10KSB 1 p15161-ksb.txt Washington, D.C. 20549 FORM 10-KSB (MARK ONE) [ X ] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (fee required) For the fiscal year ended December 31, 2001 ----------------- [ ] TRANSITION REPORT UNDER SECTION 13 OR A5(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (no fee required) Commission file number 0-23544 ------- HUMAN PHEROMONE SCIENCES, INC. ------------------------------------------------- (Name of small business issuer in its charter) California 94-3107202 -------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. employee Identification No.) incorporation or organization) 84 W Santa Clara St. , Suite 720 San Jose, California 95113 ------------------------------------------------------ ------------------------ (Address of principal executive offices) (Zip code) Issuer's telephone number: (408) 938-3030 Securities registered under Section 12(b) of the Exchange Act: None ---------------- (Title of class) Check whether the Issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [ X ] State issuer's revenues for its most recent fiscal year. $2,500,000 ---------- State the aggregate market value of the voting stock held by non-affiliates computed by reference to the price at which the stock was sold, or the average bid and asked price of such stock, as of a specified date within the past 60 days. (See definition of affiliate in rule 12b-2 of the Exchange Act.) $ 533,595 (1) (1) Excludes 465,420 shares held by directors, officers and shareholders whose ownership exceeds 5% of the outstanding shares at February 21, 2002 based on a closing bid price on that day of $0.18 per share. Exclusion of such shares should not be construed as indicating that the holders thereof possess the power, direct or indirect, to direct the management or policies of the registrant or that such person is controlled by or under common control with the registrant. (APPLICABLE ONLY TO CORPORATE REGISTRANTS) State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date. 1,451,492 shares of convertible preferred stock, 3,429,839 shares of common stock. Transitional Small Business Disclosure Format (check one): Yes [ ] No [X ] DOCUMENTS INCORPORATED BY REFERENCE: Portions of the following document are incorporated by reference into Part III of this Form 10-KSB Report: the Proxy Statement for the Registrant's 2001 Annual Meeting of Shareholders (the "Proxy Statement"). This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Except for the historical information contained in this discussion of the business and the discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to the Company's plans for sales growth and expansion into new channels of trade, expectations of gross margin, expenses, new product introduction, and the Company's liquidity and capital needs. These matters involve risks and uncertainties that could cause actual results to differ materially from the statements made. In addition to the risks and uncertainties described in "Risk Factors", below, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation. These and other factors may cause actual results to differ materially from those anticipated in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Item 1. Description of Business Introduction The Company, a California corporation, was founded in 1989 as EROX Corporation to develop and market a broad range of consumer products containing human pheromones as a component. On May 29, 1998, the shareholders of the Company voted to change the name of the Company to Human Pheromone Sciences, Inc. The Company believes that human pheromone research funded by the Company presents an opportunity to create and market an entirely new category of pheromone-based fragrances and toiletry products, as well as other types of consumer products. The Company believes that its related patents provide it a proprietary position in developing, licensing and marketing a new category of consumer products that could significantly change the consumer accepted standard for products containing a fragrance component and for cosmetic treatment products. Pheromones are chemical substances known to stimulate species-specific biological responses in animals. For eleven years, scientists and advisors engaged by Human Pheromone Sciences, Inc. ("HPS") have studied the functions and characteristics of human pheromones. The human pheromones included as a component of and as a fixative for the Company's fragrance products have been manufactured for the Company by Pherin Pharmaceuticals, Inc. The manufacturing process for human pheromones begins with hydrocarbon compounds commonly available from chemical supply houses, and involves the use of a synthetic chemistry process originally performed for the Company by Pherin at its laboratories in Salt Lake City, Utah. In early 1999, in response to the need for significant increases in production. the Company engaged the services of an independent consultant and an independent chemical laboratory to manufacture the pheromones. During 2000 and 2001, an independent laboratory has manufactured such pheromones under the direction of a consultant of HPS and Pherin scientists. All the steps in the manufacturing process are standard chemical laboratory procedures. The manufacturing process for pheromones is similar to methods by which other naturally occurring substances (such as amino acids) are synthetically produced. The HPS Technology Pheromones. People have long known that insects and animals communicate with one another through subtle, biochemical cues recognized and understood by other members of the same species. These biochemical signals warn of danger, indicate the presence of food, mark territorial boundaries and display sexual maturation or readiness. The biochemical messengers that deliver these communications are pheromones. Pheromones trigger a nerve impulse to the hypothalamus when applied within or adjacent to the nasal passages. Scientists have observed that in higher species the influence of pheromones grows increasingly more subtle and complex. Not surprisingly, reactions to pheromones are very subtle in human beings. While humans appear to have definite responses to pheromones, the research sponsored by HPS suggests that the highly developed human brain filters and masks those reactions. Rather than producing an isolated effect, as in lower level species, human pheromones act in concert with other sensory cues provided by odor, sight, taste, sound and touch to provide a cumulative influence. As a result of its sponsored research, the Company believes evidence has been developed that indicates that humans respond to human pheromones. HPS has also found that its human pheromones are sexually dimorphic: that is, some are more active in females while others show a higher level of activity in males. During the studies of human pheromones conducted by the Company, certain human subjects volunteered descriptions of their feelings. Women frequently described 2 feeling comfortable or at ease, while a number of male subjects described a feeling of confidence and self-assurance. The Company continues to explore these naturally occurring substances in a variety of tests to increase its knowledge and understanding of their range of influence on human emotions and their application as components of fine fragrance products. Fragrances and Pheromones. Animal pheromones are well known in the fragrance industry. Natural and synthetic equivalents of mammalian pheromones such as musk, civet and castoreum are found in many perfumes today. However, since pheromonal cues can trigger a response only by members of the same species, these animal pheromones have no specific effect on humans; instead, they act only as fixatives or carriers for the fragrance or as a component of the scent. A scent binds to smell receptors in the nose and stimulates a specific region of the brain resulting in the sensation of smell. A pheromone binds to separate receptors that are physically and functionally distinct from smell receptors. These pheromone receptors stimulate a region of the brain different from that stimulated by smell receptors. Since it is widely believed that traditional perfumes allure and intrigue the senses, an alliance between fine fragrances and pheromones seems quite natural. For a perfume to create a true pheromonal effect in humans, however, it must contain human pheromones. Thus, a fragrance containing human pheromones may provide more allure than a traditional fragrance. The Vomeronasal Organ. The VNO consists of two tiny sensory organs -- one in each nasal passage. The VNO had been identified earlier in animal species, from reptiles to mammals, and has been known for some time to be a receptor for pheromones in animals. In humans, however, the VNO was assumed to be a non-functioning, vestigial remnant, rarely even present in modern-day men and women. Over the course of their work on human pheromones, scientists working on behalf of HPS believe they have made a further, important discovery concerning the VNO. Not only is the VNO present in all normal adults, it appears to be an active, functional receptor for human pheromones. This has allowed scientists engaged on behalf of HPS to track the activity of human pheromones by measuring the changes in the neuroelectric potential of the VNO's receptor cells caused by pheromones. To measure these changes in humans, a proprietary noninvasive method is utilized to measure the electrical response of the VNO in a way similar to how electrical responses of the heart are recorded by an electrocardiogram. The HPS Products Products. The Company operates in one business segment and initially marketed three fragrances, REALM(R) Women, REALM(R) Men and inner REALM(R). These products are sold by the Company through independent distributors in selected markets in South East Asia (Japan, Hong Kong and China). In April 2000 the Company licensed the rights to sell these products in all parts of the world, excluding South East Asia, to Niche Marketing, Inc. (See "Markets and Competition"). These "proof-of-concept" products include a full line of fragrance and bath and body products including eau de toilette, cologne, eau de parfume, lotion, bath and shower gel, after-shave balm, deodorant, talc, soap and body cream. The Company's fragrances are supplied by recognized leaders in the worldwide fragrance business. All of the Company's products contain the Company's synthesized human pheromones as a component of the fragrance. In 1999, the Company developed a new line of fragrance and toiletry products containing synthesized human pheromones for men and women under the trademark Natural Attraction(R). The Company introduced these products via a new website, naturalattraction.com, in 2000. At the end of 2000, the company hosting this website went out of business and the site was not operational until another host was selected in March 2001. Initial commercialization of this line of products will be through the web and other direct marketing channels in the United States. The Company primarily promotes the website by placing banner ads on other sites and by selling to selective small perfume retailers on the web. The Company plans to accelerate its promotion of the Natural Attraction line in 2002. Research. Pheromones are chemical substances known to stimulate species-specific biological responses in animals. The study of the uses, effects and advantages of human pheromones is in its infancy, but abstracts from presentations of two recent studies performed at leading research universities reveal new information regarding the beneficial