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, 1997
[ ] 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
(Name of small business issuer in its charter)
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California 94-3107202
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(State or other jurisdiction of incorporation or organization) (I.R.S. employee Identification No.)
4034 Clipper Court, Fremont, California 94538
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(Address of principal executive offices) (Zip code)
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Issuer's telephone number: (510) 226-6874
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. $17,169,616
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.) $10,088,442 (1)
(1) Excludes 2,020,273 shares held by directors, officers and shareholders whose
ownership exceeds 5% of the outstanding shares at March 19, 1998 based on a
closing bid price on that day of $1.22 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. 1,433,333 shares of
convertible preferred stock, 10,289,488 shares of common stock.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [ X ]
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
1998 Annual Meeting of Shareholders (the "Proxy Statement").
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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 a broad range of 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 an entirely new category of
pheromone-based fragrances and products. The Company believes that its related
patents guarantee it a proprietary position in developing, licensing and
marketing a new category of consumer products that could significantly change
the consumer accepted standard for products containing a fragrance component and
for cosmetic treatment products.
Pheromones are chemical substances known to stimulate species-specific
biological responses in animals. For eight 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's sponsor research has focused on:
* Identification, isolation and synthetic production of naturally
occurring human pheromones;
* Demonstration of the presence of the vomeronasal organ ("VNO") in the
nasal passages of humans; and
* 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. Pheromones trigger a nerve impulse to the
hypothalamus when applied within or adjacent to the nasal passages. In humans,
the hypothalamus functions as a control center, regulating physiological
functions such as:
* Sexual desire
* Sexual maturation
* The flight or flight response
* Anxiety, fear and aggression
* Appetite, and sugar and fat metabolism
* Heart rate and blood pressure
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
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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.
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 that 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 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.
The Vomeronasal Organ. 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.
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. 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 three fragrances, REALM(R)
Women, REALM(R) Men and inner REALM(R). These "proof-of-concept" products
include a full line of fragrance and bath and body products including eau de
toilette, cologne, eau de parfume, lotion, bath and shower gel, after-shave
balm, antiperspirant, talc, soap and body cream. The Company's fragrances were
developed by Ann Gottlieb a leading consultant to the fragrance industry. All of
the Company's products contain the Company's synthesized human pheromones as a
component of the fragrance. In 1996, the Company introduced a unique refillable,
dripless roll-on applicator containing REALM eau de toilette for women. In
addition, development work commenced on a line of environmental products to be
introduced in 1998. The first of these products will be REALM Women and REALM
Men candles.
Research. Pheromones are chemical substances known to stimulate
species-specific biological responses in animals. The study of the uses, effects
and advantages of human pheromones is in its infancy, but abstracts from
presentations of two recent studies performed at leading research universities
reveal new information regarding the beneficial effects of human pheromones.
Most interestingly, these studies reveal new information regarding the
biological pathways human pheromones traverse in the body. Publication of these
findings is expected in the fall of 1998, and the Company expects increased
interest in its patented technology as the result of these studies.
Scientists working on behalf of EROX have identified and synthesized
several naturally occurring human pheromones. 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, 1997, the Company has incurred $3,597,666 in research and
development related expenses.
Markets and Competition
The Competitive Environment. The Company's current fragrance products
contain what the Company believes are
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unique components: human pheromones. Consequently, EROX believes it will be able
to differentiate its products from traditional products. If such differentiation
is successful, the Company's products initially should have little direct
competition in the marketplace, since the Company believes no other companies in
the United States have the right to produce or distribute products containing
human pheromones.
While EROX current products are fragrances, the Company feels strongly
that fine fragrances are only a "proof of concept". The Company's patented human
pheromone technology has applications far beyond traditional fragrances and bath
and body products. EROX hopes to position its technology as a desired "value
added" ingredient for any product that contains a fragrance. Synthesized human
pheromones provide the first patented technology of a component that could have
broad applications and usage in cosmetic, treatment, cleansing, over-the-counter
health supplements and home and vehicle environmental products. The Company does
not feel that it has the resources to successfully exploit the potential market
for such applications and is actively seeking licensing agreements with consumer
product manufacturers.
Marketing Strategy. EROX initial products are a line of fragrance and
bath and body products containing the Company's patented human pheromones as a
component. The first of these "proof of concept products" were developed in 1993
when the Company developed REALM Women and REALM Men. 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 following a
different approach -- one that relied on the human pheromone component in its
fragrances for product differentiation.
