-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GqICq/FTzWmMULGt2GJVvk2rHFLVT7vJGS6VsLEz2U8lGZCJH1FH+Tpc4sLxT2CK J4DM4cPuhEkv71Vaxhjluw== 0001095811-00-000868.txt : 20000403 0001095811-00-000868.hdr.sgml : 20000403 ACCESSION NUMBER: 0001095811-00-000868 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 20000331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ELECTROPURE INC CENTRAL INDEX KEY: 0000808015 STANDARD INDUSTRIAL CLASSIFICATION: PATENT OWNERS & LESSORS [6794] IRS NUMBER: 330056212 STATE OF INCORPORATION: CA FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: SB-2/A SEC ACT: SEC FILE NUMBER: 333-41289 FILM NUMBER: 591542 BUSINESS ADDRESS: STREET 1: 23456 S POINTE DR CITY: LAGUNA HILLS STATE: CA ZIP: 92653-1512 BUSINESS PHONE: 9497709347 MAIL ADDRESS: STREET 1: 23456 S POINTE DR STREET 2: SUITE A CITY: LAGUNA HILLS STATE: CA ZIP: 92653 FORMER COMPANY: FORMER CONFORMED NAME: HOH WATER TECHNOLOGY CORP DATE OF NAME CHANGE: 19920703 SB-2/A 1 FORM SB-2 1 As Filed with the Securities and Exchange Commission on March 31, 2000 Registration Statement No. 33-41289 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------- AMENDMENT NO. 2 to FORM SB-2 REGISTRATION STATEMENT Under THE SECURITIES ACT OF 1933 -------------------------- ELECTROPURE, INC. (Name of Small Business Issuer as specified in its charter) CALIFORNIA (State of Other 3589 33-0065212 Jurisdiction or (Primary Standard (IRS Employer Incorporation Industrial Classification ID No.) of Organization) Code Number) 23456 South Pointe, Laguna Hills, California 92653 (949) 770-9347 (Address and telephone number of principal executive offices) -------------------------- FLOYD H. PANNING, President ELECTROPURE, INC. 23456 South Pointe Laguna Hills, California 92653 (949) 770-9347 (Name, address and telephone number of Agent for service of process) -------------------------- Copies of communications to: Ronald P. Givner, Esq. SKADDEN, ARPS, SLATE, MEAGHER & FLOM, LLP 300 South Grand Avenue, 34th Floor Los Angeles, California 90071 (213) 687-5329 Approximate date of commencement of proposed sale to public: As soon as practicable after the registration statement becomes effective. -------------------------- If the only securities being registered on this Form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [ ] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [X] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] 2 CALCULATION OF REGISTRATION FEE
Proposed Proposed Maximum Maximum Offering Aggregate Amount of Title of Each Class of Securities Amount to be Price Per Offering Registration to be Registered Registered Share(1) Price Fee - --------------------------------- ------------ ---------- ------------ ------------- Common Stock, $0.01 par value ....... 7,547,459 $ 1.25 $ 9,434,324 $ 2,471.79 Previously paid ................ 2,743.02 ------------ Amount Due .......................... None
- ------------------------------------ (1) Based on the closing sale price as reported on the Electronic Bulletin Board on March 28, 2000. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. 1 3 P R O S P E C T U S 7,547,459 SHARES OF COMMON STOCK ELECTROPURE, INC. The selling stockholders described in this prospectus may offer and sell from time to time up to 7,547,459 shares of Common Stock of Electropure, Inc. Electropure, Inc. will not receive any proceeds from the sale of such shares of Common Stock, but may receive proceeds upon the exercise of options and warrants for such shares. The selling stockholders may sell the Common Stock offered hereby from time to time through the facilities of the Electronic Bulletin Board, through negotiated transactions or otherwise at market prices prevailing at the time of the sale or at negotiated prices. The Common Stock is quoted on the Electronic Bulletin Board under the symbol "ELTP." On March 28, 2000 the high and low bid prices of the Common Stock on the Electronic Bulletin Board were $1.25 and $1.125 per share. Investing in the Common Stock involves certain risks. See "Risk Factors" beginning on Page 8. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and financial statements appearing elsewhere in this Prospectus. THE COMPANY We have developed a point-of-use model of an electrodeionization ("EDI") water purification system. The EDI system is aimed at the high purity water treatment segment of the commercial (especially semiconductor, pharmaceutical, and cosmetic companies), and industrial (pulp and paper, laboratories, and petrochemical companies) water treatment markets. We believe that the EDI design will give the same output capacity at one-third to one-fifth the cost of current technologies. We also believe that the design allows for the ability to "modularize" the technology's capacity to service installations up to 20 times (or more) the size of current output levels (1/4 to 10 gallons per minute [gpm]). Limited sales of this product began in 1997. In late 1999, we redesigned the EDI module to improve its integration into water treatment systems. The new EDI module, named "XL by Electropure," will be offered for sale beginning in March, 2000. On February 17, 1998, we acquired the rights to certain proprietary membrane technology from Hydro Components, Inc., that we have successfully developed into ion permeable membranes utilizing the acquired technology. We intend to incorporate such membranes into our EDI product. These new ion permeable membranes will allow us to offer more cost-sensitive models of our EDI product to a broader range of users for a wider range of uses. In October, 1997, we acquired an exclusive license to certain patent and intellectual property rights involving laser light scattering techniques for use in the detection and monitoring of toxicants in drinking water. We have successfully developed near "real-time" monitoring systems as a result of our research program. Our EDI product and this new technology are not intended to be integrated into one product. In May, 1998, our Hydro Components Division began offering a line of water and wastewater treatment products for light commercial/industrial customers, including optical lens manufacturers, pharmaceutical and biotechnical firms. We also offer solvent-based coated membranes used in electrodeposition of paint. 3 5
THE OFFERING Securities Offered ...................... 7,547,459 shares of Common Stock. Number of Shares of Common Stock Outstanding ....................... 8,877,341 shares*, with one vote per share. Number of Shares of Class B Common Stock Outstanding ....................... 83,983 shares, with eight votes per share. Number of Shares of Series B Convertible Preferred Stock Outstanding. 1,000,000 shares, with four votes per share. Number of Shares of Convertible Preferred Stock Outstanding ............. 2,600,000 shares, with one vote per share. Use of Proceeds ......................... Any proceeds received by the Company upon exercise of options or warrants held by Selling Shareholders will be used for working capital. Electronic Bulletin Board Symbol ........ ELTP: Common Stock.
RISK FACTORS The securities offered hereby involve a high degree of risk, including limited working capital, and possible dilution. There can be no assurance that we can successfully manufacture and market its EDI water purification product or any other proposed product or sell such products at prices that will result in net income. Actual results of manufacturing, marketing and competitive conditions and other factors may require significant modification of our future operations from those planned operations described herein. - ------------------------------ * Excludes 83,983 shares of Common Stock issuable upon conversion of Class B Common Stock, 1,000,000 shares of Common Stock issuable upon conversion of Series B Preferred Stock and 5,151,327 shares issuable upon exercise of outstanding options or warrants. Also excludes 2,600,000 shares of Convertible Preferred Stock that became redeemable by the Company as of January 31, 1991 for $0.01 per share. 4 6 SUMMARY FINANCIAL DATA We began sales of our patented EDI product in September, 1997 and currently have orders for additional products pending. We do not anticipate that we will generate substantial revenues from the sale of these products until we can raise sufficient working capital to expand our manufacturing operations. In anticipation of such expansion, we relocated to our current, larger facilities in February, 1998. SUMMARY OPERATING STATEMENT DATA:
Fiscal Year Three Months Ended October 31, Ended January 31, -------------------------------- -------------------------------- 1999 1998 2000 1999 ----------- ----------- ----------- ----------- Sales ............................... $ 695,565 $ 805,513 $ 224,570 $ 279,971 Cost of goods sold .................. 898,386 704,365 280,750 252,746 Gross profit (loss) ................. (202,821) 101,148 (56,180) 27,225 Net loss ............................ (1,958,644) (1,506,943) (432,532) (286,037) Net loss per share, basic and diluted (0.23) (0.19) (0.06) (0.03)
SUMMARY BALANCE SHEET:
October 31, 1999 January 31, 2000 ---------------- ---------------- Working capital ..................... $ 199,456 $ (193,268) Total assets ........................ 1,415,285 1,303,651 Total current liabilities ........... 412,012 719,684 Accumulated deficit ................. (21,018,249) (21,450,781) Stockholders' equity ................ 971,292 557,967 Stockholders' equity per common share 0.11 0.07
5 7 RECENT SIGNIFICANT DEVELOPMENTS MICRO IMAGING TECHNOLOGIES In July, 1999, we settled a lawsuit we filed against Wyatt Technology Corporation for breach of the October, 1997 agreement that provided us with exclusive rights to patented laser-based technology. Pursuant to the settlement, we recovered 1.95 million of the 2.1 million shares of Common Stock issued to Wyatt and retained the right to utilize the technology as developed through our Phase 1 research program which was successfully concluded in April, 1998. Our Micro Imaging Technologies Division has recently filed for a new patent application on the method that we have developed since Phase 1 was completed to identify microorganisms such as Cryptosporidium and Giardia. Subsequent research efforts have demonstrated that the process can identify E.coli, salmonella and listeria. Consequently, we believe that our Micro Imaging Technology may result in commercial applications in the clinical laboratory and food processing sectors ANTHONY M. FRANK Between December, 1999 and in February 10, 2000, Mr. Anthony M. Frank, a majority shareholder, loaned us the principal sum of $400,000 at the rate of 10% per annum. In March, 2000, the loans, plus $5,206 in interest accrued, were converted into 405,206 shares of common stock and 202,603 three-year warrants to purchase common stock at $2.00 per share. The warrants are redeemable by us at $0.05 per warrant if the common stock equals or exceeds $4.00 per share for thirty consecutive trading days. The securities were issued pursuant to a private placement offering authorized in February, 2000. In March, 2000, Mr. Frank purchased an additional 500,000 shares and 250,000 warrants of the private placement offering for the purchase price of $500,000. STOCK ISSUANCES Between September 21, 1999 and November 1, 1999, we issued 20,710 shares of Common Stock upon the exercise of options and warrants. We received $3,071 in net proceeds from such exercises. In March, 2000, an additional 110,000 shares of common stock and 55,000 three-year warrants were issued pursuant to subscriptions to the private placement offering by three individuals. We realized $110,000 in net proceeds from these transactions. In March, 2000, we issued 2,500 shares of common stock as partial payment for public relations services to be rendered. 6 8 WHOLLY-OWNED SUBSIDIARIES In February, 2000 we filed the initial documents to form two Nevada corporations which will be wholly-owned subsidiaries of Electropure, Inc. Micro Imaging Technology was formed to conduct our research and development operations on the detection and identification of fluid-borne microorganisms. Electropure EDI, Inc. will conduct manufacturing and sales operations for our EDI line of products. LIMITED WORKING CAPITAL As a result of the delays in bringing the EDI water purification product to market, as well as delays in expanding production of the EDI product and the various legal matters we encountered over the past several years, we have limited working capital. We have sold our Common Stock and warrants to reduce this working capital shortfall. We believe we have adequate sources of working capital to support operations through approximately August 2000. However, we may need additional financing prior to that time and we are currently seeking investments through private placement offerings of securities. In addition, we propose to seek additional financing through corporate borrowing, strategic alliances and/or a public offering of securities through an underwriter. No assurances can be given that we can obtain additional working capital through the sale of Common Stock or other securities, the issuance of indebtedness or otherwise or on terms acceptable to us. Further, no assurances can be given that any such equity financing will not result in a further dilution to the existing shareholders. 7 9 RISK FACTORS An investment in the common stock involves a high degree of risk and should be made only by investors who can afford the loss of their entire investment. Prospective purchasers, prior to making an investment in the common stock, should carefully consider, along with other matters referred to herein, the following risk factors and should consult with their own legal, tax and financial advisors with respect thereto. This Prospectus contains forward-looking statements that involve risk and uncertainties. Our actual results may differ materially from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors." Prospective purchasers should carefully consider, among other factors, the following: 1. STAGE OF DEVELOPMENT OF THE COMPANY. We have redesigned certain components of our EDI product. In fiscal 2000 we plan to begin sales of the redesigned EDI using membranes which we have developed utilizing the technology acquired from Hydro Components, Inc. in February 1998. Although we believe that the redesigned EDI product will enhance our ability to compete, no assurances can be given that we can manufacture sufficient EDI products at an economical cost, or sell such products at a net profit. Further, no assurances can be given that EDI products or other products we offer will receive market acceptance. We are subject to all the risks inherent in the establishment of a new enterprise and the marketing and manufacturing of new products, any of which risks are beyond our control. Further, with regard to the technology we recently acquired, they are also subject to all the risks inherent in trying to adapt a technology for a new use. No assurances can be given that we can successfully develop or market any such products. While units of the high purity point-of-use EDI product have been placed in operation and have been operating efficiently for over two years, there is no assurance that the redesigned EDI will be commercially viable. Actual results of the development activities, manufacturing processes, technological developments, market and competitive conditions, financial resources, results of operations and other factors may require significant modifications to all or part of our proposed business. 2. ACCUMULATED DEFICIT; OPERATING LOSSES; GOING CONCERN. From our inception in 1979 through January 31, 2000, we have accumulated a loss of $21,450,782 and a net stockholders' equity of $557,967. The accumulated loss is principally due to expenses incurred in the development of the EDI product, initial manufacturing start-up costs, initial marketing efforts, administrative expenses and interest, as well as the expenses associated with the research and development of the laser-based monitoring technology acquired in 1997. The report of our independent auditors for the fiscal year ended October 31, 1999 contains an explanatory paragraph as to our ability to continue as a going concern. Our financial statements have been prepared assuming that we will continue as a going concern. As discussed in the notes to the financial statements, our negative cash flows from operations raise substantial doubt about our ability to continue as a going concern. Management's plans in regard to these matters are also described in the notes and in "MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS." 8 10 3. COMPETING PATENT CLAIMS DELAYING SALES; LIMITED PATENT PROTECTION. Delays incurred in marketing our EDI product may have allowed other companies to develop and commence production of similar products. Due to potential competitive pressures, our ability to capitalize on the features of the EDI product in the marketplace may be dependent on our ability to deliver products in the near future. Besides Ionpure Technologies (now U.S. Filter), other companies are believed to have developed or are developing products using electrodeionization or similar technology. We own a U.S. patent and limited foreign patents, with respect to certain aspects of our technology for the EDI. The U.S. patent was granted in 1984 and, subject to payment of certain maintenance fees, will expire in 2001. In the absence of significant patent protection, competitors could legally imitate our design approaches. We may not be able to afford the expenses required to enforce any patent we may have now or in the future and no assurances can be given that any patents would be upheld if challenged, or if upheld, would provide us with meaningful protection. We believe that the patent for the EDI and our technical know-how may be significant in our ability to compete. 4. NECESSITY FOR ADDITIONAL FINANCING. From time to time we have experienced and continue to experience working capital shortfalls that slowed the development of the EDI product. We will be required to raise substantial amounts of new financing, in the form of additional equity investments or loan financing, to carry out our business objectives. There can be no assurance that we will be able to obtain such additional financing on terms that are acceptable to us and at the time we require, or at all. Further, any such financing may cause dilution of the interests of our current shareholders. If we are unable to obtain such additional equity or loan financing, our financial condition and results of operations will be materially adversely affected. Moreover, our estimates of cash requirements to carry out our current business objectives are based upon certain assumptions, including certain assumptions as to revenues, net income (loss) and other factors, and there can be no assurance that such assumptions will prove to be accurate or that unbudgeted costs will not be incurred. Future events, including the problems, delays, expenses and difficulties frequently encountered by similarly situated companies, as well as changes in economic, regulatory or competitive conditions, may lead to cost increases that could have a material adverse effect on us and our plans. If we are not successful in obtaining loans or equity financing for future developments, it is unlikely that we will have sufficient cash to continue to conduct operations as currently planned. We believe that to raise needed capital, we may be required to issue debt or equity securities that are significantly lower than the current market price of our common stock. In the opinion of management, available funds will satisfy our working capital requirements through August, 2000. However, no assurances can be given that such proceeds will satisfy our working capital needs for the period estimated, or; that we can obtain additional working capital through the sale of common stock or other securities, the issuance of indebtedness or otherwise or on terms acceptable to us. Further, no assurances can be given that any such equity financing will not result in a further substantial dilution to the existing shareholders or will be on terms satisfactory to us. 5. PRIOR AND POSSIBLE FUTURE DELAYS IN DEVELOPING THE EDI TECHNOLOGY. The original concept for the EDI technology was a point-of-entry system to treat the entire house or facility. However, inherent difficulties in developing this model due to pre-treatment requirements and high production costs, led to the development of a smaller, point-of-use model of the EDI 9 11 technology aimed at the high purity water treatment segment of the commercial and industrial water treatment markets. Further, at times we have been forced to significantly reduce operations or suspend sales activities due to limited resources or patent disputes. While we have resolved the patent disputes, limited resources could again delay the development and marketing of products. Further, delays can occur in the development or improvement of potential products. Therefore, no assurances can be given as to when we will have the resources to fully market the current EDI technology or any other product. 6. RISK OF NEW PRODUCT AND TECHNOLOGY; PRODUCT LIABILITY. The proposed manufacturing and marketing of the EDI product, incorporating relatively new and unproved membrane technology, has inherent risks. No one can be sure how the products will operate over time under various conditions of actual use. Only a limited number of the EDI products have been placed in operation since 1991, with the majority of EDI products placed in operation since August, 1997. We have successfully built and tested in-house, without independent verification, several prototypes of the redesigned EDI product utilizing new membranes developed from the Hydro Components technology. Even if the product is successfully manufactured and marketed, the occurrence of warranty or product liability, or retraction of market acceptance due to product failure or failure of the product to meet expectations could prevent us from ever becoming profitable. Failure of the product to operate as expected could lead to potential product liability suits. Development of new technologies for manufacture is frequently subject to unforeseen expenses, difficulties and complications and in some cases such development cannot be accomplished. Ionpure and its licensor have significantly greater marketing and financial resources than us. In the opinion of management, the new EDI demonstrates positive attributes, but any such attributes of the EDI product must be balanced against the lack of any significant field operating experience of such product, the existence of established companies in the water purification field with greater financial resources, experience and developed products, the fact that the new EDI product has not been tested on a wide variety of water conditions, including hard water and unknown technological difficulties. The same risks, as well as many of the risks set forth in the other Risk Factors discussed below, do or will also apply to the development of the Micro Imaging Technology for use in detecting dangerous items in water. Further, since the Micro Imaging Technology has not yet been adapted for its intended use, there is a risk that such technology cannot be adapted as contemplated. Further, even if we successfully adapt such technology as intended, there can be no assurances that the developed product will be commercially viable. 7. STATUS OF THE ELECTROPURE "EDI". In late 1990, we developed the point-of-use module of the EDI, aimed at the high purity water treatment market, which is able to desalt 1/4 - 10 gallons of water per minute of pre-treated tap water to a purity level exceeding one-megohm-cm (roughly less than 0.5 parts per million ("ppm") of total dissolved solids ("TDS"). We believe that this model, which has been sold in limited quantities, is significant in its ability to compete in terms of capital cost and product efficiency. In mid-2000, we plan to begin the manufacture and sale of a redesigned model of the EDI utilizing membranes developed using the technology acquired from Hydro Components Inc. ("HCI") at a more competitive cost. Additional models of the EDI which will 10 12 provide higher flow rates are contemplated for development. Additional models of the EDI, for applications other than high purity water treatment, may also result from the development of the HCI membrane technology. No assurances can be given that the EDI will not need additional development work or require further modifications that may require re-engineering of parts and additional delays in mass marketing of the product. Further, no assurances can be given that we will successfully develop additional models of the EDI product. We acquired the right to use the Micro Imaging Technology in water monitoring and successfully completed the first phase of trying to adapt the technology for such use. Additional research and development is currently being conducted on such technology. 8. UNCERTAINTY OF MARKET ACCEPTANCE. While we believe that our EDI product should offer advantages over traditional water purification methods and indications of interest from potential customers is evident, there is no assurance that the product will attain significant market acceptance and generate adequate revenues. Generally, market acceptance of a new technology requires substantial efforts to inform potential customers of the new technology's distinctive characteristics. This effort will be crucial in marketing the EDI product. We will seek to have potential purchasers invest in the EDI product instead of currently available equipment or to treat water that is currently not being treated. While we believe that the redesigned EDI product will be able to be sold at a lower capital cost per gallon of water treated and will have lower operating and maintenance costs than existing competitive products, we have not yet demonstrated that cost savings from frequent use over an extended time period in actual production models. We have also not demonstrated that the EDI product can justify this capital cost or that the demand for high purity water equipment is sufficient to justify the cost. The price of the product is a critical factor in marketing. We believe that the redesigned EDI product will positively address this price factor. Similar risks will apply to the use of any product which may be developed using the Micro Imaging Technology. 9. GOVERNMENT REGULATIONS AND CERTIFICATION. Requirements of a California law provide that water treatment devices which are sold for residential use be certified by the State Department of Health Services, or approved certification facility, if claims are made that the device will remove or reduce a contaminant for which a primary drinking water standard has been established. In addition, California law makes it illegal to make any false claims in connection with the sale of any water treatment product. Other states have similar laws. We believe that the EDI ultrapure technology, which is not intended for drinking water applications, is not subject to these regulations. However, if we offer industrial applications of the EDI point-of-use technology, i.e., hospitals, such products will require approval by Underwriter's Laboratory or equivalent organization. We will seek all necessary approvals or certifications. 10. LARGER AND BETTER FINANCED COMPETITORS. There are many firms in the water purification and related industries, substantially all with financial resources, experience and technical staffs larger than ours. Large competitors include U.S. Filter and GE Power Systems. Several firms have successfully developed products that meet some or most of the needs intended to be met by the 11 13 EDI and have established strong market positions in these areas. These competitors may respond vigorously to any threat to their established market shares. In addition, other companies may be developing or planning the development of devices competitive with our current product. 11. CONTINUED TECHNOLOGICAL CHANGE. The technology upon which the EDI water purification product relies may undergo rapid development and change. There can be no assurance that the technology utilized by us will be competitive in light of possible future technological developments. Further, we cannot assure that our technology will not become obsolete or that we will have adequate funds to meet technological changes. 12. NEED FOR ADDITIONAL EMPLOYEES AND FACILITIES. We relocated our operations to a 30,201 sq. ft. facility in Laguna Hills, California in March 1998. Management estimates that the current facility will be adequate to conduct needed manufacturing activities. Our current employees are sufficient to conduct the manufacturing and administrative functions required at the present time. However, additional employees will be required once manufacturing operations increase and if we are successful in developing a product utilizing the Micro Imaging Technology. No assurance can be given that we can obtain such employees when required. 13. REQUIRED ROYALTIES. The total royalties granted per EDI sold is approximately $42.00, plus approximately $9.00 (until such additional $9.00 of royalties paid equals approximately $525,600 of royalties) for each point-of-entry EDI sold. Royalties for the point-of-use EDI are expected to be approximately 2.05% of net sales. Mr. Harry O'Hare, the founder of the Company, does not hold any royalties in the EDI but does have certain royalty rights in connection with two products he sold to the Company in 1987. Royalties of from 1% to 1-1/2% are payable on certain other EDI products. There can be no assurances that our profitability will not be adversely affected by such royalty payments. As of the fiscal year ended October 31, 1999, we had accrued $8,190 in royalties due pursuant to the above arrangements. 14. FLUCTUATIONS IN QUARTERLY RESULTS OF OPERATIONS. Our revenues in the next several years may be uneven depending on the timing and sales of products or the potential licensing of technology. The timing of such events, if they occur, could have a significant effect on results of operations. The results of one quarter of operations are not necessarily indicative of results of operations for any subsequent quarters. 15. CONTROL OF THE COMPANY. As of March 28, 2000 Anthony M. Frank, Harry M. O'Hare, Sr. and the current officers and directors of the Company owned approximately 43.1%, 7.5%, and 7.6% of the voting power of the Company, respectively. As a result, these individuals, if they agreed to act in concert, are in a position to materially influence, if not control, the outcome of all matters requiring shareholder approval, including the election of directors. 16. DEPENDENCE ON MANAGEMENT. We are significantly dependent upon the continued availability of Floyd H. Panning, our President and Chief Executive Officer. The loss or unavailability of Mr. Panning for an extended period of time could have a material adverse effect on our business operations and prospects. To the extent that his services are unavailable for any reason, we will be required to procure other management and operating personnel. There can be no assurance that we will be able to locate or employ such qualified personnel on acceptable terms. We 12 14 have entered into an employment agreement with Mr. Panning. However, we do not maintain key employee insurance on Mr. Panning or on any other employee of the Company. 17. POSSIBLE VOLATILITY OF COMMON STOCK PRICE. The trading prices of the common stock may respond to variations in operating results and other events or factors, including, but not limited to, the sale or attempted sale of a large amount of the common stock into the market, as could occur from sales by the Selling Shareholders. In addition, the stock market has experienced price and volume fluctuations in recent years, particularly in the securities of smaller companies. These fluctuations have had a substantial effect on the market prices of many companies, often unrelated to the operating performance of the specific companies, and similar events in the future may adversely affect the market prices of the common stock. 18. RISK OF LOW PRICED STOCKS; INABILITY TO MEET NASDAQ LISTING REQUIREMENTS. The common stock is currently traded in the over-the-counter market and is listed on the Electronic Bulletin Board under the symbol "ELTP." Our common stock is currently defined as a "penny stock." Unless exempt, for any transaction involving a penny stock, the broker/dealer must deliver, prior to any transaction, a disclosure schedule prepared by the Securities and Exchange Commission explaining important concepts involving: - the penny stock market, - the nature of such market, - the terms used in such market, - the broker/dealer's duties to the customer, - a toll-free telephone number for inquiries about the broker/dealer's disciplinary history, and - the customer's rights and remedies in cause of fraud or abuse in the sale. Disclosure also has to be made about commissions payable to both the broker/dealer and the registered representative and current quotations for the securities. In addition, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Non-NASDAQ stocks are not covered by the definition of penny stock for (i) issuers who have $2,000,000 in tangible assets, we do not meet this criteria, (ii) transaction in which the customer is an institutional accredited investor and (iii) transactions that are not recommended by the broker/dealer. For penny stocks, there are additional sales practice requirements on broker-dealers who recommend such securities to persons other than established customers and accredited investors (generally institutions with assets in excess of $5,000,000 or individuals with net worth in excess of $1,000,000 or annual income exceeding $200,000 or $300,000 jointly with their spouse). For such transactions, the broker-dealer must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to sale. Securities are also exempt from such requirements if the market price is over $5.00 per share or, for warrants, they must be exercisable for more than $5.00. As a result of the above requirements, trading in the common stock, which currently is a penny stock, may be severely limited and holders may experience difficulties in selling such securities, the market 13 15 price for the securities may be less than they may otherwise be, news coverage regarding us may be more limited and we may find obtaining new financing to be more difficult. Such reduced liquidity could result in a material adverse impact on the value of such securities. Currently, only a sporadic market exists for the common stock. NASDAQ has recently significantly increased the requirements for initial and continued listing on the NASDAQ Small Cap Market and National Market. It is unlikely that the Company, in the near future, will be able to meet even the initial listing requirements for the Small Cap Market. The recently announced proposed changes to listing on the Electronic Bulletin Board will not effect the Company, but would require brokers to deliver an explanation of the differences between the Electronic Bulletin Board and NASDAQ. 19. LARGE NUMBER OF EXISTING WARRANTS AND OPTIONS. Currently, there are 5,151,327 warrants and options outstanding, exercisable at prices ranging from $0.28 to $15.00 per share and expiring through August, 2009. For the term of such options and warrants, the holders thereof will have an opportunity to profit from the rise in the market price of the common stock without assuming the risks of ownership. The existence of all of these options and warrants may have an adverse effect on the terms upon which we may be able to obtain additional capital. Furthermore, it might be expected that the holders of all of such options and warrants would exercise their options at a time when we could obtain equity capital on terms more favorable than those provided for by the options and warrants. 20. NO DIVIDENDS. We have not paid cash dividends on the common stock and do not anticipate paying any cash dividends for the foreseeable future. DIVIDEND POLICY We have not paid any dividends on the common stock since incorporation. We anticipate that, in the foreseeable future, earnings, if any, will be retained for use in the business or for other corporate purposes and it is not anticipated that cash dividends will be paid. Payment of dividends is at the discretion of the Board of Directors and may be limited by future loan agreements or California law. Under California law, if a corporation does not have retained earnings, it may pay dividends provided that after giving effect thereto: - - the sum of the assets of the corporation (exclusive of good will, capitalized research and development expenses or deferred charges) would be at least equal to one and one-quarter times its liabilities (not including deferred taxes, deferred income and other deferred credits) and - - the current assets of the corporation would be at least equal to the current liabilities or, if the average of the earnings of the corporation before taxes on income and for interest expense for the two preceding fiscal years was less than the average of interest expense of the corporation for such fiscal years, the current assets would be at least equal to one and one-quarter times its current liabilities. 14 16 USE OF PROCEEDS We will not receive any proceeds upon the sale of any shares of common stock by the Selling Shareholders, but will receive funds upon the exercise of options or warrants held by the Selling Shareholders. Any such proceeds will be used to pay the estimated expenses of this offering (approximately $20,000) and for working capital, including, salaries, rent, overhead, marketing, production and costs associated with our research and development programs. 15 17 MARKET PRICES Our common stock is currently quoted in the OTC Electronic Bulletin Board market as a "penny stock" under the symbol "ELTP." The following table sets forth the high and low bid prices for the common stock, as reported on the Bulletin Board or "pink sheets," for the quarters that the securities were traded. The quotations reflect inter-dealer prices, without retail mark-up or mark-down or commissions and may not represent actual transactions.
