SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934: FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES ACT OF 1934:
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)
Delaware 86-0570800
State of Incorporation or Organization IRS Employer Identification Number
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 Exchange Act: None
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 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $3,168,955
At March 11, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $2,937,785 based on the closing market
price of the Common Stock on such date as reported by the OTC BB Market of
$0.39.
At March 11, 1999, there were 11,526,053 shares of Common Stock issued and
outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No[X]
Documents Incorporated by Reference: None
<PAGE>
FORWARD-LOOKING STATEMENTS
Parts of this report describe historical information, such as the 1997 and
1998 operating results, and H.E.R.C. Products Incorporated ("HERC") believes the
descriptions to be accurate. In contrast to describing the past, some sentences
in this report indicate that HERC believes that events or financial results are
likely to occur in 1999 or thereafter. These sentences typically use words or
phrases like "believe," "expects," "anticipates," "estimates," "will continue"
and similar expressions. Statements using those words or similar expressions are
intended to identify "forward looking statements" as that term is used in
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Forward-looking statements include
projections of operating results for 1999 and beyond, either concerning a
specific segment of HERC's business, or concerning HERC as a whole.
Actual results, however, may be materially different from the results
projected in the forward looking statements, due to a variety of risks and
uncertainties. These risks and uncertainties include those set forth in Item 1
of Part I hereof, entitled "Business," in Item 6 of Part II hereof, entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Exhibit 99.1 hereof and elsewhere in this report.
The forward looking statements in this report are current only as of the
date this report is filed with the Securities and Exchange Commission. After the
filing of this report, HERC's expectations of likely results may change, and
HERC may come to believe that certain forward-looking statements in this report
are no longer accurate. HERC does not have an obligation to release publicly any
corrections or revisions to any forward looking statements in this report, even
if HERC believes the forward looking statements are no longer true.
PART 1
ITEM 1. BUSINESS
GENERAL
H.E.R.C. Products Incorporated is a chemical and engineering technology
company that develops and patents products, equipment and services for use on
water scale and corrosion in soils, on surfaces and in pipeline systems. HERC
markets its products to wholesale and retail customers directly and through key
strategic alliances. HERC's cleaning services are directed toward commercial,
industrial, marine and municipal customers.
Over time, most water systems, such as water delivery systems, sprinkler
systems, waste systems, municipal pipes and water wells, become internally
corroded and openings become tuberculated. The effect is a smaller diameter
through which water and waste can travel and a less efficient system. HERC
cleaning methodologies will remove the scale and corrosion and restore the
efficiency of the system.
HERC uses patented and other proprietary chemical products in its cleaning
services. HERC's chemical technology is combined with water and then flushed
through a pipe system that is no longer functioning properly. HERC's chemicals
dissolve and remove scale and corrosion and retain the components of scale and
corrosion in solution, even at highly concentrated levels, until they are
flushed from the systems. The system may then be treated with other chemical
products that retard corrosion or suppress the environment that supports
biological growth and, thus, is maintained as a more efficient pipe system after
the HERC cleaning. Many of the chemicals used by HERC are non-fuming,
non-abrasive and non-flammable. Many of HERC's products are also certified
biodegradable by Scientific Certification Systems, an independent certifying and
testing laboratory ("Green Cross").
HERC's chemical products were developed in response to the disadvantages of
the more commonly used chemicals used in pipe system cleaning. Those chemicals
are often toxic, fuming and corrosive. Because of these characteristics and the
fact that they often are not biodegradable, they are considered to be
pollutants. Cleaning water systems using such chemicals requires expensive
clean-up and regulatory compliance costs and additional monitoring costs during
and after use. HERC's chemical products were also developed to provide a more
cost effective and efficient means of cleaning closed pipe systems in contrast
to replacement, mechanical scraping or pigging.
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HERC's products for the industrial market include Pipe-Klean(R) and
Well-Klean(R), which remove encrustation from water pumping and distribution
systems; Compound 360, Compound 400 and Slug(R) to clean and maintain cooling
and other water treatment systems; and Line-Out(R) for salt removal from soil
surfaces and the cleaning of drip irrigation systems. HERC also sells private
label products utilizing its proprietary formulations or products complementary
to its formulations for key customers.
The relative contribution of the business segments to HERC's operating
revenue and operating profit for the two years ended December 31, 1998, and the
identifiable assets of each segment at the end of each of those years are
included in Note 7 to the consolidated financial statements in this report.
HERC was incorporated in Arizona in December 1986 and re-incorporated in
Delaware in 1994. HERC executive offices, warehouse and manufacturing facility
for some of the proprietary products are located in Phoenix, Arizona and its
telephone number is (602) 492-0336.
PRODUCTS AND SERVICES
Water is critical to many industries and uses, ranging from wells,
waterlines, fire protection systems, heating and air-conditioning and most
industrial production processes. Water is a chemically active substance and any
surface that 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 from dissolved minerals or biological corrosion from water
born microbes. Scaling or corrosion will eventually lead to the plugging or
fouling of the surface, pipe, pump, air condition system or other water exposed
surface.
The generally accepted treatment methods for water systems include
replacement, mechanical cleaning, acid cleaning or hot chelating agent cleaning.
HERC offers an alternative method of chemical cleaning which it believes is a
significant improvement over these methods because it is faster, cheaper and
more complete and has a lower environmental impact.
Pipe-Klean and Well-Klean, the principal products of HERC used in its pipe
system cleaning, act to remove scale and corrosion. These products have been
tested and certified to ANSI/NSF Standard 60 by the National Sanitation
Foundation (NSF) for use as well cleaning and pipe cleaning aids in drinking
water systems. ANSI/NSF 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. HERC believes that these
products offer distinct advantages over the acid washes which are generally used
to clean water systems, since the acid can cause additional corrosion and can be
deemed to be hazardous waste for disposal purposes.
MARINE DIVISION
The marine division focuses on the cleaning of shipboard pipe systems for
water and wastewater. In particular, the vacuum waste systems aboard most marine
vessels develop an evaporative scale in the pipe interiors which requires
cleaning approximately once every 12-18 months. The principal customers of the
marine division are the United States Coast Guard and the United States Navy. In
September 1997, HERC received a five year contract from the United States
Navy-Supervisor of Shipbuilding (SupShip) office in Portsmouth, Virginia. This
contract calls for HERC to clean pipe systems on board ships based in the
Norfolk area. The Portsmouth contract permits HERC to charge set amounts for its
services. Other SupShip offices of the Atlantic Fleet and the maintenance office
of the United States Coast Guard also are using the Portsmouth contract to have
vessels cleaned. During 1997 HERC cleaned piping systems on board 23 United
States vessels for an aggregate revenue of $707,000. During 1998 HERC cleaned
piping systems on board a total of 72 United States vessels, for an aggregate
revenue of $2,746,000. The aggregate revenues from the servicing of United
States vessels represented 50% and 87% of consolidated sales from continuing
operations for the fiscal years ended December 31, 1997 and 1998, respectively.
The marine division also offers its services to non-United States owned
vessels. HERC intends to market its services to merchant marine vessels and
private recreational vessels in the future. To date, the sales attributable to
this portion of the marine business have not been significant.
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In order to meet the requirements of the Portsmouth contract, and to better
serve the East Coast market, HERC based the marine division in Portsmouth,
Virginia during 1997. In 1998, HERC opened an office in San Diego to expand its
ability to offer the marine services to the Pacific Fleet and Western United
States Coast Guard. The division employs a sales staff located in both of its
coastal offices to service its existing customers and to generate additional
merchant marine and private vessel sales.
FIRE PROTECTION DIVISION
The fire protection division is new for 1999 and these activities were
operated under the Municipal and Industrial division in 1997 and 1998. This
division developed during 1997 and 1998 as a result of two contracts with the
McCarran International Airport in Las Vegas, Nevada. As is typical of many such
systems, the sprinkler system had become severely corroded and was not achieving
required operational levels. As a result of the cleaning done on this site, HERC
has been recognized by the American and National Fire Sprinkler Associations as
a rehabilitative method for fire protection systems. HERC is also pursuing
certification by Factory Mutual and IRI-Hartford Steam Boiler, two of the major
insurance companies of fire protection systems so that it will be able to market
more aggressively its services to this segment of the pipe system market. HERC
believes that these endorsements would be beneficial in its marketing, since
insurance premiums are usually a reflection of a system performance. During 1997
and 1998, cleaning of fire protection systems provided sales of $25,000 and
$100,000, respectively.
MUNICIPAL AND INDUSTRIAL DIVISION
Municipal waterlines and industrial facilities represent the other market
in which HERC may expand its existing business of pipe system cleaning. Because
HERC's products used in this segment are ANSI/NSF Standard 60 certified HERC
believes that it has a significant advantage in this business. The standards
developed by the NSF that have been used to approve the HERC products have been
adopted legislatively in 36 states and are policy in 12 others. HERC believes
that no product can be used in a drinking water system in the United States
without NSF certification.
The most common problem found in municipal water lines and industrial water
treatment lines is tuberculation. This is the development of chemical and
biological corrosion inside the pipes to the point where the useful diameter of
the pipe is severely restricted. It is not unusual to have a four-inch mainline
with only one inch of useful diameter remaining. Tuberculation may also cause
colored water, bad odors, unpleasant taste and increased chemical treatment and
pumping costs. In industrial plants, tuberculation greatly reduces heat
exchange, condensing and flow capacities.
In addition to the cleaning done by it, HERC has developed a relationship
with Calgon Corporation to address post cleaning corrosion inhibition. HERC
works with Calgon Corporation to flush the system cleaned by HERC with their
treatments that have the effect of retarding future corrosion that if not
treated would cause the return of the tuberculation problems.
In order to aid in the development of the patented process for cleaning
municipal water lines, HERC developed a relationship with Bristol Water Company
of the United Kingdom during 1998. Bristol Water is a large private water
utility that is renowned for the development of technologies in underground
water systems. Bristol Water Holdings, PLC, the parent company of Bristol Water
also owns Newbore Systems Ltd. which was formed to engage in all types of
chemical pipe cleaning in the United Kingdom. HERC expects to earn revenues from
licensing fees, royalties and chemical sales to Newbore Systems Ltd.
