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, 1999
[ ] 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 (IRS Employer
or Organization) Identification Number)
2215 West Melinda Lane, Suite A
Phoenix, Arizona 85027
(Address of principal executive offices)
(623) 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. $3,489,743
At February 17, 2000, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $5,264,478 based on the closing market
price of the Common Stock on such date as reported by the OTC BB Market of
$0.48. This calculation assumes that the affiliates of the Company are its board
of directors and its officers.
At March 10, 2000, there were 11,666,187 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 1998 and
1999 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 2000 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 2000 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 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 I
ITEM 1. BUSINESS
GENERAL
H.E.R.C. Products Incorporated is a chemical and engineering technology
company that develops and patents products and processes for use on water scale
and corrosion on surfaces, in pipeline systems and in soils. HERC markets its
products to municipal, industrial and other customers directly and through key
strategic alliances. HERC's cleaning services are directed toward commercial,
industrial, marine, municipal and other customers.
Over time, most water systems, such as potable water delivery systems,
sprinkler systems, waste systems, process water systems 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 remove the scale and corrosion and restore the
efficiency and flow characteristics of the system.
HERC uses patented and other proprietary chemical products in its cleaning
services. HERC's chemistry is circulated 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 certified biodegradable by Scientific Certification Systems, an independent
certifying and testing laboratory ("Green Cross").
HERC's chemical products and processes were developed to provide a more
cost effective and efficient means of cleaning pipe systems in contrast to
replacement, mechanical scraping, pigging, hydro blasting or other pipe cleaning
methods. HERC's products 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.
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The relative contribution of the business segments to HERC's operating
revenue and operating profit for the two years ended December 31, 1999, 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 (623) 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 cleaning methods for various water systems include
replacement, mechanical scraping, hydro blasting, pigging and chemical cleaning.
HERC offers a method of chemical cleaning which it believes is a significant
improvement over most other cleaning methods because it is faster, cheaper and
more complete and has a lower environmental impact.
Pipe-Klean and Well-Klean, some of the 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.
PIPE CLEANING DIVISION
HERC provides pipe cleaning and other corrosion removal and control
services targeted at many customers and industries. Included are pipe systems
for marine, industrial, potable water, wastewater, fire protection, cooling,
chemical feed line and other applications. During 1999, total pipe cleaning
revenue increased 11% to $3,248,000 from $2,919,000 in 1998.
MARINE
The marine applications focus on the cleaning of shipboard pipe systems for
water and wastewater. In particular, the vacuum waste systems aboard most marine
vessels develop a scale in the pipe interiors that requires cleaning
approximately once every 12-18 months. The principal customers of the pipe
cleaning 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 is renewable on a year-to-year basis at the option of the U.S. Navy and
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 1998 HERC cleaned piping systems on board seventy-two United
States vessels. During 1999 HERC cleaned piping systems on board a total of
eighty-four United States vessels.
In order to meet the requirements of the Portsmouth contract, and to better
serve the East Coast market, HERC opened an office in Portsmouth, Virginia
during 1997. In 1998, HERC opened an office in San Diego to expand its ability
to offer its pipe cleaning services to the Pacific Fleet, Western United States
Coast Guard and other west coast customers. The division employs a sales staff
located in both of its coastal offices and its corporate headquarters in Phoenix
to service its existing customers and to generate additional pipe cleaning
sales.
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FIRE PROTECTION
HERC developed its patented process for cleaning fire protection systems in
1993. Since then, HERC has chemically cleaned many fire protection systems for
several industries and customers. HERC believes that it has a significant
advantage in securing fire protection system cleaning work because HERC has a
patent that covers the process of chemically cleaning a fire protection system
and because HERC is experienced in such work. HERC is unaware of any other
current method that could be used to economically clean such systems.
One such system was in the McCarran International Airport in Las Vegas,
Nevada. As is typical of many such systems, the sprinkler system had become
severely corroded with microbiologically influenced corrosion (MIC) and was not
achieving required operational levels. As a result of the cleaning done on this
and other sites, HERC has been recognized by the American and National Fire
Sprinkler Associations as a rehabilitative method for fire protection systems.
HERC continues to pursue 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 area of the
pipe system market. HERC believes that these endorsements would be beneficial in
its marketing, since insurance premiums are usually a reflection of system
performance. At this time HERC has no indication that it will achieve
certification or what the timing might be if it did. HERC is also pursuing
certification of its Pipe Klean product by Underwriters Laboratories, Inc.
("UL"). Sales from chemical cleaning of fire protection systems increased 200%
to $300,000 in 1999 from $100,000 in 1998.
HERC is currently in the process of establishing a licensing program
whereby HERC plans to license the use of its process patent for cleaning fire
protection systems to acceptable fire sprinkler contractors and/or other
companies involved in the fire protection industry for a minimum yearly fee plus
royalties based on the licensee's fire protection cleaning revenue. HERC has not
entered into any such agreement as of December 31, 1999. There can be no
assurance that HERC will be successful in its implementation of the licensing
program or that HERC will successfully complete any such license agreement.
POTABLE WATER
Underground potable waterlines represent another market in which HERC may
use its expertise in pipe system cleaning. HERC has many patents covering the
process of chemically cleaning potable water distribution systems. In addition,
its chemical products used for this application are ANSI/NSF Standard 60
certified. Because of the above factors and because of the size of the potable
water distribution system market, HERC believes that it has significant
potential in this business. The standards developed by NSF that have been used
to approve HERC's products have been adopted legislatively in many states and
are policy in many others.
The most common problem found in potable water 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 main line 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.
