SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   Form 10-KSB

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
    1934: FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES ACT OF 1934:

    for the transition period from ________ to ________.

                         Commission File Number 1-13012

                         H.E.R.C. PRODUCTS INCORPORATED
                 (Name of small business issuer in its charter)

               Delaware                                     86-0570800
State of Incorporation or Organization        IRS Employer Identification Number

                          2202 W. Lone Cactus Drive #15
                           Phoenix, Arizona 85027-2621
                    (Address of principal executive offices)

                                 (602) 492-0336
                (Issuer's telephone number, including area code)

    Securities registered pursuant to Section 12(b) of the Exchange Act: None

                                                     Name of each exchange
         Title of each class                          on which registered
         -------------------                          -------------------
    Common Stock, $.01 par value                     Boston Stock Exchange

    Securities registered pursuant to Section 12(g) of the Exchange Act: None

Check whether the issuer:  (1) filed all reports required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure  will be contained,  to
the  best  of  registrant's   knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part III of this Form  10-KSB or any
amendment to this Form 10-KSB. [ ]

State issuer's revenues for its most recent fiscal year. $3,168,955

At March 11,  1999,  the  aggregate  market  value of the  voting  stock held by
non-affiliates  of the  registrant  was  $2,937,785  based on the closing market
price of the  Common  Stock on such  date as  reported  by the OTC BB  Market of
$0.39.

At March 11,  1999,  there were  11,526,053  shares of Common  Stock  issued and
outstanding.

Transitional Small Business Disclosure Format: Yes [ ]  No[X]

Documents Incorporated by Reference: None
<PAGE>
FORWARD-LOOKING STATEMENTS

     Parts of this report describe historical information,  such as the 1997 and
1998 operating results, and H.E.R.C. Products Incorporated ("HERC") believes the
descriptions to be accurate.  In contrast to describing the past, some sentences
in this report indicate that HERC believes that events or financial  results are
likely to occur in 1999 or thereafter.  These  sentences  typically use words or
phrases like "believe," "expects,"  "anticipates,"  "estimates," "will continue"
and similar expressions. Statements using those words or similar expressions are
intended  to  identify  "forward  looking  statements"  as that  term is used in
Section 27A of the  Securities  Act of 1933, as amended,  and Section 21E of the
Securities Exchange Act of 1934, as amended.  Forward-looking statements include
projections  of  operating  results for 1999 and  beyond,  either  concerning  a
specific segment of HERC's business, or concerning HERC as a whole.

     Actual  results,  however,  may be  materially  different  from the results
projected  in the  forward  looking  statements,  due to a variety  of risks and
uncertainties.  These risks and uncertainties  include those set forth in Item 1
of Part I hereof,  entitled  "Business,"  in Item 6 of Part II hereof,  entitled
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations," in Exhibit 99.1 hereof and elsewhere in this report.

     The forward  looking  statements  in this report are current only as of the
date this report is filed with the Securities and Exchange Commission. After the
filing of this report,  HERC's  expectations  of likely results may change,  and
HERC may come to believe that certain forward-looking  statements in this report
are no longer accurate. HERC does not have an obligation to release publicly any
corrections or revisions to any forward looking statements in this report,  even
if HERC believes the forward looking statements are no longer true.

                                     PART 1

ITEM 1. BUSINESS

GENERAL

     H.E.R.C.  Products  Incorporated is a chemical and  engineering  technology
company that  develops and patents  products,  equipment and services for use on
water scale and corrosion in soils,  on surfaces and in pipeline  systems.  HERC
markets its products to wholesale and retail customers  directly and through key
strategic  alliances.  HERC's cleaning services are directed toward  commercial,
industrial, marine and municipal customers.

     Over time, most water systems,  such as water delivery  systems,  sprinkler
systems,  waste  systems,  municipal  pipes and water wells,  become  internally
corroded  and openings  become  tuberculated.  The effect is a smaller  diameter
through  which  water and waste can travel  and a less  efficient  system.  HERC
cleaning  methodologies  will  remove the scale and  corrosion  and  restore the
efficiency of the system.

