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, 1998
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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
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HUMAN PHEROMONE SCIENCES, INC.
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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. $10,378,717
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.) $5,586,667 (1)
(1) Excludes 1,421,763 shares held by directors, officers and shareholders whose
ownership exceeds 5% of the outstanding shares at March 19, 1999 based on a
closing bid price on that day of $0.63 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. 1,439,333 shares of
convertible preferred stock, 10,289,488 shares of common stock.
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
1999 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 as EROX
Corporation to develop and market a broad range of consumer products containing
human pheromones as a component. On May 29, 1998, the shareholders of the
Company voted to change the name of the Company to Human Pheromone Science, Inc.
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 Human Pheromone Science, Inc. ("HPSI") have studied the functions and
characteristics of 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. In early 1999, in response
to the need for significant increases in production, two independent
laboratories were engaged to manufacture such pheromones under the direction of
Pherin scientists. 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 HPSI 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.
Scientists have observed that in higher species the influence of
pheromones grows increasingly more subtle and complex. Not surprisingly,
reactions to pheromones are very subtle in human beings. While humans appear to
have definite responses to pheromones, the research sponsored by HPSI 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. HPSI
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.
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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 HPSI 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 HPSI 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 HPSI Products
Products. The Company operates in one business segment and markets
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 and inner Realm eau de toilette for women, and in 1998 REALM Women and
REALM Men candles were launched.
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 continued in 1998, and the Company expects increased interest in its
patented technology as the result of these studies and others currently being
undertaken.
Scientists working on behalf of HPSI 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.
HPSI has also developed the capability to manufacture commercial quantities of
these naturally occurring substances. HPSI intends to continue basic pheromone
research as applied to fragrances and ancillary products. Since its inception
through December 31, 1998, the Company has incurred $3,963,024 in research and
development related expenses.
Markets and Competition
The Competitive Environment. The Company's current fragrance products
contain what the Company believes are unique components: human pheromones.
Consequently, HPSI 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 HPSI's 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. HPSI 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 application and usage in cosmetic, treatment,
cleansing, over-the-counter health supplements and home and vehicle
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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. HPSI's 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, HPSI 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 HPSI 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 HPSI 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. The infomerical continued to be broadcast through
mid-1995 while the Company commenced selling its products in the U.S.retail
department stores on a limited basis in late 1994.
By the beginning of 1997, HPSI 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, HPSI 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. During 1998, the Company continued
distributing its REALM(R) Men and REALM(R) Women's fragrances in leading U.S.
department stores, while substantially completing the transfer of the sale and
marketing of inner REALM(R) fragrances to alternative markets including
perfumeries and middle market department stores. These alternative markets are
handled by independent distributors who purchase the product from the Company
without the right of return and are responsible for advertising, selling and
marketing expenses. By focusing the inner REALM(R) product line on these
secondary markets, the Company reduced its dependence on the department stores
for sales to the U.S. consumer. The Company reorganized it's U.S. sales
organization in the last quarter of 1998. Responsibility for selling and
marketing to the department stores was transferred from Company personnel to an
independent organization comprised of senior managers with significant
experience introducing and managing fragrances in this class of trade. This
group is compensated by commission on net sales generated. One of the
principal's of this organization had been and continues to be the CEO of
Northern Brands, the Company's distributor in the secondary markets. Also, in
late 1998 the Company determined that it could not profitably continue doing
business with the May Company and ceased selling products to this retailer and
its subsidiaries at such time.
To further reduce its dependence on a single market, the Company sought
to increase its non-U.S. distribution. In 1995 and 1996, HPSI 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. Also in 1998, initial shipments were made to a distributor
for the sale of the Company's products in Spain and Portugal. International
expansion will continue to be a focus of HPSI. 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
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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.
Technology Licensing and Supply Agreements
One of the strategic objectives of the company is to expand the use of
its patented human pheromone technology by working closely with consumer
products companies who are leaders in their particular markets. In December
1998, HPSI signed an agreement to supply its synthesized human pheromones to a
major cosmetics and fragrance company. Product launch is anticipated during the
third quarter of 1999. HPSI is also in supply and /or licensing discussions with
other companies.
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 1997, patents were granted in
Mexico. In June 1998, the Company was granted a Notice of Allowance of its
patents for the inclusion of synthesized human pheromones by the European Patent
Office. Individual country patents are now in the issuance process. HPSI 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 and radio 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, 1999, the Company had seventeen full-time employees. In
addition, the Company retains consultants to provide advice in the areas of
sales and marketing, public relations, advertising, product safety testing,
regulatory compliance, MIS and product development. The Company also has access
to scientific and professional consultants, some of whom 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, that provide
fragrance products to the industry, to supply such compounds to HPSI in
accordance with proprietary formulas developed for the Company. The Company has
agreements in place with suppliers for its fragrances and has been furnished
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 HPSI 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
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manufacturing services are widely available to the fragrance industry at
competitive prices and has identified additional contract manufacturing
companies.
The Company and Pherin are parties to an agreement under which Pherin
will supply HPSI with its reasonable requirements of human pheromones and will
make available to HPSI the basic manufacturing technology. At any time after
January 31, 1996, rather than supply human pheromones to HPSI, Pherin may
instead elect to provide to the Company all manufacturing technology in its
possession that it has not previously supplied to HPSI. Through 1998 only small
quantities of human pheromones, which could be produced in a laboratory
environment, were required for its fragrance and ancillary products. As a result
of the initial third party supply agreement entered into in December 1998, the
Company requires significantly more production of the synthesized human
pheromones than were needed in the past. In January 1999, HPSI and Pherin
contracted with two independent laboratories to manufacture kilogram quantities
of the synthesized human pheromones under the direction of scientists working on
behalf of the Company and Pherin. HPSI will receive initial quantities from
these independent laboratories commencing March 1999. The Company does not
believe that it would be economically feasible to establish it's own
manufacturing facilities since synthesized human pheromones are available from
chemical laboratories who now have experience in the preparation of these
compounds.
Risk Factors
The Company's future results may be affected to a greater or lesser
degree by the following factors among others:
The Company may not be able to effectively compete with larger
companies or with new products. The prestige fragrance market is extremely
competitive. Many fragrance products are better known than the Company's
products and compete for advertising and retail shelf space. Many competitors
have significantly greater resources that will allow them to develop and
introduce new competing products or increase the promotion of current products.
The product life cycle of a fragrance can be very short. Changing
fashions and fads can dramatically shift consumer preferences and demands.
Traditional fragrance companies introduce a new fragrance every year or so.
Changing fashions and new products may reduce the chance of creating long term
brand loyalty to the Company's products.
The Company's marketing strategy may not be successful. The Company may
not be able to establish and maintain the necessary sales and distribution
channels. Retail outlets and catalogs may choose not to carry the Company's
products. The Company may not have sufficient funds to successfully market its
products if the current marketing strategy is not successful.
The current retail environment may cause pricing and promotional
pressures. Four companies, Federated Department Stores, The May Company, Dayton
Hudson/Marshall Fields and Dillard Department Stores, own the majority of upper
end department stores. Because of their market share, each company will have
significant power to determine the price and promotional terms which the Company
must meet in order to sell its products in the company's department stores.
Upper end department stores face increasing competition by discount
perfumeries, drug chains and lower priced department stores for sales of
fragrances and cosmetics. To compete, upper end department stores have cut
inventories, reduced co-op advertising, and increased promotions. These tactics
may force the Company to reduce its prices or increase the cost of its
promotions.
Seasonality in sales may cause significant variation in quarterly
results. Sales in the fragrance industry are generally seasonal with sales
higher in the second half of the year because of Christmas. This seasonality
could cause a significant variation in the Company's quarterly operating
results.
The Company not be able to protect its technology or trade secrets. The
Company's patents and patent applications may not protect the Company's
technology or ensure that the Company's technology does not infringe another's
valid patent. Others may independently develop substantially equivalent
proprietary information. The Company may not be able to protect its technology,
proprietary information or trade secrets.
The Company may not be able to recruit and retain key personnel. The
Company's success substantially depends upon recruiting and retaining key
employees and consultants with research, product development and marketing
experience. The Company may not be successful in recruiting and retaining these
key people.
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The Company relies upon other companies to manufacture its products.
The Company relies upon Pherin and other companies to manufacture its
pheromones, supply components, and to blend, fill and package its fragrance
products. The Company may not be able to obtain or retain pheromones
manufacturers, fragrance suppliers, or component manufacturers on acceptable
terms. If not, the Company may not be able to obtain commercial quantities of
its products. This would adversely affect operating results.
Item 2. Description of Property
The Company presently leases 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, 2000, and which is currently cancelable by
the Company on 90 days written notice and paying a $15,000 cancellation fee
which may be waived under certain circumstances. The annual base rent was
approximately $81,916 for the 12 months ended December 31, 1998 and will be
$116,774 in 1999. 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. In
July 1998, the Company entered into an agreement to sublease approximately 5,890
feet of warehousing space under substantially the same terms as its primary
lease.. Such sublease expires November 1,1999 but may be extended for an
additional one year period with the mutual consent of HPSI and the subleasee. In
addition, the Company leases approximately 8,000 square feet of warehousing and
distribution space, at a cost of $0.60 per square foot, from an independent
company under a fulfillment agreement cancellable with 90 days notice. During
the year ended December 31, 1998, the Company incurred $129,415 in net rent
expense and related charges for these facilities.
Item 3. Legal Proceedings
During 1998, the Company instituted legal proceedings against two
companies alleging infringement of HPSI's patents. Both of these actions were
settled, with the alleged infringers agreeing to cease distribution of their
products and making nominal payments to HPSI that have covered the Company's
legal expenses in connection with these matters
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, 1999, there were approximately 320 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 by Nasdaq-Amex Online during each of the four calendar quarters of 1998
and 1997.
HIGH LOW
---- ---
1998
----
First quarter $ 1.47 $ 0.75
Second quarter $ 1.13 $ 0.56
Third quarter $ 0.91 $ 0.41
Fourth quarter $ 1.31 $ 0.19
1997
----
First quarter $ 4.88 $ 2.94
Second quarter $ 3.63 $ 1.19
Third quarter $ 2.69 $ 1.00
Fourth quarter $ 1.94 $ 0.66
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.
The Company's Board of Directors has approved an amendment to the
company's Articles of incorporation to effect a one-for-three reverse stock
split, pursuant to which three shares of Common Stock of the company will become
one share of common Stock (the "Reverse Stock Split"). The reverse Stock Split
will take effect, only if it is approved by the shareholders of the company.
The Company has been informed by the Nasdaq Stock Market (`NASDAQ")
that the Company has not been in compliance with a quantitative requirement for
stock traded on NASDAQ because the company's Common Stock has been trading below
NASDAQ's $1.00 per share minimum price requirement. The reverse Stock Split is
designed to raise the company's per share price above that threshold by
converting each three shares of Company Common Stock into one share and
correspondingly reducing the number of shares outstanding.
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Year ended December 31, 1998 compared with the year ended December 31,
1997
Net sales for the year ended December 31, 1998 were $10,378,717
compared to $17,169,616 for the prior year. This 39.6% decrease was attributed
to the decision to eliminate unprofitable retailers, and $4,000,000 decrease in
sales of inner Realm due to low market acceptance of the product after its
launch in 1997. In the second half of 1998 the Company decided to cease doing
business with certain U.S. department stores whose promotional demands had
become so excessive that the Company determined continued business with them
would be unprofitable. This decision was based on the Company's goal of reducing
losses even if it resulted in lower sales levels. These retailers accounted for
approximately 14% of our 1997 revenue and by December 1998 we had stopped doing
business with these accounts. Sales to distributors handling the Company's
products in the secondary markets in the United States (mid-level department
stores, perfumery chains and selected mass markets) increased by 14% in 1998.
While these distributor sales bear a lower selling price, they result in the
generation of operating profits since the distributor is responsible for all
sales returns, advertising and promotional expenses. Sales outside the United
States were $650,725 as compared with $1,446,285 in 1997, a factor of initial
stocking in 1997 in selected foreign markets.
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Net sales for the years 1998 and 1997 were as follows:
Markets: 1998 Net Sales 1997 Net Sales
-------- -------------- --------------
U.S. markets $ 9,727,992 $15,723,331
Foreign markets 650,725 1,446,285
------------ -----------
Total Net Sales $ 10,378,717 $17,169,616
============ ===========
Gross margin in 1998 represented 68% of sales as compared with 76% in
1997. The decreased margin is attributable to the large volume of sales in 1997
of our lower cost inner REALM product, higher than expected returns of inner
REALM, and increased sales to the lower margin secondary class of trade in 1998.
inner REALM has not enjoyed the same market acceptance as the REALM product
lines. The gross margin has been negatively impacted by our efforts to work with
our customers on the inner REALM line. The secondary market sales, while showing
lower gross margin, can have a better contribution margin since they do not
demand the level of support for advertising and marketing that the department
stores require.
