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 SEPTEMBER 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)
State of Incorporation: Delaware IRS Employer Identification Number: 86-0570800
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.
Class Outstanding at November 12, 2002
----- --------------------------------
Common Stock, $.01 par value 12,054,873
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
September 30, 2002 and December 31, 2001 3
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2002 and 2001 4
Consolidated Statements of Cash Flows
Nine Months Ended September 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 12
Item 3. Controls and Procedures 17
PART II. OTHER INFORMATION
Item 2 - Changes in Securities 18
Item 6 - Exhibits and Reports on Form 8-K 18
Signatures 18
Certifications 19
Item 1. FINANCIAL STATEMENTS
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
2002 2001
------------ ------------
(Unaudited)
ASSETS
CURRENT ASSETS
Cash $ 121,158 $ 75,759
Trade accounts receivable, net of allowance for
doubtful accounts of $124,338 and $35,269, respectively 802,526 602,468
Inventories 52,740 27,061
Costs of uncompleted contracts 107,529 150,530
Costs and estimated earnings in excess
of billings on uncompleted contracts 34,582 74,289
Other receivables, includes unbilled amounts of $33,750 and
$53,437, respectively 53,852 66,112
Prepaid expenses 250,046 51,008
------------ ------------
Total Current Assets 1,422,433 1,047,227
------------ ------------
PROPERTY AND EQUIPMENT
Property and equipment 1,535,699 1,374,993
Less: accumulated depreciation (1,103,554) (938,755)
------------ ------------
Net Property and Equipment 432,145 436,238
------------ ------------
OTHER ASSETS
Patents, net of accumulated amortization of $116,101 and
$100,397, respectively 108,034 107,366
Patents pending 115,198 117,954
Refundable deposits and other assets 8,722 9,940
------------ ------------
Total Other Assets 231,954 235,260
------------ ------------
$ 2,086,532 $ 1,718,725
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 417,226 $ 287,259
Accrued wages 62,642 117,350
Current portion of notes payable 69,907 19,944
Other accrued expenses 380,644 225,267
------------ ------------
Total Current Liabilities 930,419 649,820
LONG-TERM LIABILITIES
Notes payable, net of current portion -- 2,570
------------ ------------
Total Liabilities 930,419 652,390
------------ ------------
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 12,004,872 and 11,864,872 shares, respectively, 120,049 118,649
Additional paid-in capital 14,025,064 14,012,464
Accumulated deficit (12,989,000) (13,064,778)
------------ ------------
Total Stockholders' Equity 1,156,113 1,066,335
------------ ------------
$ 2,086,532 $ 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 Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
SALES $ 1,770,863 $ 1,740,621 $ 4,943,250 $ 4,311,629
COST OF SALES 927,071 894,290 2,713,420 2,454,111
------------ ------------ ------------ ------------
GROSS PROFIT 843,792 846,331 2,229,830 1,857,518
SELLING EXPENSES 123,471 60,455 378,811 199,790
GENERAL AND ADMINISTRATIVE EXPENSES 762,759 560,920 1,943,022 1,739,467
------------ ------------ ------------ ------------
OPERATING PROFIT (LOSS) (42,438) 224,956 (92,003) (81,739)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE)
Gain on sale of asset -- -- -- 52,378
Interest expense (18,110) (18,354) (58,171) (45,709)
Miscellaneous 262 1,458 225,952 5,393
------------ ------------ ------------ ------------
Total Other Income (Expense) (17,848) (16,896) 167,781 12,062
------------ ------------ ------------ ------------
NET INCOME (LOSS) BEFORE INCOME TAXES (60,286) 208,060 75,778 (69,677)
Income tax provision -- -- -- --
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (60,286) $ 208,060 $ 75,778 $ (69,677)
============ ============ ============ ============
NET INCOME (LOSS) PER COMMON SHARE -BASIC AND DILUTED (0.01) 0.02 $ 0.01 $ (0.01)
============ ============ ============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
BASIC 12,004,872 11,798,206 11,951,905 11,768,713
============ ============ ============ ============
DILUTED 12,004,872 11,798,788 12,025,470 11,768,713
============ ============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
4
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30,
----------------------
2002 2001
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 75,778 $ (69,677)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities
Depreciation and amortization 180,976 192,667
Gain on sale of Chlor-Rid(R)rights (225,000) --
Gain on sale of asset -- (52,378)
Common stock issued for services 14,000 18,000
Bad debt expense 89,069 --
(Increase) decrease in assets
Trade accounts receivable (289,127) (430,962)
Inventories (25,679) 12,184
Costs of uncompleted contracts 43,001 (282,231)
Costs and estimated earnings in excess of billings
