U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934:
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to ____________.
Commission File Number 1-13012
H.E.R.C. PRODUCTS INCORPORATED
(Name of small business issuer as specified in its charter)
Delaware 86-0570800
State of Incorporation IRS Employer Identification Number
2215 W Melinda Lane, Suite A
Phoenix, Arizona 85027
(Address of principal executive offices)
(623) 492-0336
(Issuer's telephone number)
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 [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Outstanding at
Class August 12, 2002
----- ---------------
Common Stock, $.01 par value 12,004,872
Transitional Small Business Disclosure Format: YES [ ] NO [X]
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Index To Consolidated Financial Statements
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Financial Statements:
Consolidated Balance Sheets
June 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations
Three and Six Months Ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
PART II. OTHER INFORMATION
Item 2 - Changes in Securities 17
Item 6 - Exhibits and Reports on Form 8-K 17
ITEM 1. FINANCIAL STATEMENTS
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
June 30, December 31,
2002 2001
------------ ------------
ASSETS (Unaudited)
CURRENT ASSETS
Cash $ 147,189 $ 75,759
Trade accounts receivable, net of allowance for
doubtful accounts of $28,908 and $35,269, respectively 781,830 602,468
Inventories 54,698 27,061
Costs of uncompleted contracts 36,409 150,530
Costs and estimated earnings in excess
of billings on uncompleted contracts 12,010 74,289
Other receivables, includes unbilled amounts of $111,554
and $53,437, respectively 117,489 66,112
Prepaid expenses 350,618 51,008
------------ ------------
Total Current Assets 1,500,243 1,047,227
------------ ------------
PROPERTY AND EQUIPMENT
Property and equipment 1,436,683 1,374,993
Less: accumulated depreciation (1,040,366) (938,755)
------------ ------------
Net Property and Equipment 396,317 436,238
------------ ------------
OTHER ASSETS
Patents, net of accumulated amortization of
$110,711 and $100,397, respectively 113,424 107,366
Patents pending 111,704 117,954
Refundable deposits and other assets 8,963 9,940
------------ ------------
Total Other Assets 234,091 235,260
------------ ------------
$ 2,130,651 $ 1,718,725
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 298,052 $ 287,259
Accrued wages 112,189 117,350
Current portion of notes payable 195,956 19,944
Other accrued expenses 314,039 225,267
------------ ------------
Total Current Liabilities 920,236 649,820
LONG-TERM LIABILITIES
Notes payable, net of current portion -- 2,570
------------ ------------
Total Liabilities 920,236 652,390
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par 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 11,944,872 and 11,864,872 shares,
respectively 119,449 118,649
Additional paid-in capital 14,019,664 14,012,464
Accumulated deficit (12,928,698) (13,064,778)
------------ ------------
Total Stockholders' Equity 1,210,415 1,066,335
------------ ------------
$ 2,130,651 $ 1,718,725
============ ============
The accompanying notes are an integral part of this consolidated balance sheet.
3
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
------------ ------------ ------------ ------------
SALES $ 1,496,335 $ 1,337,130 $ 3,172,386 $ 2,571,008
COST OF SALES 885,491 684,564 1,786,332 1,559,821
------------ ------------ ------------ ------------
GROSS PROFIT 610,844 652,566 1,386,054 1,011,187
SELLING EXPENSES 122,038 67,247 255,339 139,334
GENERAL AND ADMINISTRATIVE EXPENSES 630,915 610,378 1,180,264 1,178,547
------------ ------------ ------------ ------------
OPERATING LOSS (142,109) (25,059) (49,549) (306,694)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE)
Gain on sale of asset -- 52,378 -- 52,378
Interest expense (16,870) (18,893) (40,062) (27,356)
Miscellaneous 225,290 1,689 225,691 3,935
------------ ------------ ------------ ------------
Total Other Income 208,420 35,174 185,629 28,957
------------ ------------ ------------ ------------
NET INCOME (LOSS) BEFORE INCOME TAXES 66,311 10,115 136,080 (277,737)
Income tax provision -- -- -- --
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ 66,311 $ 10,115 $ 136,080 $ (277,737)
============ ============ ============ ============
NET INCOME (LOSS) PER COMMON SHARE - BASIC AND DILUTED $ 0.01 $ -- $ 0.01 $ (0.02)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
BASIC 11,944,872 11,769,634 11,924,982 11,753,722
============ ============ ============ ============
DILUTED 12,021,788 11,771,420 11,995,188 11,753,722
============ ============ ============ ============
The accompanying notes are an integral part of this consolidated balance sheet.
