H E R C PRODUCTS INC (HERC) - Description of business

Company Description
-Risk Factors," in Item 6, "Management's Discussion and Analysis," and elsewhere in this report.The forward-looking statements in this report are current only as of the date this report is filed with the Securities and Exchange Commission. After the filing of this report, 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. PART IITEM 1. DESCRIPTION OF BUSINESSOUR COMPANY We provide chemical cleaning services for water pipe systems, waste water systems, cooling towers and HVAC systems, tanks and boilers, and other water-based and industrial chemical process systems using our proprietary line of specialty chemical products and chemical cleaning processes. We use our patented and proprietary chemical products and chemical cleaning processes to remove scale and corrosion from pipeline systems, water systems, and surfaces. Chemical cleaning service markets are the main source of our revenue, which include municipal, industrial, governmental, commercial, and other customers serviced directly and through strategic marketing alliances. Our largest customer is currently the U.S. Navy. We provide chemical cleaning services for pipe systems and tanks on U.S. Navy and U.S. Coast Guard vessels.We derive the majority of our revenue from two sources, cleaning sewer, "CHT", systems on U.S. Navy and U.S. Coast Guard vessels (pipe cleaning) and cleaning bilge, fuel, oil, catapult and CHT tanks on ships (tank cleaning). We have been particularly subject to the deployment and servicing schedules of the U.S. Navy as well as the available maintenance funds in the Navy budget. The impact of the Navy deployment to the Middle East in support of the Afghanistan and Iraq military engagements in the first three quarters of 2003 significantly reduced the availability of ships in port for maintenance and consequently our service opportunities with our primary customer. We have experienced increased service opportunities with our largest customer beginning in the fourth quarter of 2003 and the first quarter of 2004 after the return of much of the Navy fleet from these extended deployments.Over time most water and water-based systems, such as potable water delivery systems, fire sprinkler systems, waste systems, process water systems, holding tanks, and water wells develop internal surface scale, corrosion, and tuberculation. These corrosive substances reduce the diameter through which water and waste can travel through the pipes, causing a less efficient or non-functioning system. Our cleaning methodologies remove the corrosion and restore the efficiency and flow characteristics of the system.We use patented and other proprietary chemical products and processes in our cleaning services. Our chemical formulation, when circulated through an obstructed pipe system, dissolves and removes scale and corrosion build-up in solution until flushed from the system. The system may then be treated with other chemical products that retard corrosion or suppress the environment that supports biological growth. Most of the chemicals that we use are non-fuming, non-abrasive, and non-flammable. Most of our chemical products are certified biodegradable by Scientific Certification Systems.Our chemical products and chemical cleaning processes were developed to provide a more cost effective and efficient means of cleaning pipe systems in contrast to replacement, mechanical scraping, pigging, hydro blasting, or other pipe cleaning methods. Additionally, our chemical products and chemical cleaning processes are safer than many other chemical cleaning methods. Our chemical products include the following:- Pipe-Klean and Well-Klean, which remove encrustation from water pumping and distribution systems;- Compound 360 and Compound 400 which clean and maintain cooling and other water treatment systems; and- Line-Out which cleans drip irrigation systems and removes salt from soil surfaces.We also sell private label chemical products utilizing our patented and proprietary formulations or products complementary to our formulations for key customers.Our company was incorporated in Arizona in December 1986 and re-incorporated in Delaware in May 1994. Our executive offices, service operations, warehouse and manufacturing facility for our chemical products relocated in 2003 to 1420 Columbus Avenue, Portsmouth, Virginia and our telephone number there is (757) 393-0002. Our new west coast offices, service operations, and warehouse facility for our chemical products was established in January 2004 at 155 West 55th Street, Suite C, National City, California and our telephone number in that office is (619) 427-0776.Our website is located at www.hercprod.com. Through our website, we make available free of charge our annual report on Form 10-KSB, our quarterly reports on Form 10-QSB, our current reports on From 8-K, our proxy statements, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These reports are available as soon as reasonably practicable after we electronically file those reports with the Securities and Exchange Commission. We will provide to any person without charge, upon request, charters of our Audit