constructed to facilitate the
perpetration of deception and fraud in that the outer container has substantial
empty spaces in it. The complaint seeks unspecified damages and attorney's fees
as well as other relief.
The Company considers this action to be entirely without merit and
intends to defend itself vigorously against these allegations.
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Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
The Company's Common Stock is quoted on the NASDAQ Small-Cap Market
under the symbol EROX. As of March 1, 1997, there were approximately 325 holders
of record of the Company's Common Stock. The Company believes that there is a
significant number of beneficial owners of its Common Stock whose shares are
held by nominees in "Street Name". Set forth below is the high and low bid
information for the Company's Common Stock on the NASDAQ Small-Cap Market as
reported in the Wall Street Journal during each of the four calendar quarters of
1995 and 1996.
HIGH LOW
---- ---
1995
----
First quarter $ 2.63 $1.38
Second quarter $ 2.56 $1.38
Third quarter $ 4.38 $2.00
Fourth quarter $ 4.38 $2.58
1996
----
First quarter $ 4.13 $2.50
Second quarter $ 8.78 $3.25
Third quarter $10.13 $4.63
Fourth quarter $ 6.75 $3.44
These quotations reflect interdealer prices, without retail mark-up,
mark-down or commissions and may not represent actual sales.
The Company has never paid cash dividends on its Common Stock. The
Company currently intends to retain future earnings, if any, to fund the
development and growth of its business and does not plan to pay any cash
dividends in the foreseeable future.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Year ended December 31, 1996, compared with the year ended December 31,
1995.
For the year ended December 31, 1996, the Company reported net sales of
$20,323,028. This was a 126% increase over the prior year's net sales of
$8,973,313. During 1996, the Company continued to expand its retail distribution
and product line offerings. At the end of 1996, the Company's products were
available in more than 1,350 US department store locations. This compared to 479
locations at the end of 1995. The additional doors opened during 1996 provided
the Company with distribution into new metropolitan areas and expanded its
customer base from three major chains in 1995 (Federated, Dillards and Dayton
Hudson Fields) to include May Company, Mercantile Stores, Younkers, Elder
Berman, Carson Pirie Scott, McRaes, Proffitts, ZCMI, Jacobsons and Parisian.
In addition to increasing distribution in upscale department stores in
the United States, the Company also expanded into duty free and a limited number
of international markets. In the Spring of 1996, the Company began shipping to
distributors in the Middle East. Several months later REALM(R) products were
introduced in 32 doors of Eaton Department Stores in Canada. The Company added
duty free stores in Mexico and selected border stores in the US and Canada.
Overall, the Company increased its duty free and international business by 210%
over 1995.
Net sales for the years 1996 and 1995 by class of trade were
as follows:
Class of Trade: 1996 Net Sales 1995 Net Sales
-------------- -------------- --------------
Department Store $18,768,303 $ 7,363,221
Infomercial -0- 966,276
Foreign 900,209 378,061
Duty Free 577,633 99,069
Direct Response 76,883 166,686
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Total Net Sales $20,323,028 $ 8,973,313
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Gross margin increased two percentage points in 1996 to 73% from 71% in
1995 as the Company began to reap the benefits of several major cost cutting
projects. First of these was the development of a new subcontractor to apply the
red lacquer to the Company's signature 50ml bottles. For the first time, the
automated application of colored lacquers to oblique angles of a bottle was
successfully completed in commercial quantities. Following extensive testing and
development work, the Company moved a major portion of its bottle decorating to
this new subcontractor in early 1996, thereby increasing production capacity and
reducing unit costs. In addition, the Company redesigned the most expensive
component of the women's 50 ml package reducing costs significantly without
changing the aesthetic feel or the function. These changes, coupled with a move
to a one piece pump, lowered costs on the Company's red lacquered bottles by
more than 30%. These cost savings made it possible to develop attractively
priced sets of fragrance products while maintaining competitive gross margin
levels.
Due to different pricing structures, gross margins vary considerably
between the Company's major classes of customers. Gross margins for duty free
and international sales are significantly below those of department store sales.
The Company does not consider this to be detrimental to overall profitability
since additional selling and marketing dollars are not needed to support these
non-US sales. All promotional expenditures are the contractual responsibility of
the distributor.
Research and development costs in 1996 increased to $473,420 from
$288,051 in 1995 as the Company developed new fragrance items under its REALM
Women and REALM Men fragrance lines and its new women's fragrance, inner Realm.
In addition to payments to Pherin of $270,000 in 1996, the Company made
expenditures for fragrance and primary and secondary packaging design and
development and consumer and product testing. In 1996, four new items were
introduced, a women's body cream and an after bath body talc, a men's
antiperspirant/deodorant and the REALM Roulette. Included in R&D expenditures in
1996 are testing and development costs for these products. During 1996, the
Company and scientists at Pherin developed a program of training and public
relations to convey the scientific findings that differentiate this new
fragrance. Payments to Pherin in 1995 under the Company's ongoing R&D agreement
were $240,000.
