SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934: For the Fiscal Year ended December 31, 1996
( ) TRANSITION REPORT UNDER SECTION 13 OR 15 (D) OF THE SECURITIES ACT
OF 1934 [ NO FEE REQUIRED ]: For the transition period from ________
to _________.
Commission File Number 1-13012
H.E.R.C. PRODUCTS INCORPORATED
(Name of small business issuer in its charter)
State of Incorporation: Delaware IRS Employer Identification Number: 86-0570800
2202 W. Lone Cactus Drive #15
Phoenix, Arizona 85027-2621
(Address of principal executive offices)
(602) 492-0336
(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------- -----------------------
Common Stock, $.01 par value Boston Stock Exchange
Securities registered pursuant to Section 12(g) of the Exchange Act:
None
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 13(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. $2,600,642.
At March 20, 1997, the aggregate market value of shares of Common Stock based on
the closing price of $1.563, held by nonaffiliates was $9,371,625.
At March 18, 1997, there were 7,000,381 shares of Common Stock issued and
outstanding.
Documents Incorporated by Reference: None
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PART I
Item 1. Description of Business
General
H.E.R.C. Products Incorporated ("Company") develops, manufactures and
markets two principal lines of products: (i) consumer and industrial products
incorporating the Company's proprietary chemical technology, Eliminate(R) which
clean and control scaling, corrosion and biological growth on surfaces and
containers which are exposed to water, and (ii) biorational agriculture products
which are comprised of components existing in nature rather than components that
are artificially synthesized or man-made.
The Company's Eliminate technology was developed to respond to the
disadvantages of current methods of treating water systems. Many of the
chemicals used in treating water systems are corrosive and can cause scaling,
and it is often difficult to achieve and maintain the correct combination of
chemicals. To the extent that chemicals used in treating water systems are
toxic, corrosive or non-biodegradable, they are considered to be pollutants,
subjecting the water systems to expensive clean-up and regulatory compliance
costs. Many water systems also require expensive monitoring. The Company's
Eliminate-based products, when added to water, dissolve and prevent scaling and
corrosion while suppressing the environment that supports components of scale
and corrosion in solution. Even in its concentrated form, the Eliminate
technology is non-fuming, non-abrasive and non-flammable. Many of the Company's
Eliminate products are also certified biodegradable. The Eliminate-based
products for the industrial market include Well Klean(R) and Pipe Klean(R)
(which remove encrustations from water pumping and distribution systems),
Chlor*Rid(R) (which aids in the removal of chlorides, sulfates and other soluble
salts from surfaces prior to coating) and Compounds 360, 260, 400, 200, 360
Startup, Corr-Hib(TM) Intermediate, Corr-Hib(TM) 10-84 and Corr-Hib(TM) 5-45
(which are designed for use with the Eliminate technology for the treatment and
cleaning of cooling and other water treatment systems). These products (other
than Chlor*Rid, which is sold by Chlor*Rid International, Inc., an unaffiliated
distributor) are sold directly by the Company. The Company's consumer products
include Eliminate Shower, Tub and Tile Cleaner, Clean Sweep(R) (a swimming pool
cleaner), Eliminate Evaporative Cooler Cleaner and Treatment (used to clean and
maintain evaporative cooler systems) and Eliminate Toilet Bowl Cleaner, and are
sold to the consumer market by a wholly-owned subsidiary of the Company,
H.E.R.C. Consumer Products, Inc., an Arizona corporation ("HCPI").
Through its wholly-owned subsidiary, CCT Corporation ("CCT"), the
Company develops, manufactures and markets biorational pest management and plant
growth products for the agricultural and horticultural markets. The Company
believes that, in addition to expanding the Company's product offerings through
the addition of CCT's product lines, CCT's established marketing organization
enhances the Company's sales of its existing water systems treatment products,
although there can be no assurance of this.
The Company was incorporated under the laws of the State of Arizona in
December 1986 and was reincorporated in the State of Delaware in February 1994.
The Company acquired all of the outstanding capital stock of CCT on May 1, 1995
in a merger by which CCT became a wholly-owned subsidiary of the Company. CCT
was incorporated under the laws of the State of Arizona in May 1981. Through its
subsidiary, HCPI, on July 1, 1996, the Company acquired the portion of its joint
venture, H.E.R.C. Consumer Products Company, LLC ("LLC"), with Conair
Corporation ("Conair") that it did not then own, so that the LLC became
wholly-owed. The Company's executive offices, warehouse and manufacturing
facility for certain of its Eliminate-based products are located in Phoenix,
Arizona and its telephone number is (602) 492-0336. CCT's office and certain of
its warehousing facilities are located Carlsbad, California and its telephone
number is (619) 929-9228.
Business Segments
The Company's principal business segments are the manufacture and
distribution of its consumer products and industrial water treatment chemicals
and related products and the manufacture and distribution of environmentally
friendly proprietary agricultural products. Financial information about the
Company's business segments is contained in Note 11 to the consolidated
financial statements.
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Market Overview
Eliminate Based Products
Water is critical to many industries and uses, ranging from
agriculture, pools, wells, waterlines, heating and air-conditioning as well as
most industrial production processes. Water is a chemically active substance
and, any surface which is regularly exposed to water is subject to corrosion by
oxidation (such as rust). Since water is rarely pure, water exposed surfaces are
also subject to scaling, which is the deposit of water-borne minerals. Scaling
or corrosion will eventually lead to the plugging or fouling of the surface,
pipe, pump, bathroom fixture, tiles, pool, air conditioning system, or other
water exposed surface. In addition, surfaces exposed to water are subject to
biological activity.
Current treatment methods of water containment systems (i.e., water
tanks, piping, wells, etc.) include replacement, closing and cleaning, or
treating the water to reduce or cure the problem. This latter method, referred
to in the industry as water systems treatment, is preferred because it reduces
capital costs and system downtime.
The Company estimates that in 1997 the annual U.S. market for water
systems treatment chemicals is in excess of $3.0 billion. In addition, the
Company estimates that there are more than 250,000 miles of water mains in the
United States which may be in need of rehabilitation representing an annual
market in excess of $2 billion in rehabilitation services and chemicals.
Agricultural Products
Biorational products for agriculture protect or enhance crop production
with little or no environmental impact. Products in this group are biological,
non-toxic, natural and/or organic. Although many of these types of products in
the past have had quality problems, erratic results and a lack of economic
support data, the industry is addressing these issues with greater result. The
Company believes that the demand for biorational products will continue to grow
in numbers and sales, although there can be no assurance of this. Factors that
may contribute to this growth are concern for worker safety, the decline in
available conventional chemical pesticides because of their side effects and/or
consequences, concern about chemical residue on agricultural products, in the
soil and in the water table and finally, concern about chemical drift to
non-target crops and to residential housing which is expanding into traditional
farm lands.
The Company estimates that in 1997 the worldwide markets for
agricultural insecticides is in excess of $6.0 billion. The market share of
biorational agricultural products is a small portion of these worldwide markets,
but the Company expects the market share to grow as the efficacy of biorational
products is shown and the concern grows about the impact on the environment and
human life from conventional, chemically synthesized agricultural products.
The Eliminate Technology
The Company believes that water systems treatment methods currently
offered by other companies have several disadvantages compared to products
incorporating the Company's Eliminate technology. Many of the chemicals used in
water systems treatment methods are corrosive and can cause scaling, and it is
often difficult to achieve and maintain the correct combination of chemicals. To
the extent that chemicals used in water systems treatment are toxic, corrosive
or non-biodegradable, they are considered to be pollutants, subjecting the water
systems to expensive clean-up and regulatory compliance costs.
Many water systems also require expensive monitoring.
The Company's Eliminate technology was developed to respond to the
disadvantages of current water systems treatment methods. When added to water,
it dissolves and prevents scaling and corrosion while suppressing the
environment that supports biological growth which results in more efficient
water utilization. The Eliminate chemistry keeps the dissolved components of
scale and corrosion in solution even at highly concentrated levels. The
Eliminate technology is non-fuming, non-abrasive and non-flammable. Many of the
Company's Eliminate products are also certified biodegradable by Scientific
Certification Systems, an independent certifying testing laboratory ("Green
Cross").
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A 1988 study of the acute oral toxicity of Eliminate in rats was
performed by SRI International, an independent testing laboratory, in compliance
with the Environmental Protection Agency Toxic Substances Control Act Good
Laboratory Practice Standards, as set forth in 40 CFR Part 792. No deaths or
clinical signs of toxicity occurred in male rats following treatment with 5,000
milligrams per kilogram of Eliminate. Based on the results of the study, the
acute oral LD50 of Eliminate in male Spraque - Dawley rats is greater than 5,000
milligrams per kilogram.
Products
Industrial Products
The Company's Industrial Products Group ("IPG") is actively engaged in
the application of both the Eliminate technology and additional Herc licensed
technologies to provide unique products and services to the industrial and
municipal water systems industry, as well as the high performance coating
industry. The Company's Well-Klean, Pipe-Klean, and additional licensed chemical
technologies are used as core products in what are typically complex water
systems operational enhancement, and as tools to revitalize/rehabilitate water
systems with diminished capacities. Other of the Company's chemicals are used to
maximize the performance of coatings when used as surface preparation. The IPG
Field Services Division provides turn-key application of all of the IPG
technologies. The IPG's active markets are generally defined as:
CORE MARKETS
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Industrial & Municipal Water Distribution Rehabilitation
Industrial & Municipal Source Water Well Rehabilitation
Industrial Process Water Treatment Chemicals
Surface Preparation/Coating Enhancement Chemicals
EMERGING MARKETS
- ----------------
Fire Protection Pipe Line Chemical Cleaning/Passivation
Marine-Ship Board Pipe Line Chemical Cleaning
Industrial Process Water Systems Fouled Surface Scale Removal Services (cooling
towers, high flux heat exchanger surfaces, etc.)
Chemicals used or offered to the above markets include:
Well Klean and Pipe Klean. Well Klean and Pipe Klean remove
encrustation from pumps, screens, pipes and distribution lines in water pumping
and distribution systems. The Company's products have been tested and certified
to ANSI/NSF Standard 60 by National Sanitation Foundation International ("NSF")
for use as well cleaning and pipe cleaning aids in drinking water systems.
Standard 60 was developed to establish minimum requirements for the control of
potential adverse human health effects from products added directly to water for
its treatment. The Company believes that these products offer distinct
advantages over the acid washes which are generally used to clean water systems,
since the acid can cause corrosion and can be deemed to be hazardous waste for
disposal purposes. In addition, these products provide significant cost savings
compared to other currently available solutions such as replacing a water system
or a portion of such system. In 1996, approximately 1% of the Company's total
revenues were derived from sales of Well Klean, and approximately 7% of the
Company's total revenues were derived from sales of Pipe Klean.
Pipe-Koat. Pipe-Koat is a licensed coating technology used as a tool to
provide non-structural, post cleaning protection in potable and non-potable
water distribution systems. The Company believes that this innovative
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NSF Standard 61 tested and certified lining material offers distinct advantages
over the cement mortar lining materials, which have been shown to adversely
affect water quality. Pipe-Koat, once applied will provide a permanent barrier
to internal pipeline corrosion.
Chlor*Rid(R) Chlor*Rid is an organic biodegradable chemical blend which
aids in the removal of chlorides, sulfates and most other soluble salts.
Chlor*Rid is used as a wash solution prior to the application of primers or
coatings to improve adhesion on a variety of surfaces, including ferrous and
nonferrous metals, wood, plastics and others. In 1996, approximately 1% of the
Company's total revenues were derived from sales of Chlor*Rid.
Compounds: 360, 260, 400, 200, 360 Startup, Corr-Hib(TM) Intermediate,
Corr-Hib(TM) 10-84 and Corr-Hib(TM) 5-45. Compounds 360, 260, 400, 200, 360
Startup, Corr-Hib(TM) Intermediate, Corr-Hib(TM) 10-84 and Corr-Hib(TM) 5-45
(collectively the "Process Water Products") are specialty formulations of the
Eliminate technology used for continuous treatment of commercial and industrial
process water systems. Scaling and corrosion are particularly harmful to process
water systems because they reduce cooling efficiency, deteriorate equipment
prematurely and increase energy costs. As with water distribution systems,
traditional treatments that are currently used include phosphates and heavy
metals which result in poor performance, risk of damage, excessive energy and
water use and are normally considered discharge pollutants. The Company's
Process Water Products are intended to remove and prevent deposits, and restore
operational efficiency while decreasing water use. The products contain
non-pollutant ingredients, and perform in a wide variety of systems and water
qualities. In 1996, approximately 4% of the Company's total revenues were
derived from sales of the Company's Process Water Products.