COMMON STOCK BID PRICES ---------------------- HIGH LOW ----- --- FISCAL 1998 First Quarter 2-1/8 1/2 Second Quarter 3-3/4 7/8 Third Quarter 3 1-3/8 Fourth Quarter 1-3/4 13/16 FISCAL 1999 First Quarter 1-1/2 1/2 Second Quarter 1-6/16 1 Third Quarter 1-3/16 1/2 Fourth Quarter 13/16 11/16 FISCAL 2000 First Quarter 7/8 11/16 Second Quarter (through March 28, 2000) 1-25/32 15/32
The market for the common stock is sporadic and quoted prices may not represent the true value of such securities. As of March 28, 2000 the Company had approximately 760 holders of record of its common stock. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FISCAL YEARS ENDED OCTOBER 31, 1998 AND 1999 Sales decreased for the fiscal year ended October 31, 1999 by $109,948 as compared to fiscal 1998 primarily due to several factors: (a) the current economic downturn in Japan and Europe accounted for an approximate 10% reduction in sales; (b) we lowered the selling price to be more cost competitive during the latter part of fiscal 1999, and (c) marketing efforts to sell the EDI products were reduced during the latter part of the fiscal year as design changes for such products were being completed. We anticipate EDI sales to recover and increase in fiscal year 2000 once the EDI design modifications have been completed and marketing activities increased. Cost of goods sold increased during the fiscal year ended October 31, 1999 by $194,021 as compared to fiscal 1998 due to an increase of manufacturing overhead and the write-off of obsolete inventory during the current fiscal year. 16 18 Research and development expenses for fiscal 1999 increased by $205,787 compared to fiscal 1998 due to an increase in salaries and pursuant to the allocation of overhead expenses to the program which we initiated in December 1997 to develop the Micro Imaging Technology acquired from Wyatt Technology Corporation in late October 1997. In addition, approximately $60,000 was expended on research and development of our ion permeable membranes and a power supply being developed by Mr. Heidmann for the EDI product. No such development activities occurred during fiscal 1998. General and administrative expenses for fiscal 1999 increased compared to fiscal 1998 by $305,071, the primary component of which resulted from increased expenses relating to outside consultants, legal and accounting fees, and the issuance of a $67,127 bonus to Hydro Components upon the successful development of our new EDI membranes. In addition, during fiscal 1999, we realized $78,000 in income on the sub-lease of approximately 10,000 square feet of the facility which we currently lease. We will continue to sub-lease such premises until we require the use of the area involved. Interest income and expense activity is reflected as a net figure and represents a decrease of $408,706 in interest expense for the fiscal year ended 1999 as compared to the prior year. Interest income for fiscal 1999, in the sum of $14,252, arose from short-term investments. The primary component of interest expense in fiscal 1998 was a $400,175 expense realized pursuant to the issuance of convertible debt of $400,000 in loans by a principal shareholder. We realized a net loss of $1,958,644 for fiscal 1999, representing an increase of $451,701 from the prior year level. The increase was primarily due to a reduction in sales, the bonus issued to Hydro Components and increases in salaries, consulting fees, legal and accounting expenses. THREE MONTHS ENDED JANUARY 31,1999 AND 2000 References to 1999 and 2000 are for the three months ended January 31, 1999 and 2000, respectively. Sales decreased in fiscal 2000 by $55,401 as compared to fiscal 1999 primarily due to several factors: (a) the current economic downturn in Japan and Europe accounted for an approximate 10% reduction in sales; (b) we lowered the EDI selling price to be more cost competitive during the latter part of fiscal 1999 and; (c) marketing efforts to sell EDI products were reduced during the latter part of the fiscal year as design changes for such products were being completed. We anticipate EDI sales to recover and increase through fiscal year 2000 since the EDI design modifications have been completed and marketing activities have been increased. Costs of goods sold for fiscal 2000 increased by $28,004 as compared to 1999 although sales for the comparative period decreased. The increase relates, primarily, to the allocation to cost of goods sold of depreciation expense on new manufacturing equipment placed in service in the first quarter of fiscal 2000. Research and development expenses for fiscal 2000 decreased by $66,655 compared to fiscal 1999. These expenses arise from the program which we initiated in December 1997 to develop the micro imaging technology acquired from Wyatt Technology Corporation in late October 1997. The 17 19 decrease primarily results from a reduction in equipment expenditures and consulting expenses related to the program as well as a reduction in amortization expense relating to proprietary technology which was fully amortized as of the fiscal year ended October 31, 1999. General and administrative expenses for fiscal 2000 increased by $131,855 as compared to fiscal 1999. The increase results primarily from the addition of manufacturing and research and development personnel, causing an increase of $83,693 in salaries; an increase of $72,899 in operating expenses such as in legal and accounting fees and rent expense. These increases were partially offset by a $24,737 decrease in consulting expenses in fiscal 2000. Interest income arose from short-term investments and increased by $5,634 for the fiscal period ended January 31, 2000 as compared to the prior year period. Interest expense for fiscal 2000 was $3,524, with no comparable activity during the prior period. Interest expense arises, primarily, from equipment and automobile financing activities as well as loans made to us during the current period. We realized a net loss before income taxes of $432,532 for fiscal 2000, representing an increase of $146,495 from the prior year level. The increase was primarily due, as noted above, to increases in operating expenses and costs of goods sold and a decrease in gross sales. LIQUIDITY AND CAPITAL RESOURCES At October 31, 1999, we had net working capital (total current assets less total current liabilities) of $199,456, representing a decrease of $85,501 from the prior year end. We accrued $168,755 pursuant to the prepayment by a customer for EDI products to be delivered at a later date. We delivered products totaling $105,300 in the first quarter of fiscal 2000 and expect to deliver the balance of such products under this arrangement in the second quarter. We funded our working capital and other cash needs during fiscal 1998 from the sale of securities. We received net proceeds of $550,000 pursuant to a private placement offering whereby we issued 278,363 shares of common stock and 137,500 three-year warrants to purchase common stock. We received an additional $155,928 on the exercise of warrants to purchase common stock pursuant to a private offering to temporarily reduce, to $1.00, the exercise prices of such warrants originally granted at prices ranging from $2.00 to $15.00. Finally, we received notes in the amount of $6,000 and $29,750 on the exercise of 12,000 and 25,000 warrants during fiscal 1998. During fiscal 1999, we funded our working capital requirements by acquiring $1,020,000 from the private placement issuance of 1,020,000 shares of common stock and 510,000 three-year warrants to purchase common stock at $2.00 per share. We also received an additional $1,250 in cash upon the exercise of 2,500 options to purchase common stock. On January 15, 1999, we received $1 million in net proceeds upon the sale to Anthony M. Frank of one million shares of Series B Convertible Preferred Shares. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" - Mr. Anthony Frank." We began selling our EDI products during the latter part of fiscal 1997 and initiated sales of its Hydro Components line of products in May 1998. We experienced a small gross profit of $93,265 and $16,016 on sales of its Hydro Components products in fiscal years 1998 and 1999, respectively. 18 20 Sales of EDI products were adversely effected by economic factors in Europe and Japan and sales efforts were reduced during the latter part of fiscal year 1999. We experienced a loss of $218,837 in fiscal 1999 as compared to a gross profit of $7,883 for the prior year period. We curtailed marketing activity on the EDI product while modifications could be effected to the EDI design and the ion permeable membrane derived from the Hydro Components acquisition could be developed. Sales of the EDI product are expected to increase in fiscal 2000 since the new EDI module design has been completed and now incorporates the more cost-effective ion permeable membranes we have developed. No assurances can be given that we can successfully produce or market the new EDI product. At January 31, 2000, we had working capital deficit (total current assets less total current liabilities) of $196,371. The decrease in working capital, compared to that reported at October 31, 1999, reflects diminished EDI sales activities during our redesign of the product and an increase in liabilities resulting from short term loans. Our primary sources of working capital have been from short term loans and from the sale of securities. In February 2000, we began a private placement offering of securities to generate up to $1.5 million in equity financing. As of March 9, 2000, the Company had received $1.1 million in subscriptions to the offering, of which $400,000 represented the conversion of principal loans we had received as of that date. The private placement offering is scheduled to expire on May 23, 2000. During the latter part of fiscal year 1999, we curtailed our marketing activity on the EDI product while modifications could be effected to the EDI design and the ion permeable membrane derived from the Hydro Components acquisition could be developed. Sales of the EDI product are expected to increase through fiscal 2000 since the new EDI module design has been completed and now incorporates the more cost-effective ion permeable membranes we have developed. PLAN OF OPERATION In the opinion of management, available funds and funds to be realized from the private placement subscriptions discussed above will satisfy our working capital requirements through August 2000. We intend to fund our working capital requirements by focusing on selling our EDI product. In addition, we have taken the initial steps to form two Nevada corporations which will be wholly-owned subsidiaries of Electropure. Micro Imaging Technology was formed in February 2000 and will conduct our research and development operations on the detection and identification of fluid-borne microorganisms. We formed Electropure EDI, Inc. in February 2000 to conduct manufacturing and sales operation for our EDI line of products. We are seeking to establish strategic alliances with potential joint venture partners for these subsidiaries and/or for specific products under development or now being produced by Electropure. We have had preliminary discussions with potential strategic partners regarding our EDI product, membrane technology, and with regard to our micro imaging technology. We believe that, if necessary, we will be able to raise additional working capital by the private sale of our securities. No assurances can be given that currently available funds will satisfy our working capital needs for the period estimated, or that we can obtain additional working capital through the sale of common stock or other securities, the issuance of indebtedness or otherwise or on terms acceptable to us. 19 21 Further, no assurances can be given that any such equity financing will not result in a further substantial dilution to the existing shareholders or will be on terms satisfactory to us. We will be required to raise substantial amounts of new financing, in the form of additional equity investments, loan financing, or from strategic partnerships, to carry out our business objectives. There can be no assurance that we will be able to obtain such additional financing on terms that are acceptable to us and at the time required by us, or at all. Further, any such financing may cause dilution of the interests of our current shareholders. If we are unable to obtain such additional equity or loan financing, our financial condition and results of operations will be materially adversely affected. Moreover, estimates of our cash requirements to carry out our current business objectives are based upon certain assumptions, including certain assumptions as to our revenues, net income (loss) and other factors, and there can be no assurance that such assumptions will prove to be accurate or that unbudgeted costs will not be incurred. Future events, including the problems, delays, expenses and difficulties frequently encountered by similarly situated companies, as well as changes in economic, regulatory or competitive conditions, may lead to cost increases that could have a material adverse effect on us and our plans. If we are not successful in obtaining loans or equity financing for future developments, it is unlikely that we will have sufficient cash to continue to conduct operations, particularly research and development programs, as currently planned. We believe that in order to raise needed capital, we may be required to issue debt at higher interest rates or equity securities at prices that are significantly lower than the current market price of our common stock. 20 22 BUSINESS We manufacture and market the "EDI" series of patented electrodeionization water treatment devices for commercial and industrial high purity water applications. The EDI product is marketed to original equipment manufacturers, also known as OEM's, as a specialized component for water treatment systems designed to provide ultrapure water to market segments whose major customers include, but are not limited to, semiconductor, pharmaceutical and power generation companies, as well as laboratories and petrochemical companies. The current EDI design is able to desalt pre-treated tap water, filtered and generally softened by reverse osmosis, to a purity level exceeding ten megohm-cm (roughly less than 0.2 parts per million ("ppm") of total dissolved solids) at a rate of up to 10 gallons per minute on demand. Modularized designs, which allows for the connection of additional modules in parallel formations, increase a system's capacity exponentially to service installations requiring up to hundreds of gallons per minute. In addition to its cost-effective operation, a major environmental and competitive benefit of the EDI technology is that it does not require the addition of chemicals (acids and bases) for resin regeneration. Most other competitive processes require the addition of these elements. We also began sales of light commercial/industrial water and waste water treatment equipment in May 1998. Included in the product line, known as the Hydro Components line of products, are high quality sanitary heat exchangers, sample coolers for sterile steam and water, ion exchange filter cartridges, and ion exchange membranes for electrodialysis, electrodeposition, and electrochemical separations. In February 1998, we acquired the rights to certain proprietary membrane technology from Hydro Components, Inc. See "BUSINESS - Acquisition of Intellectual Properties - Ion Exchange Membrane Technology." We then began a research project utilizing the acquired technology to develop ion permeable membranes for use with the EDI product. We have successfully developed membranes which will allow us to offer more cost-sensitive models of the EDI product to a broader range of users for a wider range of uses. In October 1997, we acquired an exclusive license to certain patent and intellectual property rights involving laser light scattering techniques to be utilized in the detection and monitoring of toxicants in drinking water. This acquisition provides the basis for our proposed development of near "real-time" drinking water monitoring systems. This technology and the EDI technology are not intended to be integrated into one product. See "BUSINESS - Acquisition of Intellectual Property - Micro Imaging Technology" and "BUSINESS - Micro Imaging Technologies Division." We were incorporated in December, 1979 in California under the name HOH Water Technology Corporation and changed our name to Electropure, Inc. in 1996. Our address and telephone number is: 23456 South Pointe Drive, Laguna Hills, California 92653, (949) 770-9347. THE MARKET FOR WATER PURIFICATION Water is essential to life and potable water, that which is fit for human consumption, is a necessity for which a market will always exist. Growing population has increased demand for potable water just as the waste and pollution created by the enlarging population has reduced nature's ability to 21 23 supply potable water. The United Nations focused attention on the world's water problem in 1980 and allocated $300 billion to the development of solutions to the problem. Beyond the need for water which is merely fit for human consumption is the demand for "high purity" water which is usable for purposes other than drinking, such as cleaning or industrial processing. Such water requires the removal of contaminants that interfere with the intended use. In fact, examination of municipal water use reveals that less than one percent of the water is actually used for human consumption, the remainder being used by industry, irrigation, bathing, laundry, etc. Enhanced treatment of such water at the point of use, therefore, is an economically viable solution for compliance with stringent standards imposed by users of high purity water. The Environmental Protection Agency ("EPA") has studied and is in favor of the point-of-use approach, provided that treatment equipment meets its Generally Available Technology (GAT) criteria. According to a 1996 report by Environmental Business International, Inc., the San Diego-based market research and consulting firm, the water/wastewater environmental services sector in the United States will grow from its then annual level of $75 billion to $96 billion by the year 2000. The report projects this growth on the basis of two expanding areas of the business: the expansion in the use of outsourcing for industrial water and wastewater treatment activities, and the trend toward privatization of municipal treatment facilities. The three largest markets for ultrapure water, wherein the EDI product finds it market, are power generation, semiconductor and pharmaceutical industries. According to the Journal of Ultrapure Water, the total capital to be spent for ultrapure water in the year 2000 is approximately $2.5 billion, with almost $2.2 billion being spent by these three segments. The market is currently growing at a steady annual rate and, given the general deterioration of the world's water supplies, this growth is likely to continue and expand as the cost of treatment falls. Advanced manufacturing technologies and the tremendous expansion seen in electronics, pharmaceuticals and bio-tech firms in the last decade alone, have been the precursors of an increased need for high purity process water and for water purification equipment. The industry is in a major growth cycle and there are about 40 major companies in the world active in supplying goods and services with an estimated 13,500 customers in the United States. CURRENT TECHNOLOGIES IN WATER PURIFICATION Water purification is a relative term referring to removing selected, but not all, of a limited number of contaminants depending on the expected use to be made of the water. There are three general types of water purification processes: 1. Physical processes which depend simply on physical properties of the impurities, such as particle size, specific gravity and viscosity. Examples of this type of process are reverse osmosis, distillation, screening, sedimentation, filtration and gas transfer. 2. Chemical processes which depend on the chemical properties of an impurity or utilize the chemical properties of added reagents. Examples are ion exchange, electrodialysis, chlorination, coagulation and precipitation. 3. Biological processes which utilize biochemical reactions to remove soluble or colloidal organic impurities. Examples are biological filtration and the activated sludge process. THE EDI TECHNOLOGY The need to satisfy the increasing demand for high purity water in a variety of industries can now be 22 24 achieved through our patented electrodeionization process. The EDI design combines two well-established water desalination technologies -- electrodialysis and ion exchange deionization. Through this technique, dissolved salts can be removed at low energy costs, and without the need for chemical regeneration; the result is high quality water of multi-megohm/cm resistivity that can be produced continuously at substantial flow rates. The EDI module has been proved to be an effective new electrodeionization process and can be used for a broad range of process applications, including the supply of high water quality for the food and beverage industry, for microelectronics production, biomedical and laboratory use, pharmaceutical compounders and for general industry. The advantages of having a dependable and high quality water source which requires no chemical regeneration, coupled with low operation and maintenance costs, makes the EDI process an attractive and environmentally-safe alternative compared with other deionization processes. 23 25 We have recently redesigned the EDI module, now called "XL by Electropure", to improve integration into water treatment systems with all water connections on the module face and all electrical connections on the rear of the module. The EDI module is 9" wide and 22" high and ranges in depth from 6" to 14" for flow rates ranging from 1/4 gallons per minute (gpm) to 10 gpm, respectively. The product has no moving parts and is capable of continuously producing ultrapure water. The module is marketed to original equipment manufacturers of water treatment equipment for incorporation into a water supply system complete with pre-treatment components (such as reverse osmosis, filters, softeners, etc.), power supply, and desired gauges and monitors. This system would then be connected to the incoming water line, to a drain line and to an electrical source. A singular module is designed to service the small industry users. For higher flow rate requirements, the existing EDI module has been successfully combined in parallel formations to provide multi-gallons per minute of multi-megohm quality water. Larger systems, which produce 25 - 200 gpm, would be marketed to medium scale users. We plan to design a higher capacity version of the EDI module that will be intended to provide volumes of high purity water at 15 gpm or more from a single module. We believe that this model, if it can be developed, will become the primary product line for desired high purity flow rates in the 25-200 gpm market segment. XL-500 MODULE [GRAPHIC] (6 to 10 GPM Flow Rate) We believe that the major advantage of the EDI technology over systems utilizing ion exchange resins only is the efficient recharging of the resins without the extensive use of caustic and acid chemicals which add excessive contamination and cost to the system's waste water. We believe that the primary advantage of the EDI technology over products using distillation and reverse osmosis is its ability to utilize electrical and chemical properties of the water molecule and of naturally occurring salts, instead of merely physical properties, in separating water from the dissolved mineral ions. The EDI can operate without booster pumps or holding tanks and the EDI module achieves a high flow rate with relatively smaller sized and less expensive equipment. EDI technology requires less maintenance than existing systems but requires more stringent pretreatment of entry water. Maintenance is a major problem with conventional electrodialysis and reverse osmosis units, particularly the clogging of membranes. Thus, the advantages of the EDI technology system, as compared to some conventional water treatment systems, include the following: - lower maintenance since nothing is consumed except small amounts of electricity. If at 24 26 all necessary, chemicals are added less frequently than existing equipment. - large flow rate relative to its size, as compared to conventional systems that purport to treat the same flow rates. Our belief as to the expected advantages of the EDI technology is based upon our experience with prototypes, pilot production units, products sold by our former licensee, and the approximately 150 EDI products sold through October 31, 1999. The EDI technology incorporates a number of design improvements to the original EDI patent. We intend to conduct continued product development on the EDI technology, with an eye toward improving the technology while reducing manufacturing costs, and allowing us to expand our market reach. Development of new technologies for manufacture, such as the EDI technology, is frequently subject to unforeseen expenses, difficulties and complications and in some cases such development cannot be accomplished. In the opinion of management, the EDI technology has demonstrated positive attributes, but any such attributes must be balanced against the lack of any substantial operating experience, the existence of established companies in the water purification field with greater financial resources, experience and developed products, and unknown technological difficulties. Consequently, no assurances can be given as to if and when the product discussed above will be successfully marketed and sold. Similar risks will apply to the use of any product which may be developed using the Micro Imaging technology and the ion permeable membrane which has been developed using the Hydro Components technology and is now being incorporated into the EDI module. THE HYDRO COMPONENTS LINE We began offering for sale our Hydro Components line of products in May 1998. The Hydro Components line includes water and wastewater treatment products for light commercial/industrial markets such as optical lens manufacturers; sterile steam samplers for pharmaceutical and biotechnical firms; industrial steam samplers for power plants, pulp and paper mills and refineries; and high-flow deionizers sold through catalog houses for humidification, rinse water, cooling water and small laboratories. The Hydro Components line also offers solvent-based coated membranes which are sold to OEM's of stabilizing equipment for electrodeposition automotive and appliance painting. MARKETING The EDI module was developed for the ultrapure light industrial segment of the water treatment market, i.e., pharmaceuticals, electronics, medical and research laboratories. We sell these products through manufacturers of commercial water treatment equipment in the United States and in foreign countries. We have patents for its EDI technology in the following foreign countries: Austria, Belgium, France, Great Britain, Luxembourg, Switzerland and Germany. ULTRAPURE MARKET. We believe that a substantial market currently exists for EDI technology in the commercial and light industrial market sector where ultrapure water is a necessity in manufacturing and where chemically pure water is demanded for laboratory uses. The electro- 25 27 regeneration feature of the EDI technology is considered a significant advantage over existing demineralization technology. The existing EDI module will provide ultrapure water at a rate of 1/2 to 10 gallons per minute (and higher volumes in parallel formations), which is generally ample for the needs of the OEM's marketing to these various end users. This model and the proposed larger scale version of the EDI will access a water system capital equipment market segment of $2.2 billion of which $200 million is immediately accessible. Our marketing strategy is to identify and target independent operating water equipment manufacturers where the EDI technology can either be incorporated into or replace certain components in the water treatment systems currently offered by such manufacturers. We have initiated this marketing strategy both in the U.S. market and overseas, but have no current intentions of entering into formal supply agreements with any such potential customers. GOVERNMENT REGULATION A California law provides that water treatment devices that are sold for residential use be certified by the State Department of Health Services, or approved certification facility, if claims are made that the device will remove or reduce a contaminant for which a primary drinking water standard has been established. In addition, California law makes it illegal to make any false claims in connection with the sale of any water treatment product. Other states have similar laws. We believe that the EDI ultrapure technology, which is not intended for drinking water applications, is not subject to the above laws. However, if we offer industrial applications of the EDI point-of-use technology, i.e., hospitals, such products will require approval by Underwriter's Laboratory or equivalent organization. We will seek all necessary approvals or certifications. PRODUCTION METHODS EDI TECHNOLOGY - The EDI module is composed of various components. All internal parts are made of engineered thermoplastics, except the membranes, electrodes and electronics. We have previously purchased certain tooling and molds required for component plastic parts and contracts for the production of the plastic parts and electrodes for the EDI product. The membranes utilized in the EDI product were purchased from outside sources until we recently began manufacturing membranes based on the technology acquired from Hydro Components. No assurances can be given that the membrane that we have recently developed will prove to be efficient for long term use with the EDI product. All final assembly is completed at our Laguna Hills, California manufacturing facility. Production and assembly functions have been designed with the flexibility to produce customized variations of the EDI for specialized usage. HYDRO COMPONENTS LINE - Except for the membranes offered by us, the Hydro Components line of products consists of component parts purchased from unaffiliated third party suppliers or sub-contractors and assembled by us into the finished product. The membranes sold under the Hydro Components line (which are not the ion permeable membranes utilized in the EDI product) are specially treated by us and currently are fabricated by an outside source. 