Selling, General and Administrative expenses increased to $13,088,248
in 1996 from $7,178,882 in 1995 mainly due to greater advertising, public
relations and salary expenses as the Company continued to expand its retail
presence and product lines. Despite the absolute increase in these expenses, at
64% of sales, SG&A expenses as a percentage of sales for 1996 were significantly
lower than the 80% of sales reported for 1995. During 1996, the Company
increased its marketing and advertising spending and added additional regional
sales personnel to support the increased number of stores selling REALM
fragrances. Advertising expenditures increased as the Company developed regional
and national radio campaigns to promote existing products and introduce new line
items. In 1996, the Company expended funds on fragrance modeling, sampling and
promotional materials in over 1,350 retail doors compared to less than 500 in
1995.
In 1996, the Company's distribution, materials and warehousing
functions expanded to accommodate the growth of its retail sales. Additional
warehousing capability and new employees were added to handle the increased
workload. By the end of the year, the Company had successfully installed 90% of
its retail department store customers on EDI (Electronic Data Interface) for all
purchase orders. This has made it possible for the Company to process the
increased volume of orders without adding proportional customer service staff.
The basic growth in the volume of retail orders resulted in increased employee
and supply expenses in 1996 as compared with the prior year.
Interest income decreased to $20,612 in 1996 from $113,142 in 1995 due
to lower cash and investment balances.
The Company recorded a provision for income taxes in 1996 equal to 5%
of pretax income. This represents federal and state alternative minimum taxes
after utilizing the allowable amount of net operating loss carryforwards for the
current year. There was no provision for income taxes in 1995 since the Company
incurred a net operating loss in that year.
Year ended December 31, 1995, compared with the year ended December 31,
1994
Net sales of $8,973,313 for the year ended December 31, 1995
represented approximately an eight fold increase over sales of $1,087,124 for
the year ended December 31, 1994. This increase was directly attributable to the
retail roll-out of the Company's REALM fragrance products in department and
specialty stores throughout the East, Midwest and Southwest principally through
Dillard Department Stores and selected divisions of Federated Department Stores.
In the second quarter of 1995, the Company discontinued the airing of its
infomercial. During the first half of the year, revenues and expenses resulting
from the infomercial were approaching a break-even point, and the Company made
the decision not to compete with its growing family of retail partners by
selling directly to consumers.
<PAGE>
In the third quarter of 1995, the Company expanded its retail presence,
and by the end of the fourth quarter, Realm fragrances had been launched in 335
retail stores and been shipped to an additional 143 stores for launch in January
1996. At the end of 1995, the Company had secured distribution in Federated
Department Stores' Bloomingdales, Rich's/Lazarus, Macy's East and South and
Jordan Marsh divisions, Dillard Department stores, Dayton Hudson/Marshall
Fields, ZCMI and Jacobsons. Catalogue placement was also made in the Holiday
books of Bloomingdale's and Neiman Marcus catalogue divisions.
Internationally in 1995, the Company opened a branch of its US
corporation in France. Sales from the branch were exclusively to the Company's
sole distributor in Italy. The branch is responsible for sales to European
customers and also oversees the manufacture and logistics of primary packaging
components manufactured in France. During the fourth quarter of 1995, the
Company shipped its Realm fragrance line to a duty free distributor for
distribution in the Caribbean.
In 1994, net sales were mainly the result of the airing of the
Company's revised infomercial. During the first seven months of 1994, sales of
the Company's fragrances were generated from public relations and reorders from
the airing of the original infomercial. In late August of 1994, the Company
commenced airing its revised infomercial. Test results of this infomercial were
in line with expectations and the Company continued its airing into early 1995.
In the last quarter of 1994, the Company made its initial foray into retail
distribution with sales to I. Magnin Company's twelve specialty stores and
Christmas catalogue. While closure of the I. Magnin division was announced by
its parent, Federated Department Stores in mid-November, Realm fragrances sold
out in all of the stores prior to the Christmas shopping season. Sales by class
of trade are detailed in the table below:
Class of Trade: 1995 Net Sales 1994 Net Sales
-------------- -------------- --------------
Department Store $ 7,363,221 $ 44,054
Infomercial 966,276 886,116
Foreign 378,061 -
Duty Free 99,069 -
Direct Response 166,686 156,954
------------- -------------
Total Net Sales $ 8,973,313 $ 1,087,124
============= =============
The Company's gross profit increased to $6,370,764 in 1995 from
$679,418 in 1994, representing in 1995 71% of net sales compared to 62.5% in
1994. This increase was primarily the result of higher sales volumes. During
1995, the Company reduced the cost of its 50ml products by more than 25%. The
majority of this decrease was due to increased volumes and more competitive
pricing obtained from a variety of suppliers. During 1994, the Company's sales
did not justify large volume purchases, and as a result, per unit costs for its
fragrances were significantly higher than in 1995. The Company has not
experienced significant price increases over the past year from its major
suppliers, but it expects to see base price increases in the future which it
anticipates will be offset in part by price decreases resulting from higher unit
volumes. Margins in the future could also be affected by the addition of sales
to distributors. The addition of independent distributors could decrease the
realized selling price to the Company and ultimately reduce the gross margin.
Research and development costs in 1995 were essentially constant with
1994 levels, $288,051 and $273,711, respectively. This was mainly the result of
the Company's research and development contract with Pherin Corporation.