Because HERC has focused its attention in the marine segment and
secondarily in the fire protection division where its margins are better and the
sales cycle is faster, sales in the municipal and industrial segment have been
minimal in 1998. One primary reason for this focus has been the long lead time
to consummate municipal sales contracts and the expense of obtaining and
servicing these contracts. Often payment is dependent on the work of other
contractors and municipal approval processes. Although HERC focused its
attention in this segment in 1995 to early 1997, it currently represents an
insignificant portion of its business. HERC does not anticipate it becoming a
significant part of its business in the near future.
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INDUSTRIAL CHEMICALS DIVISION
The industrial chemicals division manufactures and sells products using
HERC's proprietary and patented formulas for applications in the removal of salt
and scale and in the maintenance of water process systems. These products are
currently Well-Klean(R), Line Out(R) and Process Water products.
Well-Klean is used to remove scale and corrosion in deep water wells. Over
time the well screen that allows water to be lifted with pumps becomes clogged.
Well-Klean sales were $108,000 in 1998 and $109,000 in 1997.
Line Out is used in the cleaning of drip irrigation systems and for salt
removal from soils in the root zone of turf grasses on golf courses. Drip
systems will clog with scale over time and require regular maintenance in order
to continue to perform. HERC's Line Out product provides a superior method of
providing for cleaning while also improving water distribution. In addition, the
use of high salt content water by golf courses for irrigation has caused the
need for a product to remove salt from the turf root zone. HERC manufactures
Line Out as a private labeled product called Deliminate(R) for Eco Soil Systems,
Inc. under an exclusive agreement for golf courses in the United States.
Chlor*Rid is a product using HERC's core formula for removing salt from
surfaces prior to the application of high performance paints or coatings. During
1998 HERC sold its half ownership of a patent covering this application to
Chlor*Rid International. Under the sales agreement HERC will maintain
manufacturing rights of the product or royalties on future sales for the life of
the patent which is about fourteen years.
Process water products are sold primarily under the trade names Slug(R),
Compound 360 and Compound 400. These are used in the de-scaling and maintenance
of all types of process water systems. These include cooling towers, heat
exchangers and condensers.
MARKETING AND DISTRIBUTION
HERC markets its products and services through its marketing and sales
staff and independent distributors and sales representatives. In 1997 and 1998,
sales to the U.S. Navy under the 5 year Portsmouth contract were 34% and 66%
respectively of consolidated sales from continuing operations. The aggregate
revenues from the servicing of United States vessels, which includes sales from
cleaning of vessels outside of the Portsmouth Contract, represented 50% and 87%
of consolidated sales from continuing operations for the fiscal years ended
December 31, 1997 and 1998, respectively.
As discussed above, HERC has also entered into strategic relationships to
market its products and services to its customers.
ADVERTISING
HERC advertises and publishes in selected industry publications and
initiates direct mail pieces to specific groups of potential consumers of its
various products. HERC also uses an "800" number in connection with its
advertising, direct mail programs and order entry. HERC is working on a web
sight which will explain HERC's products and services and give detailed
information about the Company. HERC expects the web sight (www.hercprod.com) to
be on line by May 1, 1999. The primary emphasis of the advertising is to promote
awareness of HERC corporation and its various products.
COMPETITION
Regional contractors normally perform water well and waterline
revitalization and rehabilitation. There are no major companies that dominate
this business. The largest company in the water well field is Layne-Christensen,
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 HERC. To the extent that HERC 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 might also seek
to market its pipe rehabilitation products and technology. While they are not as
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large as the chemical producers, the contracting companies are still generally
larger and more established in the industry than HERC.
HERC anticipates that over time the companies with which it competes have
the resources to develop, have developed, are developing, or may develop and
market products and services directly competitive with those of HERC. Current
competitors or new market entrants could produce directly new or enhanced
products with features that render HERC's products obsolete or less marketable.
HERC's competitive success will depend on its ability to promote and to adapt to
technological changes and advances in the water systems treatment industry.
In the opinion of HERC's management, HERC's products and methods are
superior to other water system treatment chemicals and methods because they are
easier to use, less expensive and are less harmful to the environment. HERC
competes principally on the basis of these qualities and by securing strategic
relationships with established companies. HERC has patent protection for certain
of its technologies and is seeking to expand patent protection by making new
applications with respect to its proprietary products and technologies in order
to provide a diverse product base.
MANUFACTURING AND SUPPLIES
The majority of HERC's industrial products are formulated and packaged at
its plant in Phoenix, Arizona. The balance of these products are manufactured
and packaged for it by a third party manufacturer located in Chandler, Arizona
using HERC's formulas. HERC generally does not maintain long-term supply
agreements with its suppliers and purchases raw materials pursuant to purchase
orders or short-term contracts in the ordinary course of business. HERC believes
that the raw materials and other supplies are available from a variety of
sources and that there are numerous companies available to formulate and package
its products.
PATENT AND TRADEMARK PROTECTION
HERC has a series of United States patents for the use of its Pipe-Klean
technology in the cleaning of potable water distribution systems and a United
States patent on the mobile recirculation units employed in the pipe cleaning
process. HERC has also received a Notice of Allowance for its basic pipe
cleaning patent for the association of European countries and can obtain patents
throughout Europe in 1999. Additionally, HERC has received its U.S. Patent
application for "Pipe Cleaning and In-Line Treatment of Spent Pipe Cleaning
Solution", an improvement on the basic pipe cleaning technology. The Company
also received Notice of Allowances from the U.S. Patent Office during 1998 of
applications that cover (1) the process of chemically cleaning water
distribution systems including fire protection systems, (2) the process for
vacuum waste pipe cleaning, (3) a process for pipe system cleaning and in-line
treatment of spent cleaning solution and (4) a process for controlled carbonate
removal from water conduit systems. Other patent applications are pending.
There can be no assurance that any patents applied for will be obtained.
Moreover, there can be no assurance that any patents will afford HERC
commercially significant protection of its technology or that HERC will have
adequate resources to enforce its patents. HERC believes that it has
independently developed its proprietary technologies and they do not infringe
the proprietary rights of others. Although HERC 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 HERC's products infringe patent or proprietary rights of
others, HERC may be required to modify its processes or obtain a license. There
can be no assurance that HERC would be able to do so in a timely manner, upon
acceptable terms and conditions or at all. The failure to do so could have a
material adverse effect on HERC. In addition, there can be no assurance that
HERC will have the financial or other resources necessary to defend a patent or
proprietary rights action. Moreover, if any of HERC's products infringe patents
or proprietary rights of others, HERC under certain circumstances could become
liable for damages which could have a material adverse effect on HERC.
h.e.r.c.(R), Well-Klean(R) II Concentrate, Pipe-Klean(R), and Line-out(R)
are registered trademarks of HERC.
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HERC 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 HERC requires all of its employees to sign confidentiality agreements,
there can be no assurance that HERC will be able to protect its trade secrets or
that other companies will not acquire information that HERC 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 HERC.
GOVERNMENT REGULATION
Water pollution is a major focus of federal, state and local environment
protection laws and regulations. The discharge from water systems treatment is
subject to these laws and regulation. The water system treatment chemicals
industry and HERC'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
HERC's operations. The NSF has indicated that Pipe-Klean and Well-Klean comply
with the standards for chemicals that can be used in cleaning drinking water
systems. In addition, many of HERC'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 HERC'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 HERC will not incur environmental liability arising out of the
use of corrosive substances. To date, HERC does not believe that it has incurred
any such liability. HERC 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 HERC's products is
subject to frequently changing federal, state and local laws and substantial
regulation under these laws by governmental agencies, including the EPA, the
Occupational Health and Safety Administration, various state agencies and county
and local authorities acting in conjunction with federal and state authorities.
Among other matters, 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.
HERC has obtained certification for its Pipe-Klean, Pipe-Klean Preblend,
Acid Klean and Pipe-Klean Neutralizer products as "pipe cleaning aids" under
ANSI/NSF Standard 60 from NSF for use in potable water distribution systems.
Also, HERC has obtained ANSI/NSF Standard 60 certification for their Well-Klean
II Concentrate, Acid Klean and Well-Klean Preblend products as "well cleaning
aids" for potable water wells.
HERC 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 HERC 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 sanctions, including restrictions on its
business operations, monetary liability and criminal sanctions, any of which
could have a material adverse effect upon HERC's business.
Advertising relating to HERC'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 HERC's products.
RESEARCH AND DEVELOPMENT
The Company estimates that it spent $7,500 on research and development
activities during 1998.
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DISCONTINUED OPERATIONS
During the fourth quarter of 1997, HERC discontinued the operations of its
wholly owned subsidiary, CCT Corporation. CCT manufactured and distributed
proprietary agricultural products. CCT is treated as a discontinued operation.
On December 9, 1998, HERC sold its wholly-owned subsidiary, HERC Consumer
Products, Inc. HERC Consumer Products marketed and sold consumer products to
wholesale and retail customers. HERC received an initial payment of $200,000 at
the closing and will receive a royalty payment of 3% of the adjusted revenue
above $1,000,000 for some of the consumer products for three years after the
closing date. All remaining consumer product inventories were purchased as part
of the transaction.
The operating results relating to these businesses have been segregated
from continuing operations and reported as a separate line item on the
consolidated statement of operations. Certain 1997 amounts have been restated to
conform to the 1998 presentation.
EMPLOYEES
As of March 3, 1999, HERC had 37 employees of which 19 are full time. Two
are officers, twenty-five are engaged in field operations and production, six
are in administration, and four are in marketing and sales. Some of the field
employees are part time. None of HERC's employees is represented by labor unions
or covered by a collective bargaining agreement. HERC believes that its
relationship with its employees is satisfactory.
SEASONALITY
Sales of Pipe-Klean and Well-Klean products are seasonal in those parts of
the United States in the snow belt. Seasonal sales can result in uneven cash
flow for HERC, which may require HERC to obtain and maintain short-term
financing arrangements. In the event such financing arrangements are not
available or, once acquired, cease to be available, HERC's operations and
financial condition could be materially adversely affected.