Consumer Products
Eliminate Shower, Tub and Tile Cleaner. Eliminate Shower, Tub and Tile
Cleaner is a cleaning solution designed to remove soap scum, hard water spots
and body oils from shower doors and walls, bathtubs and sinks. It is sprayed on
and rinsed off approximately a half hour later. It is not necessary to scrub or
brush. Eliminate Shower, Tub and Tile Cleaner is Green Cross certified as
biodegradable, and it is the only such cleaner containing a fragrance which is
certified biodegradable and was listed in the Safe Shoppers Bible published in
1995 and 1996, the foreword of which was written by Ralph Nader. Eliminate
Shower, Tub and Tile Cleaner is packaged in four sizes: 16, 20 and 32 ounce
spray bottles and one gallon refill bottles. In 1996, approximately 34 % of the
Company's total revenues were derived from sales of Eliminate Shower Tub and
Tile Cleaner.
Clean Sweep(R). Clean Sweep Pool Cleaner is added to swimming pool
water to remove scale and body oils, dirt, scum and algae which attach to the
scale. After the Clean Sweep Pool Cleaner has cleaned the pool, Clean Sweep
Balance Plus is added to return the pool chemistry to normal and Clean Sweep
Pool Maintenance is added to keep the pool from accumulating stains and scale.
The pool does not have to be drained to use the Clean Sweep system. Clean Sweep
is marketed as a more convenient and less expensive method than the traditional
method of pool cleaning, which involves draining the pool and applying an acid
wash.
Eliminate Evaporative Cooler Treatment. Evaporative Cooler Cleaner and
Evaporative Cooler Treatment are used to clean and maintain evaporative cooler
systems which are used primarily in arid and semi-arid regions of the western
and southwestern United States.
Eliminate Toilet Bowl Cleaner. Eliminate Toilet Bowl Cleaner functions
like Eliminate Shower, Tub and Tile Cleaner for use in toilet bowls. It is
effective as a cleaner for removing rust, hardwater deposits and waste buildups.
Proposed Consumer Products. In order to expand its product lines,
channels of distribution and classes of trade, the Company is developing
additional products and is pursuing the acquisition and/or licensing of existing
product lines.
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Agricultural Products
CCT has six principal pest management products. Of these, four are
certified for use in organic farming in certain jurisdictions, while the others
are either non-toxic or certified biodegradable. PYRELLIN(R) is not certified
for use in organic farming in the State of California or for shipments of
organic products into the State of California. To expand and complement its
current product line, CCT continues to evaluate candidate compounds for
acquisition or licensing.
COAX(R). COAX is an insect feeding stimulant which, when combined with
biological insecticides, encourages insect pests to ingest more of the mixture
in a shorter duration. This addition of COAX results in increased efficacy of
biological insecticides. By screening out ultra violet light rays, COAX extends
the length of effective control of biologicals, making them more comparable to
conventional pesticides. COAX was developed by the United States Department of
Agriculture (USDA) and initially commercialized by the Proctor and Gamble
Company. CCT purchased and now owns both the formula and trademark COAX(R). COAX
accounted for approximately 5 % of the Company's sales in 1996.
STRESSGUARD.(R) STRESSGUARD forms a thin, gas permeable membrane on
plant foliage which reduces water loss and protects plants from environmental
conditions that are stressful to them and that retard growth. STRESSGUARD also
can be used with soft pesticides which become encapsulated in the coating
permitting the increased and extended time of effectiveness against insects.
Using STRESSGUARD in conjunction with pesticides results in fewer applications
and lower use rates resulting in savings to growers and reduces the amount of
pesticide introduced into the environment. CCT owns the product formula and
trademark for STRESSGUARD.
CO*BACIL(R). CO*BACIL was developed by CCT, together with the USDA.
CO*BACIL, available in one powder and two granular formulations, incorporates
the biological insecticide Bacillus thuringiensis with CCT's insect feeding
stimulant, COAX. CO*BACIL, now in market introduction, is principally targeted
for the control of lepidopterous insect pests in corn, vegetables, trees and
vines. CO*BACIL has been demonstrated to be more effective that other Bt
products, which do not contain COAX. CCT owns the product formula and trademark
for CO*BACIL.
PYRELLIN(R). PYRELLIN is a botanical insecticide marketed under an
agreement with its manufacturer, the Webb Wright Corporation. The exclusive
marketing agreement applies to the United States and Mexico. PYRELLIN accounted
for $929,000 in sales for the year ending December 31, 1996, representing
approximately 36% of the Company's sales. One of the active ingredients in
PYRELLIN, rotenone, is currently under review by the United States Environmental
Protection Agency (EPA) and the California Environmental Protection Agency (Cal
EPA). The EPA has rendered its decision in favor of rotenone, and the Cal EPA
decision, believed to be favorable, is due. Once the latter decision is
received, CCT will continue its negotiations to acquire or license PYRELLIN from
Webb Wright. This would then require that CCT be responsible for generating the
information required for the re-registration of rotenone, estimated to be
approximately $160,000 - $200,000 over the next three to five years. A portion
of these funds could be recouped through the data compensation program at the
EPA.
DENY(R). There are two product forms for DENY, one is a biological
fungicide and the other a biological nematicide. Both products have applications
in vegetables, specialty crops such as melons, and turf, accounting for
approximately 6% of the Company's 1996 sales. DENY provides fungus disease and
nematode damage prevention at levels competitive with current commercial
products with less restrictions and hazards. Under an exclusive marketing
agreement with Stine Microbial Products, CCT markets the DENY products on a
worldwide basis. This marketing agreement expires on November 16, 2004.
LINE-OUT(R). LINE-OUT was developed by H.E.R.C. for the agricultural
sector to clean and maintain low flow irrigation systems lines free of deposits
that restrict water flow. LINE-OUT is marketed exclusively by CCT. LINE-OUT is
also effective as a soil amendment in reclaiming salty soils. LINE-OUT is
presently being applied on golf courses to improve water penetration through the
soil. It is non-corrosive and certified biodegradable by Green Cross. In 1996,
LINE-OUT accounted for approximately 2% of the Company's sales.
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CCT also markets a line of pheromone mating disruption products for the
Thermo Trilogy Corporation. Mating disruption products are useful in Integrated
Pest Management Programs to preserve the natural populations of beneficial
insects (natural enemies of insect pests) and reduce the amount of conventional
pesticides applied.
Marketing and Distribution
The Company markets its products and services using its marketing and
sales staff, exclusive licensing arrangements with independent service
companies, independent distributors and strategic relationships. Prior to July
1996, the Company also marketed its consumer products through the joint venture
with Conair.
Industrial Products.
The Company believes that the market for its industrial products and
services is very broad. In addition to the more than 250,000 miles of potable
water mains in the United States operated by public and private water companies
and municipalities which may be in need of rehabilitation and has been the
primary focus of its marketing to date, there are extensive private waterlines
in hotels, resorts, factories, refineries, mines and other industries with
internal water distribution systems which need rehabilitation. The Company uses
its internal sales force to market its revitalization/rehabilitation products
and services through direct presentations to municipalities and industrial
companies with internal water distribution systems at pipeline engineering and
municipal services trade shows. It also advertises in related trade
publications. In addition, in 1996 the Company entered the fire protection pipe
line cleaning/passivation market and the marine-ship board pipe line chemical
cleaning market. As of March 21, 1997, the Company has cleaned the vacuum waste
water lines on board 9 United States Coast Guard Cutters.
The Company markets its industrial products and services mainly by
establishing licensing and/or distribution agreements with regional and local
independent contractors and direct sales depending upon the location and
customer needs. Under such a licensing and/or distribution arrangement, the
contractor agrees to purchase the Company's products in exchange for the
exclusive territorial marketing rights. The Company has licensed two entities in
key areas of the country to market the water system treatment products primarily
to the municipal and industrial market for water systems treatment in the areas
of Eastern New York, Eastern Pennsylvania, New Jersey and Ohio. The Company
distributes Chlor*Rid through Chlor*Rid International, Inc., an unaffiliated
distributor.
The Company markets its Process Water Products through strategic
relationships with established water system treatment companies.
Consumer Products
On July 1, 1996, the Company acquired the fifty percent interest of the
LLC owned by Conair. Prior to that date the Company and Conair equally owned the
LLC which was formed to produce and market the Company's consumer products.
The Eliminate Shower, Tub and Tile Cleaner is sold by HCPI primarily
through large hardware and home improvement chains. The pool products are
distributed by HCPI to pool specialty stores and distributors, and marketed both
under the HCPI's name and on a private label basis. During 1996, the Company
sold $783,812 of consumer products to one customer, representing approximately
88% of consumer products sales.
Agricultural Products
The Company's biorational agricultural and horticultural products are
marketed by CCT. CCT began its operations in 1981 and has established markets
and long standing relationships among users of environmentally sensitive pest
management products. CCT markets its products through local, regional and
national distributors of agricultural products in all major fruit, vegetable and
specialty crop growing areas in the United States as well as into the turf/golf
course market through key distribution channels.
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CCT regularly participates in industry trade shows and appears in selected
industry publications. CCT also continues to increase its emphasis on market
opportunities outside the United States.
Advertising
The Company actively advertises and publishes in selected industry
publications and initiates direct mail pieces to discreet groups of potential
consumers of its various products. The Company also uses an "800" number in
connection with its advertising and direct mail programs so that customer leads
may be followed up on under the coordination of the Company sales personnel. The
primary emphasis of the advertising is to promote awareness of the Company and
its various products.
Competition
Industrial Products
Waterwell and waterline revitalization/rehabilitation are normally
performed by regional contractors. There are no major companies that dominate
this business. The largest company in the waterwell field is Layne, Inc.
Chemicals used in cleaning water systems have generally been non-proprietary,
readily available acids produced by such major chemical companies as DuPont, Dow
Chemical Company, Hill Brothers Chemical Company and Vista Chemical Company.
These companies are substantially larger and have far more extensive resources
than the Company. To the extent that the Company seeks to sell its water system
pipeline rehabilitation technology directly to end users, it may be perceived as
competing with the regional contractors to which it will also seek to market its
pipe rehabilitation products and technology. While such companies are not as
large as the chemical producers, they are still generally large and more well
established in the industry than the Company.
With respect to Process Water Products, the Company does not directly
compete with the major water treatment companies, but is a supplier to those
companies by educating them of the advantages of the Company's Process Water
Products and technology. Should the water treatment companies choose to compete
with the Company, there could be an adverse effect on the Company's activities
since the Company does not have the resources to compete for full water
treatment contracts on a "stand-alone" basis. Almost all of the water treatment
and water treatment chemical companies are substantially larger and have far
more extensive resources than the Company.
In addition, the Company expects that the companies with which it
competes have the resources to develop and have developed, are developing, or
may develop and market products directly competitive with the Company's
technology. Current competitors or new market entrants could produce new or
enhanced products with features that render the Company's products obsolete or
less marketable. The Company's ability to compete successfully will depend on
the Company's continuing research and development of new and improved products
and on the Company's ability to adapt to technological changes and advances in
the water systems treatment industry.
In the opinion of the Company's management, the Company's products and
methods are superior to other water system treatment chemicals because they are
easier to use, less expensive and are less harmful to the environment.
Additionally, certain of the Company's products meet the NSF Standard 60 or are
Green Cross certified as biodegradable. The Company competes principally on the
basis of these qualities and by securing strategic relationships with
established companies, of which there can be no assurance. The Company has
patent protection for certain of its technologies and is seeking to expand
patent protection by making new applications in respect of its Eliminate
products and technology in order to provide a diverse product base.
Consumer Products
The markets for HCPI's products are highly competitive. HCPI competes
with numerous well-established chemical and consumer products companies, all of
which possess substantially greater financial, marketing, personnel and other
resources than HCPI and have established reputations. HCPI intends to expand its
product lines (by developing new products and by acquiring and/or licensing
existing product lines), channels of distribution and classes of trade in 1997.
In addition to hardware, HCPI will pursue janitorial, catalog, commercial and
warehouse club store sales. Catalog sales through U.S. Sales Corp and sales
through Bed, Bath and Beyond retail outlets are new channels of distribution
secured in January, 1997.
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Agricultural Products
The biorational products of CCT compete with other natural or organic
products as well as conventional pest control chemical products. Within the
biorational agricultural product markets, CCT competes with smaller agrichemical
manufacturers such as Ecogen, Inc., Mycogen Corporation, Troy Biosciences, Inc.,
Custom Chemicides and Miller Chemical and Fertilizer Corporation. In addition,
there are a number of sole proprietorships that also compete in these same
markets. CCT also competes with major agrichemical manufacturers such as Abbott
Laboratories and Novartis (a new company that brings together Ciba and Sandoz
Agro) which also produce and market conventional agrichemicals. These companies
are substantially larger and have far more extensive resources than does CCT.