4
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
-------------------------
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 136,080 $(277,737)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization 112,398 127,222
Gain on sale of Chlor-Rid(R)rights (225,000) --
Gain on sale of asset -- (52,378)
Common stock issued for services 8,000 12,000
(Increase) decrease in assets
Trade accounts receivable (179,362) (244,812)
Inventories (27,637) 2,388
Costs of uncompleted contracts 114,121 32,419
Costs and estimated earnings in excess of billings
on uncompleted contracts 62,279 --
Other receivables (51,377) (1,555)
Prepaid expenses 69,504 51,134
Refundable deposits and other assets 977 2,226
Increase (decrease) in liabilities
Accounts payable 10,793 252,635
Accrued wages and other accrued expenses 83,611 21,014
Customer deposits -- (777)
--------- ---------
Net cash provided by (used in) operating activities 114,387 (76,221)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (61,690) (38,610)
Cash received from sale of Chlor-Rid(R)rights 225,000 --
Cash received from sale of asset -- 135,000
Expenditures related to patents and patents pending (10,594) (36,691)
--------- ---------
Net cash provided by (used in) investing activities 152,716 59,699
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments under notes payable (195,673) (241,228)
--------- ---------
Net cash used in financing activities (195,673) (241,228)
--------- ---------
NET INCREASE (DECREASE) IN CASH 71,430 (257,750)
CASH AT BEGINNING OF PERIOD 75,759 302,392
--------- ---------
CASH AT END OF PERIOD $ 147,189 $ 44,642
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 40,062 $ 27,356
========= =========
Cash paid during the period for income taxes $ -- $ --
========= =========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Prepaid insurance financed with notes payable $ 369,114 $ 198,262
========= =========
The accompanying notes are an integral part of this consolidated balance sheet.
5
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The unaudited consolidated financial statements are presented in accordance with
the requirements of Form 10-QSB and consequently do not include all of the
disclosures normally made in an annual Form 10-KSB filing. Accordingly, the
consolidated financial statements of H.E.R.C. Products Incorporated included
herein should be reviewed in conjunction with the consolidated financial
statements and the accompanying footnotes included within the Company's Form
10-KSB for the year ended December 31, 2001.
The consolidated financial statements have been prepared in accordance with the
Company's customary accounting practices and have not been audited. In the
opinion of management, the consolidated financial statements reflect all
adjustments necessary to fairly report the Company's financial position and
results of operations for the interim period. All such adjustments are normal
and recurring in nature. The interim consolidated results of operations are not
necessarily indicative of results to be expected for the year ending December
31, 2002.
NOTE 2 - REVENUE RECOGNITION
For chemical product sales, the Company recognizes revenue at the time products
are shipped to customers. For most service projects, the Company recognizes
revenue and costs when the services are completed. For fixed price contracts in
excess of three month duration, revenue is recognized on the percentage of
completion method, measured by the percentage of cost incurred to date to
estimated total cost for each contract. This method is used because management
considers total cost to be the best available measure of progress on these
contracts.
Contract costs include all direct material, labor, subcontract labor and other
costs related to contract performance, such as indirect labor, supplies, tools
and repairs. Selling, general and administrative costs are charged to expense as
incurred. Provisions for estimated losses on uncompleted contracts are made in
the period in which such losses are determined. Changes in job performance, job
conditions, and estimated profitability, including those arising from contract
penalty provisions and final contract settlements may result in revisions to
estimates of contract costs and profits and are recognized in the period in
which the revisions are determined.
The current asset, "costs and estimated earnings in excess of billings on
uncompleted contracts" represents revenue recognized in excess of amounts
billed. The current liability, "billings in excess of costs on uncompleted
contracts," represents billings in excess of revenue recognized.
