U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (MARK ONE) [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarter ended March 31, 1998 [ ] TRANSITION REPORT UNDER SECTION 13 OR A5(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (no fee required) Commission file number 0-23544 ------- EROX CORPORATION ---------------------------------------------- (Name of small business issuer in its charter) California 94-3107202 - --------------------------------------- -------------------- (State or other jurisdiction of (I.R.S. employee incorporation or organization) Identification No.) 4034 Clipper Court, Fremont, California 94538 - --------------------------------------- -------------------- (Address of principal executive offices) (Zip code) Issuer's telephone number: (510) 226-6874 -------------- Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] (APPLICABLE ONLY TO CORPORATE REGISTRANTS) State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. 10,289,488 shares of Common Stock as of May 5, 1998. Total Pages: 21 EROX CORPORATION INDEX Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements Condensed Balance Sheets (Unaudited) as of March 31, 1998 and December 31, 1997...........................................................................2 Statements of Operations (Unaudited) for the Three Months Ended March 31, 1998 and 1997.........................................................................3 Condensed Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 1998 and 1997...................................................................4 Notes to Condensed Financial Statements (Unaudited).............................................5 Item 2. Management's Discussion and Analysis Management's Discussion and Analysis of Financial Condition and Results of Operations...........6 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K.................................................................8 SIGNATURES........................................................................................................9 PART I FINANCIAL INFORMATION Item 1. Financial Statements EROX Corporation Balance Sheets March 31, December 31, 1998 1997 ------------ ------------ Assets Current assets: Cash and cash equivalents $ 33,930 $ 248,617 Accounts receivable, net of allowances of $499,606 2,670,450 3,084,784 and $822,813 in 1998 and 1997, respectively Inventory 3,215,413 3,421,298 Other current assets 146,276 128,817 ------------ ------------ Total current assets 6,066,069 6,883,516 Property and equipment, net 84,366 99,491 ------------ ------------ $ 6,150,435 $ 6,983,007 ============ ============ Liabilities and shareholders' equity Loan payable, bank $ 614,462 $ 548,000 Accounts payable 393,631 800,648 Other accrued expenses 1,486,122 1,205,069 ------------ ------------ Total current liabilities 2,494,215 2,553,717 Commitments -- -- Shareholders' equity: Convertible preferred stock, issuable in series, no par value, 10,000,000 shares authorized, 1,433,333 shares issued and outstanding at March 31, 1998 and December 31, 1997, respectively 2,145,535 2,145,535 Common stock, no par value, 40,000,000 shares authorized, 10,289,488 shares issued and outstanding at March 31, 1998 and December 31, 1997, respectively 17,667,024 17,667,024 Accumulated deficit (16,156,339) (15,383,269) ------------ ------------ Total shareholders' equity 3,656,220 4,429,290 ------------ ------------ $ 6,150,435 $ 6,983,007 ============ ============ <FN> See accompanying notes. </FN> EROX Corporation Statements of Operations Quarter ended March 31, ----------------------- ------------ ------------ 1998 1997 ------------ ------------ Net sales $ 3,363,161 $ 5,096,289 Cost of goods sold 1,044,199 907,686 ------------ ------------ Gross profit 2,318,962 4,188,603 Expenses: Research and development 82,132 91,770 Selling, general and administrative 2,999,595 3,907,279 ------------ ------------ Total expenses 3,081,727 3,999,049 ------------ ------------ Income (loss) from operations (762,765) 189,554 Interest income 56 11,980 Interest (expense) (10,955) (2,543) Other (expense) 594 1,474 ------------ ------------ Income (loss) before income taxes (773,070) 200,466 Income taxes -- 10,783 ------------ ------------ Net income (loss) $ (773,070) $ 189,683 ============ ============ Net income (loss) per common share-basic $ (.08) $ .02 ============ ============ Net income (loss) per common share- assuming dilution $ (.08) $ .02 ============ ============ Weighted average shares used in calculation of earnings per share 10,289,488 10,221,260 ============ ============ Weighted average shares and equivalents, if dilutive, used in calculation of net income (loss) per common share 10,289,488 10,577,397 ============ ============ See accompanying notes. EROX Corporation Statements of Cash Flows Quarter ended March 31, ----------------------- 1998 1997 ----------- ----------- Cash flows from operating activities Net income (loss) $ (773,070) $ 189,682 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 15,125 15,296 Changes in operating assets and liabilities: Accounts receivable 414,334 (1,677,813) Inventory 205,885 (1,602,757) Other current assets (17,459) (385,062) Accounts