Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 1998 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the transition period
from ________ to ________.
Commission file Number 0-6333
HYDRON TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
New York 13-1574215
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1001 Yamato Road, Suite 403, Boca Raton, Florida 33431
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (561) 994-6191
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any other
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant was $4,683,602 based upon the closing price of $1.0625 on March 25,
1999.
Number of shares of Common Stock outstanding as of March 25, 1999:
4,910,136
Documents Incorporated by Reference: None
PART I
All information in this Form 10-K has been retroactively adjusted to give effect
to a one-for-five reverse stock split (the "Split") of Hydron Technologies,
Inc.'s issued and outstanding common stock, par value $.01 per share ("Common
Stock") effected on October 19, 1998.
ITEM 1. BUSINESS
INTRODUCTION
Hydron Technologies, Inc. ("the Company"), a New York corporation
organized on January 30, 1948, maintains its principal office at 1001 Yamato
Road, Suite 403, Boca Raton, Florida 33431 and its telephone number is (561)
994-6191.
The Company markets a broad range of consumer and oral health care
products using a moisture attracting ingredient (the "Hydron(R) polymers"), and
owns a non-prescription drug delivery system for topically applied
pharmaceuticals, which uses such polymer. The Company holds U.S. and
international patents on, what management believes, is the only known
cosmetically acceptable method to suspend the Hydron polymer in a stable
emulsion for use in personal care/cosmetic products. The Company has
concentrated its sales and development activities primarily on the application
of these biocompatible, hydrophilic polymers in various personal care/cosmetic
products for consumers and, to a lesser extent, oral care products for dental
professionals. The Company is developing other personal care/cosmetic products
for consumers using Hydron polymers and is using its patented technology as a
drug delivery system in one of its proprietary products, in which Hydron
polymers act as a drug release mechanism. The Company intends to continue to
explore the efficacy of using its technology for such purposes and would, when
appropriate, either seek licensing arrangements with third parties, or develop
and market proprietary products through its own efforts. Management believes
that, because of their unique properties, products that utilize Hydron polymers
have the potential for wide acceptance in consumer and professional health care
markets.
CONSUMER PRODUCTS
The Company has been engaged in the development of various consumer
products using Hydron polymers since 1966. The Company's products are designed
to address concerns about aging, and include Hydron skin care, hair care, bath
and body, sun care and over-the-counter pharmaceutical lines.
The Company launched four new consumer products in Fiscal 1998,
bringing the total number of individual products available to thirty-seven in
the following product lines: skin care (20 products), hair care (7 products),
bath and body (7 products), sun care (2 products) and over-the-counter
pharmaceutical (1 product). These products are also packaged into collections
and sold at a discounted price. The majority of the products are presently being
sold to and marketed by QVC, Inc. ("QVC") and all of the products are
2
sold directly by the Company to consumers through the Company's Hydron Catalog
("Catalog').
Management believes that the Company's product lines are unique and
offer the following competitive benefits: they become water-insoluble on the
skin's surface, and unlike all other water-based cremes and lotions, are not
removed by the skin's perspiration or plain water; they are oxygen-permeable,
allow the skin to breathe and leave no greasy afterfeel; they do not emulsify
the skin's natural moisturizing agents, as do conventional cremes and lotions;
and they attract and hold water, creating a cushion of moisture on the skin's
surface that promotes penetration of other beneficial product ingredients. The
Company's products are dermatologist tested and approved for all skin types, and
products for use around the eye area are also ophthalmologist tested and safe
for contact lens wearers. Most of the Company's moisturizing products are based
on the Company's patented emulsion system, which permits the product ingredients
to deliver their intended benefits over an extended period of time and in a more
efficient manner. See "Patented Technology."
PROFESSIONAL PRODUCTS
The Company markets its hand and body moisturizer, on a limited basis,
directly to health care professionals. Management believes that the product's
hydrophilic properties create a moisturizing film that helps protect health care
workers' hands against the irritation and minor allergic reactions that often
accompany prolonged use of latex gloves and frequent hand washing, including
dryness, itching and scaling.
The Company has reformulated six of its most popular products in an
effort to market skin care products directly to dermatologists and their
patients. The Company conducted a focus study involving dermatologists in
November 1997, which indicated that there was a market for these products and
that the marketing approach was acceptable to the dermatologists. A pilot test
is scheduled for the second quarter of 1999 to test the viability of this
marketing concept.
The Company has also developed and markets a group of Hydron
polymer-based products for dental professionals under the Hydrocryl brand name.
These include a heat cured material used in the manufacture of dentures, as well
as cold cure kits used in connection with the relining or repairing of existing
Hydrocryl or conventional acrylic dentures that is necessitated by the continual
changes that occur in the tissue structure of the mouth. Management believes
that the hydrophilic, or moisture attracting properties, of these Hydron
polymer-based products gives them competitive advantages over conventional
acrylic dentures and denture repair kits, which are not hydrophilic. Sales of
Hydrocryl brand name products were minimal in Fiscal 1998, Fiscal 1997 and
Fiscal 1996.
3
TOPICAL DRUG DELIVERY SYSTEM
Management believes that the Company's patented Hydron emulsion system
enhances the effectiveness of over-the-counter medications applied to the skin.
The system is designed to deposit a uniform film on the skin's surface and to
have a relatively low affinity for the drug associated with the application. The
emulsion system is moisture-resistant so that it is not degraded by perspiration
or sebaceous oils, but is oxygen permeable. Management believes that the Hydron
system has a number of advantages over lotions; it promotes hydration of the
stratum corneum, which improves penetration into the skin's pores and has good
tactility and flexibility. The system has also been developed to be free from
greasiness, brittleness, tackiness, gumminess or oiliness, to make it
comfortable on the skin and to be resistant to inks, dyes, oils and other
materials with which the treated skin may come in contact. The Company currently
markets an over-the-counter topical analgesic for the relief of minor arthritis
and sore muscle pain.
AGREEMENT WITH QVC
In December 1993, the Company entered into a license agreement with QVC
("QVC License Agreement"), whereby QVC was granted exclusive rights to market
and distribute the Company's proprietary consumer products using Hydron polymers
in North, Central and South America ("Western Hemisphere"), through a variety of
retail channels, including its electronic retail cable television program, other
forms of electronic retailing such as infomercials (program-length commercials)
and direct response television advertising, and conventional retail
distribution. The QVC License Agreement specifically excludes the marketing of
the Company's professional products, use of the Company's patented technology as
a drug delivery system and products specifically geared to the health care
field.
The initial two-year term of the QVC License Agreement ran through
April 1996, and the term was automatically renewable for additional two-year
terms if QVC purchased certain escalating minimum quantities of product. QVC met
the minimum product purchase requirements in order to maintain such exclusive
rights for the initial two year term of the contract, and the term of the QVC
License Agreement was renewed.
In connection with the execution and delivery of the QVC License
Agreement, the Company also entered into a Warrant Purchase Agreement whereby
the Company issued two warrants ("Initial QVC Warrants") to QVC to purchase an
aggregate of 100,000 shares of the Company's Common Stock at $12.50 per share.
QVC was also granted anti-dilution and registration rights for the shares of
Common Stock issuable upon exercise of the warrants. The Initial QVC Warrants
were exercised on July 19, 1996 in connection with an amendment of the QVC
License Agreement ("Amended License Agreement"). Under the terms of the Amended
License Agreement, effective as of May 31, 1996, the Company reacquired certain
retail marketing rights to the Hydron product line. Such retail marketing rights
include prestige retail channels of distribution such as traditional department
and specialty stores, boutique stores and beauty salons, as well as catalog
4
sales. In addition, the Amended License Agreement increased the minimum product
purchase requirements QVC must meet, on an annual basis over a two-year term
ending May 31, 1998, to maintain its exclusive rights to market Hydron consumer
products through direct response television in the Western Hemisphere. Products
sold to QVC or its affiliates for resale through infomercials are excluded from
the calculation of such minimum purchase levels. The Amended License Agreement
requires the Company to pay QVC a royalty on the Company's retail sales of
consumer products in the Western Hemisphere and decreased the prices at which
the Company is required to sell Hydron brand consumer products to QVC.
In conjunction with the execution and delivery of the Amended License
Agreement, QVC paid the Company $1.25 million upon the exercise of the Initial
QVC Warrants. Further, the Company granted a warrant to QVC to purchase an
additional 100,000 shares of the Company's Common Stock at $13.75 per share,
exercisable for a period of five years ("Additional QVC Warrant"). QVC has
agreed to a standstill provision not to purchase additional shares of the
Company's Common Stock, except upon exercise of the Additional QVC Warrant,
without the consent of the Company.
Pursuant to the Amended License Agreement, and as part of the overall
transaction with QVC, the Company granted DTR Associates ("DTR"), a
Massachusetts limited partnership, an option to purchase 300,000 shares of the
Company's Common Stock at the purchase price of $.05 per share ("DTR Option").
DTR had previously introduced the Company to QVC, held certain retail
distribution rights for Hydron products and was receiving a royalty payment from
QVC on net sales of Hydron products sold via direct response television. In
return for the DTR Option, DTR's right to receive such royalty payments was
terminated and DTR relinquished its retail distribution rights. As a result of
the Company's granting of the DTR Option, the Company incurred a one-time
non-cash charge against earnings of approximately $3.1 million ("Distribution
Agreement Expense"). DTR exercised its option in January 1997.
Also in connection with the Amended License Agreement, the Company,
through its wholly-owned subsidiary, Hydron Direct, Inc., entered into an
agreement with QDirect Ventures, Inc., an affiliate of QVC, Inc., to form a new
joint venture, known as New Hydromercial Partners, to promote and sell Hydron
products by means of a full length program commercial. SEE
"Marketing-Infomercial."
On June 11, 1997, the Company and QVC renegotiated the Amended License
Agreement ("Renegotiated License Agreement") pursuant to which the term of the
Amended License Agreement was extended for one year, with the next two year term
commencing on June 1, 1997.
Under the terms of the Renegotiated License Agreement, QVC must meet
certain minimum product purchase requirements during each two year term of the
agreement, including annual minimum product purchase requirements, to maintain
its exclusive rights. No obligation exists for QVC to purchase the Company's
product, except to maintain such exclusive rights, and no assurances can be
given that QVC will meet the
5
escalating minimum purchase levels for subsequent years in order to maintain
such exclusive rights. If QVC meets the stipulated minimum product purchase
requirements, then the Renegotiated License Agreement renews automatically.
Management does not believe that QVC will meet the stipulated minimum product
purchase requirements for the term ending May 31, 1999. If QVC does not meet the
minimum product purchase requirements, then the Company alone can elect to
continue or terminate the Renegotiated License Agreement. If the Renegotiated
License Agreement terminates, the Company may seek other marketing and
distribution arrangements for its products, which may include distribution
arrangements with QVC on a nonexclusive basis. Although management believes that
there are other avenues for selling its products, including the Hydron Catalog,
the loss of QVC as a customer would have a material adverse effect on the
Company's business.
In January 1998, the Company retained Lauren Anderson to be the new
Company spokesperson for the Hydron Care shows on QVC. Ms. Anderson spent 23
years with Estee Lauder rising to the position of Vice President of Training.
For the past seven years, Ms. Anderson has owned her own consulting firm,
designing training and sales programs for leading companies such as Givenchy,
Chanel, Yves St. Laurent, la prairie and Donna Karan. Ms. Anderson was under
contract with Hydron through December 1998. She is now performing the
spokesperson function on a month to month basis.
MARKETING AND SALES
The Company's products are currently sold in the United States
exclusively through direct response television and catalog sales, and to a
lesser degree, internationally through conventional retail stores. During the
fiscal year ended December 31, 1998 ("Fiscal 1998"), substantially all of the
Company's sales were made to QVC, the world's largest electronic retailer,
pursuant to a license agreement with QVC. SEE " Agreement with QVC."
- DIRECT RESPONSE TELEVISION
Management believes that marketing Hydron products initially through
direct response television has afforded the Company several advantages over
conventional in-store retailing, including: cash flow that has enabled the
Company to finance, internally, product development and new marketing
activities, the ability to take advantage of time-sensitive opportunities by
moving products to market quickly, and the ability to conduct real time market
research, which can allow management to make marketing decisions quickly and
cost effectively.
The Company's personal care products are presently marketed through
direct response television in the United States exclusively by QVC, whose
programming is transmitted live on cable television to approximately sixty seven
million homes. The sales of the Company's products to QVC are not conditioned
upon QVC's sale and shipment of the products to the ultimate consumer. Sales of
the Company's products to QVC, and its affiliates, accounted for approximately
79%, 82%, 97%, 98% and 98% of
6
the Company's total sales for Fiscal 1998, the fiscal years ended December 31,
1997 ("Fiscal 1997"), December 31, 1996 ("Fiscal 1996"), December 31, 1995
("Fiscal 1995"), and December 31, 1994 ("Fiscal 1994"), respectively. Although
management believes that there are other avenues for selling its products,
including attempting to reach the existing Hydron customer base utilizing
various marketing methods, the loss of QVC as a customer would have a material
adverse effect on the Company's business.
Hydron products have been marketed on QVC through regularly scheduled
"Hydron Care" hours since April 1994. The hour-long, live broadcasts generally
feature most currently available products, which are sold individually or in
collections (packaging of products in various combinations). The majority of
QVC's sales of Hydron products occur in connection with this on-air marketing,
although QVC customers may purchase the products outside these "Hydron Care"
hours. These off-air sales, or back-end sales, are considered primarily re-order
sales. The following information pertains to retail sales of Hydron products
sold by QVC to consumers in Fiscal 1998, 1997, 1996, 1995, and 1994,
respectively:
1998 1997 1996 1995 1994
QVC Retail Sales, in millions $ 9.9 $ 17.0 $ 16.6 $ 21.2 $16.3
Percentage increase (decrease) (42 %) 4 % (22 %) 33 % -
Percent of on-air retail sales 63 % 68 % 63 % 69 % 80 %
Percent of back-end retail sales 37 % 32 % 37 % 31 % 20 %
Retail sales of Hydron products by QVC are affected primarily by the
amount of hours provided by QVC, the quality of such hours (e.g., time of day or
day of the week), new product introductions, competitive products offered by QVC
and the effectiveness of the host and spokesperson.