The Company's initial marketing program was intended to educate
consumers and the trade about pheromones while suggesting the enhanced
sensuality that the wearer of an EROX fragrance might feel. The Company also
used packaging, pricing and distribution channels to communicate the uniqueness
of their products and to differentiate them from traditional fragrance products.
The Company launched its REALM products through direct marketing to ensure the
quality and clarity of the EROX message and thereafter moved to more
conventional fragrance channels based on criteria such as store location, image
and promotional support.
Distribution and Promotional Activities. During 1993, the Company
developed two fragrances, REALM Women and REALM Men, each presented in 50Ml and
5Ml sizes. Initial promotion and distribution was in the form of a one half-hour
infomercial, broadcast-tested in August 1994 and rolled-out nationally in the
last four months of the year.
Concurrent with the introduction of the infomercial, the Company
changed its secondary packaging (cartons, carton inserts, etc.) to graphically
portray its newly-developed print advertising message, Awaken your Sixth
Sense!(R). In late 1994, the Company initiated retail distribution 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 closed prior to Christmas as part of the consolidation of stores by
its new parent, Federated Department Stores, the REALM products at I. Magnin
sold out in all of the stores.
During 1995, retail distribution in the United States accelerated and
REALM products were introduced in Neiman Marcus and Bloomingdale's by Mail
catalogs (supported by inserts containing scent-strips of both fragrances),
Rich's/Lazarus divisions of Federated Department Stores, all divisions of
Dillard Department Stores and several regional chains. Scented promotional
pieces, store catalogs, the placement of in-store fragrance models and
30-second advertising spots that aired during "drive time" on local radio
stations supported these retail introductions. Radio spots contained brief
testimonial messages and invitations to consumers to purchase REALM at retailers
in their area. The Company also began a full-scale program aimed at educating
the retailers regarding the scientific differentiation of its REALM products.
This education process included training 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 was generated from local television
news stations. When the Company launched a new retailer or division of a
retailer, local television stations were provided with a short video new release
that contained product and scientific information. A majority of local
television markets provided news stories on the local REALM launches during
their evening news broadcasts.
In 1996, additional REALM products were introduced by the remaining
divisions of Federated Department Stores (Macy's, Burdines and the Bon Marche),
selected May Company units (Lord & Taylor, Famous Barr, Kaufmann's and Robinson
May stores), the more upscale divisions of Dayton Hudson/Marshall Fields, Carson
Pirie Scott, Proffitts, the Mercantile Group and selected regional department
store chains. Again, promotional activities included scented pieces, catalogs,
multifaceted spot radio advertising, educational symposia and television public
relations efforts. In both 1995 and 1996, there were significant levels of
product "pipeline fill" (initial launch quantities purchased by retailers, as
contrasted with future ongoing lower volume replenishment orders).
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At the beginning of 1997, EROX was still a single product company,
primarily involved in one class of trade -- better U.S. department stores. REALM
fragrances and toiletries were available in more than 1,300 stores in the 48
contiguous states. While this is the largest channel of distribution for basic
fragrances, the high level of retailer employee turnover required expensive
ongoing training for continued success of differentiated, scientifically based
products such as REALM fragrances. In addition, EROX provides significant
in-store fragrance modeling to ensure that consumers driven to the stores by the
Company's ongoing radio advertisements have the opportunity to actually
experience REALM products once they reach the store.
To lessen its dependence on a single class of trade and in an effort to
leverage the expense of its radio advertising and promotion, the Company entered
into agreements with distributors who focus on the fast growing perfumery and
middle market department store classes of trade. These alternative channels
provide additional exposure for the Company's products and human pheromone
technology at a significantly lower cost than the better department stores. In
mid-1997, the Company introduced a second women's fragrance line, inner REALM(R)
initially to the department store class of trade. Results of this expensive
product launch were disappointing. A decision was made to reposition this brand
to the alternative channels of distribution in 1998, and results from the
initial repositioning are encouraging. Repositioning will continue throughout
1998.
To further reduce its dependence on a single market, the Company sought
to increase its non-U.S. distribution. In 1995 and 1996, EROX entered into
distribution agreements for the sale of REALM fragrances and toiletries in
selected Middle East markets, including Saudi Arabia and the Gulf States as well
as selected Duty Free markets in the Caribbean, South America and on the Mexican
and Canadian borders. In 1997, additional South American markets were opened and
discussions were undertaken for the profitable sale of REALM products in several
European markets and the Far East. In early 1998, initial shipments were made
under distribution agreements with distributors in Switzerland and the People's
Republic of China. International expansion will continue to be a focus of EROX.