Payments to Pherin under this agreement were $240,000 and $272,000 in 1995 and
1994, respectively.
Selling and General Administrative expenses increased to $7,178,882 in
1995 from $2,847,575 in 1994. This increase was mainly due to greater
advertising, public relations and salary expenses as the Company commenced the
retail roll-out of its products. During 1995, the Company purchased $638,200 in
infomercial air time compared to $400,100 in 1994. In 1995, the Company invested
in promotional expenditures such as scented inserts, radio advertising,
catalogue inserts and fragrance modeling to promote the REALM brand and training
during retail launches. Regional sales managers were added and testers and other
sampling vehicles were provided to the Company's retail partners.
In 1995, the Company added personnel to handle warehousing and
distribution functions for its retail department and specialty store business.
During 1994, the majority of these functions had been outsourced to a
distribution fulfillment center who processed all sales from the Company's
infomercial. In mid 1995, the Company moved this function in-house when the
airing of the infomercial was terminated. The Company also invested in software
and programming expenses and installed a basic EDI (Electronic Date Interface)
system to receive customer purchase orders and send invoices. Shipping and
delivery expenses also increased in 1995 as the Company began to ship testers,
display and promotional items to retailers.
<PAGE>
Interest income decreased to $113,142 in 1995 from $216,683 in 1994 due
to lower cash and investment balances.
Liquidity
At December 31, 1996, the Company had cash and cash equivalents equal
to $2,059,084 and working capital of $5,258,089. These balances at December 31,
1995 were $2,186,828 and $3,483,016, respectively. Net cash used in operating
activities was $589,788, $2,334,656 and $2,169,349 for the years ended December
31, 1996, 1995 and 1994, respectively. This usage was offset in 1995 and 1994 by
maturities of investments in the amounts of $3,461,788 and $1,000,376,
respectively. At December 31, 1996, borrowings against the Company's $3,500,000
line of credit were $500,000. The Company repaid this balance on January 8,
1997. Assuming the Company's activities proceed substantially as planned, the
Company's current cash, line of credit and anticipated revenues from product
sales should be adequate to meet its working capital needs over the next twelve
months. Working capital requirements will primarily be for the supply of
inventory, staffing, the purchase of improved distribution/financial software
and hardware, product promotion and training and accounts receivable financing.
Additional working capital may be required should the Company's
continued expansion fail to generate anticipated consumer response levels.
Furthermore, additional working capital may be required should the Company
experience a greater than planned success with its product and retail expansion.
Funds would be needed for inventory build, accounts receivable financing and
staffing purposes. If the Company fails to achieve significant revenues from its
1997 marketing efforts, or if retail expansion proves to be more capital
intensive than planned, or if the Company's new product, inner Realm, does not
meet sales projections, the Company may require additional funding.
In February 1997, the Company renegotiated its Business Loan Agreement
with Mid-Peninsula Bank of Palo Alto, California ("the Bank"). On February 11,
1997, the Company signed a commitment letter with the Bank providing for an
increased line of credit. The Company may borrow up to $6.0 million at an
interest rate equal to the Bank's prime rate plus .25% with borrowings secured
primarily by the Company's trade receivables and inventory. The agreement, which
expires in April 1998, contains certain debt-to-equity and working capital
covenants.
Item 7. Financial Statements
See the Financial Statements listed in Item 13(a), which are
incorporated herein by reference.
Item 8. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
with Section 16(a) of the Exchange Act
The executive officers of the Company and their ages as of March 1,
1997 are as follows:
Name Age Position
---- --- --------
William P. Horgan 49 Chairman, Chief Executive Officer and Director
Michael V. Stern 38 President and Director
Maxine C. Harmatta 46 Vice President, Finance and Administration
William P. Horgan was appointed to the newly created post of Chairman of the
Board in November 1996 after serving as President, Chief Executive Officer and
Director since January 1994, when he joined the Company. From May 1992 to
January 1994, he served as Chief Financial and Administrative Officer of
Geobiotics, Inc., a biotechnology-based development stage company, and from
January 1990 to May 1992, was employed by E.S. Jacobs and Company as Senior Vice
President of Worlds of Wonder, Inc. From March 1988 to January 1990, he was
Chief Financial Officer of Advanced Polymer Systems, Inc., a manufacturer and
supplier of polymer based delivery systems for the ethical dermatology, OTC skin
care and personal care markets. Prior thereto, he held various executive and
management positions with CooperVision, Inc. and several affiliated companies,
including President of its Revo, Inc. subsidiary.
Michael V. Stern was named President in November 1996. He had served as a
Director since March 1993, and was appointed Vice President Sales and Marketing
in February 1994. Prior to that, from February 1993 until February 1994 he was
director of Marketing and Sales for Mc Guire Company, a division of Kohler
Company. He also served as a management consultant for Carter, Hawley, Hale, a
department store operation, from May 1992 until February 1993. From prior to
1989 until May 1992, Mr. Stern held various management positions with R.H. Macy
in its California Division.