CCT competes based upon the fact that the products in its entire line have
little or no adverse environmental impact, some of which are certified for use
in organic food production. CCT benefits from its extensive established
relationships in the agribusiness industry.
Manufacturing and Supply
Certain of the Company's industrial products based upon the Eliminate
technology are formulated and packaged at its plant in Phoenix, Arizona. The
balance of these industrial products and all of the Company's consumer products
are manufactured and packaged for it by third party manufacturers located in
Chandler, Arizona, Tucson, Arizona and Winterhaven, Florida, using formulations
provided by the Company. The CCT biorational agricultural products are
manufactured and packaged for it by third party manufacturers using formulations
provided by CCT. The Company generally does not maintain long-term supply
agreements with its suppliers and purchases raw materials and agricultural
products pursuant to purchase orders or short-term contracts in the ordinary
course of business. The Company believes that the raw materials and other
supplies are readily available from a variety of sources and that there are
numerous companies available to formulate and package its products.
Patent and Trademark Protection
The Company has a patent for the use of its Eliminate technology in
cleaning potable water distribution systems. The Company has several patents
covering its automated control system for using the Company's Eliminate
technology for controlling scale and corrosion in process water applications and
several patents on its process for cleaning water distribution systems. On March
11, 1997 the Company received a joint patent with Chlor*Rid International, Inc.,
for the use of its Chlor*Rid technology in removing chlorides from contaminated
surfaces. The Company also has a patent for its multi-purpose cleaning
formulation. The Company has been allowed a patent in respect of Clean Sweep.
Additionally, the Company has two United States patents pending related to the
process for cleaning water distribution systems. The Company currently is
executing a foreign patent program on the Company's basic United States patent
technology. There can be no assurance that any patents applied for will be
obtained. Moreover, there can be no assurance that any patents will afford the
Company commercially significant protection of its technology or that the
Company will have adequate resources to enforce its patents. The Company
believes that it has independently developed its proprietary technologies and
they do not infringe the proprietary rights of others. Although the Company has
received no claims of infringement, it is possible that infringement of existing
or future patents or proprietary rights may occur.
In the event that the Company's products infringe patent or proprietary
rights of others, the Company may be required to modify its processes or obtain
a license. There can be no assurance that the Company would be able to do so in
a timely manner, upon acceptable terms and conditions or at all. The failure to
do so would have a material adverse effect on the Company. In addition, there
can be no assurance that the Company will have the financial or other resources
necessary to defend a patent infringement or proprietary rights action.
Moreover, if any of the Company's products infringe patents or propriety rights
of others, the Company under certain circumstances could become liable for
damages which could have a material adverse effect on the Company.
The Company's registered trademarks are Eliminate, Clean Sweep,
h.e.r.c.(R), Well Klean, Pipe Klean, STRESSGUARD, CO*BACIL, COAX, DENY, LINE-OUT
and SPARK(R). The Company also has the Eliminate Man(C) registered as a
copyright.
Page 9
<PAGE>
The Company also relies on proprietary know-how and confidential
information and employs various methods to protect the processes, concepts,
ideas and documentation associated with its technology. However, such methods
may not afford complete protection, and there can be no assurance that others
will not independently develop such processes, concepts, ideas and
documentation. Although the Company requires all of its employees to sign
confidentiality agreements, there can be no assurance that such agreements will
be enforceable or will provide meaningful protection to the Company. There can
be no assurance that the Company will be able to adequately protect its trade
secrets or that other companies will not acquire information that the Company
considers to be proprietary. Moreover, there can be no assurance that other
companies will not independently develop know-how comparable to or superior to
that of the Company.
Government Regulation
Water pollution is a major focus of federal, state and local
environmental protection laws and regulations. The discharge from water systems
treatment is subject to these laws and regulations. The water system treatment
chemicals industry and the Company's operations are subject to extensive and
significant regulation by federal, state and local governmental authorities.
Some of such regulation is extensive and may from time to time have a
significant impact on the Company's operations. Testing and certification of
drinking water additives is performed by the NSF pursuant to Standard 60 which
is a recognized standard used as guidance by the federal and most state
environmental protection administrations and is being adopted as the regulatory
standard by many states. The NSF has indicated that Pipe Klean and Well Klean
comply with the standards for chemicals which can be used in cleaning drinking
water systems. In addition, many of the Company's products are Green Cross
certified as biodegradable. Products are biodegradable if they can be broken
down into carbon dioxide, water and minerals without harmful effects to the
environment.
Some of the Company's products require the use of a chemical that is
classified under applicable laws as a corrosive chemical and substance. There
can be no assurance that the Company will not incur environmental liability
arising out of the use of corrosive substances. To date, the Company does not
believe that it has incurred any such liability. The Company does not maintain
insurance to compensate it for any liabilities it may incur if it were to
violate environmental laws or regulations. The use of certain chemicals
contained in the Company's products is subject to frequently changing federal,
state and local laws and substantial regulation under these laws by governmental
agencies, including the United States Environmental Protection Agency, the
Occupational Health and Safety Administration, various state agencies and county
and local authorities acting in conjunction with federal and state authorities.
Among other things, these regulatory bodies impose requirements to control air,
soil and water pollution, to protect against occupational exposure to such
chemicals, including health and safety risks, and to require notification of the
storage, use and release of certain corrosive chemicals and substances.
The biorational agricultural products sold by CCT are registered with
the federal and most state environmental protection agencies. In most instances,
the federal registration is undertaken and maintained by the entities that
developed or have licensed CCT to manufacture and sell the products. CCT
maintains licenses for the sale of each of its agricultural products in those
states where it sells the products.
The Company believes that it is in substantial compliance with all
material federal, state and local laws and regulations governing its business
operations and has obtained all material licenses, authorizations, approvals,
orders, certificates and permits required for the operation of its business.
There can be no assurance that the Company in the future will be able to comply
with current or future government regulations in every jurisdiction in which it
will conduct its business operations without substantial cost or interruption of
its operations, or that any present or future federal, state or local
environmental protection regulations may not restrict the Company's present and
possible future activities. In the event that the Company is unable to comply
with such requirements, the Company could be subject to substantial sanctions,
including restrictions on its business operations, monetary liability and
criminal sanctions, any of which could have a material adverse effect upon the
Company's business.
Advertising relating to the Company's products is subject to the review
of the Federal Trade Commission and state agencies, pursuant to their general
authority to monitor and prevent unfair or deceptive trade practices. In
addition, the Consumer Products Safety Commission regulates the labeling of the
Company's products.
Page 10
<PAGE>
Research and Development
The Company believes that there are numerous additional products to
further expand or augment its current product lines that may be developed from
the Eliminate technology or acquired. The Company has not yet developed any
other products based on the Eliminate technology and there can be no assurance
that such products can be developed or that, if developed, they would be
technologically or commercially successful. The Company also anticipates that
there will be opportunities to develop products in related fields which are not
necessarily dependent on the Eliminate technology. The Company is currently
evaluating a number of new biorational agricultural products that may be
available for acquisition or licensing. There can be no assurance that future
research, development and evaluation activities or expenditures by the Company
will result in commercially viable products.
CCT participates in various cooperative product development programs
sponsored by different entities including the Biocontrol Division of the USDA,
major university extension agencies and manufacturers of newer technologies and
niche products. CCT participates at different levels such as conducting or
providing research, joint testing and providing marketing expertise which is
used to help design the product. By combining its resources with those of the
USDA, universities and manufacturers, CCT is able to leverage the use of its
research funds and review many active research products taking place in the
United States as well as to establish potential marketing relationships for new
products.
Employees
As of December 31, 1996, the Company had 31 employees, of whom five are
officers, five are engaged in field operations and production, five in
administration and twelve in marketing and sales. None of the Company's
employees is represented by labor unions or covered by a collective bargaining
agreement. The Company believes that its relations with all of its employees are
satisfactory.
Seasonality
Sales of the Company's agricultural products are seasonal. The greatest
dollar volume of sales of agricultural products occurs during the second and
third quarters of the calendar year. Sales of the Pipe Klean and Well Klean
products are also seasonal in those parts of the United States in the snow belt.
Seasonal sales can result in uneven cash flow for the Company. Uneven cash flow
may require the Company to be dependent on cash flows from sales of its water
system treatment products during those portions of the year when sales of
agricultural products experience slow down and may require the Company to obtain
and maintain short-term financing arrangements. In the event such financing
arrangements are not available or, once acquired, cease to be available, the
Company's operations and financial condition could be materially adversely
affected.
Item 2. Description of Property
The Company leases approximately 15,700 square feet of office and
warehouse facilities in Phoenix, Arizona, approximately 5,530 square feet of
office and warehouse facilities in Portsmouth, Virginia and approximately 2,500
square feet of office and warehouse facilities in Carlsbad, California. The
Phoenix facilities are leased under an operating lease expiring on July 31,
2001. The lease provides for monthly payments escalating from $8,796 to $10,053
over the term of the lease. The Portsmouth facilities are leased under an
operating lease expiring December 31, 1998, with an option to extend the lease
for three (3) additional years to December 31, 2001. The lease provides for
monthly payments escalating from $2,225 to $2,640 over the term of the lease,
including the extension term. The Carlsbad facilities are leased under an
operating lease expiring on July 31, 1997 that provides for monthly payments of
$1,655. CCT has the option of extending this lease for one year to July 31, 1998
at the same monthly rate.
Item 3. Legal Proceedings
The Company is not a party to any pending legal proceeding, nor is its
property the subject of any pending legal proceeding.
Page 11
<PAGE>
Item 4. Submission of Matters to a Vote of the Security Holders
There were no matters submitted to a vote of the security holders,
through the solicitation of proxies or otherwise during the fourth quarter ended
December 31, 1996.
Part II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
Trading Markets
The Company's Common Stock has been listed on the Nasdaq SmallCap
Market and on the Boston Stock Exchange under the symbols "HERC" and "HER",
respectively. The Nasdaq SmallCap Market is the principal market for the
Company's Common Stock.
The following table sets forth the high and low bid prices as quoted by
Nasdaq for the periods indicated. Such quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
1995 High Bid Low Bid
---- -------- -------
First Quarter $3.063 $1.625
Second Quarter 4.125 2.625
Third 4.375 1.875
Fourth Quarter 2.188 1.500
1996 High Bid Low Bid
---- -------- -------
First Quarter $1.813 $0.625
Second Quarter 2.125 0.750
Third 2.906 1.188
Fourth Quarter 3.125 1.500
(through February 29, 1997)
1997 High Bid Low Bid
---- -------- -------
First Quarter $2.375 $1.438
(through February 29, 1997)
On March 20, 1997 the last reported bid price for the Common Stock as
quoted by Nasdaq was $1.375.
Holders
As of March 18, 1997, the number of record holders of the Common Stock
of the Company was 72. According to Company estimates, there are more than 1,040
beneficial holders of the Common Stock..
Dividends
To date, the Company has not paid any cash dividends on its Common
Stock, and it does not anticipate paying any cash dividends in the foreseeable
future. There are no restrictions that limit the Company's ability to pay
dividends on its Common Stock.
Page 12
<PAGE>
Recent Sales or Grants of Unregistered Securities
The following relates to all securities of the Company sold or granted within
the last fiscal year which were not registered under the Securities Act of 1933.
<TABLE>
<CAPTION>
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
Consideration received
and description of Exemption Terms of
Date of Title of Number underwriting or other from exercise
grant security discounts to market registration
price afforded to claimed
purchasers
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
<S> <C> <C> <C> <C> <C>
Options to Options granted - no Section Exercisable for
1/96 - purchase Common 575,000 consideration received 4(2) a period
12/96 Stock granted by Company until lasting six
to employees exercise years from date
and directors of grant at
exercise prices
ranging from
$1.50 to $2.38
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
Units Units consisting of Private The Common
4/3/96 3,214,902 shares of $2,732,650* placement Stock purchase
Common Stock and pursuant to warrants are
3,214,902 Common Stock Section 4(2) exercisable at
purchase warrants $2.00, until
April 3, 1999
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
4/3/96 Unit Purchase Units consisting of Section Exercisable at
Option 321,490 shares of $100 4(2) $.935 until
Common Stock and 4/3/2001
321,490 Common Stock
purchase warrants
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
Warrants to Warrants granted as Section Exercisable at
9/27/96 purchase Common 50,000 consideration for 4(2) $2.75 until
Stock granted financial public 9/17/2001
to The Equity relations services
Group
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
Warrants to Warrants granted - as Section Exercisable for
11/19/96 purchase Common 200,000 consideration for 4(2) a period
Stock granted consulting services lasting four
to GKN years from
Securities Corp. 11/19/97 at
exercise price
of $2.50
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
12/10/96 Preferred Stock 170,000 shares $1,700,000* Private N/A
placement
pursuant to
Section 4(2)
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
Warrants to Services as placement Section Exercisable for
12/10/96 purchase Common 85,000 agent 4(2) a period
Stock granted lasting five
to Perrin, years from date
Holden & of grant at
Davenport exercise price
Capital of $3.00
Corp.("PHD")
- ------------ ----------------- ------------------------ ------------------------ -------------- -----------------
</TABLE>
*See "Item 6, Management's Discussion and Analysis of Financial Condition and
Results of Operations - Liquidity and Capital Resources" and Note 9 to Financial
Statements for a discussion of private placements of Common Stock and Preferred
Stock during 1996.