ITEM 2. DESCRIPTION OF PROPERTY
HERC leases 15,700 square feet of office and warehouse facilities in
Phoenix, Arizona, 5,530 square feet of office and warehouse facilities in
Portsmouth, Virginia, and 2400 square feet of office and warehouse facilities in
National City, California. The Phoenix location is under an operating lease that
expires on July 31, 2001 and provides for monthly payments escalating from
$8,796 to $10,053 over the term of the lease. The Portsmouth facility is 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 National City location is under a month
to month operating lease with payments of $1,440 per month and requires a 30-day
written notice to cancel.
The Company has no policy regarding investments in real estate, real estate
mortgages, or securities of persons primarily engaged in real estate activities.
However, the Company currently holds no such investments.
ITEM 3. LEGAL PROCEEDINGS
On or about January 14, 1999 in the Supreme Court of the State of New York,
County of Suffolk, the Suffolk County Water Authority and R & L Well Drilling,
LLC filed a civil claim against HERC as a third-party plaintiff in a civil
action filed on April 8, 1998 by five individual residents of Ronkonkoma, New
York, alleging negligence resulting in personal injury and seeking monetary
damages of $11 million. HERC has substantially denied liability for the original
claim, which has been submitted to its insurance carrier under its comprehensive
general liability insurance policy.
Although the resolution of this matter is not known, management and its
legal counsel believe HERC has meritorious defenses and believes the outcome
will have no material effect on HERC's financial position.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of HERC's security holders through
solicitation of proxies or otherwise during the fourth quarter of the fiscal
year ended December 31, 1998.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
TRADING MARKETS
The common stock of HERC is listed on the OTC BB Market and on the Boston
Stock Exchange under the symbols "HERC" and "HER", respectively. The OTC BB
Market is the principal market for the common stock.
The following table sets forth the high and low prices of the common stock
as quoted by OTC BB 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.
1998 High Low
---- ---- ---
First Quarter $ 0.594 $ 0.250
Second Quarter 0.438 0.250
Third Quarter 0.438 0.250
Fourth Quarter 0.375 0.188
1997 High Low
---- ---- ---
First Quarter $ 2.500 $ 1.250
Second Quarter 1.875 1.188
Third Quarter 1.719 0.969
Fourth Quarter 1.156 0.250
On March 19, 1999 the closing price for the common stock as quoted by OTC
BB was $0.375.
HOLDERS
As of March 12, 1999, there were 96 record holders of the common stock.
HERC believes that as of such date there were approximately 1,650 beneficial
holders of the common stock.
DIVIDENDS
To date, HERC has not paid any cash dividends on its common stock, and it
does not anticipate paying any cash dividends. HERC intends to retain all
earnings, if any, for use in its business for the foreseeable future.
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RECENT SALES OR GRANTS OF UNREGISTERED SECURITIES
The following relates to all securities of HERC 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
underwriting or other Exemption
discounts to market from
Title of price afforded to registration Terms of
Date of grant security Amount purchasers claimed exercise
- ------------- -------- ------ ---------------------- ------------ --------
<S> <C> <C> <C> <C> <C>
4/17/98- Common Stock 3,240,000 $999,400 Section N/A
6/5/98 4(2)
4/9/98- Incentive 218,500 Incentive stock Section Exercisable at
8/3/98 Stock Options options granted to 4(2) prices of
to purchase employees with no $0.31-$0.41
Common Stock consideration received through 8/31/04
5/1/98- Warrants to 25,000 Consulting Section Exercisable at
10/30/98 purchase services 4(2) prices of
Common Stock $0.22-$0.35
through 9/10/05
10/1/98 Common Stock 21,333 Board of Director Section N/A
Services 4(2)
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
GENERAL
During the fiscal year ended December 31, 1998, HERC sold its consumer
products division. This is currently accounted for as a discontinued operation
(See Note 2 to the consolidated financial statements). The following discussion
does not include the results of the consumer products division or the results of
CCT that was discontinued in 1997.
1998 COMPARED WITH 1997
Sales from continuing operations for the fiscal year ended December 31,
1998 were $3,169,000 compared to $1,405,000 in 1997. The marine division
accounted for $2,746,000 in 1998, of which $2,095,000 was billed under the five
year Portsmouth contract with the United States Navy-Supervisor of Shipbuilding.
The marine division accounted for $707,000 in 1997 of which $475,000 was billed
under the Portsmouth contract. Sales from pipe rehabilitation services from
municipal chemical cleaning which includes chemical feed line, fire protection
system and other industrial work produced $173,000 in 1998 and $400,000 in 1997.
Industrial chemical sales were $250,000 in 1998 compared to $246,000 in 1997.
The sales of HERC in 1998 have shifted primarily to those from the marine
division as compared to earlier years. The reason for this is that 1998
represents a full year of providing services under the Portsmouth contract
compared to four months in 1997 and the cleaning of seventy-two vessels in 1998
compared to twenty-three vessels in 1997. HERC has also focused its sales and
marketing efforts in this division because of the higher margins it yields
compared to the municipal chemical cleaning segment that was its earlier
principal focus. Sales in 1998 also reflect the commencement of offering
services in the fire protection segment. HERC plans to pursue marketing in this
segment of the pipe cleaning market in 1999 in a controlled manner. At this
time, HERC cannot predict whether it will secure many contracts and generate
profits in this segment since it is a new segment. Sales of industrial chemicals
remained about the same from one year to the next. Sales from the pipe
rehabilitation and municipal segment declined because of the focus of HERC on
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the marine sales. The shift in focus resulted from the fact that these sales
typically require substantial sales efforts and costs and a long sales cycle to
secure a contract. Additionally, servicing the contracts is subject to
dependence on other contractors, seasonality and longer payment cycles and
results in lower margins.
Consolidated gross margins were 58% in 1998 and 20% in 1997. The
improvement is a result of the shift in revenue from municipal potable water
cleaning projects to marine pipe line chemical cleaning projects.
Gross profit increased from $287,000 in 1997 to $1,841,000 in 1998 due to
the revenue shift discussed above. Selling expenses decreased from $422,000 in
1997 to $367,000 in 1998 while general and administrative expenses decreased
from $2,487,000 in 1997 to $1,631,000 in 1998. The decrease in selling, general
and administrative expenses is attributable to management's cost containment
program put into effect during the third quarter of 1997. Additionally, 1997
included $276,000 to write down certain unamortized patent costs. Management
plans to continue to find ways to contain, curtail or cut overhead expenses as
it finds opportunities to do so.
For the year ended December 31, 1998, HERC's operating loss was $157,000
compared to $2,621,000 for the same period in 1997. Additionally, net income for
1998 was $40,000 consisting of income from discontinued operations of $571,000
offset by a loss from continuing operations of $531,000. This compares to a net
loss for 1997 of $4,462,000 consisting of a loss from continuing operations of
$2,634,000 and a loss from discontinued operations of $1,828,000.
As HERC continues to focus on the marine segment and begins to sell its
services in other segments and as it continues to control expenses, it
anticipates that revenues will increase in 1999 over those of 1998. This belief
is based on the results of operations of the fourth quarter and the impact of
actions taken in 1997 and 1998, but is subject to change depending on many
factors, including continuing to provide services under the Portsmouth contract,
expanding operations to the Pacific Fleet, securing contracts from the merchant
marine fleets and controlling costs. It also depends on many factors outside the
control of HERC, such as maintenance of its competitive advantages among other
things.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $243,000 at December 31, 1998 and $135,000
at December 31, 1997 while working capital was $449,000 and a deficit of
$834,000 at those respective dates. The increase in cash and working capital
during 1998 is a function of the private placement of restricted common stock
during the second quarter of 1998 offset by cash used in operating activities,
investing activities and principal payments of short and long term debt.
As of December 31, 1998, HERC had paid off its $250,000 term loan from
InterEquity and had total other long-term debt of $25,000. Additionally, as of
December 31, 1998, HERC had no factored receivables under its factoring facility
although this credit facility is available as a source of cash if HERC needs it.
(See Note 4 to the consolidated financial statements)
During the fourth quarter of 1998, HERC concluded the sale of its wholly
owned subsidiary, HERC Consumer Products, Inc. which marketed and sold consumer
products to wholesale and retail customers. HERC was paid a cash consideration
of $200,000 at the closing and will be paid a 3% royalty of the adjusted revenue
above $1 million for certain consumer products for the three years after the
closing date. All remaining consumer products inventories were purchased as a
part of the transaction.
In the second quarter of 1998, HERC sold 3,240,000 shares of Common Stock
at $0.31 per share and received net proceeds of $999,400.
HERC currently contracts with a few customers responsible for a majority of
HERC's revenues, and HERC expects the high concentration levels to continue
through 1999. Thus, any material delay, cancellation or reduction of orders from
these customers could have a material adverse effect on HERC's operations.
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Management has no plans to sell additional securities to raise cash and can
make no guarantee that it could sell additional securities. However, any such
sale, if necessary, would substantially dilute the interest of HERC's existing
stockholders.
YEAR 2000 COMPLIANCE DISCLOSURE
Many existing computer programs and databases use only two digits to
identify a year in the date field (i.e., 99 would represent 1999). These
programs and databases were designed and developed without considering the
impact of the upcoming millennium. Consequently, in the Year 2000, date
sensitive computer programs may interpret the date "00" as 1900 rather than
2000. If not corrected, many computer systems could fail or create erroneous
results in the Year 2000.
COMPANY'S STATE OF READINESS
HERC is currently assessing all of its internal and external systems and
processes with respect to the Year 2000 issue. HERC has received notification
from its provider of financial and accounting software that such software is
structured to accommodate the year 2000 and beyond. HERC plans to continue to
test all of its mission critical internal and external systems and processes
(and the associated Year 2000 "fixes") for Year 2000 compliance during 1999. As
part of this process, HERC is assessing the potential impact of Year 2000
failures from vendors and outside parties upon its business and is currently
taking steps to minimize that risk. Based on HERC's current state of readiness
and the steps currently being taken (i.e., installing backup processes and
systems), HERC does not believe that the Year 2000 problem will have a material
adverse effect on HERC's financial position, liquidity or operations.
COMPANY'S COSTS OF YEAR 2000 COMPLIANCE
HERC estimates its total cost of Year 2000 compliance to be immaterial.