Committee and Nominating/Corporate Governance Committee; our Code of Business Conduct and Ethics, and Code of Ethics for the CEO and Senior Financial Officers, and any amendments or waivers thereto; and any other corporate governance materials contemplated by SEC or applicable regulations. To request a copy of these documents, you may contact our corporate secretary at our principal executive offices.PRODUCTS AND SERVICES Water has many uses and is therefore transported through and an integral component of many systems in use today. These systems range from wells and potable waterlines to fire protection systems, heating and air-conditioning units, cooling towers, water tanks, industrial production processes, waste water systems, collection-holding-transfer (CHT) systems, waste tanks, and landfill drainage systems. Water is a chemically active substance and any surface that is regularly exposed to water is subject to corrosion. Since water is rarely pure, water exposed surfaces are also subject to scaling from dissolved minerals or biological corrosion from water-born microbes. Scaling or corrosion will eventually lead to the plugging or fouling of the surface, pipe, pump, air condition system, or other water exposed surface.The generally accepted cleaning methods for various water systems include replacement, mechanical scraping, hydro blasting, pigging, and chemical cleaning. We offer a method of chemical cleaning which we believe is a significant improvement over most other cleaning methods due to increased efficiency, safety, and effectiveness with less environmental impact. Pipe-Klean and Well-Klean are used to remove scale and corrosion from drinking water systems and water wells. These products have been tested and certified by NSF International and Underwriters Laboratories, or UL, for use as well cleaning and pipe cleaning aids in drinking water systems. NSF Standards were developed under authority of the federal Environmental Protection Agency to establish minimum requirements for the control of potential adverse human health effects from products used in drinking water systems.TANK CLEANING In February 2001, we acquired the operating assets of a Norfolk area marine tank cleaning company to add to our marine and land based water and waste water system cleaning services. We provide marine tank cleaning services to U.S. Navy and Coast Guard vessels through our agreements with private shipyards and ship repair companies, and through a subcontract under a SupShip tank and bilge cleaning agreement renewable annually to 2005. We clean fuel, oil, bilge, catapult, and CHT tanks.PIPE CLEANINGOverview In the pipe cleaning segment of our business, we derive the majority of our revenue from chemical cleaning of marine CHT systems on U.S. Navy and U.S. Coast Guard vessels. Since we commenced CHT cleaning in 1997 and tank cleaning in 2000, our most profitable operations have been in these marine related markets despite reduced availability of ships in port available for maintenance as a result of U.S. Navy deployment to the Middle East for most of 2003. Our increased service opportunities with our largest customer increased after the return of much of the Navy fleet from these extended Middle East deployments in the fourth quarter of 2003 demonstrate the long-term demand and customer satisfaction for these services. Our non-marine pipe cleaning services have relied to a significant degree on the cash generated from these marine related service markets and have yet to demonstrate positive cash flow apart from marine services. In view of this experience, we intend to reduce our marketing and sales support efforts in non-marine related services operations in favor of expanding these non-marine services through patent licensing to third parties.While we will continue to support non-marine service operations to satisfy licensee requirements and customer demands for these services, we intend to expand our marketing and sales efforts in the marine services aspect of our pipe cleaning business.Marine Services Our marine applications focus on the cleaning of water and waste water pipe systems on ships including CHT, tank, fire main, and countermeasure washdown systems. For example, the waste systems aboard most marine vessels develop a scale in the pipe interiors that requires cleaning approximately once every 12-18 months. The principal customers of the pipe cleaning division are the U.S. Coast Guard and the U.S. Navy. Following on our five year CHT contract awarded solely to us by the U.S. Navy-Supervisor of Shipbuilding, or SupShip, office in Portsmouth, Virginia, on September 20, 2002 we were awarded a new worldwide five-year agreement with SupShip which expires during September 2007. Of all the firms responding to the Navy solicitation, two awards were made. Under this agreement, we clean pipe systems on board ships for indefinite quantities of chemical cleaning services at fixed prices. SupShip offices of the Atlantic and Pacific Fleets and the maintenance office of the United States Coast Guard use this worldwide CHT contract.To supplement our worldwide 2002 CHT contract, we utilize a five-year General Service Administration