Maxine C. Harmatta was appointed Vice President, Finance and Administration in
December 1996. She joined the Company in March 1994 and served as Vice
President, Controller until January 1996 when she assumed responsibility for
operations as Vice President, Finance and Operations. From July 1992 until
February 1994, she was Controller for Revo, Inc., a manufacturer of performance
and fashion eye wear. Ms. Harmatta was Controller of Easton Aluminum, Inc., a
manufacturer and distributor of sporting goods and consumer products, from June
1986 until July 1992.
The remainder of this item is incorporated by reference to the
Company's definitive Proxy Statement relating to its 1997 Annual Meeting of
Shareholders (the "Proxy Statement").
Item 10. Executive Compensation
Incorporated by reference to the Proxy Statement.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference to the Proxy Statement.
Item 12. Certain Relationships and Related Transactions
Incorporated by reference to the Proxy Statement.
<PAGE>
<TABLE>
Item 13. Exhibits and Reports on Form 8-K
<CAPTION>
(a) Financial Statements. The following are filed as a part of this report:
Page
----
<S> <C>
Report of Independent Auditors F-1
Balance Sheets -- December 31, 1996 and 1995 F-2
Statements of Operations -- Years Ended December 31, 1996, 1995 and 1994 F-3
Statements of Shareholders' Equity -- Years ended December 31, 1996, 1995 and 1994 F-4
Statements of Cash Flows -- Years ended December 31, 1996, 1995 and 1994 F-5
Notes to Financial Statements F-6
(b) Reports on form 8-K. None.
(c) Exhibits. The following exhibits are filed as part of this report:
EXHIBIT
NUMBER EXHIBIT TITLE
------ -------------
3.1 Copy of Registrant's Articles of Incorporation (1)
3.2 Copy of Registrant's By-laws (1)
10.1 Registrant's Stock Plan * (1)
10.2 Research and Development Agreement between Registrant and Pherin dated
July 1, 1992 (1)
10.7 Technology Transfer Agreement between Registrant and Pherin dated
August 23, 1991 (1)
10.10 Registrant's Non-employee Directors Stock Option Plan * (2)
10.12 Standard Industrial Lease - Net between
Registrant and SCI Limited Partnership-I
dated September 29, 1995 for the
Registrant's California facility) (3)
10.13 Amendment to Research and Development Agreement between Registrant and
Pherin dated February 29, 1996 (3)
10.14 Business Loan Agreement dated March 13, 1996 (3)
11.0 Statement Re: Computation of Per share Earnings (Loss) E-28
23.1 Consent of Ernst & Young LLP, independent auditors E-29
27.01 Financial Data Schedule E-30
<FN>
(1) Filed as an exhibit with corresponding exhibit no. to Registrant's
Registration Statement on Form SB-2 (Registration No. 33-52340) and
incorporated herein by reference.
(2) Filed as an exhibit with corresponding exhibit no. to Registrant's
Annual Report on Form 10-KSB for the Year Ended December 31, 1993.
(3) Filed as an exhibit with corresponding exhibit no. to Registrant's
Annual Report on Form 10-KSB for the Year Ended December 31, 1995.
* Management contract or compensatory plan
</FN>
</TABLE>
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
EROX Corporation has duly caused this Annual Report on Form 10-KSB to be signed
on its behalf by the undersigned, thereunto duly authorized, in Fremont,
California, on March 26, 1997.
EROX CORPORATION
By: /s/ William P. Horgan
---------------------------------
Name: William P. Horgan
-------------------------------
Title: Chairman of the Board
------------------------------
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Annual Report has been signed on behalf of EROX Corporation by the
following persons in the capacities and on the dates indicated.
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<S> <C> <C>
/s/ William P. Horgan Chief Executive Officer March 26, 1997
- -------------------------------------- and Director
William P. Horgan
/s/ Michael V. Stern President and Director March 26, 1997
- --------------------------------------
Michael V. Stern
/s/ Maxine C. Harmatta Vice President, March 26, 1997
- -------------------------------------- Principal Financial and
Maxine C. Harmatta Accounting Officer
/s/ Bernard I. Grosser Director March 26, 1997
- --------------------------------------
Bernard I. Grosser, MD
/s/ Helen C. Leong Director March 26, 1997
- --------------------------------------
Helen C. Leong
/s/ Robert Marx Director March 26, 1997
- --------------------------------------
Robert Marx
</TABLE>
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
EROX Corporation
We have audited the accompanying balance sheets of EROX Corporation as
of December 31, 1996 and 1995, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of EROX Corporation at
December 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
Ernst & Young LLP
Palo Alto, California
February 5, 1997
<PAGE>
EROX Corporation
<TABLE>
Balance Sheets
<CAPTION>
December 31, December 31,
1996 1995
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 2,059,084 $ 2,186,828
Accounts receivable, net of allowances of $501,677 2,813,135 1,954,508
and $316,972 in 1996 and 1995, respectively
Inventory 2,906,517 1,799,728
Other current assets 74,414 168,785
------------ ------------
Total current assets 7,853,150 6,109,849
Property and equipment, net 71,516 78,214
------------ ------------
$ 7,924,666 $ 6,188,063
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 1,218,741 $ 731,777