Recently HERC has focused its attention primarily on marine system pipe
cleaning and secondarily on fire protection system pipe cleaning where its
margins are better and the sales cycle is faster. One reason for this focus has
been the long lead-time to consummate potable water system sales contracts and
the expense of obtaining and servicing these contracts. Often payment is
dependent on the work of other contractors and lengthy approval processes.
Although HERC focused its attention in this segment from 1994 to early 1997, it
currently represents an insignificant portion of its business. HERC anticipates
it becoming a more significant part of its business over time.
INDUSTRIAL, WATER TREATMENT AND OTHER
In industrial plants, tuberculation greatly reduces heat exchange,
condensing and flow capacities. In water treatment plants, chemical feed lines
become internally clogged to the point where they do not function properly.
Anywhere there are pipes, there is a need for HERC cleaning methods. HERC is
currently working to expand its application base to multiple areas. In the
future, HERC believes that industrial, water treatment and other piping systems
will benefit from HERC's cleaning processes.
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INDUSTRIAL CHEMICALS DIVISION
The industrial chemicals division manufactures and sells chemical products
using HERC's proprietary and patented formulas for applications in the removal
of salt, scale and corrosion and in the maintenance of water process systems.
These products are currently Well-Klean(R), Line Out(R) and several Process
Water products including certain products currently being manufactured under a
private label for Dupont. Industrial chemical sales totaled $250,000 and
$242,000 in 1998 and 1999 respectively.
Well-Klean is used to remove scale and corrosion in water wells. Over time
the well screen and many other well components become clogged. When added to
wells following HERC's instructions, Well-Klean removes the harmful corrosion
and corrosion by products from the well components and the surrounding aquifer
to restore well pumping characteristics that ultimately lead to improved well
performance. With no marketing emphasis, Well-Klean sales were flat from 1998 to
1999. HERC anticipates that it will increase its marketing efforts for
Well-Klean in 2000.
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. (NASDAQ: ESSI) for golf courses in the United States.
Chlor*Rid is a product that utilizes one of HERC's core formulas 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 name Compound
360. These are used in the de-scaling and maintenance of all types of process
water systems. These include cooling towers, heat exchangers and condensers.
During 1999, HERC entered into agreements with Dupont whereby HERC will
manufacture private labeled products for Dupont using HERC formulas. In addition
to realizing the gross profit from the manufacturing of the product, HERC will
receive royalties on the sales of the defined product. HERC may also market its
products to the same customers and can use the Dupont trade name in certain
marketing pieces.
MARKETING AND DISTRIBUTION
HERC markets its products and services through its marketing and sales
staff and independent distributors and sales representatives as well as through
strategic partnerships and marketing agreements. In 1998 and 1999, sales to the
U.S. Navy under the Portsmouth contract were 66% and 70% respectively of
consolidated sales from continuing operations.
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 several "800" numbers in connection with its
advertising, direct mail programs and order entry. HERC has a web sight that
explains HERC's products and services and gives detailed information about the
Company. HERC's web site address is WWW.HERCPROD.COM. The primary emphasis of
the advertising is to promote awareness of HERC and its various products and
services.
COMPETITION
Regional contractors normally perform water well and water-based pipeline
system revitalization and rehabilitation. There are no major companies that
dominate this business in the Marine, Municipal or Industrial markets. 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
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seeks to sell its water system pipeline rehabilitation products 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 large as the chemical producers, the contracting companies
are still generally larger and more established in the industry than HERC.
HERC anticipates that 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 many other water system treatment chemicals and methods because they
work better, are easier to use, less expensive and 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 chemicals and processes 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 and fire protection
systems, a United States patent on the mobile re-circulation units employed in
the pipe cleaning process and a series of United States patents on the core
chemical technology used for pipe cleaning and industrial water applications.
HERC has also received a Notice of Allowance for its basic pipe-cleaning patents
for the association of European countries and has applied for these patents
throughout Europe in 1999. Additionally, U.S. Patent applications for Methods of
Pipe Cleaning and improvements on the basic method were issued and received by
HERC during 1999. Other patent applications for pipe cleaning markets and
methods are pending from prior years and new applications filed during 1999.
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 that could have a material adverse effect on HERC.
h.e.r.c.(R), Well-Klean(R), Pipe-Klean(R), and Line-out(R)are registered
trademarks of HERC.
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,
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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. 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
by Scientific Certification Systems. 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
HERC estimates that it spent $13,000 on research and development activities
during 1999.
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 the business of 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
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$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 statements of operations.
EMPLOYEES
As of February 21, 2000, HERC had 53 employees. 3 are officers, 39 are
engaged in field operations and production, 8 are in administration, and 3 are
in marketing and sales. 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 and certain cleaning services
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 approximately 22,000 square feet of office and warehouse
facilities in Phoenix, Arizona, 5,530 square feet of office and warehouse
facilities in Portsmouth, Virginia, and 2,400 square feet of office and
warehouse facilities in National City, California. One Phoenix location is
16,000 square feet, 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. This 16,000 square foot facility is not occupied by HERC and
has been sublet for the duration of the lease. HERC's corporate headquarters are
located in a facility approximately 6,000 square feet in size. This 6,000 square
foot facility is under an operating lease that expires April 30, 2002 and
provides for monthly payments escalating from $4,491 to $4,617 over the term of
the lease. The Portsmouth facility is under an operating lease expiring December
31, 2002. The lease provides for monthly payments escalating from $2,627 to
$2,841 over the term of the lease. 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.