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 U.S. 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, and in 1992 patents were
granted in Mexico. EROX is also the exclusive licensee for non-therapeutic uses
of pheromones in 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 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, 1998, the Company had twenty-four 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,
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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 that
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.
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 catalogs 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.
The retail environment in better department stores is increasingly
challenging. Retailers have aggressively cut inventories across the board.
Promotional support in the form of co-op advertising dollars is being cut back
and retailers are feeling pressure to become more promotional in order to
compete with price conscious chains appealing to bargain hunters. Fragrances and
cosmetics are increasingly being sold in secondary markets such as discount
perfumeries, drug chains and lower priced department stores. It is not
anticipated that the department store class of trade in the U.S. will become
more profitable in the near future.
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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. The majority
of the fragrance industry uses contract fillers, and the Company has no current
plans to set up its own filling facilities. However, as with any business that
is not vertically integrated, if 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 currently
cancelable by the Company on 90 days written notice and by paying a $15,000
cancellation fee which may be waived under certain circumstances. The annual
base rent was approximately $75,336 for the 12 months ended December 31, 1997
and will be $62,780 in 1998. 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, 1997, the Company incurred $101,023
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
alleged 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 sought unspecified damages and attorney's fees
as well as other relief. The Company considered this action to be entirely
without merit.
On October 8, 1997, a request for dismissal of the purported class
action lawsuit was filed by the plaintiff in Contra Costa County Superior Court.
The dismissal was entered as requested. The Company knows of no other pending
legal action.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
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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, 1998, there were approximately 325 holders
of record of the Company's Common Stock. The Company believes that there are 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
1996 and 1997.
HIGH LOW
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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
1997
First quarter $ 4.88 $ 2.94
Second quarter $ 3.63 $ 1.19
Third quarter $ 2.69 $ 1.00
Fourth quarter $ 1.94 $ .66
These quotations reflect interdealer prices, without retail mark-up,
markdown 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, 1997 compared with the year ended December 31,
1996
Net sales for the year ended December 31, 1997 were $17,169,616
compared to $20,323,028 for the prior year. This 15.5% decrease was attributed
to decreases in purchases by U.S. department stores. In 1997, U.S. department
store retailers began the year with significantly higher in-store fragrance
inventories than planned. These retailers began an industry wide program to
significantly reduce retail stock levels and increase inventory turns from three
turns per year to six. This negatively impacted the Company's sales to this
important class of trade. While the Company's sales to this class of trade were
off 27% overall for the year, sell-through at the retail level increased from
the prior year. During the last six months of 1997, consumer purchases of REALM
fragrances at the Company's U.S. department store customers exceeded the prior
year by over 2% compared to flat fragrance industry growth. This comparison
indicates that the Company's customer base expanded while the overall category
reflected lower consumer demand. During 1997, the Company launched its second
fragrance inner REALM(R). Sales for this product line did not meet expectations.
The Company plans to continue to distribute inner REALM on a more limited basis
in specialty stores and selected markets. The Company also developed several
secondary markets during 1997. These sales are handled through an authorized
distributor to perfumeries and mid-priced department stores.
Net sales for the years 1997 and 1996 were as follows:
Markets: 1997 Net Sales 1996 Net Sales
-------- -------------- --------------
U.S. markets $15,723,331 $18,807,594
Foreign markets 1,446,285 1,515,434
----------- -----------
Total Net Sales $17,169,616 $20,323,028
=========== ===========
Gross margin for the year ended 1997 was 76% compared to 73% in 1996.
Costs for the Company's new fragrance, inner REALM, were significantly lower
than the component costs for the original REALM line of products. In the last
quarter of 1997, the Company decreased the number of lower margin fragrance
value sets made available for sale. These factors were offset by the increase in
sales to lower margin classes of trade. The Company increased sales to secondary
markets and duty free distributors in 1997. This move was made to increase
overall operating profits as these classes of trade do not demand the same level
of co-operative advertising expenditures for store sponsored vehicles. In the
future, increasing sales to these secondary classes of trade may lower gross
margin, but should increase operating profits.
<PAGE>
Research and development costs in 1997 decreased to $332,389 from
$473,420 in 1996. Expenses in 1997 were mainly for payments to Pherin
Corporation under the Company's ongoing R&D agreement. These expenses totaled
$276,000 and $270,000 in 1997 and 1996, respectively. Total research and
development costs in 1996 were higher than in 1997 due to costs for development
of inner REALM (introduced in 1997) and for line extensions of the Company's
REALM Men and REALM Women fragrances (introduced in the prior year).