on uncompleted contracts 39,707 --
Other receivables 12,260 (5,449)
Prepaid expenses 170,076 144,776
Refundable deposits and other assets 1,218 1,982
Increase (decrease) in liabilities
Accounts payable 129,967 428,574
Accrued wages and other accrued expenses 100,669 125,061
Customer deposits -- (6,035)
--------- ---------
Net cash provided by operating activities 316,915 76,512
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (160,707) (82,672)
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 (14,088) (38,820)
--------- ---------
Net cash provided by investing activities 50,205 13,508
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments under notes payable (321,721) (307,479)
--------- ---------
Net cash used in financing activities (321,721) (307,479)
--------- ---------
NET INCREASE (DECREASE) IN CASH 45,399 (217,459)
CASH AT BEGINNING OF PERIOD 75,759 302,392
--------- ---------
CASH AT END OF PERIOD $ 121,158 $ 84,933
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for interest $ 58,171 $ 45,709
========= =========
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 these
consolidated financial statements.
5
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements (except for the
balance sheet at December 31, 2001, which is derived from audited financial
statements) have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and with the requirements of regulation S-B of the Securities and
Exchange Commission and consequently do not include all of the disclosures
normally made in complete annual financial statement 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.
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.
Certain items on the consolidated statements of cash flows for the year ended
September 30, 2001 have been reclassified to be consistent with the
classifications adopted for the period ended September 30, 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.
6
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.
NOTE 3 - AGREEMENT WITH FACTOR
The Company has a factoring agreement with the following terms:
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 September
30, 2002, there was $616,401 of factored receivables of which the Company has
received $523,941 from the factor. This $523,941 and $4,623 in interest expense
are not included in accounts receivable as of September 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 September 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 September 30, 2002:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
----------- ----------- ----------- --------- ------------
Sales to unaffiliated customers $ 352,779 $ 1,384,485 $ 33,599 $ -- $ 1,770,863
Net income (loss) (200,133) 508,870 (28,615) (340,408) (60,286)
Total assets 494,272 919,995 31,764 640,501 2,086,532
Depreciation and amortization 39,341 18,458 1,643 9,136 68,578
Capital expenditures 2,050 96,966 -- -- 99,016
7
Information by segment for the three months ended and as of September 30, 2001:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
----------- ----------- ----------- ----------- ------------
Sales to unaffiliated customers $ 1,055,988 $ 582,670 $ 101,963 $ -- $ 1,740,621
Net income (loss) 333,734 148,834 65,656 (340,164) 208,060
Total assets 945,542 566,597 63,883 506,318 2,082,340
Depreciation and amortization 46,924 5,727 1,579 11,215 65,445
Capital expenditures 12,334 31,727 -- -- 44,061
Information by segment for the nine months ended and as of September 30, 2002:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
----------- ----------- ----------- ----------- ------------
Sales to unaffiliated customers $ 2,174,887 $ 2,653,132 $ 115,231 $ -- $ 4,943,250
Net income (loss) 217,021 842,243 139,131 (1,122,617) 75,778
Total assets 494,272 919,995 31,764 640,501 2,086,532
Depreciation and amortization 117,497 31,133 4,928 27,418 180,976
Capital expenditures 52,328 104,221 -- 4,158 160,707
Information by segment for the nine months ended and as of September 30, 2001:
Pipe Tank
Cleaning Cleaning Chemicals Corporate Consolidated
----------- ----------- ----------- ----------- ------------
Sales to unaffiliated customers $ 3,257,320 $ 842,247 $ 212,062 $ -- $ 4,311,629
Net income (loss) 735,213 96,699 131,588 (1,033,177) (69,677)
Total assets 945,542 566,597 63,883 506,318 2,082,340
Depreciation and amortization 137,693 16,596 4,733 33,645 192,667
Capital expenditures 32,496 48,964 -- 1,212 82,672
We derive the majority of our revenue from two sources, cleaning vacuum sewer
"CHT" pipe 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 has
been performed pursuant to a five-year contract with the U.S. Navy (Portsmouth
CHT contract), which expired September 2002. The pipe system cleaning pursuant
to the Portsmouth CHT contract with the U.S. Navy was 35% of consolidated sales
during the nine months ended September 30, 2002 compared to 51% during the nine
months ended September 30, 2001.