Under the terms of the sublease discussed above, HERC will receive rental
payments from the sublessee in the amount of $10,210 per month until April 2001.
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 as a third-party plaintiff a civil claim against HERC in an 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, acting through its insurance carrier pursuant to the
submitted claim under its comprehensive general liability policy, has
substantially denied liability for the original claim.
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 or results of
operations.
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, 1999.
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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 trading prices of the
common stock as quoted by OTC BB for the periods indicated. Such quotations
reflect inter-dealer prices, without retail mark-up, markdown or commission and
may not necessarily represent actual transactions.
The information is believed, but not guaranteed, to be accurate.
1998 High Low
- ---- ------ ------
First Quarter $ 0.59 $ 0.25
Second Quarter 0.44 0.25
Third Quarter 0.44 0.25
Fourth Quarter 0.37 0.19
1999 High Low
- ---- ------ ------
First Quarter $ 0.41 $ 0.22
Second Quarter 0.42 0.28
Third Quarter 0.39 0.27
Fourth Quarter 0.55 0.30
On February 17, 2000 the closing price for the common stock as quoted by
OTC BB was $0.48.
HOLDERS
As of February 22, 2000, there were 117 record holders of the Common Stock.
HERC believes that as of such date there were approximately 1,530 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 that 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>
Incentive Exercisable At
Stock Options Prices of
to Incentive Stock Options $0.33-$0.39
3/14/99 - Purchase Granted to Employees With Section Through
12/22/99 Common Stock 20,000 No Consideration Received 4(2) 12/22/06
Compensation and Deferred Section
6/15/99 Common Stock 80,000 Compensation to Corporate Officers 4(2) N/a
1/1/99 - Section
10/1/99 Common Stock 80,932 Board of Director Services 4(2) N/a
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
1999 COMPARED WITH 1998
Sales for the fiscal year ended December 31, 1999 were $3,490,000 compared
to $3,169,000 in 1998. The pipe cleaning division accounted for $3,248,000 in
1999, of which $2,447,000 was billed under the Portsmouth contract with the
United States Navy. In 1998, the pipe cleaning division accounted for $2,919,000
of which $2,095,000 was billed under the Portsmouth contract. Industrial
chemical sales were $242,000 in 1999 compared to $250,000 in 1998.
HERC's sales in 1999 have continued to be generated primarily from the
cleaning of pipe systems on board ships. HERC cleaned pipe systems on
eighty-four ships in 1999 compared to seventy-two ships in 1998. HERC has
continued to focus much of its sales and marketing efforts in this area because
of its success in penetrating and expanding its presence in this market in
addition to the higher margins it yields compared to certain other chemical
cleaning applications. Sales in 1999 also reflect the third year of offering
fire protection cleaning services. During 2000, HERC plans to more aggressively
market its pipe cleaning services for fire protection systems utilizing HERC's
patented chemical cleaning process. Sales of industrial chemicals remained about
the same from one year to the next. Sales from cleaning potable and industrial
water systems increased in 1999 because of HERC's efforts to diversify the
markets in which it cleans pipes and other water systems.
Consolidated gross margins were 54% in 1999 compared to 58% in 1998. The
decrease resulted from increased pipe cleaning revenue in non-marine
applications at lower margins than are typically realized cleaning pipe on ships
in addition to certain other one time expenses.
Gross profit increased from $1,841,000 in 1998 to $1,876,000 in 1999 due to
increased revenue. Selling expenses increased to $404,000 in 1999 from $367,000
in 1998 while general and administrative expenses decreased from $1,631,000 in
1998 to $1,551,000 in 1999. The increase in selling expenses was due to
increases in payroll, advertising, trade show, travel and travel related
expenses partially offset by a decrease in commission expenses. The decrease in
general and administrative expenses is attributable primarily to decreases in
rent, amortization, payroll, legal and office equipment rental expenses offset
somewhat by increases in depreciation, telephone, moving, insurance, travel and
bad debt expenses.
10
<PAGE>
For the year ended December 31, 1999, HERC's operating loss was $79,000
compared to $157,000 for the same period in 1998. Additionally, net income for
1999 was $97,000 consisting of income from continuing operations of $24,000 and
income from discontinued operations of $73,000. This compares to net income for
1998 of $40,000 consisting of income from discontinued operations of $571,000
offset by a loss from continuing operations of $531,000.
As HERC continues to focus on marine system pipe cleaning and increases its
efforts to generate a greater percentage of its revenue from chemical sales and
other pipe cleaning applications, it anticipates that revenues in 2000 will
increase over those of 1999. This belief is based on the results of operations
in 1999, the level of activity seen thus far in the year 2000 and the
anticipated results of its increased efforts to expand its revenue base to new
customers and applications, but is subject to change depending on many factors,
including continuing to provide services under the Portsmouth contract,
expanding operations on the west coast and securing contracts in new and
existing markets and locations. It also depends on many factors outside the
control of HERC.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $66,000 at December 31, 1999 and $243,000 at
December 31, 1998 while working capital was $593,000 and $449,000 at those
respective dates. The decrease in cash was due to a temporary slowdown in
collection of accounts receivable in addition to the use of cash to fund
numerous ongoing projects during the fourth quarter. The increase in working
capital during 1999 is a function of HERC's positive EBITDA partially offset by
cash used for capital expenditures, patent expenditures and the pay down of
current debt.
As of December 31, 1999, HERC had total long-term debt of $6,000.
Additionally, as of December 31, 1999, HERC had factored $162,000 of receivables
under its factoring facility (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. that 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 2000. Thus, any material delay, cancellation or reduction of orders from
these customers could have a material adverse effect on HERC's operations.