Page 13
<PAGE>
Item 6. Management's Discussion and Analysis of Financial Condition and Results
of Operations
When used in the Form 10-KSB and in future filings by the Company with
the Securities and Exchange Commission, the words or phrases "will likely
result", "the Company expects," "will continue," "is anticipated," "estimated,"
"project," or "outlook" or similar expressions are intended to identify
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. The Company cautions readers not to place undue
reliance on any such forward-looking statements, each of which speak only as of
the date made. Such statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from historical earnings
and those presently anticipated or projected. Included in the risks and
uncertainties that may effect the Company are the following: the possible need
for additional capital to fund operations in the future; the current dependence
on significant customers; the need to obtain and maintain "environmentally
friendly" certification for its agricultural products; competition; the need for
continued market acceptance and the requirement to expand sales in all of its
segments; the seasonality of sales of certain of its products; and the need to
contain and reduce certain expenses associated with the manufacture and
distribution of its products. The Company has no obligation to release the
result of any revisions which may be made to any forward-looking statements to
reflect anticipated or unanticipated events or circumstances occurring after the
date of such statements.
Results of Operations
1996 Compared with 1995
Sales for the year ended December 31, 1996 were $2,600,642 compared to
$1,349,786 in 1995, an increase of $1,250,856 or 93%. Consolidation of H.E.R.C.
Consumer Products operations into the financial statements, effective July 1,
1996, and inclusion of agricultural sales for the entire year 1996 (see Note 3
to accompanying financial statements) account for the increase, offset by a
decline in industrial product sales.
Consumer product sales for the six months ended December 31, 1996 were
$893,754, over 98% of which were Eliminate Shower, Tub and Tile Cleaner. 88% of
consumer product sales were to one customer. Full years sales in 1996 and 1995
were $1,655,000 and $1,380,573 respectively with wider distribution of Eliminate
Shower, Tub and Tile Cleaner accounting for the increase.
Agricultural products contributed $1,377,085 to consolidated sales in
1996 compared to $736,966 for the eight months ended December 31, 1995. Full
year agricultural sales in 1995 were $1,979,852. PYRELLIN revenues declined from
$1,352,200 for the full year 1995 to $929,150 in 1996 as a result of (a) a
promotion program in late 1995 whereby customers bought ahead and carried
inventory into 1996 and (b) the loss in California of organic certification of
the product for use by organic farmers. To date, the certification has not been
restored. Sales of all agricultural products in 1996 were generally lower
because of weather conditions, but DENY sales were up 20% as product
introduction continued. The Company anticipates that DENY sales will increase in
1997 in response to registration of the product with the California
Environmental Protection Agency in the first half of 1997.
Higher industrial product sales of $612,820 in 1995 compared to
$329,803 in 1996 are largely attributable to the sale of three mobile
recirculation units in 1995. There were no such sales in 1996. Revenue from
other industrial chemical products was essentially flat from 1995 to 1996.
Pro forma consolidated sales (see Note 3 to accompanying financial
statements) decreased $611,357 from 1995 to 1996 because of the decline in
agricultural and industrial products offset by an improvement in consumer
product revenues.
Although industrial products gross margin as a percentage of sales
declined in 1996, improved margin in the agricultural business and consolidation
of consumer products operations for the final six months of 1996 contributed to
an increase in overall margin from 2% in 1995 to 23% in 1996.
The decline in industrial products margin from a negative 10% in 1995
to a negative 18% in 1996 is largely a function of start up costs associated
with the Company's initial pipeline rehabilitation projects and write down of
certain equipment used in the water system treatment process. Lower raw material
cost for PYRELLIN in 1996
Page 14
<PAGE>
accounts for the improved agricultural margin of 36% in 1996 compared with 12%
in 1995. Consumer product margin of 22% for the six months ended December 31,
1996 was adversely impacted by certain one-time product and freight costs
associated with the movement of Conair inventory after the acquisition.
Selling expenses increased from $849,812 in 1995 to $1,102,638 in 1996,
representing an increase of 30%, while general and administrative expenses
increased from $1,721,077 to $1,923,020, representing an increase of 12%.
Consolidation of consumer products accounts for $282,303 of the aggregate
increase in selling, general and administrative expense while the balance of
$172,466 is attributable to additional personnel and related costs necessary to
support revenue growth and the Company's expanding operations and services.
Interest expense is consistent from year to year. The Company
anticipates that interest expense will be virtually eliminated in 1997 since the
related indebtedness has been retired with the proceeds from issuance of stock.
The decrease in miscellaneous income is a function of (a) less interest
income as more cash was invested in the business and (b) elimination of research
and development reimbursements after the Company acquired Conair's 50% share of
the LLC.
Liquidity and Capital Resources
Cash and cash equivalents were $1,369,843 at December 31, 1996 compared
to $331,601 at December 31, 1995. Working capital was $1,926,213 at December 31,
1996 and $687,713 at December 31, 1995. Increased cash and cash equivalents and
working capital, at year end, are a result of the private placement of Preferred
Stock in December 1996 offset by the loss from operations. Net cash used in
operating activities was $2,268,512 and $2,167,560 for the years ended December
31, 1996 and 1995 respectively.
On April 3, 1996, the Company sold 3,214,902 units in a private
placement, for gross proceeds of approximately $2,733,000 and net proceeds of
approximately $2,277,000. Each unit consisted of one share of Common Stock of
the Company and one warrant. Each warrant entitles the holder thereof to
purchase one share of Common Stock for $2.00 until April 3, 1999. The Company
may call the warrants for redemption at a price of $.01 per warrant, on not less
than 30 days prior written notice, if the last sales price of the Common Stock
has been at least $5.00 per share on all 20 of the trading days ending on the
third day prior to the date on which notice of redemption is given. The Company
has an effective registration statement under the Securities Act of 1933
covering the resale of the Common Stock issued in the offering and to be issued
upon exercise of the warrants by the holders.
In December 1996 the Company completed a private equity offering of
170,000 shares of Class A Preferred Stock ("Preferred Stock") for $1,700,000 and
received net proceeds of $1,480,000. The Preferred Stock has a par and stated
value of $.01 and $10 respectively. 1,000,000 shares are authorized. The holders
of the Preferred Stock are entitled to receive dividends of 10% of the stated
value per annum from the date of issuance through the "Conversion Date," as
defined, payable solely in shares of the Company's Common Stock. The holders of
the Preferred Stock have the right to convert each share of Preferred Stock and
the accrued amount of dividends thereon, through the Conversion Date, into
shares of Common Stock determined by dividing the aggregate of the stated value
of the Preferred Stock plus accrued dividends, by the greater of (i) 75% of the
average closing bid price of the common shares, as defined, or (ii) $.10. The
Preferred Stock will automatically convert based on the above formula on
December 17, 1999. The Preferred Stock does not carry any redemption or voting
rights. In the event of a liquidation, dissolution or winding up of the Company,
the holders of the Preferred Stock will participate with the holders of the
Common Stock as if the Preferred Stock was fully converted immediately prior to
the event. The Company has an effective registration statement under the
Securities Act of 1933 covering the resale of the Common Stock issued upon
conversion of the Preferred Stock.
As of March 26, 1997, 100,780 shares of the Preferred Stock
(approximately 59.3%) have been converted to Common Stock.
The Company used the proceeds from securities sales in 1996 to purchase
Conair's 50% share of the LLC and is continuing to use such proceeds (a) to
purchase industrial, consumer and agricultural product inventory to meet its
anticipated sales; (b) to market its water system treatment product and make
capital expenditures to expand that
Page 15
<PAGE>
segment of its business; (c) to develop, license and purchase the rights of new
industrial, consumer and biorational agricultural products; and, (d) for working
capital for general corporate purposes.
Through February 1997, the Company did not generate the cash flow
necessary to support its ongoing business. However, management believes, but
cannot assure, that financial results for the balance of 1997 will provide
sufficient positive cash flow to fund ongoing operations and required capital
expenditures. Should management determine that the current operating plan will
not provide positive cash flow, the Company may take actions, particularly in
the marketing and corporate areas, until revenues and operating margins reach a
level to produce overall profitable results.
In February 1997, the Company arranged a $150,000 credit line with a
bank at the bank's prime interest rate which expires March 31, 1998. No amount
has been drawn against the line. If financing in excess of the credit line is
required, there is no assurance that such arrangements could be concluded. To
the extent that any future financing involves the sale of equity securities, the
interest of the Company's then stockholders could be substantially diluted.
Item 7. Financial Statements
See Index To Financial Statements on F-1 attached hereto.
Item 8. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
Part III
Item 9. Directors, Executive Officers, Promoters and Control Persons
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
S. Steven Carl 39 Chairman of the Board, Chief Executive Officer and
Director of the Company
Shelby A. Carl 69 Chairman Emeritus and Director of the Company
Gary S. Glatter 44 President, Chief Operating Officer, Treasurer and
Director of the Company
Dr. Jerome H. Ludwig 64 Executive Vice President, Secretary and Director of the
Company
John P. Johnson 55 Chief Financial Officer of the Company
Robert M. Leopold 71 Director of the Company
Salvatore T. DiMascio 57 Director of the Company
</TABLE>
S. Steven Carl was the general manager of CCT from 1987 to May 1992,
and President and Chief Executive Officer of CCT from May 1992 to August 1995.
Mr. Carl has been the Chief Executive Officer and a Director of the Company
since August 1995 and President of the Company from August 1995 to February 28,
1996. Effective February 28, 1996, Mr. Carl became Chairman of the Board and
resigned as President of the Company.
Page 16
<PAGE>
Shelby A. Carl was the Chief Executive Officer of the Company from
February 1988 to August 1995 and has been Chairman Emeritus since August 1995
and a Director of the Company since February 1988. Prior to joining the Company,
Mr. Carl spent over 30 years in agricultural chemical development and sales.
Shelby A. Carl is S. Steven Carl's father.
Gary S. Glatter has been Chief Operating Officer and a Director of the
Company since January 1994, Chief Financial Officer from August 1995 until
December 1996 and Treasurer of the Company since August 1995. Mr. Glatter was
the President of the Company from January 1994 to August 1995 and was re-elected
President of the Company on February 28, 1996. From 1989 to December 1993, Mr.
Glatter was President and Chief Executive Officer of Classic Properties, L.P., a
New York based real estate management, sales, marketing and investment company.
From 1985 to 1989, Mr. Glatter was senior vice president for development at M.J.
Raynes Incorporated and prior to that he was in private law practice. Mr.
Glatter is admitted to the Bar of the State of New York.
Dr. Jerome H. Ludwig has been Executive Vice President, Secretary and a
Director of the Company since June 1993. For more than five years prior thereto,
he served as a scientific consultant to the Company and also was engaged as an
independent business broker. Dr. Ludwig has spent over 40 years in marketing and
product development in the chemical, plastics and pharmaceutical industries and
holds 17 United States patents.
John P. Johnson has been Chief Financial Officer of the Company since
January 1, 1997. Mr. Johnson has held numerous senior level financial positions
with various organizations, including the New York Stock Exchange, where he
retired as Chief Financial Officer - Vice President of Finance in 1990. Prior to
this, he was on the audit staff at Price Waterhouse LLP in New York. After his
retirement from the New York Stock Exchange in 1990, Mr. Johnson has acted as an
independent financial consultant. His most recent appointments include Acting
Chief Financial Officer for Boyt Company, a manufacturer of luggage and hunting
supplies, and Interim Treasurer for Rodale Press, Inc., a book and magazine
publisher. Mr. Johnson is a Certified Public Accountant.
Robert M. Leopold has been a Director of the Company since June 5, 1996
and has been the President of Huguenot Associates, a financial and business
consulting firm, since 1977 and the Chairman of the Board of International Asset
Management Group, Inc. since 1983. From June 1982 to December 1990, Mr. Leopold
held various positions with Insituform of North America, Inc. including Vice
Chairman (1982 - 1986), Chief Executive Officer (1986 - 1989), Chairman (1986 -
1987) and Advisor to the Chairman (1989 - 1990). Mr. Leopold was also a Director
of Insituform Mid-America, Inc. Mr. Leopold currently is a Director of the
following public companies: Infodata Systems, Inc., Windsor Capital Corp. and
Dental Services of America.
