# ** **

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-KSB**

 

| (MARK ONE) |
|------------|
| **ý** |   | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|       |   |   |
|       |   | **For  the Fiscal Year Ended December 31, 2001** |
|       |   |   |
| **OR**     |   |   |
|       |   |   |
| **o**      |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|       |   |   |
|       |   | **For  Transition Period from                    to                ** |

 

 

**Commission File Number 02-23729**

 

**HYDROMAID INTERNATIONAL, INC.**

(Name of Small Business issuer in its Charter)

 

| **NEVADA**                              |   | **87-0575933**                       |
|-----------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of         |   | (I.R.S. Employer Identification No.) |
| Incorporation or organization)          |   |                                 |
|                                    |   |                                 |
| **1350 E DRAPER PARKWAY**               |   |                                 |
| **DRAPER, UTAH**                        |   | **84020**                            |
| (Address of Principal Executive Office) |   | (Zip Code)                           |

 

 

REGISTRANT’STELEPHONE NUMBER, INCLUDING AREA CODE: ** (801) 553-8790**

 

SECURITIESREGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

| NAME  OF EACH EXCHANGE |   |                 |
|------------------------|--------|----------------------|
| ON  WHICH REGISTERED   |   | TITLE  OF EACH CLASS |
| NONE                   |   | NONE                 |

 

SECURITIESREGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

 

COMMONSTOCK — $.001 PAR VALUE

**(Titleof Class)**

 

Checkwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes     ý        No    o

 

Checkif there is no disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K contained herein, and will not be contained, to the best ofregistrant’s knowledge, in definitive proxy or 

 

information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB.  

Yes     ý        No    o

 

Revenuesof the registrant for the fiscal year ended December 31, 2001 were $32,905.

 

Theaggregate market value of the Common Stock held by non-affiliates of theregistrant on December 31, 2001 was $1,883,767 based upon the average of thebid and asked prices of the Common Stock, as reported by the National QuotationBureau, LLC.

 

Thenumber of shares of the Common Stock of the registrant outstanding as ofDecember 31, 2001 was approximately 26,975,000.

 

TransitionalSmall Business Disclosure Format (check one):

 

                                     Yes    o        No    ý

 

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PART I

 

Allstatements, other than statements of historical fact, included in this Form10-KSB, including without limitation the statements under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and“Business,” are, or may be deemed to be, “forward-looking statements” withinthe meaning of Section 27A of the Securities Act of 1933, as amended (the“Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (the“Exchange Act”). Such forward-looking statements involve assumptions, known andunknown risks, uncertainties and other factors which may cause the actualresults, performance, or achievements of HydroMaid International, Inc. (the“Company”) to be materially different from any future results, performance, orachievements expressed or implied by such forward-looking statements containedin this Form 10-KSB. Such potential risks and uncertainties include, withoutlimitation, competitive pricing and other pressures from other kitchenappliance manufacturers, economic conditions generally and in the Company’sprimary markets, consumer spending patterns, perceived quality and value of theCompany’s product, availability of capital, cost of labor (foreign anddomestic), cost of raw materials, the political climate in China, and otherrisk factors detailed herein and in other of the Company’s filings with theSecurities and Exchange Commission. The forward-looking statements are made asof the date of this Form 10-KSB and the Company assumes no obligation to updatethe forward-looking statements or to update the reasons actual results coulddiffer from those projected in such forward-looking statements. Therefore,readers are cautioned not to place undue reliance on these forward-lookingstatements.

 

ITEM 1.  BUSINESS

 

BUSINESS DEVELOPMENT

 

ORGANIZATION.  The Company’s predecessor entity wasorganized under the laws of the State of Nevada on May 19, 1919, under the name“Lincoln Divide Mining Company.” Subsequently, the Company changed it nametwice and later became “Cherokee Minerals and Oil, Inc.” (“Cherokee”) in 1980,before becoming HydroMaid International, Inc. on January 20, 1999.

 

MERGERSAND REORGANIZATIONS. On December 11, 1998, the Company entered into anAgreement and Plan of Reorganization (the “Reorganization”) which resulted inthe acquisition by the Company of 100% of the issued and outstanding shares ofrestricted Common Stock of Environmental Systems & Solutions, Inc.(“ESSI”), a Nevada corporation formed in 1992. The Reorganization qualified asa tax-free reorganization under Section 368 (a) (1) (B) of the 1986 InternalRevenue Code. Under the terms 

 

 

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of the Reorganization,the former stockholders of ESSI received four shares of the Company for eachone share of ESSI and in the aggregate acquired approximately 92% of the issuedand outstanding Common Stock of the Company.

 

BUSINESS

 

Beforethe Reorganization, Cherokee was engaged in seeking and investigating potentialassets, property, or businesses to acquire, and had no material businessoperations for over five years. ESSI had been engaged primarily in research anddevelopment for six years before the Reorganization.

 

PRINCIPALPRODUCT.   The Company is engaged in the research and development,manufacturing, marketing, sale, and distribution of a patented product calledthe HydroMaid®. The HydroMaid® is the world’s first and only totallywater-powered garbage disposal.

 

TheHydroMaid® is able to process foods that conventional electric disposalscannot. The HydroMaid® is environmentally safe, quiet, and has ninety percentfewer parts than electric disposals. The HydroMaid® uses common household waterpressure to oscillate five stainless steel blades.

 

TheHydroMaid® uses normal household water pressure from the cold water lineunderneath the sink. Its multi-patented servomechanism harnesses householdwater pressure to push the five cutting blades 340 degrees. These blades cutthrough waste, which normally damages or creates problems for traditionalelectric disposals such as chicken bones, potato peels, avocado pits, walnutshells, and fibrous foods like celery. The servomechanism is able toautomatically shift into a harmless oscillating mode if silverware isaccidentally dropped into the unit allowing the user to avoid damage to bothsilverware and the disposal.

 

TheHydroMaid® is an environmentally friendly product for a variety of reasons.First, the cutting action of the HydroMaid® produces such fine cut waste thatit easily flushes through the drainage system, promoting faster decompositionas an aid to the environment. Second, because it uses no electricity, theHydroMaid® reduces the consumption of energy. The HydroMaid® retails for $299.

 

MARKETSEGMENTS.  The garbage disposal marketconsists of two main segments, domestic and international. The domestic marketpurchases approximately 5 million garbage disposals annually. The internationalmarket is virtually untapped by the electric disposal industry. In 1997, theCompany believes there were less than 244,000 disposals exported throughout theworld. The Company intends to distribute to both the domestic and internationalmarkets; although, no assurance of when significant sales may develop in eithermarket can be provided.

 

MARKETINGAND DISTRIBUTION STRATEGY.  In March2000, the Company entered into an agreement with the Appliance Division ofGeneral Electric Company (“GE”).  Underthe agreement, GE could assume rights to distribute the HydroMaid® in the USand Canada, and the Company would retain rights to distribute the HydroMaid®throughout the rest of the world.  OnApril 19, 2001 the agreement with GE was terminated.

 

Domesticmarketing was largely curtailed pending the outcome of the GErelationship.  The Company pursued andcontinues to pursue its efforts to expand international distributionchannels.  These efforts have includeddevelopment of distribution agreements for the HydroMaid® in many countriesthroughout the world.   Discussions witha European appliance manufacturer for a potential technology licensingarrangement have been delayed due to current economic conditions in theEuropean market.

 

COMPETITIVEBUSINESS CONDITIONS.  A market studyindicates that approximately 94% of the disposal market is controlled by twomajor companies, In-Sink-Erator and Anaheim Manufacturing.

 

 

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As a result, thedisposal market is extremely competitive. Because the major companies are so entrenched in the disposal marketthrough the aid of massive product recognition, established distributionchannels, and powerful financial resources, it is extremely difficult for otherdisposal manufacturers to successfully enter the market.

 

Whilethe Company’s management recognizes that it is difficult to overcomecompetition and other market entry barriers, they believe that the HydroMaid’s®unique and innovative technology will permit the Company to successfullydistinguish itself from the major industry players and capture market share.

 

SOURCESAND AVAILABILITY OF MATERIALS.  TheCompany has entered into an agreement with MVP Industries (“MVP”), a Chinacorporation, for the manufacture and assembly of the HydroMaid®.  MVP can produce up to 40,000 units permonth.  The Company also has arelationship with Metric Tool & Die (“Metric”), an Illinois corporation,which manufactured the HydroMaid® in limited quantities before primarymanufacturing responsibility was assigned to MVP.

 

TheCompany understands that there is economic and political risk in relying onjust one or a few manufacturers and suppliers. To mitigate the risk of losing all or part of its product supply in theevent that one of its manufacturers ceases to produce units of the HydroMaid®for whatever reason, the Company is taking steps to diversify its sources formaterials and the manufacturing of its product.  In particular, Latin American production has been explored and isconsidered feasible.

 

MAJORCUSTOMERS.  In the U.S., the HydroMaid®is expected to be distributed primarily through plumbing wholesale houses, homeimprovement and appliance retailers and new construction contractors.  Internationally, the Company is currentlyfocused on entering into agreements with master distributors who will provide awholesaling function to appliance dealers within a national or multi-nationalterritory.

 

PATENTSAND TRADEMARKS. The Company holds eleven patents issued in the United Statesand internationally and has one new patent pending in the United States andinternationally covering the HydroMaid®. The Company also holds registeredtrademarks on the HydroMaid® name.

 

RESEARCHAND DEVELOPMENT.  The Company spent$434,794 in 2001 and $207,415 in 2000 for research and development.  It is expected that this amount willincrease in 2002 as work is performed on the product modifications needed toincrease the efficiency and functionality of the HydroMaid®.

 

WARRANTY.The Company currently supports the HydroMaid® with a ten-year warranty to theoriginal consumer against any defects in workmanship or material, provided thatthe product has not been subject to abuse or alteration.  There is a lifetime warranty on the housingand steel blades.

 

EMPLOYEES.  As of December 31, 2001, the Companyemployed 10 employees, seven of which work full-time and three of which workpart-time for the Company and part-time for Liquitek Enterprises, Inc. and/orLighthouse, Inc., which are related parties. The Company was reimbursed by these other companies for portion of theirlabor expended on the business of these other companies. None of the Company’semployees is covered by a collective bargaining agreement, and the Companyconsiders its labor relations to be excellent.

 

ITEM 2.  DESCRIPTION OF PROPERTY

 

InJuly 2001, the Company leased a 10,000 square-foot space to combine its officesand warehouse into one location for a three-year period ending September 30,2004 at an annual rent of 

 

 

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approximately $48,000plus common area maintenance costs of $800 per month.    The Company has consequently terminated the previous warehouselease and moved all warehousing, research and development, and sales personnelto this location.  The Company continuesto occupy minimum office space previously owned by Lighthouse, Inc., the whollyowned corporation of Culley W. Davis, the former Chairman and CEO of theCompany.  It is located at 1350 E.Draper Parkway, Draper, Utah 84020, and continues to be the Company's principalexecutive office.