On September 30, 2002, the Company was awarded a new five-year contract with the
U.S. Navy to use its chemical cleaning technology to clean CHT systems on U.S.
Navy and other military vessels on a worldwide basis. The negotiated contract is
for "indefinite delivery indefinite quantity" task orders for the first year
award and four option years through the USN Supervisor of Shipbuilding,
Portsmouth, Virginia. Of all the firms responding to the Navy solicitation, two
awards were made for the contract after careful evaluation in accordance with
the solicitation based on a determination of "best value" to the Navy. The
contract minimum for the two awards is $107,097 while the contract maximum for
the two awards is a total of $5,948,312 for each of the five years; however, we
do not know the proportions as to which it will be split. Historically, we have
found that once we are on board the ship, we often have the ability to obtain
additional work.
8
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 nine months ended September 30, 2002 and 2001 is
as follows:
Three Months Ended
September 30, 2002
---------------------------
Net Loss Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- -----------
Basic EPS $ (60,286) 12,004,872 $ (0.01)
===========
Effect of stock options and warrants -- --
----------- -----------
Diluted EPS $ (60,286) 12,004,872 $ (0.01)
=========== =========== ===========
Three Months Ended
September 30, 2001
---------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- -----------
Basic EPS $ 208,060 11,798,206 $ 0.02
===========
Effect of stock options and warrants -- --
----------- -----------
Diluted EPS $ 208,060 11,798,206 $ 0.02
=========== =========== ===========
Nine Months Ended
September 30, 2002
---------------------------
Net Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- -----------
Basic EPS $ 75,778 11,951,905 $ 0.01
===========
Effect of stock options and warrants -- 73,565
----------- -----------
Diluted EPS $ 75,778 12,025,470 $ 0.01
=========== =========== ===========
9
Nine Months Ended
September 30, 2001
---------------------------
Net Loss Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- -----------
Basic EPS $ (69,677) 11,768,713 $ (0.01)
===========
Effect of stock options and warrants -- --
----------- -----------
Diluted EPS $ (69,677) 11,768,713 $ (0.01)
=========== =========== ===========
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 claim has been resolved in the amount of $85,000, which was charged to general
and administrative expenses during the three months ended September 30, 2002.
The resolution reflected an economic decision based upon a financial impact
evaluation necessary to resolve the matter.
NOTE 9 - INCOME TAXES
The Company's net operating loss carryforwards fully offset all taxable income
for the nine months ended September 30, 2002 and therefore there is no current
federal income tax expense. Deferred tax assets as of September 30, 2002 arising
primarily from loss carry forward benefits have been offset by a valuation
allowance 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 vacuum
sewer "CHT" 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 has been performed pursuant to a five-year contract with the U.S. Navy
(Portsmouth CHT contract), which expired September 2002. This has subjected our
Company to certain business risks that have caused volatility in our revenue
stream and our gross margins. We have also been 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 have been 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.
On September 30, 2002, the Company was awarded a new five-year contract
with the U.S. Navy to use its chemical cleaning technology to clean CHT systems
on U.S. Navy and other military vessels on a worldwide basis. The negotiated
contract is for "indefinite delivery indefinite quantity" task orders for the
first year award and four option years through the USN Supervisor of
Shipbuilding, Portsmouth, Virginia. Of all the firms responding to the Navy
solicitation, two awards were made for the contract after careful evaluation in
accordance with the solicitation based on a determination of "best value" to the
Navy. The contract minimum for the two awards is $107,097 while the contract
maximum for the two awards is a total of $5,948,312 for each of the five years;
however, we do not know the proportions as to which it will be split.
Historically, we have found that once we are on board the ship, we often have
the ability to obtain additional work.
12
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 as
the percentage of cost incurred to date of the estimated total cost for each
contract. We use this method because we consider the percentage of the 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
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 TAX ASSETS
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.
13
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.