     HERC uses patented and other proprietary  chemical products in its cleaning
services.  HERC's  chemical  technology  is combined with water and then flushed
through a pipe system that is no longer functioning  properly.  HERC's chemicals
dissolve and remove scale and corrosion  and retain the  components of scale and
corrosion  in  solution,  even at highly  concentrated  levels,  until  they are
flushed  from the systems.  The system may then be treated  with other  chemical
products  that  retard  corrosion  or suppress  the  environment  that  supports
biological growth and, thus, is maintained as a more efficient pipe system after
the  HERC  cleaning.  Many  of  the  chemicals  used  by  HERC  are  non-fuming,
non-abrasive  and  non-flammable.  Many of HERC's  products  are also  certified
biodegradable by Scientific Certification Systems, an independent certifying and
testing laboratory ("Green Cross").

     HERC's chemical products were developed in response to the disadvantages of
the more commonly used chemicals used in pipe system  cleaning.  Those chemicals
are often toxic, fuming and corrosive.  Because of these characteristics and the
fact  that  they  often  are  not  biodegradable,  they  are  considered  to  be
pollutants.  Cleaning  water systems  using such  chemicals  requires  expensive
clean-up and regulatory  compliance costs and additional monitoring costs during
and after use.  HERC's  chemical  products were also developed to provide a more
cost effective and efficient  means of cleaning  closed pipe systems in contrast
to  replacement,  mechanical  scraping  or  pigging.

                                                                          Page 2
<PAGE>
HERC's   products  for  the   industrial   market  include   Pipe-Klean(R)   and
Well-Klean(R),  which remove  encrustation  from water pumping and  distribution
systems;  Compound 360,  Compound 400 and Slug(R) to clean and maintain  cooling
and other water  treatment  systems;  and Line-Out(R) for salt removal from soil
surfaces and the cleaning of drip  irrigation  systems.  HERC also sells private
label products utilizing its proprietary  formulations or products complementary
to its formulations for key customers.

     The  relative  contribution  of the business  segments to HERC's  operating
revenue and operating  profit for the two years ended December 31, 1998, and the
identifiable  assets  of each  segment  at the end of each of  those  years  are
included in Note 7 to the consolidated financial statements in this report.

     HERC was  incorporated in Arizona in December 1986 and  re-incorporated  in
Delaware in 1994. HERC executive offices,  warehouse and manufacturing  facility
for some of the  proprietary  products  are located in Phoenix,  Arizona and its
telephone number is (602) 492-0336.

PRODUCTS AND SERVICES

     Water  is  critical  to many  industries  and  uses,  ranging  from  wells,
waterlines,  fire  protection  systems,  heating and  air-conditioning  and most
industrial production processes.  Water is a chemically active substance and any
surface that is regularly  exposed to water is subject to corrosion by oxidation
(such as rust).  Since water is rarely  pure,  water  exposed  surfaces are also
subject to scaling from  dissolved  minerals or biological  corrosion from water
born  microbes.  Scaling or corrosion  will  eventually  lead to the plugging or
fouling of the surface,  pipe, pump, air condition system or other water exposed
surface.

     The  generally   accepted  treatment  methods  for  water  systems  include
replacement, mechanical cleaning, acid cleaning or hot chelating agent cleaning.
HERC offers an  alternative  method of chemical  cleaning which it believes is a
significant  improvement  over these methods  because it is faster,  cheaper and
more complete and has a lower environmental impact.

     Pipe-Klean and Well-Klean,  the principal products of HERC used in its pipe
system  cleaning,  act to remove scale and  corrosion.  These products have been
tested  and  certified  to  ANSI/NSF  Standard  60 by  the  National  Sanitation
Foundation  (NSF) for use as well  cleaning and pipe  cleaning  aids in drinking
water  systems.   ANSI/NSF  Standard  60  was  developed  to  establish  minimum
requirements  for the control of potential  adverse  human  health  effects from
products  added  directly to water for its  treatment.  HERC believes that these
products offer distinct advantages over the acid washes which are generally used
to clean water systems, since the acid can cause additional corrosion and can be
deemed to be hazardous waste for disposal purposes.