Salvatore T. DiMascio has been a Director of the Company since
September 3, 1996. Since June, 1994, Mr. DiMascio has been Executive Vice
President and Chief Financial Officer of Anchor Gaming, a public company. From
1986 - 1994, Mr. DiMascio was the President of DiMascio Venture Management, a
management and investment consulting firm. Among other executive level positions
held during his 30 year career, Mr. DiMascio was Senior Vice President and Chief
Financial Officer of Conair Corporation. In addition, he has experience in
industrial products manufacturing, distribution, retailing and other service
industries. Mr. DiMascio is currently a Director of U.S. Communications Inc., a
public company. Mr. DiMascio is a Certified Public Accountant.
Directors are elected to serve until the next annual meeting of
stockholders of the Company or until their successors are elected and qualified.
Officers serve at the discretion of the Board of Directors subject to any
contracts of employment.
The Company has agreed with GKN Securities corporation ("GKN") that at
such time as at least two members of the Board of Directors are "independent,"
the Board of Directors will establish a compensation committee
Page 17
<PAGE>
of which the majority are the independent directors, which committee must
approve all compensation and other employment arrangements.
The Board of Directors recently established an Audit Committee and a
Compensation Committee.
The Audit Committee, currently comprised of Robert M. Leopold and
Salvatore T. DiMascio, has been formed to: (i) recommend annually to the Board
of Directors the appointment of the independent auditors of the Company; (ii)
review with the independent auditors the scope of the annual audit and review
their final report relating thereto; (iii) review with the independent auditors
the accounting practices and policies of the Company; (iv) review with internal
and independent auditors overall accounting and financial controls; (v) be
available to the independent auditors during the year for consultation; and (vi)
review related party transactions by the Company on an ongoing basis and review
potential conflicts of interest situations where appropriate. To date, the Audit
Committee has held one meeting.
The Compensation Committee, currently comprised of Robert M. Leopold,
Salvatore T. DiMascio and S. Steven Carl, has been formed to review overall
executive compensation and review the Company's employee benefit plans. To date,
the Compensation Committee has held one meeting.
The Company is obligated through May 1999, if so requested by Whale
Securities Co., L.P. ("Whale"), the underwriter of its initial public offering,
to nominate and use its best efforts to elect Whale's designee as a director of
the Company or, at Whale's option, as a non-voting adviser to the Board of
Directors. Whale has not exercised its right to designate such a person.
The Company is obligated through April 2001, if so requested by GKN,
the placement agent of its April 1996 private placement, to nominate and use its
best efforts to elect GKN's designee as a director of the Company or, at GKN's
option, as a non-voting adviser to the Board of Directors. GKN has not exercised
its right to designate such a person.
Compliance With Section 16 (a) of the Exchange Act
Section 16(a) of the Securities Exchanges Act of 1934, as amended,
requires the Company's directors and officers and persons who beneficially own
more than ten percent of the Company's Common Stock to file with the Securities
and Exchange Commission ("SEC"), the Nasdaq SmallCap Market and the Boston Stock
Exchange initial reports of ownership and reports of changes in ownership of
Common Stock in the Company. Officers, directors and greater-than-ten percent
shareholders are required by SEC regulation to furnish the Company with copies
of all Section 16(a) reports they filed. To the Company's knowledge, based
solely on review of the copies of such reports furnished to the Company and
written representation that no other reports were required, during the fiscal
year ended December 31, 1996, such persons complied with all Section 16 (a)
filing requirements.
Item 10. Executive Compensation
Set forth in the following table is information as to the salary paid
or accrued to each officer and director receiving compensation of at least
$100,000, and the Chief Executive Officer, (collectively, the "Named Executive
Officers") for the three years ended December 31, 1996.
Name Office Year Compensation
- ---- ------ ---- ------------
S. Steven Carl Chairman of the Board, 1996 $115,500
Chief Executive Officer 1995 $ 74,690
and Director (1)
Gary S. Glatter President, 1996 $152,000
Chief Operating Officer 1995 $143,000
Treasurer & Director (2) 1994 $125,000
Page 18
<PAGE>
- ------------------------
(1) Mr. S. Steven Carl has served as the Chief Executive Officer since
August 1995.
(2) Mr. Gary S. Glatter served as Chief Financial Officer from August
1996 until December 31, 1996.
Employment Agreements
The Company has an employment agreement with Mr. S. Steven Carl which
expires May 1, 1999. The agreement provides for an annual base salary of
$124,000 per year, which increases to $135,000 per year, commencing January 1,
1998. Mr. Carl is also currently entitled to an annual bonus equal to 1% of
revenues from sales of CCT for the period January 1, 1996 to December 31, 1998
and 0.33% of revenues from sales of CCT from January 1, 1999 to April 30, 1999,
provided CCT is profitable. The agreement also contains confidentiality and
non-compete provisions.
The Company has an employment agreement with Mr. Shelby Carl which
expires May 10, 1997. The agreement provides for an $80,000 annual base salary,
with such increases and bonuses as the Board of Directors may determine from
time to time. The agreement also contains confidentiality and non-compete
provisions.
The Company has an employment agreement with Mr. Glatter which expires
December 31, 1998. The agreement provides for an annual base salary of $175,000
per year, which increases to $200,000 per year, commencing October 1, 1997. Mr.
Glatter is also entitled to annual bonuses equal to 1% of the Company's gross
revenues, provided the Company is profitable. The agreement also contains
confidentiality and non-compete provisions. In September of 1994, the contract
was amended to provide that Mr. Glatter may be terminated by the Company only
for cause, thereby terminating the Company's right to terminate Mr. Glatter's
employment without cause, or for failure to generate adequate revenues.
The Company has an employment agreement with Dr. Ludwig which expires
May 10, 1998. The agreement provides for an annual base salary of $90,000 per
year, with such increases and bonuses as the Board of Directors may determine
from time to time. The agreement also contains confidentiality and non-compete
provisions.
CCT has an employment agreement with Mr. Gilbert C. Crowell, Jr., its
President and Chief Operating Officer, which expires May 1, 1999. The agreement
provides for an annual base salary of $95,000 per year, which increases to
$100,000 per year, commencing January 1, 1998. Mr. Gilbert C. Crowell may
receive such bonuses as the Board of Directors may determine from time to time.
The agreement also contains confidentiality and non-compete provisions.
Stock Option Plans
In 1993, the Board of Directors of the Company adopted a Stock Option
Plan ("1993 Plan") pursuant to which 350,000 shares of Common Stock were
reserved for issuance to key employees, including officers as stock options. Key
employees are persons in those positions within the Company whose efforts,
knowledge and expertise are integral to the operations and success of the
Company. The 1993 Plan is administered by the Board of Directors, but the Board
of Directors may appoint a committee to act on its behalf. Such options can be
incentive stock options ("ISOs") within the meaning of the Internal Revenue Code
of 1986, as amended, or non-incentive stock options. The exercise price of any
ISO cannot be less than 100% of the fair market value per share of Common Stock
on the date of grant (110% of such fair market value if the grantee owns stock
possessing more than 10% of the combined voting power of all classes of the
Company's stock). No options may be granted after the year 2003. As of March 18,
1997, the Company had issued under the 1993 Plan 345,000 of these incentive
stock options, exercisable at prices ranging from $1.88 to $5.00 per share.
In 1996, the Board of Directors of the Company adopted the 1996 Equity
Performance Plan ("1996 Plan") pursuant to which 1,000,000 shares of Common
Stock were reserved for issuance to key employees, officers, directors and
consultants of the Company and its subsidiaries, as both incentive options and
non-incentive options and other equity based awards. Holders of these awards are
persons in those positions with the Company whose efforts, knowledge and
expertise are integral to the operations and success of the Company. The 1996
Plan is administered by
Page 19
<PAGE>
the Board of Directors, but the Board of Directors may appoint a committee to
act on its behalf. Stock option awards may be either incentive stock options
("ISOs") within the meaning of the Internal Revenue Code of 1986, as amended, or
options not qualifying as ISOs ("Non-qualified Options"). The exercise price of
any ISO cannot be less than 100% of the fair market value per share of Common
Stock on the last trading day before the date of grant (110% of such fair market
value if the grantee owns stock possessing more than 10% of the total combined
voting power of all classes of the Company's stock). The exercise price of a
Non-qualified Option may be less than 100% of the fair market value on the last
trading day before the date of grant. No ISOs may be granted after the year
2006. As of March 18, 1997 the Company had issued options under the 1996 Plan to
acquire 422,000 shares of Common Stock, exercisable at prices ranging from $1.75
to $2.38 per share, 402,000 of which were ISO's and 20,000 of which were
non-incentive options.
Other Options and Warrants
In addition to the options under the 1993 Plan and the 1996 Plan, the
Company currently has outstanding the following options and warrants: (i)
warrants to purchase 85,000 shares of Common Stock at $3.00 per share issued to
PHD in connection with its private placement in December 1996, (ii) warrants to
purchase an aggregate of 3,214,902 shares of Common Stock at $2.00 per share
issued to investors in the April 1996 private placement, (iii) an option to
purchase 321,490 units, each unit consisting of one share of Common Stock and
one warrant to purchase one share of Commons Stock at $2.00 per share, issued to
GKN and its designees in connection with the private placement in April 1996,
(iv) warrants issued to original insiders and a consultant to purchase an
aggregate of 100,000 shares of Common Stock at $5.00 per share, (v) warrants to
purchase an aggregate of 130,000 shares of Common Stock at $6.50 per share
issued to Whale, the underwriter of the Company's initial public offering, (vi)
warrants issued to original bridge financing investors and consultants to
purchase 546,500 shares of Common Stock at prices ranging from $2.00 to $2.75
per share, and (vii) other options issued to employees and a former director to
purchase 780,000 shares of Common Stock at prices ranging from $1.50 to $4.00
per share. All of the foregoing securities (exercisable into an aggregate of
6,266,382 shares of Common Stock), represent the right to acquire Common Stock
of the Company during various periods of time and at various prices.
The following charts set forth certain information with respect to options
granted to the Named Executive Officers:
Options/Shares Granted in Last Fiscal Year
<TABLE>
<CAPTION>
% of Total Options
Options Granted to Employees Date Expiration
Named Executive Granted in Fiscal Year Exercise Price Vested Date
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
S. Steven Carl
Chairman of the Board
and Chief Executive
Officer 20,000 3.48% $1.75 1997 2002
20,000 3.48% $1.75 1998 2002
20,000 3.48% $1.75 1999 2002
20,000 3.48% $1.75 2000 2002
20,000 3.48% $1.75 2001 2002
</TABLE>
Aggregate Year-End Option Values
<TABLE>
<CAPTION>
Number of Unexercised Options Value of Unexercised in-the-money
at Fiscal Year End Options at Fiscal Year End
------------------ --------------------------
Named Executive Exercisable Unexercisable Exercisable Unexercisable
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Gary S. Glatter
President and
Chief Operating Officer 150,000 250,000 0 (1) 0 (1)
S. Steven Carl
</TABLE>
Page 20
<PAGE>
<TABLE>
<S> <C> <C> <C> <C>
Chairman of the Board
and Chief Executive Officer 12,500 137,500 0 (1) 0 (1)
</TABLE>
(1) The market value at December 31, 1996 of the Common Stock underlying the
options was $1.75 per share. The options are exercisable at prices of $1.75
or more.
Item 11. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth as of March 18, 1997 certain information
regarding the beneficial ownership of shares of Common Stock by (i) each person
who is known by the Company to beneficially own 5% or more of the outstanding
shares of Common Stock; (ii) each of the Company's directors; and (iii) all
executive officers and directors of the Company as a group.
Owner Amount and Nature of Percentage of Outstanding
Beneficial Common Stock Owned
Ownership (1) Beneficially
S. Steven Carl(2)(3) 842,351 11.4
Shelby A. Carl(2)(4) 773,065 10.7
Gary S. Glatter(2)(5) 150,000 2.1
Jerome H. Ludwig(2)(6) 131,664 1.8
Robert M. Leopold(2)(7) 1,000 *
Salvatore T. DiMascio(2)(8) 0 *
All executive officers and directors 1,898,080 24.2
as a group(9)(seven persons)
- -------------------------
* Less than 1.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days from March 18, 1997 upon the
exercise of options and warrants or conversion of convertible
securities. Each beneficial owner's percentage ownership is determined
by assuming that options, warrants and convertible securities that are
held by such person (but not held by any other person) and that are
exercisable or convertible within 60 days from March 18, 1997 have been
exercised or converted. Except as otherwise indicated, and subject to
applicable community property and similar laws, each of the persons
named has sole voting and investment power with respect to the shares
shown as beneficially owned.