service supply contract issued in December of 2000 for delivery of marine services on a worldwide basis. This GSA service supply contract allows the U. S. Navy and U.S. Coast Guard to access our marine services as an alternative contract source of procurement to our CHT contract, giving marine services procurement officers another contract option to use our Company's services.In order to meet the requirements of the worldwide CHT contract and the GSA service contract, we have located an office in Portsmouth, Virginia and in a new National City, California office, near the port in San Diego, to expand our ability to offer pipe-cleaning services to the Atlantic Fleet, Pacific Fleet, Western United States Coast Guard, and other east and west coast customers and have deployed cleaning units for service in Puget Sound, Hawaii, Japan, Guam, and Egypt.Fire Protection We patented our proprietary process method for chemically cleaning fire protection systems in 2000. Since then, we have chemically cleaned multiple fire protection systems for several customers in several industries. We believe that our company has a significant advantage in securing fire protection system chemical cleaning work because we have patents that cover the process of chemically cleaning and passivating a fire protection system.The fire protection industry is in the beginning stages of learning how to diagnose and treat the problem of microbiologically influenced corrosion, or MIC, in fire sprinkler systems. Sprinkler systems across the United States and abroad have been found to have severe internal corrosion resulting from MIC and are not achieving required operational levels. As a result of increased awareness of MIC by the fire protection industry, the American and National Fire Sprinkler Associations have recognized our method for cleaning and passivating fire protection systems. We continue to pursue certification by Factory Mutual and IRI-Hartford Steam Boiler, two of the major insurers of fire protection systems, in order to more aggressively market our services to this segment of the water pipe system market.The market for fire protection system pipe cleaning could grow rapidly if insurance companies or governmental regulation were to require building owners to maintain properly functioning fire protection systems inside their buildings. We continue to consult with members of the industry on the development of fire protection system operational maintenance standards. In addition to fire protection system performance problems, MIC causes minute leaks in water pipes, which results in damage to the building structure, equipment, and business inventory contents. To avoid operational problems and water damage, we offer fire protection system assessment services which include the following:- internal fire system pipe inspection and video; - water content analysis; - scale content analysis; and - recommended remediation method.Potable Water Underground potable waterlines represent another market in which we offer our patented water pipe system cleaning services. We have numerous product and method patents covering the process of chemically cleaning potable water distribution systems. In addition, our chemical products have been tested and certified by the NSF for use as water well cleaning and pipe cleaning aids in drinking water systems. NSF standards were developed under the authority of the EPA to establish minimum requirements for the control of potential adverse human health effects from products used in drinking water systems. Many states have enacted these and similar standards.Over time, potable water lines develop chemical and biological corrosion, a process known as tuberculation. Tuberculation is the most common problem found in potable water lines, and without proper cleaning, the useful diameter of the pipe will become severely restricted. It is not unusual to have a four-inch main line with only one inch of useful diameter remaining. Tuberculation may also cause colored water, bad odors, unpleasant taste, and increased chemical treatment and pumping costs.Public and private water infrastructure capital and maintenance funding may serve to create large markets for system rehabilitation in the future. The practical need for underground water distribution system cleaning and passivation is growing worldwide, and the U.S. Congress is beginning to budget and fund water distribution rehabilitation programs administered through the EPA. We believe our core process patents directly address this practical need with a more efficient, more economical, and less intrusive method of remediation than traditional methods.Specialty Cleaning In industrial process plants, scale and tuberculation greatly reduce heat exchange, condensing, and liquid flow capacities in a variety of systems. In water treatment plants, chemical feed lines become internally clogged to the point where they do not function properly. In fabric manufacturing plants, process pipe systems develop chemical scale deposits. We currently provide chemical cleaning services to several industrial companies and municipalities in areas such as systems in fiber plants, waste water systems, and other