 

 

ITEM 3.  LEGAL PROCEEDINGS

 

Thereare no material pending legal proceedings involving the Company, and theCompany is not aware of any threatened legal proceedings to which the Companymay be a party.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

 

                On May 19, 2001, the Company held its Annual Meetingof Stockholders in Salt Lake City, Utah. Stockholders were asked to elect directors, and ratify the appointmentof auditors.  A total of approximately26,925,000 shares were entitled to be voted at the meeting and 17,988,257 werevoted.  The stockholders elected all ofthe nominated directors and ratified Squar, Milner, Reehl and Williamson, LLPas the Company’s auditors for 2001.  OnJuly 26, 2001 a special meeting of stockholders was held to approve theaddition of 10,000,000 shares of the total authorized stock of the Company to40,000,000 shares. Approximately, 26,925,000 shares were entitled to be votedat this special meeting and 17,999,460 were voted. The stockholders voted toapprove the 10,000,000 shares increase of authorized capital stock to40,000,000 shares.  The voting on eachitem was as follows:

 

1: Election of Directors

 

| **Name**                |   | **Votes For** |
|-------------------------|--------|---------------|
| *  Culley W. Davis |   | 17,363,787    |
| Bruce  H. Haglund       |   | 17,337,495    |
| *  John W. Nagel   |   | 17,363,787    |
| Mark  S. Brewer         |   | 17,265,787    |
| *  J. Steven Young |   | 17,239,495    |

 

*  In August 2001, John W. Nagel and J. StevenYoung resigned as directors from the board. In December 2001, Culley W. Davis resigned as an officer and director ofthe Company.  As of the date of thisreport appointments have not been made to fill the director vacancies.  Mark S. Brewer was elected interim ChiefExecutive Officer in January 2002.

 

 

2: Ratify Auditors

 

| **Total For** |   | **Against** |   | **Abstain** |
|---------------|--------|-------------|--------|-------------|
| 16,968,547    |   | 7,690       |   | 6,640       |

 

3: Authorize additional10,000,000 shares of capital stock.

 

| **Total For** |   | **Against** |   | **Abstain** |
|---------------|--------|-------------|--------|-------------|
| 17,752,190    |   | 229,259     |   | 18,011      |

 

 

PART II

 

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS

 

COMMON STOCK PRICE

 

                The following table sets forth, for the period fromDecember 2000 through December 2001, the high and low bid quotations eachquarter for the Common Stock as reported by the OTC Bulletin Board.  The Company’s stock began trading on October12, 1998 and trades under the stock symbol “HYII.”  The prices represent quotations between dealers, withoutadjustment for retail markup, mark down or commission, and do not necessarilyrepresent actual transactions.

 

 

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**Common Stock Price**

 

|        |   |     |   |    |
|-------------|--------|----------|--------|---------|
| **2001**    |   | **High** |   | **Low** |
| 1st Quarter |   | 2.75     |   | .97     |
| 2nd Quarter |   | 1.63     |   | 0.41    |
| 3rd Quarter |   | 0.57     |   | 0.18    |
| 4th Quarter |   | 0.30     |   | 0.08    |
|        |   |     |   |    |
| **2000**    |   |     |   |    |
| 1st Quarter |   | 9.8125   |   | 4.3750  |
| 2nd Quarter |   | 4.4375   |   | 0.9688  |
| 3rd Quarter |   | 2.9375   |   | 1.6875  |
| 4th Quarter |   | 1.7500   |   | 0.7812  |

 

 

                The Company has not paid any cash dividends on itsCommon Stock since its incorporation and anticipates that, for the foreseeablefuture, earnings, if any, will continue to be retained for use in itsbusiness.  As of December 31, 2001, theapproximate number of record holders of the Company’s Common Stock was 469.

 

DESCRIPTION OFSECURITIES

 

TheCompany has one class of securities authorized, consisting of 40,000,000 sharesof $0.001 par value common voting stock. The holders of the Company’s CommonStock are entitled to one vote per share on each matter submitted to a vote ata meeting of stockholders. The shares of Common Stock carry cumulative votingrights in the election of directors.

 

Stockholdersof the Company have no pre-emptive rights to acquire additional shares ofCommon Stock or other securities. The Common Stock is not subject to redemptionrights and carries no subscription or conversion rights. In the event ofliquidation of the Company, the shares of Common Stock are entitled to shareequally in corporate assets after satisfaction of all liabilities. All sharesof the Common Stock now outstanding are fully paid and non-assessable.

 

                During January 2000, investors purchased a total of750,000 shares of restricted Common Stock and warrants to purchase 1 millionadditional shares of Common Stock at the price of $7.50 per share, for theaggregate purchase price of $3,337,500.  The warrants expireon January 21, 2005.

 

ITEM 6.  MANAGEMENT’S DISCUSSION AND ANALYSIS

 

Thefollowing discussion and analysis should be read in conjunction with theFinancial Statements and Notes thereto appearing elsewhere in this report.

 

 

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RESULTS OF OPERATIONS

 

The Company encountered severe operating and financialdifficulties in 2001 forcing the Company to shift its focus from marketing andsales to a concentration on design and development.  The demise of the relationship with General Electric forced theCompany to deal with critical design issues with its own relatively meagerproduct development resources.  It hadbecome apparent that the Company was prohibited from mass marketing theHydroMaid® in the domestic market as it did not contain an AtmosphericAnti-siphon Valve (AVB), which is required by the majority of domestic plumbingcodes.  The installation of the disposalalready entailed mounting an on/off valve atop the sink or nearby counter, andit was judged that the AVB had to be integrated into the on/off valve ratherthan be a second mounting atop the sink or counter.  The design had to provide for the necessary functionality and beaesthetically acceptable.  The design ofthe AVB valve is now substantially complete, but the Company is in need ofadditional capital to complete the design and begin manufacturing the improvedproduct.

 

Early in 2001, the Company became aware of anunacceptable rate of failure of the Piston U-cup seals (seals) in theHydroMaid® resulting in a significant number of returns.  The seals tended to flip out of position,thus causing the whole unit to cease working. The solution to this problem was to redesign the shape of theseals.  The Company has completed theredesign of the seal and is awaiting additional capital to create the tooling and to produce the seals.

 

The Company exhausted all of its operating capitalduring 2001 as considerable time and resources were consumed in the design anddevelopment of the new seals and the AVB valve.  Before these issues manifested themselves, and while theprospects for the relationship with General Electric still looked promising,the Company’s financial circumstances were deemed reasonably secure.  Cash that had not been needed for theCompany's operations was loaned to other businesses in anticipation that itwould be repaid before the Company needed it. The general business and venture capital markets downturn of 2001coincided with the increase in need for resources as described above. The loansto Liquitek Enterprises, Inc. (“Liquitek”) are a case in point. Liquitek andHydroMaid were both born of the same venture capital funding through PinnacleEnterprises, Ltd. (“Pinnacle”), so they have had a long-standing closerelationship.  Liquitek was engaged in acapital development effort throughout late 2000 and early 2001, primarilythrough the efforts of Culley W. Davis, who had been the general partner ofPinnacle.  By mid-2001 it was recognizedthat Mr. Davis’ sources of capital were not going to be able to fund Liquitek’sneeds, given the prevailing market conditions. Liquitek could not pay its debt to HydroMaid, HydroMaid desperatelyneeded cash for its own operating needs, and the vicissitudes of the marketprevented the resolution of the problem throughout the remainder of the yearand on into 2002. The Company maintains a receivable balance of approximately$709,000 in notes receivable and other related party transactions from Liquitekas of December 31, 2001. The Company's management believes that most ifnot all of the receivables from Liquitek will be paid either by Liquitek'scapital development and operating efforts or from the liquidation of Liquitek'sassets. However, as Liquitek has not demonstrated its ability to pay theobligation as of December 31, 2001, the Company's management has reserved thefull amount of this receivable (see Note 7 to the financial statements).

 

As the Company's attention shifted to the design anddevelopment of the HydroMaid® it made a number of changes to itsworkforce.  Early in the year, tofacilitate the correction of the design problems identified above, the Companyhired a product engineer with significant industry experience as well as adesign engineer.  Later, in 2001, theCompany reduced its staffing in the sales, marketing, warehousing, andadministrative functions.  Whenfeasible, allocations of administrative personnel to other related parties wereincreased as the staffing needs of the Company were diminished.

 

COMPARISON OF YEAR ENDEDDECEMBER 31, 2001 TO THE YEAR ENDED DECEMBER 31, 2000.  During the year ended December 31, 2001, theCompany had net sales of $32,905, compared to net sales of $885,895 during2000, a decrease of $852,990.  Theassociated cost of sales for 2001 was 823,863 compared to cost of sales of$640,105 for 2000.  Early in 2001, theCompany discovered an issue with the piston U-cup seals in the HydroMaid®, forcingthe Company to significantly decrease sales and marketing efforts until thisproblem was remedied.  Additionally, InJune 2001, the Company allowed a European distributor to return a substantialportion of product from a previous sale for full credit 

 

 

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because ofwater-pressure related performance problems of the product in theirmarketplace.  The return was recorded asa reduction in cost of goods sold and accounts receivable and an increase ininventory and returns and allowances expense. These units are being held by the distributor as Company inventory untilthey can be resold.  Subsequent to theyear ended December 31, 2001 and the date of this report all of the units heldby this distributor have been sold to other European distributors.

 

Productcosts directly associated with sales in 2001 totaled $24,622. The balance of2001 cost of goods sold is due to a significant change in management's estimateof expected warranty claims and obsolete inventory, as well as idle plantcosts, as discussed below.

 

Theprovision for warranty claims during 2001 was $424,608. This expense reflecteda $396,755 reserve for management's estimate of the costs associated withreplacing the units currently in  themarket with the new U-cup seals as explained above, which will occur sometimeduring the product's 10 year warranty. This additional provision increased theaccrued product warranty reserve total to $460,000. The remaining $27,853 ofwarranty expense was the actual cost incurred during 2001 to replace unitsreturned due to defects covered under the product's warranty.

 

Theprovision for obsolete inventory during 2001 was $249,058. Approximately$123,000 of this expense is related to the write-down of component partsinventory believed to be obsolete or slow moving. The remaining $126,000reflects the cost of replacing defective vinyl hose sets with more durablestainless steel braided hose sets.

 

Idleplant expense for 2001 was $125,575. This expense reflects the depreciationcharges for the company's tooling equipment and the shared commitment for theproduction line quality control program, which was terminated early in theyear, at the Company's China manufacturer. The production line has been idleduring the year ending December 31, 2001.

 

Sellingand distribution costs for 2001 were $944,325 compared to $1,026,805 for 2000,a decrease of $82,480.  This decrease isattributable to a reduction in staffing for the sales and warehousing functionsas a result of the decrease in sales mentioned above.  The Company’s management expects sales and distribution expensesto decrease significantly in 2002 as the Company will not attend the largerindustry trade shows as it did in 2000 and 2001.

 

Generaland administrative expenses for 2001 were $1,323,257 compared to $3,204,153 for2000, a decrease of $1,880,896.   Approximately $1.1 million of this decrease in 2001 is attributable to a2000 charge for non-cash stock option and grant compensation expensed inassociation with accounting for options and stock grants to employees anddirectors.  These expenses were notrepeated as there were no new non-cash stock options granted in 2001.  Additionally, administrative salaries andfees paid to consultants decreased by approximately $300,000 in 2001 as aresult of the reductions in force. Further, compensation of employees being shared with related parties(Liquitek Enterprises, Inc. and Lighthouse, Inc.) as described above increasedby approximately $215,000 in 2001 (see note 7 to the FinancialStatements).  The remaining $265,000decrease ocurred as a result of reduced spending in a variety of expensecategories:  travel, public relations,rent, postage, supplies, telephone, etc.