MARINE DIVISION

     The marine  division  focuses on the cleaning of shipboard pipe systems for
water and wastewater. In particular, the vacuum waste systems aboard most marine
vessels  develop  an  evaporative  scale in the pipe  interiors  which  requires
cleaning  approximately once every 12-18 months. The principal  customers of the
marine division are the United States Coast Guard and the United States Navy. In
September  1997,  HERC  received a five year  contract  from the  United  States
Navy-Supervisor of Shipbuilding (SupShip) office in Portsmouth,  Virginia.  This
contract  calls  for HERC to clean  pipe  systems  on board  ships  based in the
Norfolk area. The Portsmouth contract permits HERC to charge set amounts for its
services. Other SupShip offices of the Atlantic Fleet and the maintenance office
of the United States Coast Guard also are using the Portsmouth  contract to have
vessels  cleaned.  During 1997 HERC  cleaned  piping  systems on board 23 United
States  vessels for an aggregate  revenue of $707,000.  During 1998 HERC cleaned
piping  systems on board a total of 72 United States  vessels,  for an aggregate
revenue of  $2,746,000.  The  aggregate  revenues  from the  servicing of United
States vessels  represented  50% and 87% of  consolidated  sales from continuing
operations for the fiscal years ended December 31, 1997 and 1998, respectively.

     The marine  division  also offers its services to  non-United  States owned
vessels.  HERC  intends to market its  services to merchant  marine  vessels and
private  recreational  vessels in the future. To date, the sales attributable to
this portion of the marine business have not been significant.

                                                                          Page 3
<PAGE>
     In order to meet the requirements of the Portsmouth contract, and to better
serve the East  Coast  market,  HERC based the marine  division  in  Portsmouth,
Virginia  during 1997. In 1998, HERC opened an office in San Diego to expand its
ability to offer the marine  services  to the Pacific  Fleet and Western  United
States Coast Guard.  The division  employs a sales staff  located in both of its
coastal  offices to service its existing  customers  and to generate  additional
merchant marine and private vessel sales.

FIRE PROTECTION DIVISION

     The fire  protection  division  is new for 1999 and these  activities  were
operated  under the Municipal  and  Industrial  division in 1997 and 1998.  This
division  developed  during 1997 and 1998 as a result of two contracts  with the
McCarran  International Airport in Las Vegas, Nevada. As is typical of many such
systems, the sprinkler system had become severely corroded and was not achieving
required operational levels. As a result of the cleaning done on this site, HERC
has been recognized by the American and National Fire Sprinkler  Associations as
a  rehabilitative  method for fire  protection  systems.  HERC is also  pursuing
certification by Factory Mutual and IRI-Hartford  Steam Boiler, two of the major
insurance companies of fire protection systems so that it will be able to market
more  aggressively its services to this segment of the pipe system market.  HERC
believes that these  endorsements  would be beneficial in its  marketing,  since
insurance premiums are usually a reflection of a system performance. During 1997
and 1998,  cleaning of fire  protection  systems  provided  sales of $25,000 and
$100,000, respectively.

MUNICIPAL AND INDUSTRIAL DIVISION

     Municipal  waterlines and industrial  facilities represent the other market
in which HERC may expand its existing business of pipe system cleaning.  Because
HERC's  products  used in this segment are ANSI/NSF  Standard 60 certified  HERC
believes that it has a significant  advantage in this  business.  The  standards
developed by the NSF that have been used to approve the HERC  products have been
adopted  legislatively  in 36 states and are policy in 12 others.  HERC believes
that no product  can be used in a  drinking  water  system in the United  States
without NSF certification.

     The most common problem found in municipal water lines and industrial water
treatment  lines is  tuberculation.  This is the  development  of  chemical  and
biological  corrosion inside the pipes to the point where the useful diameter of
the pipe is severely restricted.  It is not unusual to have a four-inch mainline
with only one inch of useful diameter  remaining.  Tuberculation  may also cause
colored water, bad odors,  unpleasant taste and increased chemical treatment and
pumping  costs.  In  industrial  plants,   tuberculation  greatly  reduces  heat
exchange, condensing and flow capacities.

     In addition to the cleaning done by it, HERC has  developed a  relationship
with Calgon  Corporation  to address post cleaning  corrosion  inhibition.  HERC
works with  Calgon  Corporation  to flush the system  cleaned by HERC with their
treatments  that  have the  effect of  retarding  future  corrosion  that if not
treated would cause the return of the tuberculation problems.

     In order to aid in the  development  of the  patented  process for cleaning
municipal water lines,  HERC developed a relationship with Bristol Water Company
of the United  Kingdom  during  1998.  Bristol  Water is a large  private  water
utility that is renowned for the  development  of  technologies  in  underground
water systems.  Bristol Water Holdings, PLC, the parent company of Bristol Water
also  owns  Newbore  Systems  Ltd.  which  was  formed to engage in all types of
chemical pipe cleaning in the United Kingdom. HERC expects to earn revenues from
licensing fees, royalties and chemical sales to Newbore Systems Ltd.