6
NOTE 3 - AGREEMENT WITH FACTOR
During the second quarter of 2002, the Company signed an amendment to its
existing factoring arrangement. The terms of the amended agreement are as
follows:
The factor purchases eligible receivables and advances 85% of the purchased
amount to the Company. Purchased receivables may not exceed $1,000,000 at any
time. Either party may cancel the arrangement with 30 days notice. At June 30,
2002, there was $449,382 of factored receivables of which the Company has
received $371,056 from the factor. This $371,056 and $3,916 in interest expense
are not included in accounts receivable as of June 30, 2002. This arrangement is
accounted for as a sale of receivables on which the factor has recourse to the
15% residual of aggregate receivables purchased and outstanding. Interest
payable by the Company to the factor is calculated as a fixed discount fee equal
to .75% of the amount of the receivable factored plus a variable (1.5% above the
institutions base rate, with a minimum of 7%) discount fee computed on the
amount advanced to the Company and accruing on the basis of actual days elapsed
from the date of the 85% advance until five days after collection of such
account receivable by the factor at a per annum rate equal to an internal rate
set by the factor. The rate at June 30, 2002 was 7%. In connection with this
agreement, the Company is required to maintain certain financial covenants. In
the event of a breach of representation, warranty or agreement, the factor has a
security interest in the Company's assets.
NOTE 4 - SEGMENT INFORMATION
Information by segment for the three months ended and as of June 30, 2002:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
-------- -------- --------- --------- ------------
Sales to unaffiliated customers $ 720,568 $ 727,265 $ 48,502 $ -- $1,496,335
Income (loss) from continuing operations 126,960 165,137 192,053 (417,839) 66,311
Total assets 690,640 633,527 35,651 770,833 2,130,651
Depreciation and amortization 42,104 8,809 1,746 9,138 61,797
Capital expenditures 43,878 1,788 -- -- 45,666
Information by segment for the three months ended and as of June 30, 2001:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
-------- -------- --------- --------- ------------
Sales to unaffiliated customers $1,088,783 $ 198,397 $ 49,950 $ -- $1,337,130
Income (loss) from continuing operations 307,656 39,560 31,293 (368,394) 10,115
Total assets 1,115,807 135,097 71,154 337,745 1,659,803
Depreciation and amortization 42,015 7,210 1,535 9,875 60,635
Capital expenditures 2,779 4,482 -- -- 7,261
7
Information by segment for the six months ended and as of June 30, 2002:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
-------- -------- --------- --------- ------------
Sales to unaffiliated customers $1,822,107 $1,268,647 $ 81,632 $ -- $3,172,386
Income (loss) from continuing operations 417,155 333,374 167,761 (782,210) 136,080
Total assets 690,640 633,527 35,651 770,833 2,130,651
Depreciation and amortization 78,156 12,675 3,285 18,282 112,398
Capital expenditures 50,278 7,255 -- 4,157 61,690
Information by segment for the six months ended and as of June 30, 2001:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
-------- -------- --------- --------- ------------
Sales to unaffiliated customers $ 2,201,332 $ 259,577 $ 110,099 $ -- $ 2,571,008
Income (loss) from continuing operations 401,479 (52,134) 65,932 (693,014) (277,737)
Total assets 1,115,807 135,097 71,154 337,745 1,659,803
Depreciation and amortization 90,769 10,869 3,154 22,430 127,222
Capital expenditures 20,162 17,237 -- 1,211 38,610
NOTE 5 - EARNINGS PER SHARE
A reconciliation of the numerators and denominators (weighted average number of
shares outstanding) of the basic and diluted earnings per share (EPS)
computation for the three and six months ended June 30, 2002 and 2001 is as
follows:
Three Months Ended
June 30, 2002
--------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $ 66,311 11,944,872 $ 0.01
======
Effect of stock options and warrants -- 76,916
---------- ----------
Diluted EPS $ 66,311 12,021,788 $ 0.01
========== ========== ======
Three Months Ended
June 30, 2001
--------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $ 10,115 11,769,634 $ --
======
Effect of stock options and warrants -- 1,786
---------- ----------
Diluted EPS $ 10,115 11,771,420 $ --
========== ========== ======
8
Six Months Ended
June 30, 2002
--------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $ 136,080 11,924,982 $ 0.01
======
Effect of stock options and warrants -- 70,206
---------- ----------
Diluted EPS $ 136,080 11,995,188 $ 0.01
========== ========== ======
Six Months Ended
June 30, 2001
--------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS $ (277,737) 11,753,722 $ (0.02)
======
Effect of stock options and warrants -- --
---------- ----------
Diluted EPS $ (277,737) 11,753,722 $ (0.02)
========== ========== =======
NOTE 6 - RECENTLY ISSUED ACCOUNTING STANDARDS
SFAS No. 143, Accounting for Asset Retirement Obligations, requires recognition
of the fair value of obligations associated with the retirement of long-lived
assets when there is a legal obligation to incur such costs. This amount is
accounted for as an additional element of the corresponding asset's cost, and is
depreciated over that asset's useful life. SFAS No. 143 will become effective
for the Company on January 1, 2003. The Company does not believe that this will
have a material impact on its liquidity or results of operations.