types of systems.INDUSTRIAL CHEMICALS Our industrial chemicals division manufactures and sells specialty chemical products using our proprietary and patented formulas for applications in the removal of salt, scale, and corrosion and in the maintenance of process water systems. These products are currently Well-Klean, Line Out, and several process water products currently manufactured under private label for DuPont. Well-Klean removes scale and corrosion in water wells. Over time, the well screen and many other well components become clogged. When added to wells as directed, Well-Klean removes the harmful corrosion and corrosion by-products from the well components and the surrounding aquifer to restore well pumping characteristics, ultimately leading to improved well performance.Line Out cleans drip irrigation systems and removes salt from soils in the root zone of turf grasses on golf courses. Drip systems become clogged with scale over time and require regular maintenance in order to continue to perform. The use of high salt content water by golf courses for irrigation has caused the need for a product to remove salt from the turf root zone. We believe our Line Out product provides a superior method of cleaning while improving water distribution. We manufacture Line Out as a private labeled product called Deliminate for golf courses in the United States.Chlor*Rid is a product developed from one of our core formulas to remove salt from surfaces prior to the application of high performance paints or coatings. During 1998, we sold a 50% interest in our patent covering this application to Chlor*Rid International. We sold our remaining 50% interest in 2002, and Chlor*Rid became the sole owner of Chlor*Rid. Under the sales agreement, we retain royalties on future sales for the life of the patent, which is approximately 12 years.We sell process water products primarily under the trade name Compound 360. These products de-scale and maintain many types of process water systems, including cooling towers, heat exchangers, and condensers. During 1999, we entered into agreements with DuPont under which we manufacture private labeled products for DuPont using our formulas. In addition to realizing the gross profit from the manufacturing of the product, we receive royalties on the sales of the defined product. We may also market our products to the same customers and can use Dupont's name in certain marketing representations.MARKETING AND DISTRIBUTION We market our products and services through our marketing and sales staff, independent distributors, sales representatives, strategic partnerships, and licensing and marketing agreements. While we generate most of our revenue from relatively few customers, we expect the high concentration levels to lessen in the future as we expand the menu of marine services we provide to our existing customers through multiple governmental procurement contract vehicles and private contracting, and by licensing both our marine and land-based pipe cleaning technologies to third-parties. Nonetheless, any material delay, cancellation, or reduction of orders from these customers due to lack of opportunity to perform routine maintenance on marine vessels out of port on extended military deployments in the future or other factors could have a material adverse effect on our results of operations and financial position.Licensing our technologies to third parties allows us to expand our service opportunities in both domestic and foreign marine and land-based pipe cleaning markets while minimizing our operating business risks for associated marketing and labor costs otherwise required to service these markets. In October 2003, we granted a five-year exclusive license to a Canadian company for the cleaning of municipal potable distribution systems, municipal waste water treatment process and pipe systems, commercial, institutional and industrial piping infrastructure and facilities, and water well rehabilitation in the Canadian provinces of Ontario, Quebec, New Brunswick, Newfoundland, Nova Scotia, and Prince Edward Island. During January 2004, we granted a five-year exclusive license to Seiwa Pro, Ltd. of Osaka, Japan to use substantially all of our chemical cleaning patents and technology to clean marine ship piping systems, municipal potable distribution systems, commercial, institutional and industrial infrastructure and facilities piping, water well rehabilitation, and fire protection sprinkler systems in Japan, China, Taiwan, Korea, Singapore and Malaysia. The license agreement provides that Seiwa will pay us royalties at rates designated in the agreement ranging from 3 to 10% of sales, with such royalty percentage rates decreasing as sales volume increases. Seiwa will prepay royalties of $500,000 net of treaty withholding taxes of $50,000, in two equal installments of $225,000. The first installment was due and paid during January 2004, and accrues interest credited for the benefit of Seiwa as additional prepaid royalty at the rate of 2.25% per annum. The second installment is due and payable during July 2004, and once paid, the total prepaid royalty will accrue interest as additional prepaid royalty at a