In Fiscal 1998, the Company expanded its product lines from forty-six
items (sku's) in Fiscal 1997 to fifty-one items (sku's) in Fiscal 1998. At
December 31, 1998, the product lines marketed on QVC consisted of skin care (32
sku's), hair care (7 sku's) bath and body (10 sku's) and sun care (2 sku's).
Such products can be purchased on QVC individually (37 sku's) or in kits or
collections (14 sku's). The Company is currently reviewing its product line
distribution and is now emphasizing the skin care line of products to a greater
extent.
- CATALOG SALES
In November 1996, the Company opened a new channel of distribution for
Hydron products with the launch of the Catalog. This full color Catalog offers
the Company's personal care products for sale directly to consumers. The Catalog
also provides information on new Hydron products, educates consumers on proper
skin and hair care and facilitates re-ordering. Prior to September 19, 1997, the
Catalog was marketed through sports marketing, print advertising and community
events. Since the fourth quarter of Fiscal 1997, management has significantly
reduced the direct expenses associated with the Catalog and is currently
exploring new ways to enhance Catalog operations.
7
The Company also markets the Catalog to its shareholders, who presently
receive a twenty-five percent discount on all purchases. Consumers can order
Hydron products or a Hydron Catalog by calling 1-800-4-HYDRON (1-800-449-3766)
or by visiting the Company's web site at http://www.hydron.com.
- INFOMERCIAL
New Hydromercial Partners ("Infomercial Partnership") is an equal
partnership between the Company and QVC, which promotes and sells the Company's
Hydron polymer-based skin care products through a thirty minute commercial
("Infomercial"), which the Infomercial Partnership produced. Although the
Infomercial is not currently being aired, it has been shown on regional and
national cable networks, at various times, since September 1995. The Infomercial
Partnership continues to market to the existing Infomercial customers through a
continuity program. Management is currently reviewing the options available in
reviving the Infomercial concept.
- RETAIL STORES
Under the terms of the Company's amended agreement with QVC (SEE
"Agreement with QVC"), the Company is permitted to market Hydron brand products
through most conventional retail outlets, excluding mass merchandisers. Although
management is reviewing the available retail distribution options, at the
present time, the Company does not intend to enter into retail outlet
distribution in the United States in Fiscal 1999.
The Company has an agreement with an Australian-based health and beauty
products distributor, Doctors Formula Pty. Ltd., to market Hydron products in
retail stores in Australia and New Zealand. Sales to Doctors Formula Pty. Ltd.
in Fiscal 1998, Fiscal 1997 and Fiscal 1996 were minimal.
AGREEMENT WITH NATIONAL PATENT
Pursuant to the terms of an agreement ("Patent Agreement") with
National Patent Development Corporation ("National Patent"), the Company has the
exclusive worldwide rights to market products using Hydron polymers in the oral
health, personal care/cosmetic and other consumer product fields, the areas in
which the Company has been concentrating its research and development efforts.
The Company also has exclusive worldwide rights to utilize Hydron polymers in
its topical delivery system for non-prescription drugs only. National Patent has
the exclusive worldwide rights to market prescription drugs and medical devices
using Hydron polymers. Furthermore, each company has the right to exploit
products with Hydron polymers not in the other's exclusive fields. Products that
are not developed by the Company could be developed by National Patent, and
could benefit the Company through the payment of royalties as required under the
Patent Agreement.
8
The Patent Agreement requires the Company to pay a 5% royalty to
National Patent based on the net sales of products containing the Hydron
polymer. Additionally, National Patent is required to pay the Company a 5%
royalty on its net sales of Hydron polymer-based products, except with respect
to certain excluded products. In the area of prescription and nonprescription
drugs using Hydron polymers as a drug release mechanism, both the Company and
National Patent have agreed to pay the other a royalty equal to 5% of net sales
received from third parties with regard to such products developed. In addition,
each will pay the other 25% of any up-front license fees, royalties or similar
payments received from third parties with regard to such products developed in
the area of nonprescription drugs. For the years ended December 31, 1998, 1997,
1996, 1995 and 1994, the Company paid or accrued royalties to National Patent of
approximately $190,000, $330,000, $387,000, $338,000 and $387,000, respectively.
The Company has not received any royalties from National Patent during these
periods.
FOREIGN OPERATIONS
Direct foreign sales by the Company have never been significant as a
percentage of consolidated net sales. From 1995 to 1997, the Company marketed
its products in Europe through a QVC affiliate in the United Kingdom. In 1996,
the Company signed an agreement for conventional retail sales with Doctors
Formula Pty. Ltd., an Australia-based health and beauty products distributor.
Management is reviewing other opportunities to exploit its consumer products
through various retail marketing and distribution methods in regions not covered
under agreements with QVC, although no other marketing and distribution methods
are currently being used and there can be no assurance that any will be used in
the future.
MANUFACTURING AND RAW MATERIALS
Hydron polymer-based products are manufactured exclusively for the
Company by independent third parties. Although the Company has used principally
one manufacturer of cosmetic products because of the quality of its products and
reasonable cost, the Company and this manufacturer have established
relationships with other third party cosmetic manufacturers who could produce
the Company's cosmetic products should increased capacity be required. To date,
contract manufacturing has allowed the Company to meet inventory requirements in
a timely manner. All raw material and packaging components for the Company's
consumer and professional product lines are readily available to the Company
from a variety of sources.
The Company is not dependent on any sole manufacturer except National
Patent, which has agreed to make the Hydron polymer available to the Company as
needed, and to provide the Company with all manufacturing procedures, including
know-how, and render necessary and reasonable technical assistance should
National Patent be unable to meet the Company's requirements for the Hydron
polymer. The loss of National Patent as a supplier or a reduction in the
availability of the Hydron polymer would have a material adverse effect on the
Company's business.
9
INVENTORY
The Company did not have any backorder of firm booked orders as of
December 31, 1998, and generally delivers its orders within two weeks of the
date orders are booked. Although the Company's business in not seasonal, orders
are placed by QVC after it determines its programming, and therefore,
fluctuations in the Company's sales may occur on a monthly and quarterly basis.
Orders placed by the Company's Catalog customers are generally shipped within a
few days of the placement of the order.
The Renegotiated License Agreement provides that QVC purchase products
directly from the Company for resale to consumers, and that the Company receive
payment from QVC thirty days after QVC's receipt of such goods. In view of QVC's
thirty day payment terms, management does not anticipate any difficulty in
financing foreseeable inventory requirements.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts during Fiscal 1998
continued to achieve greater diversification among the Company's product lines
by broadening the brand's appeal primarily to the aging baby boomer marketplace.
During Fiscal 1998, the Company's contract research and development program
completed development of four new products: moisturizing body wash, an oil
balancing toner, a vitamin enriched body creme, and an under eye concealer.
At year-end, development efforts were continuing for numerous other
personal care/cosmetic products. These efforts include product formulation,
packaging design and prototypes, extensive product safety and stability testing
conducted by dermatologists, along with non-comedogenicity tests where
appropriate, certain efficacy studies to support product claims, and consumer
focus groups and panel tests. The Company's research and development is led by
Charles Fox, a consultant and a member of the Company's Board of Directors from
September 1997 to October 1998, who was formerly director of product development
for Warner Lambert Company's personal products division and president of the
Society of Cosmetic Chemists.
Management anticipates completing development of products initiated in
1998 during 1999, and expects to focus research and development resources on
additional Hydron polymer-based products as determined by management's
assessment of consumer demand, compatibility with the Company's proprietary
technology, and sales potential.
VITAMINS AND NUTRITIONAL SUPPLEMENTS
The Company's vitamin and nutritional supplement line of products,
initiated in June 1997, was discontinued by the Company in December 1997. The
results of operations for Fiscal 1997 include an expense of approximately
$501,000 relating to the write down, to net realizable value, of this line of
products.
10
PATENTED TECHNOLOGY
In addition to owning certain non-material patents relating to personal
care products, the Company was granted U.S. Patent No. 4,883,659, dated November
28, 1989, and U.S. Patent No. 5,039,516, dated August 13, 1991, which cover a
stable moisturizing emulsion containing an unusual emulsifying agent, as well as
the Hydron polymer and a unique combination of ingredients. These patents have
expiration dates of November 28, 2006 and August 13, 2008, respectively. The
Company also holds a European patent, as well as patents in numerous other
countries, for this emulsification process. According to the patents, Hydron,
utilized in cosmetic emulsions, creates a thin moisture-attracting film that is
non-greasy; is not dissolved by sebaceous oils or perspiration; does not
emulsify the skin's natural oils and humectants; and allows the skin to breathe
(air and moisture permeable). The film is insoluble in water and resistant to
rub-off, but can easily be removed with soap and water.
The Company's management believes that there are no competitive
cosmetic products with this combination of properties. Applications for the
Hydron polymer and the Company's patented technology in the cosmetics and
pharmaceutical industries include more effective and prolonged delivery of
moisturizing agents to the skin; enhanced flavor and scent releasing components;
and a delivery system for topically applied over-the-counter medications which
may enhance the penetration of active ingredients to the skin by holding them on
the skin longer, in a moist environment.
GOVERNMENT REGULATION
All of the Company's skin care, hair care, and bath and body products
are "cosmetics" as that term is defined under the Federal Food, Drug and
Cosmetics Act ("FDC Act"), and must comply with the labeling requirements of the
FDC Act, the Fair Packaging and Labeling Act ("FPL Act"), and the regulations
thereunder. Certain of the Company's products (i.e. its topical analgesic and
products that contain a sunscreen) are also classified as over-the-counter
drugs. Additional regulatory requirements for such products include additional
labeling requirements, registration of the manufacturer and semiannual update of
the drug list. Management believes that it is in compliance with these
requirements and that there are no material costs associated with such
compliance.
COMPETITION
The skin care business is characterized by vigorous competition
throughout the world. Product recognition, quality, performance and price have
significant influence on customers' choices among competing products and brands.
Advertising, promotion, merchandising, the pace and timing of new product
introductions and line extensions also have a significant impact on the consumer
buying decisions. The Company competes against a number of marketers of skin
care products, some of which have substantially greater resources than the
Company. Although the Company is in competition with all skin care companies,
direct competition in electronic retailing and catalog sales include Victoria
Principal's Principal Secret, Connie Sellecca's The Sellecca Solution, Diane
11
Young, Tova Borgnine, Jennifer Flaven-Stallone's Serious Skin, Adrienne Arpel
Cosmetics, Avon, Mary Kay Cosmetics and Nu Skin.
SEASONALITY
The Company's results of operations are not subject to seasonal
fluctuations.
EMPLOYEES
The Company currently has thirteen full-time employees, four of whom
are executive officers or directors. The Company also maintains relationships
with various consultants, who assist the Company with new product development,
packaging design and marketing. The Company's employees are covered under an
agreement with a firm that provides all administrative services relating to
payroll, personnel and employee benefits. Management continues to hire, fire,
set pay rates and supervise the employees. This arrangement enables the Company
to reduce its administrative and benefit costs relating to employees.
ITEM 2. PROPERTIES
The Company maintains its offices at Yamato Office Center, 1001 Yamato
Road, Suite 403, Boca Raton, Florida 33431, where it occupies approximately
5,500 square feet of office space. The lease on this office space expires in
August 2001 and requires monthly rent of approximately $8,300, including taxes
and common area expenses, subject to increases in the Consumer Price Index and
other increases in taxes and common area expenses over set amounts.
The Company maintains its main warehouse of approximately 31,000 square
feet at 95 Mayhill Street, Saddle Brook, New Jersey 07663, pursuant to a lease
that expires in August 2000, at a monthly rent of approximately $14,000. In
addition, the Company maintains warehouse space, of approximately 3,200 square
feet, at 1120 Holland Drive, Suites 9 and 19, Boca Raton, Florida 33487,
pursuant to a lease that expires in March 2000, at a monthly rent of
approximately $2,400. In January 1998, the Company obtained a release from a
lease involving approximately 1,200 square feet of warehouse space that was to
expire in September 1998.
Management believes that such facilities are satisfactory for its
present needs.
ITEM 3. LEGAL PROCEEDINGS
On September 30, 1997, Harvey Tauman, formerly Chairman, Chief
Executive Officer, President and Treasurer of the Company, whose employment was
terminated by the Company on September 19, 1997, commenced an action (the
"Action") against the Company in the Circuit Court of the Fifteenth Judicial
District in and for Palm Beach County, Florida. In his complaint in the Action,
Mr. Tauman alleges that the Company breached his employment contract upon the
termination of his employment and seeks
12
damages of not less than $4,000,000, plus interest and costs. Mr. Tauman also
seeks a declaration that his employment was terminated without cause and that he
may continue to exercise his stock options for the duration of their term
notwithstanding the termination of his employment.