(2) The address for Messrs. S. Steven Carl, Shelby A. Carl, Glatter,
Ludwig, Johnson, Leopold, DiMascio and Gilbert C. Crowell is c/o
H.E.R.C. Products, Incorporated, 2202 W. Lone Cactus Drive #15,
Phoenix, Arizona.
(3) Includes 377,942 shares issuable pursuant to immediately exercisable
options and warrants. Excludes 125,000 shares issuable on options which
become exercisable in the future.
(4) Includes (i) 206,183 shares issuable pursuant to immediately
exercisable options and warrants, (ii) 288,533 shares owned of record
by the Shelby A. Carl Trust, the trustee of which is Mr. Shelby A. Carl
for the benefit of his wife, Mrs. Margaret Carl, (iii) 5,623 shares
owned of record by Shelby A. Carl IRA for the benefit of Mr. Shelby A.
Carl and (iv) 29,412 shares owned of record and 29,412 shares issuable
upon exercise of immediately exercisable warrants owned by Margaret
Carl Sep IRA for the benefit of Margaret Carl, the
Page 21
<PAGE>
wife of Mr. Shelby A. Carl. Excludes 20,000 shares issuable on options
which become exercisable in the future.
(5) Includes 150,000 shares issuable pursuant to immediately exercisable
options. Excludes 250,000 shares issuable on options which become
exercisable in the future.
(6) Includes 130,083 shares issuable pursuant to immediately exercisable
options and warrants.
(7) Excludes 10,000 shares issuable on options which become exercisable in
the future.
(8) Excludes 10,000 shares issuable on options which become exercisable in
the future.
(9) Includes shares referred to as being included in notes (3), (4), (5)
and (6). Excludes shares referred to as being excluded in notes (3),
(4), (5), (7) and (8) and 15,000 shares issuable on options which
become exercisable in the future.
Item 12. Certain Relationships and Related Transactions
Messrs. S. Steven Carl and Shelby A. Carl purchased an aggregate of
382,353 units for an aggregate purchase price of $325,000 in the private
placement consummated on April 3, 1996. These individuals paid for the units by
converting indebtedness for borrowed funds owed by the Company to them in the
amounts of $300,000 and $25,000, respectively.
On May 1, 1995, the Company acquired all of the outstanding capital
stock of CCT in a merger transaction by which CCT became a wholly-owned
subsidiary of the Company ("Merger"). Prior to the Merger, a family trust
created by Shelby A. Carl, the former Chairman of the Board of the Company, was
the majority owner of CCT. S. Steven Carl, the son of Shelby A. Carl, was the
minority stockholder of CCT. Shelby A. Carl and S. Steven Carl were the Chairman
of the Board and President, respectively, of CCT prior to the Merger. Effective
August, 1995, Gilbert C. Crowell, Jr. became the President of CCT. In connection
with the Merger, the former stockholders of CCT received 500,000 shares in the
aggregate of the Company's Common Stock in exchange for all of the stock of CCT.
Item 13. Exhibits and Reports on form 8-K
(a) Exhibits
<TABLE>
<CAPTION>
Regulation S-B Sequential
Exhibit No: Exhibit Page Number
- ----------- ------- -----------
<S> <C> <C>
(3) (1) Certificate of Incorporation of the Company,
filed as Exhibit 3.1 to the Company's Registration
Statement.
(3) (2) By-Laws of the Company, filed as Exhibit 3.2 to the
Company's Registration Statement.
(3) (3) Certificate of Designations, Preferences and Other Rights
and Qualifications of the Class A Preferred Stock, as amended,
filed as Exhibit 99.1 to Form 8-K dated December 17, 1996.
(4) (1) Specimen of Common Stock certificate,
filed as Exhibit 4.1 to the Company's Registration Statement.
(4) (2) Form of Underwriter's Warrant Agreement and Warrant
Certificate, filed as Exhibit 4.2 to the Company's Registration Statement.
</TABLE>
Page 22
<PAGE>
<TABLE>
<S> <C> <C>
(4) (3) Form of Subscription Agreement between the Company and
purchasers of the Series A Preferred Stock, filed as Exhibit
4.1 of Form 8-K dated December 17, 1996.
(4) (4) Form of Warrant Agreement issued to Perrin, Holden &
Davenport Capital Corp. dated December 17, 1996, filed as
Exhibit 4.2 of Form 8-K dated December 17, 1996.
(4) (5) Form of Agency Agreement between the Company and Perrin, Holden
& Davenport Capital Corp. dated as of November 15, 1996,
as amended, filed as Exhibit 4.3 of Form 8-K dated December 17, 1996.
(4) (6) Form of Warrant Agreement between the Company and GKN Securities
Corp. dated November 19, 1996, filed as Exhibit 4.5 of Registration Statement
No. 333-19361.
(4) (7) Form of Warrant and Registration Rights Agreement between the Company
and the Equity Group, dated September 27, 1996, filed as Exhibit 4.6 of
Registration Statement No. 333-19361.
(10) (3) 1993 Incentive Stock Option Plan, as amended, filed as Exhibit 10.3
to the Company's Registration Statement No. 33-75166.
(10) (4) Employment Agreement With Shelby Carl dated March 1994,
filed as Exhibit 10.4 to the Company's Registration Statement
No. 33-75166.
(10) (5) Employment Agreement and Stock Option Agreement
dated January 1, 1994 with Gary S. Glatter, filed as
Exhibit 10.5 to the Company's Registration Statement
No. 33-75166.
(10) (6) Amendment to Employment Agreement with Gary S. Glatter,
dated September 23, 1994, filed as Exhibit 10.6 to the Company's
Annual Report on form 10K-SB for the fiscal year ended
December 31, 1994.
(10) (7) Employment Agreement with Jerome Ludwig dated
March 24, 1994, filed as Exhibit 10.6 to the Company's Registration
Statement No. 33-75166.
(10) (8) Agency Agreement between the Company and GKN Securities
Corporation dated March 4, 1996, filed as Exhibit 10.8 to the Company's
Annual Report on Form 10K-SB for the fiscal year ended December 31, 1995
(10) (9) Form of Purchase Option issued to GKN Securities Corporation
and its' designees, filed as Exhibit 10.9 to the Company's Annual
Report on Form 10K-SB for the fiscal year ended December 31, 1995
(10) (10) Form of Warrant Agreement issued to investors on April 3, 1996,
filed as Exhibit 10.10 to the Company's Annual Report on Form
10K-SB for the fiscal year ended December 31, 1995
(10) (11) Form of Subscription Agreement between the Company and
investors dated April 3, 1996, filed as Exhibit 10.11 to the Company's
Page 23
<PAGE>
Annual Report on form 10K-SB for the fiscal year
ended December 31, 1995
(10) (12) Employment Agreement between CCT Corporation, a wholly-
owned subsidiary of the Company, and S. Steven Carl dated
May 1, 1995, filed as Exhibit 10.1 to the Company's Form 10-QSB
for the quarter ended March 31, 1995.
(10) (13) Employment Agreement between CCT Corporation, a wholly-
owned subsidiary of the Company, and Gilbert Crowell dated
May 1, 1995, filed as Exhibit 10.2 to the Company's Form 10-QSB
for the quarter ended March 31, 1995.
(10) (14) 1996 Performance Equity Plan, filed as an Exhibit to the Company's
Proxy Statement dated June 11, 1996.
(22) Subsidiaries 41
(23) Consent of Independent Certified Public Accountants 42
(27) Financial Data Schedule 43
(b) Reports on Form 8-K
None.
</TABLE>
Page 24
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Page No.
Index to Consolidated Financial Statements
Report of Independent Certified Public Accountants F-2
Financial Statements:
Consolidated Balance Sheet
December 31, 1996 F-3
Consolidated Statements of Operations
Years Ended December 31, 1996 and 1995 F-4
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1996 and 1995 F-5
Consolidated Statements of Cash Flows
Years Ended December 31, 1996 and 1995 F-6
Notes to Consolidated Financial Statements F-8
F-1
<PAGE>
Report of Independent Certified Public Accountants
To the Board of Directors
H.E.R.C. Products Incorporated
Phoenix, Arizona
We have audited the accompanying consolidated balance sheet of H.E.R.C. Products
Incorporated and subsidiaries as of December 31, 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years ended December 31, 1996 and 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of H.E.R.C. Products
Incorporated and subsidiaries as of December 31, 1996, and the results of their
operations and their cash flows for the years ended December 31, 1996 and 1995,
in conformity with generally accepted accounting principles.
\s\ BDO Seidman, LLP
Chicago, Illinois
February 1, 1997
F-2
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheet
December 31, 1996
<TABLE>
<S> <C>
Assets
Current Assets
Cash and cash equivalents $ 1,369,843
Trade accounts receivable, net of allowance for
doubtful accounts of $38,621 417,534
Inventories (Note 2) 616,813
Other receivables 47,042
Prepaid expenses 87,280
------------
Total Current Assets 2,538,512
------------
Property and Equipment (Note 5)
Property and equipment 635,696
Less accumulated depreciation 139,342
------------
Net Property and Equipment 496,354
------------
Other Assets
Patents, net of accumulated amortization of $65,205 197,285
Patents pending 138,695
Refundable deposits 18,337
Other 41,699
Goodwill, net of accumulated amortization of $146,168 (Note 3) 1,691,705
------------
Total Other Assets 2,087,721
------------
$ 5,122,587
============
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable $ 347,858
Accrued wages 44,047
Other accrued expenses 220,394
------------
Total Current Liabilities 612,299
------------
Stockholders' Equity (Notes 3, 6, 8, 9 and 10)
Convertible Preferred Stock, $10.00 stated value; authorized 1,000,000 shares;
issued and outstanding 170,000 shares 1,480,000
Common Stock, $0.01 par value; authorized 40,000,000 shares;
issued and outstanding 6,356,487 shares 63,565
Additional paid-in capital 11,223,593
Accumulated deficit (8,256,870)
------------
Total Stockholders' Equity 4,510,288
------------
$ 5,122,587
============
</TABLE>
See accompanying notes to consolidated financial statements F-3
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995
----------- -----------
<S> <C> <C>
Sales $ 2,600,642 $ 1,349,786
Cost of Sales 1,995,151 1,327,755
----------- -----------
Gross Profit 605,491 22,031
Selling Expenses 1,102,638 849,812
General and Administrative Expenses 1,923,020 1,721,077
----------- -----------
Operating loss (2,420,167) (2,548,858)
----------- -----------
Other Income (Expense)
Interest expense (42,196) (44,952)
Miscellaneous 59,422 112,641
----------- -----------
Total other income 17,226 67,689
----------- -----------
Loss before taxes on income (2,402,941) (2,481,169)
Taxes on Income (Note 4) -- 941
----------- -----------
Loss Before Extraordinary Item (2,402,941) (2,482,110)
Extraordinary Item (Note 6) 137,912 --
----------- -----------
Net Loss (2,265,029) (2,482,110)
Preferred Stock Dividend (Note 8) 566,667 --
----------- -----------
Net Loss Allocable to Common Stockholders $(2,831,696) $(2,482,110)
=========== ===========
Loss Per Common Share Before Extraordinary Item (Note 8) $ (0.55) $ (0.93)
Extraordinary Item Per Common Share 0.02 --
----------- -----------
Net Loss Per Common Share $ (0.53) $ (0.93)
=========== ===========
Weighted Average Common Shares Outstanding 5,364,420 2,667,544
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements F-4
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Preferred Stock
Additional
Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance,
January 1, 1995 2,250,000 $ 22,500 -- -- $ 5,686,791 $(2,943,064) $ 2,766,227
Net loss -- -- -- -- -- (2,482,110) (2,482,110)
Issuance of shares of
Common
Stock (Notes 3 and 9) 268,750 2,687 -- -- 619,188 -- 621,875
Acquisition of CCT
Corporation (Note 3) 409,691 4,097 -- -- 1,506,640 -- 1,510,737
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance,
December 31, 1995 2,928,441 29,284 -- -- 7,812,619 (5,425,174) 2,416,729
Net loss -- -- -- -- -- (2,265,029) (2,265,029)
Issuance of shares of
Common
Stock (Notes 3, 6 and 9) 3,428,046 34,281 -- -- 2,767,234 -- 2,801,515
Issuance of shares of
Preferred Stock (Note 9) -- -- 170,000 $ 1,480,000 -- -- 1,480,000
Company expenses satisfied
by stockholders (Note 3) -- -- -- -- 29,073 -- 29,073
Warrants issued to prepay
future years' expenses
(Note 9) -- -- -- -- 48,000 -- 48,000
Imputed dividend on
Preferred Stock (Note 8) -- -- -- -- 566,667 (566,667) --
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance,
December 31, 1996 6,356,487 $ 63,565 170,000 $ 1,480,000 $11,223,593 $(8,256,870) $ 4,510,288
=========== =========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements F-5
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995
---- ----
<S> <C> <C>
Cash Flows From Operating Activities
Net Loss $(2,265,029) $(2,482,110)
----------- -----------
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 195,058 139,861
Expenses paid by stockholders and Common Stock
and warrants issued for services 45,733 --
Extraordinary item (137,912) --
(Gain) loss on sale of equipment (11,606) 20,755
(Increase) decrease in assets, net of effect of acquisitions
Trade accounts receivable 8,313 538,761
Inventories 7,540 (124,765)
Other receivables (24,620) 82,613
Prepaid expenses (19,074) 79,774
Other assets (39,915) 17,227
Increase (decrease) in liabilities, net of effect of acquisitions
Accounts payable (153,462) (302,781)
Accrued expenses 126,462 (51,862)
Other liabilities -- (85,033)
----------- -----------
Total adjustments (3,483) 314,550
----------- -----------
Net cash used in operating activities (2,268,512) (2,167,560)
----------- -----------
Cash Flows From Investing Activities
Capital expenditures (124,913) (33,801)
Cash received from the sale of equipment 32,475 --
Decrease (increase) in certificates of deposit 75,628 (4,110)
Expenditures related to patents and patents pending (77,544) (8,516)
Cash paid in acquisition of subsidiaries, net of cash acquired (218,929) (43,981)
----------- -----------
Net cash used in investing activities (313,283) (90,408)
----------- -----------
</TABLE>
See accompanying notes to consolidated financial statements F-6
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Continued)
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995
---- ----
<S> <C> <C>
Cash Flows From Financing Activities
Proceeds from issuance of Common Stock 2,083,720 621,875
Proceeds from issuance of Preferred Stock 1,480,000 --
Proceeds from issuance of notes payable
and long-term debt 336,000 70,000
Principal payments under long-term debt obligations (279,683) (118,547)
----------- -----------
Net cash provided by financing activities 3,620,037 573,328
----------- -----------
Net Increase (Decrease) in Cash and Cash Equivalents 1,038,242 (1,684,640)
Cash and Cash Equivalents, at beginning of period 331,601 2,016,241
----------- -----------
Cash and Cash Equivalents, at end of period $ 1,369,843 $ 331,601
=========== ===========
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest $ 18,331 $ 44,952
</TABLE>
Noncash Investing and Financing Activities
During the year ended December 31, 1995, equipment with a cost of $303,124 was
reclassified as inventory held for sale. Of that total, $75,706 was sold during
the year ended December 31, 1995.