effects of human pheromones. Most interestingly, these studies reveal new information regarding the biological pathways human pheromones traverse in the body. Publication of these findings continued in 2000 and in 2001, and the Company expects further interest in its patented technology as the result of these studies and others undertaken in 2001 and continuing in 2002. Scientists working on behalf of HPS have identified and synthesized several naturally occurring human pheromones. One combination of pheromones shows a measurable response in women and another a comparable response in men. HPS has also developed the capability to manufacture commercial quantities of these naturally occurring substances. HPS intends to continue basic pheromone research as applied to fragrances and ancillary products. For the years ended December 31, 2001 and 2000, research and development expense totaled $335,000 and $328,000, respectively. Since its inception through 3 December 31, 2001, the Company has incurred $4,959,000 in research and development related expenses. Markets and Competition The Competitive Environment. The Company's current fragrance products contain what the Company believes are unique components: human pheromones. Consequently, HPS believes it will be able to differentiate its products from traditional products. If such differentiation is successful, the Company's products initially should have little direct competition in the marketplace, since the Company believes no other companies in the United States have the right to produce or distribute products containing human pheromones. However, if such differentiation is not successful the Company will compete against the numerous companies in the fragrance industry, including Estee Lauder, Chanel and the fragrances subsidiaries of Unilever and L'Oreal. While HPS's current products are fragrances and toiletries, the Company feels strongly that fine fragrances and related toiletries are only "proof of concept" products. The Company's patented human pheromone technology has applications far beyond traditional fragrances and bath and body products. HPS hopes to position its technology as a desired "value added" ingredient for any product that contains a fragrance. Synthesized human pheromones provide the first patented technology of a component that could have broad application and usage in cosmetic, treatment, cleansing, over-the-counter health supplements and home and vehicle environmental products. The Company does not feel that it has the resources to successfully exploit the potential market for such applications and is actively seeking licensing agreements with consumer product manufacturers. Marketing Strategy. HPS's initial products are a line of fragrance and bath and body products containing the Company's patented human pheromones as a component. The first of these "proof of concept products" were developed in 1993 when the Company developed REALM Women and REALM Men. While new product launches in the fragrance industry frequently require considerable expenditures for promotional programs which attempt to establish product differentiation based upon imagery alone, HPS sought to develop a program in 1993 following a different approach -- one that relied on the human pheromone component in its fragrances for product differentiation. The Company's initial marketing program was intended to educate consumers and the trade about pheromones while suggesting the enhanced sensuality that the wearer of an HPS fragrance might feel. The Company also used packaging, pricing and distribution channels to communicate the uniqueness of their products and to differentiate them from traditional fragrance products. The Company launched its REALM products through direct marketing to ensure the quality and clarity of the HPS message and thereafter moved to more conventional fragrance channels based on criteria such as store location, image and promotional support. Historic Distribution and Promotional Activities through April 2000. During 1993, the Company developed two fragrances, REALM Women and REALM Men, each presented in 50ml and 5ml sizes. Initial promotion and distribution was in the form of a one half-hour infomercial, broadcast-tested in August 1994 and rolled-out nationally in the last four months of the year. The infomercial continued to be broadcast through mid-1995 while the Company commenced selling its products in the U.S. retail department stores on a limited basis in late 1994. By the beginning of 1997, HPS was still a single product company, primarily involved in one class of trade -- better U.S. department stores. REALM fragrances and toiletries were available in more than 1,300 stores in the 48 contiguous states. While this is the largest channel of distribution for basic fragrances, the high level of retailer employee turnover required expensive ongoing training for continued success of differentiated, scientifically based products such as REALM fragrances. In addition, HPS provides significant in-store fragrance modeling to ensure that consumers driven to the stores by the Company's ongoing radio advertisements have the opportunity to actually experience REALM products once they reach the store. To lessen its dependence on a single category of business and in an effort to leverage the expense of its radio advertising and promotion, the Company entered into agreements with distributors who focus on the fast growing perfumery and middle market department store classes of trade. These alternative channels provided additional exposure for the Company's products and human pheromone technology at a significantly lower cost than the better department stores. In mid-1997, the Company introduced a second women's fragrance line, innerREALM initially to the department store class of trade. Results of this expensive product launch were disappointing. A decision was made to reposition this brand to the alternative channels of distribution in 1998, and results from the initial repositioning are encouraging. During 1999, the Company continued distributing its REALM Men and REALM Women's fragrances in leading U.S. department stores, while substantially completing the transfer of the sale and marketing of innerREALM fragrances to alternative markets - including 4 perfumeries and middle market department stores. These alternative markets are handled by an independent distributor who purchases the product from the Company without the right of return and is responsible for advertising, selling and marketing expenses. By focusing the innerREALM product line on these secondary markets, the Company reduced its dependence on the department stores for sales to the U.S. consumer. To further reduce its dependence on a single market, the Company sought to increase its non-U.S. distribution. Between 1995 and 1999, HPS entered into distribution agreements for the sale of REALM fragrances and toiletries in selected Middle East markets, including Saudi Arabia and the Gulf States, selected Duty Free markets in the Caribbean, South America and on the Mexican and Canadian borders, Switzerland, Spain/Portugal and China. During 1999, the Company continued to reduce its presence in U.S. retailers whose business was not profitable to HPS. It also began a program to more tightly focus advertising, selling and promotional efforts with the remaining retail accounts and did reduce its loss on sales to this class of trade as compared with prior periods. The Company continued to rationalize its U.S. department store distribution in early 2000, but still believed that it was difficult for a company with a limited portfolio to profitably compete in the U.S. department store fragrance business. Current Distribution and Promotional Activities from May 1, 2000. On April 24, 2000, HPS signed a multi-year licensing agreement for its REALM and innerREALM fragrance and toiletry products with Niche Marketing, Inc. ("Niche"), a newly formed affiliate of Northern Brands, Inc. Since 1998, affiliates of Niche had been involved with the sales of these product lines in the United States and several International markets. Under the agreement, Niche will be responsible for the manufacture, marketing, selling and distribution of the REALM and innerREALM products in the United States and internationally, excluding the Far East. Niche purchased the Company's applicable inventories and pays a royalty, with annual minimums, on sales of the current products and line extensions under the REALM and innerREALM brand names. All such products must contain the Company's patented human pheromone technology. During the term of the agreement, HPS will also sell Niche the pheromone components required for the manufacture of the products. The initial period of the agreement is four years and may be extended with the mutual agreement of the parties for periods of up to ten years. This agreement enabled the Company to stem the significant losses incurred in selling to the department stores and the cash drain associated therewith. Under this agreement, HPS retains the rights to all of its trademarks and trademark applications. During 2000, the Company began a program to significantly expand its REALM business in South East Asia and increase the licensing of its patented human pheromone technology to third party consumer product manufacturers. On September 14, 2000, the Company entered into a Distribution Agreement with Fits Corporation K.K., a Japanese wholesaler of consumer products for the Company's REALM Women and REALM Men Brands. Under this agreement, as amended on March 12, 2001, Fits obtained the exclusive distribution rights for the brands in Japan for a three-year initial term, providing certain annual minimum purchases are made by Fits. The agreement may be extended with the mutual agreement of both parties. Fits exceeded the minimum purchase requirements for 2001. On March 23, 2001, the Company signed a Distribution Agreement with Fits Corporation K.K. granting Fits the exclusive distribution rights to the Company's innerREALM(R) fragrance in Japan. The terms of this additional agreement are similar to the agreements signed with Fits for the REALM brands. Also during 2001, the Company signed a Distribution Agreement for its REALM and innerREALM brands in the Hong Kong market. On March 7, 2002, the Company and Niche Marketing, Inc. entered into an Amendment to the License Agreement and a Settlement Agreement under which the Company regained the rights to manufacture Realm products for sale to its Southeast Asia Distributors, repurchased the rights to sell Realm products in an Asian market previously licensed to Niche, released Niche from its obligation to manufacture REALM products for sale to the Company and withdrew a breach of contract notice against Niche in connection with Niche's failure to deliver product. In addition, Niche agreed to be responsible for any product returns or requests for credit for destroyed products by department stores. The Company's direct foreign sales represented approximately 46% and 17% of net revenue during 2001 and 2000, respectively. Expansion into Southeast Asia will continue to be a focus of HPS. The Company is very conscious of the fact that numerous brands of prestige fragrances have suffered immeasurable harm due to diversion by gray marketers. While realizing that certain levels of such diversion are inevitable, the Company hopes to curtail the risk of its REALM products 5 being diverted back into the U.S. by gray market discounters by selecting duty free partners who purchase realistic quantities for sale in the regions they service. Such distribution agreements