On November 4, 1997, the Company served and filed its answer to the
complaint in the Action and asserted counterclaims against Mr. Tauman seeking
various relief against him including an award of compensatory and punitive
damages of not less than $6,000,000, together with appropriate interest, costs
and expenses. In its counterclaims, the Company seeks a declaration, among other
things, that Mr. Tauman breached his employment agreement as a result of
wrongful and fraudulent performance of his duties under the contract. Among
other allegations, the Company contends in its counterclaims that Mr. Tauman
improperly caused the Company to make payments of personal expenses upon the
submission by Mr. Tauman of false expense reports and receipts, caused the
Company improperly to enter into consulting agreements with members of his
family and with friends without Board approval, misrepresented to the Board the
financial condition of the Company and its prospects in order to obtain a grant
to himself of bonuses and stock options to which he would otherwise not have
been entitled, caused the submission to the Board of false projections of the
Company's revenues in order to cause the Board to declare dividends, of which he
was a substantial recipient, and to approve a share repurchase plan, caused the
Company to pay for accounting services rendered to him and to other members of
his family, and intentionally breached his fiduciary duties to the Company.
The litigation is currently in the discovery stage and is currently set
for trial for August 1999. Management is unable, at this time, to estimate the
likelihood or scope of liability, if any, it may incur as a result of Mr.
Tauman's claims or the likelihood of success of its counterclaims. However, a
monetary judgment in Mr. Tauman's favor, and an adverse judgment on the
Company's counterclaims, would result in a material adverse effect on the
Company's financial condition and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
quarter ended December 31, 1998.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock trades on the Nasdaq SmallCap Market tier of
the Nasdaq Stock Market (the "Nasdaq SmallCap Market") under the symbol HTECC.
There can be no assurance that the Company will be able to maintain the listing
requirements of the Nasdaq SmallCap Market. The following tables indicate the
high and low closing prices for the Company's Common Stock (restated for the
one-for-five reverse stock split effective October 19, 1998), as reported by the
Nasdaq Stock Market.
FISCAL 1998 HIGH CLOSING PRICE LOW CLOSING PRICE
Fourth Quarter $ 1.719 $ .375
Third Quarter 2.500 .940
Second Quarter 3.750 2.190
First Quarter 3.750 .406
FISCAL 1997 HIGH CLOSING PRICE LOW CLOSING PRICE
Fourth Quarter $ 5.313 $ 2.031
Third Quarter 8.125 5.000
Second Quarter 9.219 6.250
First Quarter 11.563 7.813
As of March 25, 1999, there were approximately 4,090 record holders of
the Company's Common Stock. In January 1995, the Company instituted a regular
quarterly cash dividend of twelve and one-half cents ($.125) per share and paid
a quarterly dividend from March 1995 through June 1997. In September 1997, the
Board of Directors voted to suspend the dividend. The Board of Directors will
determine the payment of dividends in the future in light of conditions then
existing, including the Company's earnings and financial condition.
The National Association of Securities Dealers, Inc., which administers
NASDAQ, has established certain criteria for continued NASDAQ eligibility. The
Company's failure to meet NASDAQ's maintenance criteria in the future may result
in the discontinuance of the inclusion of its securities in NASDAQ. In such
event, trading, if any, in the securities may then continue to be conducted in
the non-NASDAQ over-the-counter market in what are commonly referred to as the
electronic bulletin board and the "pink sheets." As a result, an investor may
find it more difficult to dispose of or to obtain accurate quotations as to the
market value of the securities. In addition, the Company would be subject to a
Rule promulgated by the Securities and Exchange Commission that, if the Company
fails to meet criteria set forth in such rule, imposes various practice
requirements on broker-dealers who sell securities governed by the Rule to
persons other
14
than established customers and accredited investors. For these types of
transactions, the broker-dealer must make a special suitability determination
for the investor and have received the investor's written consent to the
transactions prior to the sale. Consequently, the rule may have an adverse
effect on the ability of broker-dealers to sell the securities, which may affect
the ability of investors to sell the securities in the secondary market.
ITEM 6. SELECTED FINANCIAL DATA
FISCAL YEARS ENDED DECEMBER 31,
1998 1997 1996 1995 1994
Net Sales $ 3,983,303 $ 7,305,154 $ 8,112,672 $ 7,303,468 $ 8,640,234
Distribution Agreement Expense - - 3,149,718 - -
Operating Income (Loss) (2,067,349) (2,849,790) (2,997,070) 1,566,212 3,418,599
Interest and Investment Income 144,203 261,298 308,998 325,010 219,617
Net Income (Loss) (1,882,667) (2,588,492) (2,823,977) 1,782,588 3,638,206
Basic & Diluted Earnings
(Loss) per Common Share (.38) (.54) (.62) .39 .80
Total Assets 6,641,433 8,751,343 12,741,140 12,992,111 13.809.583
Total Shareholders' Equity 5,974,571 7,857,238 11,981,480 12,561,548 13,013,459
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company sells specialty personal care/cosmetics products, primarily
for skin care, and to a lesser extent oral health care products, most of which
are covered by patent, license and/or royalty agreements. The Renegotiated
License Agreement provides QVC with certain exclusive rights to purchase certain
products solely from the Company for sale in the Western Hemisphere. In
addition, the Patent Agreement with National Patent provides for reciprocal
royalty payments based on the sale of certain of each party's products. The
Company is developing other personal care/cosmetics for consumers using Hydron
polymers. The Company also uses its patented technology as a drug delivery
system in one of its proprietary products, in which Hydron polymers act as a
drug release mechanism. The Company intends to continue to explore the efficacy
of using its technology for such purposes and would, when appropriate, either
seek licensing arrangements with third parties, or develop and market
proprietary products through its own efforts. The Company commenced marketing
its skin care product line on QVC in April 1994.
Substantially all of the Company's net sales are derived from sales to QVC under
the Renegotiated License Agreement. Pursuant to the Renegotiated License
Agreement, if QVC fails to meet the stipulated minimum product purchase
requirements at the May 31, 1999 measurement date, the Company alone can elect
to continue or terminate the agreement. Management does not believe that QVC
will meet the stipulated minimum product purchase requirements for the term
ending May 31, 1999. The Company has not decided what actions, if any, it plans
to take under such circumstances.
15
RESULTS OF OPERATIONS - FISCAL 1998 VERSUS FISCAL 1997
Net sales for the fiscal year ended December 31, 1998 ("Fiscal 1998")
were $3,983,303, a decrease of $3,321,851, or 45%, from net sales of $7,305,154
for the fiscal year ended December 31, 1997 ("Fiscal 1997"). During Fiscal 1998,
catalog sales decreased by approximately $532,000, or 41%, from $1,301,000 in
Fiscal 1997 to $769,000 in Fiscal 1998. The decrease in Catalog sales resulted
primarily from decreased promotion of the catalog. Although catalog sales
decreased, the catalog was marginally profitable in Fiscal 1998 as compared to a
loss of approximately $1.9 million in Fiscal 1997. Non-catalog sales, including
sales to QVC and affiliates, decreased by approximately $2,790,000, or 46%, from
$6,004,000 in Fiscal 1997 to $3,214,000 in Fiscal 1998. The decrease in
non-catalog sales resulted primarily from decreased sales to QVC, which in turn,
resulted primarily from a reduction in QVC's retail sales due to the amount and
quality of hours provided by QVC, as well as the number of new product
introductions, the amount of competitive products offered by QVC and the
effectiveness of the host and spokesperson.
Approximately 79% and 82% of the Company's non-catalog sales during
Fiscal 1998 and Fiscal 1997, respectively, were to QVC and its related entities,
including the Infomercial Partnership and QVC Europe. Management anticipates
that sales to QVC will continue to be a large percentage of the Company's sales
and, absent the consummation of marketing or distribution arrangements with
third parties other than QVC, the Company's dependence upon QVC as a substantial
customer will remain significant. Any disruption in the Company's relationship
with QVC would have a material adverse effect on the business, financial
condition and results of operations of the Company.
The Company's overall gross profit margin remained at 60% of net sales
for both Fiscal 1998 and Fiscal 1997. The gross margin on catalog sales
decreased to 79% of net sales in Fiscal 1998 from 80% in Fiscal 1997. The gross
margin on non-catalog sales, including sales to QVC and affiliates, remained at
56% of net sales for both Fiscal 1998 and Fiscal 1997.
Research and development ("R&D") expenses reflect the Company's efforts
to identify new product opportunities, develop and package the products for
commercial sale, perform appropriate efficacy and safety tests, and conduct
consumer panel studies and focus groups. R&D expenses in Fiscal 1998 were
$350,829, an increase of $45,919, or 15%, from R&D expenses of $304,910 in
Fiscal 1997. The amount of R&D expenses per year varies, depending on the nature
of the development work during each year, as well as the number and type of
products under development at such time.
Selling, general and administrative ("SG&A") expenses in Fiscal 1998
were $2,938,992, representing a decrease of $2,478,366, or 46%, from SG&A
expenses of $5,417,358 in Fiscal 1997. This decrease is primarily the result of
lower expenses associated with the Hydron Catalog. Total Catalog SG&A expenses
in Fiscal 1998 were approximately $426,000, a decrease of approximately
$1,874,000, or 81%, from Catalog SG&A expenses of approximately $2,300,000 in
Fiscal 1997. Expenses attributed to the Catalog include advertising, additional
marketing, customer service and warehouse personnel and related telephone,
postage and supply expenses. Advertising was the most
16
significant Catalog expense, totaling approximately $119,000 in Fiscal 1998 and
approximately $1.6 million in Fiscal 1997. Included in advertising in Fiscal
1997 were sports sponsorship related expenses of approximately $771,000. Such
sports sponsorships were discontinued during Fiscal 1997.
SG&A expenses, other than Catalog related expenses, in Fiscal 1998 were
approximately $2,513,000, a decrease of approximately $618,000, or 20%, from
such expenses of approximately $3,131,000 in Fiscal 1997. This decrease was due
primarily to a reduction in legal expenses. Fiscal 1997 legal expense includes
approximately $470,000 incurred in connection with the dispute between the
Company and certain shareholders of the Company (including certain current
directors of the Company) who were members of a group ("13D Group") through
September 19, 1997, including the legal fees and expenses of the 13D Group
reimbursed by the Company. The Company incurred approximately $238,000 and
$75,000 in Fiscal 1998 and Fiscal 1997, respectively, pertaining to legal fees
and related expenses in connection with the pending litigation with Harvey
Tauman. SEE "Legal Proceedings." In November 1998, the Company incurred
approximately $391,000 in payroll and related expenses relating to the voluntary
early termination of an executive officer's employment contract that would have
otherwise provided for continued employment through August 31, 2004.
Disposal of inventory of $442,254 in Fiscal 1998 relates primarily to
the write down, to net realizable value, of components and finished goods of
products that the company does not plan to continue in the future. Substantially
all of these components and finished goods were purchased and/or manufactured
prior to September 1997. Management has decided that there is currently no
viable market for these products, which consist mainly of products outside of
the traditional skin care product line, such as hair care, sun care and bath and
body products. Disposal of inventory of $651,270 in Fiscal 1997 relates
primarily to the write down, to net realizable value, of the Company's vitamin
and nutritional supplement line of products. The Company has discontinued this
line of products.
Interest and investment income in Fiscal 1998 was $144,203, a decrease
of $67,168, or 32%, from interest income of $211,371 in Fiscal 1997, due
primarily to lower cash balances as a result of the factors discussed above. The
Company maintains a conservative investment strategy, deriving investment income
primarily from U.S. Treasury securities.
The Company had a net loss for Fiscal 1998 of $1,882,667, a decrease
of $705,825, or 27%, from the net loss of $2,588,492 for Fiscal 1997,
primarily as a result of the factors discussed above.
RESULTS OF OPERATIONS - FISCAL 1997 VERSUS FISCAL 1996
Net sales for the fiscal year ended December 31, 1997 ("Fiscal 1997")
were $7,305,154, a decrease of $807,518, or 10%, from net sales of $8,112,672
for the fiscal year ended December 31, 1996 ("Fiscal 1996"). During Fiscal 1997,
Catalog sales
17
increased by approximately $1.1 million and sales to QVC and its affiliates
decreased by approximately $1.9 million from sales in Fiscal 1996. The increase
in Catalog sales resulted from a full year of Catalog sales, which was initiated
in November 1996. The decrease in non-catalog sales resulted from decreased
sales to QVC ($1.2 million), the Infomercial Partnership ($500,000) and QVC
Europe ($200,000). QVC's purchasing patterns are affected primarily by the
amount and timing of the Hydron Care programming.
Approximately 82% and 97% of the Company's sales during Fiscal 1997 and
Fiscal 1996, respectively, were to QVC and its related entities, including the
Infomercial Partnership and QVC Europe.
The Company's overall gross profit margin increased to 60% in Fiscal
1997, compared to 59% in Fiscal 1996, primarily as a result of an increase in
Catalog sales (gross margin of 79%) offset in part by a decrease in gross
margins on products sold to QVC. The reduction in gross margins on products sold
to QVC relates primarily to fluctuations in the mix of products sold to QVC in
those periods.
R&D expenses reflect the Company's efforts to identify new product
opportunities, develop and package the products for commercial sale, perform
appropriate efficacy and safety tests, and conduct consumer panel studies and
focus groups. R&D expenses in Fiscal 1997 were $304,910, a decrease of $192,989,
or 39%, from R&D expenses of $497,899 in Fiscal 1996. The amount of R&D expenses
per year varies, depending on the nature of the development work during each
year, as well as the number and type of products under development at such time.
Included in R&D expense in Fiscal 1996 is approximately $200,000 of royalty fees
paid to a consultant relating to product development under a contract that
expired on December 31, 1996.