During the year ended December 31, 1995, H.E.R.C. acquired 100% of the Common
Stock of CCT Corporation through the issuance of 409,691 shares of its Common
Stock valued at $3.69 per share. H.E.R.C. acquired current assets of CCT
Corporation totaling $798,652, net property and equipment totaling $42,181 and
other assets totaling $17,276. Additionally, H.E.R.C. assumed current
liabilities of CCT Corporation totaling $790,207 and long-term liabilities
totaling $191,557. This transaction resulted in an increase in Common Stock of
$4,097 and an increase in additional paid-in capital of $1,506,640. The Company
allocated the excess of the purchase price over net assets acquired of CCT to
goodwill.
During 1996 notes payable to stockholder of $325,000 were repaid through the
issuance of Common Stock.
During 1996 a note payable of $237,912 was paid in full by issuing Common Stock
with a market value of $100,000 resulting in an extraordinary gain.
In conjunction with the 1996 acquisition described in Note 3, the Company
acquired current assets of $469,807, goodwill of $131,342 and current
liabilities of $367,795.
During 1996 inventory of $230,175 was reclassified to property and equipment.
During 1996 a note payable of $276,135 was paid in full by issuing 90,309
escrowed shares of Common Stock with a market value of $270,927 with the balance
paid by certain stockholders.
During 1996 200,000 warrants were issued to prepay future years' expenses of
$48,000.
See accompanying notes to consolidated financial statements F-7
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of Business and Summary of Significant Accounting Policies
Nature of Business
H.E.R.C. Products Incorporated (the "Company") commenced business in 1986 as a
manufacturer of consumer and industrial water treatment chemicals and related
products. As of May 1, 1995, the Company acquired CCT Corporation ("CCT") which
manufactures and distributes proprietary agricultural products (see Note 3). The
Company and its subsidiaries sell their products to customers throughout the
United States.
The Company markets its consumer products to wholesale and retail customers and
recently developed and introduced its industrial water treatment products. Some
agricultural products are relatively new, but many have established market
acceptance, particularly in the Western United States. The agricultural business
is seasonal with strongest sales during the second and third quarters of the
calendar year.
The Company historically has had a concentration of significant customers.
Although the Company considers its commercial relationships with its significant
customers to be good, a loss of these customers, or a significant decrease in
purchases by these customers, could have an adverse effect on the Company's
operations. In 1996, sales to two customers were 15% and 30% respectively of
consolidated sales. Sales to one customer were approximately 15% of consolidated
sales for the year ended December 31, 1995.
Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and transactions have been eliminated in consolidation. Certain 1995 balances
have been reclassified to conform with 1996 presentation.
Patents and Patents Pending
Patents and patents pending are stated at cost. Costs related to obtaining
patents for products are amortized on the straight-line basis over 10 years.
Costs for patents pending are amortized when the patents are awarded. Costs for
patents denied or abandoned are expensed at the time that they are denied or
abandoned.
Inventories
Inventories are stated at the lower of cost or market (net realizable value).
Cost is determined by various methods which approximate first-in, first-out.
Goodwill
Goodwill represents the excess price over the fair value of net assets acquired
which is being amortized on a straight-line basis over 20 years. The Company
evaluates the recoverability and measures any impairment of goodwill based upon
expectations of future undiscounted cash flows.
Property, Equipment and Depreciation
Property and equipment are stated at cost. Depreciation is computed over the
estimated useful lives of the assets by the straight-line method for financial
reporting and by accelerated methods for income taxes.
The useful lives of property and equipment for computing depreciation are five
to ten years.
F-8
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Taxes on Income
At December 31, 1996, unused net operating losses of approximately $4,000,000
are available for carryforward against future years' taxable income and expire
in various years through 2011.
The Company's ability to utilize its net operating loss carryforwards is subject
to an annual limitation in future periods due to the 1996 change in ownership,
pursuant to Section 382 of the Internal Revenue Code of 1986, as amended.
Utilization of net operating loss carryforwards will be limited to approximately
$170,000 annually plus any net operating loss carryforwards generated subsequent
to the aforementioned change in ownership. In addition, use of certain of the
net operating loss carryforwards ($325,000), which were obtained in the
acquisition of CCT, is subject to an annual limitation.
Statements of Cash Flows
For purposes of these statements, cash equivalents include cash on hand and bank
checking and money market accounts and other highly liquid debt securities with
original maturities of 90 days or less.
Recent Accounting Pronouncements
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 123, which is effective for
the Company's 1996 year end, encourages (but does not require) adoption of the
fair value method of accounting for stock-based compensation plans. The Company
has not adopted the fair value method but provides the required pro forma
disclosures. (Note 10).
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported assets and liabilities at December 31,
1996 and the amounts of revenue and expenses during the years ended December 31,
1996 and 1995. Actual results could differ from those estimates.
2. Inventories
Inventories at December 31, 1996 are:
Raw materials $ 9,126
Work in process 5,633
Finished goods 602,054
--------
$616,813
========
3. Acquisitions
CCT Corporation
---------------
On May 1, 1995, the Company acquired, for $1,510,736, all of the outstanding
capital stock of CCT which then became a wholly-owned subsidiary of the Company.
Shelby A. Carl, Chairman Emeritus of the Board of the Company, was (through the
Shelby A. Carl Trust) the majority stockholder of CCT, and his son, S. Steven
Carl, was a minority stockholder. S. Steven Carl is Chairman of the Board of the
Company. The merger transaction was accounted for as a purchase, with the
results of operations of CCT included in the Company's consolidated financial
statements from the date of the acquisition. As a result of this transaction,
goodwill of $1,706,531 was recorded.
F-9
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pursuant to the Agreement of Merger, CCT shareholders were issued 500,000 common
shares of the Company of which 90,309 shares were placed in escrow ("Escrow
Shares"), representing the number of shares, valued at $3.00 per share, equal to
the remaining amount of debt, including interest to maturity, due to an
unrelated partnership. During 1996, this partnership received the Escrow Shares
and 9,691 additional common shares from Messrs. Carl to satisfy this debt in
full. The fair value of the 9,691 common shares transferred by Messrs. Carl to
the partnership was charged to expense in the accompanying consolidated
statement of operations. The Agreement of Merger provided for a further payment
to Messrs. Carl based on the earnings of CCT for 1996, as defined, above a
stated minimum. Since CCT's earnings for 1996, as defined, were not above the
stated minimum, no additional shares will be issued.
H.E.R.C. Consumer Products Company
- ----------------------------------
On July 1, 1996, the Company acquired the 50% interest of H.E.R.C. Consumer
Products Company ("LLC") owned by Conair Corporation ("Conair") for $601,149,
including liabilities assumed. Prior to that date the Company and Conair equally
owned the LLC which was formed to produce and market the Company's consumer
products. The Company had accounted for its 50% investment in the LLC by the
equity method of accounting, and accordingly, sales of the LLC prior to July 1,
1996, were not reported as sales of the Company. No amount of the cumulative
losses of the LLC was recognized by the Company since its investment in the LLC
was zero. The Company received reimbursements from the LLC for research and
development costs attributable to products sold by the LLC of approximately
$15,000 and $34,000 in 1996 and 1995, respectively.
Under the terms of the acquisition agreement, the Company paid Conair $276,000
on July 1, 1996, and the parties terminated their respective obligations under
certain existing agreements, including, but not limited to, the partnership
agreement, operating agreement and supply agreement resulting in the settlement
of the Company's obligation to pay Conair approximately $230,000 and of the
obligation of LLC to pay the Company approximately $176,000. The Company also
became obligated to pay $276,690 to Conair in six monthly installments of
$46,115 commencing July 31, 1996, for certain inventory products manufactured by
Conair, plus shipping and handling expenses; all such installments are paid. The
transaction resulted in $131,342 in goodwill.
Pro forma results for the years ended December 31, 1996 and 1995 are unaudited
and were prepared as if the aforementioned acquisitions had occurred at the
beginning of the periods presented:
Years Ended December 31,
1996 1995
----------- -----------
Sales $ 3,361,888 $ 3,973,245
Loss before extraordinary item (2,312,453) (2,271,555)
Net loss (2,174,541) (2,271,555)
Loss per common share before extraordinary item (0.53) (0.81)
Net loss per common share (0.51) (0.81)
4. Income Taxes
The Company was in a consolidated loss position for the years ended December 31,
1996 and 1995 and therefore had no federal income tax expense.
Deferred tax assets of $1,500,000 from loss carryforward benefits have not been
recorded because of the uncertainty of realizing such benefits.
F-10
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Property and Equipment
Property and equipment at December 31, 1996 consists of the following:
Equipment $459,289
Office furniture and fixtures 176,407
--------
635,696
Less accumulated depreciation 139,342
--------
Net property and equipment $496,354
========
6. Extraordinary Item
In September 1996, the Company issued 37,210 shares of Common Stock, with a
market value of $100,000, in full satisfaction of certain long-term debt
obligations of $237,912. As a result of this transaction, the Company recognized
an extraordinary gain of $137,912 from the extinguishment of debt.
7. Lease Commitments
The Company has operating leases, expiring through 2001, for office and
warehouse facilities in Phoenix, Arizona, Portsmouth, Virginia and Carlsbad,
California and for certain computer equipment. Rent expense associated with all
operating leases was $111,957 and $85,333 for the years ended December 31, 1996
and 1995, respectively.
Future minimum payments under operating leases as of December 31, 1996 are:
Year Ending
December 31 Amount
----------- ------
1997 $176,653
1998 156,862
1999 114,670
2000 116,868
2001 70,371
--------
$635,424
========
8. Loss Per Share of Common Stock
Loss per share of Common Stock is based on the weighted average number of shares
of Common Stock outstanding during each year. Shares of Common Stock issuable
upon conversion of Preferred Stock (Note 9) and exercise of outstanding options
and warrants are anti-dilutive and are not included in the computation of shares
outstanding.
Loss per share of Common Stock for the year ended December 31, 1996 is also
impacted by a recent Securities and Exchange Commission interpretation whereby
net loss per share applicable to common stockholders must reflect the amount of
any specified discount to the market price of Common Stock into which Preferred
Stock is convertible. Because the Preferred Stock described in Note 9 has such a
conversion feature, the net loss applicable to common stockholders is increased
by $566,667 for an imputed Preferred Stock dividend equivalent to the conversion
discount. Accordingly loss per share of Common Stock is increased by $ 0.11.