 

Researchand development costs for 2001 totaled $434,794 as compared to $207,415 for2000, an increase of $227,379.  Theincrease occurred primarily in engineering salaries for two new engineers whowere were added early in the year 2001. The further product refinement projects defined above are likely toresult in increased research and development expenditures in 2002.

 

TheCompany experienced a net loss of $4,128,293 during 2001 compared to a net lossof $3,979,318 for the comparable period in 2000, an increase in losses of$148,975.  When losses are adjusted fornon-cash charges (i.e., depreciation, amortization, provisions for futurecharges and stock-based compensation), operating losses declined in 2001 byapproximately $200,000.

 

TheCompany’s inventory decreased from $974,206 at December 31, 2000 to $769,799 atDecember 31, 2001 a decrease of $204,407. Inventory decreased in 2001 by approximately $81,000 as a result ofproduct sales, warranty replacements, and promotional giveaways. There were noadditions to inventory during 2001, as the production line with the Company'sChina manufacturer was idle during the year. Additionally, the companyincreased the inventory valuation reserve by approximately $70,000 for slowmoving component parts. The remaining decrease of approximately $53,000 is a resultof the write-off of miscellaneous component parts deemed obsolete.

 

COMPARISONOF YEAR ENDED DECEMBER 31, 2000 TO THE YEAR ENDED DECEMBER 31, 1999.  During the year ended December 31, 2000, theCompany had net sales of $885,895, compared to net sales of $248,665 during1999, an increase of $637,230.  Theincrease occurred primarily in the international arena with major sales inJapan and the United Kingdom.  Theassociated cost of sales for 2000 was $640,105 compared to cost of sales of$223,085 for 1999.

 

 

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Sellingand distribution costs for 2000 were $1,026,805 compared to $1,082,250 for1999, a decrease of $55,445.  Thisdecrease is attributable to a reduction in staffing for the sales function commensuratewith the cooperative endeavor with GE underway throughout much of 2000.

 

                General and administrative expenses for 2000 were$3,204,153 compared to $2,139,794 for 1999, an increase of $1,064,359.  This increase is attributable primarily tonon-cash stock option and grant compensation of nearly $1.2 million expensed in2000 in association with accounting for options and stock grants to employeesand directors, an increase of approximately $812,000 for this expense over1999.  The remaining $252,000 inincrease occurred in a variety of expenses categories:  consulting fees, directors’ and officers’insurance premiums, 401K matching payments, etc.

 

Researchand development costs for 2000 totaled $207,415 as compared to $649,257 for1999, a decrease of $441,842.  Apotential cooperative development endeavor with GE was in an evaluation modethroughout most of 2000.  The productrefinement projects defined through that effort were expected to result inincreased research and development expenditures in 2001.

 

TheCompany experienced a net loss of $3,979,318 during 2000 compared to a net lossof $3,820,547 for the comparable period in 1999, an increase in losses of$158,771.  When losses are adjusted fornon-cash charges (i.e., depreciation, amortization, provisions for futurecharges and stock-based compensation), operating losses declined in 2000 bymore than $500,000.

 

TheCompany’s inventory increased from $905,924 at December 31, 1999 to $974,206 atDecember 31, 2000.  The productdesign review that occurred as part of the cooperative development agreement in2000 disclosed a need for some modifications to permit compliance with plumbingregulations in many markets and to reduce the probability of warranty returnsin the future.  These modifications werebeing developed and implemented in 2001, both with rework of units in inventoryand with changes in future production once it resumes.  Management anticipated that all of theinventory on hand at the end of 2000 would be sold once these modificationshave been effected.  The costs of thesemodifications to the inventory are to be expensed as they are incurred.

 

 

 

LIQUIDITY

 

Atthe end of 2001, the Company had approximately $48,000 in cash, $70,000 inaccounts receivable, and a related party receivable from Liquitek Enterprises,Inc. of $709,000, which was fully reserved for as a "doubtful"account.  Management has aggressivelyreduced expenses in anticipation of the cash shortage, and believes LiquitekEnterprises, Inc. will be successful in its capital development and operatingefforts or liquidation of assets in order to pay the Company the $709,000receivable balance (see Item 6. Management's Discussion and Analysis).  Management anticipates, based on the cashbalance, ongoing sales, collection of receivables, and collection of amountsdue from Liquitek Enterprises, Inc., to provide for the short-term operatingneeds of the company until permanent equity financing can be realized.  The Company expects to raise additionalcapital through a private placement equity offering during 2002 to fund furtherdevelopment of present and anticipated operations until the Company canaccomplish self-sustaining cash flows.

 

TheCompany has been successful in its efforts to expand international distributionchannels.   These efforts have includeddevelopment of distribution agreements for the HydroMaid® in many countriesthroughout the world including: the United Kingdom, South Africa, Poland, CzechRepublic, Hungary, Malaysia, Singapore, Indonesia, Thailand, Russia and Lithuania.  Additionally, the Company is pursuingagreements for Canada, Australia, New Zealand, China, Japan, Taiwan andothers.  Due to the successful marketingefforts in the International arenas, the Company's management anticipatesdemand for the HydroMaid® to grow substantially internationally.

 

 

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TheCompany’s design and development efforts have resulted in the design of anaesthetically acceptable on/off valve with an integral atmospheric anti-siphonvalve, which has demonstrated the capability to meet all anti-siphonrequirements.  Certification testing andapprovals for the integrated valve are anticipated to be completed during thequarter ending September 30, 2002. Management expects this product to be ready for production during thequarter ending December 31, 2002.  It isanticipated that the introduction of this integrated valve will greatly enhancedomestic sales of the HydroMaid®.

 

ITEM 7. FINANCIAL STATEMENTS

 

The financial statementslisted in the accompanying Index to Financial Statements are attached heretoand filed as a part of this Report under Item 13.

 

 

ITEM 8.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

CHANGES IN REGISTRANT’SCERTIFYING ACCOUNTANT

 

None

 

 

PART III

 

ITEM 9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS ANDCONTROL PERSONS; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE ACT

 

Incorporated by referencefrom our Proxy Statement, which we expect to be filed within 120 days from theclose of our fiscal year 2001.

 

 

ITEM 10. EXECUTIVECOMPENSATION

 

Incorporated by referencefrom our Proxy Statement, which we expect to be filed within 120 days from theclose of our fiscal year 2001.

 

 

ITEM 11.     SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT

 

Incorporated by referencefrom our Proxy Statement, which we expect to be filed within 120 days from theclose of our fiscal year 2001.

 

 

ITEM 12.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS

 

Incorporated by referencefrom our Proxy Statement, which we expect to be filed within 120 days from theclose of our fiscal year 2001.

 

 

ITEM 13.  EXHIBITS AND REPORTS ON FORM 8-K

 

(a)           The following documents are filed aspart of this report on Form 10-KSB:

 

1.             Financial Statements for the YearsEnded December 31, 2001 and 2000:

 

 

10

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IndependentAuditors’ Report

BalanceSheets

Statementsof Operations

Statementsof Stockholders’ Equity

Statementsof Cash Flows

Notesto Financial Statements

 

2.           Exhibits

 

2.1           Certificate of Amendment to Articlesof Incorporation dated July 27, 2001 respecting the 10,000,000 share increaseof the total outstanding capital stock of the Company to 40,000,000 shares.

 

(b)           Reports on Form 8-K.

 

None

 

 

11

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SIGNATURES

 

Inaccordance with Section 13 or 15(d) of the Exchange Act, the registrant causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized, in the City of Draper, State of Utah, on the 15th day ofApril 2002.

 

|   | HYDROMAID  INTERNATIONAL, INC. |
|--------|--------------------------------|
|   |                           |   |
|   | By:                            | /s/ MARK S. BREWER |
|   |                           | Mark S. Brewer,  Interim Chief Executive Officer |
|   |                           |   |
|   | By:                            | /s/ DARON SMITH |
|   |                           | Daron Smith,  Controller  (Principal Accounting Officer) |

 

 

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 

| **Signature**        |   | **Title**                                  |   | **Date**       |
|----------------------|--------|--------------------------------------------|--------|----------------|
|                 |   |                                       |   |           |
| /s/ MARK S. BREWER   |   | Interim Chief  Executive Officer, Director |   | April 15, 2002 |
| Mark S. Brewer       |   |                                       |   |           |
|                 |   |                                       |   |           |
| /s/ BRUCE H. HAGLUND |   | Director                                   |   | April 15, 2002 |
| Bruce H. Haglund     |   |                                       |   |           |
|                 |   |                                       |   |           |

 

 

 

12

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# **INDEX TOFINANCIAL STATEMENTS**

 

 

 

 

 
| Independent Auditors’  Report       |   |
|------------------------------------------|--------|
|                                     |   |
| Balance Sheets                           |   |
|                                     |   |
| Statements of Operations                 |   |
|                                     |   |
| Statements of  Stockholders’ Equity |   |
|                                     |   |
| Statements of Cash Flows                 |   |
|                                     |   |
| Notes to Financial  Statements           |   |

 

 

----

 

**INDEPENDENTAUDITORS’ REPORT**

 

 

 

###### **Tothe Board of Directors and Stockholders**

HydroMaid International, Inc.

 

We have audited the accompanying balance sheets ofHydroMaid International, Inc. (the “Company”) as of December 31, 2001 and 2000 and the related statements ofoperations, stockholders’ equity, and cash flows for the years then ended.  These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits in accordance with auditingstandards generally accepted in the United States.  Those standards require that we plan and perform the audits toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofHydroMaid International, Inc. at December31, 2001 and 2000, and the results of its operations and its cash flowsfor the years then ended in conformity with accounting principles generallyaccepted in the United States.

 

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern.  The Company has accumulated a deficit ofapproximately $17 million from inception through December 31, 2001.  As discussed in Note 1 to the financialstatements, a significant amount of additional capital will be necessary tobring liabilities current and correct the issues with the Company’s product sothat it may become commercially viable again. These conditions raise substantial doubt about the Company’s ability tocontinue as a going concern. Management’s plans regarding these matters are also described in Note1.  The accompanying financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 

 

/s/ Squar, Milner, Reehl and Williamson, LLP

 

April 12, 2002

Newport Beach,California

 

2

----

 