SG&A expenses in Fiscal 1997 were $5,417,358, an increase of
$2,093,337, or 63%, from SG&A expenses of $3,324,021 in Fiscal 1996. This
increase is primarily the result of expenses associated with the Hydron Catalog,
which was initiated in November 1996. Total Catalog SG&A expenses were
approximately $2.3 million in Fiscal 1997, as compared to approximately $449,000
in Fiscal 1996. Expenses attributed to the Catalog include advertising,
additional marketing, customer service and warehouse personnel and related
telephone, postage and supply expenses. Advertising was the most significant
Catalog expense, totaling approximately $1.5 million in Fiscal 1997 and
approximately $394,000 in Fiscal 1996. Included in advertising in Fiscal 1997
and Fiscal 1996 were sports sponsorship related expenses of approximately
$771,000 and $158,000, respectively. Such sports sponsorships were discontinued
during Fiscal 1997.
SG&A expenses, other than Catalog related expenses, in Fiscal 1997 were
approximately $3,131,000, an increase of approximately $256,000, or 9%, from
such expenses of $2,875,000 in Fiscal 1996. This increase was due primarily to
legal expenses of approximately $470,000 incurred in connection with the dispute
between the Company and the 13D Group through September 19, 1997, including the
legal fees and expenses of the 13D Group reimbursed by the Company. This
increase in legal fees was partially
18
offset by a reduction of approximately $102,000 in promotional expenses
associated with the Hydron newsletter sent to QVC customers in Fiscal 1996.
Disposal of inventory of $651,270 in Fiscal 1997 relates primarily to
the write down, to net realizable value, of the Company's vitamin and
nutritional supplement line of products. The Company has discontinued this line
of products.
Distribution Agreement expense of $3,149,718 in Fiscal 1996 pertains to
costs incurred in connection with the execution and delivery of the Amended
License Agreement, whereby the Company granted DTR an option to purchase 300,000
shares of the Company's Common Stock at $.05 per share, resulting in a one-time
non-cash charge against earnings of approximately $3.1 million. Such option was
exercised on January 6, 1997.
Interest and investment income in Fiscal 1997 was $211,371, a decrease
of $97,627, or 32%, from interest income of $308,998 in Fiscal 1996, due
primarily to lower cash balances as a result of the factors discussed above, the
payment of dividends and the repurchase of the Company's Common Stock (both of
which programs were discontinued). The Company maintains a conservative
investment strategy, deriving investment income primarily from U.S. Treasury
securities.
The Company had a net loss for Fiscal 1997 of $2,588,492, a decrease of
$235,485, or 8%, from the net loss of $2,823,977 for Fiscal 1996, primarily as a
result of the factors discussed above.
RESULTS OF OPERATIONS - FISCAL 1996 VERSUS FISCAL 1995
Net sales for Fiscal 1996 were $8,112,672, an increase of $809,204, or
11%, from net sales of $7,303,468 for the fiscal year ended December 31, 1995
("Fiscal 1995"). This increase is primarily the result of QVC's purchasing
patterns, along with increased sales to the Infomercial Partnership and QVC
Europe. QVC's purchasing patterns are primarily affected by the timing of the
Hydron Care programming.
Approximately 97% and 98% of the Company's sales during Fiscal 1996 and
Fiscal 1995, respectively, were to QVC and its related entities, including the
Infomercial Partnership and QVC Europe.
The Company's gross profit margin decreased to 59% in Fiscal 1996,
compared to 65% in Fiscal 1995. This decrease is due primarily to fluctuations
in the mix of products sold to QVC in those periods, increased sales to the
Infomercial Partnership (at lower gross margins), and reduced pricing on
products sold to QVC as a result of the Amended License Agreement.
R&D expenses reflect the Company's efforts to identify new product
opportunities, develop and package the products for commercial sale, perform
appropriate efficacy and safety tests, and conduct consumer panel studies and
focus groups. R&D
19
expenses in Fiscal 1996 were $497,899, an increase of $320,431, or 181%, from
R&D expenses of $177,468 in Fiscal 1995.The amount of R&D expenses per year
varies, depending on the nature of the development work during each year, as
well as the number and type of products under development at such time. Included
in R&D expense in Fiscal 1996 is approximately $200,000 of royalty fees paid to
a consultant relating to product development under a contract that expired on
December 31, 1996.
SG&A expenses in Fiscal 1996 were $3,324,021, an increase of
$1,035,180, or 45%, from SG&A expenses of $2,288,841 in Fiscal 1995. This
increase is attributable to an overall increase in salary requirements,
expansion of full-time staff, including customer service personnel, additional
office and warehouse rent and increased advertising expense, primarily relating
to the production, distribution and advertising for the Company's new direct
mail Catalog launched in November 1996.
Distribution Agreement expense of $3,149,718 pertains to costs incurred
in connection with the execution and delivery of the Amended License Agreement,
whereby the Company granted DTR an option to purchase 300,000 shares of the
Company's Common Stock at $.05 per share, resulting in a one-time non-cash
charge against earnings of approximately $3.1 million.
Interest and investment income in Fiscal 1996 was $308,998, a decrease
of $16,012, or 5%, from interest income of $325,010 in Fiscal 1995, due
primarily as a result of lower interest rates. The Company maintains a
conservative investment strategy, deriving investment income primarily from U.S.
Treasury securities.
Net income for Fiscal 1996 decreased to a net loss of $2,823,977 from
net income of $1,782,588 for Fiscal 1995, primarily as a result of the factors
discussed above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital was approximately $3,714,000 at December
31, 1998, including cash and cash equivalents of approximately $2,128,000.
Investing activities provided $254,383 in Fiscal 1998, as compared to a
use of $343,894 in Fiscal 1997. The investing activities proceeds in Fiscal 1998
were due primarily to a distribution of approximately $275,000 received from its
investment in Hydromercial Partners, the Company's joint venture with QVC. The
remaining undistributed investment in Hydromercial Partners is approximately
$54,000 at December 31, 1998 The Fiscal 1997 investing activities consisted
primarily of leasehold improvements for the expansion the Company's new
administrative office.
There were no financing activities in Fiscal 1998. Financing activities
in Fiscal 1997 related primarily to the payment of cash dividends totaling
$1,233,918 and the expenditure of $431,345 for the purchase of 50,200 shares of
the Company's Common Stock at an average price per share of $8.60. In September
1997, the Company's Board of Directors suspended the quarterly dividends and
canceled the stock repurchase program.
20
Based on the Company's present cash position, absence of any short or
long term debt, arrangements with third parties for contractual manufacturing
and R&D, and the Company's present business strategy, management believes that
the Company has adequate resources to meet normal, recurring obligations, for at
least the next twelve months, as they become due. Further, in view of the thirty
day payment terms in connection with sales to QVC, management does not
anticipate any difficulty in financing foreseeable inventory requirements. The
Company has had, and is continuing to have discussions with QVC regarding
possible amendments to the Renegotiated License Agreement in an effort to boast
retail sales of the Hydron products. However, there can be no assurances that
such discussions will be successful, and any further material reduction in the
volume of sales to QVC would have a material adverse effect on the Company's
business, financial condition and results of operations. In addition, ongoing
legal expenses, including attorney's fees and out-of-pocket expenses, incurred
in connection with the pending litigation between the Company and Harvey, Tauman
may have, and any adverse monetary judgment against the Company, in a material
amount, would have an adverse effect on the Company's liquidity. See Item 3.
Legal Proceedings.
The Company does not have the financial resources to sustain a national
advertising campaign to market its products in a conventional retail mode. In
view of the foregoing, management's strategy has been to enter into marketing,
licensing and distribution agreements with third parties (such as QVC and the
Infomercial Partnership) which have greater financial resources than those of
the Company and that can enhance the Company's product introductions with
appropriate national marketing support programs.
The effect of inflation has not been significant upon either the
operations or financial condition of the Company.
THE YEAR 2000 ISSUES
The Company is dependent upon computer technology to effectively carry
out its day-to-day operations. In addition, the Company is dependent on
suppliers and customers who also use computer technology in the conduct of their
business. The terms "Year 2000 issues" or "Year 2000 problems," or words of a
similar nature, refer to the potential for failure of computer applications as a
result of the failure of programs to properly recognize and handle dates beyond
the year 1999. In the case of the Company, such computer applications may
include customer order processing, inventory management, shipment of products,
internal financial systems and other information systems, among others.
- READINESS
The Company's assessment of the possible consequences of Year 2000
issues on its business, results of operations, or financial conditions is not
complete, but is continuing in accordance with a Year 2000 compliance plan (the
"Year 2000 Plan"). The Year 2000 Plan includes (1) upgrading the Company's
information technology software and embedded technology applications in its
systems, where applicable, to become Year 2000 compliant, (2) assessing the Year
2000 readiness of suppliers and customers, and (3) developing contingency plans,
if practical, for crucial system and processes. Implementation of the Year 2000
Plan has been undertaken with respect to various
21
operating and information systems in varying degrees to date. The Year 2000 Plan
is expected to be fully implemented with respect to crucial information systems
in 1999.
Progress to date includes the purchase of upgraded hardware and
software packages and reprogramming of existing systems. All internal systems
are expected to be Year 2000 compliant in 1999. Because the Company is dependent
on its suppliers and customers to successfully operate its business, the Year
2000 Plan includes an assessment process with respect to those vendors and
customers deemed most critical to the operations and business of the Company. To
date, the Company has contacted certain vendors and anticipates completing its
vendor assessment process by the end of 1999. The initial steps of an analysis
of the Company's significant customer to determine the potential effect of the
Year 2000 issues on this customer has begun and is expected to be completed in
1999. The Year 2000 Plan requires continued assessment throughout 1999 in these
areas.
- COSTS
The costs of the Year 2000 Plan include the purchase price of computer
hardware and software packages, fees for contract programmers and the cost of
internal information technology resources. The costs of achieving Year 2000
compliance have not been material to date and are not expected to be material.
- RISKS
The Company expects no material adverse effect on its results of
operations, liquidity or financial condition as a result of problems encountered
in its own business as a result of Year 2000 issues or as a result of the impact
of Year 2000 problems on its vendors or customers. However, the risks to the
Company associated with Year 2000 issues could be significant. While the Company
is undertaking its own evaluation and testing of its information technology and
non-information technology systems, it is dependent to some extent on the
assurances and guidance provided by suppliers of technology and programming
services as to Year 2000 compliance readiness.
Similarly, the Company's Year 2000 Plan calls for ongoing analysis of
the possible effects of Year 2000 problems on its suppliers of materials and
non-information technology goods and services as well as its customers and
demands for its products. The Company has limited ability to independently
verify the possible effects of Year 2000 issues on its customers and suppliers.
Therefore, the Company's assumptions concerning the effect of Year 2000 issues
on its results of operations, liquidity, and financial condition relies on its
ability to analyze the business and operations of each of its critical vendors
or customers. This process, by the nature of the problem, is limited to such
persons' public statements, their responses to the Company's inquiries, and the
information available to the Company from third parties concerning the
industries or particular vendors or customers involved.
22
Risk also exists that despite the Company's best efforts, critical
systems may malfunction due to year 2000 problems and disrupt its operations.
The Company is unable to determine at this time the nature or length of time for
such possible disruption and therefore the potential materiality thereof to its
business or profitability.
Interruptions of communication services or power supply due to Year
2000 problems can cause affected locations to cease or curtail production or
receipt and shipment of materials and products. The Company is dependent on the
suppliers of power and communication services that no such disruptions occur.
- CONTINGENCY PLANS
As part of its Year 2000 Plan, the Company will continue to identify
and evaluate risks and possible alternatives should various contingencies arise.
The Company has prioritized remediation of its most crucial information systems
and believes that they will be Year 2000 compliant by the end of 1999. Should
unforeseen circumstances result in substantial delay that may lead to disruption
of business, the Company will develop contingency plans where possible and not
cost prohibitive. To some extent the Company may not be able to develop
contingency plans, such as in the case of communication services or the supply
of power.
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The statements contained in this Report on Form 10-K that are not
purely historical are forward looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including statements regarding the Company's expectations, hopes,
intentions, beliefs or strategies regarding the future. Forward looking
statements include the Company's liquidity, anticipated cash needs and
availability, and the anticipated expense levels under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations." All
forward looking statements included in this document are based on information
available to the Company on the date of this Report, and the Company assumes no
obligation to update any such forward looking statement. It is important to note
that the Company's actual results could differ materially from those expressed
or implied in such forward looking statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information required by this item is set forth in the Consolidated
Financial Statements contained in this report and is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company are contained in
this report following Item 14.
23
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
IDENTIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
Listed below are the directors and executive officers of the Company as
of March 25, 1999:
NAME POSITION
Robert T. Austen Executive Vice President and Chief Operating Officer
Richard Banakus Director, Chairman of the Board and Interim President
Thomas G. Burns Vice President-Finance, Chief Financial Officer and
Treasurer
Mark Egide Director
Karen Gray Director
Charles Johnston Director
Chaudhury M. Prasad Vice President-Operations and Secretary
Richard Tauman Director
BUSINESS EXPERIENCE
Robert T. Austen, age 46, has served as Executive Vice President and
Chief Operating Officer since August 1998. From 1996 to August 1998, Mr. Austen
was Director of Marketing for Beirsdorf, Inc. From 1992 to 1995, Mr. Austen was
Group Product Manager with Beirsdorf. Beirsdorf is a German company, with
offices in Wilton, Connecticut, and is a global leader in skin and wound care
with major brands including Nivea, Nivea Visage, Eucerin and Curad.
Richard Banakus, age 52, has served as a director of the Company since
June 1995 and as Interim President of the Company since September 19, 1997. From
April 1991 to the present, Mr. Banakus has been a private investor with
interests in a number of privately and publicly held companies. From July 1988
through March 1991, he was managing partner of Banyan Securities, Larkspur,
California, a securities brokerage firm that he founded.