     Because  HERC  has  focused  its  attention  in  the  marine   segment  and
secondarily in the fire protection division where its margins are better and the
sales cycle is faster,  sales in the municipal and industrial  segment have been
minimal in 1998.  One primary  reason for this focus has been the long lead time
to  consummate  municipal  sales  contracts  and the  expense of  obtaining  and
servicing  these  contracts.  Often  payment is  dependent  on the work of other
contractors  and  municipal  approval  processes.   Although  HERC  focused  its
attention in this  segment in 1995 to early 1997,  it  currently  represents  an
insignificant  portion of its business.  HERC does not  anticipate it becoming a
significant part of its business in the near future.

                                                                          Page 4
<PAGE>
INDUSTRIAL CHEMICALS DIVISION

     The industrial  chemicals  division  manufactures  and sells products using
HERC's proprietary and patented formulas for applications in the removal of salt
and scale and in the  maintenance of water process  systems.  These products are
currently Well-Klean(R), Line Out(R) and Process Water products.

     Well-Klean is used to remove scale and corrosion in deep water wells.  Over
time the well screen that allows water to be lifted with pumps becomes  clogged.
Well-Klean sales were $108,000 in 1998 and $109,000 in 1997.

     Line Out is used in the  cleaning of drip  irrigation  systems and for salt
removal  from  soils in the root  zone of turf  grasses  on golf  courses.  Drip
systems will clog with scale over time and require regular  maintenance in order
to continue to perform.  HERC's Line Out product  provides a superior  method of
providing for cleaning while also improving water distribution. In addition, the
use of high salt  content  water by golf courses for  irrigation  has caused the
need for a product  to remove  salt from the turf root zone.  HERC  manufactures
Line Out as a private labeled product called Deliminate(R) for Eco Soil Systems,
Inc. under an exclusive agreement for golf courses in the United States.

     Chlor*Rid is a product  using  HERC's core  formula for removing  salt from
surfaces prior to the application of high performance paints or coatings. During
1998 HERC sold its half  ownership  of a patent  covering  this  application  to
Chlor*Rid   International.   Under  the  sales   agreement  HERC  will  maintain
manufacturing rights of the product or royalties on future sales for the life of
the patent which is about fourteen years.

     Process water  products are sold  primarily  under the trade names Slug(R),
Compound 360 and Compound 400. These are used in the de-scaling and  maintenance
of all types of process  water  systems.  These  include  cooling  towers,  heat
exchangers and condensers.

MARKETING AND DISTRIBUTION

     HERC  markets its products and  services  through its  marketing  and sales
staff and independent distributors and sales representatives.  In 1997 and 1998,
sales to the U.S.  Navy under the 5 year  Portsmouth  contract  were 34% and 66%
respectively of consolidated  sales from  continuing  operations.  The aggregate
revenues from the servicing of United States vessels,  which includes sales from
cleaning of vessels outside of the Portsmouth Contract,  represented 50% and 87%
of  consolidated  sales from  continuing  operations  for the fiscal years ended
December 31, 1997 and 1998, respectively.

     As discussed above,  HERC has also entered into strategic  relationships to
market its products and services to its customers.

ADVERTISING

     HERC  advertises  and  publishes  in  selected  industry  publications  and
initiates  direct mail pieces to specific  groups of potential  consumers of its
various  products.  HERC  also  uses an  "800"  number  in  connection  with its
advertising,  direct mail  programs  and order  entry.  HERC is working on a web
sight  which  will  explain  HERC's  products  and  services  and give  detailed
information about the Company. HERC expects the web sight  (www.hercprod.com) to
be on line by May 1, 1999. The primary emphasis of the advertising is to promote
awareness of HERC corporation and its various products.

COMPETITION

     Regional   contractors   normally   perform   water   well  and   waterline
revitalization  and  rehabilitation.  There are no major companies that dominate
this business. The largest company in the water well field is Layne-Christensen,
Inc.   Chemicals   used  in  cleaning   water   systems  have   generally   been
non-proprietary,  readily  available  acids  produced  by  such  major  chemical
companies as DuPont,  Dow Chemical  Company,  Hill Brothers Chemical Company and
Vista Chemical Company.  These companies are  substantially  larger and have far
more  extensive  resources  than HERC. To the extent that HERC seeks to sell its
water system pipeline rehabilitation technology directly to end users, it may be
perceived as competing with the regional contractors to which it might also seek
to market its pipe rehabilitation products and technology. While they are not as

                                                                          Page 5
<PAGE>
large as the chemical producers,  the contracting  companies are still generally
larger and more established in the industry than HERC.