COMPANY'S RISKS OF YEAR 2000 ISSUES
HERC believes that the risk of failure of its software due to the Year 2000
issue is minimal; however, there may be latent defects of which it is not aware
that may cause disruption. To the extent HERC's vendors, service providers, and
customers have significant Year 2000 failures, HERC may be affected by their
inability to perform or from disruption in their providing services or orders.
COMPANY'S CONTINGENCY PLANS
HERC is developing contingency plans with respect to significant Year 2000
issues within its control. For example, HERC is in the process of assessing and
verifying the Year 2000 compliance of its raw material vendors. Verification
will be accomplished through the use of written certifications. Any vendors not
found to be Year 2000 compliant will be replaced, if possible, with vendors that
are Year 2000 compliant.
OTHER MATTERS
In June 1997, SFAS No. 130, "Reporting Comprehensive Income," and SFAS No.
131, "Disclosure about Segments of an Enterprise and Related Information," were
issued. No. 130 specifies presentation of comprehensive income and its
components; No. 131 requires certain additional information on operating
segments, products and services, geographic areas and major customers.
Implementation of both statements, which are effective for 1998 and future
years, will have no material impact on HERC's financial statements.
ITEM 7. FINANCIAL STATEMENTS
See Index to Financial Statements on page F-1 attached hereto.
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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; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Name Age Position
- ---- --- --------
S. Steven Carl 41 Chairman of the Board of Directors, Chief
Executive Officer and President
Michael H. Harader 31 Vice President of Finance, Chief Financial Officer
Salvatore DiMascio 59 Director
Robert M. Leopold 73 Director
Dr. Jerome H. Ludwig 65 Director
R. John Armstrong 55 Director
S. Steven Carl has been the Chief Executive Officer and a Director of HERC since
August 1995 and was President of HERC from August 1995 to February 28, 1996.
Effective February 28, 1996, Mr. Carl became Chairman of the Board and resigned
as President of HERC. Mr. Carl was re-appointed President in May 1997. From May
1992 to August 1995, Mr. Carl was the President and Chief Executive Officer of
CCT Corporation, a wholly owned subsidiary of HERC acquired in May 1995.
Michael H. Harader has been Vice President of Finance since July 27, 1998.
Effective October 27, 1998, Mr. Harader became Chief Financial Officer. Mr.
Harader joined HERC in January 1996 and has held positions as Controller and
Accounting Manager. From January 1992 until February 1994, Mr. Harader was
Corporate Controller of 90 Clothing Company, Inc. From April 1994 until January
1996, Mr. Harader was Credit Manager of Isley's RV Service Center, Inc. Mr.
Harader is a Certified Public Accountant.
Salvatore DiMascio has been a Director of HERC since September 3, 1996. Since
1986, Mr. DiMascio has been President of DiMascio Venture Management, a
management and investment consulting firm. From June 1994 to June 1997, Mr.
DiMascio was Executive Vice President and Chief Financial Officer of Anchor
Gaming, a public company. 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 and other service industries. Mr. DiMascio
is currently a Director of U.S. Communications Inc., Fotoball USA and Colorado
Casino Resorts, Inc., all public companies. Mr. DiMascio is a Certified Public
Accountant.
Robert M. Leopold has been a Director of HERC since June 5, 1996. Mr. Leopold
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. During 1997, Huguenot Associates was a
consultant to HERC. 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 is a Director of Infodata Systems,
Inc., Dental Services of America and Standard Security Life Insurance Company of
New York, a wholly owned subsidiary of Independence Holding Company.
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Dr. Jerome Ludwig has been a Director of HERC since June 1993. He retired in
September 1997 as Executive Vice President and Secretary of HERC to which
positions he was elected in June 1993. Dr. Ludwig continues as a consultant to
HERC. For more than five years prior to 1993, he served as a scientific
consultant to HERC and also was engaged in acquisition/divestiture consulting.
Dr. Ludwig has spent over 40 years in marketing and product development in the
chemical, plastics and pharmaceutical industries and holds 25 United States
patents.
R. John Armstrong has been a Director of HERC since January 1, 1999. Mr.
Armstrong served eleven years in the U.S. Navy, with experience in ship design,
construction and maintenance, with a four year tour at a SupShip (supervisor of
shipbuilding office), serving in quality assurance, contracts and planning
departments in addition to serving two years on the engineering faculty at the
Naval Academy. Following his resignation from the Navy, Mr. Armstrong served as
a Project Manager and, ultimately, Executive Vice President of a professional
services company in Washington DC, providing engineering and computer services
to a broad spectrum of clients. In 1986 he became the President of Seaward
Marine Services, Inc., engaged in international diving services.
BOARD OF DIRECTORS; COMMITTEES
Directors are elected to serve until the next annual meeting of
stockholders of HERC or until their successors are qualified and elected.
Officers serve at the discretion of the Board of Directors subject to any
contracts of employment.
Outside Directors elected at duly convened annual shareholder's meetings or
other properly convened Board elections are compensated by an annual Outside
Director's Retainer in the amount of $15,000 per annum, payable in (a) $1,500
paid in cash semi-annually on the first day of the second and fourth quarters
following such election, (b) $1,000 paid in cash for personal attendance at duly
convened quarterly meetings of the Board, and (c) the issuance of HERC
restricted common stock payable quarterly on the first day of each quarter in an
amount equivalent to $2,000 of market value measured on the close of trading of
the last trading day of the prior quarter, plus out-of-pocket expenses.
The Board held five meetings during the year ended December 31, 1998.
The Board of Directors has established an Audit Committee and a
Compensation Committee.
The Audit Committee, currently comprised of Messrs. DiMascio and Leopold,
has been formed to: (i) recommend annually to the Board of Directors the
appointment of the independent auditors of HERC; (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 overall accounting
practices, policies, and accounting and financial controls of HERC; (iv) be
available to the independent auditors during the year for consultation and (v)
review related party transactions by HERC on an ongoing basis and review
potential conflicts of interest situations where appropriate. The Audit
Committee held one meeting during the year ended December 31, 1998.
The Compensation Committee, currently comprised of Messrs. Carl, DiMascio
and Leopold, has been formed to review overall executive compensation and review
HERC's employee benefit plans. The Compensation Committee held two meetings
during the year ended December 31, 1998.
HERC is obligated through May 1999, if so requested by Whale Securities
Co., L.P. ("Whale"), the underwriter of its initial public offering in May 1994,
to nominate and use its best efforts to elect Whale's designee as a director of
HERC, or at Whale's option, as a non-voting advisor to the Board. Whale has not
exercised its right to designate such a person.
HERC is obligated through April 2001, if so requested by GKN Securities
Corporation ("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 HERC
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.
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COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchanges Act of 1934, as amended, requires
HERC's directors and officers and persons who beneficially own more than ten
percent of HERC's Common Stock to file with the Securities and Exchange
Commission ("SEC") and the Boston Stock Exchange initial reports of ownership of
Common Stock in HERC. Officers, directors and greater-than-ten percent of
shareholders are required by SEC regulation to furnish HERC with copies of all
Section 16(a) reports they filed. To HERC's knowledge, based solely on review of
the copies of such reports furnished to HERC and written representation that no
other reports were required, during the year ended December 31, 1998, such
persons complied with all Section 16(a) filing requirements, with the exception
of Mr. John A. Gulick III, the Secretary of HERC, who did not timely file Forms
3 and 4 during 1998 in respect of two warrants.
ITEM 10. EXECUTIVE COMPENSATION
Set forth in the following table is information about 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, 1998.
Name & Principal Position Year Salary
------------------------- ---- ------
S. Steven Carl Chairman of the Board, 1998 $ 82,100
Chief Executive Officer, 1997 $100,100
President and Director 1996 $115,500
Other than the cash compensation set forth in the table, the Named
Executive Officer did not receive non-cash benefits having a value exceeding 10%
of his cash compensation.
STOCK OPTION PLANS
In 1993, the Board of Directors of HERC 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. Key employees are persons whose
efforts, knowledge and expertise are integral to the operations and success of
HERC. The Board of Directors administers the 1993 Plan, 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 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 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 HERC's stock). No options may be granted after
the year 2003. As of December 31, 1998, HERC had issued under the 1993 Plan
250,000 options exercisable at prices ranging from $0.3125 to $2.50 per share.
In 1996, the Board of Directors of HERC 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
HERC and its subsidiaries, as both ISOs and non-qualified options and other
equity based awards. Holders of these awards are persons whose efforts,
knowledge and expertise are integral to the operations and success of HERC. The
Board of Directors administers the 1996 Plan, but the Board of Directors may
appoint a committee to act on its behalf. 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 HERC's stock). The exercise price of a Non-qualified Option
may not be less than 100% of the fair market value on the last trading day
before the date of grant. No options may be granted after the year 2006. As of
December 31, 1998 HERC had issued options under the 1996 Plan to acquire 567,500
shares of Common Stock, exercisable at prices ranging from $0.3125 to $1.75 per
share.
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OTHER OPTIONS AND WARRANTS
In addition to the options under the 1993 Plan and the 1996 Plan, HERC has
outstanding the following options and warrants as of December 31, 1998: (i)
warrants to purchase 85,000 shares of Common Stock at $3.00 per share issued to
Perrin, Holden & Davenport Capital Corporation 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 171,490 units, each unit
consisting of one share of Common Stock and one warrant to purchase one share of
Common 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
HERC's initial public offering, (vi) warrants issued to original bridge
financing investors and consultants to purchase 605,000 shares of Common Stock
at prices ranging from $1.06 to $2.75 per share, (vii) other options issued to
employees and a former director to purchase 490,000 shares of Common Stock at
prices ranging from $0.31 to $4.00 per share, (viii) warrants to purchase
300,000 shares of Common Stock at prices ranging from $1.31 to $2.00 per share,
issued to GKN and its designees in connection with the exercise of 150,000 units
in June 1997 and (ix) warrants to purchase 125,000 shares of Common Stock at
prices ranging from $1.18 to $1.47 issued to InterEquity in connection with the
term loan in September 1997. All of the foregoing securities are exercisable
into an aggregate of 6,210,382 shares of Common Stock.