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.
HERC has experienced no problems as a result of the Year 2000.
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
11
<PAGE>
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.
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 42 Chairman of the Board of Directors, Chief Executive
Officer and President
Michael H. Harader 32 Vice President of Finance, Chief Financial Officer
Salvatore DiMascio 60 Director
R. John Armstrong 56 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 Fotoball USA, a public company. Mr. DiMascio is a
Certified Public Accountant.
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.
12
<PAGE>
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 as follows, (a)
$1,500 semi-annually on the first day of the second and fourth quarters
following such election, (b) $1,000 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 5 meetings during the year ended December 31, 1999.
The Board of Directors has established an Audit Committee and a
Compensation Committee.
The Audit Committee, currently comprised of Messrs. DiMascio and Armstrong,
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 2 meetings during the year ended December 31, 1999.
The Compensation Committee, currently comprised of Messrs. Carl, DiMascio
and Armstrong, has been formed to review overall executive compensation and
review HERC's employee benefit plans. The Compensation Committee held 1 meeting
during the year ended December 31, 1999.
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.
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, 1999, such
persons complied with all Section 16(a) filing requirements.
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, 1999.
<TABLE>
<CAPTION>
Name & Principal Position Year Salary Stock Grant
- ------------------------- ---- ------ -----------
<S> <C> <C> <C> <C>
S. Steven Carl Chairman of the Board, 1999 $133,913 $ 16,500
Chief Executive Officer 1998 $ 82,100 $ --
& President 1997 $100,100 $ --
</TABLE>
Other than the compensation stated in the table, the Named Executive
Officer did not receive non-cash benefits having a value exceeding 10% of his
stated compensation.
13
<PAGE>
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, 1999, HERC had issued under the 1993 Plan
88,000 options exercisable at prices ranging from $0.3125 to $0.32 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, 1999 HERC had issued options under the 1996 Plan to acquire 586,500
shares of Common Stock, exercisable at prices ranging from $0.31 to $1.75 per
share.
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, 1999: (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) 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, (iii) warrants issued to consultants
to purchase 392,500 shares of Common Stock at prices ranging from $0.21875 to
$2.75 per share, (iv) other options issued to employees to purchase 390,000
shares of Common Stock at prices ranging from $0.3125 to $1.75 per share, (v)
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 (vi) 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 2,309,980 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: NONE
Aggregate Year-End Option Values:
<TABLE>
<CAPTION>
Number of Unexercised Options Value of Unexercised in-the-money
At December 31, 1999 Options at December 31, 1999
---------------------------- -----------------------------
Name Exercisable Unexercisable Exercisable Unexercisable
- ---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
S. Steven Carl 210,000 40,000 0(1) 0(1)
</TABLE>
- ----------
(1) The market value at December 31, 1999 of the Common Stock underlying the
options was $0.30 per share. The options are exercisable at prices of
$0.3125 or more.
14
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of January 31, 2000 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.
<TABLE>
<CAPTION>
Amount and Nature of Percentage of Outstanding
Beneficial Common Stock Owned
Name and Address of Beneficial Owner Ownership (1) Beneficially
- ------------------------------------ ------------- ------------
<S> <C> <C>
S. Steven Carl (2)(3) 727,709 6.13
R. John Armstrong (2) 72,752 *
Salvatore T. DiMascio (2)(5) 59,863 *
Lance Laifer and Laifer
Capital Management, Inc. (2) 3,410,000 29.23
Norman H. Pessin (2) 1,025,000 8.79
Shelby A. Carl (2)(4) 597,470 5.10
All executive officers and directors
as a group (6) (four persons) 946,524 7.94
</TABLE>
- ----------
* 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, 2000 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, 2000 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, Armstrong and
DiMascio is c/o H.E.R.C. Products Incorporated, 2215 W. Melinda Lane, Suite
A, 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 210,000 shares issuable pursuant to immediately exercisable
options. Excludes 40,000 shares issuable on options that become exercisable
in the future.
(4) Includes 50,000 shares issuable pursuant to immediately exercisable options
and warrants.
(5) Includes 20,000 shares issuable pursuant to immediately exercisable
options.
(6) Includes shares referred to as being included in notes (3), (4) and (5),
68,200 additional shares and 18,000 shares issuable pursuant to immediately
exercisable options. Excludes shares referred to as being excluded in note
(3) and 32,000 shares issuable on options that become exercisable in the
future.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None
15
<PAGE>
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 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)(3) 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)(4) 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)(5) 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.
16
<PAGE>
(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.
(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.
(10)(16) Employment contract by and between S. Steven Carl and HERC dated June
15, 1999 filed as exhibit 10.26 to HERC's form 10-QSB for the quarter
ended September 30, 1999.
Sequential Page Number
----------------------
(21) Subsidiaries 37
(23) Consent of Independent Public Accountants
(Arthur Andersen LLP) 38
(27) Financial Data Schedule 39
(99) Risk Factors 40
(b) Reports on Form 8-K: NONE.
17
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Index to Consolidated Financial Statements
Page No.
--------
Report of Independent Public Accountants F-2
Financial Statements:
Consolidated Balance Sheet
December 31, 1999 F-3
Consolidated Statements of Operations
Years Ended December 31, 1999 and 1998 F-4
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1999 and 1998 F-5
Consolidated Statements of Cash Flows
Years Ended December 31, 1999 and 1998 F-6
Notes to Consolidated Financial Statements F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To H.E.R.C. Products Incorporated:
We have audited the accompanying consolidated balance sheet of H.E.R.C. PRODUCTS
INCORPORATED (a Delaware corporation) AND SUBSIDIARIES ("the Company") as of
December 31, 1999, and the related consolidated statements of operations,
stockholders' equity and cash flows for the years ended December 31, 1999 and
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 1999, and the results of its operations and its cash flows for the
years ended December 31, 1999 and 1998, in conformity with accounting principles
generally accepted in the United States.