     HERC  anticipates  that over time the companies with which it competes have
the resources to develop,  have developed,  are  developing,  or may develop and
market products and services  directly  competitive with those of HERC.  Current
competitors  or new market  entrants  could  produce  directly  new or  enhanced
products with features that render HERC's products  obsolete or less marketable.
HERC's competitive success will depend on its ability to promote and to adapt to
technological changes and advances in the water systems treatment industry.

     In the  opinion of HERC's  management,  HERC's  products  and  methods  are
superior to other water system treatment  chemicals and methods because they are
easier to use,  less  expensive  and are less harmful to the  environment.  HERC
competes  principally on the basis of these qualities and by securing  strategic
relationships with established companies. HERC has patent protection for certain
of its  technologies  and is seeking to expand  patent  protection by making new
applications with respect to its proprietary  products and technologies in order
to provide a diverse product base.

MANUFACTURING AND SUPPLIES

     The majority of HERC's  industrial  products are formulated and packaged at
its plant in Phoenix,  Arizona.  The balance of these products are  manufactured
and packaged for it by a third party manufacturer  located in Chandler,  Arizona
using  HERC's  formulas.  HERC  generally  does not  maintain  long-term  supply
agreements  with its suppliers and purchases raw materials  pursuant to purchase
orders or short-term contracts in the ordinary course of business. HERC believes
that the raw  materials  and other  supplies  are  available  from a variety  of
sources and that there are numerous companies available to formulate and package
its products.

PATENT AND TRADEMARK PROTECTION

     HERC has a series of United  States  patents for the use of its  Pipe-Klean
technology  in the cleaning of potable water  distribution  systems and a United
States patent on the mobile  recirculation  units  employed in the pipe cleaning
process.  HERC has also  received  a Notice  of  Allowance  for its  basic  pipe
cleaning patent for the association of European countries and can obtain patents
throughout  Europe in 1999.  Additionally,  HERC has  received  its U.S.  Patent
application  for "Pipe  Cleaning and In-Line  Treatment  of Spent Pipe  Cleaning
Solution",  an  improvement on the basic pipe cleaning  technology.  The Company
also received  Notice of Allowances  from the U.S.  Patent Office during 1998 of
applications   that  cover  (1)  the  process  of  chemically   cleaning   water
distribution  systems  including fire  protection  systems,  (2) the process for
vacuum waste pipe cleaning,  (3) a process for pipe system  cleaning and in-line
treatment of spent cleaning solution and (4) a process for controlled  carbonate
removal from water conduit systems. Other patent applications are pending.

     There can be no  assurance  that any patents  applied for will be obtained.
Moreover,  there  can  be  no  assurance  that  any  patents  will  afford  HERC
commercially  significant  protection  of its  technology or that HERC will have
adequate   resources  to  enforce  its  patents.   HERC  believes  that  it  has
independently  developed its proprietary  technologies  and they do not infringe
the  proprietary  rights of  others.  Although  HERC has  received  no claims of
infringement,  it is possible that infringement of existing or future patents or
proprietary rights may occur.

     In the event that HERC's products infringe patent or proprietary  rights of
others, HERC may be required to modify its processes or obtain a license.  There
can be no assurance  that HERC would be able to do so in a timely  manner,  upon
acceptable  terms and  conditions  or at all.  The failure to do so could have a
material  adverse  effect on HERC. In addition,  there can be no assurance  that
HERC will have the financial or other resources  necessary to defend a patent or
proprietary rights action.  Moreover, if any of HERC's products infringe patents
or proprietary rights of others,  HERC under certain  circumstances could become
liable for damages which could have a material adverse effect on HERC.

     h.e.r.c.(R),  Well-Klean(R) II Concentrate,  Pipe-Klean(R), and Line-out(R)
are registered trademarks of HERC.