26 28 WARRANTY We offer a one year limited parts and labor warranty for the EDI module and may, in the future, contract with others to provide warranty service. However, we have not made any arrangements with any persons to provide such service and we may not be able to locate competent persons to perform the services at an acceptable price. We have not experienced significant warranty returns to date; however, no assurances can be given that future warranty expenses will not be significant. Suppliers of components utilized in the Hydro Components line of products provide certain limited parts and labor warranties which we pass on to our customers. No additional warranties are offered by us at this time. SOURCES OF SUPPLY We believe that material to build the products that we currently offer are readily available from at least two sources. We currently have two sources for all such material and are not dependent upon any one or more principal supplier. ACQUISITION OF INTELLECTUAL PROPERTIES EDI COMPONENTS Effective August 5, 1997, we entered into a License Termination Agreement with EDI Components terminating the July 1992 agreements which granted EDI Components a security interest in and exclusive manufacturing and marketing rights to the our patented water purification technology. Pursuant to the termination agreement, 362,500 shares of our common stock were issued to the investors of EDI Components in amounts commensurate with their capital investment in such entity. We have agreed to issue Additional Shares upon the common stock first having a per share value for thirty consecutive trading days equal to or in excess each of $3.00, $4.00 and $5.50 per share (each a "trigger value"). The 362,500 shares issued and the additional 516,479 contingently issuable shares were valued at $0.3125, the market price per share at the date of termination of the agreement, which totals $274,681. This amount was recorded as research and development expense. ION EXCHANGE MEMBRANE TECHNOLOGY On February 17, 1998, we paid Hydro Components, Inc. ("HCI") the sum of $200,000 under the terms of an Assignment Agreement to acquire the rights to certain proprietary ion exchange membrane technology for use with its EDI water treatment technology. Pursuant to the agreement, HCI was to provide the know-how and technical support to develop extruded membranes with ion exchange materials. In April 1999, pursuant to an addendum to such agreement, HCI was granted a $65,000 bonus for the successful development of such membrane technology that is now being incorporated into a new EDI module. MICRO IMAGING TECHNOLOGY On October 25, 1997, we issued 2,100,000 shares of common stock, valued at $447,146 by independent appraisal, to Wyatt Technology Corporation as consideration for the transfer by Wyatt 27 29 of an exclusive worldwide license to certain intellectual property related to drinking water monitoring technology. The agreement encompassed exclusive patent rights, software, technical support, manufacturing services and other know-how based on Wyatt's proprietary multi-angle laser light scattering instrumentation and techniques to detect and monitor the presence of toxicants (mutagens, carcinogens, and metabolic toxins) in fluid. We refer to this technology as the "Micro Imaging Technology." In May 1998, the initial research phase proved, in a laboratory environment, a capability of the technology for identification and measurement of Cryptosporidium and Giardia cysts. We initiated further research efforts based on these successful results. See "LEGAL PROCEEDINGS." PATENTS AND LICENSE AGREEMENT Certain technology used by the EDI technology is covered by U.S. Patent No. 4,465,573, issued on August 14, 1984, to Harry M. O'Hare, Sr. Such patents expire in 2001. Corresponding patent applications have been filed in certain limited foreign countries. Improvements in the EDI technology involve upgrades of various components, including ion permeable membranes, manifolds (front and rear), and product water and waste water compartments. Such improvements increase performance quality and decrease production costs. The existence of a patent for the EDI technology may not provide us any meaningful protection because of technological changes, the decision of courts not to uphold all or part of a patent, or because of the limited financial resources that may be available to enforce our patent rights. We have recently filed a patent application with regard to the ion permeable membrane technology acquired from Hydro Components. We have not secured a registered trademark or trade name for "EDI" or "Micro Imaging Technologies." Harry M. O'Hare, Sr., the inventor of the EDI technology, entered into a License Agreement with us in 1986. The License Agreement grants to us an exclusive worldwide license to manufacture, use and sell the EDI technology and other water purification products covered by the current patent and any improvements thereon or under corresponding foreign patents for the life of such patents. Under the terms of the License Agreement, we are obligated to pay to the individuals who have royalty rights in the EDI technology, a royalty of approximately $42.00 for each EDI technology system, which has a capacity of from six to twenty gallons per minute, sold or placed in service by us and our licensees during the life of the patent. Royalties of approximately $9.00 per such EDI technology are also payable until a maximum of approximately $525,600 is paid at which time such additional royalties will terminate. In May 1987, Mr. O'Hare assigned all of his interest, including rights to future royalties, in the patent covering certain parts of the EDI technology to us. RESEARCH AND DEVELOPMENT During fiscal 1999, we expended $650,897 primarily on our research program to develop a drinking water monitoring system derived from the technology acquired from Wyatt in October 1997. We concluded Phase 1 research on the proposed drinking water monitoring technology and initiated phase two of our research program in 1998. During the three-month period ended January 31, 2000 we expended an additional $110,284 on such program and we expect to continue to incur additional 28 30 research and development costs on this Micro Imaging Technology project through product development. See "MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources." We also conducted minimal research and development activities to develop the ion permeable membrane with technology acquired from Hydro Components, Inc. in February 1998. We have successfully developed such membrane and will shortly incorporate it into the EDI product. MICRO IMAGING TECHNOLOGIES DIVISION The technology transferred under the October 25, 1997 agreement with Wyatt Technology Corporation had (at inception) two main areas for exploitation: - - and early warning of dangerous particulate materials such as parasites and other organisms, i.e., bacteria, viruses, spores, etc. If the initial efforts were successful, future efforts were to be directed to include detection and early warning of asbestos fibers and similar materials that pose a health hazard to the consumer. - - and early warning of dangerous soluble substances such as mutagens, carcinogens and metabolic poisons. The latter technology area had already been confirmed, although never commercialized, during a study by Wyatt for the U. S. Army through a Small Business Innovative Research program conducted approximately a decade ago. To transform the latter area into a viable product line will require the development of specialized instrumentation for the implementation of the methods developed (and patented) under that program, market studies, and the establishment of a marketing plan to target water consumer delivery agencies (municipalities). Although this market may well represent a major opportunity on a worldwide basis for future growth of consumer market products, the currently available instrumentation and methods being developed by us appear to provide a more immediate path to developing the parasite detection concept for the technology. It is for this reason that the current research and development efforts have focused on, and have thus far proven successful in a laboratory setting, the detection and monitoring of parasites, primarily Cryptosporidium and Giardia(1), in drinking water sources. Since these parasites form cysts that have a protective shell, they are particularly dangerous and difficult to remove as they are resistant to normal treatment levels of chlorine. The Center for Disease Control and the Environmental Protection Agency have developed a national "surveillance system" to monitor and track the incidences of water borne diseases, including those associated with Cryptosporidium and Giardia contamination. However, this system relies upon standard water sample gathering and analysis and recognition of outbreaks after they occur. The CDC documents an average of 15 to 20 waterborne outbreaks throughout the country - --------------------- (1) Cryptosporidium (Cryptosporidium parvum) and Giardia (Giardia lamblia) are waterborne protozoan parasites which contaminate water sources such as wells, rivers, streams, and lakes, generally through animal and fowl fecal deposits. 29 31 each year. Experts speculate, however, that the numbers are much higher since illnesses caused by waterborne diseases are often mistaken for the stomach flu or intestinal disorders. In 1997, the CDC reported 1,770(2) cumulative Cryptosporidiosis cases in the U.S. alone. Cryptosporidiosis was brought to national attention in 1993 in a Milwaukee incident, when over 400,000 people (more than half of the total population of the city) became ill, with more than 4,000 hospitalized and 100 deaths. Particularly susceptible were immunocompromised persons. The current method for water quality sampling is labor intensive, expensive, sporadic, time consuming, and results are untimely for corrective action. In the monitoring for bacteria or parasite detection, for example, workers will collect samples at distribution points, influent points or effluent points. These samples will then be transported to laboratories that are equipped to provide detection and identification of the contaminants in question. Samples are then physically separated to allow for microscopic visual identification by trained technicians. Standard turn-around time for information is one to two days, although some tests can often be run in as little as a few hours. Expenses increase dramatically if quick (a few hours) turn-around is requested or required. This method of "surveillance" is recognized as woefully inadequate by the water industry. While it serves to provide incidence statistics, it is operationally ineffective since problems are detected after the water already has been delivered. By the time positive detection is made, it is not possible to take corrective action to prevent exposure. Corrective actions are limited to often overblown solutions such as general boil orders or a total water system shutdown. These actions serve to only limit the initial outbreaks, rather than to prevent them. A system that would provide for "real-time" contaminant detection and monitoring could prevent or limit outbreaks, save lives and be less expensive. The availability of this technology would clearly represent a leap forward in water delivery and monitoring. The proposed system would monitor the laser light scattering properties of each particle passing through the detector region and software would examine the measurements and decide whether the particle was a parasite. Potential customers for the proposed water monitoring system would include local water utilities, both private and municipal; state water utilities and water quality and health agencies; Federal government agencies such as EPA, DoD, DoE, CDC; wastewater treatment plants; ground water and well users; and potentially, as the cost of the sensors and system decreases, homeowners. We are also researching applications for our Micro Imaging technology in the clinical laboratory and food processing areas, each of which would reap cost and efficiency benefits similar to the proposed water monitoring device under development. This technology has already demonstrated identification of the bacteria E.coli, listeria and salmonella. Based on a very preliminary evaluation of market needs and the size and number of potential customers, the market size in the water monitoring market is estimated to be greater than $20 million per year. Markets for a device which will address the needs of clinical laboratories and food processing operations are estimated to be in the range of $200 million and $55 million per year, respectively. Detailed market validation has not been completed; however, management - --------------------- (2) CDC Morbidity and Mortality Weekly Report 46(47):1121, 1997 (week ending November 22, 1997). 30 32 believes that these estimates are conservative and that market penetration of 10% is achievable within the first several years of introducing a viable product. Concurrent with conducting its research program, the Company will continue to conduct more comprehensive market studies for this proposed technology. COMPETITION The EDI technology competes with only three principal competitors: on-site regeneration, service deionization and electrodeionization. U.S. Filter licensed electrodeionization technology from Millipore Corporation in 1989 and continues to work closely with its technical staff. U.S. Filter(3) manufactures and markets electrodeionization systems for the high purity industrial segment with capacities ranging from 20 liters/hours to 100 gallons/minute. Compared to our point-of-use EDI technology, the U.S. Filter (Ionpure, Inc.) equipment is more expensive, but still offers substantial operating cost savings over service deionization. Comparison tests have shown that our EDI technology is also more efficient than the Ionpure product, resulting in better performance and a lower operating cost. Ionics, Inc., Glegg/Ecell Inc., and Christ, Ltd. also manufacture and market electrodeionization technology. The technology directly competitive with electrodeionization is service deionization. The service deionization industry is composed of a few larger companies such as Arrowhead Industrial Water, Polymetrics (acquired by U. S. Filter), and Continental Water, as well as hundreds of smaller entities, some of which are dealerships of Culligan (also recently acquired by U. S. Filter) and other water conditioning companies. The EDI unit can reduce operating costs of producing high purity water by up to 40% in comparison to service deionization. Our marketing challenge will be to convince water equipment manufacturers to utilize the EDI technology rather than conventional ion exchange resin deionization. With service deionization, the customer does not have to purchase capital equipment as he does with EDI, so the service deionization system can be upgraded or down-sized with no substantial cost to the customer. The customer pays for the water on either a cost-per-gallon basis, or a cost-per-regeneration basis. Regeneration is done at the service company's facility so that the customer does not have to handle or dispose of chemical waste. Substantially all companies in the water treatment market are established in the field, including the well-known firms mentioned above and others. All of such companies are larger and better financed, have established products and an established customer base and can accordingly devote more resources to research and development, production and marketing activities. In addition, it is possible that the water purification industry may be the subject of technological innovation or other factors that may attract additional competition in the future. We believe, however, that the EDI technology and our technical know-how may be significant in our ability to compete. Our ion permeable membrane technology is intended to reduce dependence on outside suppliers for this component of the EDI product as well as to significantly reduce the cost of such component. The cost reduction in the membrane component of the EDI product has resulted in a substantial increase in the cost competitiveness of our product. See "MANAGEMENTS' DISCUSSION AND - ---------------------------- (3) Pursuant to a March, 1999 acquisition, U.S. Filter became a wholly owned subsidiary of Vivendi, a French environmental service provider and leader in water treatment and distribution services. 31 33 ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources." With regard to the proposed Micro Imaging product, there are established methods of testing currently employed by both public and private agencies. However, these methods are labor intensive, expensive and time consuming, and do not provide the near "real time" monitoring capabilities which our product, if it can be developed, would purport to offer. EMPLOYEES As of March 28, 2000, we employed sixteen full-time employees, of which eight were engaged in marketing, development, production and design; five in administrative, accounting and clerical functions; and three are engaged in research and development of the Company's proposed Micro Imaging Technology products(s). To implement its proposed business, we will have to hire additional employees in 2000. However, we cannot predict with any certainty when we will hire such personnel. We believe that our relationship with our employees is good and we are not a party to any collective bargaining agreement. Our future success will be dependent upon our ability to attract and retain qualified personnel. PROPERTIES We currently lease, with an option to purchase, a 30,201 sq. ft. facility in Laguna Hills, California and pay a gross (including taxes, insurance and major repairs) lease payment of $16,480 per month. In March 1998, we sub-leased approximately 10,000 sq. ft. of such facility to an unaffiliated third party which utilizes such space to warehouse and distribute heating and cooling parts and equipment. Under the terms of the two-year agreement, extended through December, 2000, the sub-lessee pays us $7,000 per month. Management believes that its present facilities are adequate for all of its current operations, and those contemplated for the foreseeable future. On July 29, 1999, we exercised an option under the lease to purchase the building for the sum of $2,300,000 and paid $15,000 as part of the purchase price therefor. Under the lease, the Lessor has 18 months within which to complete the sale. We will continue to pay rent as set forth in the lease with applicable increases until the sale has been completed. LITIGATION In July 1999, we entered into an agreement to settle the February 1999 lawsuit we brought against Wyatt Technology Corporation for breach of the October 1997 Technology Transfer Agreement by which we obtained a license to use and develop certain laser-based technology and patents held by Wyatt. The lawsuit, brought in the Orange County Superior Court of California, Case No. 805529, alleged that Wyatt had failed and refused to provide the technical support indicated under the original agreement in an attempt to bring about a rescission of the license. The settlement with Wyatt Technology provided that each party has the right to utilize the licensed technology as developed through Phase I of our research program which proved, in principle, that 32 34 the instrument under development can perform instantaneous microbe identification by measuring the light scattered by particles as they pass through a laser beam. The settlement also provided for the return by Wyatt of 1.95 million of the 2.1 million common shares it received from us under the original license agreement. Warrants to purchase 10,000 shares of common stock at $1.38 per share issued to Clifford Wyatt, an officer of Wyatt, were also cancelled pursuant to the settlement. Mr. Clifford Wyatt resigned as a Director in April 1999. In August 1999, a Cross Complaint for breach of contract, misrepresentation and negligence was filed against us and other unaffiliated defendants by Douglas B. Platt d/b/a East-West Technic Group ("Platt"), the defendant in a Los Angeles Superior Court action, Case No. GC 023410, brought by Starr Surgical Company, Inc. The cross-complaint charges us with breach of contract, misrepresentation and negligence in connection with the sale to Platt of an EDI module subsequently provided by Platt to Starr Surgical. The cross-complaint seeks unspecified damages. We intend to vigorously defend this matter. We and our counsel believe that we will prevail on the merits if this matter should go to trial. 33 35 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS Our directors and executive officers are as follows:
NAME AGE POSITION ---- --- -------- William F. Farnam * 79 Director (Chairman) Randall P. Frank * 37 Director Randolph S. Heidmann * 49 Director Arthur Lipper III * 68 Director Floyd H. Panning * 71 Director, President and Chief Executive Officer Catherine Patterson 47 Chief Financial Officer and Secretary
- --------------------------- * All directors currently serve as members of the Audit Committee, with Mr. Lipper as the Chairman of such Committee. WILLIAM F. FARNAM, 79, was named to the Board of Directors on August 5, 1997. Mr. Farnam spent 1967 through 1968 as General Manager on construction of The Forum (Los Angeles) for sports entrepreneur Jack Kent Cooke. He served the City of Inglewood, California for 20 years, as Public Works Director and City Engineer and went on to become the Assistant City Manager there from 1980 to 1982. Between 1983 and 1984, he served as Project Engineer for the Park Place Associates Poker Casino in Southern California. He provided engineering consulting services for various municipalities from 1985 through 1990 when he retired. Mr. Farnam is a Registered Professional Civil Engineer in the State of California and received a Bachelor of Science Degree in Electrical Engineering from the University of Southern California and is a Management Studies Graduate from the University of California at Los Angeles. RANDALL P. FRANK, 37, joined the Board of Directors on October 25, 1997. Mr. Frank, is the son of Anthony M. Frank, who is the former Postmaster General of the United States and is a substantial shareholder. Between 1992 and 1995, Randall Frank worked in sales and marketing for Sonnet Systems, a Northern California firm which offers computerized currency exchange services. He has been engaged since 1995 as an insurance underwriter with Five Star Managers, LLC in San Francisco, California, an insurance firm whose primary business is underwriting trustees for union and corporate employee benefit plans. Mr. Frank received a B.A. degree from the University of California at Berkeley and a Masters degree in International Management from the American Graduate School of International Management ("Thunderbird"). 34 36 RANDOLPH S. HEIDMANN, 49, was employed by us between September 1990 and November 1991 as an electronics instrumentation design engineer to continue development work on innovative electronic components which we planned to engineer into our product line. He was named to the Board of Directors in September 1991. Prior to joining us, he spent nine years with Teledyne Electronics where he was responsible for data acquisition subsystems design for telemetry products. He has participated in the development of a variety of consumer electronics products and custom production test equipment. Between 1991 and June 1999, Mr. Heidmann served as an electrical engineer for Photonic Detectors, Inc. in Simi Valley, California. Currently, Mr. Heidmann provides independent electrical engineering consulting services. He holds a BS degree in Physics from the University of California at Davis. ARTHUR LIPPER III, 68, has provided financial and management consulting services to us since May 1998 and was elected to the Company's Board of Directors in June 1999. Mr. Lipper is an internationally known investment banker, financier and management consultant. He is Chairman of British Far East Holdings Ltd. and President of Communications Management Associates, privately owned companies which provide and arrange financing and offer financial and management advisory services. Mr. Lipper has been affiliated with the international financial community since 1954 and currently serves as an officer, director or advisor to a number of publicly traded and privately owned companies including, among others, Lion Brothers, an embroidered emblem manufacturer with facilities in the United States and China; MeterNet, providing set top box Internet access to television sets, Cargo4less.com, an internet marketed international freight forwarding service matching customer bids and service offerings; and Cavion.Com which services the electronic communications and processing needs of credit unions. Mr. Lipper is the author of numerous financial and investment-related books and publications and has served as the Chairman, Publisher and Editor-In-Chief of Venture Magazine. He is a member of the Financial Analysts Society of San Diego, the San Diego Press Club, and the University of California, San Diego (UCSD) Faculty Club. He has been a Trustee of the Kenan Institute of Private Enterprise of the Kenan-Flagler Business School at the University of North Carolina. Mr. Lipper has also served as a Director of the National Schools Committee for Economic Education and has served as Chairman of the New York & Foreign Securities Corporation (co-founder) and the Arthur Lipper Corporation and international subsidiaries, both New York Stock Exchange member firms. Mr. Lipper's stock and commodity exchange memberships have included the New York Stock Exchange, American, Midwest, Pacific Coast, Detroit, Boston, Philadelphia, Bangkok, NY Comex and NY Futures Exchange. FLOYD H. PANNING, 71, joined the Board of Directors and was engaged by us as President and Chief Executive Officer in August 1997. Mr. Panning came out of retirement in April 1992 to establish EDI Components and form a license relationship with us to manufacture and market the EDI technology. He has been the president of EDI Components since 1992. Prior to forming EDI Components, Mr. Panning had founded two million-dollar businesses that were sold in 1982. In 1972, he founded Formatron, Inc., a manufacturer of rotational molded plastic products such as plating and chemical storage tanks, and many other polyethylene and polypropylene containers. In 1963, he acquired Mills Engineering Co., a manufacturer of high quality aluminum products. As owner/operator he expanded the firm from a limited local sales 35 37 organization by establishing major national and international accounts with Fortune 100 companies and major municipalities. CATHERINE PATTERSON, 47, became our Secretary in May 1989, was Assistant Secretary from May 1986 to May 1988, held the position of Treasurer from August 1984 to February 1986, and was a director for a short time in 1984. In June 1990, she became Chief Financial Officer. From 1971 until she joined us in 1981, she was a legal secretary for various Michigan law offices, including General Motors Corporation, where she dealt closely with various corporate sectors and counsels throughout the United States and Puerto Rico and portions of Canada and South America. Directors serve until the next Annual Meeting of Shareholders when their successors are elected and qualified. Mr. Panning has a right to nominate one director. See "MANAGEMENT - Employment Agreement." Officers, subject to any employment agreements, serve at the pleasure of the Board of Directors. Key Employees Michael Snow, 43, a Ph.D. in Chemical Engineering, is General Manager of Electropure EDI, Inc., a wholly owned subsidiary. Dr. Snow has eight years experience in water purification industries and twelve years experience in product development and marketing of consumer, environmental, and membrane separation devices. Dr. Snow has an extensive background in manufacturing and quality control as well as budget and profit and loss responsibility. He received his Bachelor of Science degree in Engineering from U.C.L.A., and his Master of Science and Ph.D. degrees in Chemical Engineering from M.I.T. David Haavig, 45, a Ph.D. in Physics, is General Manager of Micro Imaging Technology, a wholly owned subsidiary, Dr. Haavig has over 25 years experience in instrument design in computer software with applications in optical measurements and analysis. He received his Bachelor of Science Degree in Physics (Cum Laude) from the University of Seattle and his Master of Science and Ph.D. degrees in Physics from Purdue University. 36 38 Section 16(a) Beneficial Ownership Reporting Compliance As of the date of this report, all current directors, officers and beneficial owners of more than 10 percent of any class of equity securities have filed all reports required by Section 16(a) of the Securities Exchange Act of 1934. The following table provides information regarding any of such reports which were filed late:
NAME OF TYPE OF NO. OF TRANSACTIONS REPORTING PERSON REPORT FILED LATE REPORTED LATE ---------------- ----------------- ------------------- William F. Farnam Form 4 - Statement of Changes in Beneficial Ownership 2 Anthony M. Frank Form 4 - Statement of Changes in Beneficial Ownership 2 Randall P. Frank Form 4 - Statement of Changes in Beneficial Ownership 2 Randolph S. Heidmann Form 4 - Statement of Changes in Beneficial Ownership 2 Arthur Lipper III Form 4 - Statement of Changes in Beneficial Ownership 1 Floyd H. Panning Form 4 - Statement of Changes in Beneficial Ownership 2 Catherine Patterson Form 4 - Statement of Changes in Beneficial Ownership 1 Clifford D. Wyatt (1) Form 3 - Initial Statement of Beneficial Ownership 1
(1) Clifford D. Wyatt resigned from the Board of Directors on April 14, 1999. MANAGEMENT COMPENSATION In November 1999, the Board of Directors established a Compensation and Benefits Committee to oversee compensation and benefits, i.e., option and warrant grants, to employees and service providers. The following Directors currently serve on such Committee: William F. Farnam (Chairman), Randall P. Frank and Arthur Lipper III. We had no executive officer whose annual compensation was more than $100,000 per year for the fiscal years ended October 31, 1999, 1998 and 1997. Floyd Panning, who joined us as Chief Executive Officer in August 1997, is being compensated at the rate set forth in his employment agreement that is described below under "Employment Agreement." The following table sets forth summary information regarding compensation paid for the years ended October 31, 1999, 1998 and 1997 to the chief executive officer. 37 39
NAME AND OTHER ANNUAL AWARDS PRINCIPAL POSITION YEAR SALARY ($) COMPENSATION ($) (1) OPTIONS (#) ------------------ ---- ---------- -------------------- ----------- FLOYD H. PANNING President and 2000* $25,200 - - Chief Executive Officer 1999 $97,751 - - 1998 87,346 - 250,000 (2) From August 1997 $12,000 - 125,000 (3)
* Through January 31, 2000. (1) We are not required to report the value of personal benefits unless the aggregate dollar value for 1999 was at least 10 percent of the executive officer's salary and bonus or $50,000. (2) In March 1998, we granted Mr. Panning 250,000 options to purchase common stock at an exercise price of $1.125 per share. The options, which expire in March 2008, vest in increments of 50,000 over a five-year period commencing on the grant date. (3) See "Employment Agreement." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Compensation of executive officers is determined by the Board of Directors. The Board of Directors negotiated Mr. Floyd Panning's Employment Agreement, whereby he became President and Chief Executive Officer, in connection with the License Termination Agreement with EDI Components and Mr. Panning assuming such positions with the Company. EMPLOYMENT AGREEMENT On August 14, 1997, we entered into a five-year Employment Agreement (effective August 5, 1997) with Floyd Panning whereby he became the President and Chief Executive Officer. Mr. Panning has the unilateral option to extend such employment for a period of two (2) years. The agreement provides Mr. Panning with five weeks' vacation, the use of a car and cellular telephone and participation in any benefit programs offered by us (none at this time). Pursuant to the terms of the agreement, Mr. Panning was granted 125,000 warrants to purchase common stock at $0.28125 per share. Such warrants are exercisable in increments of 25,000 annually commencing with the date of the agreement. The agreement also provides for the following: - A base monthly salary of $6,500 increasing to $8,000 per month once we had realized a minimum of $1 million in financing. Each year thereafter, the base salary shall automatically increase by an amount equal to five (5%) percent. Mr. Panning's base salary is $8,400 per month as of February 2000. 38 40 - Upon realizing the above minimum financing, we agreed to reimburse Mr. Panning for certain wages deferred while he was employed at EDI Components (a total of $63,700 was deferred). A $25,000 promissory note issued by Mr. Panning, in consideration for his exercise of 50,000 warrants to purchase common stock at $0.50 per share, will be satisfied (including accrued interest) with such deferred wages, net of normal federal, state and local income and payroll taxes. Mr. Panning agreed to waive any remaining balance of deferred wages after payment of such promissory note. - Mr. Panning has the right to nominate, subject to shareholder approval, one person to the Board of Directors during the term of his employment. In the meantime, Mr. Panning has been named to the Board of Directors as his nominee. - Mr. Panning may, without cause, terminate his employment and retain the right to the following percentage of his base monthly salary:
YEAR OF PERCENT TERMINATION OF SALARY ----------- --------- 1 60% 2 70% 3 80% 4 90% 5 100% 6 0% 7 0%
- Any termination of employment by us shall immediately vest all 125,000 warrants granted to Mr. Panning under the agreement. In addition, termination by us of Mr. Panning's employment without cause, shall automatically accelerate the issuance of Additional Shares due EDI's investors under the License Termination Agreement at the then fair market value; provided, however, Mr. Panning's successor has not been approved by simple majority vote of such EDI Components' investors (excluding Mr. Panning). COMPENSATION OF DIRECTORS In August 1997, we authorized an annual issuance of 10,000 ten-year warrants to purchase common stock to each Director for service to the Company at a 25% discount to the fair market value of the common stock as of the date of grant. In August 1998, 10,000 warrants to purchase common stock were issued to each of the then five (5) Directors (including Clifford Wyatt who resigned from the Board and surrendered such warrants in April 1999) at an exercise price of $1.375 per share. In August 1999, pursuant to the above resolution, we issued 10,000 ten-year warrants to purchase common stock to each of the five Directors at an exercise price of $0.9375 per share. 39 41 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT PRINCIPAL SHAREHOLDERS The following table sets forth information as of March 28, 2000 with respect to the common stock, Class B common stock, Series B Preferred Stock and Convertible Preferred Stock owned by the only persons known by us to own beneficially 5% or more of any such classes of stock, by each director and by all directors and officers as a group.
COMMON CLASS B SERIES B STOCK % OF COMMON % OF PREFERRED % OF NAME (1)(2) CLASS STOCK CLASS STOCK(3) CLASS ---- ------ ----- ------- ----- --------- ----- William F. Farnam 126,918 1.0% -- -- -- -- Anthony M. Frank 320 Meadowood Court Pleasant Hill, CA 94523 5,187,551 36.9% -- -- 1,000,000 100% Randall P. Frank 413,898 2.9% -- -- -- -- Randolph S. Heidmann 30,000 * -- -- -- -- Arthur Lipper III (6) -- -- -- -- -- -- Harry M. O'Hare, Sr 2035 Huntington Dr. #1 S. Pasadena, CA 91030 2,500 * 83,983 100% -- -- Floyd H. Panning 23456 South Pointe Drive Laguna Hills, CA 92653 836,792 6.0% -- -- -- -- Catherine Patterson 210,112 1.5% -- -- -- -- All officers and directors as a group (6 persons) 1,617,720 11.5% -- -- -- -- CONVERTIBLE % OF PREFERRED % OF VOTING NAME STOCK(4) CLASS POWER 5) ---- ----------- ----- -------- William F. Farnam -- -- * Anthony M. Frank 320 Meadowood Court Pleasant Hill, CA 94523 -- -- 43.1% Randall P. Frank -- -- 1.9% Randolph S. Heidmann -- -- * Arthur Lipper III (6) -- -- -- Harry M. O'Hare, Sr 2035 Huntington Dr. #1 S. Pasadena, CA 91030 931,629 35.8% 7.5% Floyd H. Panning 23456 South Pointe Drive Laguna Hills, CA 92653 7,500 * 4.0% Catherine Patterson 2,906 * 1.0% All officers and directors as a group (6 persons) 10,406 * 7.6%
- ---------------------------------------- * Less than 1% ** Includes address of five percent or more shareholders of any class. (1) Excludes 83,983 shares of common stock issuable upon conversion of Class B common stock, which carry eight (8) votes per share. If such shares of common stock were included, Mr. O'Hare and all officers and directors, as a group would own 86,483 shares (1.0%) and 1,617,720 shares (11.4%) of common stock, respectively. (2) Includes currently outstanding warrants or options to purchase an aggregate of 5,151,327 shares of common stock. (3) The Series B Convertible Preferred Stock is convertible into common stock, on a share-for-share basis, at the option of the holder or automatically if (a) we make a public 40 42 offering of its securities, or (2) if our securities are listed on NASDAQ or a national securities exchange market system. (4) The Convertible Preferred Stock was convertible into common stock only if certain earnings or market prices of the common stock were achieved prior to October 31, 1990. Such earnings and market prices were not achieved and commencing January 31, 1991, we were required to redeem such shares at $0.01 per share. We intend to redeem the Convertible Preferred Stock during fiscal 2000. (5) Reflects the voting rights of the common stock and Convertible Preferred Stock, each of which carries one (1) vote per share; Class B common stock, which carries eight (8) votes per share; and Series B Convertible Preferred Stock, which carries four (4) votes per share. (6) Excludes warrants to purchase 175,000 shares of common stock at $1.06 per share, expiring on May 14, 2006 and 10,000 options to purchase common stock at $0.9375 per share, expiring on August 13, 2009, all of which are beneficially owned by Communications Management Associates for which Arthur Lipper III disclaims beneficial ownership. Arthur Lipper III is an executive officer of Communications Management and has no control over the disposition or the voting control, if any, of the securities. In order to comply with conditions imposed by the Commissioner of Corporations of the State of California (the "Commissioner"), in connection with the public offering of Units in June 1987, Harry M. O'Hare, Sr. and Sandra O'Hare (Mr. O'Hare's former late wife) agreed that until such conditions are lifted by order of the Commissioner, all the shares of Class B common stock and Convertible Preferred Stock held by them (except for 107,848 shares of Convertible Preferred Stock issued in July 1988 to Harry M. O'Hare, Sr.) and any common stock received upon conversion of the Class B Common Stock and Convertible Preferred Stock, will be subject to the following conditions (which shall be referenced in a legend on the certificates for such shares): - - shares will not participate in dividends, other than stock dividends; - - shares will not participate in any distribution of assets in the event of liquidation; and - - shares may not be transferred without prior written consent of the Commissioner except for transfer pursuant to order or process of any court. The issuance of an order lifting such conditions is in the sole discretion of the Commissioner. However, under the Commissioner's Rules, such an order will generally be issued when we have demonstrated a satisfactory earnings record, as defined in such Rules, and we understand that in practice such an order will also be issued in the event of a merger, consolidation, or liquidation in which the holders of the common stock have received a satisfactory return on such shares. In October 1998, we agreed to seek the approval of our shareholders to enter into an agreement with Mr. O'Hare and two of his creditors which would support a petition to the Commissioner for removal of the above restrictions. The petition is currently under review by the Commissioner and, if approved, the agreement provides for the transfer of all our securities held 41 43 by Mr. O'Hare's to such creditors, including us, in exchange for certain monthly cash payments and extinguishment of debt owed by Mr. O'Hare. Our shareholders approved such agreement at the Annual Meeting of Shareholders held on June 26, 1999. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS MR. WILLIAM FARNAM On October 8, 1998, Mr. Farnam exercised 1,250 and 1,668 warrants to purchase common stock that had been assigned to him by the original holder of such warrants on October 2, 1998. Pursuant to a private placement offering authorized in September 1998, the original exercise price of such warrants ($9.00 and $15.00, respectively) had been reduced to $1.00 per share. MR. ANTHONY FRANK In fiscal year 1998, we borrowed $400,000 from Mr. Frank and issued notes which provided for conversion of the loans into shares of our common stock at any time. The intrinsic value of the beneficial conversion features was determined, and additional paid-in capital and interest expense of $400,000 was recognized. We issued 342,659 shares of common stock to Mr. Frank at fair market value of $672,897 in connection with the conversion of the notes payable and accrued interest totaling $409,847. On January 15, 1999, Mr. Frank purchased 1,000,000 shares of Series B Convertible Preferred Stock, $1 par value, for $1 million. Each share of Series B Stock carries four (4) votes per share and is convertible into common stock, on a share-for-share basis, at any time at Mr. Frank's option. Such Series B Preferred Stock is also automatically convertible, however, if either of the following events occur: - - shall make a public offering of any of its securities under the terms of an underwriting agreement with a securities dealer or underwriter; or - - common stock shall be admitted for listing on a national securities exchange market system or the NASDAQ System where it may then be traded. In July 1999, Mr. Frank purchased 900,000 shares of common stock and 450,000 three-year warrants to purchase common stock in a private placement offering and paid the sum of $900,000. The warrants are exercisable at $2.00 per share and are redeemable by us for $0.05 each if the common stock shall equal or exceed $4.00 per share for thirty consecutive trading days. On December 13, 1999 Mr. Frank executed a two-year convertible term note by which Mr. Frank has agreed to loan to us $200,000 at the rate of 10% annual interest. Mr. Frank loaned us an additional $100,000 under similar terms on January 25, 2000 and on February 10, 2000. On February 25, 2000 Mr. Frank converted these principal loans, plus $5,206 in accrued interest thereon, into 16.2 Units of a private placement offering, each Unit consisting of 25,000 shares of 42 44 common stock and 12,500 three-year warrants to purchase common stock at $2.00 per share. The warrants are redeemable by us at $0.05 per warrant at any time the common stock shall equal or exceed $4.00 per share for thirty (30) consecutive trading days. On March 6, 2000 Mr. Frank purchased an additional twenty (20) Units of the above private placement offering for the purchase price of $25,000 per Unit, or a total of $500,000. MR. RANDALL FRANK On September 21, 1998, Mr. Frank exercised 1,250 and 1,112 warrants to purchase common stock at $1.00 per share pursuant to a private placement offering to temporarily reduce the exercise price (originally $9,00 and $15.00, respectively) of such warrants. MR. RANDOLPH S. HEIDMANN Between August 1998 and October 31, 1999, we paid Mr. Heidmann a total of $42,000 pursuant to an arrangement to develop certain proprietary technology relating to a new design of a power supply which may be used with the EDI water treatment product. The parties intend to negotiate an agreement whereby we will acquire the rights to said technology once a prototype has been developed. Funds paid to Mr. Heidmann under this arrangement will be credited toward the acquisition price to be negotiated. Since November 1, 1999, an additional $11,500 has been paid to Mr. Heidmann pursuant to this arrangement. MR. ARTHUR LIPPER III In May 1998,we entered into a three-year agreement with Communications Management Associates for financial and management consulting services at the rate of $2,500 per month. Mr. Lipper is the president of Communications Management and is the primary contact for us under the consulting arrangement. Concurrent with the commencement of the agreement, we granted Communications Management 25,000 warrants to purchase common stock and 50,000 warrants each year thereafter for a period of three years. The warrants are exercisable at $1.06 per share and expire on May 13, 2006. MR. PANNING On March 25, 1998, Mr. Panning was granted 250,000 ten-year warrants to purchase common stock at $1.125 per share. Such warrants are exercisable in annual increments of 50,000, commencing on the grant date, to vest over a five-year period; provided, however, that Mr. Panning is employed by us on the exercise date. MISCELLANEOUS The Board of Directors has adopted a policy that no transaction between us and any officer, director, employee or members of their family shall be entered into without the full disclosure of such transaction to and the approval of such transaction by the non-interested members of the 43 45 Board of Directors. Furthermore, no agreements will be entered into regarding royalties, distributorships, supply agreements, sales agreements, the borrowing of money or the sale or granting of securities or options or the leasing or buying of property by us (exclusive of routine supply or sales agreements not exceeding $25,000), or any other type of contract over three months or $50,000 without the approval of the Board of Directors. SELLING SHAREHOLDERS The following table shows the names and positions, if any, with us of the Selling Shareholders, the number of shares of common stock beneficially owned by each of them as of March 28, 2000, the number of shares covered by this Prospectus and the number of shares (and percentage, if over 1%) such individuals would beneficially own if all of the shares covered by this Prospectus were fully sold: 44 46
Number of After Number of Shares Offering Number of Shares Owned After Percent of Name and Position Shares Covered by This Class, if with us, if any Owned (1) Prospectus Offering (1) Greater than 1% - --------------- --------- ---------- ------------ --------------- Addison, John 14,946 3,612 (2) 11,334 Aguirre, Gilbert G. 56,250 18,750 37,500 AM-FM Enterprises 4,446 1,112 (2) 3,334 Amato, Frank L. 2,100 500 (2) 1,600 Arndt, Douglas 2,673 2,000 (2) 673 Austin, Jackson 5,250 1,250 (2) 4,000 Barber, George 8,890 2,223 (2) 6,667 Barrett, Robert 5,250 1,250 (2) 4,000 Belk, John 13,337 3,335 (2) 10,002 Bias, Alan 2,223 556 (2) 1,667 Blaine Group, The 6,603 6,603 -- Bone, Alan 890 223 (2) 667 Boston, E. A. 5,576 112 (2) 5,464 Brown, Michael 10,846 1,112 (2) 9,734 Campbell, Eric 2,667 667 (2) 2,000 Carrillo, Ciro 104,167 39,167 (2) 65,000 Clanin, Thomas 2,625 625 (2) 2,000 Communications Mgmt. Assoc. (5) 185,000 175,000 (2) 10,000 Crosson, Albert 5,250 1,250 (2) 4,000 Cruver, James E. - Former Director and Former President 4,446 1,112 (2) 3,334 Cummus, Ann 4,446 1,112 (2) 3,334 Curtis, Tom 1,050 250 (2) 800 Danna, Gay 1,779 445 (2) 1,334 Dargenzio, Alfonso 158,971 50,000 108,971
45 47
Number of After Number of Shares Offering Number of Shares Owned After Percent of Name and Position Shares Covered by This Class, if with us, if any Owned (1) Prospectus Offering (1) Greater than 1% - ----------------- ---------- ---------- ------------- --------------- Das, Philip 2,625 625 (2) 2,000 Economic Development Bank for Puerto Rico 200,000 100,000 (2) 100,000 Edwards, Heather Tarlow 4,552 4,552 -- Egan, William 2,667 667 (2) 2,000 Ensch, Thomas 662 125 (2) 537 Farnam Living Trust - Director (3) 126,918 22,918 (2) 104,000 Fiducia Trading Co. - Former Director 8,890 2,223 (2) 6,667 Fishman, Richard L. 30,779 3,612 (2) 27,167 Fleming Profit Sharing Plan 273,000 187,500 (2) 85,500 Fleming, Ana Leigh 20,250 5,000 (2) 15,250 Fleming, Michael 25,250 10,000 (2) 15,250 Fleming, Terry L. 399,100 205,000 (2) 194,100 1.4% Fleming, Jr., Terry L. 32,750 17,500 (2) 15,250 Fonmin, John L. 5,780 1,112 (2) 4,668 Foti, A. Bert 4,446 1,112 (2) 3,334 Foti, Andrew 4,446 1,112 (2) 3,334 Frank, Anthony M. (3) (6) 6,187,551 4,057,809 (2) 2,129,742 15.7% Frank, Randall P. - Director (3) 413,898 32,362 (2) 381,536 2.8% Frank, Tracy F. 142,196 12,362 (2) 129,834 Frisenda, Quinton & Nicholson 110,696 100,000 (2) 10,696 Fuja, Megan 90,000 10,000 (2) 80,000 Haavig, David (3) 275,000 85,000 (2) 190,000 1.4% Heidmann, Randolph S. - Director (3) 30,000 20,000 (2) 10,000 Hughes, Martin 4,446 1,112 (2) 3,334
46 48
Number of After Number of Shares Offering Number of Shares Owned After Percent of Name and Position Shares Covered by This Class, if with us, if any Owned (1) Prospectus Offering (1) Greater than 1% - ----------------- ---------- ---------- ------------- --------------- Illes, Steve G. 100,446 1,112 (2) 99,334 J & L Enterprises 50,000 50,000 (2) -- Jepson, Joanne 2,223 556 (2) 1,667 Johnson, Craig 30,000 4,000 (2) 26,000 Johnson Associates, Keith M. 8,600 8,600 (2) -- Johnston, Heidi Tarlow 4,552 4,552 -- Jones, Larry 50,000 50,000 (2) -- Kearns, Jeanne M. 2,100 500 (2) 1,600 Kwan Pension Plan 4,848 1,181 (2) 3,667 Kwan Profit Sharing Plan 4,848 1,181 (2) 3,667 Landrace Corporation 4,446 1,112 (2) 3,334 Lee, William H. - former Director 10,000 10,000 (2) -- Link, F. Steven 2,788 556 (2) 2,232 Littlewood, Ken 4,446 1,112 (2) 3,334 Lorden, Gary A. 175,000 70,000 (2) 105,000 Lupo, Vince 4,446 1,112 3,334 Maichaud, Chubb 30,000 20,000 (2) 10,000 Maroka, Inc. 325,000 250,000 (2) 75,000 Martinez, Susan 446 112 (2) 334 Meier, Lon 223 223 (2) Metals Precision 1,212 303 (2) 909 Meylor, Tom 334 63 (2) 271 Mihama Corporation 150,000 50,000 (2) 100,000 MSN Securities 131,250 43,750 (2) 87,500 Nance, Edward 4,446 1,112 (2) 3,334
47 49
Number of After Number of Shares Offering Number of Shares Owned After Percent of Name and Position Shares Covered by This Class, if with us, if any Owned (1) Prospectus Offering (1) Greater than 1% - ----------------- ---------- ---------- ------------- --------------- Nathaniel, Sheldon 18,750 6,250 (2) 12,500 Neff, Merlin L. 12,020 2,223 (2) 9,797 Nemerovski, Harold 4,446 1,112 (2) 3,334 Newhuis, Gregg 56,250 18,750 (2) 37,500 O'Connell, George 112,500 37,500 (2) 75,000 O'Hare, Harry M. - Former Director and Former Chief Financial Officer (4) 86,483 83,983 2,500 O'Hare, Ronald J. - Former Director and Design Engineer 229,500 99,500 (2) 130,000 Orlandini, Jeff 20,000 20,000 (2) -- Osenblok, Johann 100,000 25,000 (2) 75,000 Ovando, Paul J. - Former Director 220,849 70,000 (2) 150,849 1.1% Panning, Floyd - Director, President and Chief Executive Officer (3) 811,792 649,202 (2) 162,590 1.2% Panning, Scott 100,000 30,000 (2) 70,000 Patterson, Catherine - Secretary and Chief Financial Officer (3) 210,112 210,000 (2) 112 Pett, Robert A. 122,838 25,000 (2) 97,838 Poss Family Trust 75,000 75,000 (2) -- Powell, Charles 16,973 7,500 (2) 9,473 Ratcliffe, Martyn 150,000 40,000 (2) 110,000 Reason, Robert 37,500 12,500 (2) 25,000 Romig, Richard 5,815 1,250 (2) 4,565 Schaeffer, Richard 788 88 (2) 700 Schmitt, Daryl 4,446 1,112 (2) 3,334
48 50
Number of After Number of Shares Offering Number of Shares Owned After Percent of Name and Position Shares Covered by This Class, if with us, if any Owned (1) Prospectus Offering (1) Greater than 1% - ----------------- ---------- ---------- ------------- --------------- Shani, Ruth - Admin. Asst 41,125 37,000 (2) 4,125 Shirley, Terry 50,000 30,000 (2) 20,000 Sikora, Thaddeus S. 7,875 1,875 (2) 6,000 Skalski, Ken 2,223 556 (2) 1,667 Snow, Michael (3) 370,000 140,000 (2) 230,000 1.7% Spencer, Charles 32,307 2,223 (2) 30,084 Stegall, Sam Ray 22,500 22,500 (2) -- Tarlow, Gardner 4,553 4,553 -- Tarlow, Garth 4,553 4,553 -- Textile Apparel Corp. 4,446 1,112 (2) 3,334 TNKRGK Family Trust 9,696 2,362 (2) 7,334 Traub, Gordon 11,751 1,112 (2) 10,639 Veraldi, William 6,546 1,112 (2) 5,434 von Leesen, Joan 22,050 6,250 (2) 15,800 von Leesen, John 28,001 10,000 (2) 18,001 Waldman Family Trust 123,157 2,500 (2) 120,657 Waldman, Jill 5,250 1,250 (2) 4,000 Wenc, Henry S. 2,625 625 (2) 2,000 White, Bryan L. 1,000 1,000 (2) -- White, Kevin C. 31,000 7,000 (2) 24,000 White, Kristi, A . 1,000 1,000 (2) -- White, Leroy - Production Manager 70,000 10,000 (2) 60,000 White, Sally J. 1,000 1,000 (2) -- Whiting, Mikel 5,576 1,112 (2) 4,464 Weider, Harriett 75,000 50,000 (2) 25,000 Wilson, Carly 7,500 2,500 5,000 Wilson, Patricia 12,750 2,500 10,250 Winokur Water Trust 91,084 18,750 72,334 Worley, Samantha L. 1,000 1,000 (2) -- Yamada, Kenneth 4,938 938 (2) 4,000 ---------- --------- --------- 13,553,805 7,547,459 6,006,346 ========== ========= =========