NOTE 7 - NOTES PAYABLE
During the month of January 2002, the Company financed $321,914 of insurance
premiums payable in nine monthly installments at an annual percentage rate of
3.68%. During the month of May 2002, the Company financed $47,200 of insurance
premiums payable in nine monthly installments at an annual percentage rate of
3.68%
NOTE 8 - COMMITMENTS AND CONTINGENCIES
LITIGATION
A civil claim under federal civil rights statutes has been filed seeking $35,000
in alleged lost earnings, $200,000 in compensation for loss of future pensions
and benefits, damages for non-pecuniary losses of $250,000, punitive damages of
9
$500,000, and attorneys fees, expert fees and costs. The Company, acting through
outside legal counsel, has denied all liability and intends to vigorously defend
against this claim. Outside legal counsel estimates the range of potential loss
to be less than $50,000.
NOTE 9 - INCOME TAXES
The Company's net operating loss carryforwards fully offset all taxable income
for the six months ended June 30, 2002 and therefore there is no current federal
income tax expense. Deferred tax assets as of June 30, 2002 arising primarily
from loss carry forward benefits have not been recorded because of the
historical operating losses and the uncertainty of realizing such benefits.
NOTE 10 - RELEASE AND ASSIGNMENT AGREEMENT
On June 14, 2002, the Company executed a release and assignment agreement which
assigned all of the Company's right, title and interest in any patents,
royalties, manufacturing rights or any other rights in the product Chlor*Rid(R).
In return, the Company received a cash payment of $225,000 from Chlor*Rid(R)
International. This $225,000 is accounted for as other income.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
PORTIONS OF THIS REPORT DESCRIBE HISTORICAL INFORMATION, SUCH AS THE 2001
AND 2002 OPERATING RESULTS, AND WE BELIEVE THE DESCRIPTIONS TO BE ACCURATE. IN
CONTRAST TO DESCRIBING THE PAST, SOME STATEMENTS IN THIS REPORT INDICATE THAT WE
BELIEVE THAT EVENTS OR FINANCIAL RESULTS ARE LIKELY TO OCCUR IN THE FUTURE.
THESE STATEMENTS 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 2002 AND BEYOND, EITHER CONCERNING A SPECIFIC SEGMENT OF
OUR BUSINESS, OR CONCERNING OUR COMPANY 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
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
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, OUR EXPECTATIONS AND BELIEFS MAY CHANGE, AND WE MAY COME
TO BELIEVE THAT CERTAIN FORWARD-LOOKING STATEMENTS IN THIS REPORT ARE NO LONGER
ACCURATE. WE DO NOT HAVE AN OBLIGATION TO CORRECT OR REVISE ANY FORWARD-LOOKING
STATEMENTS IN THIS REPORT, EVEN IF WE BELIEVE THE FORWARD LOOKING STATEMENTS ARE
NO LONGER TRUE.
OVERVIEW
We derive the majority of our revenue from two sources, cleaning piping
systems on U.S. Navy and U.S. Coast Guard vessels and cleaning bilge, fuel, oil
and CHT tanks on ships. A significant portion of the pipe cleaning is performed
pursuant to a five-year contract with the U.S. Navy (Portsmouth CHT contract).