Research and development costs in 1998 increased to $365,358 from
$332,389 in 1997. The entire increase was attributable to the Company's
additional funding of product development efforts to validate the efficacy of
its technology to potential licensees, net of reimbursements made by the
Company's initial licensee.
Selling, general and administrative expenses declined by 42% in 1998 to
$9,222,811 from $16,034,659 in 1997, primarily due to a $6,550,568 million
reduction in selling, advertising and marketing expenditures. The spending
reduction was related to the 1997 launch of inner REALM, and the Company's
decision in late 1998 to be more focuses in its advertising and promotional
efforts.
Interest expense decreased to $62,608 in 1998 from $75,989 in 1997 due
to slightly lower average borrowings under the Company's line of credit.
The Company recorded no income tax provision in 1998 or 1997 due to the
net operating losses.
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 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.
Research and development costs in 1997 decreased to $332,389 from
$473,420 in 1996. Expenses in 1997 were
10
<PAGE>
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 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.
Liquidity
At December 31, 1998, the Company had cash and cash-equivalents equal
to $76,696 and working capital of $2,315,033. These balances at December 31,
1997 were $248,617 and $4,329,799, respectively. Net cash used in operating
activities was $988,054, $4,204,364 and $589,788 for the years ended December
31, 1998, 1997 and 1996, respectively. Issuance of convertible preferred stock
to a long-term investor in the amount of $600,000 partially offset cash usage in
1998. Other cash infusions were from bank borrowings, the issuance of common
stock and maturity of investments in the amounts of $225,534, $340,290 and
$550,816 for 1998, 1997 and 1996, respectively. At December 31, 1998, borrowings
against the Company's $3,000,000 line of credit were $773,534. 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. The Company will be obtaining an additional
$300,000 from the sale of convertible preferred stock in March 1999.
Additional working capital may be required should the Company fail to
generate anticipated consumer response levels at comparable levels to 1998.
Furthermore, additional working capital may be required should the Company
experience a greater than planned success with its current products, potential
product line extensions, and department store marketing efforts. Funds would be
needed for inventory build, accounts receivable financing and staffing purposes.
If the Company fails to achieve significant revenues from its 1999 marketing
efforts or if expansion proves to be more capital intensive than planned, the
Company may require additional funding.
On March 15, 1999, the Company renewed its Business Loan Agreement with
Mid-Peninsula Bank of Palo Alto, California ("the Bank"). The Company may borrow
up to $3,000,000 at an interest rate equal to the Bank's prime rate plus 1.0 %
with borrowings secured primarily by the Company's trade receivables and
inventory. The agreement, which expires on April 1, 2000, contains certain
debt-to-equity and working capital covenants.
Impact of Year 2000
The Company has completed a comprehensive review of its internal
computer systems to identify the issues expected to arise in connection with the
Year 2000. The Company is in the process of reviewing the status of its
customers and suppliers with regard to this issue and assess the potential
impact of non-compliance by such parties on the Company's operations.
11
<PAGE>
The Company utilizes a server-based system for its material management,
manufacturing, EDI interface, and financial systems. Year 2000 compliant
software upgrades from the vendors have been installed, and tested with
satisfactory results. The total cost to upgrade and test the systems was less
than $20,000.
The Company has also completed its review of non-server based systems
and equipment (telephone system, fax machines, and off-the-shelf software). This
review found that hardware was Year 2000 compliant, and that only a few software
titles contained non-compliant Year 2000 date calculation errors. These software
titles will be upgraded to more recent Year 2000 compliant versions later in the
year if it is determined that the software is still needed by the Company. The
financial impact is minimal.
The Company is in the process of determining the extent to which it may
be impacted by third party systems, which may not be Year 2000 compliant. The
Year 2000 computer issue creates risk for the Company from third parties with
whom the Company deals on financial transactions. To date we have received
assurances from our the key customers, and suppliers that they will be Year 2000
compliant. While the Company is receiving reassurance from it's customers and
suppliers, there can be no assurance that the systems of other companies that
the Company deals with or on which the Company's systems rely on will be timely
converted, or that any such failure to convert by another company could not have
an adverse effect on the Company.
Contingency plans for suppliers, or customers that may not be compliant are part
of our material planning process and sales planning for the second half of 1999.
Failure to complete any necessary remediation by the Year 2000 may have a
material adverse impact on the operations of the Company.
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
12
<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,
1999 are as follows:
Name Age Position
---- --- --------
William P. Horgan 50 Chairman, Chief Executive Officer
and Director
Gregory S. Fredrick 44 Vice President, Controller
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.
Gregory S. Fredrick joined the Company in October 1998 as Vice President,
Controller. Prior to joining the Company Mr. Fredrick spent nearly eight years
in the Entertainment industry. From February 1997 to June 1998 he was the Vice
President, Controller for a start-up record label / internet company 911
Entertainment. Mr. Fredrick served in various finance and operations capacities
while with Windham Hill Records / BMG Entertainment from April 1990 leaving as
Director of Operations in December 1996.
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.
13
<PAGE>
<TABLE>
Item 13. Exhibits and Reports on Form 8-K
<CAPTION>
<S> <C> <C>
(a) Financial Statements. The following are filed as a part of this report:
Page
----
Report of Independent Auditors 16
Balance Sheets -- December 31, 1998 and 1997 17
Statements of Operations -- Years ended December 31, 1998, 1997 and 1996 18
Statements of Shareholders' Equity - Three Years ended December 31, 1998 19
Statements of Cash Flows -- Years ended December 31, 1998, 1997 and 1996 20
Notes to Financial Statements 21
(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 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)
10.15 Business Loan Agreement dated April 1, 1998
10.16 Extension of Industrial Lease between Registrant and SCI Limited Partnership-I
dated September 24, 1998 for the Registrant's California facility
10.17 Supply Agreement with Avon Products, Inc.
23.1 Consent of Ernst & Young LLP, independent auditors 28
27.01 Financial Data Schedule 29
<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 From 10-QSB for the
Three Months Ended June 30, 1997.
* Management contract or compensatory plan
</FN>
</TABLE>
14
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
HPSI 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, 1999
HPSI 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 Human Pheromone Sciences, Inc.
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, 1999
- - -------------------------------------- and Director
William P. Horgan
/s/ Gregory S. Fredrick Vice President, March 26, 1999
- - -------------------------------------- Principal Financial and
Gregory S. Fredrick Accounting Officer
/s/ Bernard I. Grosser Director March 30, 1999
- - --------------------------------------
Bernard I. Grosser, MD
/s/ Michael D. Kaufman Director March 30, 1999
- - --------------------------------------
Michael D. Kaufman
/s/ Helen C. Leong Director March 30, 1999
- - --------------------------------------
Helen C. Leong
/s/ Robert Marx Director March 30, 1999
- - --------------------------------------
Robert Marx
</TABLE>
15
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
Human Pheromone Sciences, Inc.
We have audited the accompanying balance sheets of Human Pheromone
Sciences, Inc. as of December 31, 1998 and 1997, and the related statements of
operations, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. 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 Human Pheromone
Sciences, Inc. at December 31, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Palo Alto, California
March 19, 1999
16
<PAGE>
<TABLE>
Human Pheromone Sciences, Inc.
Balance Sheets
<CAPTION>
December 31, December 31,
1998 1997
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 76,696 $ 248,617
Accounts receivable, net of allowances of $677,735 2,051,574 3,255,238
and $652,359 in 1998 and 1997, respectively
Inventory 2,894,541 3,421,298
Other current assets 113,635 128,817
------------ ------------
Total current assets 5,136,446 7,053,970
Property and equipment, net 58,596 99,491
------------ ------------
$ 5,195,042 $ 7,153,461
============ ============
Liabilities and shareholders' equity
Current liabilities:
Loan payable, bank $ 773,534 $ 548,000
Accounts payable 691,674 800,648
Accrued advertising 553,926 743,900
Accrued commissions 448,051 170,454
Other accrued expenses 318,228 461,169
------------ ------------
Total current liabilities 2,785,413 2,724,171
Commitments -- --
Shareholders' equity:
Preferred stock, issuable in series, no par value,
10,000,000 shares authorize 1,439,333,
and 1,433,333 convertible shares issued and
outstanding at December 31, 1998
and December 31, 1997, respectively 2,745,535 2,145,535
Common stock, no par value, 40,000,000 shares
authorized, 10,289,488 shares issued
and outstanding at December 31, 1998 and 1997 17,667,024 17,667,024
Accumulated deficit (18,002,930) (15,383,269)
------------ ------------
Total shareholders' equity 2,409,629 4,429,290
------------ ------------
$ 5,195,042 $ 7,153,461
============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
17
<PAGE>
<TABLE>
Human Pheromone Sciences, Inc.
Statements of Operations
<CAPTION>
Years ended December 31,
------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Net sales $ 10,378,717 $ 17,169,616 $ 20,323,028
Cost of goods sold 3,358,242 4,079,555 5,487,801
------------ ------------ ------------
Gross profit 7,020,475 13,090,061 14,835,227
Expenses:
Research and development 365,358 332,389 473,420
Selling, general and administrative 9,222,811 16,034,659 13,088,248
------------ ------------ ------------
Total expenses 9,588,169 16,367,048 13,561,668
------------ ------------ ------------
Income (loss) from operations (2,567,694) (3,276,987) 1,273,559
Interest income 278 12,621 20,612
Interest expense (62,608) (75,989) (7,879)
Other income (expense) 10,363 2,215 (4,651)
------------ ------------ ------------
Income (loss) before income taxes (2,619,661) (3,338,140) 1,281,641
Income taxes -- -- 64,082
------------ ------------ ------------
Net income (loss) $ (2,619,661) $ (3,338,140) $ 1,217,559
============ ============ ============
Net income (loss) per common share-basic $ (0.25) $ (0.32) $ 0.12
============ ============ ============
Net income (loss) per common share-
assuming dilution $ (0.25) $ (0.32) $ 0.12
============ ============ ============
Weighted average shares used in
calculation of net income (loss) per share 10,289,488 10,271,377 9,998,770
============ ============ ============
Weighted average shares and equivalents,
if dilutive, used in calculation of net income
(loss) per common share 10,289,488 10,271,377 10,508,680
============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
18
<PAGE>
<TABLE>
Human Pheromone Sciences, Inc.
Statements of Shareholders' Equity
<CAPTION>
Three Years ended December 31, 1998
-----------------------------------
Convertible Total
Preferred Common Accumulated Shareholders'
Stock Stock Deficit Equity
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
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
Issuance of 6,000 shares of
BB convertible preferred stock
for cash, net of issuance costs 600,000 -- -- 600,000
Net loss -- -- (2,619,661) (2,619,661)
------------ ------------ ------------ ------------
Balances at December 31, 1998 $ 2,745,535 $ 17,667,024 $(18,002,930) $ 2,409,629
============ ============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
19
<PAGE>
<TABLE>
Human Pheromone Sciences, Inc.
Statements of Cash Flows
<CAPTION>
Years ended December 31,
------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss) $(2,619,661) $(3,338,140) $ 1,217,559
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 50,296 63,953 95,470
Changes in operating assets and liabilities:
Accounts receivable 1,203,664 (442,103) (858,627)
Inventory 526,757 (514,781) (1,106,789)
Other current assets 15,182 (54,403) 94,371
Accounts payable (108,974) (418,093) 486,964
Accrued advertising (189,974) 525,651 (344,391)
Accrued commissions 277,597 170,454 --
Other accrued expenses (142,941) (196,902) (174,345)
----------- ----------- -----------
Net cash used in operating activities (988,054) (4,204,364) (589,788)
Cash flows from investing activities
Purchase of property and equipment (9,401) (91,928) (88,772)
----------- ----------- -----------
Net cash used in investing activities (9,401) (91,928) (88,772)
Cash flows from financing activities
Proceeds from bank borrowings 4,309,534 7,502,000 --
Repayment of bank borrowings (4,084,000) (7,454,000) --
Proceeds from issuance of convertible preferred stock 600,000 2,145,535 --
Proceeds from issuance of common stock -- 292,290 550,816
----------- ----------- -----------
Net cash provided by financing activities 825,534 2,485,825 550,816
Net decrease in cash and cash equivalents (171,921) (1,810,467) (127,744)
Cash and cash equivalents at beginning of the year 248,617 2,059,084 2,186,828
----------- ----------- -----------
Cash and cash equivalents at end of the year $ 76,696 $ 248,617 $ 2,059,084
=========== =========== ===========
<FN>
See accompanying notes.
</FN>
</TABLE>
20
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
Human Pheromone Sciences, Inc. (the "Company") was incorporated in the
State of California in 1989 under the name of EROX Corporation. The Company
changed the name to Human Pheromone Sciences, Inc. in May 1998. 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.
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.
Concentration of Credit Risk
The Company's concentration of credit risk consists principally of
cash, cash equivalents and trade receivables. Concentration of credit risk with
respect to trade receivables is limited because the Company's customer base
consists of a large number of geographically diverse customers in the department
and specialty store trade, in the United States and various international
markets.