                                                                          Page 6
<PAGE>
     HERC  relies on  proprietary  know-how  and  confidential  information  and
employs  various  methods  to  protect  the  processes,   concepts,   ideas  and
documentation  associated  with its  technology.  However,  such methods may not
afford complete  protection,  and there can be no assurance that others will not
independently  develop  such  processes,   concepts,  ideas  and  documentation.
Although HERC requires all of its employees to sign confidentiality  agreements,
there can be no assurance that HERC will be able to protect its trade secrets or
that other  companies  will not acquire  information  that HERC  considers to be
proprietary.  Moreover,  there can be no assurance that other companies will not
independently develop know-how comparable to or superior to that of HERC.

GOVERNMENT REGULATION

     Water  pollution is a major focus of federal,  state and local  environment
protection laws and regulations.  The discharge from water systems  treatment is
subject to these  laws and  regulation.  The water  system  treatment  chemicals
industry  and  HERC's  operations  are  subject  to  extensive  and  significant
regulation by federal,  state and local governmental  authorities.  Some of such
regulation is extensive  and may from time to time have a significant  impact on
HERC's  operations.  The NSF has indicated that Pipe-Klean and Well-Klean comply
with the  standards for chemicals  that can be used in cleaning  drinking  water
systems.  In  addition,  many of HERC's  products  are Green Cross  certified as
biodegradable. Products are biodegradable if they can be broken down into carbon
dioxide, water and minerals without harmful effects to the environment.

     Some of HERC's  products  require the use of a chemical  that is classified
under  applicable  laws as a corrosive  chemical and substance.  There can be no
assurance that HERC will not incur  environmental  liability  arising out of the
use of corrosive substances. To date, HERC does not believe that it has incurred
any such  liability.  HERC does not maintain  insurance to compensate it for any
liabilities  it  may  incur  if  it  were  to  violate   environmental  laws  or
regulations.  The use of  certain  chemicals  contained  in HERC's  products  is
subject to frequently  changing  federal,  state and local laws and  substantial
regulation  under these laws by  governmental  agencies,  including the EPA, the
Occupational Health and Safety Administration, various state agencies and county
and local authorities  acting in conjunction with federal and state authorities.
Among other matters, these regulatory bodies impose requirements to control air,
soil and water  pollution,  to protect  against  occupational  exposure  to such
chemicals, including health and safety risks, and to require notification of the
storage, use and release of certain corrosive chemicals and substances.

     HERC has obtained  certification for its Pipe-Klean,  Pipe-Klean  Preblend,
Acid Klean and  Pipe-Klean  Neutralizer  products as "pipe  cleaning aids" under
ANSI/NSF  Standard 60 from NSF for use in potable  water  distribution  systems.
Also, HERC has obtained  ANSI/NSF Standard 60 certification for their Well-Klean
II Concentrate,  Acid Klean and Well-Klean  Preblend  products as "well cleaning
aids" for potable water wells.

     HERC  believes  that it is in  substantial  compliance  with  all  material
federal,  state and local laws and regulations governing its business operations
and has obtained  all  material  licenses,  authorizations,  approvals,  orders,
certificates and permits  required for the operation of its business.  There can
be no  assurance  that HERC in the future will be able to comply with current or
future government regulations in every jurisdiction in which it will conduct its
business operations without substantial sanctions, including restrictions on its
business  operations,  monetary liability and criminal  sanctions,  any of which
could have a material adverse effect upon HERC's business.

     Advertising  relating  to HERC's  products  is subject to the review of the
Federal Trade Commission and state agencies, pursuant to their general authority
to monitor and prevent unfair or deceptive  trade  practices.  In addition,  the
Consumer Products Safety Commission regulates the labeling of HERC's products.

RESEARCH AND DEVELOPMENT

     The Company  estimates  that it spent  $7,500 on research  and  development
activities during 1998.

                                                                          Page 7
<PAGE>
DISCONTINUED OPERATIONS

     During the fourth quarter of 1997, HERC  discontinued the operations of its
wholly owned  subsidiary,  CCT  Corporation.  CCT  manufactured  and distributed
proprietary agricultural products. CCT is treated as a discontinued operation.

     On December 9, 1998, HERC sold its wholly-owned  subsidiary,  HERC Consumer
Products,  Inc. HERC Consumer  Products  marketed and sold consumer  products to
wholesale and retail customers.  HERC received an initial payment of $200,000 at
the closing and will  receive a royalty  payment of 3% of the  adjusted  revenue
above  $1,000,000  for some of the  consumer  products for three years after the
closing date. All remaining consumer product  inventories were purchased as part
of the transaction.