This subjects our Company to certain business risks that can cause volatility in
our revenue stream and our gross margins. We are also subject to the deployment
and servicing schedules of the U.S. Navy as well as the available maintenance
funds in the Navy budget. These factors can cause revenue to change dramatically
from one quarter to the next. Additionally, we are required by our Portsmouth
CHT contract to perform work on different classes of ships. Performing work on
different classes of ships can cause our gross margins to vary widely from one
quarter to the next because we realize higher gross margins on certain classes
of ships than on others. Moreover, we are often asked to perform work on ships
outside of the state of Virginia. When we perform work under the Portsmouth CHT
contract outside of the state of Virginia, we incur certain reimbursable travel
costs that are included in both revenue and cost of goods sold. These
reimbursable travel costs cause gross margins to be lower than the margins that
would have otherwise been recognized had the work been performed in Virginia.
The final option year of our five-year CHT system chemical cleaning contract
with the U.S. Navy will expire during September 2002. This contract accounted
for approximately 46% of our revenue during the six months ended June 30, 2002,
and approximately 45% of our revenue during fiscal year 2001. In addition, this
contract has been responsible for the majority of our consolidated revenue for
several years. We intend to submit an offer to the U.S. Navy for additional
services under a request for proposal for a new five-year agreement to replace
the expiring contract, and must submit a bid for negotiation to the U.S. Navy by
August 13, 2002. Prior to awarding the new contract to any provider, the U.S.
Navy will evaluate the various bids for the best value based on the non-cost
technical factors of management and organization, manpower resources and
chemical solution, the non-cost factor of past performance and, to a lesser
extent, price. We expect that several providers will submit bids to the U.S.
Navy in an effort to secure this contract. Based on this competition and the
uncertainty of this process, the U.S. Navy may choose a sole provider or
alternate providers for the services that we currently provide. In the event the
U.S. Navy does not select a provider prior to the expiration of our agreement,
we expect that our agreement will be extended during the bid negotiation
process. Our failure to secure all or part of the new CHT system chemical
cleaning agreement with the U.S. Navy would have a material adverse effect on
our business.
11
CRITICAL ACCOUNTING JUDGMENTS AND ESTIMATES
We consider the following accounting policies to be critical to an
understanding of our financial statements because their application places the
most significant demands on our judgment, with financial reporting results
relying on estimates about the effect of matters that are inherently uncertain.
Specific risks for these critical accounting policies are described in the
following paragraphs. For all of these policies, we caution that future events
rarely develop exactly as forecast, and the best estimates routinely require
adjustment.
REVENUE RECOGNITION
For chemical product sales, we recognize revenue at the time products are
shipped to customers. For most service projects, we recognize revenue when the
services are completed. For fixed price contracts that are in excess of three
months, we recognize revenue on the percentage of completion method, measured by
the percentage of cost incurred to date to estimated total cost for each
contract. We use this method because we consider total cost to be the best
available measure of progress on these contracts.
Contract costs include all direct material, subcontract labor, and other
costs related to contract performance, such as indirect labor, supplies, tools,
and repairs. Selling, general, and administrative costs are charged to expense
as incurred. Provisions for estimated losses on uncompleted contracts are made
in the period in which such losses are determined. Changes in job performance,
job conditions, and estimated profitability, including those arising from
contract penalty provisions and final contract settlements may result in
revisions to estimates of contract costs and profits and are recognized in the
period in which the revisions are determined.
The current asset, "costs and estimated earnings in excess of billings on
uncompleted contracts" represents revenue recognized in excess of amounts
billed. The current liability, "billings in excess of costs on uncompleted
contracts," represents billings in excess of revenue recognized.
ALLOWANCE FOR DOUBTFUL ACCOUNTS AND DEFERRED TAX ASSETS
We analyze accounts receivable to determine the ultimate collectibility of
those accounts. If information is available to us to make a determination that
there exists a reasonable probability that an account will not be collectible,
we create a reserve for that account at the time of the determination and
recognize a related expense. If the account is later collected, the reserve and
expense are reversed in the current accounting period. Since we must use our
best judgment as to which accounts will be collected, there exists the risk that
some accounts might not be collected and thus could have a negative impact on
our liquidity and results of operations.
Deferred taxes are provided on a liability method whereby deferred tax
assets are recognized for deductible temporary differences and deferred tax
liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets and
liabilities and their tax bases. Deferred tax assets are reduced by a valuation
allowance when it is determined to be more likely than not that some portion or
all of the deferred tax assets will not be realized. Deferred tax assets and
liabilities are adjusted for the effects of changes in tax laws and rates on the
date of enactment.