49 51 - -------------------------------- (1) Includes 3,626,327 shares currently issuable upon exercise of options or warrants or exercisable within 60 days of the date hereof. Also includes 83,983 shares issuable upon conversion of Class B common stock and 1,000,000 shares issuable upon conversion of Series B Convertible Preferred Stock. Excludes Convertible Preferred Stock owned by the Selling Shareholders. (2) Includes common stock underlying options or warrants. (3) See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" and "MANAGEMENT - Directors, Officers and Key Employees." (4) Includes 83,983 shares issuable upon conversion of Class B common stock. Through ownership of common stock, Class B common stock and Convertible Preferred Stock, Mr. O'Hare controls 7.5% of the voting power. See "PRINCIPAL SHAREHOLDERS." (5) See "PRINCIPAL SHAREHOLDERS" and CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Mr. Arthur Lipper III." (6) Includes 1,000,000 shares issuable upon conversion of Series B Convertible Preferred Stock. Through ownership of common stock and Series B Convertible Preferred Stock, Mr. Frank controls 43.1% of the voting power. See "PRINCIPAL SHAREHOLDERS" and CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Mr. Anthony Frank." Plan of Distribution The common stock may be sold by the Selling Shareholders or their pledgees, donees, transferees, or other successors-in-interest. The sale of common stock may be effected from time to time in transactions (which may include block transactions by or for the account of the Selling Shareholder) in the over-the-counter market or in negotiated transactions, through the writing of options on the common stock, through a combination of such methods of sale, or otherwise. Sales may be made at fixed prices that may be changed, at market prices prevailing at the time of sale, or at negotiated prices. If any Selling Shareholder sells his, her or its shares, or options thereon, pursuant to this Prospectus at a fixed price or at a negotiated price which is, in either case, other than the prevailing market price or in a block transaction to a purchaser who resells, or if any Selling Shareholder pays compensation to a broker-dealer that is other than the usual and customary discounts, concessions or commissions, or if there are any arrangements either individually or in the aggregate that would constitute a distribution of the shares, a post-effective amendment to the Registration Statement of which this Prospectus is a part would need to be filed and declared effective by the Securities and Exchange Commission before such Selling Shareholder could make such sale, pay such compensation or make such a distribution. We are under no obligation to file a post-effective amendment to the Registration Statement of which this Prospectus is a part under such circumstances. 50 52 The Selling Shareholders may effect transactions in their common stock by selling their securities directly to purchasers, through broker-dealers acting as agents for the Selling Shareholders or to broker-dealers who may purchase the Selling Shareholder's shares as principals and thereafter sell such securities from time to time in the over-the-counter market, in negotiated transactions, or otherwise. Such broker-dealers, if any, may receive compensation in the form of discounts, concessions or commissions from the Selling Shareholders and/or the purchasers for whom such broker-dealers may act as agents or to whom they may sell as principals or both. While this Prospectus covers the sale of common stock received upon exercise of options and warrants by the Selling Shareholders, it does not cover the exercise of such options and warrants. The Selling Shareholders and broker-dealers, if any, acting in connection with such sales might be deemed to be "underwriters" within the meaning of Section 2(11) of the Act and any commission received by them and any profit on the resale of such securities might be deemed to be underwriting discounts and commissions under the Act. The Selling Shareholders have been advised that during the time each is engaged in "distribution" (as defined under Regulation M under the Securities Exchange Act of 1934, as amended) of the securities covered by this Prospectus, each must comply with Regulation M under the Securities Exchange Act of 1934, as amended, and pursuant thereto: (i) shall not engage in any stabilization activity in connection with our securities; and (ii) shall not bid for or purchase any of our securities or attempt to induce any person to purchase any of our securities other than as permitted under the Securities Exchange Act of 1934, as amended. Any Selling Shareholder who may be an "affiliated purchaser" as defined in Regulation M has been further advised that he must coordinate his sales under this Prospectus with each other and us for purposes of Regulation M. Each Selling Shareholder must also furnish each broker through which common stock is sold copies of this Prospectus. DESCRIPTION OF CAPITAL STOCK COMMON STOCK We are authorized to issue up to 20,000,000 shares of $0.01 par value common stock. In May 1996, the Company's shareholders approved a one-for-ten reverse stock split of its then currently outstanding Class A and Class B common stock. Consequently, on July 25, 1996 the currently outstanding 18,960,695 shares of Class A common stock were reconstituted and converted into 1,896,070 shares of $0.01 par value Class A common stock. The issued and outstanding shares of common stock and the shares being offered hereby and the shares issuable upon exercise of warrants and options when exercised and issued, will be validly issued, fully paid and nonassessable. Holders of common stock are entitled to one vote per share on all matters to be voted upon by the shareholders and except as may otherwise be required by law or as set forth under "DESCRIPTION OF CAPITAL STOCK - Class B Common Stock," will vote with the holders of the Class B common stock, Series B Convertible Preferred Stock and Convertible Preferred Stock as one class. Under California law, separate class voting is required for mergers or sales 51 53 of substantially all of our assets. If, prior to the election of directors, any shareholder has given notice that he intends to cumulate his votes, then for the election of directors each shareholder may cumulate votes for any nominee, if the nominee's name was placed in nomination prior to the voting. In cumulative voting, each shareholder is entitled in the election of directors to one vote for each voting share held by him multiplied by the number of directors to be elected and may cast all such votes for a single nominee for directors or may distribute them among any two or more nominees as he sees fit. The shares of common stock have no preemptive, subscription, conversion or redemption rights. Upon liquidation, dissolution or winding up, the holders of common stock are entitled to receive pro rata our assets which are legally available for distribution to shareholders, subject to the liquidation rights held by the Class B common stock, Series B Convertible Preferred Stock and the Convertible Preferred Stock, and the prior rights, if any, that may be established in the future for Preferred Stock, if any. See "DESCRIPTION OF CAPITAL STOCK - Preferred Stock". Holders of common stock are entitled to dividends when, as and if declared by the Board of Directors out of funds legally available therefor along with the holders of the Class B common stock, subject to any prior rights when may be granted in the future to holders of Preferred Stock. As of March 28, 2000, 8,877,341 shares of the Company's common stock were outstanding. CLASS B COMMON STOCK Pursuant to the July 25, 1996 one-for-ten reverse stock split, 839,825 authorized and outstanding shares of Class B common stock (all of which are issued and owned by Harry M. O'Hare, Sr.) were reconstituted and converted into 83,983 authorized and outstanding shares of $0.01 par value Class B common stock. The Class B common stock, the common stock, the Series B Convertible Preferred Stock, and the Convertible Preferred Stock vote as a single class on all matters except as required by law and except if a reverse stock split or stock split is effected on the common stock and a similar reverse stock split or stock split is not effected on the Class B common stock or if a stock dividend in Class B common stock is not declared equal to a stock dividend declared on the common stock. In the latter situations, a separate class vote of the Class B common stock is required. Each share of Class B common stock carries eight votes per share and is entitled to non-stock dividends and liquidation payments equal to 80% of those paid on the common stock. The Class B common stock may not be transferred or assigned by the owner thereof. If a transfer is made of a share of Class B common stock in contravention of such restrictions, such share will automatically be converted into a share of common stock. Class B common stock will automatically convert, on a share-for-share basis, into shares of common stock upon the death of Harry M. O'Hare, Sr. 52 54 CONVERTIBLE PREFERRED STOCK We can also issue 2,600,000 shares of Convertible Preferred Stock, $0.01 par value. In March, 1987, an aggregate of 2,492,152 shares of Convertible Preferred Stock had been issued pro rata to all of the shareholders of the then currently outstanding common stock and Class B common stock. On July 28, 1988, the balance of 107,848 Convertible Preferred Shares were issued to Harry M. O'Hare, Sr. as a bonus. Each share of Convertible Preferred Stock has one vote per share and except as otherwise may be required by law or set forth in "DESCRIPTION OF CAPITAL STOCK - Class B Common Stock," will vote as a class on all matters with the common stock, Class B common stock, and the Series B Convertible Preferred Stock. The Convertible Preferred Stock is not entitled to receive any dividends, and in the event of liquidation, dissolution or winding up, each share is entitled to share ratably in all assets available for distribution at the rate equal to one share of common stock up to a maximum of $0.01 per share. The shares of Convertible Preferred Stock have no preemptive rights or other rights to subscribe for additional securities and there are no redemption or sinking fund provisions with respect to such shares. We did not achieve certain after-tax earnings and/or market prices and as of January 31, 1991, the Convertible Preferred Stock became redeemable by us for $0.01 per share. The Convertible Preferred Stock is not assignable or transferable (except upon death or upon approval of a majority of the members of the Board of Directors not holding shares of Convertible Preferred Stock). PREFERRED STOCK On January 15, 1999, we issued 1,000,000 shares of its Series B Convertible Preferred Stock out of the 1,000,000 shares of authorized Preferred Stock, $1.00 par value. Series B Convertible Preferred Stock provides for a $1.00 per share liquidation preference over the common stock, Class B common stock and Convertible Preferred Stock and each share of Series B Convertible Preferred Stock entitles the holder thereof to four (4) votes per share and is to vote as a class along with holders of the common stock, Class B common stock and Convertible Preferred Stock. The shares of Series B Convertible Preferred Stock are convertible, in whole or in part, into common stock on a share for share basis at any time at the option of the holder, Mr. Anthony M. Frank. Each share of Series B Convertible Preferred Stock is automatically convertible into one share of common stock upon five days' written notice from us if either of the following events shall occur: - - shall make a public offering of any of its securities under the terms of an underwriting agreement with a securities dealer or underwriter; or - - securities shall be admitted for listing on a national securities exchange market system or the NASDAQ System where the common stock may then be traded. 53 55 TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the common stock is American Stock Transfer Company, 40 Wall Street, New York, New York 10005. SHARES ELIGIBLE FOR FUTURE SALE 2,837,149 of the shares of common stock owned by our shareholders are "restricted securities" as such term is defined in the Securities Act of 1933 (the "Act"). An aggregate of approximately 429,531 shares of common stock are eligible for sale under Rule 144. In general, Rule 144 permits a shareholder who has held his shares for at least one year after payment therefor to sell within any three-month period a number of shares that does not exceed the greater of 1% of the outstanding shares of common stock (currently approximately 88,248 shares) or the average weekly trading volume of such shares for the four weeks preceding the sale. Any shareholder who is not an affiliate and has not been an affiliate for the preceding three months and who has held his shares of common stock for at least two years after payment may sell his shares under Rule 144, without any volume limitations. If a substantial number of shares of common stock are sold pursuant to Rule 144, registration statements or otherwise, the price at which the shares of common stock are traded may be adversely affected. WHERE YOU CAN FIND ADDITIONAL INFORMATION We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, and, in accordance therewith, file reports, proxy statements and other information with the SEC. Such reports, proxy statements and other information may be inspected and copied at the public reference facilities maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's regional offices located at the Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, IL 60661 and Seven World Trade Center, 13th Floor, New York, NY 10048. Copies of such material can be obtained from the Public Reference Section of the SEC upon payment of certain fees prescribed by the SEC. The SEC's Web site contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. The address of that site is http://www.sec.gov. We have filed a registration statement on Form SB-2 with the SEC under the Securities Act of 1933, as amended, in respect of the common stock offered pursuant to this prospectus. This prospectus, which is a part of the registration statement, omits certain information contained in the registration statement as permitted by the SEC's rules and regulations. For further information with respect to us and the common stock offered hereby, please reference the registration statement, including its exhibits. Statements in this prospectus concerning the contents of any contract or other document filed with the SEC as an exhibit to the registration statement are summaries of the material provisions of those documents and we recommend that you also refer to those exhibits in evaluating us. Copies of the registration statement, including all related exhibits and schedules, may be inspected without charge at the public reference facilities maintained by the SEC, or obtained at prescribed rates from the Public Reference Section of the SEC at the address set forth above. 54 56 LEGAL OPINION Skadden, Arps, Slate, Meagher & Flom, LLP, 300 South Grand Avenue, 34th Floor, Los Angeles, California 90071, securities counsel to Electropure, will render an opinion with respect to the valid issuance and nonassessability of the Common Stock being offered hereby. EXPERTS The Financial Statements of Electropure, Inc. as of October 31, 1999 and 1998, and the related statements of operations, shareholders' equity, and cash flows for each of the years in the two-year period ended October 31, 1999, included herein and elsewhere in the Registration Statement, have been included herein and in the Registration Statement in reliance upon the report of Kelly & Company, independent auditors, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The report of Kelly & Company contained explanatory paragraphs as to the Company's ability to continue as a going concern. CHANGE IN CERTIFYING ACCOUNTANTS On June 16, 1998, due to a need for expanded accounting requirements and location of accountants, the Board of Directors approved the recommendation of management to (i) engage Kelly & Company as the independent auditors for Electropure, Inc. and (ii) dismiss Alex Chaplan & Associates as such independent accountants. For the Company's fiscal years ended October 31, 1996 and 1997, the financial statements were subject to going concern qualifications and an uncertainty as to the outcome of certain litigation and claims, but were not otherwise qualified or modified as to audit scope, or accounting principles by Alex N. Chaplan & Associates. During the two fiscal years ended October 31, 1996 and 1997, and since October 31, 1997, there were not any disagreements with Alex N. Chaplan & Associates on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Alex N. Chaplan & Associates, would have caused it to make a reference to the subject matter of the disagreements in connection with its report, nor were there any "reportable events" as defined in Item 304(a)(1)(v) of Regulation S-K. During the two fiscal years ended October 31, 1996 and 1997, and between October 31, 1997 and June 16, 1998, Registrant did not consult with Kelly & Company on the application of accounting principles to a specified transaction, or the type of audit opinion that might be rendered on the Registrant's financial statements or any disagreements (as defined in Item 304(a)(1)(iv) of Regulation S-K) or a reportable event (as defined above). 55 57 REPORT OF INDEPENDENT AUDITORS To the Board of Directors Electropure, Inc. We have audited the accompanying balance sheets of Electropure, Inc. as of October 31, 1999 and 1998, and the related statements of operations, shareholders' equity and cash flows for each of the two years in the period ended October 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Electropure, Inc. as of October 31, 1999 and 1998, and the results of its operations and its cash flows for each of the two years in the period ended October 31, 1999, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company has suffered recurring losses from operations, has negative cash flow from operations and an accumulated deficit. In addition, the Company has relied primarily on the sale of its securities and borrowings to provide the cash needed for operations. These conditions raise substantial doubt about its ability to continue as a going concern. Management's plan in regard to these matters is discussed in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Kelly & Company Kelly & Company Newport Beach, California December 23, 1999 58 ELECTROPURE, INC. BALANCE SHEETS OCTOBER 31, 1999 AND 1998 ASSETS
1999 1998 ---------- ---------- Current assets: Cash and equivalents $ 204,328 $ 57,440 Trade accounts receivable 97,745 161,225 Note receivable, related party -- 3,500 Note receivable, individual -- 67,127 Inventories 204,888 320,532 Prepaid legal fees 92,500 -- Other prepaid expenses 12,007 24,505 ---------- ---------- Total current assets 611,468 634,329 Property and equipment, net 566,872 134,045 Acquired technology, net of accumulated amortization 131,945 528,192 Building purchase option 105,000 90,000 ---------- ---------- TOTAL ASSETS $1,415,285 $1,386,566 ========== ==========
The accompanying notes are an integral part of the financial statements. F-2 59 ELECTROPURE, INC. BALANCE SHEETS OCTOBER 31, 1999 AND 1998 LIABILITIES AND SHAREHOLDERS' EQUITY
1999 1998 ------------ ------------ Current liabilities: Trade accounts payable $ 86,544 $ 126,843 Current portion of obligations under capital leases 9,465 -- Note payable to officer 7,632 6,216 Customer deposit 168,755 100,000 Accrued payroll 87,986 79,345 Other accrued liabilities 51,630 36,968 Total current liabilities 412,012 349,372 Obligations under capital leases, net of current portion 1,298 -- Note payable to officer, net of current portion 4,683 12,315 ------------ ------------ TOTAL LIABILITIES 417,993 361,687 ------------ ------------ Commitments and contingencies Redeemable preferred stock; $.01 par value; 2,600,000 shares authorized, issued and outstanding 26,000 26,000 Shareholders' equity: Series B convertible preferred stock; $1.00 par value; 1,000,000 and no shares authorized, issued and outstanding (Notes 2 and 25) 1,000,000 -- Common stock; $.01 par value; 20,000,000 shares authorized; 7,791,425 and 8,618,925 shares issued and outstanding 77,914 86,189 Class B common stock; $.01 par value; 83,983 shares authorized, issued and outstanding 840 840 Additional paid-in capital 20,971,537 20,032,205 Accumulated deficit (21,018,249) (19,059,605) Notes receivable on common stock (60,750) (60,750) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 971,292 998,879 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,415,285 $ 1,386,566 ============ ============
The accompanying notes are an integral part of the financial statements. F-3 60 ELECTROPURE, INC. STATEMENTS OF OPERATIONS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
1999 1998 ----------- ----------- Net sales $ 695,565 $ 805,513 Cost of sales 898,386 704,365 ----------- ----------- Gross profit (loss) (202,821) 101,148 ----------- ----------- Operating costs and expenses: Research and development 650,897 445,110 Salaries 364,697 263,953 Consulting 243,392 142,919 Other operating expenses 512,793 407,939 ----------- ----------- Total operating expenses 1,771,779 1,259,921 ----------- ----------- Loss from operations (1,974,600) (1,158,773) Other income (expense): Interest income 14,252 7,556 Other income 3,920 22,449 Interest expense (1,416) (403,426) ----------- ----------- Other income (expense), net 16,756 (373,421) ----------- ----------- Loss before provision for income taxes and extraordinary item (1,957,844) (1,532,194) Provision for income tax (800) (800) Extraordinary gain -- 26,051 ------------ ----------- NET LOSS $(1,958,644) $(1,506,943) =========== =========== NET LOSS PER SHARE, BASIC AND DILUTED $ (0.23) $ (0.19) =========== ===========
The accompanying notes are an integral part of the financial statements. F-4 61 ELECTROPURE, INC. STATEMENTS OF SHAREHOLDERS' EQUITY FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
Series B Series B Convertible Class B Convertible Preferred Common Common Preferred Common Shares Shares Shares Stock Stock ----------- ------ ------- ----------- ------ BALANCE, OCTOBER 31, 1997, AS RESTATED -- 7,734,293 83,983 -- $ 77,343 Common shares issued for convertible debt to a related party -- 342,659 -- -- 3,427 Common shares issued on the exercise of warrants with beneficial conversion features -- 155,928 -- -- 1,559 Paid-in capital arising from beneficial conversion features on convertible debt issued -- -- -- -- -- Common shares issued on exercise of warrants -- 25,000 -- -- 250 Common shares issued on exercise of options -- 12,000 -- -- 120 Common shares and warrants issued in a private placement offering -- 278,363 -- -- 2,784 Common shares issued for an option to purchase real estate -- 60,000 -- -- 600 Common shares issued for real estate broker commission -- 6,579 -- -- 66 Common shares issued for consulting and public relations services -- 4,103 -- -- 40 Payment of note receivable arising from an earlier issuance of common stock -- -- -- -- -- Warrants granted on common stock to employees and consultants for services -- -- -- -- -- Net loss -- -- -- -- -- ---- --------- ------ ---- -------- BALANCE, OCTOBER 31, 1998 -- 8,618,925 83,983 -- $ 86,189 ==== ========= ====== ==== ======== Note Class B Additional Receivable Common Paid-in Accumulated Common Stock Capital Deficit Stock Total ------- ---------- ----------- ----------- ----- BALANCE, OCTOBER 31, 1997, AS RESTATED $ 840 $18,244,073 $(17,552,662) $(50,000) $719,594 Common shares issued for convertible debt to a related party -- 406,420 -- -- 409,847 Common shares issued on the exercise of warrants with beneficial conversion features -- 154,369 -- -- 155,928 Paid-in capital arising from beneficial conversion features on convertible debt issued -- 400,175 -- -- 400,175 Common shares issued on exercise of warrants -- 29,500 -- (29,750) -- Common shares issued on exercise of options -- 5,880 -- (6,000) -- Common shares and warrants issued in a private placement offering -- 547,216 -- -- 550,000 Common shares issued for an option to purchase real estate -- 89,400 -- -- 90,000 Common shares issued for real estate broker commission -- 9,934 -- -- 10,000 Common shares issued for consulting and public relations services -- 7,460 -- -- 7,500 Payment of note receivable arising from an earlier issuance of common stock -- -- -- 25,000 25,000 Warrants granted on common stock to employees and consultants for services -- 137,778 -- -- 137,778 Net loss -- -- (1,506,943) -- (1,506,943) -------- ----------- ------------- --------- ---------- BALANCE, OCTOBER 31, 1998 $ 840 $20,032,205 $(19,059,605) $(60,750) $998,879 ======== =========== ============= ========= ==========
The accompanying notes are an integral part of the financial statements. F-5 62 ELECTROPURE, INC. STATEMENTS OF SHAREHOLDERS' EQUITY (Continued) FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
Series B Series B Convertible Class B Convertible Preferred Common Common Preferred Common Shares Shares Shares Stock Stock ----------- --------- ------ ----------- ---------- BALANCE, OCTOBER 31, 1998 -- 8,618,925 83,983 -- $ 86,189 Common shares issued upon exercise of options -- 2,500 -- -- 25 Common shares and warrants issued in private placement -- 1,020,000 -- -- 10,200 Common shares issued as prepaid legal fees -- 100,000 -- -- 1,000 Common shares cancelled pursuant to a settlement -- (1,950,000) -- -- (19,500) Class B convertible preferred shares issued in private placement to a related party 1,000,000 -- -- $1,000,000 -- Options and warrants granted to employees and consultants for services -- -- -- -- -- Net loss -- -- -- -- -- --------- ---------- ------ ---------- ---------- BALANCE, OCTOBER 31, 1999 1,000,000 7,791,425 83,983 $1,000,000 $ 77,914 ========= ========== ====== ========== ========== Note Class B Additional Receivable Common Paid-in Accumulated Common Stock Capital Deficit Stock Total ---------- ------------ ------------- ------------- ---------- BALANCE, OCTOBER 31, 1998 $ 840 $20,032,205 $(19,059,605) $ (60,750) $ 998,879 Common shares issued upon exercise of options -- 1,225 -- -- 1,250 Common shares and warrants issued in private placement -- 1,009,800 -- -- 1,020,000 Common shares issued as prepaid legal fees -- 99,000 -- -- 100,000 Common shares cancelled pursuant to a settlement -- (273,000) -- -- (292,500) Class B convertible preferred shares issued in private placement to a related party -- -- -- -- 1,000,000 Options and warrants granted to employees and consultants for services -- 102,307 -- -- 102,307 Net loss -- -- (1,958,644) -- (1,958,644) ---------- ----------- ------------- ----------- ---------- BALANCE, OCTOBER 31, 1999 $ 840 $20,971,537 $(21,018,249) $ (60,750) $ 971,292 ========== =========== ============= =========== ==========
The accompanying notes are an integral part of the financial statements. F-6 63 ELECTROPURE, INC. STATEMENTS OF CASH FLOWS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
1999 1998 ----------- ----------- Cash flows from operating activities: Net loss $(1,958,644) $(1,506,943) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 43,080 11,937 Amortization 103,747 117,484 Provision for (recovery on) uncollectible accounts 560 (7,278) Issuance of warrants for services 102,307 137,778 Interest expense arising from issuance of convertible debt -- 400,175 Services provided in payment of note receivable - related party 70,627 69,627 Issuance of common stock for services -- 17,500 Extraordinary gain on settlement of debt -- (26,051) (Increase) decrease in assets: Trade accounts receivable 62,920 (145,965) Accounts receivable - related party -- 19,500 Prepaid legal and other expenses 19,998 (19,606) Inventories 115,644 (216,239) Building purchase - option (15,000) -- Increase (decrease) in liabilities: Trade accounts payable (40,299) 70,668 Customer deposit 68,755 100,000 Accrued payroll and other liabilities 23,303 70,884 ----------- ----------- CASH USED IN OPERATING ACTIVITIES (1,403,002) (906,529) ----------- -----------