Thomas G. Burns, age 41, has served as Chief Financial Officer of the
Company since June 1994, as Vice President, Finance since April 1995 and as
Treasurer since September 1997. Mr. Burns served most recently as Audit Senior
Manager for Ernst & Young LLP of West Palm Beach, Florida, where he worked as a
certified public accountant since 1981.
Mark Egide, age 42, has served as a director of the Company since
September 1997. Since September 1989, Mr. Egide has served as President of
Avalon Natural Products, Inc., a cosmetics manufacturing and importing company
which he founded.
25
Karen Gray, age 40, has served as a director of the Company since
December 1997 and has been a consultant to the Company on marketing and
communications matters since November 1996. Ms. Gray has over 16 years of
management experience in marketing communications in various capacities with
various companies. From 1993 to November 1996, Ms. Gray served as Vice
President, Corporate Communications, of the Company. From June 1992 to November
1993, Ms. Gray served as President of MarCom Associates, Inc., a marketing
communications company that she founded.
Charles Johnston, age 63, has served as a director of the Company since
December 1997. During the past 10 years he has served on various boards. Mr.
Johnston is currently Chairman of Ventex Technology, Inc. an electronic
transformer company in Riviera Beach, Florida and AFD Technologies, LLC a
chemical company in Jupiter, Florida. He was previously founder, Chairman and
CEO of ISI Systems, a computer software company listed on the American Stock
Exchange prior to its sale in November 1989 to Teleglobe Corporation in
Montreal, Canada. Mr. Johnston also serves as a Trustee of Worcester Polytechnic
Institute in Worcester and of the Psychiatric Research Center at the University
of Pennsylvania. In addition, he serves as a director of the following
companies: Infosafe Systems, an internet company in New York City; Kideo
Productions, an educational software company in New York City; Spectrum Signal
Processing, a digital signal processing computer hardware and software company
in Vancouver, Canada; and Waste Systems International, a landfill remodeling
company in Cambridge, Massachusetts.
Chaudhury M. Prasad, age 51, was a director of the Company from 1975
through December 1997 and has served as Vice President, Operations, of the
Company since 1976.
Richard Tauman, age 32, has served as a director of the Company since
March 1994 and has been a consultant to the Company since November 1998. Mr.
Richard Tauman served as Executive Vice President (April 1995 to November 1998),
Chief Operating Officer (May 1996 to August 1998) and Vice President,
Production, (March 1994 to April 1995) and various other capacities at the
Company since 1989.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934
The Company's officers, directors and beneficial owners of more than
10% of any class of its equity securities registered pursuant to Section 12 of
the Securities Exchange Act of 1934 ("Reporting Persons") are required under the
Act to file reports of ownership and changes in beneficial ownership of the
Company's equity securities with the Securities and Exchange Commission. Copies
of those reports must also be furnished to the Company. Based solely on a review
of the copies of reports furnished to the Company pursuant to the Act, the
Company believes that during the fiscal year ended December 31, 1998, all filing
requirements applicable to Reporting Persons were complied with, except with
respect to (1) Mr. Richard Banakus, Interim President and Chairman of the Board
of the Company, for whom there was one late filing on Form 4 for the month of
April (the grant of an option); (2) Mr. Robert Austen, Chief Operating Officer
of the Company, for whom there were two late filings, his initial filing on Form
3 and his filing for the month of October (a purchase of Common Stock); and (3)
Mr. Thomas G. Burns, Vice President, Finance and Chief Financial Officer of the
Company, for
26
whom there was one late filing on Form 4 for the month of December (the grant of
an option).
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information for the years ended December
31, 1998, 1997 and 1996 with respect to all compensation awarded to, earned by,
or paid to the Company's Chief Executive Officer and to each of the Company's
executive officers who received salary and bonus payments in excess of $100,000
during the year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM AWARDS
OTHER SECURITIES ALL
ANNUAL UNDERLYING OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS COMPENSATION
Richard Banakus, Interim President 1998 $120,016 - - 2,000 -
1997 $32,312 - - - -
Richard Tauman, Former Executive 1998 $100,960 - $373,388(1) - -
Vice President and Chief Operating 1997 $105,040 - $3,232 - -
Officer 1996 $102,496 $15,000 $2,860 - -
During Fiscal 1998, The Company's Interim President was granted options
to purchase 2,000 shares of the Company's common stock for his participation on
the Company's Board of Directors while serving as the Interim President.
The following table sets forth certain information relating to option
exercises effected during the year ended December 31, 1998, and the value of
options held as of such date by the Company's Chief Executive Officer and all
other persons who were executive officers of the Company and its subsidiaries
for the year ended December 31, 1998. The Company does not have any outstanding
stock appreciation rights.
- ----------------
1 On November 30, 1998, Mr. Richard Tauman's employment was voluntarily
terminated under the terms of his Employment Agreement prior to the end of such
Agreement. This amount reflects additional compensation required under such
Employment Agreement.
27
AGGREGATE OPTION EXERCISES FOR THE YEAR ENDED DECEMBER 31, 1998
AND YEAR END OPTION VALUES
NUMBER OF
SECURITIES UNDERLYING VALUE(2) OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT DECEMBER 31, 1998 AT DECEMBER 31, 1998
SHARES ACQUIRED VALUE ($) EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE REALIZED(3) UNEXERCISABLE UNEXERCISABLE
Richard Banakus -0- -0- 4,000/2,000 -0-/-0-
Richard Tauman -0- -0- 12,000/-0- -0-/-0-
EMPLOYMENT AGREEMENT
Chaudhury M. Prasad has an employment agreement with the Company for a
term extending through April 30, 2003 at a current annual salary of $84,344. His
annual salary may be increased at any time at the discretion of the Board. Mr.
Prasad's employment agreement provides that if (i) a change in control of the
Company has occurred and thereafter such employee shall terminate his employment
with the Company, or (ii) the employment of such employee is terminated by the
Company for any reason other than death, disability or cause, then such employee
shall be entitled to receive (A) his regular compensation, including all awards,
perquisites and benefits, through the date on which his employment terminated
and (B) either (1) a lump sum payment in an amount equal to 2.99 times his "base
salary" (as defined in Section 280G(b)(3) of the Internal Revenue Code of 1986,
as amended) or (2) his base salary in such periodic installments throughout the
balance of the term of such employment agreement as would have been payable if
the employee had not been terminated.
On September 19, 1997, the Board of Directors appointed Richard Banakus
to serve as President of the Company on an interim basis. The Board has agreed
to pay Mr. Banakus a monthly salary of $10,000 and to reimburse his lodging
expenses in Boca Raton, Florida and travel expenses to and from California,
where Mr. Banakus resides. Effective April 1, 1999, Mr. Banakus' salary will be
reduced to $5,000 per month.
On August 10, 1998, the Company hired Robert T. Austen as chief
operating officer and executive vice president The Company is finalizing the
terms of an employment agreement for a term extending through December 1999.
Under this proposed agreement, his salary for the year ended December 31, 1998,
payable at the rate of $135,000 per year, would increase to $140,000 for the
year ended December 31, 1999. The agreement would also provide for a guaranteed
bonus of $25,000 in 1999, equaling to his bonus of $25,000 for 1998. In
addition, the proposed agreement includes additional
- ----------------
2 Total value of unexercised options is based upon the
closing price ($.563) of the Common Stock as reported by NASDAQ on December 31,
1998.
3 Value realized in dollars is the amount that the shareholder is deemed to
have received as the result of the exercise of options, based upon the
difference between the fair market value of the Common Stock as reported by
NASDAQ on the date of exercise and the exercise price of the options.
28
bonuses based on performance standards and the granting of options based on
performance standards.
COMPENSATION OF DIRECTORS
Employees of the Company who also serve as directors are not entitled
to any additional compensation for such service, except for Mr. Richard Banakus,
who is currently Chairman of the Board and is also serving as Interim President.
Nonemployee directors receive an annual fee of $5,000, paid quarterly.
During the Fiscal 1998, each of Messrs. Richard Banakus, Mark Egide, Karen Gray
and Charles Johnston were paid $5,000 for their service as a director; and each
of Messrs. Frank Fiur, Charles Fox, Hugues Lamotte and Samuel Leb was paid
$3,750 for their service as a director.
The 1993 Nonemployee Director Stock Option Plan ("1993 Plan") was
adopted by the Board of Directors on December 22, 1993, approved by the
shareholders on July 19, 1994 and approved, as amended, by the shareholders on
December 17, 1997. The purpose of the 1993 Plan was to assist the Company in
attracting and retaining key directors who are responsible for continuing the
growth and success of the Company. No options were granted under the 1993 Plan
during the year ended December 31, 1998.
On November 10, 1997, the Board of Directors of the Company adopted the
1997 Nonemployee Stock Option Plan ("1997 Plan"). This plan was approved by the
shareholders on December 17, 1997. The purpose of the 1997 Plan is to assist the
Company in attracting and retaining experienced and knowledgeable nonemployee
directors who will continue to work for the best interests of the Company.
The 1997 Plan provides nonqualified stock options for nonemployee
directors to purchase an aggregate of 100,000 shares of Common Stock, with
grants of options to purchase 2,000 shares to each nonemployee director on
October 1, 1997, grants of options to purchase 2,000 shares on each May 1st
thereafter (starting in 1999), and grants of options to purchase 2,000 shares
upon election or appointment of any new nonemployee directors. The options are
not exercisable for a one year period and are to be granted at an exercise price
equal to the average fair market value of the Common Stock during the ten
business days preceding the day of the grant of the option. No options were
granted under the 1997 Plan during the year ended December 31, 1998.
The 1997 Plan also provides nonqualified stock options for nonemployee
directors who serve on committees of the Board of Directors. The options are not
exercisable for a one year period and are to be granted at an exercise price
equal to the average fair market value of the Common Stock during the ten
business days preceding the day of the grant of the option. No options were
granted under this provision of the 1997 Plan during the year ended December 31,
1998.
29
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information as of March 25, 1999
regarding (i) the share ownership of the company by each person who is known to
the Company to be the record or beneficial owner of more than five percent (5%)
of the Common Stock, (ii) the share ownership of each director of the Company,
(iii) the Chief Executive Officer of the Company and each other most highly paid
executive officer of the Company who earned in excess of $100,000 during the
year ended December 31, 1998, and (iv) the share ownership of the Company of all
directors and executive officers of the Company, as a group (eight persons).
NAME AND ADDRESS OF AMOUNT AND NATURE OF APPROXIMATE
BENEFICIAL OWNER BENEFICIAL OWNERSHIP PERCENT OF CLASS
Richard Banakus 344,000(4) 7.0%
82 Verssimo Drive
Novato, CA 94947
Mark Egide 8,000(5) Less than 1%
2505 Vineyard Road
Novato, CA 94952
Karen Gray 17,000(6) Less than 1%
1107 Key Plaza, #244
Key West, FL 33040
Charles Johnston 82,500(7) 1.7%
706 Ocean Drive
Juno Beach, FL 33408
Richard Tauman 17,000(8) Less than 1%
Hydron Technologies, Inc.
1001 Yamato Road, Suite 403
Boca Raton, FL 33431
All directors and executive officers as 560,040(9) 11.3%
a group (8 persons)
- ----------------
4 Consists of 340,000 shares held directly and 4,000 shares issuable upon
exercise of options. Does not include 2,000 shares of Common Stock underlying
options not currently exercisable.
5 Consists of 5,000 shares held directly and 3,000 shares issuable upon
exercise of options.
6 Consists of 3,000 shares held directly and 14,000 shares issuable upon
exercise of options.
7 Consists of 80,000 shares held directly and 2,500 shares issuable upon
exercise of options.
8 Consists of 5,000 shares held directly and 12,000 shares issuable upon
exercise of options.
9 Consists of 502,040 shares held directly and 58,000 shares issuable upon
exercise of options. Does not include 2,000 shares of Common Stock underlying
options not currently exercisable.
30
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During Fiscal 1998, Charles Fox, a director of the Company from
September 1997 to October 1998, was paid a total of $101,000 in advisory fees
and reimbursement of disbursements incurred on behalf of the Company. Mr. Fox
advises the Company on matters relating to research and development.
During Fiscal 1998, Karen Gray, a director of the Company since
December 1997, was paid a total of $48,000 in consulting fees and reimbursement
of disbursements incurred on behalf of the Company. Ms. Gray advises the Company
on matters relating to marketing and communications.
31
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements
The following financial statements required by Item 8 follow Item 14 of this
Report:
PAGE
Report of Independent Certified Public Accountants 36
Financial Statements:
Consolidated Balance Sheets, December 31,
1998 and 1997 37
Consolidated Statements of Operations for the
Years ended December 31, 1998, 1997 and 1996 38
Consolidated Statements of Shareholders'
Equity for the Years ended December 31,
1998, 1997 and 1996 39
Consolidated Statements of Cash Flows for the
Years ended December 31, 1998, 1997 and 1996 40-41
Notes to Consolidated Financial Statements 42-57
All financial schedules are omitted since the required information is not
present, is not in significant amounts sufficient to require submission of the
schedules or because the information required is included in the Consolidated
Financial Statements or notes thereto.
(a)(3) Exhibits
3.1 Restated Certificate of Incorporation of Dento-Med Industries, Inc.
("Dento-Med"), as filed with the Secretary of State of New York on March 4,
1981.(10)
3.2 By-laws of the Company, as amended March 17, 1988.(11)
- -------------
10 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1985.
11 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1987.