Arthur Andersen LLP
Phoenix, Arizona,
March 3, 2000.
F-2
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheet
December 31, 1999
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 65,722
Trade accounts receivable, net of allowance for
doubtful accounts of $44,620 873,045
Inventories 45,990
Deferred expenses 118,443
Other receivables 8,611
Prepaid expenses 120,380
------------
Total Current Assets 1,232,191
------------
PROPERTY AND EQUIPMENT
Property and equipment 1,107,000
Less accumulated depreciation 508,773
------------
Net Property and Equipment 598,227
------------
OTHER ASSETS
Patents, net of accumulated amortization of $109,465 108,017
Patents pending 89,104
Refundable deposits and other assets 62,579
------------
Total Other Assets 259,700
------------
$ 2,090,118
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 263,462
Accrued wages 77,503
Current portion of notes payable 30,592
Other accrued expenses 267,601
------------
Total Current Liabilities 639,158
LONG-TERM LIABILITIES
Notes payable, net of current portion 6,134
------------
Total Liabilities 645,292
------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $10.00 stated value;
authorized 1,000,000 shares;
issued and outstanding zero shares --
Common Stock, $0.01 par value; authorized
40,000,000 shares; issued and outstanding
11,652,853 shares 116,529
Additional paid-in capital 13,972,584
Accumulated deficit (12,644,287)
------------
Total Stockholders' Equity 1,444,826
------------
$ 2,090,118
============
The accompanying notes are an integral part of this consolidated balance sheet.
F-3
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31,
----------------------------
1999 1998
------------ ------------
SALES $ 3,489,743 $ 3,168,955
COST OF SALES 1,613,620 1,327,782
------------ ------------
GROSS PROFIT 1,876,123 1,841,173
SELLING EXPENSES 403,955 366,946
GENERAL AND ADMINISTRATIVE EXPENSES 1,550,992 1,630,966
------------ ------------
OPERATING LOSS (78,824) (156,739)
------------ ------------
OTHER INCOME (EXPENSE)
Interest expense (18,105) (85,760)
Miscellaneous 24,698 18,760
Expenses relating to settlement of lawsuits -- (120,000)
Gain (loss) on sale or disposal of equipment 96,028 (265,222)
Gain on sale of patent -- 77,597
------------ ------------
Total Other Income (Expense) 102,621 (374,625)
------------ ------------
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE INCOME TAXES 23,797 (531,364)
Income tax provision -- --
------------ ------------
INCOME (LOSS) FROM CONTINUING OPERATIONS 23,797 (531,364)
DISCONTINUED OPERATIONS:
Income from Operations of
Discontinued Segments -- 256,792
Income from Disposition of
Discontinued Segments 73,063 315,002
------------ ------------
NET INCOME $ 96,860 $ 40,430
============ ============
INCOME (LOSS) PER COMMON SHARE -
BASIC AND DILUTED
INCOME (LOSS) FROM CONTINUING OPERATIONS $ -- $ (0.05)
INCOME FROM DISCONTINUED OPERATIONS 0.01 0.05
------------ ------------
NET INCOME PER COMMON SHARE $ 0.01 $ --
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
BASIC 11,596,318 10,391,936
============ ============
DILUTED 11,658,081 10,391,936
============ ============
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
<TABLE>
<CAPTION>
Common Stock Additional
--------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
---------- -------- ----------- ------------ ----------
<S> <C> <C> <C> <C> <C>
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
Net Income -- -- -- 96,860 96,860
Issuance of shares of Common Stock 160,932 1,610 48,791 -- 50,401
---------- -------- ----------- ------------ ----------
BALANCE,
DECEMBER 31, 1999 11,652,853 $116,529 $13,972,584 $(12,644,287) $1,444,826
========== ======== =========== ============ ==========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------
1999 1998
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 96,860 $ 40,430
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Depreciation and amortization 219,969 311,234
(Gain) loss on sale or disposal of equipment (96,028) 265,222
Gain on sale of patent -- (77,597)
Common stock issued for services 43,800 6,000
(Increase) decrease in assets
Trade accounts receivable (256,689) (605,852)
Inventories (26,560) 946
Deferred expenses (104,450) (13,993)
Other receivables (4,356) 7,708
Prepaid expenses (63,748) (16,875)
Refundable deposits and other assets 14,414 17,019
Increase (decrease) in liabilities
Accounts payable 107,812 (174,070)
Accrued wages and other accrued expenses 139,032 11,676
Customer Deposits (42,447) 42,447
Change in net liabilities of discontinued operations (40,314) (167,707)
--------- ---------
Net cash used in operating activities (12,705) (353,412)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (164,885) (232,276)
Cash received from the sales of equipment 106,000 5,974
Expenditures related to patents and patents pending (51,025) (48,677)
--------- ---------
Net cash used in investing activities (109,910) (274,979)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock -- 999,400
Proceeds from issuance of notes payable and long-term debt 155,996 137,431
Principal payments under notes payable (210,526) (400,969)
--------- ---------
Net cash provided by (used in) financing activities (54,530) 735,862
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (177,145) 107,471
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 242,867 135,396
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 65,722 $ 242,867
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE>
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
H.E.R.C. Products Incorporated (the "Company") provides pipeline rehabilitation
services for marine, fire protection, potable water, wastewater and industrial
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).