Loan payable, bank 500,000 500,000
Accrued advertising 218,249 562,640
Accrued compensation 176,038 78,137
Other accrued expenses 482,033 754,279
------------ ------------
Total current liabilities 2,595,061 2,626,833
Commitments -- --
Shareholders' Equity:
Convertible preferred stock, issuable in series, no par value,
10,000,000 shares authorized, no shares issued and outstanding -- --
Common stock, no par value, 40,000,000 shares authorized,
10,156,905 shares issued and outstanding at December 31, 1996
and 9,911,972 shares at December 31, 1995 17,374,734 16,823,918
Accumulated deficit (12,045,129) (13,262,688)
------------ ------------
Total shareholders' equity 5,329,605 3,561,230
------------ ------------
$ 7,924,666 $ 6,188,063
============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
EROX Corporation
<TABLE>
Statements of Operations
<CAPTION>
Years ended December 31,
--------------------------------------------
1996 1995 1994
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 20,323,028 $ 8,973,313 $ 1,087,124
Cost of goods sold 5,487,801 2,602,549 407,706
------------ ------------ ------------
Gross profit 14,835,227 6,370,764 679,418
Expenses:
Research and development 473,420 288,051 273,711
Selling, general and administrative 13,088,248 7,178,882 2,847,575
------------ ------------ ------------
Total expenses 13,561,668 7,466,933 3,121,286
------------ ------------ ------------
Income (loss) from operations 1,273,559 (1,096,169) (2,441,868)
Interest income 20,612 113,142 216,683
Interest expense (7,879) -- --
Other (expense) (4,651) -- (7,701)
------------ ------------ ------------
Income (loss) before taxes 1,281,641 (983,027) (2,232,886)
Income taxes 64,082 -- --
Net income (loss) $ 1,217,559 $ (983,027) $ (2,232,886)
============ ============ ============
Net income (loss) per share $ 0.12 $ (0.10) $ (0.23)
============ ============ ============
Shares used in calculation of net income (loss) per share 10,508,680 9,866,260 9,849,505
============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
EROX Corporation
Statements of Shareholders' Equity
Total
Common Accumulated Shareholders'
Stock Deficit Equity
------------ ------------ ------------
Balances at December 31, 1993 16,687,918 (10,046,775) 6,641,143
Exercise of stock options for
12,000 shares of common
stock for cash 6,000 6,000
Net loss (2,232,886) (2,232,886)
------------ ------------ ------------
Balances at December 31, 1994 16,693,918 (12,279,661) 4,414,257
Exercise of stock options for
60,000 shares of common
stock for cash 130,000 130,000
Net loss (983,027) (983,027)
------------ ------------ ------------
Balances at December 31, 1995 16,823,918 (13,262,688) 3,561,230
Exercise of stock options for
234,933 shares of common
stock for cash 530,816 530,816
Exercise of warrants for
10,000 shares of common
stock for cash 20,000 20,000
Net income 1,217,559 1,217,559
------------ ------------ ------------
Balances at December 31, 1996 $ 17,374,734 $(12,045,129) $ 5,329,605
============ ============ ============
See accompanying notes.
<PAGE>
EROX Corporation
<TABLE>
Statements of Cash Flows
<CAPTION>
Years ended December 31,
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Cash Flows from Operating Activities
Net income (loss) $ 1,217,559 $ (983,027) $(2,232,886)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization 95,470 171,242 272,171
Amortization of premium/discount on purchase of
T Bills and Notes, net -- (53) (5,419)
Changes in operating assets and liabilities:
Accounts receivable (858,627) (1,813,108) (89,187)
Inventory (1,106,789) (993,585) (374,241)
Other current assets 94,371 (49,902) 3,915
Accounts payable 486,964 392,857 242,586
Accrued advertising (344,391) 562,640 --
Accrued compensation and other accrued expenses (174,345) 378,280 13,712
----------- ----------- -----------
Net cash used in operating activities (589,788) (2,334,656) (2,169,349)
Cash Flows from Investing Activities
Purchase of held-to-maturity investments -- -- (448,549)
Proceeds from maturity of held-to-maturity investments -- 3,461,788 1,000,376
Purchase of property and equipment (88,772) (90,485) (44,309)
Proceeds from sale of property and equipment -- -- 8,294
----------- ----------- -----------
Net cash provided by (used in) investing activities (88,772) 3,371,303 515,812
Cash Flows from Financing Activities
Proceeds from bank borrowings -- 500,000 --
Proceeds from issuance of common stock 550,816 130,000 6,000
----------- ----------- -----------
Net cash provided by financing activities 550,816 630,000 6,000
Net increase/(decrease) in cash and cash equivalents (127,744) 1,666,647 (1,647,537)
Cash and cash equivalents at beginning of the year 2,186,828 520,181 2,167,718
----------- ----------- -----------
Cash and cash equivalents at end of the year $ 2,059,084 $ 2,186,828 $ 520,181
=========== =========== ===========
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
EROX Corporation (the "Company") was incorporated in the State of
California in 1989. The Company is engaged in the research, development,
manufacturing and marketing of fragrances containing synthetic human pheromones
as a component. The Company initiated commercial operations in late 1994. The
Company currently sells its REALM fragrance products through department and
specialty stores across the United States and selected International markets.