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 SEPTEMBER 30, 2002 COMPARED WITH THREE MONTHS ENDED
SEPTEMBER 30, 2001
Sales for the three months ended September 30, 2002 were $1,770,863
compared with $1,740,621 during the same period in 2001. Pipe cleaning services
accounted for $352,779 during the three months ended September 30, 2002, of
which $257,153 was billed under the Portsmouth CHT contract with the United
States Navy. For the three months ended September 30, 2001, pipe-cleaning
services accounted for $1,055,988 of which $745,594 was billed under the
Portsmouth CHT contract. Tank cleaning services totaled $1,384,485 during the
three months ended September 30, 2002 compared with $582,670 during the same
period in 2001. Industrial chemical sales were $33,599 during the three months
ended September 30, 2002 compared with $101,963 during the same period in 2001.
The pipe system cleaning pursuant to the Portsmouth CHT contract with the
U.S. Navy was 15% of consolidated sales during the three months ended September
30, 2002 compared to 43% during the three months ended September 30, 2001.
Sales of pipe cleaning services decreased 67% during the three months ended
September 30, 2002 compared to the same period in 2001. The decrease in pipe
cleaning revenue represents a slowdown in orders for cleaning pipe systems on
board U.S. Navy and U.S. Coast Guard vessels. Sales of tank cleaning services
increased 138% during the three months ended September 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
14
to our focus on customer satisfaction. Sales of industrial chemicals decreased
67% during the three months ended September 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 as a result of the assignment of 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) during the second quarter
of 2002.
Consolidated gross margins remained relatively flat at 48% during the three
months ended September 30, 2002 compared with 49% during the same period in
2001.
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 decreased slightly to $843,792 during the three months ended
September 30, 2002 from $846,331 during the same period in 2001. The small
change in gross profit reflects the relatively flat revenue and gross margin
from one period to the next.
Selling expenses increased to $123,471 during the three months ended
September 30, 2002 from $60,455 during the same period in 2001 while general and
administrative expenses increased to $762,759 for the three months ended
September 30, 2002 from $560,920 during the same period in 2001. The increase in
selling expenses was primarily the result of additional sales personnel and
related marketing expenses. General and administrative expenses were higher as a
result of increases in legal expenses and bad debt expenses.
For the three months ended September 30, 2002, we incurred a net loss of
$60,286 compared to net income of $208,060 during the same period in 2001.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED WITH NINE MONTHS ENDED
SEPTEMBER 30, 2001,
Sales for the nine months ended September 30, 2002 were $4,943,250 compared
with $4,311,629 during the same period in 2001. Pipe cleaning services accounted
for $2,174,887 during the nine months ended September 30, 2002, of which
$1,744,211 was billed under the Portsmouth CHT contract with the United States
Navy. For the nine months ended September 30, 2001, pipe-cleaning services
accounted for $3,257,320 of which $2,201,886 was billed under the Portsmouth CHT
contract. Tank cleaning services totaled $2,653,132 during the nine months ended
September 30, 2002 compared with $842,247 during the same period in 2001.
Industrial chemical sales were $115,231 during the nine months ended September
30, 2002 compared with $212,061 during the same period in 2001.
15
The pipe system cleaning pursuant to the Portsmouth CHT contract with the
U.S. Navy was 35% of consolidated sales during the nine months ended September
30, 2002 compared to 51% during the nine months ended September 30, 2001.
Sales of pipe cleaning services decreased 33% during the nine months ended
September 30, 2002 compared to the same period in 2001. The decrease in pipe
cleaning revenue represents a slowdown in orders for cleaning pipe systems on
board U.S. Navy and U.S. Coast Guard vessels. Sales of tank cleaning services
increased 315% during the nine months ended September 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
46% during the nine months ended September 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 as a result of the assignment of 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) during the second quarter
of 2002.
Consolidated gross margin was 45% during the nine months ended September
30, 2002 compared with 43% during the same period in 2001. The increase in
consolidated gross margin was the result of higher gross margins in tank
cleaning as compared to the same period in 2001.
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 $2,229,830 during the nine months ended September
30, 2002 from $1,857,518 during the same period in 2001. The increase in gross
profit was the result of higher consolidated revenue combined with higher
consolidated gross margins.