payable and accrued liabilities (125,964) 862,406 ----------- ----------- Net cash used in operating activities (281,149) (2,598,247) Cash flows from investing activities Purchase of property and equipment -- (87,254) ----------- ----------- Net cash provided by (used in) investing activities -- (87,254) Cash flows from financing activities Proceeds from bank borrowings 66,462 442,378 Proceeds from issuance of common stock -- 184,039 ----------- ----------- Net cash provided by financing activities 66,462 626,417 Net increase/(decrease) in cash and cash equivalents (214,687) (2,059,084) Cash and cash equivalents at beginning of the year 248,617 2,059,084 ----------- ----------- Cash and cash equivalents at end of the year $ 33,930 $ -- =========== =========== See accompanying notes. EROX Corporation Notes to Condensed Financial Statements (unaudited) March 31, 1998 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 1998 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 1998. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-KSB for the year ended December 31, 1997. Inventory Inventories are stated at the lower of cost (first in - first out method) or market. The inventory at March 31, 1998 consists of finished goods inventory valued at $1,512,065 work in process of $210,754 and raw materials of $1,492,594. At December 31, 1997, these balances were $1,665,393, $151,143 and $1,604,762, respectively. Net (Loss) Income Per Share In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings per Share. Statement 128 replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to the previously reported fully diluted earnings per share. All per share amounts for all periods have been presented, and where necessary, restated to conform to Statement 128 requirements. Basic net (loss) income per share is computed using the weighted-average number of common shares outstanding. Diluted net income per share is computed using the weighted-average number of common shares and dilutive common equivalent shares outstanding during the period. Dilutive common share equivalents consist of employee stock options using the treasury stock method and dilutive convertible securities using the if-converted method. Diluted loss per share is computed using the weighted-average number of common shares outstanding during the period. Common stock equivalents are excluded from the diluted loss per share computation as their effect in antidilutive. The following table sets forth the computation for basic and diluted (loss) income per share: March 31, 1998 March 31 1997 ------------ ------------ Numerator: Net (loss) income from operations $ (773,070) $ 189,683 Denominator: Denominator for basic earnings per share-data 10,289,488 10,221,260 Effect of dilutive securities: Employee stock options -- 356,137 ------------ ------------ Denominator for diluted earnings per share-data 10,289,488 10,577,397 Basic net (loss) income per share $ (0.08) $ 0.02 ------------ ------------ Diluted net (loss) income per share $ (0.08) $ 0.02 ------------ ------------ Item 2. Management's Discussion and Analysis This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Except for the historical information contained in this discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to the Company's plans for sales growth and expansion into new channels of trade, expectations of gross margin, expenses, new product introduction, and the Company's liquidity and capital needs. These matters involve risks and uncertainties that could cause actual results to differ materially from the statements made. In addition to the risks and uncertainties described in "Risk Factors", below, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation. These and other factors may cause actual results to differ materially from those anticipated in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Risk Factors The Company's future results may be affected to a greater or lesser degree by the following factors among others: Competition: The prestige fragrance market is volatile and extremely competitive. Consumer preferences and demands can shift dramatically reflecting changes in fashion and current fads. There are numerous fragrance products that are better known than the products marketed by the Company. There are also many companies which have substantially greater resources than EROX and which have the ability to invest heavily in new product development and introduction. The Company can expect that its competitors will attempt to compete with the Company through the introduction of new products and promotion of existing products. In addition, the product life cycle of fragrances is shortening. Traditional fragrance companies now introduce a new fragrance every one to two years compared to every four to five years as in the past. This increase in competing fragrances makes it difficult for any one fragrance to hold the consumer's attention on a long-term basis. Although the Company believes the inclusion of human pheromones as a component clearly differentiates its products, other fragrances are competing for space with the Company's products at both the store level and in print and media advertising. Marketing: The failure to establish and maintain the necessary sales or distribution channels could have a material adverse effect on the Company's business. Although the Company believes its marketing strategy is the most cost-effective way to introduce its products, there can be no assurance that broader-scale retail launches will be successful. The Company cannot guarantee that retail outlets or catalogs will continue to carry the EROX products. If the current strategy is unsuccessful, marketing of the Company's products would require a new strategy and may require a significantly more expensive sales effort for which the Company may not have sufficient funds. Retail environment: Continued consolidation in the retail trade has led to the emergence of four major retail players who control the major share of the market. Federated Department Stores, The May Company, Dayton Hudson/Marshall Fields and Dillard Department Stores now comprise the majority of US upper end department stores. This consolidation could lead to price and promotional pressure and increased credit risk for the Company. The retail environment in better department stores is increasingly challenging. Retailers have aggressively cut inventories across the board. Promotional support in the form of co-op advertising dollars is being cut back and retailers are feeling pressure to become more promotional in order to compete with price conscious chains appealing to bargain hunters. Fragrances and cosmetics are increasingly being sold in secondary markets such as discount perfumeries, drug chains and lower priced department stores. It is not anticipated that the department store class of trade in the U.S. will become more profitable in the near future. Seasonality: Sales in the fragrance industry are generally seasonal, with generally higher sales in the second half of the calendar year as a result of increased demand for fragrance products in anticipation of and during the Christmas holiday season. The anticipated seasonality of the Company's sales could cause a significant variation in its quarterly operating results. Patent protection: There can be no assurance that any patent or patent application owned or controlled by the Company will continue to provide commercially significant protection of the Company's technology or ensure that the Company may not be determined to infringe valid patents of others. No assurance can be given that others will not independently develop substantially equivalent proprietary information or otherwise gain access to the Company's trade secrets or that the Company can meaningfully protect its technology, proprietary information or trade secrets. Attraction and retention of key employees: The success of the Company's future operations depends in large part on the Company's ability to recruit and retain key employees and consultants with research, product development and marketing experience, as well as other professionals who are in considerable demand. There can be no assurance that the Company will be successful in retaining or recruiting such key personnel. Dependence on third parties for manufacturing: The Company does not have facilities to manufacture its products and relies on Pherin to manufacture its pheromones and third parties to supply components and to blend, fill and package its fragrance products. The Company believes that such manufacturing services are the most effective method of producing its products. The majority of the fragrance industry uses contract fillers, and the Company has no current plans to set up its own filling facilities. However, as with any business that is not vertically integrated, if the Company is unable to obtain or retain fragrance suppliers, component manufacturers or third party manufacturing on acceptable terms, it may not be able to obtain commercial quantities of its products, which would adversely affect results. Results of Operations Three Months ended March 31, 1998 as compared to the Three Months ended March 31, 1997 Net sales for the first quarter of 1998 were $3,363,161 representing a decrease of 34% from sales of $5,096,289 for the prior year's quarter. Sales in the first quarter of 1997 included the launch of inner REALM(R) into the major department store chains in the U.S. The Company attributes the 34% decrease in net sales entirely to inner REALM. Initial launch quantities shipped in the first quarter of 1997 were not duplicated by reorders in the first quarter of 1998. The Company's first fragrance offerings: Realm Women(R) and Realm Men(R) have shown level reorder quantities between the two quarters. During the first quarter of 1998, the Company expanded sales to distributors for secondary markets. Also in 1998, international shipments increased with expansion into selected European markets for both retail and direct marketing. The Company plans to aggressively pursue these outlets as they offer a cost-effective method of distribution. Net sales for the quarters ended March 31, 1998 and 1997 were as follows: - -------------------------------------------------------------------------------- Markets 1998 1997 - -------------------------------------------------------------------------------- U.S. Markets $ 2,952,227 $ 4,752,101 International Markets 410,934 344,188 ---------------- ----------------- Net Sales $ 3,363,161 $ 5,096,289 Gross margin for the quarter ended March 31, 1998 declined 13% to $2,318,962 from $4,188,603 in the prior year primarily due to the decrease in full price launch shipments of inner REALM. The Company created inner REALM to be a product with a higher gross margin than Realm Women and Realm Men, and the decrease in the quantity of inner REALM items sold resulted in the margin shortfall. Also contributing to the margin shortfall was the increase in sales to secondary and international classes of trade. The Company sells into these markets through distributors. While the net selling price is lower to distributors than the wholesale price to department stores, the Company anticipates seeing long term benefits as there are no ongoing advertising or field support chargebacks to lower overall operating results. Research and Development expenses for the first quarters of 1998 and 1997 were $82,132 and $91,770, respectively. These costs principally reflect payments and costs under the Company's contract with Pherin Corporation. Operating expenses decreased $907,684 to $2,999,595 in the first quarter of 1998 from $3,907,279 in the first quarter of 1997. While $781,105 of this decrease was attributable to lower advertising and marketing costs, costs in all operational areas were decreased. Headcount in the sales area decreased due to attrition, and the Company used this opportunity to change its focus to emphasizing selling-through at the retail level from selling-into Department stores. The Company replaced regional managers primarily responsible for making headquarters calls with additional field selling staff responsible for in-store activities geared toward selling directly to the retail consumer. The Company anticipates this change in selling strategy will increase retail turns and lead to higher volume sales to its department store customers. Distribution and general and administrative costs decreased as well as selling and marketing in the first quarter of 1998. MIS consulting costs were lower in the 1998 quarter due to completion of the Company's installation of automated warehousing and EDI systems. Additionally, temporary workers employed during the first quarter 1997 launch of inner REALM were not required during 1998. The Company incurred $10,899 in net interest expense during the first quarter of 1998 compared to $9,437 net interest income in 1997. During the first quarter of 1998, the Company was in a net borrowing position as compared to the same period in 1997 when the Company was earning interest on cash balances. LIQUIDITY At March 31, 1998, the Company had borrowed $614,462 against its $3,000,000 line of credit. Working capital was $3,571,854. At March 31, 1997, the Company had net borrowings of $942,378 and working capital of $5,559,853. For the first quarter of 1998, net cash used in operating activities was $281,149 compared to $2,598,247 for the prior year's quarter. Assuming the Company's activities proceed substantially as planned, the Company's line of credit and anticipated revenues from product sales should be adequate to meet its working capital needs over the next twelve months. Working capital requirements will primarily be for the supply of inventory and accounts receivable financing. Additional working capital may be required should the Company's continued expansion fail to generate anticipated consumer response levels. Furthermore, additional working capital may be required should the Company experience a greater than planned success with its product and retail expansion. Funds would be needed for inventory build, accounts receivable financing and staffing purposes. If the Company fails to achieve significant revenues from its 1998 marketing efforts, or if retail expansion proves to be more capital intensive than planned, the Company may require additional funding. On April 1, 1998, the Company signed a renegotiated loan agreement with Mid-Peninsula Bank of Palo Alto, California (the "Bank") providing for a continued line of credit. The Company may borrow up to $3,000,000 at an interest rate equal to the Bank's prime rate plus .75% with borrowings secured primarily by the Company's trade receivables and inventory. The agreement, which expires in April, 1999, contains certain debt-to-equity and working capital covenants. There are no charges for any unused portions of the line. PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibit 10.14 Business Loan Agreement dated April 1, 1998 E- 11 Exhibit 27.01-Financial Data Schedule E- 19 (b) The Company did not file any reports on Form 8-K during the three months ended March 31, 1998. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this Report to be signed on behalf by the undersigned thereunto duly authorized. EROX CORPORATION Registrant Date: May 15, 1998 /s/ William P. Horgan ------------------------------------------ William P. Horgan Chairman and Chief Executive Officer Date: May 15, 1998 /s/ Maxine C. Harmatta ------------------------------------------ Maxine C. Harmatta Vice President, Finance and Administration