**HYDROMAIDINTERNATIONAL, INC.**

**BALANCE SHEETS**

**December31, 2001 and 2000**

 
|                                                                                                                                                                                                    |   | **2001**    |       | **2000**    |       |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------|------------|-------------|------------|
| **ASSETS**                                                                                                                                                                                              |   |        | ** ** |        | ** ** |
| **Current Assets**                                                                                                                                                                                      |   |        |       |        |       |
| Cash                                                                                                                                                                                                    |   | $           | 47,560     |        | $          | 711,904 |   |
| Accounts  receivable, net                                                                                                                                                                               |   | 69,431      |       | 621,208     |       |
| Inventory,  current portion                                                                                                                                                                             |   | 43,785      |       | 974,206     |       |
| Prepaid  expenses and other assets                                                                                                                                                                      |   | 14,694      |       | 131,093     |       |
| Notes  receivable from related parties                                                                                                                                                                  |   | —      |       | 825,000     |       |
| Note  receivable                                                                                                                                                                                        |   | —      |       | 500,000     |       |
|                                                                                                                                                                                                    |   | 175,470     |       | 3,763,411   |       |
|                                                                                                                                                                                                    |   |        |       |        |       |
| **Property  and Equipment, net**                                                                                                                                                                        |   | 598,567     |       | 804,415     |       |
| **Patents,  net**                                                                                                                                                                                       |   | 107,015     |       | 85,183      |       |
| **Inventory,  net of current portion**                                                                                                                                                                  |   | 726,014     |       | —      |       |
| **Advances  to Foreign Contractor**                                                                                                                                                                     |   | 645,052     |       | 667,752     |       |
| **Due  from Related Parties, net**                                                                                                                                                                      |   | —      |       | 303,833     |       |
|                                                                                                                                                                                                    |   |        |       |        |       |
|                                                                                                                                                                                                    |   | $           | 2,252,118  |        | $          | 5,624,594 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                          |   |        | ** ** |        | ** ** |
| **Current Liabilities**                                                                                                                                                                                 |   |        |       |        |       |
| Accounts  payable and accrued expenses                                                                                                                                                                  |   | $           | 552,724    |        | $          | 294,738 |   |
|                                                                                                                                                                                                    |   |        |       |        |       |
| **Accrued  Product Warranty**                                                                                                                                                                           |   | 460,000     |       | 78,245      |       |
|                                                                                                                                                                                                    |   |        |       |        |       |
| **Commitments and Contingencies**                                                                                                                                                                       |   |        |       |        |       |
|                                                                                                                                                                                                    |   |        |       |        |       |
| **Stockholders’ Equity**                                                                                                                                                                           |   |        |       |        |       |
| Common  stock, par value $0.001 per share, 40,000,000 shares authorized; 26,974,538  shares issued and outstanding at December  31, 2001; 26,914,538 shares issued and outstanding at December 31, 2000 |   | 26,975      |       | 26,915      |       |
| Additional  paid-in capital                                                                                                                                                                             |   | 18,276,990  |       | 18,274,550  |       |
| Subscriptions  and deferred compensation                                                                                                                                                                |   | (18,000     | )          | (131,576    | )          |
| Accumulated  deficit                                                                                                                                                                                    |   | (17,046,571 | )          | (12,918,278 | )          |
|                                                                                                                                                                                                    |   | 1,239,394   |       | 5,251,611   |       |
|                                                                                                                                                                                                    |   |        |       |        |       |
|                                                                                                                                                                                                    |   | $           | 2,252,118  |        | $          | 5,624,594 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

----

 

**HYDROMAIDINTERNATIONAL, INC.**

**STATEMENTS OF OPERATIONS**

**For theYears Ended December 31, 2001 and 2000**

 
|                                                                     |   | **2001**   |       | **2000**   |       |
|--------------------------------------------------------------------------|--------|------------|------------|------------|------------|
| **REVENUES**                                                             |   |       |       |       |       |
| Sales                                                                    |   | $          | 152,983    |       | $          | 924,383 |   |
| Less:  returns and allowances                                            |   | (120,078   | )          | (38,488    | )          |
|                                                                     |   | 32,905     |       | 885,895    |       |
|                                                                     |   |       | ** ** |       | ** ** |
| **COST  OF GOODS SOLD**                                                  |   |       |       |       |       |
| *  Product costs                                                    |   | 24,622     |       | 640,105    |       |
| *   Provision for warranty claims                                   |   | 424,608    |       | —     |       |
| *  Provision for obsolete  inventory                                |   | 249,058    |       | —     |       |
| *  Idle  plant expense                                              |   | 125,575    |       | —     |       |
|                                                                     |   | 823,863    |       | 640,105    |       |
|                                                                     |   |       |       |       |       |
| **GROSS PROFIT (LOSS) **                                            |   | (790,958   | )          | 245,790    |       |
|                                                                     |   |       |       |       |       |
| **OPERATING EXPENSES**                                                   |   |       | ** ** |       | ** ** |
| Selling  and distribution expenses                                       |   | 944,325    |       | 1,026,805  |       |
| General  and administrative expenses                                     |   | 1,323,257  |       | 3,204,153  |       |
| Research  and development                                                |   | 434,794    |       | 207,415    |       |
|                                                                     |   | 2,702,376  |       | 4,438,373  |       |
|                                                                     |   |       |       |       |       |
| **LOSS  BEFORE INTEREST AND TAXES**                                      |   | (3,493,334 | )          | (4,192,583 | )          |
|                                                                     |   |       |       |       |       |
| **OTHER INCOME (EXPENSE) **                                         |   |       |       |       |       |
| Provision  for doubtful related party receivable                    |   | (709,870   | )          | —     |       |
| Interest income  and other                                          |   | 74,911     |       | 213,265    |       |
|                                                                     |   | (634,959   | )          | 213,265    |       |
|                                                                     |   |       |       |       |       |
| **LOSS  BEFORE TAXES**                                                   |   | (4,128,293 | )          | (3,979,318 | )          |
|                                                                     |   |       |       |       |       |
| **INCOME TAX BENEFIT**                                                   |   |       |       |       |       |
| Current                                                                  |   | —     |       | —     |       |
| Deferred                                                                 |   | 1,000,000  |       | 1,300,000  |       |
| Less change in  valuation allowance                                      |   | (1,000,000 | )          | (1,300,000 | )          |
|                                                                     |   | —     |       | —     |       |
|                                                                     |   |       |       |       |       |
| **NET LOSS**                                                             |   | $          | (4,128,293 | )          | $          | (3,979,318 | ) |
|                                                                     |   |       |       |       |       |
| **BASIC  AND DILUTED LOSS PER SHARE**                                    |   | $          | (0.15      | )          | $          | (0.15 | ) |
|                                                                     |   |       |       |       |       |
| **WEIGHTED AVERAGE NUMBER OF COMMON  SHARES OUTSTANING DURING THE YEAR** |   | 26,964,000 |       | 26,864,000 |       |
|                                                                     |   |       |       |       |       |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

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**HYDROMAIDINTERNATIONAL, INC.**

**STATEMENTS OF STOCKHOLDERS' EQUITY**

**For theYears Ended December 31, 2001 and 2000**

 
|                                                       |   | **Common  Stock** |   | **Additional  Paid-in** |   | **Subscriptions  and Deferred** |   | **Accumulated**  |   |        |       |
|------------------------------------------------------------|--------|-------------------|--------|------------------------------|--------|---------------------------------|--------|------------------|--------|-------------|------------|
|                                                       |   | **Shares**        |   | **Amount**                   |   | **Capital**                     |   | **Compensation** |   | **Deficit** |       | **Total** |   |
|                                                       |   |              |   |                         |   |                            |   |             |   |        |       |   |   |
| **BALANCE  — December 31, 1999**                      |   | 26,807,000        |   | $                            | 26,807 |                            | $      | 18,041,093       |   | $           | (4,567,408 | ) | $ | (8,938,960 | ) | $ | 4,561,532 |   |
| Common stock  issued for cash                              |   | 2,872             |   | 3                            |   | 11,485                          |   | —           |   | —      |       | 11,488 |   |
| Common stock  issued for services                          |   | 28,000            |   | 28                           |   | 124,972                         |   | —           |   | —      |       | 125,000 |   |
| Stock options  exercised                                   |   | 76,666            |   | 77                           |   | 19,090                          |   | —           |   | —      |       | 19,167 |   |
| Cash received  for subscribed stock and warrants           |   | —            |   | —                       |   | —                          |   | 3,337,500        |   | —      |       | 3,337,500 |   |
| Stock options granted                                      |   | —            |   | —                       |   | 77,910                          |   | —           |   | —      |       | 77,910 |   |
| Deferred  compensation recognized                          |   | —            |   | —                       |   | —                          |   | 1,098,332        |   | —      |       | 1,098,332 |   |
| Net loss                                                   |   | —            |   | —                       |   | —                          |   | —           |   | (3,979,318  | )          | (3,979,318 | ) |
| **BALANCE  — December 31, 2000**                      |   | 26,914,538        |   | 26,915                       |   | 18,274,550                      |   | (131,576         | )      | (12,918,278 | )          | 5,251,611 |   |
| Common stock  issued under Don Sullivan agreement (Note 8) |   | 50,000            |   | 50                           |   | (50                             | )      | —           |   | —      |       | — |   |
| Stock options  exercised                                   |   | 10,000            |   | 10                           |   | 2,490                           |   | —           |   | —      |       | 2,500 |   |
| Deferred  compensation recognized                          |   | —            |   | —                       |   | —                          |   | 113,576          |   | —      |       | 113,576 |   |
| Net loss                                                   |   | —            |   | —                       |   | —                          |   | —           |   | (4,128,293  | )          | (4,128,293 | ) |
|                                                       |   |              |   |                         |   |                            |   |             |   |        |       |   |   |
| **BALANCE  — December 31, 2001**                      |   | 26,974,538        |   | $                            | 26,975 |                            | $      | 18,276,990       |   | $           | (18,000    | ) | $ | (17,046,571 | ) | $ | 1,239,394 |   |

 

*Theaccompanying notes are an integral part of these financial statements*

 

5

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**HYDROMAIDINTERNATIONAL, INC.**

**STATEMENTS OF CASH FLOWS**

**For theYears Ended December 31, 2001 and 2000**

 
|                                                                         |   | **2001**   |       | **2000**   |   |
|------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                    |   |       |       |       |   |
| Net  loss                                                                    |   | $          | (4,128,293 | )          | $      | (3,979,318 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities: |   |       |       |       |   |
| Depreciation  and amortization                                               |   | 263,896    |       | 227,718    |   |
| Provision  for bad debts                                                     |   | 141,328    |       | 11,738     |   |
| Provision  for doubtful related party receivable                             |   | 709,870    |       | —     |   |
| Provision  for obsolete inventory                                            |   | 249,058    |       | (13,742    | )      |
| Provision  for warranty claims                                               |   | 424,608    |       | 32,245     |   |
| Stock  option and grant expense                                              |   | 113,576    |       | 1,176,242  |   |
| Stock  issued for professional services                                      |   | —     |       | 125,000    |   |
| Changes  in operating assets and liabilities:                                |   |       |       |       |   |
| Accounts receivable                                                          |   | 410,448    |       | (561,685   | )      |
| Inventory                                                                    |   | (61,804    | )          | (54,540    | )      |
| Prepaid expenses and other assets                                            |   | 116,400    |       | (52,386    | )      |
| Advances to foreign contractor                                               |   | —     |       | (561,585   | )      |
| Due from related parties                                                     |   | (106,037   | )          | (136,338   | )      |
| Accounts payable and accrued expenses                                        |   | 254,986    |       | (167,020   | )      |
| **Net cash used in operating  activities**                                   |   | (1,611,964 | )          | (3,953,671 | )      |
|                                                                         |   |       |       |       |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES**                                    |   |       |       |       |   |
| Acquisition of  property and equipment                                       |   | (41,949    | )          | (271,131   | )      |
| Patent costs                                                                 |   | (37,931    | )          | (8,207     | )      |
| Collection (issuance)  of notes receivable                                   |   | 1,025,000  |       | (1,325,000 | )      |
| **Net cash provided by (used in)  investing activities**                     |   | 945,120    |       | (1,604,338 | )      |
|                                                                         |   |       |       |       |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES**                                    |   |       |       |       |   |
| Proceeds from  issuance of common stock                                      |   | 2,500      |       | 30,655     |   |
| Proceeds from issuance  of subscribed stock and warrants                     |   | —     |       | 3,337,500  |   |
| **Net cash provided by financing  activities**                               |   | 2,500      |       | 3,368,155  |   |
|                                                                         |   |       |       |       |   |
| **NET DECREASE IN CASH**                                                     |   | (664,344   | )          | (2,189,854 | )      |
|                                                                         |   |       |       |       |   |
| **CASH** — beginning of year                                            |   | 711,904    |       | 2,901,758  |   |
|                                                                         |   |       |       |       |   |
| **CASH** — end of year                                                  |   | $          | 47,560     |       | $      | 711,904 |   |
|                                                                         |   |       |       |       |   |
| **SUPPLEMENTAL  DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES**   |   |       |       |       |   |
|                                                                         |   |       |       |       |   |
| Stock  options granted                                                       |   | —     |       | 77,910     |   |
| Less:  stock option and grant expense                                        |   | (113,576   | )          | (1,176,242 | )      |
|                                                                         |   |       |       |       |   |
| Deferred  compensation recognized, net                                       |   | (113,576   | )          | (1,098,332 | )      |
|                                                                         |   |       |       |       |   |
| Deferred  compensation — beginning of year                              |   | 113,576    |       | 1,211,908  |   |
|                                                                         |   |       |       |       |   |
| Deferred  compensation — end of year                                    |   | $          | —     |       | $      | 113,576 |   |
|                                                                              |        |            |            |            |        |  |  |  |  |

** **

The accompanyingnotes are an integral part of these financial statements.