Revenue Recognition
Revenue is recorded at the time of merchandise shipment, net of
provisions for returns. The majority of the Company's sales are to large,
financially stable department store chains. During 1996, three customers
comprised 34%, 21% and 15% of the Company's total sales. The Company's foreign
sales approximated 4.4% and 4.2% of net sales during fiscal 1996 and 1995,
respectively. Foreign currency transaction gains and losses are included in the
results of operations and were immaterial for all periods presented.
Advertising Expense
The cost of advertising is expensed as incurred. The Company incurred
$4,447,061, $2,716,997, and $885,638 in advertising costs during 1996, 1995, and
1994, respectively.
Stock Based Compensation
The Company grants stock options to employees and consultants for a
fixed number of shares with an exercise price equal to the fair value of the
shares at the date of grant. The Company accounts for the stock option grants in
accordance with APB Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to
Employees," and accordingly, recognizes no compensation expense for the stock
option grants. In 1995, the Financial Accounting Standards Board released the
Statement of Financial Accounting Standard No. 123 ("SFAS 123"), "Accounting for
Stock Based Compensation." SFAS 123 provides an alternative to APB 25 and is
effective for fiscal years beginning after December 15, 1995. The Company is
continuing to account for its employee stock plans in accordance with the
provisions of APB 25.
Net Income/Loss Per Share
Net income per share is computed using the weighted average number of
common shares and dilutive common equivalent shares attributable to stock
options outstanding during the period. Net loss per share is computed using the
weighted average number of common shares outstanding during the period. Common
stock equivalents relating to stock options are excluded from the net loss per
share computation as their effect in antidilutive.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.
Inventories
Inventories are stated at the lower of cost (first-in, first-out
method) or market. The inventory at December 31, 1996 consists of finished goods
inventory valued at $1,188,882, work in process of $154,347 and raw materials of
$1,563,288. At December 31, 1995, these balances were $352,313, $279,177 and
$1,168,238, respectively.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Reclassification
The Company has reclassified certain prior year balances to conform
with the current year's presentation.
Property and Equipment
The Company's property and equipment, which consists of molds, computer
hardware and software, and furniture and fixtures, are being depreciated on a
straight-line basis over their estimated useful lives of up to three years.
Use of Estimates
The preparation of the 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 those estimates.
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Years ended December 31,
------------------------
1996 1995
--------- ---------
Molds $ 477,769 $ 437,972
Computer hardware 62,204 48,342
Computer software 87,394 81,091
Furniture and other office equipment 71,171 42,361
--------- ---------
698,538 609,766
--------- ---------
Less: Accumulated depreciation (627,022) (531,552)
--------- ---------
$ 71,516 $ 78,214
========= =========
3. LOAN PAYABLE, BANK
At December 31, 1996, there was a loan payable of $500,000 under the
Company's Line of Credit with Mid-Peninsula Bank. Under the terms of this
agreement the Company may borrow up to 75% of allowable accounts receivable as
defined. The interest rate on borrowings is the bank's prime rate plus 0.50%.
Borrowings are secured by the Company's accounts receivables and inventories,
and the agreement will expire April 15, 1997. The Company repaid all borrowings
on January 8, 1997. See Note 9.
4. COMMITMENTS
Effective September 29, 1995, the Company entered into a lease
arrangement for office space in Fremont, California until October 31, 1998. The
annual base rent will be approximately $75,336 and $62,780 for the years ended
December 31, 1997 and 1998, respectively. The lease also provides for payments
related to taxes, common area charges and outside maintenance. Total rental
expense was $88,776, $68,168 and $76,285 for the years ended December 31, 1996,
1995 and 1994, respectively.
5. SHAREHOLDERS' EQUITY
Warrants
In connection with its initial public offering, the Company issued a
warrant to purchase 10,000 shares of the Company's common stock at an exercise
price of $4.00 per share. In June 1994, this warrant was exchanged for a warrant
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
5. SHAREHOLDERS' EQUITY (continued)
to purchase 10,000 shares of common stock at an exercise price of $2.00 per
share and an expiration date of January 1996. In 1996, the expiration date of
this warrant was extended to June 1998. This warrant was exercised in 1996.
Stock Plan
In 1990, the Company adopted a stock option plan (the "Plan"), which is
administered by the Compensation and Stock Option Committee of the Board of
Directors. The maximum number of shares that may be issued under the Plan is
2,125,000. Terms and conditions of stock options are set by the Board of
Directors. Options may be granted at the fair value at the date of the grant as
determined by the Board of Directors. Options for a holder of more than 10% of
the voting stock of the Company may be granted at not less than 110% of fair
market value. Options have a maximum term of ten years, or shorter period set
forth in the option agreement, and generally vest over a four year period unless
otherwise specified. Options granted to a shareholder with 10% or more of the
voting stock of the Company have a maximum term of five years.