IMPAIRMENT OF LONG-LIVED ASSETS
We periodically evaluate the carrying value of long-lived assets and
intangibles. We review long-lived assets and certain identifiable intangible
assets to be held and used in operations for potential 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. Future losses may be recorded if cash flows
are less than expected.
12
ACCRUALS
Loss contingencies are recorded as liabilities when it is probable that a
liability has been incurred and the amount of the loss is reasonably estimable.
Disclosure is required when there is a reasonable possibility that the ultimate
loss will exceed the recorded provision. Contingent liabilities are often
resolved over long time periods. Estimating probable losses requires analysis of
multiple forecasts that often depend on judgments about potential actions by
third parties such as regulators.
Other significant accounting policies, not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to a complete understanding of the financial statements.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2001
Sales for the three months ended June 30, 2002 were $1,496,335 compared
with $1,337,130 during the same period in 2001. Pipe cleaning services accounted
for $720,568 during the three months ended June 30, 2002, of which $478,630 was
billed under the Portsmouth CHT contract with the United States Navy. For the
three months ended June 30, 2001, pipe cleaning services accounted for
$1,088,783 of which $593,028 was billed under the Portsmouth CHT contract. Tank
cleaning services totaled $727,265 during the three months ended June 30, 2002
compared with $198,397 during the same period in 2001. Industrial chemical sales
were $48,502 during the three months ended June 30, 2002 compared with $49,950
during the same period in 2001.
We began offering tank cleaning services in the first quarter of 2001. Our
entrance into the tank cleaning services market has helped to reduce the
percentage of consolidated sales generated from pipe system cleaning pursuant to
the Portsmouth CHT contract with the U.S. Navy from 44% during the three months
ended June 30, 2001 to 32% during the three months ended June 30, 2002. We
currently focus specific sales and marketing efforts in the areas of marine,
industrial and municipal pipe cleaning as well as in the areas of marine and
land based tank cleaning. In the future, we will continue our efforts to
diversify our revenue sources and thereby further reduce our reliance on a
single customer for a significant portion of our revenue.
Sales of pipe cleaning services decreased 34% during the three months ended
June 30, 2002 compared to the same period in 2001. The decrease in pipe cleaning
revenue represents a slowdown in orders for cleaning piping systems on board
U.S. Navy and U.S. Coast Guard vessels. Sales of tank cleaning services
increased 267% during the three months ended June 30, 2002 compared to the same
period in 2001. The increase in tank cleaning revenue reflects our successful
penetration into the tank cleaning market, strong general demand for tank
cleaning services and additional demand for our services in particular due to
our focus on customer satisfaction. Sales of industrial chemicals were
relatively flat with a decrease of 3% during the three months ended June 30,
2002 compared to the same period in 2001.
Consolidated gross margin was 41% during the three months ended June 30,
2002 compared with 49% during the same period in 2001. The decrease in
consolidated gross margin was the result of the increase in tank cleaning
revenue performed at a lower gross margin combined with the decrease in pipe
cleaning revenue performed at a higher gross margin.
Performing pipe cleaning services on different classes of ships can cause
our gross margins to vary widely from one quarter to the next because we make
higher gross margins on certain classes of ships than we do on others.
Additionally, when we perform work under the Portsmouth CHT contract outside of
the state of Virginia, we incur certain reimbursable travel costs that are
included in both revenue and cost of goods sold. These reimbursable travel costs
cause gross margins to be lower than the margins that would have otherwise been
recognized had the work been performed in Virginia.
We anticipate that future gross margins from pipe cleaning and tank
cleaning will fluctuate with changes in revenue mix and other operational
factors such as our ability to bid work at profitable levels as well as our
ability to control costs on projects.
13
Gross profit decreased to $610,844 during the three months ended June 30,
2002 from $652,566 during the same period in 2001. The decrease in gross profit
was the result of lower consolidated gross margins offset slightly by higher
consolidated revenue.
Selling expenses increased to $122,038 during the three months ended June
30, 2002 from $67,247 during the same period in 2001 while general and
administrative expenses increased to $630,915 for the three months ended June
30, 2002 from $610,378 during the same period in 2001. The increase in selling
expenses was primarily the result of additional sales personnel. General and
administrative expenses remained relatively flat from one period to the next.