32
3.3 Certificate of Amendment of the Restated Certificate of Incorporation of
Dento-Med, as filed with the Secretary of State of New York on November 14, 1988
(filed as Exhibit 3.2 therein).(12)
3.4 Certificate of Amendment of the Restated Certificate of Incorporation of
Dento-Med, as filed with the Secretary of State of New York on July 30,
1993.(13)
4.0 Non-Qualified Stock Option Plan.(14)
4.1 Incentive Stock Option Plan, as amended January 2, 1987.(11)
4.2 1989 Stock Option Plan(15)
4.10 1993 Nonemployee Director Stock Option Plan.(13)
4.11 Warrant Purchase Agreement dated as of May 31, 1996 between QVC and the
Company, filed as Exhibit 4.1 therein.(16)
10.6 Indemnification Agreement dated September 23, 1988 between Dento-Med and
Harvey Tauman (filed therein as Exhibit 10.8).(12)
10.8 Indemnification Agreement dated September 23, 1988 between Dento-Med and
Frank Fiur (filed therein as Exhibit 10.10).(12)
10.9 Indemnification Agreement dated September 23, 1988 between Dento-Med and
Chaudhury M. Prasad (filed therein as Exhibit 10.11).(12)
10.10 Agreement between Dento-Med and National Patent dated November 30,
1989.(17)
10.11 Indemnification Agreement dated May 9, 1989 between Dento-Med and
Samuel M. Leb, M.D.(15)
10.12 Indemnification Agreement dated May 9, 1989 between Dento-Med and Richard
Tauman.(15)
10.13 Indemnification Agreement dated January 14, 1992 between Dento-Med and
Joseph A. Caccamo, Attorney at Law, P.C.(18)
- -------------
12 Incorporated by reference to the Company's report on Form 10-K for the
year ended December 31, 1988.
13 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1993.
14 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1986.
15 Incorporated by reference to the Company's report on Form 10-K for the
year ended December 31, 1989.
16 Incorporated by reference to the Company's report on Form 8-K (date of
event - July 19, 1996).
17 Incorporated by reference to the Company's report on Form 8-K (date of
event - November 30, 1989).
18 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1991.
33
10.23 License Agreement dated December 6, 1993 between QVC Network, Inc. and the
Company (filed in excised form, as confidential treatment has been granted for
certain portions thereof).(19)
10.24 Amended and Restated Employment Agreement between Dento-Med and Harvey
Tauman dated May 13, 1993.(13)
10.25 Amendment to Amended and Restated Employment Agreement between the Company
and Harvey Tauman dated December 20, 1993.(13)
10.26 Amended and Restated Employment Agreement between Dento-Med and Chaudhury
M. Prasad dated May 13, 1993.(13)
10.27 Indemnification Agreement dated April 22, 1993 between the Company and
Nestor Cardero.(13)
10.28 Indemnification Agreement dated April 22, 1993 between the Company and
Karen Gray.(13)
10.31 Letter Agreement among QDirect, Inc., Hydron Direct, Inc. and DTR
Associates dated January 17, 1995.(20)
10.35 Employment Agreement dated September 16, 1994 between the Company and
Richard Tauman.(21)
10.36 Letter Agreement dated December 22, 1994 among the Company, Roy Reiner and
Chemaid Laboratories, Inc.(21)
10.37 Indemnification Agreement dated February 21, 1995 between the Company
and Thomas G. Burns.(21)
10.38 Lease for 1001 Yamato Road, Suite 403, Boca Raton, Florida between PFRS
Yamato Corp. and the Company dated May 8, 1995.(22)
10.39 First Amendment to Lease for 1001 Yamato Road, Suite 403, Boca Raton,
Florida between PFRS Yamato Corp. and the Company dated September 15, 1995.(22)
10.40 Agreement for use and occupancy of a portion of 5 East Building, 95
Mayhill Street, Saddle Brook, New Jersey, between Chemaid Laboratories, Inc. and
the Company dated February 9, 1996.(22)
- --------------
19 Incorporated by reference to the Company's report on Form 8-K (date of
event - December 6, 1993), as amended by the Form 8, Amendment No. 1 to such
Report.
20 Incorporated by reference to the Company's report on Form 8-K (date of
event - January 21, 1995).
21 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1994.
22 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1995.
34
10.41 Depository Agreement between Chemaid Laboratories, Inc. and the Company
dated February 9, 1996.(22)
10.42 Consulting Agreement between Charles Fox Associates, Inc. and the
Company dated February 5, 1996.(22)
10.43 First Amendment to Licensing Agreement dated May 31, 1996 between QVC and
the Company, files as Exhibit 10.1 therein.(16)
10.44 Letter Agreement between QDirect, Inc. and Hydron Direct, Inc. dated
May 31, 1996, filed as Exhibit 10.2 therein.(16)
10.45 Lease Agreement between Industrial Office Associates and the Company dated
March 10, 1997.(23)
10.46 Sponsorship Agreement with Pro Player Stadium dated January 1, 1997.(23)
10.48 Executive Suite License Agreement dated March 4, 1997.(23)
10.49 Sponsorship Agreement with Miami Heat Limited Partnership and Sunshine
Network dated December 1996.(23)
10.50 Consulting Agreement between Charles Fox Associates, Inc. and the
Company dated May 20, 1997.(24)
10.51 Personal Appearance Agreement between Mr. Charles Fox and the Company
dated May 20, 1997.(24)
10.52 Second Amendment to Licensing Agreement dated June 11, 1997 between QVC
and the Company.(24)
10.53 Letter Agreement between QVC and the Company dated October 17, 1997.(24)
10.54 Consulting Agreement between Gloria Barton and the Company dated November
1, 1997.(24)
10.55 Services Agreement between Lauren Anderson and the Company dated January
1, 1998.(24)
10.56 Amendment to Employment Agreement between Richard Tauman and the Company
dated August 13, 1998(25)
- ---------------
23 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1996.
24 Incorporated by reference to the Company's report on Form 10-K for the year
ended December 31, 1997.
25 Filed herewith.
35
10.57 Consulting Agreement between Richard Tauman and the Company dated December
1, 1998.(25)
Amendment to 1993 Nonemployee Director Stock Option Plan.(26)
1997 Nonemployee Director Stock Option Plan.(26)
21 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young, LLP Independent Certified Public Accountants.
27 Financial Data Schedule
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed during the fourth quarter of Fiscal
1998.
- --------------
26 Incorporated by reference to the Company's Definitive Proxy Statement
on Schedule 14A for the year ended December 31, 1996.
36
Report of Independent Certified Public Accountants
The Board of Directors and Shareholders
Hydron Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Hydron
Technologies, Inc. and subsidiaries (the Company) as of December 31, 1998 and
1997, and the related consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Hydron
Technologies, Inc. and subsidiaries at December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1998, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
West Palm Beach, Florida
March 5, 1999
37
Hydron Technologies, Inc. and Subsidiaries
Consolidated Balance Sheets
DECEMBER 31
1998 1997
----------- -----------
ASSETS
Current assets:
Cash, including cash equivalents of $1,896,521
and $1,494,695 at December 31, 1998 and 1997 $ 2,127,781 $ 2,133,722
Trade accounts receivable 428,817 554,476
Inventories 1,751,353 2,798,395
Prepaid expenses and other current assets 72,610 131,562
----------- -----------
Total current assets 4,380,561 5,618,155
Property and equipment, less accumulated depreciation
of $635,816 and $431,762 at December 31, 1998
and 1997, respectively 550,773 734,670
Deferred product costs, less accumulated
amortization of $4,623,451 and $4,313,950 at
December 31, 1998 and 1997, respectively 1,350,978 1,660,479
Investment in joint venture 53,534 288,055
Deposits 305,587 449,984
----------- -----------
$ 6,641,433 $ 8,751,343
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 261,581 $ 580,597
Accrued liabilities 405,281 313,508
----------- -----------
Total current liabilities 666,862 894,105
Commitments and contingencies
Shareholders' equity:
Common Stock; $.01 par value; 30,000,000 shares
authorized, 4,960,336 shares issued and
4,910,136 shares outstanding at both
December 31, 1998 and 1997 49,603 49,603
Additional paid-in capital 19,429,931 19,429,931
Accumulated deficit (13,073,618) (11,190,951)
Treasury Stock, at cost, 50,200 shares (431,345) (431,345)
----------- -----------
Total shareholders' equity 5,974,571 7,857,238
----------- -----------
$ 6,641,433 $ 8,751,343
=========== ===========
SEE ACCOMPANYING NOTES.
38
Hydron Technologies, Inc. and Subsidiaries
Consolidated Statements of Operations
YEAR ENDED DECEMBER 31
1998 1997 1996
----------- ----------- -----------
Net sales $ 3,983,303 $ 7,305,154 $ 8,112,672
Cost of sales 1,590,148 2,904,042 3,323,056
----------- ----------- -----------
Gross profit 2,393,155 4,401,112 4,789,616
Expenses:
Royalty expense 214,414 386,707 386,679
Research and development 350,829 304,910 497,899
Selling, general and administrative 2,938,992 5,417,358 3,324,021
Write down of inventory 442,254 651,270 -
Distribution agreement expense - - 3,149,718
Amortization of deferred product costs 309,501 308,374 308,176
Depreciation and amortization 204,514 182,283 120,193
----------- ----------- -----------
4,460,504 7,250,902 7,786,686
----------- ----------- -----------
Operating loss (2,067,349) (2,849,790) (2,997,070)
Other income (expense):
Interest and investment income 144,203 211,371 308,998
Equity in earnings (loss) of joint venture 40,479 49,927 (135,905)
----------- ----------- -----------
184,682 261,298 173,093
----------- ----------- -----------
Loss before income taxes (1,882,667) (2,588,492) (2,823,977)
Income tax expense - - -
----------- ----------- -----------
Net loss $(1,882,667) $(2,588,492) $(2,823,977)
=========== =========== ===========
Basic and diluted earnings per share
Net loss per common share $ (.38) $ (.54) $ (.62)
=========== =========== ===========
SEE ACCOMPANYING NOTES.
39
Hydron Technologies, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
ADDITIONAL TREASURY
COMMON STOCK PAID-IN ACCUMULATED STOCK TOTAL
SHARES AMOUNT CAPITAL DEFICIT (AT COST) EQUITY
------ ------ ---------- ----------- --------- ------
Balance at December 31, 1995 4,528,936 $45,289 $18,294,741 $(5,778,482)$ - $12,561,548
Issuance of common stock
for services 17,339 173 184,688 - - 184,861
Value of common stock options
issued for non-cash consideration - - 3,100,000 - - 3,100,000
Issuance of common stock upon
exercise of stock options 100,400 1,004 1,251,996 - - 1,253,000
Net loss - - - (2,823,977) - (2,823,977)
Cash dividends ($.50 per share) - - (2,293,952) - - (2,293,952)
--------- ------ ---------- ---------- --------- ----------
Balance at December 31, 1996 4,646,675 46,466 20,537,473 (8,602,459) - 11,981,480
Issuance of common stock
for services 2,661 27 33,236 - - 33,263
Issuance of common stock upon
exercise of stock options 311,000 3,110 93,140 - - 96,250
Purchase of treasury shares, at
cost (50,200 shares) - - - - (431,345) (431,345)
Net loss - - - (2,588,492) - (2,588,492)
Cash dividends ($.25 per share) - - (1,233,918) - - (1,233,918)
--------- ------ ---------- ---------- --------- ----------
Balance at December 31, 1997 4,960,336 49,603 19,429,931 (11,190,951) (431,345) 7,857,238
Net loss - - - (1,882,667) - (1,882,667)
--------- ------ ---------- ---------- --------- ----------
Balance at December 31, 1998 4,960,336 $49,603 $19,429,931 $(13,073,618) $(431,345) $ 5,974,571
========= ====== ========== ========== ========= ==========
SEE ACCOMPANYING NOTES.
40
Hydron Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
1998 1997 1996
----------- ----------- -----------
OPERATING ACTIVITIES
Cash received from customers $ 4,108,962 $ 7,362,409 $ 8,503,910
Cash paid to suppliers and employees (4,515,344) (9,116,272) (6,245,766)
Proceeds from interest on investments 146,058 210,784 318,499
Cash paid for income taxes - (14,000) (40,000)
----------- ----------- -----------
Net cash provided (used) by operating activities (260,324) (1,557,079) 2,536,643
INVESTING ACTIVITIES
Purchase of investments - - (1,949,212)
Proceeds from sale of investments - - 1,949,212
Capital expenditures (20,617) (337,261) (79,568)
Payments for registering patents - (6,633) (6,335)
Proceed from (investment in) joint venture 275,000 - (152,667)
----------- ----------- -----------
Net cash provided (used) by investing activities 254,383 (343,894) (238,570)
FINANCING ACTIVITIES
Proceeds from issuance of common stock - 96,250 1,253,000
Dividends paid - (1,233,918) (2,293,952)
Purchase of treasury stock - (431,345) -
----------- ----------- -----------
Net cash used by financing activities - (1,569,013) (1,040,952)
----------- ----------- -----------
Increase (decrease) in cash and cash equivalents (5,941) (3,469,986) 1,257,121
Cash and cash equivalents at beginning of year 2,133,722 5,603,708 4,346,587
----------- ----------- -----------
Cash and cash equivalents at end of year $ 2,127,781 $ 2,133,722 $ 5,603,708
=========== =========== ===========
CONTINUED ON FOLLOWING PAGE.
41
Hydron Technologies, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
YEAR ENDED DECEMBER 31
1998 1997 1996
----------- ----------- -----------
RECONCILIATION OF NET LOSS TO NET CASH
PROVIDED (USED) BY OPERATING ACTIVITIES
Net loss $(1,882,667) $(2,588,492) $ (2,823,977)
----------- ----------- -----------
Adjustments to reconcile net loss to net cash provided (used) by operating
activities:
Depreciation and amortization 514,015 490,657 428,369
Equity in (earnings) loss of joint venture (40,479) (49,927) 135,905
Issuance of common stock for services - 33,263 184,861
Write down of inventory 442,254 651,270 -
Issuance of stock options for
non-cash consideration - - 3,100,000
Changes in operating assets and
liabilities:
Trade accounts receivable 125,659 57,255 391,238
Inventories 604,788 (622,981) 1,171,620
Prepaid expenses and other current
assets 58,952 386,021 (386,676)
Deposits 144,397 (48,590) 6,206
Accounts payable (319,016) 127,260 217,692
Accrued liabilities 91,773 7,185 111,405
----------- ----------- -----------
Total adjustments 1,622,343 1,031,413 5,360,620
----------- ----------- -----------
Net cash provided (used) by
operating activities $(260,324) $(1,557,079) $ 2,536,643
=========== =========== ===========
SEE ACCOMPANYING NOTES.