 

6

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**HYDROMAIDINTERNATIONAL, INC.**

**NOTES TO FINANCIAL STATEMENTS**

**December31, 2001 and 2000**

** **

**1.NATURE OF BUSINESS**

#  

***Nature of Business***

 

HydroMaid International,Inc. (the “Company”) was incorporated in 1992 in the State of Nevada, andengages in the development, manufacture, and sale of a patented water-poweredgarbage disposal known as the HydroMaidâ. Technological improvements and field-testing were completed in 1997, andthe HydroMaidâ was introduced to the market in1999.  The Company markets the HydroMaidâ to aworldwide customer base. The Company operates from a leased facility near SaltLake City, Utah.  The majority of itsmanufacturing is performed by a single contractor in China.

 

The Company’s commonstock trades on the OTC Bulletin Board of the National Association ofSecurities Dealers under the symbol “HYII”.

 

***Termination of Proposed Agreement with General Electric***

 

On March 10, 2000, theCompany entered into a non-binding letter of intent with the Appliance Divisionof General Electric Company (“GE”) under which GE might obtain exclusivedistribution rights to the HydroMaidâ in the United States and Canada throughOctober 31, 2003.  The mutualexploration being conducted under this letter of intent was terminated on April19, 2001.

 

***Going Concern***

 

As discussed above, theCompany manufactures and markets the HydroMaidâwater-powered garbage disposal.  Sincethe introduction of the HydroMaidâ to the marketplace in 1999, sales havenot been sufficient to provide positive operating cash flow.  The Company’s operating cash flow deficitfor the years ended December 31, 2001and 2000 was approximately $1.6 million and $4.0 million, respectively, and theCompany has accumulated a deficit of approximately $17 million from inceptionthrough December 31, 2001. Additionally, during the year ended December 31, 2001, the Companydiscovered a design flaw with a certain seal in the HydroMaidâ,forcing the Company to reduce its sales efforts until the problem iscorrected.  The Company is nearingcompletion of a redesigned seal, but additional capital is required to finishthis project and to mass-produce the new seal. These conditions raise substantial doubt about the Company’s ability tocontinue as a going concern.  Theaccompanying financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

At the end of 2001, theCompany had approximately $48,000 in cash, $70,000 in accounts receivable, anda related party receivable from Liquitek Enterprises, Inc. of $709,000, whichwas fully reserved for as a "doubtful" account. Management hasagressively reduced expenses in anticipation of the cash shortage, and believesLiquitek Entereprises, Inc. will be successful in its capital development andoperating efforts or liquidation of assets in order to pay the Company the$709,000 receivable balance (see Item 6. Management's Discussion and Analysis).Management anticipates, based on the cash balance, ongoing sales, collection ofreceivables, and collection of amounts due from Liquitek Enterprises, Inc., toprovide for the short-term operating needs of the company until permanentequity financing can be realized. The Company expects to raise additionalcapital through a private placement equity offering during 2002 to fund furtherdevelopment of present and anticipated operations until the Company canaccomplish self-sustaining cash flows.

 

The Company has beensuccessful in its efforts to expand international distribution channelsthroughout the world. These efforts have included development of distributionagreements for the HydroMaidä in many countries throughout the worldincluding: the United Kingdom, South Africa, Poland, Czech Republic, Hungary,Malaysia, Singapore, Indonesia, Thailand, Russia and Lithuania. Additionally,the Company is pursuing agreements for Canada, Australia, New Zealand, China,Japan, Taiwan and others. Due to the successful marketing efforts in theinternational arenas, the Company management anticipates demand for theHydroMaidä to grow substantially internationally.

 

The Company's design anddevelopment efforts have resulted in a design of an aesthetically acceptableon/off valve with an integral atmospheric anti-siphon valve, which hasdemonstrated the capability to meet all anti-siphon requirements. Certificationtesting and approvals for the integrated valve are anticipated to be completedduring the quarter ending June 30, 2002. Management expects this product to beready for production during the quarter ending September 30, 2002. It isanticipated that the introduction of this integrated valve will greatly enhancedomestic sales of the HydroMaidä.

 

 

7

----

 

 

**2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

The summary ofsignificant accounting policies presented below is designed to assist inunderstanding the Company’s financial statements.  Such financial statements and accompanying notes are therepresentations of Company management, who are responsible for their integrityand objectivity.  These accountingpolicies conform to accounting principles generally accepted in the UnitedStates (“GAAP”) in all material respects, and have been consistently applied inpreparing the accompanying financial statements.

 

***Use of Estimates***

 

The Company prepares itsfinancial statements in conformity with GAAP, which require management to makeestimates and assumptions that affect the reported amounts of assets andliabilities, disclosure of contingent assets and liabilities at the date of thefinancial statements, and reported amounts of revenues and expenses during thereporting period.  Significant estimatesinclude the allowance for doubtful accounts, accrued product warranty provision,deferred tax asset valuation allowance, and the provision for obsoleteinventory.  These estimates may beadjusted as more current information becomes available, and any adjustmentcould be significant.

 

***Concentration of Credit Risk***

 

Financial instrumentsthat may subject the Company to credit risk principally consist of uninsuredcash-in-bank balances.  At times, theCompany’s bank balance may exceed the amount insured by the Federal DepositInsurance Corporation.

 

***Other Concentrations***

 

The Company’s businessplan calls for virtually all product assembly and cutting blade manufacturingto take place in China.  The majority ofthe Company’s product assembly has been contracted to one company inChina.  Additionally, productionequipment with a gross cost of approximately $249,000 is located in China.  Suchequipment is subject to various political, economic, and other risks anduncertainties inherent in China.

 

The Company’s accountsreceivable result from sales to a broad customer base of domestic andinternational customers.  The Companyextends credit to its customers based upon its evaluation of each customer’sfinancial condition and credit history. The Company generally does not require collateral from its customers.

 

At December 31, 2001 and 2000,one and three customers, respectively, accounted for approximately 81% and 84%,respectively, of gross accounts receivable; no other individual customeraccounted for more than 10%.  For theyears ended December 31, 2001 and 2000,one and three customers, respectively accounted for approximately 12% and 62%,respectively, of gross sales; no other customer accounted for more than 10%.

 

8

----

 

 

The Company performsperiodic reviews of collectibility and provides an allowance for doubtfulaccounts receivable.  Managementconsiders the allowance for doubtful accounts at December 31, 2001 and 2000 of approximately $136,000 and $9,000,respectively, to be adequate to provide for losses which may be sustained inthe realization of these accounts.

 

***Revenue Recognition***

 

Except when the Companyhas significant future performance obligations, revenue is recognized uponshipment of the HydroMaidâ. Shipments with unexpired rights-of-return or which otherwise do notqualify for full-accrual revenue recognition are accounted for by the Companyas consignment transactions or are recorded as deferred revenue at the time ofsale.

 

***Inventory***

 

Inventory is stated atthe lower of cost (using the average cost method) or estimated marketvalue.  Management periodically reviewsinventory and outstanding purchase commitments to identify any significantobsolete or slow-moving items and provides allowances for such items.  Inventory held in excess of expected salesin the following year is classified as a long-term asset.

 

The Company’s provision for obsolete inventory isbased on the Company’s best estimates of product sales prices and customerdemand patterns. Due to the short amount of time that the HydroMaidâ hasbeen in the market, it is at least reasonably possible that the estimates used by theCompany to determine its provisions for obsolete inventory will be materiallydifferent from the actual amounts or results. These differences could result inmaterially higher than expected inventory provisions and related costs, whichcould have a materially adverse effect on the Company’s results of operationsand financial condition in the near term.

 

***Property and Equipment***

 

Equipment, fixtures, andleasehold improvements are stated at cost less accumulated depreciation or amortization.  Repairs, maintenance, and similar costs thatdo not significantly improve or extend the useful lives of the assets areexpensed as incurred.  When an asset issold or retired, the cost and accumulated depreciation or amortization areremoved from the accounts and any gain or loss is included in currentoperations.

 

9

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Equipment and fixturesare depreciated on a straight-line basis over an estimated useful life of fiveyears.  Leasehold improvements areamortized over the shorter of the remaining lease term or their estimatedeconomic life.

 

Completed tooling used incommercial production, which is idle at this time but is expected to be used inthe future (see Note 5), is carried at cost less accumulated depreciation.  The cost of special-purpose property andequipment (such as tools, dies, and molds) constructed by a related-partyvendor includes design/production labor and an allocation of estimated overhead.  Completed tooling is depreciated using thestraight-line method over its estimated useful life of five years.

 

***Patents***

 

The Company has 11 activepatents on the HydroMaidâ, which expire on dates through2019.  The Company capitalizes the costand related expenses of patents and patents pending, and amortizes patents overthe shorter of their remaining legal lives or their estimated economiclife.  In 2001, the Company wrote offcosts related to abandoned patents pending of approximately $50,000.  Additionally, two expired and fullyamortized patents with a gross cost of approximately $57,000 were written-offduring the year ended December 31, 2001. Accumulated amortization at December31, 2001 and 2000 approximated $117,000 and $158,000, respectively.

 

***Impairment of Long-Lived Assets***

 

The Company reviews thecarrying values of its long-lived and identifiable intangible assets forpossible impairment whenever events or changes in circumstance indicate thatthe carrying amount of the assets may not be recoverable.  If the cost basis of a long-lived asset isgreater than the projected future undiscounted net cash flows from such asset(excluding interest), an impairment loss is recognized.  Impairment losses are calculated as thedifference between the cost basis of an asset and its estimated fair value.  Any long-lived assets held for disposal arereported at the lower of their carrying amounts or fair values less costs tosell.  During the years ended December 31, 2001 and 2000, novaluation adjustments were recorded.  Assuch, the Company’s long-lived assets are stated at cost less accumulateddepreciation and amortization. There can be no assurance, however, that marketconditions or demand for the Company's products or services will not change,which could result in future long-lived asset impairments.

 

10

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***Income Taxes***

 

Using the liabilitymethod required by Statement of Financial Accounting Standards No. 109, “*Accountingfor Income Taxes*” (“SFAS 109”), the estimated tax effects oftemporary differences between financial and income tax reporting are recordedin the period in which the events occur. Such differences between the financial and tax bases of assets andliabilities result in future tax deductions or taxable income (Note 12).

