SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934: For the Quarterly Period Ended September 30, 1997
Commission File Number 1-13012
H.E.R.C. PRODUCTS INCORPORATED
State of Incorporation: Delaware IRS Employer Identification Number: 86-0570800
2202 W Lone Cactus Drive #15
Phoenix, Arizona 85027
(602) 492-0336
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 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 November 10, 1997
----- -----------------
Common Stock, $.01 par value 8,230,588
Transitional Small Business Development Format:
YES NO X
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H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Index To Consolidated Financial Statements
PART I. FINANCIAL INFORMATION Page No.
Consolidated Financial Statements:
Consolidated Balance Sheets
September 30, 1997 and December 31, 1996 3
Consolidated Statements of Operations
Three Months and Nine Months Ended September 30, 1997 and 1996 4
Consolidated Statement of Stockholders' Equity
Nine Months Ended September 30, 1997 5
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1997 and 1996 6
Notes to Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
PART II. OTHER INFORMATION 11
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Balance Sheets
September 30, December 31,
1997 1996
------------- ------------
(Unaudited)
Assets
Current Assets
Cash and cash equivalents $ 104,015 $ 1,369,843
Trade accounts receivable, net of allowance for
doubtful accounts of $51,361 and $38,621 respectively 886,754 417,534
Inventories (Note 2) 226,981 616,813
Other receivables 27,925 47,042
Prepaid expenses 126,826 87,280
------------ ------------
Total Current Assets 1,372,501 2,538,512
------------ ------------
Property and Equipment
Property and equipment 1,095,333 635,696
Less accumulated depreciation 207,266 139,342
------------ ------------
Net Property and Equipment 888,067 496,354
------------ ------------
Other Assets
Patents, net of accumulated amortization
of $86,078 and $65,205 respectively 206,327 197,285
Patents pending 204,318 138,695
Refundable deposits 19,609 18,337
Other 73,990 41,699
Goodwill, net of accumulated amortization
of $215,390 and $146,168 respectively 1,599,809 1,691,705
------------ ------------
Total Other Assets 2,104,053 2,087,721
------------ ------------
$ 4,364,621 $ 5,122,587
============ ============
Liabilities and Stockholders' Equity
Current Liabilities
Accounts payable $ 895,570 $ 347,858
Accrued wages 130,911 44,047
Current portion of notes payable 93,876 --
Other accrued expenses 190,425 220,394
------------ ------------
Total Current Liabilities 1,310,782 612,299
------------ ------------
Long-Term Liabilities
Notes payable, net of current portion 302,687 --
------------ ------------
Total Liabilities 1,613,469 612,299
------------ ------------
Stockholders' Equity
Preferred Stock, $10.00 stated value; authorized 1,000,000 shares;
issued and outstanding zero and 170,000 shares respectively -- 1,480,000
Common Stock, $0.01 par value; authorized 40,000,000 shares;
issued and outstanding 8,230,588 and 6,356,487 shares respectively 82,306 63,565
Additional paid-in capital 12,923,026 11,223,593
Accumulated deficit (10,254,180) (8,256,870)
------------ ------------
Total Stockholders' Equity 2,751,152 4,510,288
------------ ------------
$ 4,364,621 $ 5,122,587
============ ============
See accompanying notes to consolidated financial statements
3
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
Three Months Ended September 30, Nine Months Ended September 30,
1997 1996 1997 1996
---- ---- ---- ----
Sales $ 1,485,109 $ 1,082,522 $ 4,044,994 $ 2,051,507
Cost of Sales 950,750 828,517 2,746,333 1,373,521
----------- ----------- ----------- -----------
Gross Profit 534,359 254,005 1,298,661 677,986
Selling Expenses 384,370 329,413 1,174,218 796,495
General and Administrative Expenses 614,089 475,841 2,067,904 1,262,652
----------- ----------- ----------- -----------
Operating Loss (464,100) (551,249) (1,943,461) (1,381,161)
----------- ----------- ----------- -----------
Other Income (Expense)
Interest expense (7,907) (1,512) (15,330) (16,384)
Miscellaneous 554 6,850 24,323 48,276
----------- ----------- ----------- -----------
Total Other Income (7,353) 5,338 8,993 31,892
----------- ----------- ----------- -----------
Loss Before Taxes on Income (471,453) (545,911) (1,934,468) (1,349,269)
Taxes on Income -- -- -- --