     The operating  results  relating to these  businesses  have been segregated
from  continuing  operations  and  reported  as a  separate  line  item  on  the
consolidated statement of operations. Certain 1997 amounts have been restated to
conform to the 1998 presentation.

EMPLOYEES

     As of March 3, 1999,  HERC had 37 employees of which 19 are full time.  Two
are officers,  twenty-five are engaged in field  operations and production,  six
are in  administration,  and four are in marketing and sales.  Some of the field
employees are part time. None of HERC's employees is represented by labor unions
or  covered  by a  collective  bargaining  agreement.  HERC  believes  that  its
relationship with its employees is satisfactory.

SEASONALITY

     Sales of Pipe-Klean and Well-Klean  products are seasonal in those parts of
the United  States in the snow belt.  Seasonal  sales can result in uneven  cash
flow for  HERC,  which  may  require  HERC to  obtain  and  maintain  short-term
financing  arrangements.  In the  event  such  financing  arrangements  are  not
available  or, once  acquired,  cease to be  available,  HERC's  operations  and
financial condition could be materially adversely affected.

ITEM 2. DESCRIPTION OF PROPERTY

     HERC  leases  15,700  square  feet of office and  warehouse  facilities  in
Phoenix,  Arizona,  5,530  square  feet of office and  warehouse  facilities  in
Portsmouth, Virginia, and 2400 square feet of office and warehouse facilities in
National City, California. The Phoenix location is under an operating lease that
expires on July 31, 2001 and  provides  for  monthly  payments  escalating  from
$8,796 to $10,053 over the term of the lease.  The Portsmouth  facility is under
an operating  lease  expiring  December  31, 1998,  with an option to extend the
lease for three (3)  additional  years to December 31, 2001.  The lease provides
for  monthly  payments  escalating  from  $2,225 to $2,640  over the term of the
lease, including the extension term. The National City location is under a month
to month operating lease with payments of $1,440 per month and requires a 30-day
written notice to cancel.

     The Company has no policy regarding investments in real estate, real estate
mortgages, or securities of persons primarily engaged in real estate activities.
However, the Company currently holds no such investments.

ITEM 3. LEGAL PROCEEDINGS

     On or about January 14, 1999 in the Supreme Court of the State of New York,
County of Suffolk,  the Suffolk County Water  Authority and R & L Well Drilling,
LLC filed a civil  claim  against  HERC as a  third-party  plaintiff  in a civil
action filed on April 8, 1998 by five  individual  residents of Ronkonkoma,  New
York,  alleging  negligence  resulting in personal  injury and seeking  monetary
damages of $11 million. HERC has substantially denied liability for the original
claim, which has been submitted to its insurance carrier under its comprehensive
general liability insurance policy.

     Although the  resolution  of this matter is not known,  management  and its
legal  counsel  believe HERC has  meritorious  defenses and believes the outcome
will have no material effect on HERC's financial position.

                                                                          Page 8
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were  submitted  to a vote of HERC's  security  holders  through
solicitation  of proxies or  otherwise  during the fourth  quarter of the fiscal
year ended December 31, 1998.

PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

TRADING MARKETS

     The  common  stock of HERC is listed on the OTC BB Market and on the Boston
Stock  Exchange  under the symbols  "HERC" and "HER",  respectively.  The OTC BB
Market is the principal market for the common stock.

     The following  table sets forth the high and low prices of the common stock
as  quoted  by  OTC  BB for  the  periods  indicated.  Such  quotations  reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily represent actual transactions.

         1998                                         High          Low
         ----                                         ----          ---
     First Quarter                                  $ 0.594       $ 0.250
     Second Quarter                                   0.438         0.250
     Third Quarter                                    0.438         0.250
     Fourth Quarter                                   0.375         0.188

         1997                                         High          Low
         ----                                         ----          ---
     First Quarter                                  $ 2.500       $ 1.250
     Second Quarter                                   1.875         1.188
     Third Quarter                                    1.719         0.969
     Fourth Quarter                                   1.156         0.250


     On March 19, 1999 the closing  price for the common  stock as quoted by OTC
BB was $0.375.

HOLDERS

     As of March 12,  1999,  there were 96 record  holders of the common  stock.
HERC believes  that as of such date there were  approximately  1,650  beneficial
holders of the common stock.

DIVIDENDS

     To date,  HERC has not paid any cash dividends on its common stock,  and it
does not  anticipate  paying  any cash  dividends.  HERC  intends  to retain all
earnings, if any, for use in its business for the foreseeable future.