 

***Advertising***

 

Advertising costs areexpensed as incurred.

 

***Research and Development Costs***

 

Research and developmentcosts are charged to expense when incurred.

 

***Warranty Costs and Related Matters***

 

The Company provides alifetime warranty on the HydroMaid’sâ housing and steel blades, and anunconditional ten-year warranty on workmanship and other components.  Estimated warranty expense is recorded basedon historical experience, product performance, and management’s review of productquality as compared to the current state of the technology.  During the year ended December 31, 2001,engineering studies discovered certain product design issues related to theHydroMaidâ that caused management to significantlyincrease the warranty reserve as of December 31, 2001.   It is reasonably possibly that management’sestimate of warranty expense and the related accrued product warranty willchange in the near term.

 

***Stock Options and Similar Equity Instruments***

 

The Company accounts fornon-employee stock-based compensation under Statement of Financial AccountingStandards No. 123 (“SFAS 123”), “Accounting for Stock Based Compensation.” SFAS123 defines a fair value based method of accounting for stock-basedcompensation. However, SFAS 123 allows an entity to continue to measure compensationcost related to stock and stock options issued to employees using the intrinsicmethod of accounting prescribed by Accounting Principles Board Opinion No. 25(“APB 25”), “Accounting for Stock Issued to Employees.” Under APB 25,compensation cost, if any, is recognized over the respective vesting periodbased on the difference, on the date grant, between the fair value of theCompany's common stock and the exercise price. Entities electing to remain withthe accounting method of APB 25 must make pro forma disclosures of net incomeand earnings per share, as if the fair value method of accounting defined inSFAS 123 had been applied. The Company has elected to account for itsstock-based compensation to employees under APB 25 (see Notes 9 and 10).

 

In March 2000, theFinancial Accounting Standards Board issued Interpretation No. 44 (“FIN 44”),“Accounting for Certain Transactions Involving Stock Compensation,” aninterpretation of APB 25. FIN 44 clarifies the application of APB 25 for (a)the definition of employee for purposes of applying APB 25 (b) the criteria fordetermining whether a plan qualifies as a non-compensatory plan, (c) theaccounting consequence for various modifications to the terms of a previouslyfixed stock option or award, and (d) the accounting for an exchange of stockcompensation awards in a business combination. FIN 44 is effective July 1,2000, but certain provisions cover specific events that occur after eitherDecember 15, 1998, or January 12, 2000. The adoption of FIN 44 did not have amaterial effect on the financial statements.

 

11

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***Loss per Common Share***

 

Loss per common share isbased on the weighted average number of common shares and potential commonstock outstanding during the year in accordance with Statement of FinancialAccounting Standards No. 128, *“Earnings per Share”*. Securities thatcould potentially dilute basic loss per share in the future (Notes 9, 10 and11) were not included in the diluted-loss-per-share computation because theireffect is antidilutive.

 

***Elements of Other Comprehensive Income***

 

For the years ended December 31, 2001 and 2000, theCompany did not have any elements of other comprehensive income as defined byStatement of Financial Accounting Standards No. 130, “*Reporting Comprehensive Income*.”  Therefore, a statement of comprehensiveincome has not been presented.

 

***Segment Reporting***

 

The Company has adopted Statement of Financial AccountingStandards No. 131 (“SFAS131”), “*Disclosures about Segments of anEnterprise and Related Information*.” SFAS 131 changes the way publiccompanies report information about segments of their business in their businessin their annual financial statements and requires them to report selectedsegment information in their quarterly reports issued to shareholders. It alsorequires entity-wide disclosures about the products and services an entityprovides, the material countries in which it holds assets and reports revenuesand its major customers. The Company operates entirely in one business segmentin the United States.

 

12

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***Recent Accounting Pronouncements***

 

The Company has adoptedStatement of Financial Accounting Standards No. 133 (“SFAS 133”), “*Accounting for Derivative Instruments and HedgingActivities.*” SFAS 133 establishes accounting and reporting standardsfor derivative instruments, including certain derivative instruments embeddedin other contracts, and for hedging activities. It requires that an entityrecognize all derivatives as either assets or liabilities on the balance sheetat their fair value. This statement, as amended by SFAS 137 and 138, iseffective for financial statements for all fiscal quarters of fiscal yearsbeginning after June 15, 2000. The adoption of this standard did not have amaterial impact on the Company's results of operations, financial position orcash flows as it currently does not engage in any derivative or hedgingactivities.

 

Additionally, in July2001, the Financial Accounting Standards Board issued Statements No. 141,“Business Combinations” (“SFAS 141”) and No. 142 “Goodwill and Other IntangibleAssets” (“SFAS 142”). SFAS 141 supersedes APB Opinion No. 16, “BusinessCombinations” and SFAS No. 38, “Accounting for Pre-acquisition Contingencies ofPurchased Enterprises”. SFAS 141 is effective for fiscal years beginning afterJune 30, 2001 and requires that all business combinations be accounted for bythe purchase method. SFAS 142 supersedes APB Opinion No. 17, “IntangibleAssets”. SFAS 142 is effective for fiscal years beginning after December 15,2001 and provides that all existing and newly acquired goodwill and intangibleassets will no longer be amortized but will be tested for impairment annuallyand written down only when impaired. Management has not determined whether therequirements of such pronouncements will have a significant impact on theCompany’s future financial statements.

 

Also, the FinancialAccounting Standards Board has recently issued Statements No. 143, “Accountingfor Asset Retirement Obligations” (“SFAS 143”) and No. 144, “Accounting for theImpairment or Disposal of Long-Lived Assets” (“SFAS 144”).  SFAS 143 addresses financial accounting andreporting for obligations associated with the retirement of tangible long-livedassets and the associated asset retirement costs, and is effective forfinancial statements issued for fiscal years beginning after June 15,2002.  SFAS 144 supersedes Statement No.121, “Accounting for the Impairment of Long-Lived Assets and for Long-LivedAssets to Be Disposed Of”, and addresses financial accounting and reporting forthe impairment or disposal of long-lived assets, including accounting for asegment of a business accounted for as a discontinued operation.  SFAS 144 is effective for financialstatements issued for fiscal years beginning after December 15, 2001.  Management has not determined exactly howthe requirements of such pronouncements will affect the Company’s futurefinancial statements.

 

***Fair Value of Financial Instruments***

 

TheCompany’s financial instruments include cash, accounts receivable, due fromrelated party, and accounts payable. Except for notes due from related party,the Company believes that the fair value of these financial instrumentsapproximates their carrying amounts based on current market indicators, such asprevailing market interest rates. It is not practicable to estimate the fairvalue of due from related parties, due primarily to the uncertainty surroundingthe timing of cash flows.

 

13

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**3. RELATED PARTY TRANSACTIONS AND RELATIONSHIPS**

 

The names andrelationships of related parties referred to in these notes are set forthbelow:

 

•                  Culley W. Davis, founder, CEO and Chairman of the Board of Directorsthrough December 31, 2001; sole owner and CEO of Lighthouse, Inc.("LI"), formerly Pinnacle Enterprises, Inc., a debtor of the Company;a stockholder and Chairman of the Board of Directors through August 3, 2001 ofLiquitek Enterprises, Inc., a debtor of the Company; manager of Family Legacy,Ltd., a direct and beneficial owner of Company stock through August 9, 2001;and owner of Company stock options (Note 9). The Company occupied office space owned by LI from September 2000through June 2001, and paid rent on a month-to-month basis.  Rent paid to LI in 2001 and 2000approximated $82,000 and $38,000, respectively.

 

•                  Bruce H. Haglund, a director of the Company and owner of Company stockoptions (Note 9), is a partner in the law firm of Gibson, Haglund, &Paulsen (“GHP”), legal counsel to the Company. For the years ended December 31, 2001 and 2000, the Company paid orincurred legal fees to GHP of approximately $77,000 and $150,000, respectively.At December 31, 2001, the Company owed GHP approximately $45,000, which isincluded in accounts payable and accrued expenses in the accompanying balancesheet.

 

Included in accountsreceivable at December 31, 2001 is approximately $50,000 due to a shareholderfor purchased product.  At December 31,2001, approximately $17,000 in unreimbursed expenses to certain employees wasincluded in accounts payable and accrued expenses on the accompanying balancesheet.

 

Because the Company,Lighthouse, Inc., Liquitek Enterprises, Inc., Family Legacy, Ltd, and otherentities have had commonality of ownership and/or management control during2001 and 2000, the reported operating results and/or financial position of theCompany could significantly differ from what would have been obtained if suchentities were autonomous.

 

Other related partytransactions are discussed elsewhere in these notes to the financialstatements.

 

14

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**4. INVENTORY**

 

Inventory consists of thefollowing at December 31:

 
|                                    |   | **2001** |    | **2000**  |   |
|-----------------------------------------|--------|----------|---------|-----------|--------|
| Components                              |   | $        | 195,447 |      | $      | 551,039 |   |
| Finished goods,  current portion        |   | 43,785   |    | 827,098   |   |
| Finished goods,  net of current portion |   | 726,014  |    | —    |   |
|                                    |   | 965,246  |    | 1,378,137 |   |
| Less valuation allowance                |   | (195,447 | )       | (403,931  | )      |
|                                    |   |     |    |      |   |
|                                    |   | $        | 769,799 |      | $      | 974,206 |   |

 

During the year endedDecember 31, 2001, the Company disposed of fully reserved inventory with a costof approximately $278,000, writing off both the asset and the correspondingvaluation allowance. Additionally, the Company increased the valuationallowance by approximately $70,000 during 2001 for certain components which itdeemed to have no future value.

 

**5. PROPERTY AND EQUIPMENT**

 

Property and equipmentconsist of the following at December 31:

 
|                                       |   | **2001**  |    | **2000**  |   |
|--------------------------------------------|--------|-----------|---------|-----------|--------|
| Machinery, equipment, and tooling          |   | $         | 89,377  |      | $      | 477,877 |   |
| Idle machinery  and tooling                |   | 388,500   |    | —    |   |
| Computer  hardware and software            |   | 72,615    |    | 49,594    |   |
| Furniture and  fixtures                    |   | 58,743    |    | 58,743    |   |
| Vehicles                                   |   | 126,147   |    | 126,147   |   |
| Leasehold  improvements                    |   | 120,392   |    | 111,812   |   |
| Demonstration  equipment                   |   | 404,226   |    | 393,878   |   |
|                                       |   | 1,260,000 |    | 1,218,051 |   |
| Accumulated  depreciation and amortization |   | (661,433  | )       | (413,636  | )      |
|                                       |   |      |    |      |   |
|                                       |   | $         | 598,567 |      | $      | 804,415 |   |

 

Production machinery andtooling approximating $389,000 was not used during the year ended December 31,2001 and is reported above as idle machinery and tooling.  Included in this amount is equipment costingapproximately $249,000 that is located in China.  As the Company intends to use this machinery in the future, afull year of depreciation, approximating $78,000, was recorded during the yearended December 31, 2001.

 

Depreciation andamortization expense related to property and equipment approximated $248,000 and $211,000, respectively, for the years ended December 31, 2001 and 2000.

 

15

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**6. NOTES RECEIVABLE**

 

In August 2000, theCompany loaned $500,000 to an unrelated party in the water filtrationbusiness.  The loan was evidenced by anunsecured note receivable maturing August 7, 2001 and bore interest at 12% perannum.  Such note and accrued interestthereon were repaid in full during the year ended December 31, 2001.