The following charts set forth certain information with respect to options
granted to the Named Executive Officers:
Options Granted in Last Fiscal Year
% of Total Options
Options Granted to Employees Exercise Date Expiration
Name Granted (1) In Fiscal Year Price Vested Date
- -------------- ----------- -------------------- -------- ------ ----
S. Steven Carl 100,000 46% $0.3125 1998 2003
Aggregate Year-End Option Values
Number of Value of
Unexercised Options Unexercised in-the-money
At December 31, 1998 Options at December 31, 1998
---------------------------- ----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- -------------- ----------- ------------- ----------- -------------
S. Steven Carl 177,500 72,500 0(2) 0(2)
(1) During 1998, S. Steven Carl had 150,000 options repriced to $0.3125.
(2) The market value at December 31, 1998 of the Common Stock underlying the
options was $0.2344 per share. The options are exercisable at prices of
$0.3125 or more.
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ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of January 31, 1999 certain information
regarding the beneficial ownership of shares of Common Stock by (i) each person
who is known by HERC to beneficially own 5% or more of the outstanding shares of
Common Stock; (ii) each of HERC's directors; and (iii) all executive officers
and directors of HERC as a group.
Percentage of
Amount and Nature of Outstanding
Beneficial Common Stock Owned
Name and Address of Beneficial Owner Ownership (1) Beneficially
- ------------------------------------ ------------- ------------
S. Steven Carl (2)(3) 994,851 8.25
Jerome H. Ludwig (2)(5) 177,225 1.52
Robert M. Leopold (2)(6) 61,644 *
R. John Armstrong (2) 48,533 *
Salvatore T. DiMascio (2)(7) 35,644 *
Lance Laifer and Laifer Capital
Management, Inc. (2) 3,410,000 29.59
Norman H. Pessin(2) 867,500 7.53
Shelby A. Carl(2)(4) 823,653 6.98
All executive officers and directors
as a group (8) (six persons) 1,340,597 10.91
* 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 January 31, 1999 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 January 31, 1999 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, Leopold, Ludwig,
Armstrong and DiMascio is c/o H.E.R.C. Products, Incorporated, 2202 W. Lone
Cactus Drive #15, Phoenix, Arizona 85027. The address for Norman H. Pessin
is c/o Neuberger & Berman, LLC, 605 Third Avenue, New York, NY 10158. The
address for Lance Laifer is c/o Laifer Capital management, Inc., 45 West
43rd Street, 9th Floor, New York, NY 10036.
(3) Includes 530,442 shares issuable pursuant to immediately exercisable
options and warrants. Excludes 72,500 shares issuable on options that
become exercisable in the future.
(4) Includes (i) 226,771 shares issuable pursuant to immediately exercisable
options and warrants, (ii) 288,553 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 wife of Mr. Shelby A. Carl. Excludes 20,000 shares
issuable on warrants that become exercisable in the future.
(5) Includes 160,083 shares issuable pursuant to immediately exercisable
options and warrants.
(6) Includes 45,000 shares issuable pursuant to immediately exercisable options
and warrants.
(7) Includes 20,000 shares issuable pursuant to immediately exercisable
options.
(8) Includes shares referred to as being included in notes (3), (5), (6) and
(7), 14,700 additional shares and 8,000 shares issuable pursuant to
immediately exercisable options. Excludes shares referred to as being
excluded in note (3) and 42,000 shares issuable on options that become
exercisable in the future.
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ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No: Exhibit
- ----------- -------
(3)(1) Certificate of Incorporation of HERC, filed as Exhibit 3.1 to
HERC's Registration Statement (No. 33-75166).
(3)(2) By-Laws of HERC, filed as Exhibit 3.2 to HERC's Registration Statement
(No. 33-75166).
(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 (reference also made to exhibit
3.1 and 3.2), filed as Exhibit 4.1 to HERC's Registration Statement
(No. 33-75166).
(4)(2) Form of Underwriter's Warrant Agreement and Warrant Certificate, filed
as Exhibit 4.2 to HERC's Registration Statement (No. 33-75166).
(4)(3) Form of Warrant Agreement issued to Perrin, Holden & Davenport Capital
Corporation dated December 17, 1996, filed as Exhibit 4.2 of Form 8-K
dated December 17, 1996.
(4)(4) Form of Agency Agreement between HERC and Perrin, Holden & Davenport
Capital Corporation dated as of November 15, 1996, as amended, filed as
Exhibit 4.3 of Form 8-K dated December 17, 1996.
(4)(5) Form of Warrant Agreement between HERC and GKN Securities Corp. dated
November 19, 1996, filed as Exhibit 4.5 of Registration Statement No.
333-19361.
(4)(6) Form of Warrant and Registration Rights Agreement between HERC and the
Equity Group, dated September 27, 1996, filed as Exhibit 4.6 of
Registration Statement No. 333-19361.
(10)(1) 1993 Incentive Stock Option Plan, as amended, filed as Exhibit 10.3 to
HERC's Registration Statement No. 33-75166.
(10)(2) Agency Agreement between HERC and GKN Securities Corporation dated
March 4, 1996, filed as Exhibit 10.8 to HERC's Annual Report on Form
10K-SB for the fiscal year ended December 31, 1995
(10)(3) Form of Purchase Option issued to GKN Securities Corporation and its'
designees, filed as Exhibit 10.9 to HERC's Annual Report on Form 10K-SB
for the fiscal year ended December 31, 1995
(10)(4) Form of Warrant Agreement issued to investors on April 3, 1996, filed
as Exhibit 10.10 to HERC's Annual Report on Form 10K-SB for the fiscal
year ended December 31, 1995
(10)(5) Form of Subscription Agreement between HERC and investors dated April
3, 1996, filed as Exhibit 10.11 to HERC's Annual Report on Form 10K-SB
for the fiscal year ended December 31, 1995
(10)(6) 1996 Performance Equity Plan, filed as Annex A to HERC's Proxy
Statement dated June 11, 1996.
(10)(7) Form of Purchase Option issued to GKN Securities Corporation and its
designees dated June 18, 1997, filed as Exhibit 10.15 to HERC's Form
10-KSB for the year ended December 31, 1997.
(10)(8) Loan Agreement by and between HERC and InterEquity Capital Partners,
LLP dated September 15, 1997 filed as Exhibit 10.18 to HERC's Form
10-KSB for the year ended December 31, 1997.
(10)(9) Account Transfer and Purchase Agreement by and between HERC, H.E.R.C.
Consumer Products, Inc., and KBK Financial Incorporated dated September
22, 1997 filed as Exhibit 10.19 to HERC's Form 10-KSB for the year
ended December 31, 1997.
(10)(10) Agreement by and between HERC and the U.S. Navy dated August 8, 1997
filed as Exhibit 10.20 to HERC's Form 10-KSB for the year ended
December 31, 1997.
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(10)(11) Lease by and between HERC and Roger Buttrum dated May 14, 1996 filed as
Exhibit 10.21 to HERC's Form 10-KSB for the year ended December 31,
1997.
(10)(12) Form of Warrant Agreement between HERC and Jerry Ludwig and Associates
dated September 3, 1997 filed as Exhibit 10.22 to HERC's Form 10-KSB
for the year ended December 31, 1997.
(10)(13) Form of Warrant Agreement between HERC and Shelby Carl dated September
3, 1997 filed as Exhibit 10.23 to HERC's Form 10-KSB for the year ended
December 31, 1997.
(10)(14) Amendment to Stock Option Agreement by and between Gary S. Glatter and
HERC dated March 23, 1995 filed as Exhibit 10.24 to HERC's Form 10-KSB
for the year ended December 31, 1997.
(10)(15) Amendment Number two to Stock Option Agreement by and between Gary S.
Glatter and HERC dated February 1, 1997 filed as Exhibit 10.25 to
HERC's Form 10-KSB for the year ended December 31, 1997.
Sequential Page Number
----------------------
(21) Subsidiaries 40
(22)(1) Consent of Independent Certified Public
Accountants (BDO Seidman, LLP) 41
(23)(2) Consent of Independent Public
Accountants (Arthur Andersen LLP) 42
(27) Financial Data Schedule 43
(99)(1) Risk Factors 44
(b) Reports on Form 8-K: None.
Page 19
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
Index to Consolidated Financial Statements
Page No.
--------
Reports of Independent Public Accountants F-2
Financial Statements:
Consolidated Balance Sheet
December 31, 1998 F-4
Consolidated Statements of Operations
Years Ended December 31, 1998 and 1997 F-5
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1998 and 1997 F-6
Consolidated Statements of Cash Flows
Years Ended December 31, 1998 and 1997 F-7
Notes to Consolidated Financial Statements F-8
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
H.E.R.C. Products Incorporated:
We have audited the accompanying consolidated balance sheet of H.E.R.C. PRODUCTS
INCORPORATED AND SUBSIDIARIES as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of the Company
as of December 31, 1997, were audited by other auditors whose report dated
January 31, 1998, expressed an unqualified opinion on those statements and
included an explanatory paragraph concerning the Company's ability to continue
as a going concern.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of H.E.R.C. Products
Incorporated as of December 31, 1998, and the results of their operations and
their cash flows for the year then ended, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Phoenix, Arizona,
February 5, 1999.