Supplier Concentration
The Company is dependent on third parties to manufacture its fragrance
products, as well as the synthesized human pheromones used in these products.
Capacity limitations at these essential suppliers, or any other occurrences
leading to an interruption of supply could have a material adverse effect on the
Company.
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 1998 two customers comprised 22% and 16% of the
Company's total sales. The Company's foreign sales approximated 6.3%, 8.4% and
7.5% of net sales during fiscal 1998, 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
$2,160,148, $5,912,176, and $4,447,061 in advertising costs during 1998, 1997,
and 1996, 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.
21
<PAGE>
Human Pheromone Sciences. Inc.
Notes to Financial Statements
December 31, 1998
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Net Income/Loss Per Share
<TABLE>
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 in
1996. Common stock equivalents are excluded from the diluted loss per share
computation in 1998 and 1997 as their effect in antidilutive. The following
table sets forth the computation for basic and diluted earnings/(loss) per
share:
<CAPTION>
December 31, December 31, December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Numerator:
Net income (loss) from operations $ (2,619,661) $ (3,338,140) $ 1,217,559
Denominator:
Denominator for basic per share
data--Weighted-average shares 10,289,488 10,271,377 9,998,770
Effect of dilutive securities:
Employee stock options -- -- 509,910
------------ ------------ ------------
Denominator for diluted per share data 10,289,488 10,271,377 10,508,680
Basic net income (loss) per share $ (0.25) $ (0.32) $ 0.12
------------ ------------ ------------
Diluted net income (loss) per share $ (0.25) $ (0.32) $ 0.12
------------ ------------ ------------
</TABLE>
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, 1998 consists of finished goods
inventory valued at $1,114,443, work in process of $264,599 and raw materials of
$1,515,499. At December 31, 1997, these balances were $1,665,393, $151,143 and
$1,604,762, 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.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
current year's presentation.
2. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
Years ended December 31,
------------------------
1998 1997
--------- ---------
Molds $ 477,769 $ 477,769
Computer hardware 103,381 93,487
Computer software 139,952 128,647
Furniture and other office equipment 78,765 90,563
--------- ---------
799,867 790,466
--------- ---------
Less: Accumulated depreciation (741,271) (690,975)
--------- ---------
$ 58,596 $ 99,491
========= =========
22
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
3. LOAN PAYABLE, BANK
At December 31, 1998, there was a loan payable of $773,534 under the
Company's Business Loan Agreement 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 Company was in default of certain financial covenants of its
borrowing agreements at December 31, 1998, and waivers were obtained from the
Bank. The agreement was to expire April 1, 1999.
On March 15, 1999, 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 1.0% with
borrowings secured primarily by the Company's trade receivables and inventory.
The agreement, which expires on April 1, 2000, contains certain debt-to-equity
and working capital covenants.
Because the Company's borrowing arrangement is renewed annually, and because it
bears interest at a variable rate, the fair value of the Company's borrowings
reasonably approximates carrying value.
4. COMMITMENTS
Effective November 1, 1998, the Company extended the existing lease
arrangement for office space in Fremont, California until October 31, 2000. The
annual base rent will be approximately $116,774 and $100,970 for the years ended
December 31, 1999 and 2000, respectively. The lease also provides for payments
related to taxes, common area charges and outside maintenance. In July 1998 the
Company entered into a sublease arrangement for a portion of the Fremont
facilities. The sublease expires October 31, 1999 and requires a total rent of
$77,748 plus reimbursement of common area charges, property taxes, and
maintenance. The sublease income is netted against rent expense. Total rental
expense was $129,415, $138,540 and $88,776 for the years ended December 31,
1998, 1997 and 1996, respectively.
5. SHAREHOLDERS' EQUITY
Convertible Preferred Stock
On December 23, 1998, the Company issued 6,000 shares of Series BB
convertible preferred stock for $600,000, net of issuance costs, to a current
shareholder. The cash was used to reduce bank borrowings.
Holders of shares of Series BB 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. 600,000 shares of common stock are
reserved for the future conversion of this preferred stock. No dividends are
payable in connection with these preferred shares.
Initially, each share of Series BB preferred stock shall be convertible
at $1.00 to one share of common stock. The initial conversion price shall be
increased quarterly beginning April 1, 1999 by $2.00 such that the original
issue price shall increase by $8.00 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.
On August 25, 1997, the Company obtained additional equity capital from
affiliates of a current shareholder by issuing 1,433,333 shares of Series AA
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.
23
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
5. SHAREHOLDERS' EQUITY (Continued)
Holders of shares of Series AA 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 Series AA 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 Option 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.
A summary of the option activity under the Plan is as follows:
WEIGHTED
SHARES AVERAGE
UNDER EXERCISE
OPTION PRICE
------ -----
Balance, December 31, 1995 796,000 $1.97
Options granted 498,600 $4.95
Options exercised (234,933) $2.26
Options canceled (8,167) $3.54
---------
Balance, December 31, 1996 1,051,500 $3.16
Options granted 100,000 $1.58
Options exercised (102,583) $2.05
Options canceled (12,500) $3.30
---------
Balance, December 31, 1997 1,036,417 $3.11
Options granted 127,500 $0.64
Options canceled (487,817) $3.65
---------
Balance, December 31, 1998 676,100 $2.27
=========
At December 31, 1998, a total of 623,384 shares of the Company's common stock
was reserved for future grants under the Plan, and options to purchase 419,558
shares were exercisable.
24
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
5. SHAREHOLDERS' EQUITY (continued)
In June 1993, the Company's Board of Directors adopted a Non-Employee Directors'
Stock Option Plan (Directors' 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 stock option activity under the Plan was as follows:
WEIGHTED
SHARES AVERAGE
UNDER EXERCISE
OPTION PRICE
------ -----
Balance, December 31, 1995 155,000 $2.77
Options granted 40,000 $7.88
-------
Balance, December 31, 1996 195,000 $3.82
Options granted 55,000 $7.88
Options exercised (30,000) $2.73
-------
Balance, December 31, 1997 220,000 $3.45
Options granted 40,000 $0.67
-------
Balance, December 31, 1998 260,000 $3.02
=======
At December 31, 1998, a total of 15,000 shares of the Company's common stock was
reserved for future grants under the Directors' Plan, and options to purchase
239,996 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 (loss) 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 Option Grants
1998 1997 1996
---- ---- ----
Risk-Free Interest Rates 4.00% to 5.50% 5.91% to 6.44% 4.95% to 6.50%
Dividend Yield -0- -0- -0-
Volatility factor of the
Company's common stock 1.7 .99 .88
Weighted average expected life
beyond each respective
vesting period 1 year 1 year 1 year
The weighted average fair value of options granted during 1998, 1997
and 1996 was $0.59, $0.90 and $2.60, respectively.
25
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
5. SHAREHOLDERS' EQUITY (continued)
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:
1998 1997 1996
----- ---- ----
Pro forma net income (loss) $(3,015,684) $(4,081,816) $ 719,981
Pro forma income (loss) per share $ (.29) $ (.40) $ 0.07
<TABLE>
Because SFAS 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect is not fully reflected until 1998. The
following table summarizes information about stock options outstanding at
December 31, 1998:
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ---------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
PRICES AT 12/31/98 LIFE PRICE AT 12/31/98 PRICE
------ ----------- ---- ----- ----------- -----
<S> <C> <C> <C> <C> <C>
$0.38 to $1.58 488,000 3.7 $1.25 281,454 $1.47
$1.58 to $2.37 227,500 5.0 $1.95 220,000 $1.96
$2.37 to $4.74 55,600 4.3 $3.86 55,600 $3.86
$4.74 to $7.91 165,000 4.6 $6.37 102,500 $6.67
----------- --- ----- ------- -----
$0.79 to $7.91 936,100 4.2 $2.48 659,554 $2.64
=========== =======
</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 HPSI with its required synthesized human
pheromones and also provides to HPSI research and development and scientific
public relations services. This renewal expired on March 1, 1998, the Company is
in the process of renegotiating the research and supply agreements.. The total
expense incurred pursuant to the Company's research and development agreement
with Pherin Corporation during the fiscal years ended December 31, 1998, 1997,
and 1996 was $303,625, $280,000 and $270,000, respectively.
7. INCOME TAXES
There was no provision for income taxes for the year ended December 31,
1998 or 1997 as the Company incurred net operating losses.
At December 31, 1998, the Company had net operating loss carryforwards
of approximately $15,500,000. The Company also had federal research and
development tax carryforwards of approximately $146,000. The net operating loss
and credit carryforwards will expire between 2004 and 2013.
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.
26
<PAGE>
Human Pheromone Sciences, Inc.
Notes to Financial Statements
December 31, 1998
7. INCOME TAXES
Significant components of the Company's deferred tax assets and
liabilities for federal and state income taxes are as follows:
Deferred tax asset: 1998 1997
---- ----
Net operating loss carryforward $ 5,500,000 $ 4,590,000
Research credit carryforward 200,000 180,000
Returns Reserve 300,000 330,000
Other, net 400,000 360,000
Valuation allowance for deferred
tax assets (6,400,000) (5,460,000)
----------- -----------
Net deferred tax assets $ -- $ --
=========== ===========
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 by $940,000 and $1,750,000 in 1998 and 1997.
8. SUBSEQUENT EVENT (unaudited)
On March 26, 1999, the Company obtained $300,000 additional equity
capital from a current shareholder by issuing shares of convertible preferred
stock.
27
<TABLE>
BUSINESS LOAN AGREEMENT
<CAPTION>
Principal Loan Date Maturity Loan No Call Collateral Account Officer Initials
<S> <C> <C> <C> <C> <C> <C> <C>
$3,000,000.00 04-01-1998 04-01-1999 0108143855 CL 10 04 JS JS
References in the shaded area are for Lender's use only and do not limit the applicability of this document to any
particular loan or item.
</TABLE>
Borrower: EROX Corporation Lender: Mid-Peninsula Bank
4034 Clipper Court c/o Greater Bay Bancorp
Fremont, CA 94538 2860 W. Bayshore Road
Palo Alto, CA 94303
================================================================================
THIS BUSINESS LOAN AGREEMENT between EROX Corporation ("Borrower") and
Mid-Peninsula Bank ("Lender") is made and executed on the following terms and
conditions. Borrower has received prior commercial loans from Lender or has
applied to Lender for a commercial loan or loans and other financial
accommodations, including those which may be described on any exhibit or
schedule attached to this Agreement. All such loans and financial
accommodations, together with all future loans and financial accommodations from
Lender to Borrower, are referred to in this Agreement individually as the "Loan"
and collectively as the "Loans." Borrower understands and agrees that: (a) in
granting, renewing, or extending any Loan, Lender is relying upon Borrower's
representations, warranties, and agreements, as set forth in this Agreement; (b)
the granting, renewing, or extending of any Loan by Lender at all times shall be
subject to Lender's sole judgment and discretion; and (c) all such Loans shall
be and shall remain subject to the following terms and conditions of this
Agreement.
TERM. This Agreement shall be effective as of March 27, 1998, and shall continue
thereafter until all Indebtedness of Borrower to Lender has been performed in
full and the parties terminate this Agreement in writing.
DEFINITIONS. The following words shall have the following meanings when used in
this Agreement. Terms not otherwise defined in this Agreement shall have the
meanings attributed to such terms in the Uniform Commercial Code. All references
to dollar amounts shall mean amounts in lawful money of the United States of
America.
Agreement. The word "Agreement" means this Business Loan Agreement, as this
Business Loan Agreement may be amended or modified from time to time,
together with all exhibits and schedules attached to this Business Loan
Agreement from time to time.
Borrower. The word "Borrower" means EROX Corporation. The word "Borrower"
also includes, as applicable, all subsidiaries and affiliates of Borrower
as provided below in the paragraph titled "Subsidiaries and Affiliates."
CERCLA. The word "CERCLA" means the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980, as amended.
Cash Flow. The words "Cash Flow" mean net income after taxes, and exclusive
of extraordinary gains and income, plus depreciation and amortization.
Collateral. The word "Collateral" means and includes without limitation all
property and assets granted as collateral security for a Loan, whether real
or personal property, whether granted directly or indirectly, whether
granted now or in the future, and whether granted in the form of a security
interest, mortgage, deed of trust, assignment, pledge, chattel mortgage,
chattel trust, factor's lien, equipment trust, conditional sale, trust
receipt, lien, charge, lien or title retention contract, lease or
consignment intended as a security device, or any other security or lien
interest whatsoever, whether created by law, contract, or otherwise.
Debt. The word "Debt" means all of Borrower's liabilities excluding
Subordinated Debt.
ERISA. The word "ERISA" means the Employee Retirement Income Security Act
of 1974, as amended.
Event of Default. The words "Event of Default" mean and include without
limitation any of the Events of Default set forth below in the section
titled "EVENTS OF DEFAULT."
Grantor. The word "Grantor" means and includes without limitation each and
all of the persons or entities granting a Security interest in any
Collateral for the Indebtedness, including without limitation all Borrowers
granting such a Security Interest.