Selling, general and administrative expenses increased in 1997 to
$16,034,659 from $13,088,248 in 1996 mainly due to advertising expenditures of
$3,421,018 primarily related to the launch of inner REALM. Selling and
advertising expenditures of $12,382,012 in 1997 compared to $9,639,617 in 1996.
Advertising agreements to promote the launch of inner REALM were entered into
early in 1997. The Company was unable to cancel these advertising agreements
when it became apparent that inner REALM sales were not approaching the
Company's internal sales plan. In the second half of 1997, the Company reduced
the level of commitments for co-operative programs and focused expenditures on
radio programs and in-store fragrance modeling.
General and administrative expenses increased in 1997. Distribution and
facilities costs increased as the Company added inner REALM to its line of
products. Additional warehouse space was required and additional personnel were
required for shipping. In 1996, the Company had employed mainly temporary
workers in its warehouse operations. In 1997, the Company installed new shipping
hardware and software required of all vendors by U.S. department stores. The
level of accuracy required by these systems demands a higher level of skilled
worker, and the Company has found it necessary to train full-time permanent
employees for these jobs.
Interest expense increased to $75,989 in 1997 from $7,879 in 1996 due
to higher short term borrowings under the Company's line of credit.
The Company recorded no income tax provision in 1997 due to the current
year's net operating loss. In 1996, the Company recorded a provision equal to 5%
of pretax income. This represented the federal and state alternative minimum
taxes after utilizing the allowable amount of net operating loss carryforward
for that year.
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, Dillard Department
Stores 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 U.S. and Canada.
Overall, the Company increased its duty free and international business by 210%
over 1995.
Net sales for the years 1997 and 1996 were as follows:
Markets: 1996 Net Sales 1995 Net Sales
------- -------------- --------------
U.S. markets $18,807,594 $ 8,496,183
Foreign markets 1,515,434 477,130
----------- ------------
Total Net Sales $20,323,028 $ 8,973,313
=========== ============
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 50ml 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.
<PAGE>
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-U.S. 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.
Liquidity
At December 31, 1997, the Company had cash and cash-equivalents equal
to $248,617 and working capital of $4,329,799. These balances at December 31,
1996 were $2,059,084 and $5,258,089, respectively. Net cash used in operating
activities was $4,204,364, $589,788 and $2,334,656 for the years ended December
31, 1997, 1996 and 1995, respectively. Issuance of convertible preferred stock
to a long-term investor in the amount of $2,145,535 partially offset cash usage
in 1997. Other cash infusions were from bank borrowings, the issuance of common
stock and maturity of investments in the amounts of $340,290, $550,816 and
$4,091,788 for 1997, 1996 and 1995, respectively. At December 31, 1997,
borrowings against the Company's $3,000,000 line of credit were $548,000.
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, accounts receivable financing and staffing.
Additional working capital may be required should the Company fail to
generate anticipated increased consumer response levels. Furthermore, additional
working capital may be required should the Company experience a greater than
planned success with its current products and expanded product lines and
geographical territories. Funds would be needed for inventory build, accounts
receivable financing and staffing purposes. If the Company fails to achieve
significant revenues from its 1998 marketing efforts or if expansion proves to
be more capital intensive than planned, the Company may require additional
funding.
In March 1997, the Company renegotiated its Business Loan Agreement
with Mid-Peninsula Bank of Palo Alto, California ("the Bank"). On March 23,
1998, the Company signed a commitment letter with the Bank providing for a
renewal of the line of credit. The Company may borrow up to $3,000,000 million
at an interest rate equal to the Bank's prime rate plus .75 % with borrowings
secured primarily by the Company's trade receivables and inventory. The
agreement,
<PAGE>
which expires on April 1, 1999, 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
<TABLE>
The executive officers of the Company and their ages as of March 1,
1998 are as follows:
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
William P. Horgan 50 Chairman, Chief Executive Officer and Director
Michael V. Stern 39 President and Director
Maxine C. Harmatta 47 Vice President, Finance and Administration
</TABLE>
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 McGuire 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 eyewear. 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 1998 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, 1997 and 1996 F-2
Statements of Operations -- Years ended December 31, 1997, 1996 and 1995 F-3
Statements of Shareholders' Equity - Three Years ended December 31, 1997 F-4
Statements of Cash Flows -- Years ended December 31, 1997, 1996 and 1995 F-5
Notes to Financial Statements F-6
</TABLE>
(b) Reports on form 8-K. None
<TABLE>
(c) Exhibits. The following exhibits are filed as part of this report:
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
------ -------------
<S> <C> <C>
3.1 Copy of the Registrant's Articles of Incorporation (1)
3.1.1 Certificate of Determination of Preferences of Series AA Preferred Stock of Registrant
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 July 1, 1997 (4)
23.1 Consent of Ernst & Young LLP, independent auditors E-27
27.01 Financial Data Schedule E-28
<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, 1996.