42
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 1998, 1997 and 1996
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION OF BUSINESS
Hydron Technologies, Inc. and subsidiaries (the "Company") sell consumer and
professional products, primarily in the personal care/cosmetics field. The
Company has an exclusive licensing agreement with QVC, Inc. (QVC) for the sale
of the Company's Hydron polymer-based consumer products in the Western
Hemisphere. QVC, a significant customer, purchases the Company's products and
takes physical possession of these products prior to QVC's sale to the ultimate
end user. The products are sold and shipped to the end user by QVC. The sales of
the Company's products to QVC are not conditioned upon QVC's sale of the
products to the ultimate end user. The Company also holds the exclusive license
with National Patent Development Corporation (National Patent) to a Hydron
polymer-based drug delivery system for topically applied, nonprescription
pharmaceutical products, which the Company intends to use to develop proprietary
products or license to third parties.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
all subsidiaries. All significant intercompany balances and transactions have
been eliminated in consolidation. The Company's investment in a joint venture is
accounted for using the equity method of accounting. The preparation of
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of three
months or less at the date of acquisition to be cash equivalents. The credit
risk associated with cash equivalents is considered low due to the credit
quality of the issuers of the financial instruments.
CONCENTRATION OF CREDIT RISK
Trade accounts receivable are due primarily from QVC which, by contract, must be
paid to the Company within 30 days after QVC's receipt of goods. The Company
performs ongoing evaluations of its significant customers and does not require
collateral.
43
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or market, and
include finished goods, work-in-progress and raw materials (see Note 2).
LONG-LIVED ASSETS
Long-lived assets, consisting primarily of deferred product costs, are accounted
for in accordance with Financial Accounting Standards Board (FASB) Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of." FASB Statement No. 121 requires impairment losses be
recognized for long-lived assets when indicators of impairment are present and
the undiscounted cash flows are not sufficient to recover the assets' carrying
amount. The Company analyzes undiscounted cash flows on an annual basis. No
impairment losses have been recognized in the three year period ended December
31, 1998.
PROPERTY AND EQUIPMENT
Property and equipment, consisting primarily of office leasehold improvements,
furniture and equipment, is carried at cost. Depreciation and amortization is
computed using the straight-line method over the estimated useful lives of the
assets, ranging from four to six years.
DEFERRED PRODUCT COSTS
Deferred product costs consist primarily of costs incurred for the purchase and
development of patents and product rights (see Note 3). The deferred product
costs are being amortized over their estimated useful lives of eight to 20 years
using the straight-line method.
COMMON STOCK, COMMON STOCK OPTIONS AND NET LOSS PER SHARE
On October 1, 1998, the Company's shareholders approved a one-for-five reverse
stock split of the Company's Common Stock, which became effective on October 19,
1998. All share data and per share amounts have been adjusted to reflect the
reverse stock split on a retroactive basis.
When the Company issues shares of common stock in exchange for services, an
expense is recognized over the period in which the services are rendered based
upon the fair value of such shares at the date such arrangements are consummated
or authorized by the Board of Directors, with a corresponding credit to capital.
44
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(CONTINUED)
COMMON STOCK, COMMON STOCK OPTIONS AND NET LOSS PER SHARE (CONTINUED)
The Company has elected to follow Accounting Principles Board (APB) Opinion No.
25, "Accounting for Stock Issued to Employees," and related Interpretations in
accounting for its stock options and has adopted the disclosure-only provisions
of FASB Statement No. 123, "Accounting and Disclosure of Stock-Based
Compensation." Accordingly, no compensation cost has been recognized for the
Company's stock option plans.
REVENUE RECOGNITION AND PRODUCT WARRANTY
Revenue from product sales is recognized at the time of shipment. Provision is
made currently for estimated product returns from the ultimate end user.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations when incurred and are
included in operating expenses.
ADVERTISING
Advertising costs are expensed as incurred and are included in "selling, general
and administrative expenses." Advertising expenses amounted to approximately
$112,000, $1,516,000 and $665,000 for 1998, 1997 and 1996, respectively.
2. INVENTORIES
At December 31, 1998 and 1997, inventories consist of the following:
1998 1997
----------- ----------
Finished goods $ 909,928 $1,731,767
Work-in-process 199,374 270,480
Raw materials and components 642,051 796,148
----------- ----------
$1,751,353 $2,798,395
=========== ==========
45
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
2. INVENTORIES (CONTINUED)
The results of operations for the year ended December 31, 1998 include a charge
of $442,254, relating primarily to the write down, to net realizable value, of
components and finished goods of products that the company does not plan to
continue in the future, which consist mainly of products outside of the
traditional skin care product line, such as hair care, sun care and bath and
body products. The results of operations for the year ended December 31, 1997
include a charge of $651,270, relating primarily to the write down, to net
realizable value, of the Company's vitamin and nutritional supplement line of
products. The Company has discontinued this product line.
3. DEFERRED PRODUCT COSTS AND ROYALTY AGREEMENTS
From 1976 through 1989, the Company and National Patent entered into various
agreements, wherein the Company obtained the exclusive worldwide rights to
market products using Hydron polymers in the consumer and oral health fields,
the two fields in which the Company has concentrated its research and
development efforts, and to utilize the Hydron polymer as a drug release
mechanism in topically applied, nonprescription pharmaceutical products. The
Hydron polymer is the underlying technology in substantially all of the
Company's products. National Patent has the exclusive worldwide rights to market
prescription drugs and medical devices using Hydron polymers. Further, each has
the right to exploit products with Hydron polymers not in the other's exclusive
fields. As consideration for product rights obtained, the Company issued
National Patent an aggregate of 220,000 shares of common stock through 1989,
valued at $5,370,000. The valuation for these shares was based on the market
prices of the Company's common stock at the dates the agreements were made.
The agreements require the Company to pay a 5% royalty to National Patent based
on the net sales of products containing the Hydron polymer. Additionally,
National Patent is required to pay the Company a 5% royalty on its net sales of
Hydron polymer-based products, except with respect to certain excluded products.
In the area of prescription and nonprescription drugs using Hydron polymers as a
drug release mechanism, both the Company and National Patent have agreed to pay
the other a royalty equal to 5% of net sales received from third parties with
regard to such products developed. In addition, each will pay the other 25% of
any up-front license fees, royalties or similar payments received from third
parties with regard to such products developed in the area of nonprescription
drugs.
46
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
3. DEFERRED PRODUCT COSTS AND ROYALTY AGREEMENTS (CONTINUED)
For the years ended December 31, 1998, 1997 and 1996, the Company incurred
royalties payable to National Patent of approximately $190,000, $330,000 and
$387,000, respectively. The Company has not received any royalties from National
Patent during these periods.
4. INVESTMENT IN JOINT VENTURE
During 1995, the Company entered into an agreement with QVC and another company
to form a joint venture know as Hydromercial Partners (the Joint Venture). The
purpose of the Joint Venture was to provide and sell the Company's Hydron
polymer-based skin care line by means of a thirty (30) minute commercial
(Infomercial) which the Joint Venture produced. Sales to the Joint Venture
totaled approximately $459,000 in 1996.
On July 19, 1996, in conjunction with the amended QVC license agreement (see
Note 5), the Joint Venture was dissolved and a new partnership (New Hydromercial
Partners) was formed between the Company and QVC to continue the same activities
as the Joint Venture. There were no sales to New Hydromercial Partners in 1998.
Sales to New Hydromercial Partners were approximately $42,000 and $60,000 in
1997 and 1996, respectively. During 1998, the Company received a cash
distribution of $275,000 from New Hydromercial Partners.
5. SIGNIFICANT CUSTOMER
The Company presently sells a substantial portion of its products to QVC. During
the years ended December 31, 1998, 1997 and 1996, approximately 79%, 82% and
97%, respectively, of the Company's sales were made to QVC and its affiliates.
At December 31, 1998 and 1997, amounts due from QVC included in trade accounts
receivable were approximately $427,000 and $538,000, respectively. The Company
entered into a license agreement with QVC in 1993, whereby QVC was granted
exclusive rights to market and distribute the Company's proprietary consumer
products using Hydron polymers in the Western Hemisphere. On July 19, 1996, the
Company and QVC modified their license agreement (Amended License Agreement).
The Amended License Agreement provides the Company with certain retail marketing
rights, and increases the minimum product purchase requirements QVC must meet on
a biannual basis to maintain their exclusive rights to market Hydron consumer
products through direct response television.
47
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
5. SIGNIFICANT CUSTOMER (CONTINUED)
Pursuant to the Amended License Agreement, certain retail marketing rights
formerly held by Direct to Retail (DTR), which rights were granted by QVC to DTR
under a separate agreement, reverted to the Company. Such retail marketing
rights include prestige retail channels of distribution such as traditional
department and specialty stores, boutique stores and beauty salons, as well as
catalog sales. QVC is entitled to receive a commission from the Company on any
such sales.
Concurrent with the execution of the Amended License Agreement, and as part of
the overall transaction, the Company granted DTR a warrant to purchase 300,000
shares of the Company's common stock at $.05 per share. As a result, the Company
incurred, during 1996, a one-time non-cash charge against earnings of
approximately $3.15 million (Distribution Agreement Expense). Also during 1996,
QVC exercised options to purchase 100,000 shares of the Company's common stock,
at $12.50 per share, and paid the Company $1.25 million. The Company also
granted to QVC, in 1996, warrants to purchase an additional 100,000 shares at
$13.75 per share. Both QVC and DTR have agreed to standstill provisions not to
purchase additional shares of the Company's stock without the Company's
permission.
On June 11, 1997, the Company and QVC renegotiated the Amended License Agreement
(Renegotiated License Agreement) pursuant to which the term of the Amended
License Agreement was extended for one year, with the next two year term
commencing on June 1, 1997.
Under the terms of the Renegotiated License Agreement, QVC must meet certain
minimum product purchase requirements for a two year period, including annual
minimum product purchase requirements, to maintain its exclusive rights. No
obligation exists for QVC to purchase the Company's product except to maintain
such exclusive rights, and no assurances can be given that QVC will meet the
escalating minimum purchase levels for subsequent years in order to maintain
such exclusive rights. If QVC meets the stipulated minimum product purchase
requirements, then the Renegotiated License Agreement renews automatically. If
QVC does not meet the annual or biannual minimum product purchase requirements,
then the Company alone can elect to continue or terminate the Renegotiated
License Agreement. If the Renegotiated License Agreement terminates, the Company
may seek other marketing and distribution arrangements for its products, which
may include distribution agreements with QVC on a nonexclusive arrangement.
Although management believes that there are other avenues for selling its
products, including the Hydron catalog, the loss of QVC as a customer would have
a material adverse effect on the Company's business.
48
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES
The Company accounts for income taxes under FASB Statement No. 109, "Accounting
for Income Taxes" (FASB 109). Deferred income tax assets and liabilities are
determined based upon differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
There has been no income tax expense during the three years ended December 31,
1998.
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's net deferred income taxes are as follows:
1998 1997 1996
----------- ----------- ----------
Net operating loss carryforwards $ 5,414,000 $ 4,956,000 $3,070,000
Tax credit carryforwards 215,000 191,000 190,000
Deferred compensation - - 1,178,000
Other 819,000 392,000 67,000
----------- ----------- ----------
Deferred tax assets 6,448,000 5,539,000 4,505,000
Less valuation allowance (6,448,000) (5,539,000) (4,505,000)
----------- ----------- ----------
Total net deferred taxes $ - $ - $ -
=========== =========== ==========
FASB 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that a $6,448,000 valuation allowance at December 31, 1998 is
necessary to reduce the deferred tax assets to the amount that will more likely
than not be realized. The valuation allowance increased (decreased) by $909,000,
$1,034,000 and $805,000 in 1998, 1997 and 1996, respectively. At December 31,
1997, the Company has available net operating loss carryforwards of $14,248,000,
which will expire beginning in the year 2002 and through the year 2013. The tax
benefit relating to $2,745,000 of the above net operating loss carryforwards
will be charged to shareholders' equity in the period in which the benefit is
recognized.
49
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
The reconciliation of income tax rates, computed at the U.S. federal statutory
tax rates, to income tax expense is as follows:
YEAR ENDED DECEMBER 31
1998 1997 1996
---- ---- ----
Tax at U.S. statutory rates (34) % (34) % (34) %
State income taxes, net of federal tax benefit (4) (4) (4)
Valuation allowance adjustments 38 38 38
---- ---- ----
-0- % -0- % -0- %
==== ==== ====
7. STOCK OPTIONS AND WARRANTS
The number of shares of common stock reserved for issuance at December 31, 1998
and 1997 was 363,100 and 373,101, respectively.