Guarantor. The word "Guarantor" means and includes without limitation each
and all of the guarantors, sureties, and accommodation parties in
connection with any Indebtedness.
Indebtedness. The word "Indebtedness" means and includes without limitation
all Loans, together with all other obligations, debts and liabilities of
Borrower to Lender, or any one or more of them, as well as all claims by
Lender against Borrower, or any one or more of them; whether now or
hereafter existing, voluntary or involuntary, due or not due, absolute or
contingent, liquidated or unliquidated; whether Borrower may be liable
individually or jointly with others; whether Borrower may be obligated as a
guarantor, surety, or otherwise; whether recovery upon such Indebtedness
may be or hereafter may become barred by any statute of limitations; and
whether such Indebtedness may be or hereafter may become otherwise
unenforceable.
Lender. The word "Lender" means Mid-Peninsula Bank, its successors and
assigns.
Liquid Assets. The words "Liquid Assets" mean Borrower's cash on hand plus
Borrower's readily marketable securities.
Loan. The word "Loan" or "Loans" means and includes without limitation any
and all commercial loans and financial accommodations from Lender to
Borrower, whether now or hereafter existing, and however evidenced,
including without limitation those loans and financial accommodations
described herein or described on any exhibit or schedule attached to this
Agreement from time to time.
Note. The word "Note" means and includes without limitation Borrower's
promissory note or notes, if any, evidencing Borrower's Loan obligations in
favor of Lender, as well as any substitute, replacement or refinancing note
or notes therefor.
Permitted Liens. The words "Permitted Liens" mean: (a) liens and security
interests securing indebtedness owed by Borrower to Lender; (b) liens for
taxes, assessments, or similar charges either not yet due or being
contested in good faith; (c) liens of materialmen, mechanics, warehousemen,
or carriers, or other like liens arising in the ordinary course of business
and securing obligations which are not yet delinquent; (d) purchase money
liens or purchase money security interests upon or in any property acquired
or held by Borrower in the ordinary course of business to secure
indebtedness outstanding on the date of this Agreement or permitted to be
incurred under the paragraph of this Agreement titled "Indebtedness and
Liens"; (e) liens and security interests which, as of the date of this
Agreement, have been disclosed to and approved by the Lender in writing;
and (f) those liens and security interests which in the aggregate
constitute an immaterial and insignificant monetary amount with respect to
the net value of Borrower's assets.
Related Documents. The words "Related Documents" mean and include without
limitation all promissory notes, credit agreements, loan agreements,
environmental agreements, guaranties, security agreements, mortgages, deeds
of trust, and all other instruments, agreements and documents, whether now
or hereafter existing, executed in connection with the Indebtedness.
Security Agreement. The words "Security Agreement" mean and include without
limitation any agreements, promises, covenants, arrangements,
understandings or other agreements, whether created by law, contract, or
otherwise, evidencing, governing, representing, or creating a Security
<PAGE>
04-01-1998 BUSINESS LOAN AGREEMENT Page 2
Loan No 0108143855 (Continued)
================================================================================
Interest.
Security Interest. The words "Security Interest" mean and include without
limitation any type of collateral security, whether in the form of a lien,
charge, mortgage, deed of trust, assignment, pledge, chattel mortgage,
chattel trust, factor's lien, equipment trust, conditional sale, trust
receipt, lien or title retention contract, lease or consignment intended as
a security device, or any other security or lien interest whatsoever,
whether created by law, contract, or otherwise.
SARA. The word "SARA" means the Superfund Amendments and Reauthorization
Act of 1986 as new or hereafter amended.
Subordinated Debt. The words "Subordinated Debt" mean indebtedness and
liabilities of Borrower which have been subordinated by written agreement
to indebtedness owed by Borrower to Lender in form and substance acceptable
to Lender.
Tangible Net Worth. The words "Tangible Net Worth" mean Borrower's total
assets excluding all intangible assets (i.e., goodwill, trademarks,
patents, copyrights, organizational expenses, and similar intangible items,
but including leaseholds and leasehold improvements) less total Debt
Working Capital. The words "Working Capital" mean Borrower's current
assets, excluding prepaid expenses, less Borrower's current liabilities.
CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial
Loan Advance and each subsequent Loan Advance under this Agreement shall be
subject to the fulfillment to Lender's satisfaction of all of the conditions set
forth in this Agreement and in the Related Documents.
Loan Documents. Borrower shall provide to Lender in form satisfactory to
Lender the following documents for the Loan: (a) the Note, (b) Security
Agreements granting to Lender security interests in the Collateral, (c)
Financing Statements perfecting Lender's Security Interests; (d) evidence
of insurance as required below; and (e) any other documents required under
this Agreement or by Lender or its counsel.
Borrower's Authorization. Borrower shall have provided in form and
substance satisfactory to Lender property certified resolutions, duly
authorizing the execution and delivery of this Agreement, the Note and the
Related Documents, and such other authorizations and other documents and
instruments as Lender or its counsel, in their sole discretion, may
require.
Payment of Fees and Expenses. Borrower shall have paid to Lender all fees,
charges, and other expenses which are then due and payable as specified in
this Agreement or any Related Document.
Representations and Warranties. The representations and warranties set
forth in this Agreement, in the Related Documents, and in any document or
certificate delivered to Lender under this Agreement are true and correct.
No Event of Default. There shall not exist at the time of any advance a
condition which would constitute an Event of Default under this Agreement.
REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as
of the date of this Agreement, as of the date of each disbursement of Loan
proceeds, as of the date of any renewal, extension or modification of any Loan,
and at all times any Indebtedness exists:
Organization. Borrower is a corporation which is duly organized, validly
existing, and in good standing under the laws of the State of California
and is validly existing and in good standing in all states in which
Borrower is doing business. Borrower has the full power and authority to
own its properties and to transact the businesses in which it is presently
engaged or presently proposes to engage. Borrower also is duly qualified as
a foreign corporation and is in good standing in all states in which the
failure to so qualify would have a material adverse effect on its
businesses or financial condition.
Authorization. The execution, delivery, and performance of this Agreement
and all Related Documents by Borrower, to the extent to be executed,
delivered or performed by Borrower, have been duly authorized by all
necessary action by Borrower; do not require the consent or approval of any
other person, regulatory authority or governmental body; and do not
conflict with, result in a violation of, or constitute a default under (a)
any provision of its articles of incorporation or organization, or bylaws,
or any agreement or other instrument binding upon Borrower or (b) any law,
governmental regulation, court decree, or order applicable to Borrower.
Financial Information. Each financial statement of Borrower supplied to
Lender truly and completely disclosed Borrower's financial condition as of
the date of the statement, and there has been no material adverse change in
Borrower's financial condition subsequent to the date of the most recent
financial statement supplied to Lender. Borrower has no material contingent
obligations except as disclosed in such financial statements.
Legal Effect. This Agreement constitutes, and any instrument or agreement
required hereunder to be given by Borrower when delivered will constitute,
legal, valid and binding obligations of Borrower enforceable against
Borrower in accordance with their respective terms.
Properties. Except as contemplated by this Agreement or as previously
disclosed in Borrower's financial statements or in writing to Lender and as
accepted by Lender, and except for property tax liens for taxes not
presently due and payable, Borrower owns and has good title to all of
Borrower's properties free and clear of all Security Interests, and has not
executed any security documents or financing statements relating to such
properties. All of Borrower's properties are titled in Borrower's legal
name, and Borrower has not used, or filed a financing statement under, any
other name for at least the last five (5) years.
Hazardous Substances. The terms "hazardous waste," "hazardous substance,"
"disposal," "release," and "threatened release," as used in this Agreement,
shall have the same meanings as set forth in the "CERCLA," "SARA," the
Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq.,
the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et
seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and
Safety Code, Section 25100, et seq., or other applicable state or Federal
laws, rules, or regulations adopted pursuant to any of the foregoing.
Except as disclosed to and acknowledged by Lender in writing, Borrower
represents and warrants that: (a) During the period of Borrower's ownership
of the properties, there has been no use, generation, manufacture, storage,
treatment, disposal, release or threatened release of any hazardous waste
or substance by any person on, under, about or from any of the properties.
(b) Borrower has no knowledge of, or reason to believe that there has been
(i) any use, generation, manufacture, storage, treatment disposal, release,
or threatened release of any hazardous waste or substance on, under, about
or from the properties by any prior owners or occupants of any of the
properties, or (ii) any actual or threatened litigation or claims of any
kind by any person relating to such matters. (c) Neither Borrower nor any
tenant, contractor, agent or other authorized user of any of the properties
shall use, generate, manufacture, store, treat, dispose of, or release any
hazardous waste or substance on, under, about or from any of the
properties; and any such activity shall be conducted in compliance with all
applicable federal, state, and local laws, regulations, and ordinances,
including without limitation those laws, regulations and ordinances
described above. Borrower authorizes Lender and its agents to enter upon
the properties to make such inspections and tests as Lender may deem
appropriate to determine compliance of the properties with this section of
the Agreement. Any inspections or tests made by Lender shall be at
Borrower's expense and for Lender's purposes only and shall not be
construed to create any responsibility or liability on the part of Lender
to Borrower or to any other person. The representations and warranties
contained herein are based on Borrower's due diligence in investigating the
properties for hazardous waste and hazardous substances. Borrower hereby
(a) releases and waives any future claims against Lender for indemnity or
contribution in the event Borrower becomes liable for cleanup or other
costs under any such laws, and (b) agrees to indemnify and hold harmless
Lender against any and all claims, losses, liabilities, damages, penalties,
and expenses which Lender may directly or indirectly sustain or suffer
resulting from a breach of this section of the Agreement or as a
consequence of any use, generation, manufacture, storage, disposal, release
or threatened release occurring prior to Borrowers ownership or interest in
the properties, whether or not the same was or should have been known to
Borrower. The provisions
<PAGE>
04-01-1998 BUSINESS LOAN AGREEMENT Page 3
Loan No 0108143855 (Continued)
================================================================================
of this section of the Agreement, including the obligation to indemnify,
shall survive the payment of the Indebtedness and the termination or
expiration of this Agreement and shall not be affected by Lender's
acquisition of any interest in any of the properties, whether by
foreclosure or otherwise.
Litigation and Claims. No litigation, claim, investigation, administrative
proceeding or similar action (including those for unpaid taxes) against
Borrower is pending or threatened, and no other event has occurred which
may materially adversely affect Borrower's financial condition or
properties, other than litigation, claims, or other events, if any, that
have been disclosed to and acknowledged by Lender in writing.
Taxes. To the best of Borrower's knowledge, all tax returns and reports of
Borrower that are or were required to be filed, have been filed, and all
taxes, assessments and other governmental charges have been paid in full,
except those presently being or to be contested by Borrower in good faith
in the ordinary course of business and for which adequate reserves have
been provided.
Lien Priority. Unless otherwise previously disclosed to Lender in writing,
Borrower has not entered into or granted any Security Agreements, or
permitted the filing or attachment of any Security Interests on or
affecting any of the Collateral directly or indirectly securing repayment
of Borrower's Loan and Note, that would be prior or that may in any way be
superior to Lender's Security Interests and rights in and to such
Collateral.
Binding Effect. This Agreement, the Note, all Security Agreements directly
or indirectly securing repayment of Borrower's Loan and Note and all of the
Related Documents are binding upon Borrower as well as upon Borrower's
successors, representatives and assigns, and are legally enforceable in
accordance with their respective terms.
Commercial Purposes. Borrower intends to use the Loan proceeds solely for
business or commercial related purposes.
Employee Benefit Plans. Each employee benefit plan as to which Borrower may
have any liability complies in all material respects with all applicable
requirements of law and regulations, and (i) no Reportable Event nor
Prohibited Transaction (as defined in ERISA) has occurred with respect to
any such plan, (ii) Borrower has not withdrawn from any such plan or
initiated steps to do so, (iii) no steps have been taken to terminate any
such plan, and (iv) there are no unfunded liabilities other than those
previously disclosed to Lender in writing.
Location of Borrower's Offices and Records. Borrower's place of business,
or Borrowers Chief executive office, if Borrower has more than one place of
business, is located at 4034 Clipper Court, Fremont, CA 94538. Unless
Borrower has designated otherwise in writing this location is also the
office or offices where Borrower keeps its records concerning the
Collateral.
Information. All information heretofore or contemporaneously herewith
furnished by Borrower to Lender for the purposes of or in connection with
this Agreement or any transaction contemplated hereby is, and all
information hereafter furnished by or on behalf of Borrower to Lender will
be, true and accurate in every material respect on the date as of which
such information is dated or certified; and none of such information is or
will be incomplete by omitting to state any material fact necessary to make
such information not misleading.
Survival of Representations and Warranties. Borrower understands and agrees
that Lender, without independent investigation, is relying upon the above
representations and warranties in extending Loan Advances to Borrower.