A summary of the option activity under the Plan is as follows:
WEIGHTED
SHARES AVERAGE
UNDER OPTION PRICE EXERCISE
OPTION PER SHARE PRICE
------ --------- -----
Balance, December 31, 1993 1,325,534 $ .50 - $6.00 $2.38
Options granted 447,000 $1.53 - $2.25 $1.84
Options canceled (1,123,534) $1.00 - $6.00 $2.42
Options exercised (12,000) $.50 $ .50
----------
Balance, December 31, 1994 637,000 $1.53 - $2.25 $1.98
Options granted 219,000 $1.38 - $3.72 $2.02
Options exercised (60,000) $2.00 - $2.25 $2.17
----------
Balance, December 31, 1995 796,000 $1.38 - $3.72 $1.97
Options granted 498,600 $2.94 - $7.91 $4.95
Options exercised (234,933) $1.56 - $4.00 $2.26
Options canceled (8,167) $1.53 - $3.72 $3.54
----------
Balance, December 31, 1996 1,051,500 $1.38 - $7.91 $3.16
At December 31, 1996, a total of 350,567 shares of the Company's common stock
were reserved for future grants under the Plan, and options to purchase 459,923
shares were exercisable.
Non-Employee Directors' Stock Option Plan
In June 1993, the Company's Board of Directors adopted, subject to
shareholder approval, a Non-Employee Directors' Stock Option Plan covering a
total of 275,000 shares of common stock, which provides for a one-time automatic
grant of options to purchase 25,000 shares of common stock and annual grants
thereafter of options to purchase 10,000 shares of common stock to each
non-employee director at an exercise price equal to the fair market value of the
stock on the date of grant. The shareholders of the Company approved the
Non-Employee Directors' Stock Option Plan in June 1994.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
5. SHAREHOLDERS' EQUITY (continued)
The stock option activity under the Plan was as follows:
WEIGHTED
SHARES AVERAGE
UNDER OPTION PRICE EXERCISE
OPTION PER SHARE PRICE
------ --------- -----
Balance, December 31, 1993 60,000 $4.00 $4.00
Options granted 55,000 $1.64 - $2.00 $1.84
----------
Balance, December 31, 1994 115,000 $1.64 - $4.00 $2.97
Options granted 40,000 $2.20 $2.20
----------
Balance, December 31, 1995 155,000 $1.64 - $4.00 $2.77
Options granted 40,000 $7.88 $7.88
----------
Balance, December 31, 1996 195,000 $1.64 - $7.88 $3.82
At December 31, 1996, a total of 80,000 shares of the Company's common
stock were reserved for future grants under the Plan, and options to purchase
174,996 shares were exercisable.
Stock Compensation
The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123, "Accounting for
Stock-Based Compensation," requires the use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25, because
the exercise price of the Company's 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 income and earnings per share is
required by SFAS 123, which also requires that the information be determined as
if the Company had accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of the Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
multiple option pricing model with the following weighted average assumptions:
OPTION GRANTS OPTION GRANTS
1996 1995
---- ----
Risk-Free Interest Rates 4.95% to 6.50% 5.82% to 7.09%
Dividend Yield -0- -0-
Volatility factor of the
Company's common stock .88 .88
Weighted average expected life
beyond each respective vesting period 1 year 1 year
The weighted average fair value of options granted during 1995 and 1996
was $.87 and $2.60, respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
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.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
5. SHAREHOLDERS' EQUITY (continued)
Had compensation cost for the Company's employee stock option plan been
determined based on the fair value at the grant dates for awards under those
plans consistent with the methodology of SFAS 123, the Company's net income
(loss) and earnings (loss) per share would have been reduced (increased) to the
pro forma amounts indicated:
1996 1995
---- ----
Pro forma net income/(loss) $ 719,981 $(1,146,808)
Pro forma income/(loss) per share $ .07 $ (.12)
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1998.
The following table summarizes information about stock options outstanding at
December 31, 1996:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/96 LIFE PRICE AT 12/31/96 PRICE
------ ----------- ----------- -------- ----------- --------
$1.38 to $1.64 334,833 4.2 $1.52 245,206 $1.54
$2.00 to $2.94 435,167 4.3 $2.26 309,467 $2.09
$3.13 to $4.84 257,000 5.9 $4.45 60,250 $4.00
$5.94 to $7.91 219,500 6.3 $6.52 19,996 $7.88
----------- --------
$1.38 to $7.91 1,246,500 5.0 $3.26 634,919 $2.24
=========== =========
6. RELATED PARTY TRANSACTIONS
In July 1992, the Company entered into a consulting agreement for
financial, technical and research and development advisory services, with a
shareholder/former president of the Company, which required monthly payments of
$4,333. During 1996, 1995 and 1994, the Company made payments of $52,000 per
year. The current term of this agreement expires July 1997 and may be canceled
by either party with 30 days prior notice.
On February 29, 1996, the Company renewed a research and development
agreement with Pherin Corporation ("Pherin"), a company related by common
shareholders, whereby Pherin supplies EROX with its required synthesized human
pheromones and also provides to EROX research and development and scientific
public relations services. This renewal expires on March 1, 1998. The total
expense incurred pursuant to the Company's research and development agreement
with Pherin Corporation during the fiscal years ended December 31, 1996, 1995,
and 1994 was $270,000, $240,000 and $272,000 respectively.