The accompanying notes are an integral part of the financial statements. F-7 64 ELECTROPURE, INC. STATEMENTS OF CASH FLOWS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999
1999 1998 ----------- ----------- Cash flows used in investing activities: Purchase of property and equipment $ (471,360) $ (117,670) Purchase of acquired technology -- (200,000) Increase in notes receivable, related parties -- (203,500) ----------- ----------- CASH USED IN INVESTING ACTIVITIES (471,360) (521,170) ----------- ----------- Cash flows provided by (used in) financing activities: Principal payments on notes payable -- (13,469) Proceeds from the issuance of notes payable to a related party -- 400,000 Payments on notes receivable for common stock -- 25,000 Proceeds from exercise of warrants 1,250 155,928 Proceeds from issuance of stock - private placement 1,020,000 550,000 Proceeds from issuance of preferred stock to a related party 1,000,000 -- ----------- ----------- CASH PROVIDED BY FINANCING ACTIVITIES 2,021,250 1,117,459 ----------- ----------- NET INCREASE (DECREASE) IN CASH 146,888 (310,240) CASH AT BEGINNING OF PERIOD 57,440 367,680 ----------- ----------- CASH AT END OF PERIOD $ 204,328 $ 57,440 =========== ===========
The accompanying notes are an integral part of the financial statements. F-8 65 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 Supplemental Disclosure of Cash Flow Information
1999 1998 --------- --------- Interest paid $ 2,543 $ 3,251 Income taxes paid $ 1,600 $ 800 Supplemental Schedule of Non-Cash Investing and Financing Activities Acquisition of assets in non-cash transactions: Assets acquired -- $ 200,108 Accounts receivable, related party satisfied -- $ (19,306) Notes receivable satisfied -- $ (70,802) Issuance of note payable to officer -- $ (20,000) Issuance of common stock -- $ (90,000) Litigation settlement: Return and cancellation of common stock $ 292,500 -- Surrender of acquired technology $(292,500) -- Issuance of common stock for prepaid legal fees: Prepaid legal fees $ 100,000 -- Issuance of common stock $(100,000) -- Issuance of common stock for note receivable: Notes receivable received -- $ 35,750 Issuance of common stock -- $ (35,750) Convertible debt retired by issuance of common stock: Reduction of liabilities -- $ 409,847 Issuance of common stock -- $(409,847)
F-9 66 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 1. DESCRIPTION OF BUSINESS Electropure, Inc. (the "Company") manufactures and markets electrodeionization ("EDI") water treatment devices for commercial and industrial high purity water applications. The Company holds an exclusive patent on its EDI product and markets it to original equipment manufacturers as a specialized component for water treatment systems, whose major customers include semiconductor, pharmaceutical and cosmetic companies, as well as laboratories and petrochemical companies. The Company's Hydro Components ("HC") products are sanitary heat exchangers, sample coolers for sterile steam and water, based on ion exchange membrane technology for electrodialysis, electrodeposition, and electrochemical separations. The Company's Micro Imaging ("MI") technology is in the development phase, which, when completed, will provide a product that will enable real time identification of contamination in water. 2. MANAGEMENT'S PLAN (UNAUDITED) The Company incurred net losses of $1,958,644 and $1,506,943 in fiscal years October 31, 1999 and 1998, respectively, and at October 31, 1999 had an accumulated deficit of $21,018,249 and is in default under the redemption provisions of its redeemable preferred stock (Note 24). Despite negative cash flows from operations of $1,403,002 and $906,529 in the years ended October 31, 1999 and 1998, respectively, the Company has been able to secure additional operating capital through private equity funding sources, a significant portion of which is from an individual who is a related party and the largest shareholder. No assurances can be given that the Company can or will continue to obtain sufficient working capital through the sale of the Company's securities, borrowing, or through the sale of products that will generate sufficient revenues in the future to sustain ongoing operations. The Company's ability to continue as a going concern will be reliant upon its ability to gain access to equity and debt capital or achieve profitable operations. The Company believes, however, that the current market interest in its products is strong and will enhance its ability to generate the funds necessary through equity and debt capital and the sale of its products to meet its needs. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition Revenues on the sale of the Company's products are recognized when the products are shipped. F-10 67 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Cash and Cash Equivalents The Company invests portions of its excess cash in highly liquid investments. Cash and equivalents include time deposits and commercial paper with original maturities of three months or less. The Company has no requirements for compensating balances. The Company maintains cash balances in accounts which exceeded the federally insured limits by $166,684 and $0 at October 31, 1999 and 1998, respectively; however, the Company has not experienced any losses in such accounts. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. Exposure to losses on accounts receivable is principally dependent on the individual customer's financial condition, as credit sales are not collateralized. The Company monitors its exposure to credit losses and reserves for those accounts receivable that it deems to be not collectible. Inventories Inventories are stated at the lower of cost or market. Cost is determined on a standard cost basis, which approximates the first in - first out method of valuation. The Company's management monitors inventories for excess and obsolete items and makes necessary valuation corrections when such adjustments are required. Property and Equipment Property and equipment are recorded at cost and are depreciated using the straight-line method over the expected useful lives noted below. Expenditures for normal maintenance and repairs are charged to operations. The cost and related accumulated depreciation of assets are removed from the accounts upon retirement or other disposition, and the resulting profit or loss is reflected in the Statement of Operations. Renewals and betterments that materially extend the life of the assets are capitalized.
Estimated Useful Lives ---------------- Machinery and equipment 5 years Automobiles 5 years Furniture and fixtures 5 years Leasehold improvements 3 years
F-11 68 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Intangible Assets Intangible assets represent the cost of intellectual properties described as acquired patented technology and unpatented process technology that are amortized on a straight-line method over the shorter of the estimated useful life of the technology or the remaining term of the patent. Impairment of Long-Lived Assets The Company annually evaluates its long-lived assets, including identifiable intangible assets for potential impairment. When circumstances indicate that the carrying amount of an asset is not recoverable, as demonstrated by the projected undiscounted cash flows, an impairment loss is recognized. The Company's management has determined that there was no such impairment present at October 31, 1999 and 1998. Debt Issued with Stock Purchase Warrants Proceeds from debt issued were allocated between the debt and the warrants based on their relative fair values. The value ascribed to the warrants, based on the Black-Scholes Option Pricing Model, is amortized to interest expense over the term of the related debt using the effective interest method. Induced Conversion of Debt The Company in certain instances will grant or modify conversion privileges of debt to equity after its issuance. These grants or modifications take the form of new or reduced conversion prices of the debt into the Company's common stock available to the applicable debt holders. When the debt is converted into equity, the Company recognizes, as debt conversion expense, the excess of the fair value of the common stock issued at that time over the fair value of the common stock that would be issuable under the original terms. Income Taxes The Company accounts for income taxes under the liability method. Under the liability method, deferred income taxes are determined based on differences between the financial reporting and tax bases of assets and liabilities. They are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company is required to adjust its deferred tax liabilities in the period when tax rates or the provisions of the income tax laws change. Valuation allowances are established to reduce deferred tax assets to the amounts expected to be realized. F-12 69 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED Stock Based Compensation Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), established accounting and disclosure requirements using a fair value based method of accounting for stock-based employee compensation plans. As permitted by SFAS No. 123, the Company will continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). Compensation cost for stock options, if any, will be measured as the excess of the quoted market price of the Company's stock at the date of grant over the amount an employee must pay to acquire the stock. Compensation cost is amortized over the requisite vesting periods. Product Warranty Cost Provision for estimated warranty cost is recorded at the time of sale and periodically adjusted to reflect actual experience. Research and Development Research and development expenditures are charged to expense as they are incurred. The Company's research and development activities include ongoing work on various uses of the micro imaging multi-angle laser light scattering technology. Additionally, efforts are continuing on development of improved production processes and cost reduction techniques for the ion permeable membranes for their application in the HC products. Contract research and development expenditures are expensed as incurred. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual amounts could differ from those estimates. Financial Statement Classification Certain amounts presented within the 1998 financial statements have been reclassified in order to conform to the 1999 financial statement presentation. F-13 70 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 4. NOTE RECEIVABLE, INDIVIDUAL In February 1998, the Company received a note receivable from an individual with a fixed annual interest rate of 8%. During the year ended October 31, 1999, the unpaid balance of the note plus the accrued interest was offset against a vendor contract incentive bonus earned by the same individual (Notes 11 and 26). 5. INVENTORIES At October 31, 1999 and 1998, inventories consisted of the following:
1999 1998 -------- -------- Raw materials $125,292 $320,532 Finished goods 79,596 -- -------- -------- INVENTORIES $204,888 $320,532 ======== ========
6. PROPERTY AND EQUIPMENT At October 31, 1999 and 1998, property and equipment consisted of the following:
1999 1998 --------- --------- Machinery and equipment $ 424,999 -- Automobiles 39,797 $ 23,000 Furniture and fixtures 111,018 94,711 Leasehold improvements 45,954 28,443 --------- --------- 621,768 146,154 Less: accumulated depreciation (54,896) (12,109) --------- --------- TOTAL PROPERTY AND EQUIPMENT, NET $ 566,872 $ 134,045 ========= =========
Depreciation expense for the years ended October 31, 1999 and 1998 was $43,080 and $11,937, respectively. F-14 71 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 7. ACQUIRED TECHNOLOGY At October 31, 1999 and 1998, intangible assets consisted of the following:
1999 1998 --------- --------- Micro imaging multi-angle laser light scattering instrumentation (Note 26) -- $ 447,146 Ion exchange membrane technology (Note 26) $ 200,000 200,000 --------- --------- Total acquired technology 200,000 647,146 Less: accumulated amortization (68,055) (118,954) --------- --------- TOTAL ACQUIRED TECHNOLOGY, NET $ 131,945 $ 528,192 ========= =========
Amortization expense for the years ended October 31, 1999 and 1998 was $103,747 and $117,484, respectively. The Company currently holds a patent on certain electrodeionization water treatment technology. This patent was issued in 1984 and will expire in 2001. 8. CAPITAL LEASE OBLIGATIONS The Company acquired machinery and equipment under the provisions of two long-term leases during the year ended October 31, 1999. For financial reporting purposes, minimum lease payments relating to the equipment have been capitalized. One of the leases expires in 2000, and one expires in 2001. The leased property under capital leases as of October 31, 1999, has a cost of $17,594, accumulated amortization of $1,787, and a net book value of $15,807. Amortization of the leased property is included in depreciation expense. The future minimum lease payments under capital leases and the net present value of the future minimum lease payments at October 31, 1999 are as follows: 2000 $ 10,347 2001 1,394 -------- Total minimum lease payments 11,741 Less: amount representing interest (978) -------- Present value of net minimum lease payments 10,763 Less: current maturities (9,465) -------- LONG-TERM CAPITAL LEASE OBLIGATION $ 1,298 ========
F-15 72 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 9. NOTE PAYABLE TO AN OFFICER At October 31, 1999 and 1998, a note payable to an officer consisted of the following:
1999 1998 -------- -------- Note payable to officer, collateralized by an automobile, with interest at 9% per annum, payable in monthly installments of $636 through July 15, 2001 $ 12,315 18,531 Less: current portion (7,632) (6,216) -------- -------- LONG TERM PORTION OF NOTE PAYABLE TO AN OFFICER $ 4,683 12,315 ======== ========
Maturities of notes payable to an officer as of October 31, 1999 are as follows: 2000 $7,632 2001 $4,683
10. INCOME TAXES At October 31, 1999 and 1998, the components of the provision for income taxes are as follows:
1999 1998 ---- ---- Current tax expense: Federal -- -- State $800 $800 ---- ---- 800 800 ---- ---- Deferred tax expense (benefit): Federal -- -- State -- -- ---- ---- TOTAL PROVISION $800 $800 ==== ====
F-16 73 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 10. INCOME TAXES, CONTINUED Significant components of the Company's deferred income tax assets and liabilities at October 31, 1999 and 1998 are as follows:
1999 1998 ----------- ----------- Deferred income tax assets: Net operating loss carryforward $ 5,527,023 $ 4,536,592 Allowance for doubtful accounts -- 9,902 Amortization 19,635 35,989 Other 4,473 1,026 Accrued expenses 38,536 6,553 ----------- ----------- Total deferred income tax asset 5,589,667 4,590,062 Valuation allowance (5,589,667) (4,590,062) ----------- ----------- NET DEFERRED INCOME TAX ASSET -- -- =========== ===========
The Company, based upon its history of losses and management's assessment of when operations are anticipated to generate taxable income, has concluded that it is more likely than not that none of the net deferred income tax assets will be realized through future taxable earnings and has established a valuation allowance for them. Reconciliation of the effective income tax rate to the U.S. statutory income tax rate is as follows:
1999 1998 ---- ---- Tax expense at U.S. statutory income tax rate (34.0)% (34.0)% State tax provision 0.1 0.1 Increase in the valuation allowance 34.0 34.0 ---- ---- EFFECTIVE INCOME TAX RATE 0.1% 0.1% ==== ====
The Company has federal and state net operating loss carryforwards of $14,579,267 and $6,448,779, respectively. The federal and state net operating loss carryforwards will begin to expire in 2000 and will continue to lapse through 2019. F-17 74 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 11. COMMITMENTS Facilities Lease Agreement The Company entered into a three year lease agreement that began on February 1, 1998 for its facility located in Laguna Hills, California. Monthly lease payments were $16,000 through January 1999, $16,480 through January 2000 and $16,974 through January 2001. The Company has an option to extend the lease for two additional three year terms. In March 1998, the Company entered into a two year sub-lease agreement for a portion of the facility to a third party at the rate of $6,500 per month. Future minimum facilities lease payments and facilities sublease rental income as of October 31, 1999, are as follows:
Minimum Minimum Lease Sublease Payments Rental Income -------- ------------- 2000 $202,206 $ 26,000 2001 50,922 -- -------- -------- TOTAL $253,128 $ 26,000 ======== ========
Rent expense was $196,320 and $151,956 for the years ended October 31, 1999 and 1998, respectively. Sublease rental income was $78,000 and 58,500 for the years ended October 31, 1999 and 1998, respectively. The sublease rental income has been treated as a reduction of the rent expense on the Statement of Operations. Building Purchase Escrow As part of the original facilities lease agreement, the Company issued 60,000 shares of its common stock for an option to purchase the Laguna Hills building at any time prior to January 31, 2001 for $2,300,000. The value of the facility purchase option for which the shares were issued was $90,000. In July 1999, the Company notified the lessor of its intent to exercise its purchase option by opening an escrow with a $15,000 deposit. The purchase option provides the Company with 18 months within which to close the escrow and complete the sale. The Company will continue to make lease payments as prescribed by the lease agreement until the sale transaction is completed. If the sales transaction is not completed, the terms of the lease agreement remain in effect. To date, financing for the building purchase has not been obtained. F-18 75 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 11. COMMITMENTS, CONTINUED Consulting Agreement In May 1998, the Company entered into a three year agreement for financial consulting services for which it pays $2,500 per month and granted warrants to purchase 175,000 shares of common stock (Note 16). Agreement with Harry O'Hare In October 1998, the Company entered into an agreement with Mr. Harry O'Hare, a significant shareholder and founder of the Company. In June 1999, the shareholders approved the agreement at the annual shareholders' meeting. The agreement provides for the Company to pay into a special bank account, controlled by Mr. O'Hare's wife, $1,000 per month for ten years and to issue to her a warrant to purchase 10,000 shares of the Company's common stock at $.50 per share with a ten year term. Also, the Company will cancel $9,105 owed by Mr. O'Hare to the Company, for which 2,500 of his shares of the Company's common stock is pledged as collateral. In exchange, the Company is to receive from Mr. O'Hare all of his 931,629 shares of redeemable preferred stock, 31,205 shares of his Class B common stock, and all the 2,500 shares of his common stock pledged for payment of the $9,105 he owes the Company. Mr. O'Hare will transfer 52,678 of his remaining Class B common stock (52,778 shares) to others in satisfaction of claims against him. Mr. O'Hare will also waive any claims he may have to any royalties for technology the Company now owns, and he will not seek any modification of this agreement. The agreement also provides for the full mutual release of any and all claims between the Company and Mr. O'Hare. In connection with a public offering made by the Company in 1987, the California Commissioner of Corporations (the "Commissioner") imposed transfer and other restrictions on Mr. O'Hare's Class B common stock and redeemable preferred stock. Even though the agreement was executed by the parties and approved by the shareholders, the closing, and therefore the effectiveness of this agreement, is subject to approval from the Commissioner for the transfer of the shares as described above. The Company and Mr. O'Hare agreed to jointly prepare an application to obtain authorization from the Commissioner to transfer the shares, and in October 1999 the application was filed. There is no assurance such authorization will be obtained. F-19 76 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 11. COMMITMENTS, CONTINUED Agreement with Harry O'Hare, Continued During the year ended October 31, 1999, the Company made advances of the monthly payments contemplated under the agreement totaling $12,000 to the special bank account controlled by Mr. O'Hare's wife. 12. GAIN ON THE EXTINGUISHMENT OF DEBTS Lapse in Statutory Collection Period In the year ended October 31, 1998, the Company received a legal determination that applicable state statutes with regard to enforcement of the collectability of a $17,308 note payable due from the Company had lapsed. Accordingly, the resulting gain on the lapsing of the enforceability of the debt has been recognized as an extraordinary item. There is no income tax effect on this extraordinary item. Settlement of Judgment In the year ended October 31, 1998, the Company settled a $30,744 liability it recognized as an account payable resulting from a 1993 default judgment rendered against the Company for unpaid corporate credit card charges. The Company paid a total of $22,000 to satisfy the judgment. The resulting gain on settlement of $8,744 has been recognized as an extraordinary item. There is no income tax effect on this extraordinary item. 13. ROYALTIES In 1986, the former owner of the EDI patents and an original officer of the Company, entered into agreements to pay two separate royalties of $42 and $9 to a group of individuals for each EDI water purification unit sold by the Company or any sublicensees. The royalty at $42 per unit continues until the last patent related to these products expires. The last patent expires in August 2001. The second royalty at $9 per unit is payable until a maximum of $525,600 has been paid. The Company sold 68 and 81 EDI water purification units in fiscal years 1999 and 1998, respectively. No units affected by these royalty agreements were sold prior to fiscal year 1997. The amounts due under the $42 per unit royalty totaled $6,249 and $3,402 in fiscal years 1999 and 1998, respectively. Under the $9 per unit royalty the amounts totaled $1,341 and $729 in fiscal years 1999 and 1998, respectively. These royalties have been accrued and have not been paid. F-20 77 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 14. LICENSED TECHNOLOGY AGREEMENTS Nonexclusive licenses for the worldwide use of the EDI technology were issued to Glegg Water Consulting, Inc. ("Glegg") and to Polymetrics, Inc. ("Polymetrics"). The license granted to Glegg is a paid up license with no continuing royalty requirements. The license provides Glegg the right to sublicense the technology to its subsidiaries and affiliates and to a Japanese entity. The license granted to Polymetrics has continuing royalty requirements with royalty fee percentages of five (5) percent of net sales of "greater than 100 gallon per minute ("gpm")" systems and ten (10) percent of the "less than 100 gpm" systems. Polymetrics has not sold any units subject to the license since inception of the agreement. 15. CONTINGENCIES Litigation In August 1999, the Company was named as a cross defendant in a cross complaint by Douglas B. Platt doing business as East-West Technic Group ("Platt") arising from a lawsuit brought by Staar Surgical Company, Inc. ("Staar") against East-West Technic Group, Douglas B. Platt, and Does 1 through 100. The cross complaint alleges breach of contract, breach of implied duty of good faith and fair dealing, misrepresentation, negligence and common counts. More specifically, Platt claims that in December 1997, the Company and Platt entered into a written agreement wherein the Company agreed to supply, service, and support an electrodeionization module to be part of a system installed by Platt for Staar. Platt claims that the Company knew the details and specifications of the systems and participated in its design, but failed to provide a module that could be operated as part of the system. As a result, Platt seeks to recover damages he suffered under the contract. The amount of such damages has not yet been determined. The Company believes the lawsuit is without merit and intends to vigorously defend itself. While it is not practical to estimate a range of possible loss, if any, for the Company's litigation of this matter, a loss could have a material adverse effect on the Company's results of operations, liquidity and financial position. Concentrations of Risk One customer represents 35% and 67% of the Company's sales of its HC products for the years ended October 31, 1999 and 1998, respectively, and at October 31, 1999 accounts receivable included $11,800 due from this customer, which represents 12% of trade accounts receivable. F-21 78 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 15. CONTINGENCIES, CONTINUED Concentrations of Risk, Continued During the years ended October 31, 1999 and 1998, two customers accounted for 48% and 10% and 23% and 10% of EDI product sales, respectively. At October 31, 1999 and 1998, no amounts were due from either of these customers. Management believes the trade accounts receivable are fully collectible, and therefore no provision has been recorded for uncollectable trade accounts receivable at the years ended October 31, 1999 and 1998. 16. STOCK OPTIONS AND WARRANTS In May 1999, the Company adopted the Electropure, Inc. 1999 stock option plan (the "plan"), for officers, directors, employees, consultants, and advisors of the Company. The plan authorizes the granting of options on up to 1,000,000 shares of common stock. The exercise price per share on options granted may not be less than the fair market value per share of the Company's common stock at the date of grant. The exercise price per share of options granted to anyone who owns more than 10% of the voting power of all classes of the Company's common stock is a minimum of 110% of the fair market value per share at the date of grant. The options exercise price may be paid in cash or its equivalent including cashless exercises as determined and approved by the plan administrator. The plan provides two types of options: (i) Incentive Stock Options and (ii) Non-Qualified Stock Options. In fiscal year 1999, the Company granted options to purchase 455,000 shares of its common stock under this plan. The term of each stock option granted is fixed by the plan administrator and shall not exceed 10 years, except that for those who own 10% of the voting power of the Company the term of the option may be no more than 5 years. The vesting period is determined by the administrator at or after the date of grant. From time-to-time prior to the adoption of the plan, the Company has granted warrants to officers, key employees, consultants, advisors and vendors to attract and retain personnel, provide for performance incentives, and promote the success of the Company by providing warrant holders the opportunity to acquire an equity interest. Only non-employees have been granted warrants outside the stock option plan since its adoption. F-22 79 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 16. STOCK OPTIONS AND WARRANTS, CONTINUED Issued to Employees The following table summarizes information about options granted to employees. Unless otherwise noted, options vest on an annual pro rata basis over various periods of time and are exercisable, upon proper notice, in whole or in part at any time upon vesting. Generally, unvested options terminate when an employee leaves the Company. The options granted have contractual lives ranging from 3 to 10 years. The weighted average fair value of the options granted during the years ended October 31, 1999 and 1998 were $.94 and $1.31, respectively.