Borrower further agrees that the foregoing representations and warranties
shall be continuing in nature and shall remain in full force and effect
until such time as Borrower's indebtedness shall be paid in full, or until
this Agreement shall be terminated in the manner provided above, whichever
is the last to occur.
AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while
this Agreement is in effect, Borrower will:
Litigation. Promptly inform Lender in writing of (a) all material adverse
changes in Borrower's financial condition, and (b) all existing and all
threatened litigation, claims, investigations, administrative proceedings
or similar actions affecting Borrower or any Guarantor which could
materially affect the financial condition of Borrower or the financial
condition of any Guarantor.
Financial Records. Maintain its books and records in accordance with
generally accepted accounting principles, applied on a consistent basis,
and permit Lender to examine and audit Borrower's books and records at all
reasonable times.
Additional Information. Furnish such additional information and statements,
lists of assets and liabilities, agings of receivables and payables,
inventory schedules, budgets, forecasts, tax returns, and other reports
with respect to Borrower's financial condition and business operations as
Lender may request from time to time.
Financial Covenants and Ratios. Comply with the following covenants and
ratios:
Tangible Net Worth. Maintain a minimum Tangible Net Worth of not less
than $3,200,000.00.
Net Worth Ratio. Maintain a ratio of Total Liabilities to Tangible Net
Worth of less than 1.25 to 1.00.
Other Ratio. Maintain a ratio of Minimum Quick Ratio of 0.90 to 1.00.
Except as provided above, all computations made to determine
compliance with the requirements contained in this paragraph shall be
made in accordance with generally accepted accounting principles,
applied on a consistent basis, and certified by Borrower as being true
and correct.
Insurance. Maintain fire and other risk insurance, public liability
insurance, and such other insurance as Lender may require with respect
to Borrower's properties and operations, in form, amounts, coverages
and with insurance companies reasonably acceptable to Lender.
Borrower, upon request of Lender, will deliver to Lender from time to
time the policies or certificates of insurance in form satisfactory to
Lender, including stipulations that coverages will not be cancelled or
diminished without at least ten (10) days' prior written notice to
Lender. Each insurance policy also shall include an endorsement
providing that coverage in favor of Lender will not be impaired in any
way by any act, omission or default of Borrower or any other person.
In connection with all policies covering assets in which Lender holds
or is offered a security interest for the Loans, Borrower will provide
Lender with such loss payable or other endorsements as Lender may
require.
Insurance Reports. Furnish to Lender, upon request of Lender, reports on
each existing insurance policy showing such information as Lender may
reasonably request including without limitation the following: (a) the name
of the insurer; (b) the risks insured; (c) the amount of the policy; (d)
the properties insured; (e) the then current property values on the basis
of which insurance has been obtained, and the manner of determining those
values; and (f) the expiration date of the policy. In addition, upon
request of Lender (however not more often than annually), Borrower will
have an independent appraiser satisfactory to Lender determine, as
applicable, the actual cash value or replacement cost of any Collateral.
The cost of such appraisal shall be paid by Borrower.
Other Agreements. Comply with all terms and conditions of all other
agreements, whether now or hereafter existing, between Borrower and any
other party and notify Lender immediately in writing of any default in
connection with any other such agreements.
Loan Proceeds. Use all Loan proceeds solely for Borrower's business
operations, unless specifically consented to the contrary by Lender in
writing.
Taxes, Charges and Liens. Pay and discharge when due all of its
indebtedness and obligations, including without limitation all assessments,
taxes, governmental charges, levies and liens, of every kind and nature,
imposed upon Borrower or its properties, income, or profits, prior to the
date on which penalties would attach, and all lawful claims that, if
unpaid, might become a lien or charge upon any of Borrower's properties,
income, or profits. Provided however, Borrower will not be required to pay
and discharge any such assessment, tax, charge, levy, lien or claim so
<PAGE>
04-01-1998 BUSINESS LOAN AGREEMENT Page 4
Loan No 0108143855 (Continued)
================================================================================
long as (a) the legality of the same shall be contested in good faith by
appropriate proceedings, and (b) Borrower shall have established on its
books adequate reserves with respect to such contested assessment, tax,
charge, levy, lien, or claim in accordance with generally accepted
accounting practices. Borrower, upon demand of Lender, will furnish to
Lender evidence of payment of the assessments, taxes, charges, levies,
liens and claims and will authorize the appropriate governmental official
to deliver to Lender at any time a written statement of any assessments,
taxes, charges, levies, liens and claims against Borrower's properties,
income, or profits.
Performance. Perform and comply with all terms, conditions, and provisions
set forth in this Agreement and in the Related Documents in a timely
manner, and promptly notify Lender if Borrower learns of the occurrence of
any event which constitutes an Event of Default under this Agreement or
under any of the Related Documents.
Operations. Maintain executive and management personnel with substantially
the same qualifications and experience as the present executive and
management personnel; provide written notice to Lender of any change in
executive and management personnel; conduct its business affairs in a
reasonable and prudent manner and in compliance with all applicable
federal, state and municipal laws, ordinances, rules and regulations
respecting its properties, charters, businesses and operations, including
without limitation, compliance with the Americans With Disabilities Act and
with all minimum funding standards and other requirements of ERISA and
other laws applicable to Borrower's employee benefit plans.
Inspection. Permit employees or agents of Lender at any reasonable time to
inspect any and all Collateral for the Loan or Loans and Borrower's other
properties and to examine or audit Borrower's books, accounts, and records
and to make copies and memoranda of Borrower's books, accounts, and
records. If Borrower now or at any time hereafter maintains any records
(including without limitation computer generated records and computer
software programs for the generation of such records) in the possession of
a third party, Borrower, upon request of Lender, shall notify such party to
permit Lender free access to such records at all reasonable times and to
provide Lender with copies of any records it may request, all at Borrower's
expense.
Compliance Certificate. Unless waived in writing by Lender, provide Lender
at least annually with a certificate executed by Borrower's chief financial
officer, or other officer or person acceptable to Lender, certifying that
the representations and warranties set forth in this Agreement are true and
correct as of the date of the certificate and further certifying that, as
of the date of the certificate, no Event of Default exists under this
Agreement.
Environmental Compliance and Reports. Borrower shall comply in all respects
with all environmental protection federal, state and local laws, statutes,
regulations and ordinances; not cause or permit to exist, as a result of an
intentional or unintentional action or omission on its part or on the part
of any third party, on property owned and/or occupied by Borrower, any
environmental activity where damage may result to the environment, unless
such environmental activity is pursuant to and in compliance with the
conditions of a permit issued by the appropriate federal, state or local
governmental authorities; shall furnish to Lender promptly and in any event
within thirty (30) days after receipt thereof a copy of any notice,
summons, lien, citation, directive, letter or other communication from any
governmental agency or instrumentality concerning any intentional or
unintentional action or omission on Borrower's part in connection with any
environmental activity whether or not there is damage to the environment
and/or other natural resources.
Additional Assurances. Make, execute and deliver to Lender such promissory
notes, mortgages, deeds of trust, security agreements, financing
statements, instruments, documents and other agreements as Lender or its
attorneys may reasonably request to evidence and secure the Loans and to
perfect all Security Interests.
NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this
Agreement is in effect, Borrower shall not, without the prior written consent of
Lender:
Indebtedness and Liens. (a) Except for trade debt incurred in the normal
course of business and indebtedness to Lender contemplated by this
Agreement, create, incur or assume indebtedness for borrowed money,
including capital leases, (b) except as allowed as a Permitted Lien, sell,
transfer, mortgage, assign, pledge, lease, grant a security interest in, or
encumber any of Borrower's assets, or (c) sell with recourse any of
Borrower's accounts, except to Lender.
Continuity of Operations. (a) Engage in any business activities
substantially different than those in which Borrower is presently engaged,
(b) cease operations, liquidate, merge, transfer, acquire or consolidate
with any other entity, change ownership, change its name, dissolve or
transfer or sell Collateral out of the ordinary course of business, (c) pay
any dividends on Borrower's stock (other than dividends payable in its
stock), provided, however that notwithstanding the foregoing, but only so
long as no Event of Default has occurred and is continuing or would result
from the payment of dividends, if Borrower is a "Subchapter S Corporation"
(as defined in the Internal Revenue Code of 1986, as amended), Borrower may
pay cash dividends on its stock to its shareholders from time to time in
amounts necessary to enable the shareholders to pay income taxes and make
estimated income tax payments to satisfy their liabilities under federal
and state law which arise solely from their status as Shareholders of a
Subchapter S Corporation because of their ownership of shares of stock of
Borrower.
Loans, Acquisitions and Guaranties. (a) Loan, invest in or advance money or
assets, (b) purchase, create or acquire any interest in any other
enterprise or entity, or (a) incur any obligation as surety or guarantor
other than in the ordinary course of business.
CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to
Borrower, whether under this Agreement or under any other agreement Lender shall
have no obligation to make Loan Advances or to disburse Loan proceeds if: (a)
Borrower or any Guarantor is in default under the terms of this Agreement or any
of the Related Documents or any other agreement that Borrower or any Guarantor
has with Lender; (b) Borrower or any Guarantor becomes insolvent, files a
petition in bankruptcy or similar proceedings, or is adjudged a bankrupt (c)
there occurs a material adverse change in Borrower's financial condition, in the
financial condition of any Guarantor, or in the value of any Collateral securing
any Loan; or (d) any Guarantor seeks, claims or otherwise attempts to limit,
modify or revoke such Guarantor's guaranty of the Loan or any other loan with
Lender.
ADVANCES AGAINST ACCOUNTS RECEIVABLE/INVENTORY. Lender shall make advances to
Borrower, at Borrowers request, equal to a maximum of seventy five (75%) of
Eligible Accounts Receivable. The definition of Accounts Receivable and Eligible
Accounts Receivable is described on Exhibit "A" consisting of two (2) pages
which is attached hereto and made a part of this Business Loan Agreement by this
reference. The maximum line borrowing will be limited by the advance rates
specified above, based on the trading assets levels at the end of each monthly
period.
ADDITIONAL FINANCIAL REPORTING. Borrower will provide to Lender the following:
Monthly Accounts Receivable Agings, Accounts Payable Agings and Borrowing Base
Certificate to be received within 20 days of month end.
FINANCIAL REPORTING. Borrower will provide to Lender the following:
1.) Company prepared Financial Statements including Balance Sheet, Income
Statement, and Statement of Cash flows on a monthly basis.
2.) Audited financial statement, bearing an unqualified opinion, will be
provided within 120 days of fiscal year end, by way of submission of the 10-K
filing.
EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default
under this Agreement:
Default on Indebtedness. Failure of Borrower to make any payment when due
on the Loans.
Other Defaults. Failure of Borrower or any Grantor to comply with or to
perform when due any other term, obligation, covenant or condition
<PAGE>
04-01-1998 BUSINESS LOAN AGREEMENT Page 5
Loan No 0108143855 (Continued)
================================================================================
contained in this Agreement or in any of the Related Documents, or failure
of Borrower to comply with or to perform any other term, obligation,
covenant or condition contained in any other agreement between Lender and
Borrower.
Default In Favor of Third Parties. Should Borrower or any Grantor default
under any loan, extension of credit, security agreement, purchase or sales
agreement, or any other agreement, in favor of any other creditor or person
that may materially affect any of Borrower's property or Borrower's or any
Grantor's ability to repay the Loans or perform their respective
obligations under this Agreement or any of the Related Documents.
False Statements. Any warranty, representation or statement made or
furnished to Lender by or on behalf of Borrower or any Grantor under this
Agreement or the Related Documents is false or misleading in any material
respect at the time made or furnished, or becomes false or misleading at
any time thereafter.
Defective Collateralization. This Agreement or any of the Related Documents
ceases to be in full force and effect (including failure of any Security
Agreement to create a valid and perfected Security Interest) at any time
and for any reason.
Insolvency. The dissolution or termination of Borrower's existence as a
going business, the insolvency of Borrower, the appointment of a receiver
for any part of Borrower's property, any assignment for the benefit of
creditors, any type of creditor workout, or the commencement of any
proceeding under any bankruptcy or insolvency laws by or against Borrower.
Creditor or Forfeiture Proceedings. Commencement of foreclosure or
forfeiture proceedings, whether by judicial proceeding, self-help,
repossession or any other method, by any creditor of Borrower, any creditor
of any Grantor against any collateral securing the Indebtedness, or by any
governmental agency. This includes a garnishment, attachment, or levy on or
of any of Borrower's deposit accounts with Lender. However, this Event of
Default shall not apply if there is a good faith dispute by Borrower or
Grantor, as the case may be, as to the validity or reasonableness of the
claim which is the basis of the creditor or forfeiture proceeding, and if
Borrower or Grantor gives Lender written notice of the creditor or
forfeiture proceeding and furnishes reserves or a surety bond for the
creditor or forfeiture proceeding satisfactory to Lender.