The Company's strategy involves concentrating its efforts on providing pipeline
rehabilitation services to a diverse group of customers. The company has
undertaken and continues to undertake substantial efforts to diversify its
customer base and expand its markets. In 1999 and 1998, sales to the U.S. Navy
under the Portsmouth contract were 70% and 66%, respectively, of consolidated
sales. The 5-year U.S. Navy contract is renewable each year at the option of the
U.S. Navy. If the U.S. Navy renews the contract for any such year, the minimum
annual amount that the U.S. Navy must spend with HERC to meet the obligations of
the contract is approximately $75,000.
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. All references to the
Company herein refer to the Company and its subsidiaries. CCT and HCP are
accounted for as discontinued operations (Note 2).
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.
F-7
<PAGE>
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
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.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards ("SFAS") 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.
STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25 (APB No. 25), under which no compensation cost
is recognized. In October 1995, the Financial Accounting Standards Board issued
SFAS No.123 requiring companies that account for stock-based compensation as
prescribed by APB No. 25 to disclose the pro forma effects on earnings and
earnings per share as if SFAS No.123 had been adopted and certain disclosures
with respect to stock compensation and the assumptions used to determine the pro
forma effects of SFAS No.123.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair value of financial instruments has been determined by the
Company using available market information and valuation methodologies.
Considerable judgment is required in estimating fair values. Accordingly, the
estimates may not be indicative of the amounts that would be realized in a
current market exchange. The carrying values of cash equivalents, accounts
receivable, accounts payable and other accrued liabilities approximate fair
value due to the short maturities of these instruments.
INVENTORIES
Inventories consist primarily of finished goods and are stated at the lower of
cost or market (net realizable value). Cost is determined by a method that
approximates 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 tax reporting purposes.
Property and equipment at December 31, 1999 are:
Equipment $ 951,856
Office furniture and computers 155,144
-----------
1,107,000
Less accumulated depreciation (508,773)
-----------
Net property and equipment $ 598,227
===========
The Company periodically evaluates the carrying value of long-lived assets in
accordance with SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
AND FOR LONG LIVED ASSETS TO BE DISPOSED OF. Under SFAS No. 121, long-lived
assets and certain identifiable intangible assets to be held and used in
operations are reviewed for impairment whenever events or circumstances indicate
that the carrying amount of an asset may not be fully recoverable. An impairment
loss is recognized if the sum of the expected long-term undiscounted cash flows
is less than the carrying amount of the long-lived assets being evaluated.
The useful lives of property and equipment for computing depreciation range from
three to ten years. Depreciation expense was $193,111 and $161,728 for the years
ended December 31, 1999 and 1998, respectively.
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
approximately $9,000 and $4,000 for the years ended 1999 and 1998, 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.
Costs related to uncompleted projects of $118,443 at December 31, 1999 are
deferred until the projects are completed.
F-9
<PAGE>
EARNINGS PER SHARE
The Company has 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.
A reconciliation of the basic and diluted earnings per share (EPS) computation
for the years ended December 31, 1999 and 1998 is as follows:
Year Ended December 31, 1999
----------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $96,860 11,596,318 $ 0.01
========
Effect of stock options and warrants -- 61,763
------- ----------
Diluted EPS $96,860 11,658,081 $ 0.01
======= ========== ========
Year Ended December 31, 1998
----------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $40,430 10,391,936 $ --
========
Effect of stock options and warrants -- --
------- ----------
Diluted EPS $40,430 10,391,936 $ --
======= ========== ========
RECENTLY ADOPTED ACCOUNTING STANDARDS
In 1998, the Company adopted SFAS 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.
2. DISCONTINUED OPERATIONS
During the fourth quarter of 1997, the Company discontinued operations of its
agricultural business, CCT, and wrote down its related assets. CCT is accounted
for as a discontinued operation in the accompanying financial statements. During
the fourth quarter of 1998, the Company concluded the sale of the business 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 annual revenues above $1 million on certain consumer products
for a period of three years from the closing date. These royalties will be
recognized as revenue when and if they are earned. All remaining consumer
products inventories were purchased as a part of the transaction.
F-10
<PAGE>
CCT Operating Results were:
Year Ended December 31,
-----------------------
1998
--------
Sales $341,965
Expenses 203,588
--------
Income from discontinued operation $138,377
========
HCP Operating Results were:
Year Ended December 31,
-----------------------
1998
----------
Sales $1,171,556
Expenses 1,053,141
----------
Income from discontinued operation $ 118,415
==========
During 1999, a disputed marketing agreement and certain other issues were
resolved resulting in income from disposal of discontinued segments of $73,063.
3. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Year Ended December 31,
-----------------------
1999 1998
--------- ---------
Current $ -- $ --
Deferred -- --
--------- ---------
$ -- $ --
========= =========
The components of deferred taxes as of December 31, 1999, are as follows:
Current deferred tax assets:
Accruals not currently deductible for tax $ 78,146
Current portion of valuation allowance (78,146)
-----------
$ --
===========
Non-current deferred tax assets:
Book amortization/depreciation in excess of tax and other $ 112,152
Net operating loss carry forwards 2,640,000
Non-current portion of valuation allowance (2,752,152)
-----------
$ --
===========
F-11
<PAGE>
The Company was in a consolidated tax loss position for the years ended December
31, 1999 and 1998, and therefore had no current federal income tax expense.