rate of 4.5% per annum. Any interest accrued on the prepaid royalty will increase the amount of the prepaid royalty as additional consideration for the use of the prepaid royalty advanced. The agreement requires Seiwa to meet minimum royalties of $50,000 in 2005 and $100,000 in each of 2006, 2007, and 2008. If, at the end of the primary term, there is any remaining prepaid royalty balance after application of credit for minimum royalties, we will repay to Seiwa the balance plus accrued interest. In the event the parties agree on applicable terms, we may permit Seiwa to convert any unearned prepaid royalty balance we owe them into shares of our common stock. In addition to these licenses, we continue negotiations with other potential foreign and domestic licensee prospects for use of patented and proprietary technologies.COMPETITION Several small regional companies and certain larger customers compete with us for our marine business. Our company competes directly with Layne-Christensen, Inc. in the market for water well cleaning. Chemicals used in cleaning water systems have generally been non-proprietary, readily available acids produced by such major chemical companies as DuPont, Dow Chemical Company, Hill Brothers Chemical Company and Vista Chemical Company. These companies are substantially larger and have far more extensive resources than we do. To the extent that we seek to sell our water system pipeline rehabilitation products directly to end users, we may be perceived as competing with the regional contractors to which we might also seek to market our pipe rehabilitation products and technology. While they are not as large as the chemical producers, the contracting companies are still generally larger and more established in the industry than our company.We anticipate that the companies with which we compete have the resources to develop, have developed, are developing, or may develop and market products and services that directly compete with those of our company. Current competitors or new market entrants could produce new or enhanced products or services with features that render our company's products and services obsolete or less marketable. Our company's competitive success will depend on our ability to promote and to adapt to technological changes and advances in the water systems treatment industry.We compete principally on the basis of our methodology, ease of use, price, and environmental impact. We also strive to secure strategic relationships with established companies. We have patent protection for certain of our chemicals and processes, and we are seeking to expand our patent protection by making new applications with respect to our proprietary products and technologies in order to provide a diverse product and service offering.MANUFACTURING AND SUPPLIES We formulate and package our industrial products at our plant in Portsmouth, Virginia. We generally do not maintain long-term supply agreements with our suppliers, and we purchase raw materials pursuant to purchase orders or short-term contracts in the ordinary course of business. We believe that the raw materials and other supplies are available from a variety of sources and that there are numerous companies available to formulate and package our products.PATENT AND TRADEMARK PROTECTION We rely on patent protection, including the following:- a series of U.S. patents for the use of our Pipe-Klean technology in the cleaning of potable water distribution and fire protection systems; - a U.S. patent on the mobile re-circulation units employed in the pipe cleaning process; and - a series of U.S. patents on the core chemical technology used for pipe cleaning and industrial water applications.We received a Notice of Allowance for our basic pipe-cleaning patents from the association of European countries and applied for these patents throughout Europe, the Far East, Australia, and Brazil during 1999 and 2000. Additionally, U.S. Patent applications for Methods of Pipe Cleaning and improvements on the basic method were issued to by us during 1999 and 2000. In 2002, we filed an application for chemical pipe cleaning of certain systems on military marine vessels. The marks h.e.r.c., Well-Klean, Pipe-Klean, and Line-out are registered trademarks of our company.There can be no assurance that any patents applied for will be obtained. Moreover, there can be no assurance that any of the patents will afford our company commercially significant protection of our technology or that we will have adequate resources to enforce our patents. We believe that our company has independently developed its proprietary technologies and that these technologies do not infringe the proprietary rights of others. We have received no claims of infringement concerning our patented or proprietary processes and products, although it is possible that infringement of existing or future patents or proprietary rights may occur.Our company relies on proprietary know-how and confidential information and employs various methods to protect the processes, concepts, ideas, and documentation associated with our technology. However, such methods may not afford complete protection, and others may