Events Affecting Guarantor. Any of the preceding events occurs with respect
to any Guarantor of any of the Indebtedness or any Guarantor dies or
becomes incompetent, or revokes or disputes the validity of, or liability
under, any Guaranty of the indebtedness. Lender, at its option, may, but
shall not be required to, permit the Guarantor's estate to assume
unconditionally the obligations arising under the guaranty in a manner
satisfactory to Lender, and, in doing so, cure the Event of Default.
Change In Ownership. Any change in ownership pursuant to which any person
or controlled group acquires twenty-five percent (25%) or more of the
common stock of Borrower.
Adverse Change. A material adverse change occurs in Borrower's financial
condition, or Lender believes the prospect of payment or performance of the
indebtedness is impaired.
Right to Cure. If any default, other than a Default on Indebtedness, is
curable and if Borrower or Grantor, as the case may be, has not been given
a notice of a similar default within the preceding twelve (12) months, it
may be cured (and no Event of Default will have occurred) if Borrower or
Grantor, as the case may be, after receiving written notice from Lender
demanding cure of such default: (a) cures the default within fifteen (15)
days; or (b) if the cure requires more than fifteen (15) days, immediately
initiates steps which Lender deems in Lender's sole discretion to be
sufficient to cure the default and thereafter continues and completes all
reasonable and necessary steps sufficient to produce compliance as soon as
reasonably practical.
EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where
otherwise provided in this Agreement or the Related Documents, all commitments
and obligations of Lender under this Agreement or the Related Documents or any
other agreement immediately will terminate (including any obligation to make
Loan Advances or disbursements), and, at Lender's option, all Indebtedness
immediately will become due and payable, all without notice of any kind to
Borrower, except that in the case of an Event of Default of the type described
in the "Insolvency" subsection above, such acceleration shall be automatic and
not optional. In addition, Lender shall have all the rights and remedies
provided in the Related Documents or available at law, in equity, or otherwise.
Except as may be prohibited by applicable law, all of Lender's rights and
remedies shall be cumulative and may be exercised singularly or concurrently.
Election by Lender to pursue any remedy shall not exclude pursuit of any other
remedy, and an election to make expenditures or to take action to perform an
obligation of Borrower or of any Grantor shall not affect Lender's right to
declare a default and to exercise its rights and remedies.
MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of
this Agreement:
Amendments. This Agreement, together with any Related Documents,
constitutes the entire understanding and agreement of the parties as to the
matters set forth in this Agreement. No alteration of or amendment to this
Agreement shall be effective unless given in writing and signed by the
party or parties sought to be charged or bound by the alteration or
amendment.
Applicable Law. This Agreement has been delivered to Lender and accepted by
Lender in the State of California. If there is a lawsuit, Borrower agrees
upon Lender's request to submit to the jurisdiction of the courts of Santa
Clara County, the State of California. This Agreement shall be governed by
and construed in accordance with the laws of the State of California.
Caption Headings. Caption headings in this Agreement are for convenience
purposes only and are not to be used to interpret or define the provisions
of this Agreement.
Consent to Loan Participation. Borrower agrees and consents to Lender's
sale or transfer, whether now or later, of one or more participation
interests in the Loans to one or more purchasers, whether related or
unrelated to Lender. Lender may provide, without any limitation whatsoever,
to any one or more purchasers, or potential purchasers, any information or
knowledge Lender may have about Borrower or about any other matter relating
to the Loan, and Borrower hereby waives any rights to privacy it may have
with respect to such matters. Borrower additionally waives any and all
notices of sale of participation interests, as well as all notices of any
repurchase of such participation interests. Borrower also agrees that the
purchasers of any such participation interests will be considered as the
absolute owners of such interests in the Loans and will have all the rights
granted under the participation agreement or agreements governing the sale
of such participation interests. Borrower further waives all rights of
offset or counterclaim that it may have now or later against Lender or
against any purchaser of such a participation interest and unconditionally
agrees that either Lender or such purchaser may enforce Borrower's
obligation under the Loans irrespective of the failure or insolvency of any
holder of any interest in the Loans. Borrower further agrees that the
purchaser of any such participation interests may enforce its interests
irrespective of any personal claims or defenses that Borrower may have
against Lender.
Costs and Expenses. Borrower agrees to pay upon demand all of Lender's
expenses, including without limitation attorneys' fees, incurred in
connection with the preparation, execution, enforcement, modification and
collection of this Agreement or in connection with the Loans made pursuant
to this Agreement. Lender may pay someone else to help collect the Loans
and to enforce this Agreement, and Borrower will pay that amount. This
includes, subject to any limits under applicable law, Lender's attorneys*
fees and Lender's* legal expenses, whether or not there is a lawsuit,
attorneys' fees for bankruptcy proceedings (including efforts to modify or
vacate any automatic stay or injunction), appeals, and any anticipated
post-judgment collection services. Borrower also will pay any court costs,
in addition to all other sums provided by law.
* reasonable
Notices. All notices required to be given under this Agreement shall be
given in writing, may be sent by telefacsimile (unless otherwise required
by law), and shall be effective when actually delivered or when deposited
with a nationally recognized overnight courier or deposited in the United
<PAGE>
04-01-1998 BUSINESS LOAN AGREEMENT Page 6
Loan No 0108143855 (Continued)
================================================================================
States mall, first class, postage prepaid, addressed to the party to whom
the notice is to be given at the address shown above. Any party may change
its address for notices under this Agreement by giving formal written
notice to the other parties, specifying that the purpose of the notice is
to change the party's address. To the extent permitted by applicable law,
if there is more than one Borrower, notice to any Borrower will constitute
notice to all Borrowers. For notice purposes, Borrower will keep Lender
informed at all times of Borrower's current address(es).
Severability. If a court of competent jurisdiction finds any provision of
this Agreement to be invalid or unenforceable as to any person or
circumstance, such finding shall not render that provision invalid or
unenforceable as to any other persons or circumstances, If feasible, any
such offending provision shall be deemed to be modified to be within the
limits of enforceability or validity; however, if the offending provision
cannot be so modified, it shall be stricken and all other provisions of
this Agreement in all other respects shall remain valid and enforceable.
Subsidiaries and Affiliates of Borrower. To the extent the context of any
provisions of this Agreement makes it appropriate, including without
limitation any representation, warranty or covenant, the word "Borrower" as
used herein shall include all subsidiaries and affiliates of Borrower.
Notwithstanding the foregoing however, under no circumstances shall this
Agreement be construed to require Lender to make any Loan or other
financial accommodation to any subsidiary or affiliate of Borrower.
Successors and Assigns. All covenants and agreements contained by or on
behalf of Borrower shall bind its successors and assigns and shall inure to
the benefit of Lender, its successors and assigns. Borrower shall not
however, have the right to assign its rights under this Agreement or any
interest therein, without the prior written consent of Lender.
Survival. All warranties, representations, and covenants made by Borrower
in this Agreement or in any certificate or other instrument delivered by
Borrower to Lender under this Agreement shall be considered to have been
relied upon by Lender and will survive the making of the Loan and delivery
to Lender of the Related Documents, regardless of any investigation made by
Lender or on Lender's behalf.
Time is of the Essence. Time is of the essence in the performance of this
Agreement.
Waiver. Lender shall not be deemed to have waived any rights under this
Agreement unless such waiver is given in writing and signed by Lender. No
delay or omission on the part of Lender in exercising any right shall
operate as a waiver of such right or any other right. A waiver by Lender of
a provision of this Agreement shall not prejudice or constitute a waiver of
Lender's right otherwise to demand strict compliance with that provision or
any other provision of this Agreement. No prior waiver by Lender, nor any
course of dealing between Lender and Borrower, or between Lender and any
Grantor, shall constitute a waiver of any of Lender's rights or of any
obligations of Borrower or of any Grantor as to any future transactions.
Whenever the consent of Lender is required under this Agreement, the
granting of such consent by Lender in any instance shall not constitute
continuing consent in subsequent instances where such consent is required,
and in all cases such consent may be granted or withheld in the sole
discretion of Lender.
BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN
AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF APRIL
1, 1998.
BORROWER:
EROX Corporation
By: /s/ William P. Horgan
--------------------------------------------------------
William P. Horgan, Chairman & Chief Executive Officer
LENDER:
Mid-Peninsula Bank
By: /s/ J. H. Stafford
--------------------------------------------------------
Authorized Officer
================================================================================
<PAGE>
EXHIBIT "A"
A. Definitions
(1) "Account Receivable" shall mean an account arising in the ordinary
course of Borrower's business from the sale of goods or the performance of
services.
(2) "Account Debtor" shall mean the obligor on any Account Receivable.
(3) "Eligible Account" shall mean an Account Receivable, excluding the
following.
a. Accounts Receivable which remain uncollected more than 90
days from invoice date ("Delinquent Accounts");
b. Accounts Receivable due from an Account Debtor which has
suffered a business failure or the termination of its existence, or as to which
a dissolution, insolvency or bankruptcy proceeding has been commenced, any
assignment for the benefit of creditors has been made or a trustee, receiver or
conservator has been appointed for all or any part of the property of such
Account Debtor;
c. Accounts Receivable due from an Account Debtor affiliated
with Borrower in any manner, including without limitation, as a stockholder,
owner, officer, director, agent or employee;
d. Accounts Receivable with respect to which payment is or may
be conditional;
e. Accounts Receivable due from an Account Debtor who is not a
resident or citizen of, located in, or subject to service of process in the
United States of America;
f. Accounts Receivable due from an Account Debtor who is any
national, federal or state government, including without limitation, an
instrumentality, division, agency, body or department thereof;
g. Accounts Receivable commonly known as "bill and hold" or a
similar arrangement;
h. Accounts Receivable due from an Account Debtor as to which
20% or more of the aggregate dollar amount of all outstanding Accounts
Receivable owing from such Account Debtor are Delinquent Accounts;
(1)
<PAGE>
EXHIBIT "A"
Page Two.
i. That portion of Accounts Receivable due from an Account
Debtor which is in excess of 50% of the Borrower's aggregate dollar amount of
all outstanding Accounts Receivable;
j. Accounts Receivable as to which Borrower is or may become
liable to the Account Debtor for any reason;
k. Accounts Receivable which are not free of all liens,
encumbrances, charges, rights and interest of any kind, except in favor of
Lender;
1. Accounts Receivable which are supported or represented by a
promissory note, post-dated check or letter of credit unless such instrument is
actually delivered to Lender;
m. Accounts Receivable which are unsuitable as collateral, as
determined by Lender in the exercise of its reasonable sole discretion;
Dated: April 1, 1998 Borrower:
By: /s/ William P. Horgan
-------------------------------------
William P. Horgan, Chairman &
By: Chief Executive Officer
-------------------------------------
Lender: Mid-Peninsula Bank
By: /s/ J. H. Stafford
-------------------------------------
J. H. Stafford, Senior Vice President
<PAGE>
<TABLE>
PROMISSORY NOTE
<CAPTION>
Principal Loan Date Maturity Loan No Call Collateral Account Officer Initial
<S> <C> <C> <C> <C> <C> <C> <C>
$3,000,000.00 04-01-1998 04-01-1998 0108143855 CL 10 04 JS JS
References in the shaded area are for Lender's use only and do not limit the applicability of this document to any
particular loan or item.
</TABLE>
Borrower: EROX Corporation Lender: Mid-Peninsula Bank
4034 Clipper Court c/o Greater Bay Bancorp
Fremont, CA 94538 2860 W. Bayshore Road
Palo Alto, CA 94303
================================================================================
Principal Amount: $3,000,000.00 Initial Rate: 9.250% Date of Note: April 1, 1998
PROMISE TO PAY. EROX Corporation ("Borrower") promises to pay to Mid-Peninsula
Bank ("Lender"), or order, in lawful money of the United States of America, the
principal amount of Three Million & 00/100 Dollars ($3,000,000.00) or so much as
may be outstanding, together with interest on the unpaid outstanding principal
balance of each advance. Interest shall be calculated from the date of each
advance until repayment of each advance.
PAYMENT. Borrower will pay this loan on demand, or if no demand is made, in one
payment of all outstanding principal plus all accrued unpaid interest on April
1, 1999. In addition, Borrower will pay regular monthly payments of accrued
unpaid interest beginning May 1, 1998, and all subsequent interest payments are
due on the same day of each month after that. The annual interest rate for this
Note is computed on a 365/360 basis; that is, by applying the ratio of the
annual interest rate over a year of 360 days, multiplied by the outstanding
principal balance, multiplied by the actual number of days the principal balance
is outstanding. Borrower will pay Lender at Lender's address shown above or at
such other place as Lender may designate in writing. Unless otherwise agreed or
required by applicable law, payments will be applied first to accrued unpaid
interest, then to principal, and any remaining amount to any unpaid collection
costs and late charges.