----------- ----------- ----------- -----------
Loss Before Extraordinary Item (471,453) (545,911) (1,934,468) (1,349,269)
----------- ----------- ----------- -----------
Extraordinary Gain on Extinguishment of Debt -- 137,912 -- 137,912
----------- ----------- ----------- -----------
Net Loss (471,453) (407,999) (1,934,468) (1,211,357)
Dividend on Preferred Stock Payable
in Common Stock upon conversion -- -- 62,842 --
----------- ----------- ----------- -----------
Net Loss Allocable to Common Stockholders $ (471,453) $ (407,999) $(1,997,310) $(1,211,357)
=========== =========== =========== ===========
Loss Per Share Before Extraordinary Item $ (0.06) $ (0.09) $ (0.26) $ (0.27)
Gain on Extraordinary Item -- 0.02 -- 0.03
----------- ----------- ----------- -----------
Net Loss Per Common Share $ (0.06) $ (0.07) $ (0.26) $ (0.24)
=========== =========== =========== ===========
Weighted Average Common Shares Outstanding 8,230,588 6,172,675 7,620,067 5,044,767
=========== =========== =========== ===========
See accompanying notes to consolidated financial statements
4
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
(Unaudited)
Preferred Stock Common Stock Additional
Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------ ------ ------ ------ ------- ------- -----
Balance,
January 1, 1997 170,000 $ 1,480,000 6,356,487 $63,565 $ 11,223,593 $ (8,256,870) $ 4,510,288
Net loss -- -- -- -- -- (1,934,468) (1,934,468)
Conversion of Preferred
Stock to Common Stock (170,000) (1,480,000) 1,714,101 17,141 1,462,859 -- --
Exercise of stock options -- -- 10,000 100 19,275 -- 19,375
Exercise of warrant -- -- 150,000 1,500 138,750 -- 140,250
Preferred Stock offering costs -- -- -- -- (30,393) -- (30,393)
Net warrants issued to prepay
future expenses -- -- -- -- 46,100 -- 46,100
Dividend on Preferred Stock payable
in Common Stock upon conversion -- -- -- -- 62,842 (62,842) --
-------- ----------- --------- ------- ------------ ------------ -----------
Balance,
September 30, 1997 -- $ -- 8,230,588 $82,306 $ 12,923,026 $(10,254,180) $ 2,751,152
======== =========== ========= ======= ============ ============ ===========
See accompanying notes to consolidated financial statements
5
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30,
1997 1996
---- ----
Cash Flows From Operating Activities
Net Loss $(1,934,468) $(1,211,657)
----------- -----------
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 238,161 130,497
Extraordinary item, before tax -- (137,912)
Loss on sale or disposal of equipment 3,255 1,522
(Increase) decrease in assets
Trade accounts receivable (486,916) (225,857)
Inventories 178,147 21,267
Other receivables 19,117 (2,886)
Prepaid expenses (39,546) (50,660)
Other assets (6,363) (10,177)
Increase (decrease) in liabilities
Accounts payable 547,712 25,130
Accrued expenses 97,265 2,430
Other liabilities 145,201 30,297
----------- -----------
Total adjustments 696,033 (216,349)
----------- -----------
Net cash used in operating activities (1,238,435) (1,428,006)
----------- -----------
Cash Flows From Investing Activities
Capital expenditures (287,711) (149,242)
Cash received from the sale of equipment -- 21,000
Cash paid in acquisition of subsidiary, net of cash acquired -- (220,969)
Proceeds from redemption of certificates of deposit -- 75,628
Expenditures related to patents and patents pending (95,537) (64,022)
----------- -----------
Net cash used in investing activities (383,248) (337,605)
----------- -----------
Cash Flows From Financing Activities
Proceeds from issuance of Common Stock -- 1,981,670
Proceeds from exercise of stock options 19,375 --
Proceeds from exercise of warrant 140,250 --
Proceeds from issuance of notes payable,
including consideration for warrants 250,000 410,943
Private offering costs (30,393) --
Principal payments under long-term debt and capital lease obligations (23,377) (415,935)
----------- -----------
Net cash provided by financing activities 355,855 1,976,678
----------- -----------
Net increase (decrease) in cash and cash equivalents (1,265,828) 211,067
Cash and cash equivalents at beginning of period 1,369,843 331,601
----------- -----------
Cash and cash equivalents at end of period $ 104,015 $ 542,668
=========== ===========
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for interest $ 15,330 $ 10,109
During 1996, notes payable to shareholder of $325,000 were repaid through the issuance of common stock.