F-2
<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 statements of operations,
stockholders' equity and cash flows of H.E.R.C. Products Incorporated and
subsidiaries for the year ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations and cash flows of
H.E.R.C. Products Incorporated and subsidiaries for the year ended December 31,
1997, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. The Company has experienced
recurring losses from operations and had a net working capital deficiency as of
December 31, 1997. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
BDO SEIDMAN, LLP
Chicago, Illinois
January 31, 1998
F-3
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
Consolidated Balance Sheet
December 31, 1998
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 242,867
Trade accounts receivable, net of allowance for
doubtful accounts of $11,630 616,356
Inventories 19,430
Net assets of discontinued operations (Note 2) 114,192
Costs in excess of billings 13,993
Other receivables 4,255
Prepaid expenses 62,832
------------
Total Current Assets 1,073,925
------------
PROPERTY AND EQUIPMENT
Property and equipment 958,736
Less accumulated depreciation 322,311
------------
Net Property and Equipment 636,425
------------
OTHER ASSETS
Patents, net of accumulated amortization of $95,407
(Note 1) 64,971
Patents pending 95,182
Refundable deposits and other assets 76,993
------------
Total Other Assets 237,146
------------
$ 1,947,496
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 155,650
Accrued wages 42,030
Billings in excess of costs 42,447
Current portion of notes payable (Note 4) 66,109
Liabilities of discontinued operation (Note 2) 154,506
Other accrued expenses 164,042
------------
Total Current Liabilities 624,784
------------
LONG-TERM LIABILITIES
Notes payable, net of current portion (Note 4) 25,147
------------
Total Liabilities 649,931
------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (NOTES 4, 5 AND 6)
Common Stock, $0.01 par value; authorized 40,000,000
shares; issued and outstanding 11,491,921 114,919
Additional paid-in capital 13,923,793
Accumulated deficit (12,741,147)
------------
Total Stockholders' Equity 1,297,565
------------
$ 1,947,496
============
The accompanying notes are an integral part of this consolidated balance sheet
F-4
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
Consolidated Statements of Operations
Years Ended December 31,
---------------------------
1998 1997
---- ----
SALES $ 3,168,955 $ 1,404,641
COST OF SALES 1,327,782 1,117,550
------------ -----------
GROSS PROFIT 1,841,173 287,091
SELLING EXPENSES 366,946 421,567
GENERAL AND ADMINISTRATIVE EXPENSES 1,630,966 2,486,780
------------ -----------
OPERATING LOSS (156,739) (2,621,256)
------------ -----------
OTHER INCOME (EXPENSE)
Interest expense (85,760) (35,614)
Loss on sale or disposal of equipment (265,222) (5,032)
Miscellaneous 18,760 27,750
Expenses relating to settlement of lawsuits (120,000) --
Gain on sale of patent 77,597 --
------------ -----------
Total Other Income (Expense) (374,625) (12,896)
------------ -----------
LOSS FROM CONTINUING OPERATIONS (531,364) (2,634,152)
DISCONTINUED OPERATIONS (NOTE 2):
Income (Loss) from Operations of
Discontinued Segments 256,792 (87,713)
Income (Loss) from Disposition of
Discontinued Segments 315,002 (1,740,000)
------------ -----------
Income (Loss) from Discontinued
Operations 571,794 (1,827,713)
------------ -----------
NET INCOME (LOSS) 40,430 (4,461,865)
NON-CASH DIVIDEND ON PREFERRED STOCK (NOTE 5) -- 62,842
------------ -----------
NET INCOME (LOSS) ALLOCABLE TO COMMON
STOCKHOLDERS $ 40,430 $(4,524,707)
============ ===========
EARNINGS (LOSS) PER COMMON SHARE - BASIC
AND DILUTED
LOSS FROM CONTINUING OPERATIONS $ (0.05) $ (0.35)
INCOME (LOSS) FROM DISCONTINUED OPERATIONS 0.05 (0.23)
------------ -----------
NET INCOME (LOSS) PER COMMON SHARE $ 0.00 $ (0.58)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
BASIC 10,391,936 7,773,951
============ ===========
DILUTED 10,392,616 7,773,951
============ ===========
The accompanying notes are an integral part of these consolidated statements
F-5
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
Consolidated Statement of Stockholders' Equity
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional
------------------- ---------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------ ------ ------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1996 170,000 $ 1,480,000 6,356,487 $ 63,565 $11,223,593 $ (8,256,870) $ 4,510,288
Net Loss -- -- -- -- -- (4,461,865) (4,461,865)
Conversion of Preferred
Stock to Common Stock
(Note 5) (170,000) (1,480,000) 1,714,101 17,141 1,462,859 -- --
Exercise of stock options
(Note 5) -- -- 10,000 100 19,275 -- 19,375
Exercise of warrant (Note 5) -- -- 150,000 1,500 138,750 -- 140,250
Costs associated with
Preferred Stock -- -- -- -- (34,813) -- (34,813)
Warrants issued to prepay
future year's expenses
(Note 5) -- -- -- -- 74,900 -- 74,900
Dividend on Preferred Stock
payable in Common
Stock upon conversion
(Notes 1 and 5) -- -- -- -- 62,842 (62,842) --
-------- ----------- ----------- -------- ----------- ------------ -----------
BALANCE,
DECEMBER 31, 1997 -- -- 8,230,588 82,306 12,947,406 (12,781,577) 248,135
-------- ----------- ----------- -------- ----------- ------------ -----------
Net Income -- -- -- -- -- 40,430 40,430
Warrants issued for
services -- -- -- -- 3,600 -- 3,600
Issuance of shares of
Common Stock -- -- 3,261,333 32,613 972,787 -- 1,005,400
-------- ----------- ----------- -------- ----------- ------------ -----------
BALANCE,
DECEMBER 31, 1998 -- $ -- $11,491,921 $114,919 $13,923,793 $(12,741,147) $ 1,297,565
======== =========== =========== ======== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of this consolidated balance sheet
F-6
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
Consolidated Statements of Cash Flows
Years Ended December 31,
------------------------
1998 1997
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (Loss) $ 40,430 $(4,461,865)
Adjustments to reconcile net income (loss)
to net cash used in operating activities
Depreciation and amortization 311,234 524,152
Provision for loss on discontinued operation -- 1,740,000
Expenses paid by stockholders and Common Stock
and warrants issued for services 6,000 34,592
Loss on sale or disposal of equipment 265,222 5,032
(Increase) decrease in assets
Trade accounts receivable (605,852) 59,175
Inventories 946 73,194
Costs in excess of billings (13,993) --
Other receivables 7,708 10,104
Prepaid expenses (16,875) 14,241
Other assets (60,578) (44,108)
Increase (decrease) in liabilities
Accounts payable (174,070) 305,268
Accrued expenses 11,676 8,969
Billings in excess of costs 42,447 --
Change in net liabilities of discontinued
operations (167,707) 404,890
--------- -----------
Total adjustments (393,842) 3,135,509
--------- -----------
Net cash used in operating activities (353,412) (1,326,356)
--------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (232,276) (311,645)
Cash received from the sale of equipment 5,974 12,969
Expenditures related to patents and patents pending (48,677) (99,021)
--------- -----------
Net cash used in investing activities (274,979) (397,697)
--------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of Common Stock 999,400 --
Expenses from issuance of Preferred Stock -- (34,813)
Proceeds from exercise of stock options -- 19,375
Proceeds from exercise of warrant -- 140,250
Proceeds from issuance of notes payable
and long-term debt 137,431 393,583
Principal payments under notes payable (400,969) (28,789)
--------- -----------
Net cash provided by financing activities 735,862 489,606
--------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 107,471 (1,234,447)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 135,396 1,369,843
--------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 242,867 $ 135,396
========= ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 85,760 $ 35,919
Capital lease obligations incurred $ 31,484 $ 134,057
The accompanying notes are an integral part of this consolidated balance sheet
F-7
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
H.E.R.C. Products Incorporated (the "Company") provides water pipeline
rehabilitation services for marine, fire protection and municipal water systems
and manufactures and sells water treatment chemicals. The Company's wholly owned
subsidiaries, CCT Corporation ("CCT") which manufactured and distributed
proprietary agricultural products and HERC Consumer Products, Inc. ("HCP") which
marketed consumer products toward wholesale and retail customers, are accounted
for as discontinued operations (Note 2).
PRINCIPLES OF CONSOLIDATION AND PREPARATION OF FINANCIAL STATEMENTS
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. CCT and HCP are
accounted for as discontinued operations (Note 2). Certain 1997 amounts have
been restated to conform to 1998 presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, cash equivalents include cash on
hand, bank checking and money market accounts and other highly liquid
investments with original maturities of 90 days or less.
INVENTORIES
Inventories consist primarily of raw materials and are stated at the lower of
cost or market (net realizable value). Cost is determined by various methods
that approximate first-in, first-out.
F-8
<PAGE>
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.
Property and equipment for continuing operations at December 31, 1998 are:
Equipment $ 841,869
Office furniture and fixtures 116,867
958,736
Less accumulated depreciation (322,311)
---------
Net property and equipment $ 636,425
=========
The useful lives of property and equipment for computing depreciation range from
three to ten years.
PATENTS AND PATENTS PENDING
Patents issued are stated at cost and amortized on the straight-line basis over
10 years. Costs for patents pending are amortized when the patents are awarded.
Unamortized costs for patents that are denied or have no continuing application
to the Company's ongoing product base are expensed. Such expenses amounted to
$4,000 and $276,000 for the years ended 1998 and 1997, respectively.
REVENUE RECOGNITION
The Company recognizes revenue when products are shipped. The Company also
performs pipe-cleaning services, which are recorded when the work is complete.
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
During 1997, 1,714,101 shares of Common Stock were issued upon the conversion of
170,000 shares of Preferred Stock. During 1997, certain adjustments were made to
assets and liabilities acquired in the purchase of the 50% interest of H.E.R.C.
Consumer Products Company and, as a result, goodwill was reduced by $22,673.
During 1997, inventory with a value of $211,685 was reclassified to property and
equipment. During 1998 and 1997, the value attributed to warrants issued to
prepay future expenses was $3,600 and $74,900, respectively.
EARNINGS (LOSS) PER SHARE
During 1997, the Company adopted SFAS No. 128, EARNINGS PER SHARE. Pursuant
to SFAS No. 128, basic earnings per common share are computed by dividing net
income (loss) by the weighted average number of shares of common stock
outstanding during the year. For the year ended December 31, 1997, regarding the
computation of diluted loss per common share, no outstanding options or warrants
were assumed to be exercised for purposes of calculating diluted loss per share
as their effect was anti-dilutive.
F-9
<PAGE>
The preferred stock dividend in 1997 was paid in common stock at the time of
conversion of the preferred stock and was determined according to the formula
set forth in Note 5.
RECENTLY ADOPTED ACCOUNTING STANDARDS
In 1998, the Company adopted Statement of Financial Accounting Standards No.
131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. The
new rules establish revised standards for public companies relating to the
reporting of financial and descriptive information about their operating
segments in financial statements. The Company adopted SFAS No. 131 and all of
the required disclosures (Note 7).