 

On December 20, 2000, theCompany issued a $525,000 note receivable to Liquitek Enterprises, Inc. (seeNote 3).  The note bore interest at therate of 6.2% per annum; principal and unpaid interest were due March 31,2001.  Such note and accrued interestthereon, approximating $20,000, were repaid in full during the year endedDecember 31, 2001.

 

The Company loaned$300,000 on November 8, 2000 to Lighthouse, Inc. (see Note 3).  The note bears interest at the rate of 6.2%per annum; principal and unpaid interest were due November 8, 2001.  On December 31, 2001, the Company,Lighthouse, Inc., and Liquitek Enterprises, Inc. agreed that LiquitekEnterprises, Inc. would be responsible for the repayment of this note andaccrued interest to the Company.  Atsuch date, the note was reclassified to due from related party (see Note 7) onthe accompanying balance sheets.

 

 

**7. DUE FROM RELATED PARTIES**

 

Lighthouse, Inc. andLiquitek Enterprises, Inc. reimburse the Company for certain allocatedadministrative expenses.  These expensesgenerally consist of salaries and related benefits paid to Company personnelwho perform services for Lighthouse, Inc. and Liquitek Enterprises, Inc.  Allocations of personnel costs have beenbased primarily on actual time spent by Company employees; management believesthat such allocation method is reasonable. Amounts charged to Lighthouse, Inc. and Liquitek Enterprises, Inc. havedirectly offset the Company’s operating expenses by approximately $392,000 and$213,000 for the years ended December 31, 2001 and 2000, respectively.

 

The Company reimbursesLighthouse, Inc. for certain allocated overhead expenses related to its rentedoffice space.  The Company nets theamount charged by Lighthouse, Inc. against the amounts charged foradministrative expenses described in the preceding paragraph. Lighthouse, Inc.charged approximately $31,000 and $59,000, respectively, to the Company forallocated overhead for the years ended December 31, 2001 and 2000.

 

On December 31, 2001, theCompany, Lighthouse, Inc. and Liquitek Enterprises, Inc. agreed that LiquitekEnterprises, Inc. would assume the responsibility for the total Lighthouse,Inc. obligation of $433,055 to the Company in consideration for LiquitekEnterprises, Inc. being relieved of $433,055 of its obligation to Lighthouse,Inc.  The $433,055 obligation consistedof a $300,000 note and accrued interest of $21,300 (see Note 6) as well as$111,755 in unpaid allocated administrative expenses as explained above.  The net effect of this transaction was toeliminate Lighthouse, Inc. from any obligation to the Company and resulted in atotal related party receivable from Liquitek Enterprises, Inc. of$709,870.  The Company's managementbelieves that this receivable will be collected in the future from LiquitekEnterprises, Inc.  However, the Companyhas fully reserved the $709,870 as a doubtful account because substantial doubtexists as to Liquitek Enterprises, Inc.'s ability to continue as a goingconcern.

 

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**8. EQUITY SECURITIES**

 

In January 1999, theCompany entered into a contract to memorialize the manufacturing and consultingarrangement with Metric Tool & Die (“MTD”), a research facility and theformer manufacturer for the Company, and Don Sullivan.  This contract required the Company toexecute an agreement whereby 50,000 shares of its restricted common stock wouldbe issued at no cost to Don Sullivan, contingent upon (1) his continuedemployment by MTD and (2) MTD maintaining its existing business relationshipwith the Company.  As this equityinstrument has an exercise price of zero, its grant-date fair value ofapproximately $130,000 has been estimated based exclusively on the market priceof the Company’s stock. Such amount was booked as deferred compensation in 1999and was amortized through the year ended December 31, 2001. Stock optioncompensation expense approximating $44,000 was recorded in each of the years endedDecember 31, 2001 and 2000.

 

During the year endedDecember 31, 2000, the parties executed a definitive agreement regarding thematters discussed above, and during theyear ended December 31, 2001, the Company issued 50,000 shares of itsrestricted common stock to Don Sullivan in full satisfaction of theaforementioned agreement.

 

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**9. STOCK OPTIONS**

 

***1999 Stock Option and Incentive Plan***

 

Effective September 20,1999, the Company adopted the 1999 Stock Option and Incentive Plan (the “1999Plan”), which permits the issuance of options for a maximum of 1.2 millionshares.

 

On December 28, 2000, theCompany granted options for a total of 247,500 shares under the 1999 Plan asfollows:

 
| Directors,  exercisable at $1.00 per share in three equal installments ending December  31, 2002, and expiring ten years from the date of grant. |   | 50,000  |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------|--------|
| Employees,  exercisable at $1.00 per share in three equal installments ending December  31, 2002, and expiring ten years from the date of grant. |   | 197,500 |   |
|                                                                                                                                             |   |    |   |
|                                                                                                                                             |   | 247,500 |   |

 

As described in the“Non-Statutory Stock Options and Other Issuances” section of this note, optionsfor a total of 500,000 shares (not under the 1999 Plan) were granted to RobertC. Gay, Culley W. Davis, Lester W.B. Moore, and Bruce H. Haglund during theyear ended December 31, 2000.

 

***1997 Stock Option and Incentive Plan***

 

Effective June 1, 1997,the Company adopted the 1997 Stock Option and Incentive Plan (the “1997 Plan”),which permits the issuance of options for a maximum of 2 million shares and hasa life of ten years.  Employee optionsto purchase common stock for $0.25 per share are generally exercisable in threeequal annual installments beginning in January 2000.

 

For employees who ownmore than 10% of the Company’s outstanding stock, such options are required tohave a minimum exercise price of 110% of the grant-date estimated fair marketvalue and expire five years after issuance. Options granted to other employees have a ten-year term.  The pre-March 18, 1998 options of otheremployees have an exercise price of not less than the grant-date estimated fairmarket value.

 

The employees’ rightsunder the 1997 Plan are contingent upon (a) continued employment with theCompany for at least six months after the grant date and (b) providing arepresentation that option shares are acquired for investment only, and not forsale.  Employees may not dispose ofshares acquired from exercising stock options within two years of the grantdate or within one year after the exercise date.

 

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***Non-Statutory Stock Options and Other Issuances***

 

At December 31, 2001,Bruce H. Haglund owned non-statutory options to acquire a total of 175,000shares as follows: (a) 100,000 shares under the 1997 Plan at $0.25 per share,which are exercisable in three equal annual installments beginning January 1,2000, (b) 50,000 shares as a director under the 1999 Plan at $5.50 per share,which are exercisable in four equal quarterly installments beginning January 1,2000, and (c) 25,000 shares as a director at $1.00 per share, which becameexercisable on December 28, 2000.  Theseoptions expire ten years from their respective grant dates.

 

On December 28, 2000,Lester W.B. Moore (Chairman of the Board of Directors of Liquitek Enterprises,Inc.) was granted non-statutory options to acquire 50,000 shares. These optionswere issued at $1.00 per share and were exercisable on the date of grant.  These options expire ten years from suchdate.

 

On December 28, 2000,Robert C. Gay (a former director of the Company) was granted non-statutoryoptions to acquire 200,000 shares at $1.00 per share. These options were notissued under either the 1999 Plan or the 1997 Plan. Of the total optionsgranted, 25,000 were issued for his services as a director.  The options are exercisable on the date ofgrant and expire ten years from such date.

 

On December 28, 2000,Culley W. Davis was granted non-statutory options to acquire 225,000 shares at$1.00 per share. These options were not issued under either the 1999 or the1997 Plan. Of the total options granted, 25,000 were issued for his services asa director.  The options are exercisableon the date of grant and expire ten years from such date.

 

Any grant of non-statutorystock options must be approved by a majority of disinterested directors of theCompany.  For accounting purposes, thevesting of such options is not contingent upon the optionee providing anyfuture services.

 

No stock options,statutory or non-statutory, were issued during the year ended December 31,2001.

 

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***Stock Option Activity***

 

A summary of theaggregate stock option activity for the 1999 and 1997 Plans (including thenon-statutory stock options and other issuances discussed above) for the yearsended December 31, 2001 and 2000is presented below as required by SFAS 123:

 
|                                          |   | **Shares** |   | **Exercise Price  Range** |          | **Weighted  Average Price  Per Share** |   |
|-----------------------------------------------|--------|------------|--------|---------------------------|---------------|----------------------------------------|--------|
| Options outstanding — December 31,  1999 |   | 1,300,834  |   | $                         | 0.25 to $5.50 |                                   | $      | 2.88 |   |
| Options granted                               |   | 747,500    |   | $                         | 1.00          |                                   | $      | 1.00 |   |
| Options exercised                             |   | (76,667    | )      | $                         | 0.25          |                                   | $      | 0.25 |   |
| Options expired or forfeited                  |   | (35,000    | )      | $                         | 0.25 to $5.00 |                                   | $      | 3.30 |   |
|                                          |   |       |   |                      |          |                                   |   |
| Options outstanding — December 31,  2000 |   | 1,936,667  |   | $                         | 0.25 to $5.50 |                                   | $      | 2.19 |   |
| Options granted                               |   | —     |   |                      |          | $                                      |   |   |
| Options exercised                             |   | (10,000    | )      | $                         | 0.25          |                                   | $      | 0.25 |   |
| Options expired or forfeited                  |   | (72,500    | )      | $                         | 0.25 to $5.00 |                                   | $      | 2.45 |   |
|                                          |   |       |   |                      |          |                                   |   |
| Options outstanding — December 31,  2001 |   | 1,854,167  |   | $                         | 0.25 to $5.50 |                                   | $      | 2.19 |   |
|                                          |   |       |   |                      |          |                                   |   |
| Options exercisable — December 31,  2001 |   | 1,508,334  |   | $                         | 0.25 to $5.50 |                                   | $      | 1.81 |   |

 

On January 1, 2002,additional options for 152,500 shares became exercisable.

 

Theweighted average grant-date fair value of options granted during 2000 was $0.48.  The weighted average fair value of optionsgranted during 2000 when the exercise price exceeded the grant-date marketprice was $0.48.  As noted above, nooptions were granted during the year ended December 31, 2001.

 

Thefollowing schedule reflects additional disclosures required by SFAS 123. Thisinformation is provided to assist readers in assessing the timing and uncertainties related tothe exercise of the outstanding options to purchase common stock.

 

20

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| **Options  Outstanding at  December 31, 2001** |   | **Exercise Price  Range** |   | **Weighted  Average  Exercise Price** |   | **Weighted  Average  Remaining  Contractual  Life** |    |
|------------------------------------------------|--------|---------------------------|--------|---------------------------------------|--------|-----------------------------------------------------|---------|
| 514,167                                        |   | $0.25                     |   | $                                     | 0.25   |                                                | 6 years |   |
| 725,000                                        |   | $1.00                     |   | $                                     | 1.00   |                                                | 9 years |   |
| 365,000                                        |   | $5.00                     |   | $                                     | 5.00   |                                                | 8 years |   |
| 250,000                                        |   | $5.50                     |   | $                                     | 5.50   |                                                | 8 years |   |
|                                           |   |                      |   |                                  |   |                                                |    |
| 1,854,167                                      |   | $0.25 to $5.50            |   | $                                     | 2.19   |                                                | 8 years |   |

 

 

***Other Matters***

 

The disclosures in thisparagraph apply to both the 1999 and the 1997 Plans.  The estimated fair value of the options granted is amortized toexpense over the options’ vesting period. The fair value of stock options granted has been estimated using theBlack-Scholes stock option pricing model based on the exercise price per share,the market price of the Company’s common stock, and the weighted-averageassumptions set forth below for issuances in the year ended December 31, 2000:

 
| Expected life            |   | 2.2 years |   |
|--------------------------|--------|-----------|--------|
| Estimated  volatility    |   | 125       | %      |
| Risk-free  interest rate |   | 5.1       | %      |
| Dividends                |   | Zero      |   |

 

Under both stock optionplans, the Company may grant stock appreciation rights and restricted stockawards. As of December 31, 2001, no such equity instruments had been granted.