During 1996, pledged certificates of deposit of $75,628 were applied in partial satisfaction of certain long term debt obligations.
During 1996, note payable of $237,912 was paid in full by issuing common stock with a market value of
$100,000 resulting in an extraordinary gain.
In conjunction with the 1996 acquisition of H.E.R.C. Consumer Products Company, the Company acquired current assets of
$469,807, goodwill of 125,490 and current liabilities of $367,795.
During 1997, capital lease obligations of $134,000 were incurred when the Company entered into certain leases for new equipment.
During 1997, 1,714,101 shares of Common Stock were issued upon the conversion of 170,000 shares of Preferred Stock.
During 1997, certain adjustments were made to assets and liabilities acquired in the purchase of the 50% interest of
H.E.R.C. Consumer Products Company and, accordingly, goodwill was reduced by $22,673.
During 1997, inventory with a value of $211,685 was reclassified to property and equipment.
See accompanying notes to consolidated financial statements
6
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 ("Company")
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, 1996.
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 report fairly 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, 1997.
NOTE 2 - Inventories
During 1997, certain finished goods inventory used to service customers for the
Company's industrial products was reclassified to property and equipment. Such
equipment was carried at $212,000 and is now being depreciated.
Inventories are summarized as follows:
September 30, 1997 December 31, 1996
------------------ -----------------
Raw materials $ 9,654 $ 9,126
Work in progress 2,274 5,633
Finished goods 215,053 602,054
-------- --------
Total $226,981 $616,813
======== ========
NOTE 3 - Acquisition
On July 1, 1996, the Company acquired the 50% interest of H.E.R.C. Consumer
Products Company ("LLC") owned by Conair Corporation. This transaction was
accounted for by the purchase method. The Company had accounted for its 50%
investment in the LLC by the equity method, and accordingly, sales of the LLC
prior to July 1, 1996, were not reported as sales of the Company.
Pro forma results for the nine months ended September 30, 1996 are unaudited and
were prepared as if the aforementioned acquisition had occurred at the beginning
of the period presented:
Nine Months Ended September 30, 1996
------------------------------------
Net sales $ 2,812,753
Net loss (1,121,169)
Net loss per Common Share (0.22)
7
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 - Long Term Debt and Other Financing Arrangements
In September 1997 the Company closed on a five year term loan and borrowed
$250,000. Interest is payable monthly at an annual rate of 14%; principal
repayments are over 54 months and begin 6 months after take-down. In connection
with the closing, the Company issued two warrants to the lender, each to
purchase 62,500 shares of common stock at $1.18 (market price at closing) and
$1.475 (25% premium over market price at closing), respectively. The Company may
prepay the loan; certain fees and conditions, including issue of two identical
warrants, apply if prepayment is not made within two years of takedown.
In October 1997, the Company concluded arrangements for a factoring facility
whereby 80% of a maximum of $600,000 in eligible receivables may be financed at
an effective annual interest rate of approximately 16%. The initial term of the
facility is two years which may be extended.