2. DISCONTINUED OPERATIONS
During the fourth quarter of 1997, the Company discontinued operations of its
agricultural business, CCT, which is accounted for as a discontinued operation
in the accompanying financial statements. During the fourth quarter of 1998, the
Company concluded the sale of its wholly owned subsidiary HCP, which is also
accounted for as a discontinued operation in the accompanying financial
statements. In connection with this sale, the Company received cash
consideration of $200,000, plus a 3% royalty of future adjusted revenues above
$1 million on certain consumer products for a period of three years from the
closing date. All remaining consumer products inventories were purchased as a
part of the transaction. Accordingly the Consolidated Statement of Operations
for the year ended December 31,1997 is reclassified.
CCT Operating Results were:
Years Ended December 31,
--------------------------
1998 1997
---- ----
Sales $ 341,965 $1,662,318
Expenses 203,588 1,756,391
--------- -----------
Income (loss) from discontinued operation ($0.01
and $0.01 per Common Share respectively) $ 138,377 $ ( 94,073)
========= ==========
F-10
<PAGE>
HCP Operating Results were:
Years Ended December 31,
--------------------------
1998 1997
---- ----
Sales $1,171,556 $1,758,205
Expenses 1,053,141 1,751,845
---------- ----------
Income from discontinued operation ($0.01
and $0.00 per Common Share respectively) $ 118,415 $ 6,360
========== ==========
Liabilities of CCT and HCP at December 31, 1998 consist of trade payables and
miscellaneous accrued expenses. The loss from the disposition of CCT in 1997 is
comprised of a write off of goodwill of $1,478,000 and other wind down expenses
of $262,000.
3. INCOME TAXES
The Company has adopted Statement of Financial Accounting Standards No. 109,
ACCOUNTING FOR INCOME TAXES. SFAS No. 109 requires the use of an asset or
liability approach in accounting for income taxes. Deferred tax assets and
liabilities are recorded based on the differences between the financial
statement and tax bases of assets and liabilities and the tax rates in effect
when these differences are expected to reverse.
The provision (benefit) for income taxes consists of the following:
Years Ended December 31,
--------------------------
1998 1997
---- ----
Current $ -- $ --
Deferred -- --
-------- ---------
$ -- $ --
======== =========
The components of deferred taxes as of December 31, 1998, are as follows:
Current deferred tax assets:
Accruals not currently deductible for tax $ 46,466
Current portion of valuation allowance (46,466)
-----------
$ --
===========
Noncurrent deferred tax assets:
Book amortization in excess of tax amortization $ 35,695
Patent reserve 71,220
Net operating loss carryforwards 4,106,157
Book depreciation in excess of tax depreciation 43,287
Noncurrent portion of valuation allowance (4,256,359)
-----------
$ --
===========
F-11
<PAGE>
The Company was in a consolidated tax loss position for the years ended December
31, 1998 and 1997, and therefore had no federal income tax expense. Deferred tax
assets of approximately $4,106,000 as of December 31, 1998 ($2,600,000 as of
December 31, 1997), from loss carryforward benefits have not been recorded
because of the uncertainty of realizing such benefits.
A reconciliation of the U.S. Federal statutory rate to the Company's effective
tax rate is as follows:
1998
----
Statutory federal rate 34%
Effect of state taxes 6%
40%
Net operating loss carryforwards for federal tax purposes totaled approximately
$10,265,000 at December 31, 1998. These losses are available for carryforward
against future years' taxable income, subject to certain limitations, and expire
in various years through 2018.
4. LONG TERM DEBT AND OTHER FINANCING ARRANGEMENTS
Long term debt and other financing arrangements consist of the following at
December 31, 1998:
Equipment financing $ 69,649
Insurance and other financing 21,607
--------
Total financing 91,256
Less current portion (66,109)
--------
Total long term debt $ 25,147
========
In September 1997 the Company closed on a five-year term loan and borrowed
$250,000. Interest was payable monthly at an annual rate of 14%; principal
repayments were over 54 months and began 6 months after takedown. In connection
with the closing, the Company issued two warrants to the lender, each to
purchase 62,500 shares of Common Stock at $1.18 (market price at closing) and
$1.475 (25% premium over market price at closing), respectively. During the
fourth quarter of 1998, the Company paid off the term loan in full.
Equipment financings are payable in monthly installments over varying periods
through November 2001. Interest rates range from 11.5% to 22.4%. Principal
payments are $66,109 in 1999, $20,261 in 2000 and $4,886 in 2001.
F-12
<PAGE>
In October 1997, the Company concluded an arrangement for a factoring facility
whereby the factor purchases eligible receivables and advances 80% of the
purchased amount to the Company. Purchased receivables may not exceed $600,000
at any one time. The arrangement may be canceled by either party with 30 days
notice. If the Company cancels, certain penalties apply. At December 31, 1998,
there were no factored receivables. This arrangement is accounted for as a sale
of receivables on which the factor has recourse to the 20% residual of aggregate
receivables purchased and outstanding.
5. 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 had a par and stated
value of $.01 and $10, respectively.
The holders of the Preferred Stock were 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 Stock and accrued dividends thereon through the Conversion Date, were
converted into 1,714,101 shares of Common Stock during the first and second
quarters of 1997. Such amount was determined by dividing the aggregate of the
stated value of the Preferred Stock plus accrued dividends by 75% of the five
day average closing bid price of the shares of Common Stock immediately prior to
conversion.
COMMON STOCK
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. The placement agent was granted a
warrant to acquire 321,490 units at .935 per unit which consists of one share of
Common Stock and one warrant to acquire one share of Common Stock at $2.00 per
share. In May 1997, the placement agent partially exercised the warrant and
acquired 150,000 warrants. The remaining 171,490 units are currently exercisable
and expire April 3, 2001. In connection with the partial exercise, the Company
granted warrants for purchase of an aggregate 150,000 shares of Common Stock at
$1.3125 per share to the placement agent. Such warrants are currently
exercisable and expire on June 18, 2002.
Included in the April 1996 private placement were 382,353 units to satisfy the
Company's obligation to S. Steven Carl and his father, the Chairman Emeritus,
who had advanced $325,000 to the Company.
F-13
<PAGE>
During 1997, employee stock options were exercised to purchase 10,000 shares of
Common Stock at $1.9375 per share.
During 1998, the Company sold 3,240,000 shares of Common Stock at $0.31 per
share and received net proceeds of $999,400.
During 1998, the Company issued 21,333 shares of Common Stock to its outside
directors as a part of their annual compensation.
WARRANTS
In May and September 1993 and January 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 through 1999. At December 31, 1998
such warrants for 212,500 shares of Common Stock remain outstanding and expire
in 1999.
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, which are currently
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.
As of December 31, 1998, outstanding warrants issued for the purchase of shares
of Common Stock to various consultants at exercise prices ranging from $0.22 to
$5.00 per share totaled 442,500. Of the warrants outstanding, 425,000 are
currently exercisable within the above price range and expire at various dates
through September 2004.
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 2001.
Warrants for the purchase of 125,000 shares were issued to a lender in September
1997 (Note 4). Such warrants are exercisable September 1998 through August 2003.
F-14
<PAGE>
6. STOCK BASED COMPENSATION
In October 1993, the Company adopted an incentive stock option plan for 350,000
shares of Common Stock that 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 2007.
In addition to the above plans, the Company granted:
a. an officer/director options to purchase 250,000 shares of Common Stock at
an exercise price of $1.75 per share. The options are currently exercisable
and expire not later than December 31, 2005.
b. a former Director options to purchase 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 290,000 shares of Common Stock
at exercise prices ranging from $0.31 to $2.50 per share. The options,
granted through 1997, are exercisable from 1997 to 2001 and expire in
various years through 2001. At December 31, 1998, 140,000 options are
outstanding of which 130,000 are exercisable.
F-15
<PAGE>
Overall activity in the Company's stock options:
Years Ended December 31,
-----------------------------------------------
1998 1997
-------------------- --------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----
Outstanding, at beginning
of year 1,351,400 $ 1.79 1,547,000 $ 2.54
Granted (including repriced
options) 763,500 0.31 1,042,500 1.34
Exercised -- -- (10,000) 1.94
Canceled (including options
cancelled due to repricing) (807,400) 0.65 (1,228,100) 2.35
--------- ----------
Outstanding at end of year 1,307,500 0.95 1,351,400 1.79
========= ==========
Exercisable at end of year 1,078,700 1.07 889,000 1.52
========= ==========
Details regarding the options outstanding at December 31, 1998:
Outstanding Exercisable
------------------------------------------------ ---------------------
Weighted Weighted Weighted
Exercise Average Average Average
Price Remaining Exercise Exercise
Range Number Life Price Number Price
----- ------ ---- ----- ------ -----
$0.31 - $0.41 755,500 4.27 $ 0.31 538,700 $ 0.31
$0.41 - $5.00 552,000 3.15 1.82 540,000 1.82
--------- ---------
1,307,500 1,078,700
========= =========
F-16
<PAGE>
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,
-----------------------------
1998 1997
---- ----
Grant-date fair value per options $ 0.23 $ 1.42
Significant assumptions (weighted average)
Risk-free interest rate at grant date 5.6% 5.51%
Expected stock price volatility 87.8% 134%
Expected dividend payout -- --
Expected option life 5 years 1.2 years
Net Income (loss)
As reported $ 40,430 $(4,461,865)
Pro forma (207,789) (5,279,252)
Net loss per share of Common Stock
As reported $ -- $ (0.58)
Pro forma (0.02) (0.69)
The expected option life considers historical option exercise patterns and
future changes to those exercise patterns anticipated at the date of grant.
7. SEGMENT INFORMATION
For the year ended December 31, 1998, the Company's major business segments
included in continuing operations are pipeline rehabilitation services in the
marine and municipal markets and sales of industrial chemicals.
Segment information for agricultural products and consumer products are not
provided since CCT and HCP are accounted for as discontinued operations in the
accompanying consolidated financial statements.