independently develop such processes, concepts, ideas, and documentation. Although we require all of our employees to sign confidentiality agreements and covenants not to compete, we may not be able to protect our trade secrets, and other companies may acquire information that we consider to be proprietary.GOVERNMENT REGULATION Water pollution is a major focus of federal, state, and local environmental protection laws and regulations. The discharge from water systems treatment is subject to these laws and regulations. The water system treatment industry andour operations are subject to extensive and significant regulation by federal, state, and local governmental authorities. Some of such regulation is extensive and may from time to time have a significant impact on our operations. NSF has indicated that Pipe-Klean and Well-Klean comply with the standards for chemicals that can be used in cleaning drinking water systems. In addition, many of our products are certified as biodegradable by Scientific Certification Systems. Products are biodegradable if they can be broken down into carbon dioxide, water, and minerals without harmful effects to the environment.Some of our products require the use of a chemical that is classified under applicable laws as a corrosive chemical and substance, and our use of these chemicals and substances may subject us to environmental liability. The use of certain chemicals contained in our products is subject to frequently changing federal, state, and local laws and substantial regulation under these laws by governmental agencies, including the EPA, the Occupational Health and Safety Administration, various state agencies, and county and local authorities acting in conjunction with federal and state authorities. Among other matters, these regulatory bodies impose requirements- to control air, soil and water pollution; - to protect against occupational exposure to such chemicals, including health and safety risks; and - to require notification of the storage, use, and release of certain corrosive chemicals and substances.We have obtained certification for our Pipe-Klean, Pipe-Klean Preblend, Acid Klean, and Pipe-Klean Neutralizer products as "pipe cleaning aids" under ANSI/NSF Standard 60 from NSF for use in potable water distribution systems. Additionally, we have obtained ANSI/NSF Standard 60 certification for our Well-Klean II Concentrate, Acid Klean, and Well-Klean Preblend products as "well cleaning aids" for potable water wells.We believe that we are in substantial compliance with all material federal, state, and local laws and regulations governing our business operations and that we have obtained all material licenses, authorizations, approvals, orders, certificates, and permits required for the operation of our business. We cannot provide assurance that in the future we will be able to comply with current or future government regulations in every jurisdiction in which we will conduct our business operations without substantial sanctions, including restrictions on our business operations, monetary liability, and criminal sanctions, any of which could have a material adverse effect on our business.Advertising relating to our products is subject to the review of the Federal Trade Commission and state agencies pursuant to their general authority to monitor and prevent unfair or deceptive trade practices. In addition, the Consumer Products Safety Commission regulates the labeling of our products.RESEARCH AND DEVELOPMENT We estimate that we incurred approximately $20,000 during fiscal 2003 and $10,000 during fiscal 2002 on research and development activities related to improving our cleaning methodologies. A focus of our recent research and development has been to support the expansion of our patent protected processes and methods into the marine services market, thereby increasing our service opportunities with our primary customers. In 2002, a new application was filed for chemical cleaning of certain military marine vessel systems.In January 2004, we entered into a joint development agreement for the further development of our HERC-KOAT technology for post-cleaning water pipe surface coating. Our development associate paid us $25,000 for the right and obligation to fund further develop the existing technology to a stage capable of filing a patent application with the United States Patent and Trade Office. Any potential patent granted would be jointly owned. Prior to the filing of a patent application, either party may terminate the agreement with the consent of the other party. In the event of agreed termination, the party desiring the technology shall obtain from the other assignment of all right and title to the technology in exchange for repayment of all development costs incurred by the assigning party.EMPLOYEES As of March 5, 2004, we had 70 employees. Two of our employees are executive officers, 60 are engaged in field operations and production, four are in administration, and four are in marketing and sales. None of our employees are covered by a collective bargaining agreement with us. We believe that our relationship with our employees is good.SEASONALITY Sales of specialty chemical