are subject to cancellation if significant diversion occurs. Technology Licensing and Supply Agreements One of the strategic objectives of the company is to expand the use of its patented human pheromone technology by working closely with consumer products companies who are leaders in their particular markets. In December 1998, HPS signed its first agreement to supply Avon Products, Inc. with its synthesized human pheromones. Revenues commenced in 1999 and continued in 2000 and 2001. Total revenues from this agreement and others aggregated $790,000 in 2001 and $666,000 in 2000, respectively. HPS is also in supply and /or licensing discussions with other companies in several consumer products fields and markets. Revenues from the agreement with Niche Marketing are not included in these amounts since this is considered a product licensing and not a technology licensing agreement. During 2001, three companies represented 36%, 31% and 18% of the Company's net sales and revenues. During 2000, three companies comprised 27%, 19% and 13% of the Company's net sales. Patents and Other Intellectual Property In December 1993 and January 1994, the Company received two United States patents for non-therapeutic compositions of fragrances and human pheromones for use as components in perfumes and personal care products and consumer and industrial products such as clothing, air fresheners and paper products. In 1995, patents were granted in Taiwan, and in 1997, patents were granted in Mexico. In June 1998, the Company was granted a Notice of Allowance of its patents for the inclusion of synthesized human pheromones by the European Patent Office. Individual country patents are pending issuance. HPS is also the exclusive licensee for non-therapeutic uses of pheromones in consumer products under a royalty-free worldwide perpetual license to five United States patent applications covering pheromone technology owned by Pherin Corporation. This technology is also the subject of foreign patent applications. The Company also relies on trade secrets protection for confidential and proprietary information. Other patent applications are currently in process. In October 2000, the Company signed a License Agreement with Pherin Pharmaceuticals, Inc. under which the Company was granted a license to a new vomeropherin compound developed by Pherin researchers. An initial study completed in 2001 showed promising results and the Company is now seeking outside sources of grants to continue consumer studies of this new compound. Under this Agreement, the Company paid Pherin $50,000 upon signing and has agreed to pay royalties based upon future sales by the Company or any of its licensees. The license has no expiration date. Regulation Unless the FDA extends its regulatory authority, regulation by governmental authorities in the United States and other countries is not expected to be a significant consideration in the sale of the Company's fragrance products and in its ongoing research and development activities. Under current regulations, the market introduction of the majority of non-medicated cosmetics products does not require prior formal registration or approval by the FDA, although this could change in the future. The cosmetic industry has established self-regulating procedures and most companies perform their own toxicity and consumer tests. Voluntary filings related to manufacturing facilities are made with the FDA. The Cosmetics Division of the FDA, however, does monitor closely problems of safety, adulteration and labeling. In addition, if the FDA should determine that claims made by the Company for its fragrances involve the cure, mitigation or treatment of disease, the FDA could take regulatory action against the Company and its products. In addition, the United States Federal Trade Commission ("FTC") monitors product claims made in television and radio commercials and print advertising to ensure that any claim can be substantiated. If the FTC believes that any advertising claim made by the Company with regard to the effect or benefit of its products is not substantiated by adequate data or research and the Company cannot support such claim, the FTC could also take regulatory action against the Company and its products. Employees At March 1, 2002, the Company had three full-time employees and one part-time employee. In addition, the Company retains consultants to provide advice in the areas of sales and marketing, public relations, advertising, product safety testing, regulatory compliance, MIS and product development. The Company also has access to scientific and professional consultants, some of whom are retained directly by Pherin Pharmaceuticals, Inc., and who undertake projects for 6 the Company by virtue of the Company's agreement with Pherin. None of the Company's employees is represented by a labor union. The Company considers its relations with its employees and consultants to be good. Manufacturing The Company and its licensees are dependent on third parties to manufacture the fragrance products. The Company has selected two essential oil companies that provide fragrance products to the industry, to supply such compounds to HPS and Niche in accordance with proprietary formulas developed for the Company. The Company has agreements in place with suppliers for its fragrances and has been furnished with commercial quantities of the Company's and its licensees' products for sale to consumers. While the Company is responsible for blending the human pheromones with these fragrances, final bottling and packaging of the fragrance and ancillary product lines are performed by independent manufacturers. These manufacturers selected by HPS and its licensees have extensive experience in blending, filling and packaging fragrance, cosmetic and related products, and have the capacity to satisfy the Company's and its licensees' manufacturing needs, at least for the foreseeable future. The Company believes that such manufacturing services are widely available to the fragrance industry at competitive prices and has identified additional contract manufacturing companies. The Company and Pherin are parties to an agreement under which Pherin will supply HPS with its reasonable requirements of human pheromones and will make available to HPS the basic manufacturing technology. At any time after January 31, 1996, rather than supply human pheromones to HPS, Pherin may instead elect to provide to the Company all manufacturing technology in its possession that it has not previously supplied to HPS. Through 1998 only small quantities of human pheromones, which could be produced in a laboratory environment, were required for its fragrance and ancillary products. As a result of the initial third party supply agreement entered into in December 1998, the Company required significantly more production of the synthesized human pheromones than were needed in the past. In January 1999, HPS and Pherin contracted with two independent laboratories to manufacture kilogram quantities of the synthesized human pheromones under the direction of scientists working on behalf of the Company and Pherin. HPS received initial quantities primarily from these independent laboratories commencing March 1999. During 2000 and 2001, only one of these manufacturers was needed to furnish all of the Company's human pheromone requirements. The Company does not believe that it would be economically feasible to establish its own manufacturing facilities since synthesized human pheromones are available from chemical laboratories that now have experience in the preparation of these compounds. Risk Factors The Company's future results may be affected to a greater or lesser degree by the following factors among others: The Company has not had sustained profitable operations since 1997. Since 1997, the Company has incurred losses from operations. However, effective May 1, 2000 the Company refocused its business model based on product licensing agreements. While the Company anticipates that this change in its business will result in profitable operations there is no assurance that the Company's license based business model will be successful. The Company and/or Niche may not be able to effectively compete with larger companies or with new products. The prestige fragrance market is extremely competitive. Many fragrance products are better known than the Company's products and compete for advertising and retail shelf space. Many competitors have significantly greater resources that will allow them to develop and introduce new competing products or increase the promotion of current products. The product life cycle of a fragrance can be very short. Changing fashions and fads can dramatically shift consumer preferences and demands. Traditional fragrance companies introduce a new fragrance every year or so. Changing fashions and new products may reduce the chance of creating long-term brand loyalty to the REALM and innerREALM product lines. The Company's marketing strategy may not be successful. The Company or its distributors may not be able to establish and maintain the necessary sales and distribution channels. Retail outlets and catalogs may choose not to carry the products. The Company or its distributors may not have sufficient funds to successfully market its products if the current marketing strategy is not successful. The current retail environment may cause pricing and promotional pressures. Five companies, Federated Department Stores, The May Company, Target, Dillard Department Stores and Saks (formerly Proffitts), own the majority of upper end department stores. Because of their market share, each company will have significant power to determine the price and promotional terms that the Company and its distributor/licensee, Niche, must meet in order to sell its products in the department stores. 7 Upper end department stores face increasing competition by discount perfumeries, drug chains and lower priced department stores for sales of fragrances and cosmetics. To compete, upper end department stores have cut inventories, reduced co-op advertising, and increased promotions. These tactics may force the Company's licensee to reduce its prices or increase the cost of its promotions. Seasonality in sales may cause significant variation in quarterly results. Sales in the fragrance industry are generally seasonal with sales higher in the second half of the year because of Christmas. This seasonality could cause a significant variation in the Company's recognition of royalty income in its quarterly operating results. The Company may not be able to protect its technology or trade secrets. The Company's patents and patent applications may not protect the Company's technology or ensure that the Company's technology does not infringe another's valid patent. Others may independently develop substantially equivalent proprietary information. The Company may not be able to protect its technology, proprietary information or trade secrets. The Company may not be able to recruit and retain key personnel. The Company's success substantially depends upon recruiting and retaining key employees and consultants with research, product development and marketing experience. The Company may not be successful in recruiting and retaining these key people. The Company relies upon other companies to manufacture its products. The Company and its distributors/licensees rely upon Pherin and other companies to manufacture its pheromones, supply components, and to blend, fill and package its fragrance products. The Company and its distributors/licensees may not be able to obtain or retain pheromones manufacturers, fragrance suppliers, or component manufacturers on acceptable terms. This would adversely affect operating results. Item 2. Description of Property The Company presently occupies a 1,767 square feet of space for its headquarters offices in San Jose, California., pursuant to a lease signed on March 5, 2001 that expires March 31, 2004. The minimum annual rental is $60,431, with annual rent increases in accordance with the increase in the Consumer Price Index in the local area. Commencing in February 2001, the Company leases storage space in Fremont, California on a month-to-month basis for approximately $0.75 per square foot. The Company previously occupied approximately 2,700 square feet of office and space for its headquarters in Fremont, California, pursuant to a sublease that expired on March 31, 2001. The base rent was approximately $10,125 through the expiration date of March 31, 2001. Total rent expense was increased by the Company's proportional share of any escalation related to taxes, common area charges and outside maintenance incurred by the complex in which the facility is located. The Company leased between 2,000 and 8,000 square feet of warehousing and distribution space, at a cost of $0.60 per square foot, from an independent company under a fulfillment agreement cancelable with 90 days notice. Such lease was cancelled in February 2001. During the year ended December 31, 2001, the Company incurred $124,722 in net rent expense and related charges for these facilities. Item 3. Legal Proceedings Not applicable. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 8 Item 5. Market for Common Equity and Related Stockholder Matters The Company's Common Stock is quoted on the NASDAQ Bulletin Board under the symbol EROX OB. As of March 1, 2002, there were approximately 300 holders of record of the Company's Common Stock. The Company believes that there are a significant number of beneficial owners of its Common Stock whose shares are held by nominees in "Street Name". Set forth below is the high and low bid information for the Company's Common Stock on the NASDAQ Bulletin Board or the NASDAQ Small-Cap Market as reported by Nasdaq-Amex Online during each of the four calendar quarters of 2001 and 2000. HIGH LOW ---- --- 2001 First quarter $ 0.75 $ 0.19 Second quarter $ 0.60 $ 0.25 Third quarter $ 0.55 $ 0.18 Fourth quarter $ 0.39 $ 0.18 2000 First quarter $ 2.50 $ 0.75 Second quarter $ 3.03 $ 1.00 Third quarter $ 1.36 $ 1.00 Fourth quarter $ 1.06 $ 0.16 These quotations reflect interdealer prices, without retail mark-up, markdown or commissions and may not represent actual sales. The Company has never paid cash dividends on its Common Stock. The Company currently intends to retain future earnings, if any, to fund the development and growth of its business and does not plan to pay any cash dividends in the foreseeable future. Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations On April 24, 2000, the Company signed a multi-year licensing agreement for its REALM and innerREALM fragrance and toiletry products with Niche Marketing, Inc. ("Niche"), a newly formed affiliate of Northern Brands, Inc. Under the agreement, Niche is responsible for the manufacture, marketing, selling and distribution of the REALM and innerREALM products in the United States and internationally, excluding the Far East. Niche purchased the Company's applicable inventories and pays a royalty, with annual minimums, on sales of the current products and line extensions under the REALM and innerREALM brand names. During the term of the agreement, HPS will also sell Niche the pheromone components required for the manufacture of the products. Prior to this agreement, the company recorded in its financial statements the revenues, costs and expenses directly attributable to the product sales to the U.S. Department stores and held the inventories, recorded the accounts receivable and reflected the accounts payable/accrued expenses attributable to the department store business. Accordingly, the data for the year 2000 includes this business through April 30, 2000 while the data for the year 2001 reflects an entire year of operations without any U.S. Department store or secondary market sales in the United States, thereby making some line-by-line comparisons between both years difficult. Year ended December 31, 2001 compared with the year ended December 31, 2000 Net sales and revenues for the year ended December 31, 2001 were $2,500,000 compared to $3,239,000 for the prior year. Included in the year 2000 are $1,877,000 of sales of Realm and innerREALM products that were licensed to Niche Marketing effective May 1, 2000. As such, on a comparable, continuing business basis, net sales for the year ended December 31, 2001 increased by $1,088,000 from $1,362,000 in 2000, an 80% growth. The Company received revenues from sales and licensing of its patented human pheromone technology and royalties from the license of its REALM and innerREALM product lines aggregating approximately $ 1,276,0000 and $907,000 for the years ended December 31, 2001 and 2000, respectively. Sales to distributors in South East Asia of the Company's core brands were $1,155,000 and $446,000 for the years ended December 31, 2001 and 2000, respectively. Gross margin in 2001 represented 61% of sales as compared with 67% in the prior year. The decrease is attributable to the increased sales to international accounts that bear lower prices than sales to department stores included in the prior year 9 margin; however, virtually all of the gross profit generated from distributor sales becomes operating profit since no promotional spending is required by the Company. In future years, increasing distributor sales may reduce gross margin, but operating income will increase as a percentage of sales as a result of the elimination of promotional expenses. Increases in future licensing fees will have a positive effect on gross profit and related margin, since these fees have no costs associated with them. Research and development costs increased slightly in 2001 to $335,000 from the $328,000 incurred in the prior year. The majority of such expenditures result from contractual payments made to Pherin Corporation under our Research and Development agreement with them and consulting fees. Selling, general and administrative expenses declined 49% to as compared with 2000. This $1,159,000 reduction in spending is attributable to operating the entire year under the license agreement noted above, which eliminated the need for promotional spending associated with the U.S. department store business. The prior year results bore four months of such promotional spending prior to the signing of the License Agreement with Niche. Sales, marketing and distribution expenses declined $1,210,000, while other administrative expenses grew by $51,000. Other income increased by $33,000 to $26,000 from a net expense of $7,000 in 2000, which was primarily a result of the elimination of bank borrowings in May 2000 and interest received from investments for the entire 2001 year. The Company recorded no income tax provision in either 2001 or 2000 due to the net operating losses generated, or the utilization of net losses carried forward from prior years. As of December 31, 2001 the Company's gross deferred tax asset, which relates primarily to net operating losses carried forward, was approximately $6,220,000. However, a full valuation allowance was provided for the gross deferred tax asset as management could not determine whether its realization was more likely than not. Seasonality Sales in the fragrance industry are generally seasonal with sales higher in the second half of the year because of the Holiday period. This seasonality could cause a significant variation in the Company's quarterly operating results and recognition of royalty revenues on sales of licensees and from the Company's own sales efforts in South East Asia. Liquidity At December 31, 2001, the Company had cash and cash-equivalents of $1,355,000, working capital of $1,879,000, and no bank borrowings outstanding. These balances at December 31, 2000 were $982,000 and $1,866,000, respectively with no bank borrowings outstanding. Net cash provided by operating activities was $378,000 for the year ended 2001 as compared with $1,443,000 for the year ended December 31, 2000. The cash provided from operations for 2000 was $1,065,000 greater than in 2001 and is attributed to the May 1, 2000 licensing of the REALM and innerRealm brands. Upon licensing the REALM and innerRealm brands the Company had significant one-time decreases in accounts receivables and inventories, offset by a decrease in accounts payable and accrued expenses as the Company exited the direct manufacturing and selling of the Realm and innerRealm brands in most of the world. Issuance of convertible preferred stock to a long-term investor in the amount of $410,000 in 2000 partially offset the $900,000 cash used to pay off bank borrowings. The Company's Business Loan Agreement with Mid-Peninsula Bank of Palo Alto, California ("the Bank") expired on June 30, 2000 and was not renewed by the Company. All outstanding borrowings were paid to the Bank prior to the expiration of the agreement. The Company's current cash position and projected results of operations for the year 2002 are not expected to require additional outside financing. 10 New Accounting Pronouncements In December 1999, the SEC staff released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, which provides interpretive guidance on the recognition, presentation, and disclosure of revenue in financial statements. SAB 101 must be applied to financial statements no later than the quarter ended September 30, 2000. There was no material impact from the application of SAB 101 on the Company's financial position, results of operations, or cash flows. In March 2000, the FASB issued Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the definition of an employee for purposes of applying Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 2, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. FIN 44 did not have a material impact on the Company's financial position, results of operations, or cash flows. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and/or the normal operation of long-lived assets, except for certain obligations of lessees. This statement is not applicable to the Company. In July 2001, the FASB issued SFAS NO. 141, Business Combinations. This statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Bulleting ("ABP") Opinion No. 16, Business Combinations, and SFAS No. 38, Accounting for Pre-Acquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this statement are to be accounted for using one method, the purchase method. The provisions of this statement apply to all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method for those business combinations is prohibited. This statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. This statement is not applicable to the Company. In July 2001, the FASB issued SFAS No, 142, Goodwill and Other Intangible Assets. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. It is effective for fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been issued previously. This statement is not applicable to the Company. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and/or the normal operation of long-lived assets, except for certain obligations of lessees. This statement is not applicable to the Company. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business, and amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company does not expect adoption of SFAS No. 144 to have a material impact, if any, on its financial position or results of operations. 11 Item 7. Financial Statements See the Financial Statements listed in Item 13(a), which are incorporated herein by reference. Item 8. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. 12 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act The executive officers of the Company and their ages as of March 1, 2001 are as follows: Name Age Position ---- --- -------- William P. Horgan 54 Chairman, Chief Executive Officer and Director Gregory S. Fredrick 47 Vice President, Finance William P. Horgan was appointed to the newly created post of Chairman of the Board in November 1996 after serving as President, Chief Executive Officer and Director since January 1994, when he joined the Company. From May 1992 to January 1994, he served as Chief Financial and Administrative Officer of Geobiotics, Inc., a biotechnology-based development stage company, and from January 1990 to May 1992, was employed by E.S. Jacobs and Company as Senior Vice President of Worlds of Wonder, Inc. From March 1988 to January 1990, he was Chief Financial Officer of Advanced Polymer Systems, Inc., a manufacturer and supplier of polymer based delivery systems for the ethical dermatology, OTC skin care and personal care markets. Prior thereto, he held various executive and management positions with CooperVision, Inc. and several affiliated companies, including President of its Revo, Inc. subsidiary. Gregory S. Fredrick joined the Company in October 1998 as Vice President, Controller. Prior to joining the Company Mr. Fredrick spent nearly eight years in the Entertainment industry. From February 1997 to June 1998 he was the Vice President, Controller for a start-up record label / internet company 911 Entertainment. Mr. Fredrick served in various finance and operations capacities while with Windham Hill Records / BMG Entertainment from April 1990, leaving as Director of Operations in December 1996. The remainder of this item is incorporated by reference to the Company's definitive Proxy Statement relating to its 2001 Annual Meeting of Shareholders (the "Proxy Statement"). Item 10. Executive Compensation Incorporated by reference to the Proxy Statement. Item 11. Security Ownership of Certain Beneficial Owners and Management Incorporated by reference to the Proxy Statement. Item 12. Certain Relationships and Related Transactions Incorporated by reference to the Proxy Statement. 13
Item 13. Exhibits and Reports on Form 8-K (a) Financial Statements. The following are filed as a part of this report: Page Report of Singer Lewak Greenbaum & Goldstein LLP, Independent Certified Public Accountants 17 Report of BDO Seidman, LLP, Independent Certified Public Accountants 18 Consolidated Balance Sheets -- December 31, 2001 and 2000 19 Consolidated Statements of Operations and Comprehensive Income (Loss) - Years ended December 31, 2001 and 2000 20 Consolidated Statements of Shareholders' Deficiency -Years ended December 31, 2001 and 2000 21 Consolidated Statements of Cash Flows -- Years ended December 31, 2001 and 2001 22 Notes to Consolidated Financial Statements 23 (b) Reports on form 8-K. During the quarter ended June 30, 2001 the Company filed a current report on Form 8-K dated June 15, 2001 to report the termination of its previous independent accounting firm BDO Seidman, LLP. During the quarter ended June 30, 2001 the Company filed a current report on Form 8-K dated June 29, 2001 to report the appointment of its current independent accounting firm Singer Lewak Greenbaum & Goldstein, LLP. (c) Exhibits. The following exhibits are filed as part of this report.
EXHIBIT NUMBER EXHIBIT TITLE 3.1 Copy of the Registrant's Articles of Incorporation (1) 3.1.1 Certificate of Determination of Preferences of Series AA Preferred Stock of Registrant 3.2 Copy of Registrant's By-laws (1) 10.1 Registrant's Stock Plan * (1) 10.2 Research and Development Agreement between Registrant and Pherin dated July 1, 1992 (1) 10.7 Technology Transfer Agreement between Registrant and Pherin dated August 23, 1991 (1) 10.10 Registrant's Non-employee Directors Stock Option Plan * (2) 10.12 Standard Industrial Lease - Net between Registrant and SCI Limited Partnership-I dated September 29, 1995 for the Registrant's California facility (3) 10.13 Amendment to Research and Development Agreement between Registrant and Pherin dated February 29, 1996 (3) 10.14 Business Loan Agreement dated July 1, 1997 (4) 10.15 Business Loan Agreement dated April 1, 1998(5) 10.16 Extension of Industrial Lease between Registrant and SCI Limited Partnership-I dated September 24, 1998 for the Registrant's California facility(5) 10.17 Supply Agreement with Avon Products, Inc.(5) 10.18 Business Loan Agreement and Change In Terms dated March 22, 2000 (6) 10.19 Business Loan Agreement dated March 24, 2000(7)) 10.20 License Agreement between Registrant and Niche Marketing, Inc, dated April 24, 2001(7)) 10.21 Amendment to License Agreement with Niche Marketing, Inc. (8) 10.22 Sublease Agreement between Registrant and PixArt Technology, Inc., dated July 7, 2000 for the Registrant's California facility (9) 10.23 Lease Surrender Agreement dated July 18, 2000 between Registrant and ProLogis Limited Partnership-I for the Registrant's California facility(9) 10.24 Lease Agreement between Registrant and Ernest E. Pestana and Irene Pestana, dated March 5, 2001 for the Registrant's California offices. 23.1 Consent of Independent Certified Public Accountants BDO Seidman LLP
14 Item 13. Exhibits and Reports on Form 8-K (continued) (1) Filed as an exhibit with corresponding exhibit no. to Registrant's Registration Statement on Form SB-2 (Registration No. 33-52340) and incorporated herein by reference. (2) Filed as an exhibit with corresponding exhibit no. to Registrant's Annual Report on Form 10-KSB for the Year Ended December 31, 1993. (3) Filed as an exhibit with corresponding exhibit no. to Registrant's Annual Report on Form 10-KSB for the Year Ended December 31, 1996. (4) Filed as an exhibit with corresponding exhibit no. to Registrant's Quarterly Report on From 10-QSB for the Three Months Ended June 30, 1997. (5) Filed as an exhibit with corresponding exhibit no. to Registrant's Annual Report on Form 10-KSB for the Year Ended December 31, 1998. (6) Filed as an exhibit with corresponding exhibit no. To Registrant's Annual Report on Form 10-KSB for the Year ended December 31, 1999. (7) Filed as an exhibit with corresponding exhibit no. to Registrant's Quarterly Report on From 10-QSB for the Three Months Ended March 31, 2000. (8) Filed as an exhibit with corresponding exhibit no. to Registrant's Quarterly Report on From 10-QSB for the Three Months Ended June 30, 2000. (9) Filed as an exhibit with corresponding exhibit no. To Registrant's Annual Report on Form 10-KSB for the Year ended December 31, 2000. * Management contract or compensatory plan 15 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, HPS Corporation has duly caused this Annual Report on Form 10-KSB to be signed on its behalf by the undersigned, thereunto duly authorized, in Fremont, California, on March 25, 2002. HUMAN PHEROMONE SCIENCES, INC. By: /s/ William P. Horgan ----------------------------------- Name: William P. Horgan -------------------------------- Title: Chairman of the Board ------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed on behalf of Human Pheromone Sciences, Inc. by the following persons in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE --------- -------- ---- /s/ William P. Horgan Chief Executive Officer March 25, 2002 -------------------------------------- and Director William P. Horgan /s/ Gregory S. Fredrick Vice President, Finance March 25, 2002 -------------------------------------- (Principal Financial and Gregory S. Fredrick Accounting Officer) /s/ Bernard I. Grosser Director March 25, 2002 ------------------------------------- Bernard I. Grosser, MD /s/ Michael D. Kaufman Director March 25, 2002 ------------------------------------- Michael D. Kaufman /s/ Helen C. Leong Director March 25, 2002 ------------------------------------- Helen C. Leong /s/ Robert Marx Director March 25, 2002 ------------------------------------- Robert Marx
16 Report of Independent Certified Public Accountants To the Board of Directors and Shareholders Human Pheromone Sciences, Inc. We have audited the accompanying consolidated balance sheets of Human Pheromone Sciences, Inc. and subsidiary as of December 31, 2001, and the related consolidated statements of operations and comprehensive income, shareholders' deficiency and cash flows for each of the year then ended. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Human Pheromone Sciences, Inc. and subsidiary as of December 31, 2001, and the related consolidated statements of operations and comprehensive income, shareholders' deficiency, and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ Singer Lewak Greenbaum & Goldstein LLP SINGER LEWAK GREENBAUM & GOLDSTEIN LLP Los Angeles, California February 22, 2002 17 Report of Independent Certified Public Accountants To the Board of Directors and Shareholders Human Pheromone Sciences, Inc. We have audited the accompanying consolidated balance sheet of Human Pheromone Sciences, Inc. and subsidiary as of December 31, 2000, and the related consolidated statements of operations and comprehensive loss, shareholders' deficiency and cash flows for the year ended December 31, 2000. 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Human Pheromone Sciences, Inc. and subsidiary as of December 31, 2000, and the results of their operations and their cash flows for the year ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman, LLP BDO Seidman, LLP San Jose, California February 22, 2001 18
Human Pheromone Sciences, Inc. Consolidated Balance Sheets December 31, December 31, (in thousands except share data) 2001 2000 Assets ------------ ------------ Current assets: Cash and cash equivalents $ 1,355 $ 982 Accounts receivable, net of allowances of $6 and $125 in 2001 and 2000, respectively 803 754 Inventories 378 347 Other current assets 31 55 ------------- ------------ Total current assets 2,567 2,138 Property and equipment, net 8 16 Product license 50 50 ------------- ------------ $ 2,625 $ 2,204 ============= ============ Liabilities, Convertible Redeemable Preferred Stock and Shareholders' Deficiency Current liabilities: Accounts payable $ 230 $ 85 Deferred income 315 20 Accrued professional fees 53 83 Accrued vacation 32 24 Accrued sales returns 44 - Other accrued expenses 14 60 ------------- ------------ Total current liabilities 688 272 ------------- ------------ Commitments and Contingencies Convertible redeemable preferred stock: Preferred stock, issuable in series, no par value, 10,000,000 shares authorized: Series AA 1,433,333 convertible shares issued and outstanding at each date, total liquidation value $2,150; 2,146 2,146 Series BB 17,448 convertible shares issued and outstanding at each date, total liquidation value $1,745 1,560 1,560 ------------- ------------ Total convertible redeemable preferred stock 3,706 3,706 ------------- ------------ Shareholders' deficiency: Common stock, no par value, 13,333,333 shares authorized, 3,429,839 shares issued and outstanding at each date 17,667 17,667 Foreign currency translation (68) ( 64) Accumulated deficit (19,368) (19,377) ------------- ------------ Total shareholders' deficiency (1,769) (1,774) ------------- ------------ $ 2,625 $ 2,204 ============= ============ See accompanying notes to consolidated financial statements.