F-11
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
9. Stockholders' Equity
Convertible Preferred Stock
In December 1996 the Company completed a private equity offering of 170,000
shares of Class A Preferred Stock ("Preferred Stock") for $10 per share and
received net proceeds of $1,480,000. The Preferred Stock has a par and stated
value of $.01 and $10, respectively.
The holders of the Preferred Stock are entitled to receive dividends of 10% of
the stated value per annum from the date of issuance through the "Conversion
Date," as defined, payable solely in shares of the Company's Common Stock. The
preferred stockholders have the right to convert each share of Preferred Stock
and the accrued amount of dividends thereon, through the Conversion Date, into
shares of Common Stock determined by dividing the aggregate of the stated value
of the Preferred Stock plus accrued dividends, by the greater of (i) 75% of the
average closing bid price of the shares of Common Stock, as defined, or (ii)
$.10. The Preferred Stock will automatically convert based on the above formula
on December 17, 1999. The Preferred Stock does not carry any redemption or
voting rights. In the event of a liquidation, dissolution or winding up of the
Company, the holders of the Preferred Stock will participate with the holders of
the Common Stock as if the Preferred Stock was fully converted immediately prior
to the event.
Common Stock
In April 1995, the Company issued 100,000 shares of Common Stock to an affiliate
of two of the principal stockholders of the Company at a purchase price of $2.00
per share. The Company also issued the buyer warrants to purchase 400,000 shares
of Common Stock at a price of $2.50 per share which expired on October 6, 1995.
In April 1996, the Company completed the private placement of 3,214,902 units at
a price of $.85 per unit and received net proceeds of approximately $2,277,000.
Each unit consisted of one share of Common Stock and one warrant, which entitles
the holder to purchase one share of Common Stock at a price of $2 per share,
subject to adjustment, until April 3, 1999.
During 1996, the Company's Chief Executive Officer and Chairman Emeritus
advanced an aggregate of $325,000 to the Company. Concurrent with the
aforementioned April 1996 private placement, the Company satisfied its
repayment obligation through the issuance of 382,353 units which are included in
the amounts noted above.
Also, during 1996:
a. Various consultants were paid for services through the issuance of
19,625 shares of Common Stock, and $29,932 was charged to expense based
on the market price at the measurement dates.
b. Certain shares of Common Stock related to the CCT merger were issued.
See Note 3.
c. Warrants were exercised to acquire 66,000 shares of Common Stock at $2
per share.
d. 37,210 shares of Common Stock were issued in satisfaction of certain
debt obligations. See Note 6.
Warrants
In May and September of 1993 and January of 1994, the Company issued warrants
for 600,000 shares of Common Stock. The warrants became exercisable in May 1994
at $2.50 per share and expire at various dates from 1995 through 1999. During
1995, warrants for 168,750 shares of the Company's Common Stock were exercised
at $2.50 per share resulting in proceeds of $421,875. At December 31, 1996 such
warrants for 212,500 shares of Common Stock remain outstanding and expire in
1999.
F-12
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the public offering of its Common Stock in May 1994, the
Company was required to reduce the existing number of shares of its outstanding
Common Stock to no more than 950,000 shares. As consideration for the reduction
of shares, the stockholders were granted warrants exercisable until December 31,
1999 to acquire 50,000 shares of the Company's Common Stock at $5.00 per share.
In 1994, the underwriter of the Company's public offering acquired, for $130,
warrants for the purchase of 130,000 shares of the Common Stock of the Company
at $6.50 per share. The warrants are currently exercisable and expire May 10,
1999.
Through 1996, the Company issued warrants for the purchase of 450,000 shares of
Common Stock to various consultants at exercise prices ranging from $2 to $5 per
share. During 1996, 66,000 warrants were exercised at $2 per share. 184,000 of
the warrants are currently exercisable within the above price range and expire
at various dates through November 19, 2001.
In 1996, the placement agent for the 1996 private offering of shares of Common
Stock was granted a warrant to acquire 321,490 units at $.935 per unit. A unit
consists of one share of Common Stock and one warrant to acquire one share of
Common Stock at $2.00 per share. The warrant is currently exercisable and
expires April 3, 2001.
In 1996, the placement agent for the 1996 private offering of Preferred Stock
was granted a warrant to acquire 85,000 shares of Common Stock at $3.00 per
share. The warrants are currently exercisable and expire December 10, 2001.
10. Stock Based Compensation
In October 1993, the Company adopted an incentive stock option plan for 350,000
shares of Common Stock which may be granted to employees. The Company adopted an
additional plan in 1996 for 1,000,000 shares of Common Stock for grant to
employees, officers, directors and consultants of the Company and its
wholly-owned subsidiaries. The exercise price per share may not be less than the
fair market value per share on the date the options are granted. Generally,
options granted vest over a period up to five years and expire over varying
periods through 2004.
In addition to the above plans, the Company granted:
(a) an officer/director options to purchase 400,000 shares of Common Stock
at exercise prices ranging from $2.50 to $3.75 per share. The options
vest not later than December 1, 1998 and 150,000 are currently
exercisable;
(b) a former Director options to purchase a total of 100,000 shares of
Common Stock at exercise prices ranging from $2.50 to $4.00 per share.
The options, granted in 1995, are currently exercisable and expire in
December 1999;
(c) various key employees options to purchase a total of 280,000 shares of
Common Stock at exercise prices ranging from $1.50 to $3.63 per share.
The options, granted through 1996, are exercisable from 1996 to 2001
and expire in various years through 2001. At December 31, 1996, 138,000
options are currently exercisable.
F-13
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Overall activity in the Company's stock options:
Years Ended December 31,
1996 1995
====================== =====================
Weighted - Weighted -
Average Average
Exercise Exercise
Shares Price Shares Price
Outstanding, at beginning
of year 1,117,000 $ 3.23 712,000 $ 5.46
Granted 575,000 1.75 1,045,000 3.27
Exercised -- -- -- --
Forfeited (145,000) 4.76 (640,000) 5.78
---------- ----- ---------- -----
Outstanding at end of year 1,547,000 $ 2.54 1,117,000 $ 3.23
========== ===== ========== =====
Exercisable, at end of year 595,000 $ 2.79 360,000 $ 3.68
========== ===== ========== =====
Details regarding the options outstanding at December 31, 1996.
Outstanding Exercisable
================================================== ====================
Weighted - Weighted - Weighted -
Exercise Average Average Average
Price Number Remaining Exercise Number Exercise
Range ------ Life Price ------ Price
$1.50 - $2.50 1,065,000 5.03 yrs $ 2.05 430,500 $ 2.42
$3.13 - $3.75 430,000 6.90 yrs $ 3.56 112,500 $ 3.63
$4.00 - $5.00 52,000 2.90 yrs $ 4.04 52,000 $ 4.04
The weighted-average grant-date fair value of stock options granted to employees
during the year and the weighted average significant assumptions used to
determine those fair values using a modified Black-Scholes option pricing model,
and the pro forma effect on earnings of the fair value accounting for stock
options under SFAS No. 123 are:
Years Ended December 31,
------------------------
1996 1995
------------- -------------
Grant-date fair value per option $ 1.51 $ 0.33
Significant assumptions (weighted-average)
Risk-free interest rate at grant date 5.67% 5.85%
Expected stock price volatility 236% 24%
Expected dividend payout -- --
Expected option life* 2.7 yrs 2.0 yrs
Net loss
As reported $ (2,265,029) $ (2,482,110)
Pro forma $ (2,567,641) $ (2,568,322)
Net loss per share of Common Stock
As reported $ (0.53) $ (0.93)
Pro forma $ (0.59) $ (0.96)
*The expected option life considers historical option exercise patterns and
future changes to those exercise patterns anticipated at the date of grant.
F-14
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Segment Information
The Company's major business segments are the manufacture and distribution of:
a. Consumer water treatment and related products
b. Industrial water treatment and related products
c. Proprietary agricultural products
No amounts are included in the 1995 consolidated financial statements for
consumer water treatment and related products. (Note 3).
Information by segment for the year ended December 31, 1996:
<TABLE>
<CAPTION>
Consumer Industrial Agricultural
Products Products Products Corporate Consolidated
-------- -------- -------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales to unaffiliated customers $ 893,754 $ 329,803 $ 1,377,085 -- $ 2,600,642
Operating loss (117,896) (838,892) (257,797) $(1,205,582) (2,420,167)
Identifiable assets 491,425 883,764 2,074,986 1,672,412 5,122,587
Depreciation and amortization 3,284 41,845 92,471 57,458 195,058
Capital expenditures -- 51,352 28,214 45,347 124,913
</TABLE>
Information by segment for the year ended December 31, 1995:
<TABLE>
<CAPTION>
Agricultural
Industrial Products
Products (Note 3) Corporate Consolidated
-------- ----------- --------- ------------
<S> <C> <C> <C> <C>
Sales to unaffiliated customers $ 612,820 $ 736,966 -- $ 1,349,786
Operating loss (1,872,970) (112,933) $ (562,955) (2,548,858)
Identifiable assets 1,296,957 1,836,777 337,418 3,471,152
Depreciation and amortization 131,056 8,805 -- 139,861
Capital expenditures 16,120 17,681 -- 33,801
</TABLE>
12. Commitments and Contingencies
The Company has employment agreements with its executive officers, the terms of
which expire at various dates through May 1, 1999. Such agreements, which have
been revised from time to time, provide for minimum salary levels and incentive
bonuses on prescribed formulas over their terms. The aggregate commitment for
future salaries at December 31, 1996, excluding bonuses, was approximately
$1,073,000.
F-15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, H.E.R.C. Products Incorporated has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
H.E.R.C. PRODUCTS INCORPORATED
By: /s/ Gary S. Glatter
-------------------------------------
Dated: March 28, 1997 Gary S. Glatter, President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Name Title Date
- ---- ----- ----
<S> <C> <C>
/s/ S. Steven Carl Chairman of the Board, Chief Executive Officer March 28, 1997
- ------------------------
S. Steven Carl and Director
/s/ Shelby A. Carl Chairman Emeritus and Director March 28, 1997
- ------------------------
Shelby A. Carl
/s/ Gary S. Glatter President, Chief Operating Officer, Treasurer March 28, 1997
- ------------------------
Gary S. Glatter and Director
/s/ Jerome H. Ludwig Executive Vice President, Secretary and Director March 28, 1997
- ------------------------
Jerome H. Ludwig
/s/ Robert M. Leopold Director March 28, 1997
- ------------------------
Robert M. Leopold
/s/ Salvatore DiMascio Director March 28, 1997
- ------------------------
Salvatore DiMascio
/s/ John P. Johnson Chief Financial Officer (Principal Financial and March 28, 1997
- ------------------------
John P. Johnson Accounting Officer)
</TABLE>
Page 40
Exhibit 22
SUBSIDIARIES
Name State of Incorporation
---- ----------------------
CCT Corporation Arizona
H.E.R.C. Consumer Products, Inc. Arizona
Exhibit 23
CONSENT OF INDEPENDENT
CERTIFIED PUBLIC ACCOUNTANTS
H.E.R.C. PRODUCTS INCORPORATED
Phoenix, Arizona
We hereby consent to the incorporation by reference in the Prospectus
constituting a part of the previously filed Registration Statements (Nos.
33-92870, 333-5175, 333-13349 and 333-19361) of H.E.R.C. PRODUCTS INCORPORATED
of our report dated February 1, 1997, relating to the consolidated financial
statements of H.E.R.C. PRODUCTS INCORPORATED and subsidiaries appearing in the
Company's Annual Report on Form-10KSB for the year ended December 31, 1996.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
\s\ BDO Seidman, LLP
Chicago, Illinois
March 28, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<CIK> 919010
<NAME> H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 1,369,843
<SECURITIES> 0
<RECEIVABLES> 503,197
<ALLOWANCES> 38,621
<INVENTORY> 616,813
<CURRENT-ASSETS> 2,538,512
<PP&E> 635,696
<DEPRECIATION> 139,342
<TOTAL-ASSETS> 5,122,587
<CURRENT-LIABILITIES> 612,299
<BONDS> 0
0
1,480,000
<COMMON> 63,565
<OTHER-SE> 2,966,723
<TOTAL-LIABILITY-AND-EQUITY> 5,122,587
<SALES> 2,600,642
<TOTAL-REVENUES> 2,600,642
<CGS> 1,995,151
<TOTAL-COSTS> 3,025,658
<OTHER-EXPENSES> (59,422)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 42,196
<INCOME-PRETAX> (2,402,941)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,402,941)
<DISCONTINUED> 0
<EXTRAORDINARY> 137,912
<CHANGES> 0
<NET-INCOME> (2,265,029)
<EPS-PRIMARY> (0.53)
<EPS-DILUTED> (0.53)
</TABLE>