 

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Both stock option plansinclude a “poison-pill” clause that is triggered by certain definedevents.  Such events include (1) theacquisition of a majority of the Company’s outstanding common stock, (2) areorganization/merger/consolidation whereby the Company is not the survivingentity, and (3) the sale of all or substantially all of the Company’s assets intheir entirety.  If such an eventoccurs, all outstanding stock options and stock appreciation rights may becomeimmediately exercisable or fully vested at the discretion of the Board ofDirectors; similarly, restricted stock may be freed of any restrictions at thediscretion of the Board of Directors.

 

 

**10. STOCK-BASED COMPENSATION AND OTHER EXPENSES**

 

As discussed in Note 2,compensatory stock options and similar equity instruments issued tonon-employees are accounted for using the fair value method of SFAS 123.  The Company recognized compensation expenserelated to such equity instruments of approximately $30,000 and $111,000 forthe years ended December 31, 2001 and2000, respectively.  The expenserecorded in 2001 represents the amortization of deferred compensation relatedto services performed by non-employees. The expense incurred in 2000 representscosts associated with services performed by non-employees.

 

Incentive stock optionsgranted to employees are accounted for using the intrinsic value method of APB25.  Estimated compensation expenserelated to such options approximated $91,000 for the year ended 2000. No such expense was recorded forthe year ended December 31, 2001.  Ifthe fair value method of accounting had been applied to such options, theCompany’s reported net loss and loss per share would have been as follows forthe years ended December 31:

 
|                                          |   | **2001**                                   |   | **2000** |   |
|-----------------------------------------------|--------|--------------------------------------------|--------|----------|--------|
|                                          |   | **(In  thousands, except per share data)** |   |
| Net loss, as reported                         |   | $                                          | (4,128 | )        | $      | (3,979 | ) |
|                                          |   |                                       |   |     |   |
| Net loss, pro forma                           |   | $                                          | (4,584 | )        | $      | (4,848 | ) |
|                                          |   |                                       |   |     |   |
| Basic and diluted loss per share, as reported |   | $                                          | (0.15  | )        | $      | (0.15 | ) |
|                                          |   |                                       |   |     |   |
| Basic and diluted loss per share, pro forma   |   | $                                          | (0.17  | )        | $      | (0.18 | ) |

 

The above pro formaeffects of applying SFAS 123 are not necessarily representative of the impacton reported net loss for future years.

 

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**11. SUBSCRIBED COMMON STOCK AND WARRANTS**

 

In January 2000, theCompany received payment for 750,000 subscribed common shares at a price of$4.44 per share and simultaneously issued 1,000,000 detached stock- purchasewarrants at a price of $0.01 per warrant. All such warrants are outstanding at December 31, 2001.  Each warrant entitles the owner, on orbefore January 21, 2005, to (a) purchase one share of Company stock at a priceof $7.50 per share or (b) convert the warrant directly to common shares, usinga formula based on the then current market price of the Company’s stock.  If the market price of the Company’s commonstock exceeds $10.00 for 30 consecutive trading days and the average dailytrading volume for such period exceeds 100,000 shares, the Company has theright to accelerate the expiration date of the warrants to a date not earlierthan 60 days after providing notice to that effect.

 

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The warrants discussedabove (and any stock issued upon their exercise or conversion) have not beenregistered under the Securities Act of 1933. Thus, such warrants and any stock issued as a result thereof arerestricted securities.  Because of suchrestrictions and the magnitude of the investment, management determined that itwas appropriate to discount the then current market price (approximately $5.00per share) of the Company’s common stock in the above transaction.

 

The Company has enteredinto an agreement with the investors who purchased the stock and warrantsdescribed above to make a good faith effort under certain circumstances to filea maximum of two effective registration statements under the Securities Act of1933. No such effective registration statements have been filed as of December31, 2001.

 

 

**12. INCOME TAXES**

 

The Company wasconsidered a start-up entity for federal and state income tax purposes from its1992 inception through 1998. As a result, start-up expenses, including researchand development, were capitalized during such period for tax purposes, whilesuch costs were expensed as incurred for financial reporting purposes. TheCompany also has a tax net operating loss carryforward of approximately$12,000,000 at December 31, 2001, which principally expires in 2019 through2021.

 

The Company’sdeferred tax asset approximated $5,500,000 and $4,500,000 at December 31, 2001 and 2000,respectively.  Because there is noreasonable assurance that such asset will be realized in future years, theCompany has recorded a 100% valuation allowance against this deferred taxasset.

 

A summary of the activityin the deferred tax asset and related 100% valuation allowance for the yearsended December 31, 2001 and 2000follows:

 
| Balance — December 31, 1999 |   | $         | 3,200,000 |   |
|----------------------------------|--------|-----------|-----------|--------|
|                             |   |      |      |
| Deferred benefit for 2000        |   | 1,300,000 |      |
|                             |   |      |      |
| Balance — December 31, 2000 |   | 4,500,000 |      |
|                             |   |      |      |
| Deferred benefit for 2001        |   | 1,000,000 |      |
|                             |   |      |      |
| Balance — December 31, 2001 |   | $         | 5,500,000 |   |

 

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The components ofthe deferred tax asset are as follows at December 31:

 
|                                 |   | **2001**   |      | **2000**   |   |
|--------------------------------------|--------|------------|-----------|------------|--------|
| Tax  net operating loss carryforward |   | $          | 4,480,000 |       | $      | 3,367,000 |   |
| Deferred  start-up costs             |   | 760,000    |      | 1,097,000  |   |
| Other                                |   | 260,000    |      | 36,000     |   |
| Deferred  tax asset                  |   | 5,500,000  |      | 4,500,000  |   |
| Less  valuation allowance            |   | (5,500,000 | )         | (4,500,000 | )      |
|                                 |   |       |      |       |   |
| Net  deferred tax asset              |   | $          | —    |       | $      | — |   |

 

The income taxbenefit for the years ended December31, 2001 and 2000 differs from the amount that would result fromapplying the federal statutory rate to the pre-tax loss because of state incometaxes and revisions of prior year estimates.

 

The Company’s income taxreturns for the open years are subject to examination and adjustment by theapplicable taxing authorities.

 

 

**13. COMMITMENTS AND CONTINGENCIES**

 

***Lease Commitments***

 

The Company leases officespace (“old office space”) for a five-year period ending October 31, 2003, withan option to renew until September 2005. Such space has been subleased to atenant, expiring October 31, 2003. Rent expense under this lease approximates$7,000 per month, plus common area expenses, and related sub-lease rent incomeapproximates $7,000 per month. In September 2000, the Company moved from theold office space into a new building owned by Lighthouse, Inc. (Note 3) on amonth-to-month basis. The Company formerly leased a 10,000 square-footwarehouse for a two-year period ended September 30, 2000 at an annual rent ofapproximately $50,000. In July 2001, the Company leased a new space to combineits offices and warehouse into one location, and consequently moved out oftheir other offices and warehouse. Such lease requires monthly payments ofapproximately $4,000 through September 2004, plus common area maintenancecosts.

 

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Minimum annual rentalcommitments required under these non-cancelable operating leases are as followsfor the years ending December 31:

 
|   |   | **Minimum  Lease  Commitment** |    | **Sub-lease  Income** |   | **Net Lease  Commitment** |   |
|--------|--------|--------------------------------|---------|-----------------------|--------|---------------------------|--------|
| 2002   |   | $                              | 136,770 |                  | $      | (89,300                   | )      | $ | 47,470 |   |
| 2003   |   | 121,427                        |    | (76,268               | )      | 45,159                    |   |
| 2004   |   | 37,764                         |    | —                |   | 37,764                    |   |
|   |   |                           |    |                  |   |                      |   |
|   |   | $                              | 295,961 |                  | $      | (165,568                  | )      | $ | 130,393 |   |

 

 

Total rent expense,including common area maintenance and other related expenses, approximated$146,000 and $205,000 for the years ended December 31, 2001 and 2000, respectively.

 

At December 31, 2001, the Company was severalmonths delinquent in paying the rent on its old office space.  Such rent is fully accrued and included inaccounts payable and accrued expenses on the accompanying balance sheets.  Such non-payments could be considered anevent of default under the terms of the lease agreement.  The lessor has not contacted the Companyabout such non-payments, and management does not estimate that the Company hasany liability beyond rent accrued at December 31, 2001.  The Company intends to cure the delinquentpayments as cash flow permits in the future.

 

***Purchase Commitment and Related Contingent Liability***

 

At December 31, 2001, the Company hadoutstanding commitments of approximately $1,925,000 to purchase finished goodsfrom its contractor in China.  Due tothe Company’s current financial condition, the contractor has agreed to suspendproduction of certain units representing approximately $1,650,000 of suchcommitment.  The Company has indemnifiedthe contractor in the amount of approximately $645,000 for any loss that mayresult from contractor-owned components if such inventory becomes obsolete dueto a change in the product’s design.  The indemnification has been made in the form of a cash deposit to thecontractor, included on the accompanying balance sheets as advances to foreigncontractor.  The contractor has agreedthat when production resumes, a credit of approximately $18 will be appliedagainst the cost of each unit shipped to the Company.  Management believes that such deposit will be fully realized inthe future.  It is reasonably possiblythat management’s estimate of the realization of this deposit will change inthe near term. Since the accompanying financial statements have been preparedassuming the Company will continue as a going concern, management has assumedamortization of this non-refundable cash deposit in the ordinary course ofbusiness.

 

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**14. PROFIT SHARING PLAN**

 

In January 2000, theCompany established a defined contribution profit sharing plan (the “Plan”) foreligible employees.  Employees maycontribute up to 15% of their gross wages, as defined in the Plan, subject tocertain statutory limits.  The Companymay, at its discretion, make a profit-sharing contribution at year-end up to15% of eligible employees’ gross wages. During the year ended December31, 2001, the Company provided matching contributions equal to 50% ofthe first 5% of each eligible employee’s contribution. During the year endedDecember 31, 2000, the Company provided a profit sharing contribution equal to3% of such employees’ gross wages.  Nosuch profit sharing contribution was made during the year ended December 31,2001.  These matching contributions vestto the employees over various periods as defined in the Plan agreement.  The Company’s contribution to the Plan forthe years ended December 31, 2001 and2000 approximated $ 12,000 and $45,000, respectively.

 

Between April 2001 andNovember 2001, the Company retained employee deferral amounts beyond themaximum limitations as defined by the Department of Labor.  Such deferrals, approximating $15,000, areincluded at December 31, 2001 in accounts payable and accrued expenses in theaccompanying balance sheets.  Suchamount is subject to interest due to the Plan and tax penalties due to theInternal Revenue Service (“IRS”).  TheCompany has not filed the required Form 5330 with the IRS as of April 12,2002.  The Company has not remittedprincipal or interest amounts due to the Plan.

 

 

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