19 Human Pheromone Sciences, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss) Years ended December 31, -------------------------- (in thousands except per share data) 2001 2000 --------------------------------------------------------------------------------------- --------- ---------- Net revenue, including license fees of $1,296 in 2001 and $1,046 in 2000 $ 2,500 $ 3,239 Cost of goods sold 975 1,068 --------- ---------- Gross profit 1,525 2,171 --------- ---------- Operating expenses: Research and development 335 328 Selling, general and administrative 1,207 2,366 --------- ---------- Total operating expenses 1,542 2,694 --------- ---------- Loss from operations (17) (523) --------- ---------- Other (expense) income Interest income (expense) 29 (25) Other income (3) 18 --------- ---------- Total other income (expense) 26 (7) --------- ---------- Net income (loss) available to common shareholders 9 (530) Other comprehensive loss - translation adjustment (4) (14) --------- ---------- Comprehensive income (loss) $ 5 $ (544) ========= ========== Net earnings (loss) per common share-basic and fully diluted $ 0.00 $ (0.15) ========= ========== Weighted average common shares outstanding 3,430 3,430 ========= ==========
See accompanying notes to consolidated financial statements. 20
Human Pheromone Sciences, Inc. Consolidated Statements of Shareholders' Deficiency (In thousands) -------------------------------------------------------------------------------------------------------------------------------- Common Stock --------------------------- Foreign Currency Total Shareholders' Shares Amount Translation Accumulated Deficit Deficiency ------------ ------------- ------------------ ----------------------- --------------------- Balances, at December 31, 1999 3,430 $17,667 $(50) $(18,847) $(1,230) Foreign currency translation -- -- (14) -- (14) Net loss -- -- -- (530) (530) ------------ ------------- ------------------ ----------------------- --------------------- Balances, at December 31, 2000 3,430 17,667 (64) (19,377) (1,774) Foreign currency translation -- -- (4) -- (4) Net income -- -- -- 9 9 ------------ ------------- ------------------ ----------------------- --------------------- Balances, at December 31, 2001 3,430 $17,667 $(68) $(19,368) $(1,769) ============ ============= =================== ======================= =====================
See accompanying notes to consolidated financial statements. 21 Human Pheromone Sciences, Inc. Consolidated Statements of Cash Flows
Years ended December 31, (in thousands) 2001 2000 -------------------------------------------------------------------------------- ---------- ---------- Cash flows from operating activities: Net income (loss) $ 9 $ (530) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 9 13 Changes in operating assets and liabilities: Accounts receivable (49) 1,296 Inventories (31) 1,957 Other current assets 24 (19) Accounts payable and accruals 121 (1,294) Deferred income 295 20 ---------- ----------- Net cash provided by operating activities 378 1,443 ---------- ----------- Cash flows used in investing activities: Investment in pheromone license - (50) Purchase of property and equipment (1) (15) ---------- ----------- Net cash (used in) investing activities (1) (65) ---------- ----------- Cash flows from financing activities: Proceeds from bank borrowings - 100 Repayments of bank borrowings - (1,000) Proceeds from issuance of convertible redeemable preferred stock - 410 ---------- ----------- Net cash (used in) financing activities - (490) ---------- ----------- Effect of currency translation (4) (14) ---------- ----------- Net increase in cash and cash equivalents 373 874 Cash and cash equivalents at beginning of the year 982 108 ---------- ----------- Cash and cash equivalents at end of the year $ 1,355 $ 982 ========== ===========
See accompanying notes to consolidated financial statements. 22 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Nature of Operations Human Pheromone Sciences, Inc. (the "Company") was incorporated in the State of California in 1989 under the name of EROX Corporation. The Company changed the name to Human Pheromone Sciences, Inc. in May 1998. The Company is engaged in the research, development, manufacturing and marketing of consumer products containing synthetic human pheromones as a component. The Company initiated commercial operations in late 1994 with a line of fine fragrances and toiletries. In April 2000, the Company licensed the sale of its REALM fragrance products through department and specialty stores across the United States and selected international markets to Niche Marketing, Inc. The Company currently sells its REALM fragrance lines through distributors in selected markets in South East Asia, and licenses and sells its human pheromones for inclusion in other companies products in exchange for supply revenues and/or royalties. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary in France. All significant intercompany accounts and transactions have been eliminated. Use of Estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the 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 revenue and expenses during the reporting period. Actual results could differ from those estimates. Segment Reporting During the years ended December 31, 2001 and 2000, the Company received revenues from sales and licensing of its patented human pheromone technology. Currently, the Company's management does not regularly review operating results or assess its operating performance by operating segment. Consequently, it will not report this revenue as an individual segment. As the Company's sales and licensing revenues of its patented human pheromone technology progresses, it will begin to develop systems to monitor this segment, and report its results accordingly. Concentration of Credit Risk Since the Company has refocused its business based on a product licensing model, the Company's concentration of credit risk consists principally of cash, cash equivalents and trade receivables. The Company places its cash and cash equivalents with high quality institutions. As of December 31, 2001 and 2000, the Company had deposits at one financial institution which aggregated $1,355,000 and $936,000, respectively. Such funds are insured by the Federal Deposit Insurance Corporation up to $100,000. Concentration of credit risk with respect to trade receivables has increased because the Company's customer base consists of several large customers in the United States and distributors in several international markets. On-going credit evaluations of customers' financial condition are performed and generally, no collateral is required. However, until the credit worthiness of these international customers is acceptable to the Company, the customer pays in advance of shipment or by placing an irrevocable letter of credit. During the year ended December 31, 2001, export sales, primarily to the Far East, were $1,148,000, or 46% of consolidated net sales. Export sales were $621,000, or 19% for the year ended December 31, 2000. The Company maintains an allowance for potential losses based upon management analysis of possible uncollectable accounts. Customer Concentration During 2001, three customers comprised 36%, 32% and 18% of the Company's net sales. Accounts receivable from these customers at December 31, 2001 account for 24%, 10% and 61%, respectively, of the net receivables. During 2000, three customers comprised 27%, 19% and 13% of the Company's net sales and revenues. 23 Human Pheromone Sciences. Inc. Notes to Consolidated Financial Statements December 31, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Supplier Concentration The Company is dependent on third parties to manufacture its fragrance products, as well as the synthesized human pheromones used in these products. Capacity limitations at these essential suppliers, or any other occurrences leading to an interruption of supply could have a material adverse effect on the Company. During the year two suppliers comprised 90% of the cost of goods sold . Revenue Recognition Revenue is recorded at the time of merchandise shipment, net of provisions for returns. License fees are earned over the license period according to the terms of the license agreement and interpretative guidance provided by Staff Accounting Bulletin (SAB) No. 101. The majority of the Company's sales are to distributors and licensees, and these distributors and licensees have no right to return products. Advertising Costs The cost of advertising is expensed as incurred. Advertising costs were $15,000 and $327,000 in 2001 and 2000, respectively. Research and Development Research and development costs are charged to expense when incurred. Research and development costs were $335,000 and $328,000 in 2001 and 2000, respectively. Fair Value of Financial Instruments The Company believes that the book value of financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximates their fair value. Income Taxes The Company follows the provisions of SFAS No. 109, Accounting for Income Taxes, which requires use of the "liability method." Accordingly, deferred tax liabilities and assets are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Stock Options The Company applies Accounting Principles Board Opinion ("APB") 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for all stock option plans. Under APB 25, compensation cost is recognized for stock options granted at prices below the market price of the underlying common stock on the date of grant. SFAS No. 123, Accounting for Stock - Based Compensation, requires the Company to provide pro forma information regarding net income as if compensation had been determined in accordance with the fair value based method. Comprehensive Income Comprehensive income is comprised of net income and all changes to the statements of shareholders' deficit, except those due to investment by shareholders, changes in paid-in capital and distributions to shareholders. 