On June 14, 2002, the Company executed a release and assignment agreement
which assigned all of the Company's right, title and interest in any patents,
royalties, manufacturing rights or any other rights in the product Chlor*Rid(R).
In return, the Company received a cash payment of $225,000 from Chlor*Rid(R)
International. This $225,000 is accounted for as other income. During the three
months ended June 30, 2001, the Company sold an asset and realized a gain of
$52,378, which is included in other income.
For the three months ended June 30, 2002, we generated net income of
$66,311 compared to net income of $10,115 for the same period in 2001.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001,
Sales for the six months ended June 30, 2002 were $3,172,386 compared with
$2,571,008 during the same period in 2001. Pipe cleaning services accounted for
$1,822,107 during the six months ended June 30, 2002, of which $1,465,286 was
billed under the Portsmouth CHT contract with the United States Navy. For the
six months ended June 30, 2001, pipe cleaning services accounted for $2,201,332
of which $1,412,010 was billed under the Portsmouth CHT contract. Tank cleaning
services totaled $1,268,647 during the six months ended June 30, 2002 compared
with $259,577 during the same period in 2001. Industrial chemical sales were
$81,632 during the six months ended June 30, 2002 compared with $110,099 during
the same period in 2001.
The continuing growth of our tank cleaning service revenue has helped to
reduce the percentage of consolidated sales generated from pipe system cleaning
pursuant to the Portsmouth CHT contract with the U.S. Navy from 55% during the
six months ended June 30, 2001 to 46% during the six months ended June 30, 2002.
We currently focus specific sales and marketing efforts in the areas of marine,
industrial and municipal pipe cleaning as well as in the areas of marine and
land based tank cleaning. In the future, we will continue our efforts to
diversify our revenue sources and thereby further reduce our reliance on a
single customer for a significant portion of our revenue.
Sales of pipe cleaning services decreased 17% during the six months ended
June 30, 2002 compared to the same period in 2001. The decrease in pipe cleaning
revenue represents a slowdown in orders for cleaning piping systems on board
U.S. Navy and U.S. Coast Guard vessels. Sales of tank cleaning services
increased 389% during the six months ended June 30, 2002 compared to the same
period in 2001. The increase in tank cleaning revenue reflects our successful
penetration into the tank cleaning market, strong general demand for tank
cleaning services and additional demand for our services in particular due to
our focus on customer satisfaction. Sales of industrial chemicals decreased 26%
during the six months ended June 30, 2002 compared to the same period in 2001.
The reduction in chemical sales represents the lack of any Chlor*Rid(R) chemical
sales during the period.
Consolidated gross margin was 44% during the six months ended June 30, 2002
compared with 39% during the same period in 2001. The increase in consolidated
gross margin was the result higher gross margins in both pipe and tank cleaning
as compared to the same period in 2001.
14
Performing pipe cleaning services on different classes of ships can cause
our gross margins to vary widely from one quarter to the next because we make
higher gross margins on certain classes of ships than we do on others.
Additionally, when we perform work under the Portsmouth CHT contract outside of
the state of Virginia, we incur certain reimbursable travel costs that are
included in both revenue and cost of goods sold. These reimbursable travel costs
cause gross margins to be lower than the margins that would have otherwise been
recognized had the work been performed in Virginia.
We anticipate that future gross margins from pipe cleaning and tank
cleaning will fluctuate with changes in revenue mix and other operational
factors such as our ability to bid work at profitable levels as well as our
ability to control costs on projects.
Gross profit increased to $1,386,054 during the six months ended June 30,
2002 from $1,011,187 during the same period in 2001. The increase in gross
profit was the result of higher consolidated revenue offset slightly by lower
consolidated gross margins.
Selling expenses increased to $255,339 during the six months ended June 30,
2002 from $139,334 during the same period in 2001 while general and
administrative expenses increased to $1,180,264 during the six months ended June
30, 2002 from $1,178,547 during the same period in 2001. The increase in selling
expenses was primarily the result of additional sales personnel. General and
administrative expenses remained relatively flat from one period to the next.
On June 14, 2002, the Company executed a release and assignment agreement
which assigned all of the Company's right, title and interest in any patents,
royalties, manufacturing rights or any other rights in the product Chlor*Rid(R).