Weighted Average Number of Exercise Options Price ---------- ---------- BALANCE AT OCTOBER 31, 1997 518,478 $ 0.57 Granted 1,265,000 1.05 Exercised (12,000) 0.50 Canceled (4,978) 2.80 ---------- ---------- OUTSTANDING AT OCTOBER 31, 1998 1,766,500 0.91 Granted 890,000 0.96 Exercised (2,500) 0.50 Repriced (25,000) 1.78 Canceled (500,000) 0.86 ---------- ---------- OUTSTANDING AT OCTOBER 31, 1999 2,129,000 $ 0.93 ========== ==========
The Company continues to account for stock-based compensation to employees using the intrinsic value method prescribed in APB No. 25 whereby no compensation cost is recognized for options granted at or above fair market value. Had compensation expense for options awards been determined based upon fair values at the grant dates in accordance with SFAS No. 123, the Company's pro forma net loss and net loss per share would have been the amounts indicated in the following schedule. For purposes of pro forma disclosures, the estimated fair value of the options is amortized over their vesting periods. The pro forma effects of applying SFAS No. 123 are not indicative of future results because this statement does not apply to awards granted prior to fiscal year 1997. F-23 80 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 16. STOCK OPTIONS AND WARRANTS, CONTINUED Issued to Employees, Continued
October 31 ------------------------------------------ 1999 1998 ------------- ------------- Net loss: As reported $ (1,958,644) $ (1,506,943) Pro forma $ (2,382,137) $ (1,811,487) Loss per share: As reported $ (0.23) $ (0.19) Pro forma $ (0.28) $ (0.20)
For purposes of the above pro forma calculation, the fair value of options granted by the Company during the years ended October 31, 1999 and 1998, is estimated using the Black-Scholes Option Pricing Model with the weighted average assumptions listed below:
1999 1998 ---- ---- Risk-free interest rate 5.51% 4.99% Expected dividend yield 0 0 Expected stock price volatility 2.042 2.125 Expected life in years 10 10
Summary information about the Company's options outstanding at October 31, 1999:
Weighted Average Weighted Weighted Range of Options Remaining Average Options Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices October 31, 1999 Life Price October 31, 1999 Price - ------------ ---------------- ----------- -------- ---------------- -------- $.28 - $.58 164,000 7.3 $ 0.32 114,000 $ 0.33 $.58 - $.88 455,000 4.9 $ 0.76 100,000 $ 0.79 $.88 - $1.78 1,510,000 6.0 $ 1.07 321,000 $ 1.10 --------- --------- 2,129,000 535,000 ========= =========
F-24 81 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 16. STOCK OPTIONS AND WARRANTS, CONTINUED Issued to Non-Employees The Company accounts for stock-based compensation awards to non-employees based upon fair values at the grant dates in accordance with SFAS No. 123. The consideration received for the issuance of stock purchase warrants is based on the fair value of the warrants or of the goods or services received for the warrants issued, whichever is more reliably measurable. When the value of the services is based on the fair value of the warrants, the value is calculated using the Black-Scholes Option Pricing Model. The fair value of the options or warrants is amortized over the period the Company received the goods or services. In this connection, during the years ended October 31, 1999 and 1998 the Company granted warrants as follows: Issued to Directors for Services In August 1998, the Board of Directors granted to each of four Directors of the Company 10,000 warrants, each with a ten year term to purchase common stock at $1.375 per share. The issuance of these warrants for services resulted in an aggregate expense of $6,000 in fiscal year 1998. In August 1999, the Board of Directors granted to each of four Directors of the Company 10,000 warrants, each with a ten year term to purchase common stock at $1.375 per share. The issuance of these warrants for services resulted in aggregate expense of $3,000 in fiscal year 1999. Issued for Consulting Services In March 1998, the Company granted 20,000 warrants at $1.125 per share for consulting services. The warrants expire on March 31, 2002. The fair value of the services provided was $2,000 and is recorded as a consulting expense in fiscal year 1998. In May 1998, as part of a financial consulting contract, the Company granted warrants to purchase 175,000 shares of common stock at an exercise price of $1.06 per share. The warrants issued have a term of five years. The value of the warrants issued in conjunction with this agreement is $90,000 and is being recognized as a consulting expense ratably over its life. F-25 82 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 16. STOCK OPTIONS AND WARRANTS, CONTINUED Issued to Non-Employees, Continued Issued for Consulting Services, Continued During the year ended October 31, 1999, the Company granted a total of 303,600 warrants to purchase common stock to various individuals for consulting services. The warrants have exercise prices ranging from $.94 to $1.00, and have contractual lives ranging from 5 to 10 years. The fair value of the consulting services received was $94,700 and is being charged to expense over the life of the consulting arrangements. Consulting expense of $28,380 relating to these services was recognized for the year ended October 31, 1999. The following table summarizes the information relating to warrants granted to non-employees as of October 31, 1999 and 1998 and changes during the years then ended:
Weighted Average Warrants Exercise Outstanding Price ----------- ---------- BALANCE AT OCTOBER 31, 1997 991,362 $ 2.60 Granted 382,500 1.80 Exercised (180,928) 0.44 Canceled (51,600) 0.07 ---------- ---------- OUTSTANDING AT OCTOBER 31, 1998 1,141,334 2.35 Granted 853,600 1.59 Exercised -- -- Canceled (12,000) 0.01 ---------- ---------- OUTSTANDING AT OCTOBER 31, 1999 1,982,934 $ 2.03 ========== ==========
The values of the consideration received were based on the values of the warrants, which granted were estimated using the Black-Scholes Option Pricing Model with the following weighted average assumptions for grants made in 1999 and 1998:
1999 1998 ---- ---- Risk-free interest rate 5.51 % 4.99% Expected dividend yield 0 0 Expected stock price volatility 2.042 2.125 Expected life in years 10 10
F-26 83 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 16. STOCK OPTIONS AND WARRANTS, CONTINUED Issued to Non-Employees, Continued Summary information about the Company's warrants outstanding at October 31, 1999 is as follows:
Weighted Average Weighted Weighted Range of Warrants Remaining Average Warrants Average Exercise Outstanding Contractual Exercise Exercisable Exercise Prices October 31, 1999 Life Price October 31, 1999 Price -------- ---------------- ----------- --------- ---------------- --------- $.10 - $.50 48,210 4.89 $ 0.28 48,210 $ 0.28 $.50 - $1.00 473,600 5.26 $ 0.98 238,600 $ 0.97 $1.00 - $1.50 322,500 5.61 $ 1.16 222,500 $ 1.20 $1.50 - $3.00 1,071,250 1.95 $ 2.14 1,071,250 $ 2.14 $3.00 - $10.00 22,376 1.50 $ 9.00 22,376 $ 9.00 $10.00 - $15.00 44,998 1.50 $ 15.00 44,998 $ 15.00 --------- --------- 1,982,934 1,647,934 ========= =========
Private Placement Offerings During the year ended October 31, 1998, the Company issued 137,500 detachable warrants as part of a private placement offering. The warrants have a three year term to purchase common stock at $3.00 per share. These warrants were valued at $1.97 and resulted in an offsetting increase and decrease to additional paid-in capital. The warrants are redeemable by the Company at $.05 per warrant if the price of the common stock equals or exceeds $4.00 per share for 30 consecutive business days. During the year ended October 31, 1999, the Company issued 510,000 detachable warrants as part of a private placement offering. The warrants have a three year term to purchase common stock at $2.00 per share. These warrants were valued at $.90 and resulted in an offsetting increase and decrease to additional paid-in capital. The warrants are redeemable by the Company at $.05 per warrant if the price of the common stock equals or exceeds $4.00 per share for 30 consecutive business days. Issuances by the Company of warrants from all sources at exercise prices below fair market value at the date of grant resulted in an expense to the Company of $102,307 and $116,920 for the years ended October 31, 1999 and 1998, respectively. F-27 84 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 17. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS The estimated fair value amounts of all financial instruments on the Company's October 31, 1999 and 1998 balance sheets have been determined by using available market information and appropriate valuation methodologies. Fair value is described as the amount at which the instrument could be exchanged in a current transaction between informed willing parties, other than in a forced liquidation. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The Company does not have any off balance sheet financial instruments. The following methods and assumptions were used by the Company in estimating fair value disclosures for financial statements: Cash and equivalents, trade accounts receivable, notes receivable, inventories, prepaid expenses, trade accounts payable, current portion of notes payable and capital leases, and certain other current liability amounts are reported in the balance sheet at approximate fair value due to the short term maturities of these instruments. The fair value of non-current notes payable is estimated by determining the net present value of future payments. The carrying amount on the balance sheet approximates the fair value as the interest rates approximate current market rates. 18. RELATED PARTY TRANSACTIONS Note Receivable In August 1998, the Company acquired a note receivable for $3,500 from a director resulting from cash advances. The note was unsecured and had an annual interest rate of 5.58%, which became due in October 1998. The note became delinquent but was eventually satisfied by offsetting it against consulting fees due to the same individual for services during the year ended October 31, 1999. F-28 85 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 18. RELATED PARTY TRANSACTIONS Purchase of a Vehicle During the year ended October 31, 1998, the Company purchased an automobile from an officer for $23,000. The Company paid $3,000 in cash and issued a note payable collateralized by the automobile for the balance. In the year ended October 31, 1999, the Company exchanged the automobile for another automobile. The Company paid $7,797 in cash and issued a note payable for $16,008. 19. LOSS PER COMMON SHARE In accordance with the disclosure requirements of SFAS No. 128, Earnings per Share, a reconciliation of the numerator and denominator of the basic and diluted loss per share calculation and the computations of net loss per common share for the years ended October 31, 1999 and 1998 are as follows.
1999 1998 ----------- ----------- Net loss available to common shareholders: Loss before extraordinary gain $(1,958,644) $(1,532,994) Extraordinary gain -- 26,051 ----------- ----------- Net loss available to common shareholders $(1,958,644) $(1,506,943) =========== =========== WEIGHTED AVERAGE SHARES OUTSTANDING 8,404,713 8,240,951 =========== =========== Basic and diluted loss per common share: Loss before extraordinary gain $ (0.23) $ (0.19) Extraordinary gain -- -- ----------- ----------- NET LOSS $ (0.23) $ (0.19) =========== ===========
The following securities and contingently issuable shares are excluded in the calculation of diluted shares outstanding as their effects would be antidilutive for the years ended October 31, 1999 and 1998 as follows:
1999 1998 --------- --------- Stock options and warrants 4,111,934 2,607,834 Convertible preferred stock 1,000,000 --
F-29 86 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 20. SHARE TRANSACTIONS Common Shares Issued for Debt with a Beneficial Conversion Feature During the year ended October 31, 1998, the Company borrowed $400,000 from a related party who is the largest shareholder. The terms of the notes provided for conversion into shares of the Company's common stock at any time after their issuance. The intrinsic value of the beneficial conversion features was determined, and additional paid-in capital and interest expense of $400,000 was recognized. The Company issued 342,659 shares of common stock to the major shareholder of the Company at fair market value of $672,897 in connection with the conversion of convertible notes payable and accrued interest totaling $409,847. Common Shares Issued for Warrants Exercised with a Beneficial Conversion Feature During the year ended October 31, 1998, the Company offered to reduce the exercise price to $1.00 per share on any warrants with original exercise prices greater than $2.00 per share. As a result of this beneficial conversion feature, warrants were exercised for the purchase of 155,928 shares of common stock for $155,928. Common Shares Issued for Options and Warrants Exercised During the year ended October 31, 1998, warrants were exercised resulting in the purchase of 25,000 shares of common stock for $29,750. A note receivable of $29,750 was acquired in payment for the shares issued. The note receivable is recorded as a reduction of shareholders' equity. During the year ended October 31, 1998, options were exercised to purchase 12,000 shares of common stock for $6,000. A note receivable for $6,000 was acquired in payment of the shares issued. The note receivable is recorded as a reduction of shareholders' equity. During the year ended October 31, 1999, warrants were exercised resulting in the purchase of 2,500 shares of common stock for $1,250. Private Placement Offering - Common Stock In April 1998, a private placement offering resulted in the issuance of 275,000 shares of common stock and 137,500 detachable warrants to purchase common stock at an exercise price of $3.00 per share, and the Company received net proceeds of $550,000. In connection with this private placement offering, the Company issued 3,363 shares of common stock as a finder's fee valued at $7,500, which was treated as a reduction of the proceeds from the private placement offering. F-30 87 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 20. SHARE TRANSACTIONS, CONTINUED Private Placement Offering - Common Stock, Continued During the year ended October 31, 1999, a private placement offering resulted in the issuance of 1,020,000 shares of common stock and 510,000 detachable warrants to purchase common stock at $2.00 per share, and the Company received net proceeds of $1,020,000. Common Shares Issued in Consideration of an Option to Purchase Real Estate During the year ended October 31, 1998, the Company issued 60,000 shares of common stock with a fair market value of $90,000 at the date of issue to the lessors of the Company's new facility in exchange for a three year option to purchase the building. The $90,000 value attributable to the option to purchase the building has been recorded as a building purchase option. Common Shares Issued for Services In the year ended October 31, 1998, the Company issued 6,579 shares of common stock to the real estate broker who negotiated the lease on the Company's current facility in satisfaction of a $10,000 commission. The value of the services involved in the transaction has been expensed and added to common stock and additional paid-in capital. In the year ended October 31, 1998, the Company issued 4,103 shares of common stock, valued at $7,500, to a consulting firm in partial payment for public relations services to be rendered. The value of the services involved in the transaction has been expensed and added to common stock and additional paid-in capital. Prepaid Legal Services In May 1999, the Company issued to a law firm involved with its patent work, 100,000 shares of common stock with a fair value of $100,000 as a retainer against which fees and expenses incurred will be paid. The value of the services to be received in this transaction has been recorded as prepaid legal services and added to common stock and additional paid-in capital. Settlement In July 1999, pursuant to the terms of a settlement, the Company cancelled 1,950,000 shares of common stock previously held by Wyatt Technology Corporation (Note 26). F-31 88 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 20. SHARE TRANSACTIONS, CONTINUED Private Placement Offering - Preferred Shares In January 1999, the Company sold 1,000,000 shares of its Series B convertible preferred stock to a related party who is the largest shareholder of the Company in a private transaction for $1,000,000. The Series B convertible preferred stock is convertible into 1,000,000 shares of the Company's common stock in whole or in part at any time by its holder. The Series B convertible preferred stock is automatically convertible on the same basis if either of two events occur: a) the Company makes a public offering of any of its securities, or b) the Company's securities are admitted for listing on a national securities exchange market system. In the event the number of shares of the Company's common stock is increased or decreased as a result of a stock split, stock dividend, reverse stock split, or otherwise, the number of shares of common stock into which each share of Series B convertible preferred stock may be converted shall concurrently be proportionately increased or decreased. The Series B convertible preferred stock has no rights for participation in any new or additional issuances of any Company equity instruments. Each share of Series B convertible preferred stock is entitled to four votes on all matters, including the election of directors and shall vote as a single class along with the common stock, Class B common stock and redeemable preferred stock. In any liquidation or dissolution of the Company, the holders of the Series B convertible preferred stock will be entitled to a liquidation preference of $1 per share. 21. NOTES RECEIVABLE FOR ISSUANCE OF COMMON STOCK On various dates during the years ended October 31, 1998 and 1997, the Company allowed certain individuals, who were current or former officers and directors, to purchase shares and to exercise options or warrants held by them in exchange for notes receivable at fixed interest rates ranging from 5.49% to 5.63%. As of October 31, 1999 and 1998, the notes receivable related to the issuance of common stock are reflected as a reduction in equity and are summarized as follows:
1999 1998 ------- ------- Note receivable from an officer and director of the Company for the issuance of 50,000 shares of common stock in August 1997, with interest at 5.49% per annum, due in July 2002. The note receivable is collateralized by the shares issued resulting from the exercise of warrants $25,000 $25,000
F-32 89 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 21. NOTES RECEIVABLE FOR ISSUANCE OF COMMON STOCK, CONTINUED Note receivable from a former director of the Company for the issuance of 12,000 shares of common stock in July 1998, with interest at 5.51% per annum. The note receivable is collateralized by the shares issued resulting from the exercise of warrants and is due 90 days after their registration $ 6,000 $ 6,000 Note receivable from a former director of the Company for the issuance of 25,000 shares of common stock in July 1998, with interest at 5.63% per annum. The note receivable is collateralized by the shares issued resulting from the exercise of warrants and is due 90 days after their registration 29,750 29,750 ------- ------- TOTAL $60,750 $60,750 ======= =======
22. EQUITY RIGHTS AND PREFERENCES Voting Rights Each share of the Company's common stock is entitled to one vote per share, and the Class B common stock of the Company is entitled to eight votes per share. The holders of the outstanding redeemable preferred stock of the Company are entitled to one vote per share. Each share of Series B convertible preferred stock is entitled to four votes per share. Liquidation Preferences In the event of liquidation or dissolution of the Company, the holders of the common stock, Class B common stock and redeemable preferred stock, subject to the rights of the holders of the Series B convertible preferred stock, shall be entitled to receive an equal amount per share, provided, however, in no instance shall a share of redeemable preferred stock receive more than $0.01 per share and in no instance shall each share of Class B common stock receive an amount greater than 80% of the amount each share of common stock receives, subject to the restrictions imposed by the Commissioner as described in Note 23. F-33 90 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 23. CLASS B COMMON STOCK The Class B common stock is entitled to non-stock dividends and liquidation payments equal to 80% of those paid to the common stock. All of the Class B common stock is held by one individual (a significant shareholder and the founder of the Company) and may not be transferred or assigned. These shares automatically convert on a share for share basis into common stock upon the death of the current owner. However, in connection with an order imposed by the Commissioner, all shares held by this individual will not participate in dividends, other than for stock in distribution of assets in the event of liquidation and may not be transferred without prior consent of the Commissioner or pursuant to a court order. 24. REDEEMABLE PREFERRED STOCK The redeemable preferred stock was issued in 1987 to the then holders of the common and Class B common stock had a redemption date in 1991. The redeemable preferred stock has not been redeemed due to a lack of "legally available funds." These shares must be redeemed by the Company as soon as possible for $0.01 per share at any time the Company has the "legally available funds" for the redemption. There was a conversion feature to this redeemable preferred stock, which, with the passing of time, has lapsed. The Company believes the definition of "legally available funds" to be the amount under California law from which dividends could be paid by a corporation that does not have retained earnings. In general, California law provides that to the extent a corporation's assets, excluding intangible and deferred assets, are at least equal to 1.25 times its liabilities, excluding deferred taxes, deferred income, and deferred credits, a corporation may pay dividends. Under this definition, the Company had "legally available funds" as of October 31, 1999 and 1998. As a result, the Company is in default under the redemption provisions of the redeemable preferred stock. The impact of this default on the Company's financial position is uncertain. The redeemable preferred stock is not assignable or transferable, except upon death or upon approval of a majority of the members of the Board of Directors not holding such shares and are not entitled to receive any dividends. In the event of liquidation, dissolution, or winding up of the Company, each share is entitled to share ratably in all assets available for distribution equal to that of a share of common stock up to a maximum of $.01 per share. 25. SERIES B CONVERTIBLE PREFERRED STOCK Each share of Series B convertible preferred stock is entitled to four votes on all matters, including the election of directors and shall vote as a single class along with the common stock, Class B common stock, and redeemable preferred stock. In any liquidation or dissolution of the Company, the holders of the Series B convertible preferred stock will be entitled to a liquidation preference of $1 per share. F-34 91 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 26. ACQUISITION AND DISPOSITION OF TECHNOLOGY Micro Imaging Technology In October 1997, the Company completed a technology transfer agreement (the "Agreement") for the acquisition of certain intellectual property described in seven patents from Wyatt Technology Corporation ("Wyatt"). The intellectual property acquired relates to clean water monitoring through the utilization of multi-angle laser light scattering instrumentation, which the Company refers to as its "micro imaging technology." The cost of the intellectual property acquired was 2,100,000 shares of the Company's common stock valued at $447,146. As part of the Agreement, Wyatt was to manufacture and sell at prices including a reasonable profit all components involving the intellectual property that the Company requires for a period of three years. During year ended October 31, 1999, disagreements arose between the Company and Wyatt regarding the performance of each under the terms of the Agreement. In February 1999, the Company filed a lawsuit claiming Wyatt breached the terms of the Agreement. Wyatt filed a counter suit claiming the Company breached the Agreement. In July 1999, the Company and Wyatt entered into a settlement agreement whereby the Company and Wyatt each retain the right to commercially exploit the technology that was the subject of the Agreement, including that which was developed during "Phase I" (as defined) of the Agreement (the "Retained Rights"). The Company's Retained Rights are limited to use in detection of harmful substances in drinking water and may not be transferred or assigned except to resellers and end users of products developed by the Company from such Retained Rights. As consideration for the settlement, the Company delivered to Wyatt items obtained from Wyatt during the term of the agreement and copies of the technology, consisting of certain papers and software, developed by the Company through April 1998. Wyatt in turn, delivered all remaining shares it held of the Company's common stock, which it received for entering into the Agreement, and all stock purchase warrants received by Clifford Wyatt for services as a member of the Company's Board of Directors. The settlement has been recorded at $292,500, the fair value at the settlement date of the 1,950,000 shares returned. The Company believes there is no remaining value in the Retained Rights. Since the fair value of the shares received in the settlement is equal to the net book value of the related intangible assets at the settlement date, no gain or loss has been recognized as a result of the settlement. F-35 92 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 26. ACQUISITION AND DISPOSITION OF TECHNOLOGY, CONTINUED Ion Exchange Membrane Technology In February 1998 the Company acquired the HC ion exchange membrane process technology for $200,000. The process technology is comprised of certain production processes, intellectual properties, and know-how. None of the acquired intangible assets are protected by patent, copyright or trademark. 27. BUSINESS SEGMENTS The Company has three reportable segments: water purification ("EDI"), hydro components ("HC"), and clean water monitoring (Micro Imaging ["MI"]) (a start up segment). The water purification segment produces water treatment modules for sale to manufacturers. The hydro component segment sells water and wastewater treatment products to the light commercial/industrial markets. The clean water monitoring segment is developing technology that is anticipated will enable real time identification of contamination in water. The Company's reportable segments are strategic business units that offer different products, are managed separately, and require different technology and marketing strategies. The accounting policies of the segments are those described in the summary of significant accounting policies. The Company evaluates performance based on results from operations before income taxes not including nonrecurring gains and losses. Business Segment Information:
1999 1998 ----------- ----------- Revenue EDI $ 278,943 $ 372,742 HC 416,622 432,771 MI -- -- ----------- ----------- TOTAL REVENUE $ 695,565 $ 805,513 =========== =========== Operating Loss EDI $ (642,835) $ 7,883 HC (239,768) 93,265 MI (650,897) (445,110) Corporate (437,180) (792,362) ----------- ----------- TOTAL OPERATING LOSS $(1,970,680) $(1,136,324) =========== ===========
F-36 93 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 27. BUSINESS SEGMENTS, CONTINUED Business Segment Information, Continued:
1999 1998 ---------- ---------- Depreciation and Amortization EDI $ 1,418 $ 8,952 HC 40,717 31,040 MI 65,425 89,429 Corporate 39,271 -- ---------- ---------- TOTAL DEPRECIATION AND AMORTIZATION $ 146,831 $ 129,421 ========== ========== Identifiable Assets EDI $ 426,103 $ 292,806 HC 634,154 522,734 MI 122,374 356,247 All others 232,654 214,779 ---------- ---------- Total identifiable assets $1,415,285 $1,386,566 ========== ========== Expenditures for Long Lived Assets EDI $ 122,258 $ 86,227 HC 292,368 200,000 MI 10,373 -- Corporate 17,809 -- ---------- ---------- TOTAL EXPENDITURES FOR LONG LIVED ASSETS $ 442,808 $ 286,227 ========== ========== Geographic Information: Revenues United States $ 502,228 $ 506,996 Japan 132,490 183,117 Ireland 28,668 83,600 Other foreign countries 32,179 31,800 ---------- ---------- TOTAL REVENUES $ 695,565 $ 805,513 ========== ==========
F-37 94 ELECTROPURE, INC. NOTES TO FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED OCTOBER 31, 1999 28. SUBSEQUENT EVENT Financial Arrangement with a Related Party In December 1999, the Company entered into a financing arrangement with the principal shareholder. The terms of the agreement are for the principal shareholder to lend the Company $200,000 and receive in return from the Company an unsecured convertible note with a term of two years and an annual interest rate of 10%. The conversion terms and the number of warrants have not as of yet been described and then approved by the Company's Board of Directors. The $200,000 note payable has been issued, and $100,000 of the proceeds therefrom have been received. The remainder of the proceeds is anticipated by the Company in January 2000. F-38 95 UNAUDITED INTERIM FINANCIAL STATEMENTS The accompanying interim condensed Financial Statements are unaudited and have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission. These statements should be read in connection with the Financial Statements for the two years ended October 31, 1999, and the notes thereto included in this Prospectus. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In our opinion, the accompanying unaudited interim condensed Financial Statements contain all adjustments (consisting of normal recurring accruals and prior period adjustments) necessary to present fairly our financial position as of January 31, 2000, and the results of its operations and its cash flows for the three months ended January 31, 2000 and 1999. The results of operations for the three-month period ended January 31, 2000 are not necessarily indicative of the results to be expected for the full year. F-39 96 ELECTROPURE, INC. Balance Sheets ASSETS
January 31, October 31, 2000 1999 ---------- ---------- (UNAUDITED) Current assets: Cash and equivalents $ 109,118 $ 204,328 Trade accounts receivable 91,720 97,745 Inventories 208,650 204,888 Prepaid legal fees 92,500 92,500 Other prepaid expenses 21,325 12,007 ---------- ---------- Total current assets 523,313 611,468 Property and equipment, net 553,393 566,872 Acquired technology, net of accumulated amortization 121,945 131,945 Building purchase option 105,000 105,000 ---------- ---------- TOTAL ASSETS $1,303,651 $1,415,285 ========== ==========
The accompanying notes are an integral part of the financial statements. F-40 97 ELECTROPURE, INC. Balance Sheets LIABILITIES AND SHAREHOLDERS' EQUITY
January 31, October 31, 2000 1999 ------------ ------------ (UNAUDITED) Current liabilities: Trade accounts payable $ 164,074 $ 86,544 Current portion of obligations under capital leases 8,585 9,465 Notes payable to shareholder 302,849 -- Note payable to officer 7,632 7,632 Customer deposit 63,455 168,755 Accrued payroll 105,602 87,986 Other accrued liabilities 64,384 51,630 ------------ ------------ Total current liabilities 716,581 412,012 Obligations under capital leases, net of current portion 64 1,298 Note payable to officer, net of current portion 3,039 4,683 ------------ ------------ TOTAL LIABILITIES 719,684 417,993 ------------ ------------ Commitments and contingencies Redeemable preferred stock; $0.01 par value; 2,600,000 shares authorized, issued and outstanding 26,000 26,000 Stockholders' equity: Series B convertible preferred stock; $1.00 par value; 1,000,000 and no shares authorized, issued and outstanding 1,000,000 1,000,000 Common stock; $0.01 par value; 20,000,000 shares authorized; 7,791,415 and 7,809,635 shares issued and outstanding 78,096 77,914 Class B common stock; $0.01 par value; 83,983 shares authorized, issued and outstanding 840 840 Additional paid-in capital 20,996,942 20,971,537 Accumulated deficit (21,450,781) (21,018,249) Notes receivable on common stock (67,130) (60,750) ------------ ------------ TOTAL SHAREHOLDERS' EQUITY 557,967 971,292 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,303,651 $ 1,415,285 ------------ ------------
The accompanying notes are an integral part of the financial statements. F-41 98 ELECTROPURE, INC. Statements of Operations (UNAUDITED)
Three months ended January 31, ----------------------------- 2000 1999 --------- --------- Net sales $ 224,570 $ 279,971 Cost of sales 280,750 252,746 --------- --------- Gross profit (loss) (56,180) 27,225 --------- --------- Operating costs and expenses: Research and development 100,284 166,939 Salaries 116,262 32,569 Consulting 27,809 52,546 Other operating expenses 135,057 62,158 --------- --------- Total operating expenses 379,412 314,212 --------- --------- Loss from operations (435,592) (286,987) Other income (expense): Interest income 6,584 950 Other income Interest expense (3,524) -- --------- --------- Other income (expense), net 3,060 950 --------- --------- NET LOSS $(432,532) $(286,037) NET LOSS PER SHARE, BASIC AND DILUTED $ (0.06) $ (0.03)
The accompanying notes are an integral part of the financial statements. F-42 99 ELECTROPURE, INC. Statements of Stockholders' Equity (UNAUDITED)
Series B Series B Convertible Class B Convertible Preferred Common Common Preferred Common Shares Shares Shares Stock Stock ----------- --------- ------- ----------- ---------- BALANCE, OCTOBER 31, 1999 1,000,000 7,791,425 83,983 $1,000,000 $ 77,914 Common shares issued upon exercise of options -- 18,210 -- -- 182 Options and warrants granted to employees and consultants for services -- -- -- -- -- Increase in notes receivable on common stock -- -- -- -- -- Net loss -- -- -- -- -- BALANCE, JANUARY 31, 2000 1,000,000 7,809,635 83,983 $1,000,000 $ 78,096 ========= ========= ====== ========== ========== Note Class B Additional Receivable Common Paid-in Accumulated Common Stock Capital Deficit Stock Total ---------- ------------ ------------ ----------- ---------- BALANCE, OCTOBER 31, 1999 $ 840 $20,971,537 (21,018,249) $ (60,750) $ 971,292 Common shares issued upon exercise of options -- 1,639 -- -- 1,821 Options and warrants granted to employees and consultants for services -- 23,766 -- -- 23,766 Increase in notes receivable on common stock -- -- (6,380) (6,380) Net loss -- -- (432,532) -- (432,532) BALANCE, JANUARY 31, 2000 $ 840 $20,996,942 $(21,450,781) $ (67,130) $ 557,967 ========== =========== ============ ========== ==========
The accompanying notes are an integral part of the financial statements. F-43 100 ELECTROPURE, INC. Statements of Cash Flows (Unaudited)
Three months ended January 31, -------------------------- 2000 1999 --------- --------- Cash flows from operating activities: Net loss $(432,532) $(286,037) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation 33,511 8,422 Amortization 10,000 32,357 Provision for (recovery on) uncollectible accounts -- 560 Issuance of warrants for services 23,766 20,542 Services provided in payment of note receivable - related party -- (6,353) (Increase) decrease in assets: Trade accounts receivable 6,025 85,320 Prepaid legal and other expenses (9,318) 8,000 Inventories (3,762) (46,298) Increase (decrease) in liabilities: Trade accounts payable 77,530 4,773 Customer deposit (105,300) 70,000 Accrued payroll and other liabilities 29,461 (23,395) --------- --------- CASH USED IN OPERATING ACTIVITIES (370,619) (132,109) --------- ---------
The accompanying notes are an integral part of the financial statements. F-44 101 ELECTROPURE, INC. Statements of Cash Flows (UNAUDITED) Cash flows used in investing activities Purchase of property and equipment (20,032) (5,146) Purchase of acquired technology -- Interest accrued on notes receivable on common stock (6,380) -- ----------- ----------- CASH USED IN INVESTING ACTIVITIES (26,412) (5,146) ----------- ----------- Cash flows provided by (used in) financing activities: Principal payments on notes payable -- (505) Proceeds from the issuance of notes payable to a related party 300,000 -- Proceeds from exercise of warrants 1,821 -- Proceeds from issuance of preferred stock to a related party -- 1,000,000 ----------- ----------- Cash provided by financing activities 301,821 999,495 ----------- ----------- Net increase (decrease) in cash (95,210) 862,240 Cash at beginning of period 204,328 57,440 ----------- ----------- Cash at end of period $ 109,118 $ 919,680 ----------- -----------
The accompanying notes are an integral part of the financial statements. F-45 102 1. BASIS OF PRESENTATION The accompanying unaudited condensed financial statements include all adjustments which management believes are necessary for a fair presentation of the results of operations for the periods presented, except those which may be required to adjust assets and liabilities to the net realizable value should the Company not be able to continue operations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. The results of operations for the periods presented are not necessarily indicative of the results to be expected for the full year. It is suggested that the accompanying condensed financial statements be read in conjunction with the Company's audited financial statements and footnotes as of and for the year ended October 31, 1999, included in the Company's Annual Report on Form 10-KSB. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Financial Statement Classification Certain amounts presented within the 1999 financial statements have been reclassified in order to conform to the 2000 financial statement presentation. 3. NOTES PAYABLE TO OFFICER AND SHAREHOLDERS At January 31, 2000 and 1999, notes payable to officer and shareholders consisted of the following:
2000 1999 --------- --------- NOTES PAYABLE TO SHAREHOLDER Notes payable to shareholder, without collateral, with an interest rate of 10% per annum, originally due beginning December 13, 2001 (Note 5) $ 302,849 -- --------- --------- NOTE PAYABLE TO OFFICER Note payable to officer, collateralized by an automobile, with interest at 9% per annum, payable in monthly installments of $636 through July 15, 2001 10,671 18,026 Less: Current portion (7,632) (6,357) --------- --------- LONG TERM PORTION OF NOTES PAYABLE TO OFFICER $ 3,039 11,669
Maturities of notes payable to an officer as of January 31, 2000 are as follows: 2000 $7,632 2001 $3,039
F-46 103 4. CONTINGENCIES Litigation In August 1999, the Company was named as a cross defendant in a cross complaint by Douglas B. Platt doing business as East-West Technic Group ("Platt") arising from a lawsuit brought by Staar Surgical Company, Inc. ("Staar") against East-West Technic Group, Douglas B. Platt, and Does 1 through 100. The cross complaint alleges breach of contract, breach of implied duty of good faith and fair dealing, misrepresentation, negligence and common counts. More specifically, Platt claims that in December 1997, the Company and Platt entered into a written agreement wherein the Company agreed to supply, service, and support an electrodeionization module to be part of a system installed by Platt for Staar. Platt claims that the Company knew the details and specifications of the systems and participated in its design, but failed to provide a module that could be operated as part of the system. As a result, Platt seeks to recover damages he suffered under the contract. The amount of such damages has not yet been determined. The Company believes the lawsuit is without merit and intends to vigorously defend itself. While it is not practical to estimate a range of possible loss, if any, for the Company's litigation of this matter, a loss could have a material adverse effect on the Company's results of operations, liquidity and financial position. Concentration of Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. Exposure to losses on accounts receivable is principally dependent on the individual customer's financial condition, as credit sales are not collateralized. The Company monitors its exposure to credit losses and reserves for those accounts receivable that it deems to be not collectible. Approximately 88% of the Company's sales of EDI products during the three months ended January 31, 2000 were made to foreign customers. One such foreign customer accounted for 81% of EDI product sales. The Company makes all sales and receives all payments in U.S. dollars on all foreign sales. Management believes that trade accounts receivable, aggregating $91,720 for the period ended January 31, 2000, are fully collectable, and therefore no provision has been recorded for uncollectable trade accounts receivable. 5. SUBSEQUENT EVENTS In February 2000, the Board of Directors authorized a private placement offering of Units of Electropure's securities, each Unit consisting of 25,000 shares of common stock and 12,500 three-year warrants to purchase common stock at $2.00 per share. The warrants are redeemable by us at any time that the common stock of Electropure shall equal or exceed $4.00 per share for thirty (30) consecutive trading days. On February 25, 2000, Mr. Anthony Frank, a majority shareholder, converted $300,000 in principal loans made to us as of January 31, 2000, plus interest accrued thereon through the F-47 104 conversion date, into the above private placement Units. Mr. Frank received 304,822 shares of common stock and 152,411 two-year warrants to purchase common stock at $2.00 per share pursuant to such conversion. On February 10, 2000, Mr. Anthony Frank loaned us an additional $100,000 at 10% annual interest for two years which was also converted into private placement Units on February 25, 2000. We issued an additional 100,384 shares of common stock and 50,192 two-year warrants pursuant to this conversion. On March 6, 2000, Mr. Frank purchased an additional 20 Units of the above-described private placement offering for the sum of $500,000. In March 2000, we realized an additional $110,000 on the sale of 110,000 shares of common stock and 55,000 warrants pursuant to the above private placement offering. In March 2000, we issued 2,500 shares of common stock, valued at $2,500, as partial payment for public relations services to be rendered. In February 2000, we entered into a one-year agreement for administrative and financial consulting services for which we pay $1,000 per month for the first six months and $1,500 per month for the last six months of the agreement. We also granted 75,000 warrants to purchase common stock at $0.625 per share. The warrants vest in 25,000 annual increments commencing on February 1, 2000 and will expire on February 1, 2006. The fair value of the warrants was $46,500 and will be recorded as a consulting expense over the period we receive the services. F-48 105 No dealer, salesman or other person is authorized to give any information or to make any representations not contained in this Prospectus in connection with the offer made hereby, and if given or made, such information or presentations must not be relied upon as having been authorized by the Company. This Prospectus does not constitute an offer to sell or a solicitation of any offer to buy the securities offered hereby to any person in any state or other jurisdiction in which such offer or solicitation would be unlawful. The delivery of this Prospectus at any time does not imply that information contained herein is correct as of any time subsequent to its date. TABLE OF CONTENTS AVAILABLE INFORMATION .............................................. PROSPECTUS SUMMARY ................................................. THE COMPANY ........................................................ RECENT SIGNIFICANT DEVELOPMENTS .................................... RISK FACTORS ....................................................... DILUTION ........................................................... DIVIDEND POLICY .................................................... USE OF PROCEEDS .................................................... MARKET PRICES ...................................................... MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS ..... BUSINESS ........................................................... LITIGATION ......................................................... MANAGEMENT ......................................................... SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ............................... CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ..................... SELLING SHAREHOLDERS ............................................... DESCRIPTION OF CAPITAL STOCK........................................ LEGAL OPINION ...................................................... EXPERTS ............................................................ CHANGE IN CERTIFYING ACCOUNTANTS.................................... ACCOUNTANTS' REPORT ................................................ FINANCIAL STATEMENTS ............................................... UNAUDITED INTERIM FINANCIAL STATEMENTS .............................
ELECTROPURE, INC. COMMON STOCK PROSPECTUS __________ __, 2000 106 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF OFFICERS AND DIRECTORS Section 317 of the California Corporations Code allows a corporation to advance expenses incurred by an officer or director in defending any proceeding prior to the final disposition of such proceeding upon receipt of an undertaking to repay such amount if such person is not ultimately entitled to indemnification. In non-derivative actions, an officer or director is entitled to reimbursements for expenses, fines, judgments and settlements if such individual has acted in good faith and in a manner he believed to be in the best interests of the corporation and in the case of criminal proceedings, he had no reasonable cause to believe the conduct was unlawful. With regard to derivative actions (a suit brought on behalf of the Registrant), such person is entitled to reimbursements for expenses if the officer or director acted in good faith, in a manner the officer or director believed to be in the best interests of the corporation and with such care, including reasonable injury, as an ordinary and prudent person in like position would use in similar circumstances; provided, however, that no indemnification shall be made (1) if the officer or director is found liable to the corporation, except as may be determined by the court in which the action is pending; (2) for amounts paid in settling an action without court approval; or (3) for amounts paid in defending such action which is terminated without court approval. If indemnification is authorized by Section 317, but not required, then it shall be determined by (i) a majority vote of the disinterested members of the Board of Directors, (ii) a majority vote of the disinterested shareholders, (iii) the court in which the action is pending; or (iv) if a quorum of independent directors is not available, by independent legal counsel in a written opinion. If the officer or director is successful in the defense of an action, Section 317 provides that such individual shall be entitled to indemnification. Finally, Section 317 authorizes a corporation to maintain officers' and directors' liability insurance. Article III, Section 16 of the By-Laws of Registrant provides for indemnification of officers and directors in the situations authorized by Section 317. See also "WHERE YOU CAN FIND ADDITIONAL INFORMATION." ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the estimated expenses in connection with the offering described in this Registration Statement. Registration Fee Under Securities Act of 1933 .............................................. $ 4,000 Accounting Fees and Expenses .................................. 1,500 Legal Fees and Expenses ....................................... 10,000 Miscellaneous ................................................. 4,500 ------- Total .................................... $20,000
II-1 107 ITEM 26. RECENT SALE OF UNREGISTERED SECURITIES During the past three years, the Registrant has issued or sold the securities set forth in "RECENT SIGNIFICANT DEVELOPMENTS - Stock Issuances," "BUSINESS - Acquisition of Intellectual Properties - EDI Components and Micro Imaging Technology," "LITIGATION," "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS," and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources." The issuance of securities in these transactions, except as described below, were exempt from registration under the Securities Act of 1933, as amended (the "Act"), by virtue of Sections 3(b) and 4(2) of the Act, including Regulation D promulgated thereunder. The Company believes that the recipients in each case acquired the securities for investment only and not with a view to the distribution thereof and legends were affixed to the stock certificates. ITEM 27. EXHIBITS 3.1 Articles of Incorporation of the Registrant, as amended. *** 3.2 By-Laws of the Registrant, as amended. * 5.0+ Opinion of Skadden, Arps, Slate Meagher & Flom, LLP. 10.19 Form of Indemnity Agreement with each current Officer and Director. ** 10.47.8 License Termination Agreement with EDI Components dated August 14, 1997 (effective 08/05/97). ***** 10.47.9 Employment Agreement with Floyd H. Panning dated August 14, 1997 (effective 08/05/97). ***** 10.52 Technology Transfer Agreement with Wyatt Technology Corporation dated October 25, 1997. ****** 10.53 8% Sixty-Day Term Note from Hydro Components, Inc. dated February 17, 1998, including Assignment Agreement, Security Agreement and Unlimited Personal Guaranty.******* 24.1 Consent of Kelly & Company. 24.2 Consent of Skadden, Arps, Slate, Meagher & Flom, LLP (included in Exhibit 5.0). 25 Power of Attorney (see page II-5).
II-2 108 - -------------------- + To be filed in an amendment. * Previously filed on December 15, 1986 in connection with Registration Statement of Registrant on Form S-1, File No. 33-10669. ** Incorporated by reference to Exhibit "B" to Registrant's Definitive Proxy Statement, dated April 20, 1988, for the Annual Meeting held May 18, 1988, as filed on May 4, 1988. *** Previously filed on February 28, 1989 in connection with Registrant's Form 10-K for the fiscal year ended October 31, 1988. **** Previously filed on October 11, 1995 in connection with Registrant's Form 10-KSB for the fiscal year ended October 31, 1994. ***** Previously filed on July 16, 1997 in connection with Registrant's form 10-KSB for the fiscal year ended October 31, 1996. ****** Previously filed on September 11, 1997 in connection with Registrant's Form 10-QSB for the fiscal quarter ended July 31, 1997. ******* Previously filed on November 14, 1997 in connection with Schedule 13-D filed by Wyatt Technology Corporation. ******** Previously filed on February 11, 1998 in connection with Registrant's Form 10-KSB for the fiscal year ended October 31, 1997. ********* Previously filed on March 5, 1998 in connection with Registrant's Form 10-QSB for the fiscal quarter ended January 31, 1998. II-3 109 ITEM 17. UNDERTAKINGS (a) The undersigned Registrant hereby undertakes: (1) to file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any Prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the Prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereto) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement; provided, however, that paragraphs (a)(1)(i) and (a)(1)(ii) do not apply if the registration statement is on Form S-3, Form S-8 or Form F-3 and the information required to be included in a post-effective amendment by those paragraphs is contained in periodic reports filed with or furnished to the Securities and Exchange Commission by the registrant pursuant to Section 13 or Section 13(d) of the Securities Exchange Act of 1934 that are incorporated by reference in the registration statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (b) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions in Item 14 hereof, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless, in the opinion of its counsel, the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. II-4 110 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Company certifies that it has reasonable grounds to believe that it meets all of the requirements for filing this Amendment No. 2 on Form SB-2 and authorized this Registration Statement and any and all amendments thereto to be signed on its behalf by the undersigned thereunder duly authorized, in the City of Laguna Hills, California, on March 28, 2000. ELECTROPURE, INC. BY /S/ CATHERINE PATTERSON -------------------------------- CATHERINE PATTERSON Chief Financial Officer POWER OF ATTORNEY Each person whose individual signature appears below hereby constitutes and appoints Catherine Patterson and Floyd H. Panning as his true and lawful attorneys-in-fact with full power of substitution to execute in the name and on behalf of such person, individually and in each capacity stated below, and to file, any and all amendments to this Registration Statement, including any and all post-effective amendments. Pursuant to the requirements of the Securities Act of 1933, as amended, this Registration Statement has been signed below by the following persons in the capacities and on the dates indicated. SIGNATURES /S/ WILLIAM F. FARNAM Director March 28, 2000 - ------------------------------------ WILLIAM F. FARNAM Director - ------------------------------------ RANDALL P. FRANK /S/ RANDOLPH S. HEIDMANN Director March 28, 2000 - ------------------------------------ RANDOLPH S. HEIDMANN /S/ ARTHUR LIPPER III Director March 28, 2000 - ------------------------------------ ARTHUR LIPPER III /S/ FLOYD H. PANNING Chief Executive Officer March 28, 2000 - ------------------------------------ and Director FLOYD H. PANNING Chief Financial Officer /S/ CATHERINE PATTERSON (Principal Financial and March 28, 2000 - ------------------------------------ Accounting Officer) CATHERINE PATTERSON
II-5 111
Exhibit Page No. - ------- -------- 5.0+ Opinion of Skadden, Arps, Slate, Meagher & Flom, LLP. 24.1 Consent of Kelly & Company.
- ---------------- + To be filed in an amendment. II-6 EX-24 2 CONSENT OF KELLY & COMPANY. 1 EXHIBIT 24.1 CONSENT OF INDEPENDENT AUDITORS We consent to the inclusion in this registration statement on Form SB-2 (File No. 33-41289) Amendment No. 2 of our report, which includes an explanatory paragraph as to the Company's ability to continue as a going concern, dated December 23, 1999, on our audits of the financial statements of Electropure, Inc. We also consent to the references to our firm under the captions "Experts" and "Change in Certifying Accountants". Kelly & Company Kelly & Company Newport Bach, California March 30, 2000 -----END PRIVACY-ENHANCED MESSAGE-----