(4) Filed as an exhibit with corresponding exhibit no. to Registrant's
Quarterly Report on Form 10-QSB for the Three Months ended June 30,
1997.
* 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, 1998.
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, 1998
- -------------------------------------------- and Director
William P. Horgan
/s/ Michael V. Stern President and Director March 30, 1998
- --------------------------------------------
Michael V. Stern
/s/ Maxine C. Harmatta Vice President, March 26, 1998
- --------------------------------------------- Principal Financial and
Maxine C. Harmatta Accounting Officer
/s/ Bernard I. Grosser Director March 30, 1998
- --------------------------------------------
Bernard I. Grosser, MD
/s/ Michael D. Kaufman Director March 30, 1998
- --------------------------------------------
Michael D. Kaufman
/s/ Helen C. Leong Director March 30, 1998
- --------------------------------------------
Helen C. Leong
/s/ Robert Marx Director March 30, 1998
- -------------------------------------------
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, 1997 and 1996, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. 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, 1997 and 1996, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1997, in conformity
with generally accepted accounting principles.
Ernst & Young LLP
Palo Alto, California
February 6, 1998
<PAGE>
<TABLE>
EROX Corporation
Balance Sheets
<CAPTION>
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 248,617 $ 2,059,084
Accounts receivable, net of allowances of $822,813
and $501,677 in 1997 and 1996, respectively 3,084,784 2,813,135
Inventory 3,421,298 2,906,517
Other current assets 128,817 74,414
------------ ------------
Total current assets 6,883,516 7,853,150
Property and equipment, net 99,491 71,516
------------ ------------
$ 6,983,007 $ 7,924,666
============ ============
Liabilities and shareholders' equity
Current liabilities:
Loan payable, bank $ 548,000 $ 500,000
Accounts payable 800,648 1,218,741
Accrued advertising 743,900 218,249
Accrued compensation 38,733 176,038
Other accrued expenses 422,436 482,033
------------ ------------
Total current liabilities 2,553,717 2,595,061
Commitments -- --
Shareholders' equity:
Convertible preferred stock, issuable in series,
no par value, 10,000,000
shares authorized, 1,433,333, and -0- shares
issued and outstanding at
December 31, 1997 and December 31, 1996,
respectively
2,145,535 --
Common stock, no par value, 40,000,000 shares
authorized, 10,289,488 shares
issued and outstanding at December 31, 1997
and 10,156,905 shares at
December 31, 1996 17,667,024 17,374,734
Accumulated deficit (15,383,269) (12,045,129)
------------ ------------
Total shareholders' equity 4,429,290 5,329,605
------------ ------------
$ 6,983,007 $ 7,924,666
============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
<TABLE>
EROX Corporation
Statements of Operations
<CAPTION>
Years ended December 31,
---------------------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 17,169,616 $ 20,323,028 $ 8,973,313
Cost of goods sold 4,079,555 5,487,801 2,602,549
------------ ------------ ------------
Gross profit 13,090,061 14,835,227 6,370,764
Expenses:
Research and development 332,389 473,420 288,051
Selling, general and administrative 16,034,659 13,088,248 7,178,882
------------ ------------ ------------
Total expenses 16,367,048 13,561,668 7,466,933
------------ ------------ ------------
Income (loss) from operations (3,276,987) 1,273,559 (1,096,169)
Interest income 12,621 20,612 113,142
Interest (expense) (75,989) (7,879) --
Other (expense) 2,215 (4,651) --
------------ ------------ ------------
Income (loss) before income taxes (3,338,140) 1,281,641 (983,027)
Income taxes -- 64,082 --
------------ ------------ ------------
Net income (loss) $ (3,338,140) $ 1,217,559 $ (983,027)
============ ============ ============
Net income (loss) per common share-basic $ (0.32) $ 0.12 $ (0.10)
============ ============ ============
Net income (loss) per common share-
assuming dilution $ (0.32) $ 0.12 $ (0.10)
============ ============ ============
Weighted average shares used in
calculation of earnings per share 10,271,377 9,998,770 9,866,260
============ ============ ============
Weighted average shares and equivalents,
if dilutive, used in calculation of net income
(loss) per common share 10,271,377 10,508,680 9,866,260
============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
<TABLE>
EROX Corporation
Statements of Shareholders' Equity
<CAPTION>
Three Years ended December 31, 1997
-------------------------------------------------------------------------
Convertible
Preferred Total
Stock Common Accumulated Shareholders'
Series AA Stock Deficit Equity
----------------- --------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Balances at December 31, 1994 - 16,693,918 (12,279,661) 4,414,257
Exercise of stock options for
60,000 shares 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 for cash 530,816 530,816
Exercise of warrants for
10,000 shares 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