Deferred tax assets of approximately $2,640,000 as of December 31, 1999
($4,106,000 as of December 31, 1998), from loss carry forward benefits have not
been recorded because of the uncertainty of realizing such benefits. For the
year ended December 31, 1999, the Company has reduced the value of its deferred
tax asset from loss carry forwards in order to take into account loss carry
forwards expected to expire due to tax limitations. The valuation allowance has
been decreased to reflect the change.
A reconciliation of the U.S. Federal statutory rate to the Company's effective
tax rate is as follows:
1999
----
Statutory federal rate 34%
Effect of state taxes 6%
Change in valuation allowance (40)%
----
--
====
Net operating loss carry forwards for federal tax purposes totaled approximately
$6,732,000 at December 31, 1999. These losses are available for carry forward
against future years' taxable income, subject to certain limitations, and expire
in various years through 2019.
4. LONG TERM DEBT AND OTHER FINANCING ARRANGEMENTS
Long term debt and other financing arrangements consist of the following at
December 31, 1999:
Equipment financing $ 29,106
Insurance financing 7,620
--------
Total financing 36,726
Less current portion (30,592)
--------
Total long term debt $ 6,134
========
Equipment financings are payable in monthly installments over varying periods
through November 2001. Interest rates range from 11.5% to 30.2%. Principal
payments are scheduled to be $22,972 in 2000 and $6,134 in 2001.
The Company has 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. Either
party may cancel the arrangement with 30 days notice. At
F-12
<PAGE>
December 31, 1999, there were approximately $162,000 of 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. Interest payable by the Company to the factor is calculated as a
fixed discount fee equal to 1% of the amount of the receivable factored plus a
variable discount fee computed on the amount advanced to the Company and
accruing on the basis of actual days elapsed from the date of the 80% advance
until 5 days after
collection of such account receivable by the factor at a per annum rate equal to
an internal rate set by the factor.
5. STOCKHOLDERS' EQUITY
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 entitled
the holder to purchase one share of Common Stock at a price of $2 per share,
subject to adjustment, until April 3, 1999. All 3,214,902 warrants expired on
April 3, 1999. In addition, 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 June
1997, the placement agent partially exercised the units and acquired 150,000
shares of common stock and 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 to purchase an aggregate of 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.
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 and 1999, the Company issued 21,333 and 80,932 shares of Common
Stock, respectively, to its outside directors as a part of their annual
compensation.
During 1999, the Company issued 80,000 shares of Common Stock to its executive
officers as compensation.
F-13
<PAGE>
WARRANTS
In May and September 1993 and January 1994, the Company issued warrants to
purchase 600,000 shares of Common Stock. The warrants became exercisable in May
1994 at $2.50 per share and expired at various dates through 1999. As of
December 31, 1999 all such warrants had expired.
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 were exercisable until
December 31, 1999, to acquire 50,000 shares of the Company's Common Stock at
$5.00 per share. All 50,000 warrants expired on December 31, 1999.
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. All 130,000 warrants expired on May 10, 1999.
As of December 31, 1999, outstanding warrants issued for the purchase of shares
of Common Stock to various consultants at exercise prices ranging from $0.21875
to $2.75 per share totaled 392,500. The Company valued the warrants at the date
of grant using a modified Black-Scholes model and is amortizing the costs over
the service period. All such warrants are currently exercisable within the above
price range and expire at various dates through September 2005.
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 of common stock were issued to a
lender in September 1997. Such warrants are currently exercisable at prices
ranging from $1.18 to $1.475 through August 2003.
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. 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 2008.
F-14
<PAGE>
In addition to the above plans, the Company granted: (1) a former officer
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. (2) 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 expired in December 1999. (3) various key employees options to purchase
140,000 shares of Common Stock at an exercise price of $0.3125 per share. The
options, granted through 1995, are currently exercisable and expire no later
than 2002.
Overall activity in the Company's stock options:
Years ended December 31,
----------------------------------------------
1998 1999
--------------------- ----------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Options Price Options Price
------- ----- ------- -----
Outstanding, at
beginning of year 1,351,400 $ 1.79 1,307,500 $ 0.95
Granted 763,500 0.31 50,000 0.33
Exercised -- -- -- --
Canceled/Expired (807,400) 0.65 (293,000) 1.80
--------- --------
Outstanding at end of year 1,307,500 0.95 1,064,500 0.69
========= =========
Exercisable at end of year 1,078,700 1.07 879,100 0.75
========= =========
During the second quarter of 1998, 543,000 options were repriced to market
value. The repricings are counted as a cancellation and grant of a new option in
the above table.
Details regarding the options outstanding at December 31, 1999:
Outstanding Exercisable
- ---------------------------------------------------- -------------------
Weighted Weighted Weighted
Exercise Average Average Average
Price Remaining Exercise Exercise
Range Number Life Price Number Price
----- ------ ---- ----- ------ -----
$0.31 - $0.41 784,500 3.50 $ 0.31 607,100 $ 0.31
$1.00 - $2.50 280,000 4.28 $ 1.72 272,000 $ 1.72
--------- -------
1,064,500 879,100
========= =======
F-15
<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 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 1999
---- ----
Weighted average grant-date fair value $ 0.23 $ 0.24
Significant assumptions (weighted average)
Risk-free interest rate at grant date 5.6% 5.1%
Expected stock price volatility 87.8% 87.8%
Expected dividend payout -- --
Expected option life 5 years 5.5 years
Net income (loss)
As reported $ 40,430 $ 96,860
Pro forma (89,062) (771)
Net income (loss) per share of Common Stock
As reported -- $ 0.01
Pro forma (0.01) --
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 years ended December 31, 1999 and 1998, the Company's major business
segments are pipe cleaning services and industrial chemical sales.