24 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Translation of Foreign Currencies The financial statements of the Company's foreign branch are measured in the local currency and then translated into U. S. dollars. All balance sheet accounts have been translated using the current rate of exchange at the balance sheet date. Results of operations have been translated using the average rate prevailing throughout the year. Translation gains and losses resulting from the change in exchange rates from year-to-year are accumulated in a separate account of shareholders' equity. Foreign currency transaction gains and losses are included in consolidated net income. New Accounting Pronouncements In December 1999, the SEC staff released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements, which provides interpretive guidance on the recognition, presentation, and disclosure of revenue in financial statements. SAB 101 must be applied to financial statements no later than the quarter ended September 30, 2000. There was no material impact from the application of SAB 101 on the Company's financial position, results of operations, or cash flows. In March 2000, the FASB issued Interpretation No. 44 (FIN 44), Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion No. 25 for (a) the definition of an employee for purposes of applying Opinion No. 25, (b) the criteria for determining whether a plan qualifies as a non-compensatory plan, (c) the accounting consequences of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 became effective July 2, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. FIN 44 did not have a material impact on the Company's financial position, results of operations, or cash flows. In July 2001, the FASB issued SFAS NO. 141, Business Combinations. This statement addresses financial accounting and reporting for business combinations and supersedes Accounting Principles Bulleting ("ABP") Opinion No. 16, Business Combinations, and SFAS No. 38, Accounting for Pre-Acquisition Contingencies of Purchased Enterprises. All business combinations in the scope of this statement are to be accounted for using one method, the purchase method. The provisions of this statement apply to all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method for those business combinations is prohibited. This statement also applies to all business combinations accounted for using the purchase method for which the date of acquisition is July 1, 2001 or later. This statement is not applicable to the Company. In July 2001, the FASB issued SFAS No, 142, Goodwill and Other Intangible Assets. This statement addresses financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. It is effective for fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been issued previously. This statement is not applicable to the Company. In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development, and/or the normal operation of long-lived assets, except for certain obligations of lessees. This statement is not applicable to the Company. 25 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) New Accounting Pronouncements (continued) In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement replaces SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual, and Infrequently Occurring Events and Transactions, for the disposal of a segment of a business, and amends Accounting Research Bulletin No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. The Company does not expect adoption of SFAS No. 144 to have a material impact, if any, on its financial position or results of operations. Net Earnings (Loss) Per Share The Company follows the provisions of SFAS No. 128, Earnings Per Share. SFAS No. 128 provides for the calculation of "Basic" and Diluted" earning per share. Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding. Diluted earnings (loss) per share is computed using the weighted-average number of common shares and dilutive common shares outstanding during the period. For the years ended December 31, 2001 and 2000, options to purchase 489,000 and 464,000 shares of common stock, respectively, were excluded from the computation of diluted earnings per share since their effect would be antidilutive. Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market. Property and Equipment The Company's property and equipment is stated at cost, net of accumulated depreciation. Depreciation is provided on a straight-line basis over three years for all categories. Reclassifications Certain prior year amounts have been reclassified to conform with current year presentation. 2. INVENTORIES A summary of inventories follows (in thousands): December 31, ---------------------------- 2001 2000 ---------- ---------- Components (raw materials) $ 223 $ 263 Work-in-process 36 13 Finished goods 119 71 ---------- ---------- $ 378 $ 347 ========== ========== 26 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 3. PROPERTY AND EQUIPMENT Property and equipment consist of the following (in thousands): December 31, --------------------------- 2001 2000 ----------- ----------- Molds $ 478 $ 478 Computer hardware 81 81 Computer software 106 106 Furniture and other office equipment 44 43 ----------- ----------- 709 708 Accumulated depreciation (701) (692) ----------- ----------- $ 8 $ 16 =========== =========== Depreciation expense for the years ended December 31, 2001 and 2000 were $9,000 and $13,000, respectively. 4. BANK BORROWING The Company had a revolving line of credit with Mid-Peninsula Bank that expired June 30, 2000. This credit line was not renewed by the Company. 5. COMMITMENTS AND CONTINGENCIES The Company presently occupies a 1,767 square feet of space for its headquarters offices in San Jose, California., pursuant to a lease signed on March 5, 2001 that expires March 31, 2004. Future minimum lease payments under this non-cancelable lease as of December 31, 2001 are as follows: Year Ending Minimum December 31, Lease Payment ------------ ------------- 2002 $ 60,431 2003 60,431 2004 15,108 --------- $ 135,970 Commencing in February 2001, the Company leases storage space in Fremont, California on a month-to-month basis for approximately $0.75 per square foot. Rent expense was $79,000 and $125,000 for the years ended December 31, 2001 and 2000, respectively. 6. CONVERTIBLE REDEEMABLE PREFERRED STOCK Series BB During 2000, the Company issued 3,245 shares of Series BB convertible preferred stock for $410,000, net of issuance costs, to a current shareholder. The cash was used to reduce bank borrowings. Holders of shares of Series BB convertible preferred stock shall be entitled to the number of votes equal to the number of shares of common stock into which such shares could be converted. 600,000 shares of common stock are reserved for the future conversion of this preferred stock. No dividends are payable in connection with these preferred shares. 27 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 6. CONVERTIBLE REDEEMABLE PREFERRED STOCK (continued) Initially, each share of Series BB preferred stock shall be convertible at the option of the holder into shares of common stock at an initial conversion price of $1.00 per share of common stock. The initial conversion price shall be increased quarterly beginning April 1, 1999 by $2.00 such that the original conversion price shall increase by $8.00 per share each year. In addition, each preferred share shall automatically convert in the event of any of the following: o Immediately after the closing bid price of the common stock on the NASDAQ Stock Market exceeds $5.00 per share for a period of twelve consecutive weeks. o Immediately after the Company reports earnings per common share for any fiscal year of $.50 or greater. o Upon the written request for such conversion by sixty-six and two-thirds percent (66 2/3%) of the then outstanding preferred stockholders. o At the time that sixty-six and two-thirds percent (66 2/3%) of the preferred stock ever outstanding have converted to common stock Series AA Holders of shares of Series AA convertible preferred stock shall be entitled to the number of votes equal to the number of shares of common stock into which such shares could be converted. Reserved for the future conversion of this preferred stock are 1,433,333 shares of common stock. No dividends are payable in connection with these preferred shares. Initially,each share of Series AA preferred stock shall be convertible at the option of the holder into shares of common stock at an initial conversion price of $1.50 per share of common stock. The initial conversion price shall be increased quarterly beginning October 1, 1997 by $.0225 such that the original issue price shall increase by $.09 per share each year. In addition, each preferred share shall automatically convert in the event of any of the following: o Immediately after the closing bid price of the common stock on the NASDAQ Stock Market exceeds $5.00 per share for a period of twelve consecutive weeks. o Immediately after the Company reports earnings per common share for any fiscal year of $.50 or greater. o Upon the written request for such conversion by sixty-six and two-thirds percent (66 2/3%) of the then outstanding preferred stockholders. o At the time that sixty-six and two-thirds percent (66 2/3%) of the preferred stock ever outstanding have converted to common stock. Redemption Features The terms of the preferred stock provide that in the event of a change of control, among other events, the preferred shareholders shall be entitled to receive an amount equal to the sum of $100 and $1.50 per share of Series BB and AA preferred stock, respectively, plus all declared and unpaid dividends, if any, prior to and in preference to any distributions to the holders of common stock. As the preferred stock has conditions for redemption which are not solely within the control of the Company, such preferred stock has been classified outside of shareholders' equity. 7. SHAREHOLDERS' EQUITY In 1999, the Company's shareholders authorized a 1-for-3 reverse stock split. All share and per share amounts in the accompanying financial statements have been restated to give effect to the stock split. 