In return, the Company received a cash payment of $225,000 from Chlor*Rid(R)
International. This $225,000 is accounted for as other income. During the six
months ended June 30, 2001, the Company sold an asset and realized a gain of
$52,378, which is included in other income.
For the six months ended June 30, 2002, we generated net income of $136,080
compared to a net loss of $277,737 for the same period in 2001.
LIQUIDITY AND CAPITAL RESOURCES
Cash was $147,189 at June 30, 2002 and $75,759 at December 31, 2001 while
working capital was $580,007 and $397,407 at those respective dates. The
increase in cash and working capital is primarily the result of our net income.
During the second quarter of 2002, the Company signed an amendment to its
existing factoring arrangement. The terms of the amended agreement are as
follows:
The factor purchases eligible receivables and advances 85% of the purchased
amount to our Company. Purchased receivables may not exceed $1,000,000 at any
one time. Either party may cancel the arrangement with 30 days notice. At June
30, 2002, there was $449,382 of factored receivables of which we have received
$371,056 from the factor. This $371,056 and $3,916 in interest expense are not
shown as receivables. This arrangement is accounted for as a sale of receivables
on which the factor has recourse to the 15% residual of aggregate receivables
purchased and outstanding. Interest payable by us to the factor is calculated as
a fixed discount fee equal to 0.75% of the amount of the receivable factored
plus a variable (1.5% above the institutions base rate, with a minimum of 7%)
discount fee computed on the amount advanced to us and accruing on the basis of
actual days elapsed from the date of the 85% 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. The rate at June 30, 2002 was 7%. In
connection with this agreement, we are required to maintain certain financial
covenants. In the event of a breach of representation, warranty or agreement,
the institution has a security interest in our assets.
Our five-year Portsmouth CHT contract with the U.S. Navy is due to expire
in September 2002. This contract has been responsible for the majority of our
consolidated revenue for several years. Management is currently working on the
re-solicitation by the U.S. Navy for these services. If the new contract is not
awarded to us, it could have a material impact on our revenue and results of
operations.
15
We rely primarily on our internally generated operating cash flow and our
factoring arrangement to fund our operations and our business. We currently
contract with a few major customers responsible for a large percentage of our
revenue and we expect the high concentration levels to continue through 2002.
Thus, any material delay, cancellation or reduction of orders from these
customers could have a material adverse effect on our liquidity and operations.
The table below describes our contractual obligations as of June 30, 2002
to make future payments under contracts such as debt and lease agreements:
Payments Due by Fiscal Year
Contractual ------------------------------
Obligations 2002 2003 2004
----------- ---- ---- ----
Long-Term Debt and Other Financing Arrangements $178,199 $ 11,940 $ --
Capital Lease Obligations 4,585 1,232 --
Operating Leases 31,414 50,757 3,700
While we believe that we will not need to raise additional capital because
our current cash and cash flows expected to be generated from operations are
anticipated to be sufficient for the foreseeable future, we may, in the future,
sell additional securities to raise capital. Any such sale, if necessary, could
substantially dilute the interest of our existing stockholders. We cannot
provide any assurance that we will be able to sell additional securities at
terms acceptable to us. We may, in the future, make acquisitions by utilizing
debt financing if available. Any such acquisition and debt financing could have
a material adverse impact on our liquidity and results of operations.
16
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
RECENT SALES OF UNREGISTERED SECURITIES
During the second quarter of 2002 the Company issued 40,000 shares of common
stock as compensation to its outside Board of Directors. These shares were
issued under an exemption from registration pursuant to Section 4(2) of the
Securities Act of 1933.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Reports on Form 8-K: None
Exhibits:
10.17 Amendment to Account Transfer and Purchase Agreement by and between the
Registrant, H.E.R.C. Consumer Products, Inc., and KBK Financial
Incorporated dated September 22, 1997.
99.1 Certification of the Chief Executive Officer of the Registrant, pursuant
to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer of the Registrant, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
Signatures
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
H.E.R.C. PRODUCTS INCORPORATED
-----------------------------------
(Registrant)
Date: August 14, 2002 By: /s/ S. Steven Carl
-------------------------------
S. Steven Carl
Chief Executive Officer
By: /s/ Michael H. Harader
-------------------------------
Michael H. Harader
Chief Financial Officer
(Principal Financial and
Accounting Officer)