Substantially all of the Company's assets are pledged as security pursuant to
the above agreements.
8
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations
Forward-Looking Statements
- --------------------------
When used in this Form 10-QSB and in future filings by the Company with the
Securities and Exchange Commission ("SEC") , in the Company's press releases and
in oral statements made with the approval of an authorized executive officer of
the Company, the words or phrases "are expected", "the Company anticipates",
"will continue", "estimated", "will enhance" or similar expressions (including
confirmations by an authorized executive officer of the Company of any such
expressions made by a third party with respect to the Company) are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Readers are cautioned not to place
undue reliance on any such forward-looking statements, each of which speak only
as of the date made. Such statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from
historical earnings and those currently anticipated or projected. Such risks
include, but are not limited to, adequate cash flow and financing for
implementation of its business plan, continued growth in its various customer
segments and effective marketing of its products directly by the Company and
through marketing partners. The Company has no obligation to publicly release
the result of any revisions which may be made to any forward-looking statements
to reflect any anticipated events or circumstances occurring after the date of
such statements.
Results of Operations
- ---------------------
Three Months Ended September 30, 1997 Compared to Three Months Ended September
- --------------------------------------------------------------------------------
30, 1996
- --------
Sales of $1,485,000 in the third quarter were $403,000 ahead of 1996 third
quarter sales principally because of $300,000 from Marine Ship Board Pipe Line
Chemical Cleaning. Of the marine work, $200,000 was performed pursuant to a five
year contract recently signed with the United States Navy, which calls for
billings between an annual minimum of approximately $100,000 to an annual
estimate of $1,600,000. Also the Company completed two mechanical cleaning
projects for aggregate billings of $125,000 in 1997.
Higher Agricultural sales in 1997 were offset by lower Consumer Products sales.
Consolidated gross margins were 36% and 23% in 1997 and 1996 respectively.
Improved Industrial margin of 30% in 1997 compared with negative 2% in 1996 is a
function of 1996 start up costs and equipment write downs associated with the
Company's initial commercial pipeline rehabilitation projects. Consumer Products
margin was 29% in 1997 compared with 24% in 1996 when the Company absorbed
certain one time product and freight costs associated with inventory acquired
from Conair (see Note 3). Agricultural margins improved by approximately 10%
through increased sales of higher margin products.
The increase in gross profit from $254,000 in 1996 to $534,000 in 1997 was
partially offset by an increase in aggregate selling, general and administrative
expenses of $193,000. The result was a net loss of $471,000 in 1997 compared
with $546,000 before extraordinary item in 1996. Increased selling, general and
administrative expenses from higher professional services (including
consideration in the form of warrants to acquire the Company's common stock),
marketing and promotion, occupancy and depreciation were offset somewhat by the
Company's cost containment efforts which began to take effect during the third
quarter (See comments on cost containment in Liquidity and Capital Resources
section below).
9
H.E.R.C. PRODUCTS INCORPORATED AND SUBSIDIARIES
Management's Discussion and Analysis of Financial
Condition and Results of Operations (Continued)
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30,
- --------------------------------------------------------------------------------
1996
- ----
Sales of $4,045,000 for the nine months ended September 30, 1997 were $1,993,000
ahead of nine month sales in 1996. Consolidation of Consumer Products accounted
for $1,008,000 of the increase. Higher Industrial sales of $799,000 in 1997
resulted from additional pipe cleaning projects for municipalities and expansion
of marine cleaning - both for the U.S. Navy and the U.S. Coast Guard. Increased
Agricultural sales of $240,462 are attributable to Pyrellin and Deny.
Consolidated gross margins were 32% and 33% in 1997 and 1996 respectively.
Industrial margins were approximately 15% in both years because of start up
costs in 1996 and cost overruns on municipal projects in the second quarter of
1997. Staging costs in September 1997 for the Navy contract also depressed 1997
margins.
Agricultural margins went from 40% in 1996 to 48% in 1997 because of a higher
sales mix of Deny and Coax, both of which have low raw material cost. Also
Pyrellin inventory was purchased in 1997 at a lower cost than in 1996.