VARIABLE INTEREST RATE. The interest rate on this Note is subject to change from
time to time based on changes in an independent index which is the Prime Rate as
published in the Wall Street Journal (Western Edition) (the "Index"). The Index
is not necessarily the lowest rate charged by Lender on its loans. If the Index
becomes unavailable during the term of this loan, Lender may designate a
substitute index after notice to Borrower. Lender will tell Borrower the current
Index rate upon Borrower's request. Borrower understands that Lender may make
loans based on other rates as well. The interest rate change will not occur more
often than each day. The index currently is 8.500%. The interest rate to be
applied to the unpaid principal balance of this Note will be at a rate of 0.750
percentage points over the Index, resulting in an initial rate of 9.250%.
NOTICE: Under no circumstances will the interest rate on this Note be more than
the maximum rate allowed by applicable law.
PREPAYMENT; MINIMUM INTEREST CHARGE. Borrower agrees that all loan fees and
other prepaid finance charges are earned fully as of the date of the loan and
will not be subject to refund upon early payment (whether voluntary or as a
result of default), except as otherwise required by law. In any event, even upon
full prepayment of this Note, Borrower understands that Lender is entitled to a
minimum interest charge of $250.00. Other than Borrower's obligation to pay any
minimum interest charge, Borrower may pay without penally all or a portion of
the amount owed earlier than it is due. Early payments will not, unless agreed
to by Lender in writing, relieve Borrower of Borrower's obligation to continue
to make payments of accrued unpaid interest. Rather, they will reduce the
principal balance due.
LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged
$15.00.
DEFAULT. Borrower will be in default if any of the following happens: (a)
Borrower fails to make any payment when due. (b) Borrower breaks any promise
Borrower has made to Lender, or Borrower fails to comply with or to perform when
due any other term, obligation, covenant, or condition contained in this Note or
any agreement related to this Note, or in any other agreement or loan Borrower
has with Lender. (c) Borrower defaults under any loan, extension of credit,
security agreement, purchase or sales agreement, or any other agreement, in
favor of any other creditor or person that may materially affect any of
Borrowers property or Borrower's ability to repay this Note or perform Borrowers
obligations under this Note or any of the Related Documents. (d) Any
representation or statement made or furnished to Lender by Borrower or on
Borrowers behalf is false or misleading in any material respect either now or at
the time made or furnished. (e) Borrower becomes insolvent, a receiver is
appointed for any part of Borrower's property, Borrower makes an assignment for
the benefit of creditors, or any proceeding is commenced either by Borrower or
against Borrower under any bankruptcy or insolvency laws. (f) Any creditor tries
to take any of Borrower's property on or in which Lender has a lien or security
interest. This includes a garnishment of any of Borrower's accounts with Lender.
(g) Any guarantor dies or any of the other events described in this default
section occurs with respect to any guarantor of this Note. (h) A material
adverse change occurs in Borrower's financial condition, or Lender believes the
prospect of payment or performance of the Indebtedness is impaired.
If any default, other than a default in payment, is curable and if Borrower has
not been given a notice of a breach of the same provision of this Note within
the preceding twelve (12) months, it may be cured (and no event of default will
have occurred) if Borrower, after receiving written notice from Lender demanding
cure of such default: (a) cures the default within fifteen (15) days; or (b) if
the cure requires more than fifteen (15) days, immediately initiates steps which
Lender deems in Lender's sole discretion to be sufficient to cure the default
and thereafter continues and completes all reasonable and necessary steps
sufficient to produce compliance as soon as reasonably practical.
LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal
balance on this Note and all accrued unpaid interest immediately due, without
notice, and then Borrower will pay that amount. Upon Borrower's failure to pay
all amounts declared due pursuant to this section, including failure to pay upon
final maturity, Lender, at its option, may also, if permitted under applicable
law, increase the variable interest rate on this Note to 5.750 percentage points
over the Index. Lender may hire or pay someone else to help collect this Note if
Borrower does not pay. Borrower also will pay Lender that amount. This includes,
subject to any limits under applicable law, Lender's attorneys' fees and
Lender's legal expenses whether or not there is a lawsuit, including attorneys'
fees and legal expenses for bankruptcy proceedings (including efforts to modify
or vacate any automatic stay or injunction), appeals, and any anticipated
post-judgment collection services. Borrower also will pay any court costs, in
addition to all other sums provided by law. This Note has been delivered to
Lender and accepted by Lender in the State of California. If there is a lawsuit,
Borrower agrees upon Lender's request to submit to the jurisdiction of the
courts of Santa Clara County, the State of California. This Note shall be
governed by and construed in accordance with the laws of the State of
California.
COLLATERAL. This Note is secured by the collateral as described in that certain
Commercial Security agreement dated July 17, 1995.
LINE OF CREDIT. This Note evidences a revolving line of credit. Advances under
this Note, as well as directions for payment from Borrower's accounts, may be
requested orally or in writing by Borrower or by an authorized person. Lender
may, but need not, require that all oral requests be confirmed in writing. The
following party or parties are authorized to request advances under the line of
credit until Lender receives from Borrower at Lender's address shown above
written notice of revocation of their authority: William P. Horgan, Chairman &
Chief Executive Officer; and Maxine C. Harmatta, Vice President, Finance.
Borrower agrees to be liable for all sums either: (a) advanced in accordance
with the instructions of an authorized person or (b) credited to any of
Borrower's accounts with Lender. The unpaid principal balance owing on this Note
at any time may be evidenced by endorsements on this Note or by Lender's
internal records, including daily computer print-outs. Lender will have no
obligation to advance funds under this Note if: (a) Borrower or any guarantor is
in default under the terms of this Note or any agreement that Borrower or any
guarantor has with Lender, including any agreement made in connection with the
signing of this Note; (b) Borrower or any guarantor ceases doing
<PAGE>
04-01-1998 PROMISSORY NOTES Page 2
Loan No 0108143855 (Continued)
================================================================================
business or is insolvent; (c) any guarantor seeks, claims or otherwise attempts
to limit, modify or revoke such guarantor's guarantee of this Note or any other
loan with Lender; or (d) Borrower has applied funds provided pursuant to this
Note for purposes other than those authorized by Lender.
BUSINESS LOAN AGREEMENT. In addition to the terms and conditions contained in
the Note, it is also subject to the terms and conditions contained in that
certain Business Loan Agreement (the "Agreement") dated April 1, 1998, executed
by Borrower in favor of Lender.
PRIOR NOTE. The Promissory Note from EROX Corporation to Lender dated July 1,
1997.
GENERAL PROVISIONS. This Note is payable on demand. The inclusion of specific
default provisions or rights of Lender shall not preclude Lender's right to
declare payment of this Note on its demand. Lender may delay or forgo enforcing
any of its rights or remedies under this Note without losing them. Borrower and
any other person who signs, guarantees or endorses this Note, to the extent
allowed by law, waive any applicable statute of limitations, presentment, demand
for payment, protest and notice of dishonor. Upon any change in the terms of
this Note, and unless otherwise expressly stated in writing, no party who signs
this Note, whether as maker, guarantor, accommodation maker or endorser, shall
be released from liability. All such parties agree that Lender may renew or
extend (repeatedly and for any length of time) this loan, or release any party
or guarantor or collateral; or impair, fail to realize upon or perfect Lender's
security interest in the collateral; and take any other action deemed necessary
by Lender without the consent of or notice to anyone. All such parties also
agree that Lender may modify this loan without the consent of or notice to
anyone other than the party with whom the modification is made.
PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF
THIS NOTE, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO
THE TERMS OF THE NOTE AND ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE NOTE.
BORROWER:
EROX Corporation
By: /s/ William P. Horgan
------------------------------------------------------
William P. Horgan, Chairman & Chief Executive Officer
================================================================================
EXTENSION AGREEMENT
THIS EXTENSION AGREEMENT is entered into as of the 24th day of
September, 1998, by and between ProLogis Limited Partnership I, a Delaware
Limited Partnership (formerly known as SCI Limited Partnership I, a Delaware
Limited Partnership) (the "Landlord") and Human Pheromone Sciences. Inc., a
California Corporation (formerly known as Erox Corporation, a California
Corporate) (the "Tenant").
WITNESSETH:
WHEREAS, Landlord and Tenant have entered into a Lease, dated as of the
29th day of September, 1995, pursuant to which Landlord leased to Tenant certain
premises located at 4034 Clipper Court, Fremont, CA (such lease, as heretofore
and hereafter modified, being herein referred to as the "Lease").
WHEREAS, Landlord and Tenant desire to extend the term of the Lease on
the terms and conditions set forth below.
NOW THEREFORE, in consideration of Ten Dollars ($10.00) and other good
and valuable consideration, the receipt and sufficiency of which is hereby
acknowledged, the Landlord and Tenant agree as follows:
1. The term of the Lease is extended for twenty four (24) months,
such that the Lease shall terminate on the 31st day of October,
2000. All of the terms and conditions of the Lease shall remain
in full force and effect during such extension period except
that the Monthly Base Rent shall be as follows during such
extension:
Months Rent
------ ----
1-12 $ 9,658.00
13-24 $10,097.00
2. Except as modified herein, the Lease, and all of the terms and
conditions thereof, shall remain in full force and effect.
3. Any obligation or liability whatsoever of Security Capital
Industrial Trust, a Maryland real estate investment trust, which may arise at
any time under the Lease or this Agreement or any obligation or liability which
may be incurred by it pursuant to any other instrument, transaction or
undertaking contemplated hereby, shall not be personally binding upon, nor shall
resort for the enforcement thereof be had to the property of, its trustees,
directors, shareholders, officers, employees, or agents regardless of whether
such obligation or liability is in the nature of contract, tort or otherwise.
IN WITNESS WHEREOF, the parties hereto have signed this Extension
Agreement as of the day and year first above written.
ProLogis Limited Partnership I, a Delaware
Limited Partnership
By: /s/ Ned K. Anderson
-------------------------------------
Name: Ned K. Anderson
Title: Senior Vice President
LANDLORD
Human Pheromone Sciences, Inc. a
California Corporation
By: /s/ William P. Horgan
-------------------------------------
Name: William P. Horgan
Title: CFO
TENANT
THE SYMBOL '*' IS USED THROUGHOUT THIS EXHIBIT TO INDICATE THAT A PORTION OF THE
EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION.
SUPPLY AGREEMENT
----------------
THIS AGREEMENT is entered into this 15th day of December, 1998 between
HUMAN PHEROMONE SCIENCES, INC., a corporation, with an office at 4034 Clipper
Court, Fremont, California 94538 (hereinafter referred to as "HPSI"), and AVON
PRODUCTS, INC., a New York corporation, with an office at 1345 Avenue of the
Americas, New York, New York 10105 (hereinafter referred to as "AVON").
WHEREAS, HPSI represents that it owns patent rights relating to the use
of certain human pheromones;
WHEREAS, AVON is interested in developing a business relationship with
HPSI for the manufacture, supply, sale and distribution of a global line of
products containing such human pheromones;
NOW, THEREFORE, in consideration of the foregoing promises and mutual
covenants hereinafter contained, the parties hereby agree as follows:
ARTICLE I.
DEFINITIONS
-----------
The following terms shall have the respective meanings hereinafter
indicated:
(a) "Affiliate" shall mean (i) any person, firm or company of which
AVON now or hereafter owns or controls, directly or indirectly, forty percent
(40%) or more, or (ii) any person, firm or company which now or hereafter owns
or controls, directly or indirectly, forty percent (40%) or more of AVON, or
(iii) any person, firm or company which is under common control with AVON. For
the purpose of this definition, where ownership is by stock ownership, the stock
owned or controlled by a particular person, firm or company shall be deemed to
include all stock owned or controlled, directly or indirectly, by any other
person, firm or company of which the particular person, firm or company owns or
controls, directly or indirectly, forty percent (40%) or more of the stock
having the right to vote for directors thereof.
(b) "Effective Date" shall mean January 1, 1999.
(c) "Field of Use" shall mean the global market served by AVON,
including, but not limited to: (i) the market serviced by a distribution system
utilizing a sales force of independent sales representatives selling the
Products (as hereafter defined) primarily
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to the general public; (ii) catalogs and direct mail; (iii) direct
telecommunications sales, including, without limitation, sales by means of
radio, television, telephone, the Internet or on-line computer services; and
(iv) any retail outlet (including, without limitation, the Avon Centre, Avon
Sales Centers, Avon Beauty Centers, Avon Express Centers, mall carts and kiosks)
where primarily AVON products are sold. Field of Use shall expressly exclude
mass merchandisers and drug chains/stores in the United States and Canada.
(d) "Patents" shall mean United States Patent Nos. 5,272,134 and
5,278,141 and all divisions, continuations, and continuation-in-part
applications, reissues and re-examinations thereof and patents issuing
therefrom, and all corresponding foreign patent applications and granted foreign
parents.
(e) "Pheromone(s)" shall mean the steroid(s), [*] and [*] referred to
in the claims of the Patents which will be at the [*]of [*] of [*] and [*] of
[*].
(f) "Product(s)" shall mean fragrances and fragrance ancillary products
(such as lotions, creams, shower gel, talc, body products, bath preparations,
bath products and bath soaps), fragrances for inclusion in home scents, candles
and room sprays, all of which use a Pheromone as a component. Notwithstanding
the foregoing, in no event shall Products include any product for which a claim
is made that such product may be used for the cure, prevention, treatment,
mitigation or diagnosis of any disease. Nothing shall prevent AVON from making
any other types of substantiated claims for these Products.