Exercise of stock options for
132,583 shares for cash 292,290 292,290
Issuance of 1,433,333 shares of
AA convertible preferred
stock for cash, net of issuance
costs 2,145,535 2,145,535
Net loss (3,338,140) (3,338,140)
----------------- --------------- ---------------- ----------------
Balances at December 31, 1997 $ 2,145,535 $ 17,667,024 $ (15,383,269) $ 4,429,290
================= =============== ================ ================
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
<TABLE>
EROX Corporation
Statements of Cash Flows
<CAPTION>
Years ended December 31,
------------------------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss) $(3,338,140) $ 1,217,559 $ (983,027)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 63,953 95,470 171,242
Amortization of premium/discount on
securities, net -- -- (53)
Changes in operating assets and liabilities:
Accounts receivable (271,649) (858,627) (1,813,108)
Inventory (514,781) (1,106,789) (993,585)
Other current assets (54,403) 94,371 (49,902)
Accounts payable (418,093) 486,964 392,857
Accrued advertising 525,651 (344,391) 562,640
Accrued compensation and other accrued expenses (196,902) (174,345) 378,280
----------- ----------- -----------
Net cash used in operating activities (4,204,364) (589,788) (2,334,656)
Cash flows from investing activities
Proceeds from maturity of held-to-maturity investments -- -- 3,461,788
Purchase of property and equipment (91,928) (88,772) (90,485)
----------- ----------- -----------
Net cash provided by (used in) investing activities (91,928) (88,772) 3,371,303
Cash flows from financing activities
Proceeds from bank borrowings 48,000 -- 500,000
Proceeds from issuance of common stock 292,290 550,816 130,000
Proceeds from issuance of convertible preferred stock 2,145,535 -- --
----------- ----------- -----------
Net cash provided by financing activities 2,485,825 550,816 630,000
Net increase/(decrease) in cash and cash equivalents (1,810,467) (127,744) 1,666,647
Cash and cash equivalents at beginning of the year 2,059,084 2,186,828 520,181
----------- ----------- -----------
Cash and cash equivalents at end of the year $ 248,617 $ 2,059,084 $ 2,186,828
=========== =========== ===========
<FN>
See accompanying notes.
</FN>
</TABLE>
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
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 consumer products containing synthetic human
pheromones as a component. The Company initiated commercial operations in late
1994 with a line of fine fragrances and toiletries. 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
department store chains. During 1997 three customers comprised 30%, 21% and 15%
of the Company's total sales. The Company's foreign sales approximated 3.2% and
4.4% of net sales during fiscal 1997 and 1996, 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
$5,912,176, $4,447,061, and $2,716,997 in advertising costs during 1997, 1996,
and 1995, 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.
Net Income/Loss Per Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), Earnings per Share. Statement
128 replaced the previously reported 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 similar to
the previously reported fully diluted earnings per share. All per share amounts
for all periods have been presented and where necessary, restated to conform to
Statement 128 requirements.
Basic net income/(loss) per share is computed using the
weighted-average number of common shares outstanding. Diluted net income/(loss)
per share is computed using the weighted-average number of common shares and
dilutive common equivalent shares outstanding during the period. Dilutive common
share equivalents consist of employee stock options using the treasury stock
method and dilutive convertible securities using the if-converted method.
Diluted loss per share is computed using the weighted-average number of common
shares outstanding during the period. Common stock equivalents are excluded from
the diluted loss per share computation as their effect in antidilutive.
<TABLE>
The following table sets forth the computation for basic and diluted
earnings/(loss) per share:
<CAPTION>
December 31, December 31, December 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Numerator:
Net income (loss) from operations $ (3,338,140) $ 1,217,559 $ (983,027)
Denominator:
Denominator for basic earnings per share-data 10,271,377 9,998,770 9,866,260
Effect of dilutive securities:
Employee stock options -- 509,910 --
------------ ------------ ------------
Denominator for diluted earnings per share-data 10,271,377 10,508,680 9,866,260
Basic net income (loss) per share $ (0.32) $ 0.12 $ (0.10)
------------ ------------ ------------
Diluted net income (loss) per share $ (0.32) $ 0.12 $ (0.10)
------------ ------------ ------------
</TABLE>
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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, 1997 consists of finished goods
inventory valued at $1,665,393, work in process of $151,143 and raw materials of
$1,604,762. At December 31, 1996, these balances were $1,188,882, $154,347 and
$1,563,288, respectively.