Selling expenses increased to $378,811 during the nine months ended
September 30, 2002 from $199,790 during the same period in 2001 while general
and administrative expenses increased to $1,943,022 during the nine months ended
September 30, 2002 from $1,739,467 during the same period in 2001. The increase
in selling expenses was primarily the result of additional sales personnel and
related marketing expenses. General and administrative expenses were higher as a
result of increases in legal expenses and bad debt expenses.
16
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 nine
months ended September 30, 2001, the Company sold an asset and realized a gain
of $52,378, which is included in other income.
For the nine months ended September 30, 2002, we generated net income of
$75,778 compared to a net loss of $69,677 for the same period in 2001.
LIQUIDITY AND CAPITAL RESOURCES
Cash was $121,158 at September 30, 2002 and $75,759 at December 31, 2001
while working capital was $492,014 and $397,407 on those respective dates. The
increase in cash and working capital is primarily the result of our net income.
The Company has a factoring arrangement whereby 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 September 30, 2002, there was
$616,401 of factored receivables of which we have received $523,941 from the
factor. This $523,941 and $4,623 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 September 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 existing five-year Portsmouth CHT contract with the U.S. Navy expired
in September 2002. This contract had been responsible for the majority of our
consolidated revenue for several years.
On October 14, 2002, the Company was awarded a new five-year contract with
the U.S. Navy to use its chemical cleaning technology to clean CHT systems on
U.S. Navy and other military vessels on a worldwide basis. The negotiated
contract is for "indefinite delivery indefinite quantity" task orders for the
first year award and four option years through the USN Supervisor of
Shipbuilding, Portsmouth, Virginia. Of all the firms responding to the Navy
solicitation, two awards were made for the contract after careful evaluation in
accordance with the solicitation based on a determination of "best value" to the
Navy. The contract minimum for the two awards is $107,097 while the contract
maximum for the two awards is a total of $5,948,312 for each of the five years;
however, we do not know the proportions as to which it will be split.
Historically, we have found that once we are on board the ship, we often have
the ability to obtain additional work.
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 September 30,
2002 to make future payments under contracts such as debt and lease agreements:
Contractual
Obligations Payments Due by Fiscal Year
----------- ---------------------------
2002 2003 2004
------- ------- -------
Long-Term Debt and Other Financing Arrangements $53,307 $11,940 $ --
Capital Lease Obligations 3,428 1,232 --
Operating Leases 13,118 50,757 3,700
17
While we believe that we will not need to raise additional capital because
our current cash and expected cash flows 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.
Item 3. CONTROLS AND PROCEDURES
Based on their evaluation of the effectiveness of our controls and
procedures conducted as of a date within 90 days prior to the date of the filing
of this report, our Chief Executive Officer and Chief Financial Officer have
each concluded that our disclosure controls and procedures are effective and
sufficient to (a) assure that we record, process, summarize, and report
information required to be disclosed by us in our periodic reports filed under
the Securities Exchange Act within the time periods specified by the Securities
and Exchange Commission's rules and forms; and (b) accumulate and communicate
information required to be disclosed by us in our periodic reports to
management, as appropriate to allow for timely decision making regarding the
required disclosure.
Subsequent to the date of their evaluation, there have not been any
significant changes in our internal controls or in other factors that could
significantly affect these controls, including any corrective action with regard
to significant deficiencies and material weaknesses.
18
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
RECENT SALES OF UNREGISTERED SECURITIES
During the third quarter of 2002 the Company issued 60,000 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:
10.18 Employment Agreement between S. Steven Carl and the Registrant.
10.19 Solicitation, Offer and Award Contract dated September 30, 2002
between the Supervisor of Shipbuilding, C & R, USN and the
Registrant. *
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.
* Certain information in this exhibit has been omitted and filed separately with
the Securities and Exchange Commission. Confidential treatment has been
requested with respect to the omitted portions.
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: November 13, 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)
19
CERTIFICATION
I, S. Steven Carl, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of H.E.R.C.
Products Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ S. Steven Carl
----------------------------------------
S. Steven Carl
Chief Executive Officer and President
20
CERTIFICATION
I, Michael H. Harader, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of H.E.R.C.
Products Incorporated;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize, and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: November 13, 2002
/s/ Michael H. Harader
----------------------------------------
Michael H. Harader
Chief Financial Officer and
Vice President -- Finance
21