(g) "Quest" shall mean Quest International, the fragrance company that
will purchase the Pheromones from HPSI on AVON's behalf.
(h) "Specifications" shall mean Pheromones with the characteristics set
forth by AVON.
(i) "Technical Information" shall mean any and all information,
including manufacturing information, trade secrets, data, expertise and
know-how, known by HPSI and relating to the use of pheromones.
ARTICLE II.
SUPPLY OF PHEROMONES
--------------------
2.1. Purchase and Sale of Pheromones: During the term of this
Agreement, HPSI shall provide to AVON, and Quest will purchase from HPSI on
AVON's behalf, for sale only to Avon and its Affiliates and not to any other
party or to be used by Quest or any other party, all of AVON's requirements of
the Pheromones for inclusion in Products to be sold on a non-exclusive basis in
the Field of Use. It is understood by the parties that, upon Quest's payment to
HPSI for the supply of Pheromones or to any third party as
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set forth in 2.6, it is agreed that neither Quest nor any third party having
rights under the Patents will bring any claim or action against AVON or any of
its Affiliates based on or asserting that the use, sale or offer for sale or
import of Products in the Field of Use violates any proprietary or patent rights
of HPSI.
2.2. Placement of Orders by Quest: Quest will submit firm purchase
orders on AVON's behalf to HPSI from time to time specifying the quantity of
Pheromones desired and the shipment date of dates for the quantity (or specific
quantities, if more than one shipment date is specified) of the Pheromones set
forth in the purchase order. The shipping date shall not be less than ninety
(90) days after the date of the written purchase order. Prior to placing any
orders with HPSI, Quest shall be required to sign a confidentiality agreement
which will govern the use by Quest of the Technical Information provided by
HPSI.
2.3. Specifications: HPSI will supply the Pheromones in accordance with
AVON's Specifications, a copy of which will be attached and incorporated herein.
2.4. Delivery of the Pheromones: HPSI will deliver the quantities of
the Pheromones as set forth in each Quest purchase order. The Pheromones shall
be shipped F.O.B. Salt Lake City to Quest International, 400 International
Drive, Mt. Olive, New Jersey 97828, Attention: Neil Wasser. Quest will specify
to HPSI the method of shipment. AVON shall be solely responsible for payment of
all delivery costs to Quest. HPSI will deliver [*] of Pheromones to Quest no
later than [*]. HPSI will send [*] of Pheromones to Quest no later than [*].
HPSI agrees to deliver [*] additional [*] of Pheromones to Quest no later than
[*]. HPSI agrees to keep a one (1) pound minimum quantity of Pheromones in
inventory at all times during the term of this Agreement for sale to AVON. HPSI
will also deliver [*] of [*] and [*] of [*] to AVON's Research & Development
facility within seven days of signing this Agreement.
2.5. Guarantee: HPSI shall provide AVON with a certificate for each
shipment of Pheromones representing, warranting and guaranteeing that, at the
time of delivery of the Pheromones to Quest, such Pheromones (i) will have been
manufactured, packaged, held and shipped in accordance with AVON's
Specifications and (ii) will have expiration dating of not less than [*] after
the date of delivery thereof. HPSI shall retain a sufficient quantity of
retention samples of each lot of the Pheromones that are shipped to Quest
throughout the term of this Agreement.
2.6. Notification: In the event that HPSI, at any time during the term
of this Agreement, shall have reason to believe that it will be unable to timely
supply Quest with the full quantity of the Pheromones ordered by Quest, HPSI
shall promptly notify AVON thereof. In the event it is determined that HPSI will
be unable to completely fulfill its commitment to supply AVON's required amount
of Pheromones, HPSI shall fully cooperate with AVON in locating third party
supplier(s) and permit such third party
3
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supplier(s) to complete AVON's supply requirement of Pheromones. In such event,
HPSI agrees to disclose to the third party supplier(s), pursuant to a
confidentiality agreement, all Technical Information necessary to enable the
third party supplier(s) to complete such supply. Any consideration paid by AVON
to such third party supplier(s) shall be taken as a credit by AVON against the
supply fees due to HPSI under this Agreement. Compliance by HPSI with this
Section 2.7 shall not relieve HPSI of any other obligation or liability under
this Agreement, including without limitation any provision of this Section 2.
ARTICLE III.
SUPPLY FEES
-----------
3.1. Fee: The fee to be paid for the Pheromones is [*] in crystallized
form. This fee shall remain firm through [*].
3.2. Invoicing by Quest: HPSI will invoice Quest for each quantity of
Pheromones on or after the date on which HPSI ships such quantity to Quest. All
invoices from HPSI to Quest will be due in full thirty (30) days after the date
of invoice. In the event that Quest does not make payment to HPSI, AVON shall be
obligated to make such payment to HPSI forthwith.
ARTICLE IV.
REPRESENTATIONS AND WARRANTIES
------------------------------
4.1. HPSI covenants, represents and warrants:
(a) That it is the exclusive owner of all rights in and to all
the Patents;
(b) That, to the best of its knowledge, there are no (i)
facts, claims or threats that would adversely affect AVON's ability to use or
sell the Pheromones in the Products or (ii) other person(s), firm(s),
corporation(s) or other entity having any right, title or interest in, any or
all of the Patents in the Field of Use;
(c) That it has full power to grant the rights, and privileges
herein given;
(d) That HPSI has the expertise, facilities and personnel
necessary to manufacture the Pheromones in a timely manner in accordance with
the terms and conditions of this Agreement.
(e) That the Pheromones are produced from materials meeting
all of AVON Specifications.
4
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(f) Except as otherwise set forth in Sections 4.1 and 2.5,
HPSI makes no warranty or representation, express or implied, including but not
limited to any warranty of merchantability or fitness for any particular
purpose.
ARTICLE V.
TERM
----
5.1. The term of this Agreement shall begin on the Effective Date and
will expire on [*]. This Agreement may be renewed by mutual agreement for one or
more successive renewal terms, provided that such agreement is reached at least
thirty (30) days before the expiration of the initial term or any renewal term.
5.2. AVON shall have the right to terminate this Agreement at any time
upon ninety (90) days prior written notice to HPSI. In the event of any such
termination of this Agreement, AVON shall continue to have the right to use and
sell the Products until such time as AVON completely consumes its remaining
inventory of Products. Termination of this Agreement shall not relieve AVON of
any requirement to make any payment that has accrued prior to such termination.
ARTICLE VI.
INDEMNIFICATION
---------------
6.1. Notwithstanding anything to the contrary contained or suggested
herein, HPSI agrees to indemnify and hold harmless AVON from and against any and
all claims, damages and liabilities asserted by any third party for any finders
fee(s), commission(s) or the like arising from or out of any claim made by such
third party in connection with this Agreement or the subject matter hereof.
ARTICLE VII.
MISCELLANEOUS
-------------
7.1. Assignability: Neither this Agreement nor any license or right
hereunder shall be assignable or otherwise transferable by either party hereto,
except to a successor to substantially all of the business to which this
Agreement relates, provided that such successor shall expressly assume all of
the obligations and liabilities of the assigning party hereunder.
7.2. Bankruptcy: This Agreement may be terminated by either party if
the other party makes an assignment for the benefit of creditors, files a
petition in bankruptcy, petitions or applies to any tribunal for the appointment
of a custodian, receiver, trustee or similar official for it or a substantial
part of its assets, or commences any case or proceeding under any bankruptcy,
reorganization, arrangement, readjustment of debt,
5
<PAGE>
dissolution or liquidation law or statute of any jurisdiction, whether now or
hereafter in effect; or if any such petition or application is filed or any such
case or proceeding is commenced against the other party, in which an order for
relief is entered or which remains undismissed for a period of sixty (60) days
or more; or if by any act or omission the other party indicates its consent to,
approval of or acquiescence in any such petition, application or a case or
proceeding or order for relief or the appointment of a custodian, receiver or
any trustee or similar official for it or any substantial part of any of its
assets, or suffers any such custodianship, receivership, trusteeship or
jurisdiction of a similar official to continue undischarged for a period of
sixty (60) days or more.
7.3. Avon Independent Contractors: Notwithstanding anything to the
contrary contained in this Agreement, it is understood that Avon's Sales
Representatives are independent contractors who are not under Avon's control,
and Avon shall not be responsible in any way for any sales by such
Representatives which, if undertaken by Avon itself, would be in violation of
this Agreement.
7.4. Force Majeure: Neither party shall be liable for delay in
performance, or nonperformance caused by circumstances beyond the reasonable
control of the party affected, including, but not limited to, acts of God, fire,
floods, acts of war or violence, labor disputes or shortages, plant shutdown,
governmental actions, or inability to obtain materials, equipment or
transportation.
7.5. Governing Law: This Agreement shall be deemed to have been made
and executed in the State of New York, and its form, execution, validity and
construction shall be determined in accordance with the laws of that State,
without giving any effect to any conflict of laws provisions.
7.6. Modifications: This Agreement including the Attachments hereto
comprise the entire understanding of the parties with respect to the subject
matter hereof, and each party agrees, upon the request of the other, to execute
and deliver such documents and take such actions as may be reasonably requested
in order to carry out the intent and purposes of this Agreement. No amendment to
or modification of this Agreement shall be valid or binding upon a party hereto
unless signed by a duly authorized signatory of the party claimed to be bound
thereby.
7.7. Notices: Any notice or request expressly provided for under this
Agreement shall be in writing, shall be given either manually or by mail or
facsimile, and shall be deemed sufficiently given if and when received by the
party to be notified at its address set forth below or, if and when mailed by
registered mail, postage prepaid, addressed to such party at such address.
Notices to AVON shall be addressed to:
Avon Products, Inc.
1251 Avenue of the Americas
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New York, New York 10020
Attention: Donna Edbril, Esq.
Notice to HPSI shall be addressed to:
Chief Executive Officer
Human Pheromone Sciences, Inc.
3034 Clipper Court
Fremont, California 94538
With a Copy to:
Heller Ehrman White & McAuliffe
525 University Avenue
Palo Alto, California 94301
Attention: Julian N. Stern
Either party may, by notice to the other, change its address for
receiving such notices and requests.
7.8. Publicity: HPSI agrees that it shall not issue any press
release(s) or make any other public statement(s) with respect to the existence
of and/or the term and/or conditions of this Agreement or the relationship of
the parties, without the prior written consent of AVON provided that, subject to
AVON's reasonable review and approval, HPSI may issue any press release(s) or
other public statements that its legal counsel reasonably determines to be
legally advisable or is required by law or regulation.
7.9. No Waiver: The waiver of any breach of this Agreement by either
party hereto shall in no event constitute a waiver as to any future breach,
whether similar or dissimilar in nature.
7.10. Partial Invalidity: Invalidity of any part of this Agreement
under applicable governing law shall not invalidate any other part or parts
hereof which are otherwise valid under applicable governing law. In the event
that any provision(s), term(s) and/or condition(s) herein are determined to be
invalid or partially invalid under applicable governing law, the parties shall
thereupon negotiate in good faith to amend this Agreement so as to comply with
applicable governing law.
7
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first set forth above.
AVON PRODUCTS, INC. HUMAN PHEROMONES SCIENCES, INC.
By: _____________________________ By: _______________________________
Name: ____________________________ Name: ____________________________
Title: ___________________________ Title: ____________________________
8
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 Human Pheromone Sciences, Inc. of
our report dated March 19, 1999, with respect to the financial statements of
Human Pheromone Sciences, Inc. included in the Annual Report (Form 10-KSB) for
the year ended December 31, 1998.
ERNST & YOUNG LLP
Palo Alto, California
March 25, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
The Schedule Contains Summary Financial Information Extracted
From Balance Sheets and Statements of Income
</LEGEND>
<CIK> 0000878616
<NAME> HPSI Corporation
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> DEC-31-1998
<CASH> 76,696
<SECURITIES> 0
<RECEIVABLES> 2,729,309
<ALLOWANCES> (677,735)
<INVENTORY> 2,894,541
<CURRENT-ASSETS> 5,136,446
<PP&E> 799,867
<DEPRECIATION> (741,271)
<TOTAL-ASSETS> 5,195,042
<CURRENT-LIABILITIES> 2,785,413
<BONDS> 0
0
2,745,535
<COMMON> 17,667,024
<OTHER-SE> (18,002,930)
<TOTAL-LIABILITY-AND-EQUITY> 5,195,042
<SALES> 10,378,717
<TOTAL-REVENUES> 10,378,717
<CGS> 3,358,242
<TOTAL-COSTS> 3,358,242
<OTHER-EXPENSES> 365,358
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 62,608
<INCOME-PRETAX> (2,619,661)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,619,661)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,619,140)
<EPS-PRIMARY> (0.25)
<EPS-DILUTED> (0.25)
</TABLE>