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,
---------------------------
1997 1996
---------- ----------
Molds $477,769 $477,769
Computer hardware 93,487 62,204
Computer software 128,647 87,394
Furniture and other office equipment 90,563 71,171
--------- ---------
790,466 698,538
--------- ---------
Less: Accumulated depreciation (690,975) (627,022)
--------- ---------
$ 99,491 $ 71,516
========= =========
3. LOAN PAYABLE, BANK
At December 31, 1997, there was a loan payable of $548,000 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 0.75%.
Borrowings are primarily secured by the Company's accounts receivable and
inventories. The agreement will expire April 1, 1998. See Note 8.
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 $138,540, $88,776 and $68,168 for the years ended December 31, 1997,
1996 and 1995, respectively.
5. SHAREHOLDERS' EQUITY
Convertible Preferred Stock
On August 25, 1997, the Company obtained additional equity capital from
affiliates of a current shareholder by issuing 1,433,333 shares of convertible
preferred stock. This investment provided the Company with $2,145,535, net of
issuance costs, in equity capital that was used to reduce bank borrowings and
finance accounts receivable.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
5. SHAREHOLDERS' EQUITY (continued)
Holders of shares of convertible preferred stock shall be entitled to
the number of votes equal to the number of shares of common stock into which
such shares could be converted. Reserved for the future conversion of this
preferred stock are 1,433,333 shares of common stock. No dividends are payable
in connection with these preferred shares.
Each share of preferred stock shall be convertible at $1.50 per share
of common stock. Such initial conversion price shall be increased quarterly
beginning October 1, 1997 by $.0225 such that the original issue price shall
increase by $.09 per share each year. In addition, each preferred share shall
automatically convert in the event of any of the following:
1. Immediately after the closing bid price of the common stock on the NASDAQ
Stock Market exceeds $5.00 per share for a period of twelve consecutive
weeks.
2. Immediately after the Company reports earnings per common share for any
fiscal year of $.50 or greater.
3. Upon the written request for such conversion by sixty-six and two-thirds
percent (66 2/3%) of the then outstanding preferred stockholders.
4. At the time that sixty-six and two-thirds percent (66 2/3%) of the
preferred stock ever outstanding have converted to common stock.
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 a shorter period as
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.
<TABLE>
A summary of the option activity under the Plan is as follows:
<CAPTION>
WEIGHTED WEIGHTED
SHARES AVERAGE
UNDER OPTION PRICE EXERCISE
OPTION PER SHARE PRICE
------ ----------- -------
<S> <C> <C> <C>
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
Options granted 100,000 $1.58 $1.58
Options exercised (102,583) $1.53 - $2.13 $2.05
Options canceled (12,500) $1.60 - $3.72 $3.30
-----------
Balance, December 31, 1997 1,036,417 $1.38 - $7.91 $3.11
=========
</TABLE>
At December 31, 1997, a total of 263,067 shares of the Company's common stock
was reserved for future grants under the Plan, and options to purchase 549,787
shares were exercisable.
In June 1993, the Company's Board of Directors adopted 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.
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
<TABLE>
5. SHAREHOLDERS' EQUITY (Continued)
The stock option activity under the Plan was as follows:
<CAPTION>
WEIGHTED
SHARES AVERAGE
UNDER OPTION PRICE EXERCISE
OPTION PER SHARE PRICE
------ --------- -----
<S> <C> <C> <C>
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
Options granted 55,000 $1.58 $1.58
Options exercised (30,000) $2.00 - $4.00 $2.73
----------
Balance, December 31, 1997 220,000 $1.64 - $7.88 $3.45
==========
</TABLE>
At December 31, 1997, a total of 25,000 shares of the Company's common stock was
reserved for future grants under the Plan, and options to purchase 188,330
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.
<TABLE>
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:
<CAPTION>
Option Grants Option Grants Option Grants
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Risk-Free Interest Rates 5.91% to 6.44% 4.95% to 6.50% 5.82% to 7.09%
Dividend Yield -0- -0- -0-
Volatility factor of the Company's common stock .99 .88 .88
Weighted average expected life beyond each
respective vesting period 1 year 1 year 1 year
</TABLE>
The weighted average fair value of options granted during 1995, 1996
and 1997 was $.87, $2.60 and $.90, respectively.