Although gross profit increased from $678,000 in 1996 to $1,299,000 in 1997, net
loss was $1,934,000 in 1997 compared to $1,349,000 (before extraordinary gain in
1996) primarily because of an increase of $1,184,000 in aggregate selling,
general and administrative expenses. Consolidation of Consumer Products accounts
for $312,000 of the increase while the balance is attributable to settlement of
an employment contract during the first quarter, an expenditure for development
of technology in the second quarter and to additional selling and other
personnel and support costs, primarily at the Corporate and Industrial levels.
Liquidity and Capital Resources
- -------------------------------
Cash and cash equivalents were $104,000 and $1,370,000 at September 30, 1997 and
December 31, 1996 while working capital was $62,000 and $1,926,000 at those
respective dates. These declines are a function of the 1997 net loss with the
impact on cash somewhat mitigated by the term loan of $250,000 (see Note 4)
and depreciation and amortization.
The conversion during 1997 of all preferred stock outstanding at December 31,
1996 into common stock had no impact on cash and cash equivalents or working
capital.
The Company does not project sufficient revenue to produce positive cash flow in
the fourth quarter, nor does it expect that additional debt financing can be
arranged in the near future to absorb the continuing cash drain through December
1997. Accordingly, the Company is aggressively pursuing a cost containment
program which may include closing or curtailing some of its operations, at least
temporarily. In addition, the Company is actively seeking buyers for certain
assets as well as for certain of its operating segments.
Another offering of the Company's equity securities is a possible source of
capital, but such a course of action would substantially dilute the interest of
the Company's then stockholders.
No assurance can be given that the Company will succeed in raising cash to fund
ongoing operations through sale of assets and/or equity securities. If the
Company is unsuccessful in raising cash during the fourth quarter of 1997, it
will not be able to continue operations.
10
PART II: OTHER INFORMATION
Item 2. Changes in Securities
Recent Sales of Unregistered Securities
The following relates to all securities of the Company sold within the first
nine months of 1997 which were not registered under the Securities Act of 1933.
Title of Security Consideration Exemption from Terms of
Date of Sale & Number Sold received registration claimed conversion / exercise
------------ ------------- -------- -------------------- ---------------------
2/6/97-5/12/97 170,000 shares of Conversion of Section 4(2) 75% of five day
Preferred Stock Preferred Stock average closing bid
converted into price of share of
1,714,101 shares of common stock
common stock immediately prior to
conversion
6/18/97 Warrants to purchase None Section 4(2) Exercisable
150,000 shares of at $1.3125 through
Common Stock 8/18/02
6/21/97-9/30/97 Warrants to purchase Consulting Section 4(2) Exercisable at
130,000 shares of Services prices of $1.00 - $2.00
Common Stock from
8/29/97 to 9/3/04
Item 4. Submission of Matter to a Vote of Security Holders
The Company held its annual meeting of stockholders on August 4, 1997. The only
matter presented to the stockholders was the election of directors. The votes
cast on this issue were as follows:
Name For Against
- -----------------------------------------------------------------------------
S. Steven Carl 6,256,376 87,000
Shelby A. Carl 6,256,376 87,000
Jerome H. Ludwig 6,256,376 87,000
Robert M. Leopold 6,256,376 87,000
Robert Spane 6,256,376 87,000
Salvatore DiMascio 6,256,376 87,000
11
Item 6. Exhibits and Reports on Form 8-K
Reports on Form 8-K: None
Exhibits
Regulation S-B
Exhibit No. Exhibit
- ---------------------------
(27) Financial Data Schedule
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
H.E.R.C. PRODUCTS INCORPORATED
------------------------------
(Registrant)
Date: November 13, 1997 By: /s/ S. Steven Carl
---------------------
S. Steven Carl
Chief Executive Officer
By: /s/ John P. Johnson
---------------------
John P. Johnson
Chief Financial Officer
12