products and certain chemical cleaning services are seasonal in the Snow Belt regions of the United States. Sales to our primary customers, the U.S. Navy and the U.S. Coast Guard, and the private shipyard customers who prime contract with them, are not subject to seasonal variations.RISK FACTORS The following factors, in addition to those discussed elsewhere in this report, should be carefully considered in evaluating our business. OUR COMPANY HAS NOT RECENTLY BEEN PROFITABLE, MAY NEED FINANCING IN THE FUTURE, DOES NOT HAVE COMMITTED SOURCES OF FINANCING APART FROM OUR FACTORING ARRANGEMENT, AND CONTINUES TO FACE SIGNIFICANT CONSTRAINTS ON CASH FLOW AND LIQUIDITY THAT MAY AFFECT OUR OPERATIONS.Our company has not been profitable in recent years. If our company is not profitable in the future for an extended period of time, it will require additional financing to cover operating expenses. Also, any major capital expenditures or the need for capital to finance growth may require capital from independent financing sources. Our company does not have any accumulated retained earnings to fund cash flow deficits and significant capital requirements. Other than our factoring arrangement and debt financing from affiliates, we do not have any specifically identified sources for future financing requirements.We may need additional sources of financing in order to carry on our operations as presently conducted. Any financing will likely include short-term debt borrowings from affiliates. We cannot assure you that such additional sources of financing will be available on acceptable terms, if at all. If additional financing is not available to us, we will have to implement additional measures to conserve cash and reduce costs, which may include, among other things, making additional cost reductions, and reducing the scale of marketing and sales expenses in certain unprofitable operations. However, we cannot assure you that such measures will be successful. Our failure to raise required additional funds would adversely affect our ability to:- maintain, develop, or enhance our service offerings; - take advantage of future opportunities; - respond to competitive pressures; - continue operations; - acquire and retain a chief financial officer; or - maintain our status as a publicly traded companyDURING FISCAL 2003, THE U.S. NAVY ACCOUNTED FOR 15% OF OUR REVENUE; METRO MACHINE ACCOUNTED FOR 12% OF OUR REVENUE; MHI ACCOUNTED FOR 10% OF OUR REVENUE; AND EARL INDUSTRIES ACCOUNTED FOR 21% OF OUR REVENUE.The loss of all or a substantial portion of the business from any of these customers could result in a material adverse effect on our revenue and results of operations. Our GSA services contract extends through November, 2005, and our CHT chemical pipe cleaning agreement with the U.S. Navy currently extends through September 2007. If the U.S. Navy cuts back on the procurement of our services for an extended length of time, we may not be able to replace this customer in a timely enough fashion. While we do not have a long-term contract with Earl Industries, a prime contractor for ship repair and maintenance services with the U.S. Navy in the Norfolk, Virginia port area, we continue to obtain competitively bid subcontract purchase orders from Earl Industries under their prime contracts with the Navy.Long-term deployments of the fleet in 2003 significantly reduced the availability of Navy ships for routine maintenance, including our marine services during that period. The impact of significant long-term military naval deployments have had and could have a significant impact upon our business since many of the U.S. Navy ships would be at sea or on call rather than being in maintenance in port.POTENTIAL COMPETITION EXISTS FOR CUSTOMERS IN THE MARINE BUSINESS. We do not believe that there are any substantial capital requirements for or other barriers to entry into the chemical cleaning of pipe systems or tanks for the marine industry. Therefore, there is potential competition from entities that elect to enter into this industry. As with any competition, there may be an adverse effect on market share and current margins of our company.THE LACK OF PATENTS MAY LIMIT OUR ABILITY TO PROTECT OUR CURRENT COMPETITIVE POSITION IN THE MARINE BUSINESS.Our company competes on the basis of our knowledge and experience of marine and other closed loop systems. The chemical products used in the marine business are based mainly on proprietary chemistry, but this chemistry is not patented or, we believe, patentable. Therefore, others may develop the same or similar chemistry through reverse technology or by experimentation. If that happens, another entity could offer some of the same benefits as we do and increase the competition in the marine pipe systems chemical cleaning market. Also, the lack of patents limits our ability to market an absolutely unique product or service. While we recently made application for patent protection for chemical cleaning in certain military marine vessel systems to address this market, Our company to a significant degree relies on trade secret and confidentiality protection with respect to the chemicals and methodologies we use in our