28 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 7. SHAREHOLDERS' EQUITY (continued) Stock Option Plan In 1990, the Company adopted a stock option plan (the "Plan"), which is administered by the Compensation and Stock Option Committee of the Board of Directors. The maximum number of shares that may be issued under the Plan is 708,333. The Board of Directors sets terms and conditions of stock options. Options may be granted at the fair value at the date of the grant as determined by the Board of Directors. Options for a holder of more than 10% of the voting stock of the Company may be granted at not less than 110% of fair market value. Options have a maximum term of ten years or a shorter period as set forth in the option agreement, and generally vest over a four-year period unless otherwise specified. Options granted to a shareholder with 10% or more of the voting stock of the Company have a maximum term of five years. A summary of the option activity under the Plan is as follows (in thousands except per share data): WEIGHTED AVERAGE SHARES EXERCISE PRICE ------ -------------- Outstanding, January 1, 2000 267 $2.19 Granted 208 $1.03 Canceled (121) $4.46 ----- Outstanding, December 31, 2000 354 $3.18 Granted 15 $0.27 Canceled or Expired (3) $4.80 ----- Outstanding, December 31, 2001 366 $3.01 ===== At December 31, 2001, a total of 342,837 shares of the Company's common stock were reserved for future grants under the Plan, and options to purchase 271,615 shares were exercisable. In June 1993, the Company's Board of Directors adopted a Non-Employee Directors' Stock Option Plan (Directors' Plan) covering a total of 158,333 shares of common stock, which provides for a one-time automatic grant of options to purchase 8,333 shares of common stock and annual grants thereafter of options to purchase 3,333 shares of common stock to each non-employee director at an exercise price equal to the fair market value of the stock on the date of grant. A summary of the stock option activity under the Director's Plan is as follows (in thousands except per share data): WEIGHTED AVERAGE SHARES EXERCISE PRICE ------ -------------- Outstanding, January 1, 2000 100 $ 8.10 Granted 13 $ 1.19 Canceled or Expired (3) $23.64 ----- Outstanding, December 31, 2000 110 $ 6.79 Granted 13 $ 0.54 Canceled or Expired - $ - ----- Outstanding, December 31, 2001 123 $ 6.27 ===== At December 31, 2001, a total of 35,006 shares of the Company's common stock were reserved for future grants under the Directors' Plan, and options to purchase 116,659 shares were exercisable. 29 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 7. SHAREHOLDERS' EQUITY (continued) The following table summarizes information about stock options outstanding at December 31, 2001 (in thousands except per share data) under both of the Company's plans
OPTIONS OUTSTANDING OPTIONS EXERCISABLE -------------------------------------------------------------- ----------------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE EXERCISE OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE PRICES AT 12/31/01 LIFE (YEARS) PRICE AT 12/31/01 PRICE -------- ------------- -------------- ---------- ------------- ---------- $ 0.20 to $ 2.00 348 5.0 $ 1.01 247 $ 1.06 $ 2.01 to $ 5.00 38 3.9 $ 3.83 38 $ 3.83 $ 5.01 to $10.00 35 3.8 $ 5.79 35 $ 5.79 $10.01 to $23.72 68 1.9 $17.17 68 $17.17 -- --- ------ --- ------ $ 0.95 to $23.72 489 5.0 $ 4.03 388 $ 6.81 === ===
The weighted average fair value of options granted during 2001 and 1999 was $0.40 and $0.23, respectively. Stock Compensation The Company applies APB 25 and related Interpretations in accounting for its employee stock options. Had compensation expense been determined based upon the fair value of the awards at the grant date and consistent with the method under SFAS No. 123, the Company's net loss per share would have been increased as shown by the proforma amount indicated in the following table (in thousands): Years ended December 31, ------------------------ 2001 2000 ------ ------ Net income (loss): As reported $ 9 $ (530) ====== ====== Pro forma $ (21) $ (755) ====== ====== Basic and diluted loss per share: As reported $ 0.00 $(0.15) ====== ====== Pro forma $(0.01) $(0.22) ====== ======
2001 Option Grants 2000 Option Grants ------------------ ------------------ Weighted Average Interest Rates 3.9% 4.25% to 6.625% Dividend Yield 0% 0% Volatility factor of the Company's common stock 100% 180% Weighted average expected life beyond each respective vesting period 1 year 1 year
30 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 8. RELATED PARTY TRANSACTIONS On March 1, 1999, the Company renewed a research and development agreement with Pherin Pharmaceuticals Corporation ("Pherin"), a company related by common shareholders, whereby Pherin supplies HPS with its required synthesized human pheromones and also provides to HPS research and development and scientific public relations services. This renewal has been extended to expire on March 1, 2002. The total expense incurred pursuant to the Company's research and development agreement with Pherin during the fiscal years ended December 31, 2001 and 2000 was $240,000 and $250,000, respectively. In October 2000, the Company signed a License Agreement with Pherin Pharmaceuticals, Inc. under which the Company was granted the license to a new vomeropherin compound developed by Pherin researchers. An initial study completed in 2001 showed promising results and the Company is now seeking outside sources of grants to continue consumer studies of this new compound. Under this Agreement, the Company paid Pherin $50,000 upon signing and has agreed to pay royalties based upon future sales by the Company or any of its licensees. The Company also retained the consulting services of Dr. David Berliner, a founder and current CEO of Pherin. The total expense incurred to retain Dr. Berliner's services for the fiscal years ended December 31, 2000 was $73,000. The agreement was terminated in November 2000. In 1999 the Company retained the marketing and consulting services of Robert Marx, a member of the Company's Board of Directors. Mr. Marx was paid $48,000 in 2000 for his services. The Company canceled Mr. Marx's agreement in July 2000. 9. INCOME TAXES There was no provision for income taxes for the year ended December 31, 2001 or 2000 as the Company incurred net operating losses for which no benefit was recognized, or utilized tax loss carryforwards. A reconciliation of the effective tax and the statutory U.S. federal income tax is as follows: Years ended December 31, ------------------------ 2001 2000 ---- ---- Federal tax (tax benefit) at the federal statutory rate $ 5 $(180) Other differences 2 167 Permanent differences 2 (2) Increase (decrease) in valuation allowance (9) 15 ----- ----- Income tax benefits $ -- $ -- ===== ===== At December 31, 2001, the Company had net operating loss carryforwards of approximately $17,849,000. The Company also had federal research and development tax carryforwards of approximately $136,000. The net operating loss and credit carryforwards will expire between 2005 and 2020. The utilization of certain of the loss carryforwards is limited under Section 382 of the Internal Revenue Code. Temporary differences that give rise to a significant portion of the deferred tax asset are as follows (in thousands): December 31, -------------------------- 2001 2000 ---- ---- Deferred tax asset: Net operating loss carryforward $ 5,969 $ 6,266 Research credit carryforward 136 187 Reserves and accruals 115 190 Other, net -- 64 Valuation allowance for deferred tax assets (6,220) (6,707) ------- ------- Net deferred tax assets $ -- $ -- ======= ======= 31 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements December 31, 2001 9. INCOME TAXES (continued) Because of the Company's lack of earnings history, the deferred tax asset has been fully offset by a valuation allowance. The net valuation allowance decreased by $487,000 in 2001 and increased by $15,000 in 2000. The valuation allowance was established because the Company was not able to determine that it is more likely than not that the deferred tax asset will be realized. 10. STATEMENTS OF CASH FLOWS Cash was paid during the years ended December 31, 2001 and 2000 for: Years ended December 31, ---------------------------- 2001 2000 ---- ---- Income taxes $ 4,000 $ 1,000 ======== ======= Interest $ 3,000 $25,000 ======== ======= 11. LICENSING ACTIVITIES Product Licensing On April 24, 2000, HPS signed a multi-year licensing agreement for its REALM and innerREALM fragrance and toiletry products with Niche Marketing, Inc. ("Niche"), a newly formed affiliate of Northern Brands, Inc. Since 1998, affiliates of Niche had been involved with the sales of these product lines in the United States and several International markets. Under the agreement, Niche will be responsible for the manufacture, marketing, selling and distribution of the REALM and innerREALM products in the United States and Internationally, excluding the Far East. Niche purchased the Company's applicable inventories and pays a royalty on sales of the current products and line extensions, with annual minimums, under the REALM and innerREALM brand names. All such products must contain the Company's patented human pheromone technology. During the term of the agreement, HPS will also sell Niche the pheromone components required for the manufacture of the products. The initial period of the agreement is four years and may be extended with the mutual agreement of the parties for periods of up to ten years. Technology Licensing In December 1998, HPS signed its first agreement to supply Avon Products, Inc with its synthesized human pheromones. Revenues commenced in 1999 and continued in the years 2000 and 2001. 12. SUBSEQUENT EVENTS (unaudited) On March 7, 2002, the Company and Niche Marketing, Inc. entered into an Amendment to the License Agreement and a Settlement Agreement under which the Company regained the rights to manufacture Realm products for sale to its Southeast Asia Distributors, repurchased the rights to sell Realm products in an Asian market previously licensed to Niche, released Niche from its obligation to manufacture REALM products for sale to the Company and withdrew a breach of contract notice against Niche in connection with Niche's failure to deliver product. In addition, Niche agreed to be responsible for any product returns or requests for credit for destroyed products by department stores. 32