1989 STOCK OPTION PLAN
Under the 1989 Stock Option Plan, the Company may grant incentive stock options,
nonqualified stock options and/or stock appreciation rights to key employees,
officers, directors and consultants of the Company, and its present and future
subsidiaries to purchase an aggregate of 200,000 shares of the Company's common
stock. Activity with respect to this plan is as follows:
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
Outstanding at December 31, 1995 and 1996 15,200 7.19 to 15.00 10.80
Stock options expired (5,000) 7.19 7.19
--------
Outstanding at December 31, 1997 10,200 12.50 to 15.00 12.55
Stock options expired (10,000) 12.50 12.50
--------
Outstanding at December 31, 1998 200 15.00 15.00
========
50
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
1989 STOCK OPTION PLAN (CONTINUED)
These options expire five years from the date of the grant and all outstanding
options are exercisable at December 31, 1998. There are 11,900 options available
for grant under this plan at December 31, 1998.
1993 STOCK OPTION PLAN
Under the 1993 Stock Option Plan, the Company may grant incentive stock options,
nonqualified stock options and/or stock appreciation rights to key employees,
officers, directors and consultants of the Company to purchase an aggregate of
200,000 shares of the Company's common stock. Activity with respect to this plan
is as follows:
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
Outstanding at December 31, 1995 91,500 11.43 to 25.00
Stock options expired (5,000) 25.00
--------
Outstanding at December 31, 1996 86,500 11.43 to 23.03 15.20
Stock options granted 13,000 9.38 to 10.00 9.81
Stock options expired (68,000) 9.38 to 13.13 12.22
--------
Outstanding at December 31, 1997 31,500 10.00 to 23.03 17.81
Stock options granted 15,500 .53 TO 2.42 .78
Stock options expired (2,000) 10.00 10.00
--------
Outstanding at December 31, 1998 45,000 .53 TO 23.03 12.29
========
These options expire five years from the date of the grant and all outstanding
options are exercisable at December 31, 1998. There are 82,000 options available
for grant under this plan at December 31, 1998.
51
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
1993 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
The 1993 Nonemployee Director Stock Option Plan provides grants of stock options
to nonemployee directors of the Company to purchase an aggregate of 50,000
shares of the Company's common stock. Activity with respect to this plan is as
follows:
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
Outstanding at December 31, 1995 24,000 12.50 to 28.44 20.90
Stock options granted 12,000 12.50 12.50
-------
Outstanding at December 31, 1996 36,000 12.50 to 28.44 18.10
Stock options granted 10,000 12.50 12.50
Stock options expired (24,000) 12.50 to 28.44 15.755
-------
Outstanding at December 31, 1997 22,000 12.50 to 28.44 18.125
Stock options expired (2,000) 12.50 12.50
-------
Outstanding at December 31, 1998 20,000 12.50 TO 28.44 18.69
=======
These options expire five years from the date of the grant and all outstanding
options are exercisable at December 31, 1998. There are 2,000 options available
for grant under this plan at December 31, 1998.
52
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
1997 NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
During 1997, the Company adopted the 1997 Nonemployee Director Stock Option
Plan. Such plan provides grants of stock options to nonemployee directors of the
Company to purchase an aggregate of 100,000 shares of the Company's common
stock. Each nonemployee director shall be granted an option to purchase 2,000
shares of the Company's common stock on each October 1st throughout the term of
this plan at exercise prices equal to the average of the fair market value of
the Company's common stock during the ten business days preceding the date of
the grant. In addition, each nonemployee director who sits on a committee of the
Board of Directors shall be granted an option to purchase 500 shares of the
Company's common stock under the same pricing arrangements as above. Subject to
certain exceptions, no options granted under this plan shall be exercisable
until one year after the date of grant. Activity with respect to this plan is as
follows:
WEIGHTED
AVERAGE
NUMBER OF OPTION PRICE EXERCISE
OPTIONS PER SHARE PRICE
Outstanding at December 31, 1996 - - -
Stock options granted 17,000 3.02 to 3.53 3.32
-------
Outstanding at December 31, 1997 and 1998 17,000 3.02 TO 3.53 3.32
=======
These options expire five years from the date of grant and all of the
outstanding options are exercisable at December 31, 1998. There are 83,000
options available for grant under this plan at December 31, 1998.
OTHER OPTIONS AND WARRANTS
The Company has agreements with several consultants who are to provide
financial, business and technical advice to the Company in connection with the
research, development, marketing and promotion of its products and other
matters. In exchange, these consultants were granted warrants and nonqualified
stock options to purchase shares of the Company's common stock at prices
representing the fair market value of the shares at the date of grant. Activity
with respect to options and warrants granted to these consultants is summarized
below:
53
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
OTHER OPTIONS AND WARRANTS (CONTINUED)
WEIGHTED
NUMBER OF AVERAGE
OPTIONS/ PRICE EXERCISE
WARRANTS PER SHARE PRICE
Outstanding at December 31, 1995 252,400 6.88 to 23.13 12.80
Stock warrants granted 400,000 .05 to 13.75 3.50
Stock options exercised (117,739) 7.50 to 12.50 12.20
Stock options expired (3,000) 23.13 23.15
--------
Outstanding at December 31, 1996 531,661 .05 to 15.00 5.85
Stock options and warrants exercised (313,661) .05 to 12.50 .42
Stock options expired (106,000) 6.88 to 15.00 13.52
--------
Outstanding at December 31, 1997 112,000 12.50 to 25.00 13.84
Stock options expired (10,000) 12.50 12.50
--------
Outstanding at December 31, 1998 102,000 13.75 TO 25.00 13.97
========
The options and warrants outstanding at December 31, 1998 expire five years
after the date of grant. At December 31, 1998, all outstanding options and
warrants are exercisable.
The options under this plan that were exercised in fiscal 1997 and 1996 resulted
in proceeds of $96,250 and $1,253,000, respectively. In addition, during 1997
and 1996, options were exercised for services valued at $33,263 and $184,861,
respectively.
See Note 5 relating to options exercised by QVC and warrants granted to DTR and
QVC in conjunction with the Amended License Agreement.
Pro forma information regarding net income and earnings per share is required by
FASB Statement No. 123, which also requires that the information be determined
as if the Company has accounted for its stock options granted subsequent to
December 31, 1994 under the fair value method of that Statement. The fair value
for these options was estimated at the date of the grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for the
years ended December 31, 1998, 1997 and 1996:
54
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
7. STOCK OPTIONS AND WARRANTS (CONTINUED)
1998 1997 1996
Risk-free interest rate 6.5 % 6.5 % 6.5 %
Expected life 3 YEARS 3 years 3 years
Expected volatility .757 .572 .575
Expected dividend yield 0 % 5 % 3.34 %
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock options have characteristics significantly different than
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its stock options.
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The effect of
compensation expense from stock option awards on proforma net income reflects
only the vesting of 1996 and 1995 awards in 1996; the vesting of 1997, 1996 and
1995 awards in 1997; and the vesting of 1998, 1997, 1996 and 1995 awards in
1998, in accordance with Statement No. 123. Because compensation expense
associated with the stock option award is recognized over the vesting period,
the initial impact of applying Statement No. 123 may not be indicative of
compensation expense in future years, when the effect of the amortization of
multiple awards will be reflected in pro forma net income. The effect of
Statement No. 123 resulted in a pro forma net loss of $1,493,025, $2,606,181 and
$2,867,177 for the years ended December 31, 1998, 1997 and 1996, respectively.
In addition, the pro forma net loss per share was $.30, $.55 and $.65 per share
for the years ended December 31, 1998, 1997 and 1996, respectively.
The weighted average grant-date fair value of options granted during the year
ended December 31, 1998 was $.42 for options whose exercise price was equal to
the market price on the date of the grant. The weighted average remaining
contractual life of all options outstanding at December 31, 1998 was 2.49 years.
55
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted loss per
share:
YEARS ENDED DECEMBER 31,
1998 1997 1996
Numerator:
Net loss is both the numerator for basic
loss per share (income available to
common shareholders) and the numerator
for diluted loss per share (income
available to common shareholders after
assumed conversions) $(1,882,667) $(2,588,492) $(2,823,977)
=========== =========== ===========
Denominator:
Denominator for basic loss per share
(weighted-average shares) 4,910,136 4,805,562 4,581,035
Effect of dilutive securities:
Stock options and warrants - - -
----------- ----------- -----------
Denominator for dilutive loss per
share (adjusted weighted-average) 4,910,136 4,805,562 4,581,035
=========== =========== ===========
Basic loss per share $ (.38) $ (.54) $ (.62)
=========== =========== ===========
Diluted loss per share $ (.38) $ (.54) $ (.62)
=========== =========== ===========
See Note 7 for additional disclosures regarding the stock options and warrants.
Options and warrants to purchase 184,200, 192,700 and 669,361 shares of common
stock were outstanding during 1998, 1997 and 1996, respectively, but were not
included in the computation of diluted loss per share because the effect would
be antidilutive to the net loss per share for the respective periods.
56
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
9. RELATED PARTY TRANSACTIONS
During 1997, the Company hired a director as a marketing consultant, who was
paid approximately $48,000 and $21,000 for the years ended December 31, 1998 and
1997, respectively. This consulting relationship ended in October 1998.
The Company has also paid a consultant, who was a director from September 1997
to October 1998, advisory fees and expense reimbursements of approximately
$101,000, $92,000 and $289,000 during the years ended December 31, 1998, 1997
and 1996, respectively.
During the years ended December 31, 1997 and 1996, the Company paid
approximately $68,000 and $79,000, respectively, in legal fees to an attorney
who was also a director of the Company until September 1997.
10. COMMITMENTS
The Company leases office and warehouse space under noncancelable lease
agreements. There is one office lease, which expires in September 2001, and two
warehouse leases, which expire in April 2000 and September 2000. At December 31,
1998, the future minimum rental payments due under such noncancelable leases are
as follows:
1999 $ 288,000
2000 217,000
2001 73,000
---------
$ 578,000
=========
The warehouse lease agreement required a deposit of approximately $385,000 that
is being utilized to pay rent and certain expenses during the last half of the
lease term. Commencing in March 1998, approximately $11,400 of the deposit is
being used to pay for approximately 83% of the monthly warehouse rent and
expenses. Total rent expense was approximately $269,000, $258,000 and $240,000
in 1998, 1997 and 1996, respectively.
The Company has an employment agreement with an executive officer, providing for
his continued employment through April 30, 2003. The current annual salary is
approximately $84,000. The agreement provides for salary increases at the
discretion of the Board of Directors. On November 30, 1998, the Company incurred
expenses of approximately $391,000 relating to the early voluntary termination
of an executive officer's employment agreement that would have otherwise
provided for continued employment through August 31, 2004.
57
Hydron Technologies, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)
11. CONTINGENCIES
On September 30, 1997, Harvey Tauman, formerly Chairman, Chief Executive
Officer, President and Treasurer of the Company, whose employment was terminated
by the Company on September 19, 1997, commenced an action (the "Action") against
the Company in the Circuit Court of the Fifteenth Judicial District in and for
Palm Beach County, Florida. In his complaint in the Action, Mr. Tauman alleges
that the Company breached his employment contract upon the termination of his
employment and seeks damages of not less than $4,000,000, plus interest and
costs. Mr. Tauman also seeks a declaration that his employment was terminated
without cause and that he may continue to exercise his stock options for the
duration of their term notwithstanding the termination of his employment.
On November 4, 1997, the Company served and filed its answer to the complaint in
the Action and asserted counterclaims against Mr. Tauman seeking various relief
against him including an award of compensatory and punitive damages of not less
than $6,000,000, together with appropriate interest, costs and expenses. In its
counterclaims, the Company seeks a declaration, among other things, that Mr.
Tauman breached his employment agreement as a result of wrongful and fraudulent
performance of his duties under the contract. Among other allegations, the
Company contends in its counterclaims that Mr. Tauman improperly caused the
Company to make payments of personal expenses upon the submission by Mr. Tauman
of false expense reports and receipts, caused the Company improperly to enter
into consulting agreements with members of his family and with friends without
Board approval, misrepresented to the Board the financial condition of the
Company and its prospects in order to obtain a grant to himself of bonuses and
stock options to which he would otherwise not have been entitled, caused the
submission to the Board of false projections of the Company's revenues in order
to cause the Board to declare dividends of which he was a substantial recipient
and to approve a share repurchase plan, caused the Company to pay for accounting
services rendered to him and to other members of his family, and intentionally
breached his fiduciary duties to the Company.
The litigation is currently in the discovery stage and is currently set for
trial for August 1999. Management is unable, at this time, to estimate the
likelihood or scope of liability, if any, it may incur as a result of Mr.
Tauman's claims or the likelihood of success of its counterclaims. However, a
monetary judgment in Mr. Tauman's favor, and an adverse judgment on the
Company's counterclaims, would result in a material adverse effect on the
Company's financial condition and results of operations.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HYDRON TECHNOLOGIES, INC.
(Registrant)
By: /S/ RICHARD BANAKUS
------------------------------
Richard Banakus, Interim President
Date: March 25, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant in the capacities and on the dates indicated:
By: /S/ RICHARD BANAKUS By: /S/ THOMAS G. BURNS
------------------- -------------------
Richard Banakus, Thomas G. Burns
Chairman of the Board (principal financial and
(principal executive officer) accounting officer)
Date: March 25, 1999 Date: March 25, 1999
By: /S/ MARK EGIDE By: /S/ KAREN GRAY
-------------- --------------
Mark Egide, Director Karen Gray, Director
Date: March 25, 1999 Date: March 25, 1999
By: /S/ CHARLES JOHNSTON By: /S/ RICHARD TAUMAN
-------------------- ------------------
Charles Johnston, Director Richard Tauman, Director
Date: March 25, 1999 Date: March 25, 1999
59
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
10.56 Amendment to Employment Agreement between Richard Tauman and the
Company dated August 13, 1998.
10.57 Consulting Agreement between Richard Tauman and the Company
dated December 1, 1998.
21 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young, LLP Independent Certified Public
Accountants.
27 Financial Data Schedule.