7. INCOME TAXES
The provision for taxes consists for the year ended December 31, 1996,
of the following:
Current:
Federal $24,903
State 39,179
-------
$64,082
=======
There was no provision for income taxes for the years ended December 31, 1995 or
1994 since the Company incurred a net operating loss in those years.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1996
7. INCOME TAXES (continued)
The Company's effective income tax provision for the year ended
December 31, 1996 differs from the statutory federal income tax rate of 34% due
to the following:
Expected tax provision at federal statutory rate $ 423,345
State Taxes 39,179
Benefit of net operating loss carryforward (398,442)
---------
Provision for income taxes $ 64,082
=========
At December 31, 1996, the Company had net operating loss carryforwards
of approximately $8,700,000. The Company also had federal research and
development tax carryforwards of approximately $170,000. The net operating loss
and credit carryforwards will expire between 2004 and 2011.
Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of the
Internal Revenue Code of 1986 and similar state provisions. The annual
limitations may result in the expiration of net operating losses and credits
before utilization.
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes are as follows:
Deferred tax asset: 1996 1995
---- ----
Net operating loss carryforward $ 3,030,000 $ 3,500,000
Research credit carryforward 170,000 150,000
Other 510,000 450,000
Valuation allowance for deferred tax assets (3,710,000) (4,100,000)
----------- -----------
$ -- $ --
=========== ===========
Because of the Company's lack of earnings history, the deferred tax
asset has been fully offset by a valuation allowance. The net valuation
allowance decreased in 1996 by $390,000 and increased by $1,100,000 in 1995.
8. LITIGATION
The Company is subject to a legal claim arising out of the ordinary
course of business. Management currently believes that the ultimate amount of
liability, if any, with respect to any pending action, will not materially
affect the financial position, results of operations or liquidity of the
Company. However, the ultimate outcome of any litigation is uncertain. If an
unfavorable outcome was to occur, the impact could be material. Furthermore, any
litigation, regardless of the outcome, can have an adverse impact on the
Company's results of operations as a result of defense costs, diversion of
management resources, and other factors.
9. SUBSEQUENT EVENT (unaudited)
On February 20, 1997, the Company renegotiated its Business Loan
Agreement with Mid Peninsula Bank of Palo Alto, California. The Company may
borrow up to $6.0 million at an interest rate equal to the bank's prime rate
plus .25% with borrowings secured primarily by the Company's trade receivables
and inventory. The agreement, which expires on April 1, 1998, contains certain
debt-to-equity and working capital covenants.
<TABLE>
Statement Re:
Computations of Per share Earnings (Loss)
<CAPTION>
December 31, December 31, December 31,
----------- ----------- -----------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Primary
Average shares outstanding 9,998,770 9,866,260 9,849,505
Net effect of dilutive stock options-based
on the treasury stock method using
average market price 509,910 -- --
----------- ----------- -----------
Total 10,508,680 9,866,260 9,849,505
Net income (loss) $ 1,217,559 $ (983,027) $(2,232,886)
=========== =========== ===========
Per share amount $ 0.12 $ (0.10) $ (0.23)
=========== =========== ===========
Fully Diluted
Average shares outstanding 9,998,770 9,866,260 9,849,505
Net effect of dilutive stock options-based
on the treasury stock method using the
period-end market price if higher than
average market price 540,229 -- --
----------- ----------- -----------
Total 10,538,999 9,866,260 9,849,505
Net income (loss) $ 1,217,559 $ (983,027) $(2,232,886)
=========== =========== ===========
Per share amount $ 0.12 $ (0.10) $ (0.23)
=========== =========== ===========
</TABLE>
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 33-98836) pertaining to the Stock Plan and the
Non-Employee Directors' Stock Option Plan of EROX Corporation of our report
dated February 5, 1997, with respect to the financial statements of EROX
Corporation included in the Annual Report (Form 10-KSB) for the year ended
December 31, 1996.
ERNST & YOUNG LLP
Palo Alto, California
March 26, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The Schedule Contains Summary Financial Information Exracted From Balance Sheets
and Statements of Income
</LEGEND>
<CIK> 0000878616
<NAME> Erox Corporation
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,059,084
<SECURITIES> 0
<RECEIVABLES> 3,314,812
<ALLOWANCES> (501,677)
<INVENTORY> 2,906,517
<CURRENT-ASSETS> 7,853,150
<PP&E> 698,538
<DEPRECIATION> (627,022)
<TOTAL-ASSETS> 7,924,666
<CURRENT-LIABILITIES> 2,595,061
<BONDS> 0
<COMMON> 17,374,734
0
0
<OTHER-SE> (12,045,129)
<TOTAL-LIABILITY-AND-EQUITY> 5,329,605
<SALES> 20,323,028
<TOTAL-REVENUES> 20,323,028
<CGS> 5,487,801
<TOTAL-COSTS> 5,487,801
<OTHER-EXPENSES> 473,420
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 7,879
<INCOME-PRETAX> 1,281,641
<INCOME-TAX> 64,082
<INCOME-CONTINUING> 1,217,559
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,217,559
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