marine business. It is possible that these protections will not be adequate to protect us from competitors.THE LOSS OF ANY OF OUR KEY EXECUTIVES AND OUR FAILURE TO ATTRACT, INTEGRATE, MOTIVATE, AND RETAIN ADDITIONAL KEY EMPLOYEES, INCLUDING A CHIEF FINANCIAL OFFICER, COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS. Our success depends to a large degree upon the skills of our senior management team and current key employees and upon our ability to identify, hire, and retain additional sales, marketing, technical, and financial personnel. The loss of any of our key executives or the failure to attract, integrate, motivate, and retain additional key employees could have a material adverse effect on our business. We may be unable to retain our existing key personnel or attract and retain additional key personnel.We depend particularly upon our Chief Executive Officer and President, S. Steven Carl, who also serves as the acting Chief Financial Officer. We have an employment agreement with Mr. Carl in the capacity of President and Chief Executive Officer originally due to expire in June 2003. The agreement terms provide that employment will automatically renew six months prior to its expiration date unless the Board of Directors notifies him of its intent not to renew his contract. His employment agreement was automatically renewed under its terms in December 2002 until June of 2004. In December of 2003, the Board of Directors resolved to allow his employment agreement to automatically renew under its terms for another year until June 2005.THE EFFECT OF LIABILITY CLAIMS IN EXCESS OF THE INSURANCE LIMITS COULD AFFECT THE FINANCIAL CONDITION OF OUR COMPANY. We are engaged in a business that might expose our company to claims for personal or property injury. Suits may result from personnel or bystanders who are injured on site from damage to a pipe system being cleaned or from other issues arising from the performance of our services. Our company maintains liability insurance in the aggregate amount of $2,000,000 and $1,000,000 per occurrence. We also have an umbrella liability policy in the amount of $5,000,000. A successful claim against our company that exceeds the insurance limits or that is not covered will have a material adverse effect on our financial condition.A SUBSTANTIAL NUMBER OF SHARES ARE ELIGIBLE FOR FUTURE SALE. As of March 5, 2004, there were outstanding 12,365,586 shares of our common stock. Approximately 12,198,347 of these shares are freely tradable without restriction or further registration under the securities laws, unless held by an "affiliate" of our company, as that term is defined in Rule 144 under the securities laws. Shares held by affiliates of our company are subject to the resale limitations of Rule 144. The eligibility of these shares for resale may have a depressive effect on the price of our common stock or may reduce the liquidity of our common stock.THE EFFECT OF OUTSTANDING OPTIONS AND WARRANTS ON MARKET PRICE AND LIQUIDITY. As of March 5, 2004, we had outstanding options and warrants to purchase 797,500 shares of our common stock. The exercise price of these options or warrants exceeds the current market price of our common stock. In the circumstance where the exercise of some of these options or warrants are equal or less than the current market price of our common stock, these options and warrants may have an adverse impact on the price and liquidity of our common stock in the public market. Also, the issuance of these shares will result in dilution to current stockholders.DIRECTORS, OFFICERS, AND CERTAIN OTHER STOCKHOLDERS OWN A SIGNIFICANT PORTION OF OUR STOCK. Our directors and executive officers beneficially own a total of approximately 30.4% of the issued and outstanding shares of our common stock, and one non-management stockholder beneficially owns approximately 27% of the issued and outstanding shares of our common stock. As a result of this ownership, these persons have the power effectively to control our company, including the election of directors, the determination of matters requiring stockholder approval, and other matters pertaining to corporate governance. This concentration of ownership also may have the effect of delaying or preventing a change in control of our company.ENVIRONMENTAL AND OTHER REGULATORY ISSUES MAY IMPACT OUR OPERATIONS. Our business operations at our facility in Portsmouth, Virginia include some storing, mixing, and shipping of chemical cleaning agents that we use at customer sites to clean water pipe systems or sell to customers. Sometimes, we may remove liquid product consisting of approximately 90% water and 10% petroleum (diesel) product from a customer's job site during our tank cleaning operations and take this waste to our facility prior to processing. While this residual is not classified as hazardous waste, we are monitored by the Division of Environmental Quality and Hampton Roads Sanitation Division and subject to various federal, state and local laws and regulations. If a spill were to occur, we could be subject to civil liability to third parties for remediation costs or other damages if leakage migrates onto the property of others.