Information by segment for the year ended December 31, 1998:
Pipe Industrial
Cleaning Chemical
Services Sales Corporate Consolidated
-------- ----- --------- ------------
Sales $2,919,016 $249,939 $ -- $ 3,168,955
Income (loss) from
continuing operations 903,983 91,325 (1,526,672) (531,364)
Total assets 1,342,549 100,559 504,388 1,947,496
Depreciation and
amortization 128,141 -- 183,093 311,234
Capital expenditures 208,233 -- 24,043 232,276
F-16
<PAGE>
Information by segment for the year ended December 31, 1999:
Pipe Industrial
Cleaning Chemical
Services Sales Corporate Consolidated
-------- ----- --------- ------------
Sales $3,247,613 $242,130 $ -- $3,489,743
Income (loss) from
continuing operations 1,036,347 44,092 (1,056,642) 23,797
Total assets 1,728,201 35,106 326,811 2,090,118
Depreciation and
amortization 156,093 5,999 57,877 219,969
Capital expenditures 129,769 -- 35,116 164,885
8. COMMITMENTS AND CONTINGENCIES
LITIGATION
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 as a third-party plaintiff a civil claim against the Company in an
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. The Company, acting through its insurance carrier
pursuant to the submitted claim under its comprehensive general liability
policy, has substantially denied liability for the original claim. Although the
resolution of this matter is not known, management and its legal counsel believe
the Company has meritorious defenses and believes the outcome will have no
material effect on the Company's financial position or results of operations.
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-17
<PAGE>
LEASE COMMITMENTS
The Company has operating leases, expiring through 2002, for office and
warehouse facilities in Phoenix, Arizona, Portsmouth, Virginia and National
City, California and for office and other equipment. Rental expense associated
with all operating leases was $220,929 and $166,995 for the years ended December
31, 1999 and 1998, respectively.
Future minimum payments under operating leases as of December 31, 1999 are:
Years Ending
December 31, Amount
- ------------ ------
2000 $ 217,699
2001 220,850
2002 55,187
--------
$ 493,736
=========
HERC has entered into a sublease for one of its two Phoenix locations. Under the
terms of this sublease, HERC will receive payments of $122,520 and $102,100 for
the years ending December 31, 2000 and 2001, respectively.
9. RELATED PARTY TRANSACTIONS
The Company has entered into transactions with a subcontractor whose President
is a member of the Company's Board of Directors. Under the terms of this
agreement, the subcontractor has the right of first refusal for subcontractor
work in certain territories. In exchange, the subcontractor will notify the
Company of any business opportunities in these territories. Amounts paid to the
subcontractor pursuant to this contract were $24,695 and $2,807 in 1999, and
1998, respectively.
F-18
<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 16, 2000 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 16, 2000
- ---------------------- Chief Executive Officer
S. Steven Carl and President
/s/ Salvatore DiMascio Director March 16, 2000
- ----------------------
Salvatore DiMascio
/s/ R. John Armstrong Director March 16, 2000
- ----------------------
R. John Armstrong
/s/ Michael H. Harader Chief Financial Officer March 16, 2000
- ---------------------- (Principal Financial and
Michael H. Harader Accounting Officer)
36
EXHIBIT 21
SUBSIDIARIES
Name State of Incorporation
---- ----------------------
H.E.R.C. Consumer Products, Inc. Arizona
CCT Corporation Arizona
37
EXHIBIT 23
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 previously filed Registration
Statements (File No.'s 33-92870, 333-5175, 333-13349 and 333-19361).
\s\ Arthur Andersen LLP
Phoenix, Arizona
March 22, 2000.
38
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-13-1999
<EXCHANGE-RATE> 1
<CASH> 65,722
<SECURITIES> 0
<RECEIVABLES> 917,665
<ALLOWANCES> 44,620
<INVENTORY> 45,990
<CURRENT-ASSETS> 1,232,191
<PP&E> 1,107,000
<DEPRECIATION> 508,773
<TOTAL-ASSETS> 2,090,118
<CURRENT-LIABILITIES> 639,158
<BONDS> 0
0
0
<COMMON> 116,529
<OTHER-SE> 1,339,741
<TOTAL-LIABILITY-AND-EQUITY> 2,090,118
<SALES> 3,489,743
<TOTAL-REVENUES> 3,489,743
<CGS> 1,613,620
<TOTAL-COSTS> 3,568,567
<OTHER-EXPENSES> (120,726)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 18,105
<INCOME-PRETAX> 23,797
<INCOME-TAX> 0
<INCOME-CONTINUING> 23,797
<DISCONTINUED> 73,063
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 96,860
<EPS-BASIC> 0.01
<EPS-DILUTED> 0.01
</TABLE>
EXHIBIT 99
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 an operating loss for both of
the years ended December 31, 1998 and December 31, 1999. 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 might require capital from independent financing
sources. HERC does not have any accumulated retained earnings to fund cash flow
deficits and significant capital requirements. Other than its factoring
arrangement, 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 70 % 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 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 some of the
same benefits as HERC and increase the competition in the marine pipe systems
cleaning market. 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 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 or
bystanders who are injured on site, from damage to a pipe system being cleaned
or from other issues arising from the performance of HERC's services. 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 in excess of
the insurance limits or that is not covered, HERC will have a material adverse
effect on its financial condition.
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 became 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 2,309,980 shares of common stock of
which a large percentage 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.
40