Information by segment for the year ended December 31, 1998:
<TABLE>
<CAPTION>
Industrial
Marine Municipal Chemicals Corporate Consolidated
------ --------- --------- --------- ------------
<S> <C> <C> <C> <C> <C>
Sales to unaffiliated customers $2,746,003 $ 173,013 $249,939 $ -- $ 3,168,955
Income (loss) from continuing operations 1,063,785 (159,802) 91,325 (1,526,672) (531,364)
Total assets 1,055,381 287,168 100,559 504,388 1,947,496
Depreciation and amortization 88,397 39,744 -- 183,093 311,234
Capital expenditures 127,023 81,210 -- 24,043 232,276
</TABLE>
F-17
<PAGE>
Information by segment for the year ended December 31, 1997:
Industrial
Products Corporate Consolidated
-------- --------- ------------
Sales to unaffiliated customers $ 1,404,641 -- $ 1,404,641
Income (loss) from continuing
operations (668,176) $(1,965,976) (2,634,152)
Total assets 894,381 755,769 1,650,150
Depreciation and amortization 366,978 152,307 519,285
Capital expenditures 294,600 17,045 311,645
During 1997, the Company monitored its pipe cleaning and industrial chemical
segments in the industrial products segment. In 1998, the Company split
industrial products into three segments consisting of marine, municipal and
industrial chemicals.
The Company's strategy involves concentrating its efforts on providing water
rehabilitation services to a diverse group of customers. The company has been
undertaking substantial efforts to diversify its customer base and expand its
markets. In 1997 and 1998, sales to the U.S. Navy under the five year Portsmouth
contract were 34% and 66%, respectively, of consolidated sales from continuing
operations. The aggregate revenues from the servicing of United States vessels,
which includes sales from cleaning of vessels outside of the Portsmouth
Contract, represented 50% and 87% of consolidated sales from continuing
operations for the fiscal years ended December 31, 1997 and 1998, respectively.
8. COMMITMENTS AND CONTINGENCIES
LITIGATION
The Company is a defendant in various legal actions and claims incident to the
conduct of its business. Although the ultimate resolution of these matters is
not known, management and its legal counsel believe the Company has meritorious
defenses and the outcome will have no material effect on the Company's financial
position.
ENVIRONMENTAL MATTERS
Management believes the Company is in compliance with federal and state
environmental regulations that pertain to the sale and use of its products.
F-18
<PAGE>
LEASE COMMITMENTS
The Company has operating leases, expiring through 2001, for office and
warehouse facilities in Phoenix, Arizona, Portsmouth, Virginia and National
City, California and for office equipment. Rental expense associated with all
operating leases of continuing operations was $166,995 and $167,761 for the
years ended December 31, 1998 and 1997, respectively.
Future minimum payments under operating leases as of December 31, 1998 are:
Years Ending
December 31, Amount
------------ ------
1999 $ 153,187
2000 123,837
2001 75,878
2002 443
----------
353,345
==========
F-19
<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/ S. Steven Carl
-----------------------
Dated: March 26, 1999 S. Steven Carl, President and
Chief Executive Officer
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.
Name Title Date
- ---- ----- ----
/s/ S. Steven Carl Chairman of the Board, March 26, 1999
- ------------------------ Chief Executive Officer
S. Steven Carl and President
/s/ Jerome H. Ludwig Director March 26, 1999
- ------------------------
Jerome H. Ludwig
/s/ Robert M. Leopold Director March 26, 1999
- ------------------------
Robert M. Leopold
/s/ Salvatore Dimascio Director March 26, 1999
- ------------------------
Salvatore DiMascio
/s/ R. John Armstrong Director March 26, 1999
- ------------------------
R. John Armstrong
/s/ Michael H. Harader Chief Financial Officer March 26, 1999
- ------------------------ (Principal Financial and
Michael H. Harader Accounting Officer)
Page 39
Exhibit 21
SUBSIDIARIES
Name State of Incorporation
---- ----------------------
H.E.R.C. Consumer Products, Inc. Arizona
CCT Corporation Arizona
Page 40
Exhibit 23 (1)
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 January 31, 1998, (which contained an explanatory paragraph
relating to the Company's ability to continue as a going concern), 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, 1998.
We also consent to the reference to us under the caption "Experts" in the
Prospectus.
/s/ BDO Seidman, LLP
Chicago, Illinois
March 29, 1999
Page 41
Exhibit 23 (2)
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-KSB, into the Company's previously filed
Registration Statement File No.'s 33-92870, 333-5175, 333-13349 and 333-19361.
/s/ Arthur Andersen LLP
Phoenix, Arizona
February 5, 1999.
Page 42
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
H.E.R.C. PRODUCTS INCORPORATED
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 242,867
<SECURITIES> 0
<RECEIVABLES> 627,986
<ALLOWANCES> 11,630
<INVENTORY> 19,430
<CURRENT-ASSETS> 1,073,925
<PP&E> 958,736
<DEPRECIATION> 322,311
<TOTAL-ASSETS> 1,947,496
<CURRENT-LIABILITIES> 624,784
<BONDS> 0
0
0
<COMMON> 114,919
<OTHER-SE> 1,182,646
<TOTAL-LIABILITY-AND-EQUITY> 1,947,496
<SALES> 3,168,955
<TOTAL-REVENUES> 3,168,955
<CGS> 1,327,782
<TOTAL-COSTS> 3,325,694
<OTHER-EXPENSES> 288,865
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 85,760
<INCOME-PRETAX> (531,364)
<INCOME-TAX> 0
<INCOME-CONTINUING> (531,364)
<DISCONTINUED> 571,794
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 40,430
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
EXHIBIT 99 (1)
RISK FACTORS
CURRENT PROFITABLE PERIODS MAY NOT INDICATE PERMANENT TREND. HERC had
substantial losses from continuing operations for each fiscal year from 1994,
the year it went public, until 1998. HERC reported a profit for each of the
quarters ended September 30, 1998 and December 31, 1998. Although HERC believes
that the revenues will continue to grow and it will operate profitably on a
current basis, it is possible that HERC will not be profitable in the future.
The current trend of profit should not be taken as an assurance of future
profitable periods.
HERC MAY NEED FINANCING IN THE FUTURE AND DOES NOT HAVE ANY COMMITTED SOURCES OF
FINANCING. If HERC is not profitable in the future for an extended period of
time, it will require additional financing to cover operating expenses. Also,
any major capital expenditures will require capital from independent financing
sources. HERC does not have any accumulated retained earnings to fund cash flow
deficits and significant capital requirements. HERC does not have any
specifically identified sources for future financing requirements.
THE CURRENT DEPENDENCE ON ONE SIGNIFICANT CUSTOMER HAS THE POTENTIAL FOR ADVERSE
FINANCIAL RESULTS. During the most recent fiscal year, the United States Navy
accounted for approximately 66 % of the HERC revenues. The loss of a substantial
portion or all of the business from this customer will result in a material
adverse effect on the revenues and profits of HERC. If the United States Navy
cuts back or stops using HERC, the sales staff may not be able to replace this
customer in a timely enough fashion for HERC to continue operations.
POTENTIAL COMPETITION EXISTS FOR CUSTOMERS IN THE MARINE BUSINESS. HERC believes
that there are no substantial capital requirements for or other barriers to
entry into the chemical cleaning of pipe systems for the marine industry.
Therefore, there is potential competition from entities that elect to enter into
this growing industry. As with any competition, there may be an adverse effect
on market share and current margins of HERC.
THE LACK OF PATENTS MAY LIMIT THE ABILITY OF HERC TO PROTECT ITS CURRENT
COMPETITIVE POSITION IN THE MARINE BUSINESS. HERC competes on the basis of its
knowledge and experience of marine and other closed loop systems. The chemical
products used in the marine business are based on proprietary chemistry, but
this chemistry is not patented or, HERC believes, patentable. Therefore, others
may develop the same chemistry through reverse technology methodology or by
experimentation. If that happens, another entity could offer the same benefits
as HERC and increase the competition in the marine pipe systems cleaning. Also,
the lack of patents limits the ability of HERC to market an absolutely unique
product or service. HERC relies on trade secret and confidentiality protection
with respect to the chemicals and methodologies it uses in its marine business.
It is possible that these means will not be adequate to protect HERC from
competitors.
EFFECT OF PRODUCT LIABILITY CLAIMS IN EXCESS OF THE INSURANCE LIMITS COULD
AFFECT THE FINANCIAL CONDITION OF HERC. HERC is engaged in a business that might
expose it to claims for personal or property injury. Suits may result from
personnel who are injured on site or from damage to a pipe system being cleaned.
HERC has not been sued to date. HERC maintains liability insurance in the
aggregate amount of $2,000,000 and $1,000,000 per occurrence. HERC also has an
umbrella liability policy in the amount of $3,000,000. If there is a successful
claim against HERC that is in excess of the insurance limits or that is not
covered, HERC would have a material adverse effect on its financial condition.
HERC DEPENDS ON THIRD PARTY SUPPLIERS WHICH, IF LOST, MIGHT DISRUPT OPERATIONS
OR EFFECT MARGINS. Some of the chemical products that are used in pipe system
cleaning must be packed to NFS standards. There are only a few suppliers which
meet these requirements. If the current supplier is unable to or will not supply
HERC, or becomes too expensive, HERC may have difficulty in finding an
alternative supplier. If HERC is not prepared for a change in suppliers, it will
disrupt its business because it does not maintain any significant inventories of
the items it obtains from this supplier. Also, any change in suppliers may
result in higher prices which might lower margins and profits.
Page 44
<PAGE>
EFFECT OF OUTSTANDING RESTRICTED COMMON STOCK ON FUTURE SALES BY HERC AND
STOCKHOLDERS. HERC sold an aggregate of 3,240,000 shares of common stock in the
fiscal quarter ended June 30, 1998 at $.31 per share. This amount represented
about 30% of the current outstanding common stock immediately after the
transaction. These shares were sold to finance the business in 1998. One year
after the date of sale, these shares will become eligible for public sale
without any registration statement. As a result there may be an adverse impact
on the price and liquidity of the common stock in the public market because of
the volume of their possible sale.
EFFECT OF OUTSTANDING OPTIONS AND WARRANTS ON MARKET PRICE AND LIQUIDITY. HERC
has issued options and warrants to purchase 6,210,382 shares of common stock. Of
that number, 3,214,902 shares are subject to warrants that expire on April 3,
1999 and are exercisable at $2.00 per share. Of the remaining options and
warrants after April 3, 1999, about 30% of them have a purchase price per share
at less than the current market price of the common stock and are currently
exercisable and may be sold in the public market. The existence of the options
and warrants may have an adverse impact on the price and liquidity of the common
stock in the public market because of the overhang they create. Also, the
issuance of these shares at prices below the market price will result in
dilution to current shareholders.
Page 45