<TABLE>
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 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. 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:
<CAPTION>
1997 1996 1995
----- ---- ----
<S> <C> <C> <C>
Pro forma net income (loss) $(4,081,816) $ 719,981 $(1,146,808)
Pro forma income (loss) per share $ (.40) $ .07 $ (.12)
</TABLE>
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will
<PAGE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
5. SHAREHOLDERS' EQUITY (continued)
not be fully reflected until 1998. The following table summarizes information
about stock options outstanding at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------------- -----------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
- -------------- ------------- ----------- -------- ------------ ----------
<S> <C> <C> <C> <C> <C>
$0.79 to $1.58 375,000 3.3 $1.52 239,373 $1.51
$1.58 to $2.37 344,317 4.6 $1.96 278,562 $2.00
$2.37 to $4.74 167,600 4.3 $3.32 95,310 $3.55
$4.74 to $7.91 379,500 5.1 $5.81 124,875 $6.31
--------- --- ----- ------- -----
$0.79 to $7.91 1,256,417 4.3 $3.17 738,120 $2.77
========= =======
</TABLE>
6. RELATED PARTY TRANSACTIONS
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, 1997, 1996,
and 1995 was $280,000, $270,000 and $240,000, respectively. See Note 8.
7. INCOME TAXES
There was no provision for income taxes for the year ended December 31,
1997 as the Company incurred a net operating loss. For the year ended December
31, 1996, the provision for income taxes consists of the following:
Current:
Federal $24,903
State 39,179
---------
$64,082
=========
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, 1997, the Company had net operating loss carryforwards
of approximately $12,940,000. The Company also had federal research and
development tax carryforwards of approximately $140,000. The net operating loss
and credit carryforwards will expire between 2004 and 2012.
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.
<TABLE>
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes are as follows:
<CAPTION>
Deferred tax asset: 1997 1996
----- ----
<S> <C> <C>
Net operating loss carryforward $4,590,000 $3,030,000
Research credit carryforward 180,000 170,000
Returns Reserve 330,000 201,000
Other, net 360,000 309,000
Valuation allowance for deferred tax assets (5,460,000) (3,710,000)
---------- ----------
Net deferred tax assets $ - $ -
========== ==========
</TABLE>
EROX Corporation
Notes to Financial Statements
December 31, 1997
7. INCOME TAXES (continued)
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 increased in 1997 by $1,750,000 and decreased by $390,000 in 1996.
8. SUBSEQUENT EVENT (unaudited)
On February 10, 1998, the Company renewed its research and development
agreement with Pherin Corporation. The term of the agreement is a minimum of one
year and the stipulated payments are $23,000 per month.
On March 23, 1998, the Company renegotiated its Business Loan Agreement
with Mid-Peninsula Bank of Palo Alto, California. The Company may borrow up to
$3.0 million at an interest rate equal to the bank's prime rate plus .75% with
borrowings secured primarily by the Company's trade receivables and inventory.
The agreement, which expires on April 1, 1999, contains certain debt-to-equity
and working capital covenants.
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 6, 1998, with respect to the financial statements of EROX
Corporation included in the Annual Report (Form 10-KSB) for the year ended
December 31, 1997.
ERNST & YOUNG LLP
Palo Alto, California
March 26, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> The Schedule Contains Summary Financial
Information Extracted 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-31-1997
<PERIOD-START> Jan-1-1997
<PERIOD-END> Dec-31-1997
<CASH> 248,617
<SECURITIES> 0
<RECEIVABLES> 3,907,597
<ALLOWANCES> (822,813)
<INVENTORY> 3,421,298
<CURRENT-ASSETS> 6,883,516
<PP&E> 790,466
<DEPRECIATION> (690,975)
<TOTAL-ASSETS> 6,983,007
<CURRENT-LIABILITIES> 2,553,717
<BONDS> 0
0
2,145,535
<COMMON> 17,667,024
<OTHER-SE> (15,383,269)
<TOTAL-LIABILITY-AND-EQUITY> 4,429,290
<SALES> 17,169,616
<TOTAL-REVENUES> 17,169,616
<CGS> 4,079,555
<TOTAL-COSTS> 4,079,555
<OTHER-EXPENSES> 332,389
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 75,989
<INCOME-PRETAX> (3,338,140)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,338,140)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,338,140)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
</TABLE>