                                                                          Page 9
<PAGE>
RECENT SALES OR GRANTS OF UNREGISTERED SECURITIES

The following  relates to all securities of HERC sold or granted within the last
fiscal year which were not registered under the Securities Act of 1933.
<TABLE>
<CAPTION>
                                        Consideration received
                                          and description of
                                        underwriting or other    Exemption
                                         discounts to market       from
                Title of                  price afforded to     registration    Terms of
Date of grant   security       Amount          purchasers         claimed       exercise
-------------   --------       ------   ----------------------  ------------    --------
<S>           <C>            <C>       <C>                        <C>         <C>
4/17/98-       Common Stock  3,240,000         $999,400           Section          N/A
6/5/98                                                              4(2)

4/9/98-         Incentive      218,500     Incentive stock        Section     Exercisable at
8/3/98        Stock Options               options granted to        4(2)        prices of
               to purchase                employees with no                    $0.31-$0.41
              Common Stock              consideration received               through 8/31/04

5/1/98-        Warrants to      25,000        Consulting          Section     Exercisable at
10/30/98        purchase                       services             4(2)        prices of
              Common Stock                                                     $0.22-$0.35
                                                                             through 9/10/05

10/1/98       Common Stock      21,333     Board of Director      Section         N/A
                                               Services             4(2)
</TABLE>

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

RESULTS OF OPERATIONS

GENERAL

     During the fiscal year ended  December  31,  1998,  HERC sold its  consumer
products division.  This is currently accounted for as a discontinued  operation
(See Note 2 to the consolidated financial statements).  The following discussion
does not include the results of the consumer products division or the results of
CCT that was discontinued in 1997.

1998 COMPARED WITH 1997

     Sales from  continuing  operations  for the fiscal year ended  December 31,
1998 were  $3,169,000  compared  to  $1,405,000  in 1997.  The  marine  division
accounted for $2,746,000 in 1998, of which  $2,095,000 was billed under the five
year Portsmouth contract with the United States Navy-Supervisor of Shipbuilding.
The marine division  accounted for $707,000 in 1997 of which $475,000 was billed
under the  Portsmouth  contract.  Sales from pipe  rehabilitation  services from
municipal  chemical  cleaning which includes chemical feed line, fire protection
system and other industrial work produced $173,000 in 1998 and $400,000 in 1997.
Industrial chemical sales were $250,000 in 1998 compared to $246,000 in 1997.

     The sales of HERC in 1998 have  shifted  primarily to those from the marine
division  as  compared  to  earlier  years.  The  reason  for this is that  1998
represents  a full year of  providing  services  under the  Portsmouth  contract
compared to four months in 1997 and the cleaning of seventy-two  vessels in 1998
compared to  twenty-three  vessels in 1997.  HERC has also focused its sales and
marketing  efforts in this  division  because  of the  higher  margins it yields
compared  to the  municipal  chemical  cleaning  segment  that  was its  earlier
principal  focus.  Sales in 1998  also  reflect  the  commencement  of  offering
services in the fire protection segment.  HERC plans to pursue marketing in this
segment of the pipe  cleaning  market in 1999 in a  controlled  manner.  At this
time,  HERC cannot  predict  whether it will secure many  contracts and generate
profits in this segment since it is a new segment. Sales of industrial chemicals
remained  about  the  same  from  one  year to the  next.  Sales  from  the pipe
rehabilitation  and municipal  segment  declined because of the focus of HERC on

                                                                         Page 10
<PAGE>
the marine  sales.  The shift in focus  resulted  from the fact that these sales
typically require  substantial sales efforts and costs and a long sales cycle to
secure  a  contract.  Additionally,   servicing  the  contracts  is  subject  to
dependence  on other  contractors,  seasonality  and longer  payment  cycles and
results in lower margins.

     Consolidated  gross  margins  were  58%  in  1998  and  20%  in  1997.  The
improvement  is a result of the shift in revenue from  municipal  potable  water
cleaning projects to marine pipe line chemical cleaning projects.

     Gross profit  increased  from $287,000 in 1997 to $1,841,000 in 1998 due to
the revenue shift discussed above.  Selling expenses  decreased from $422,000 in
1997 to $367,000 in 1998 while  general and  administrative  expenses  decreased
from $2,487,000 in 1997 to $1,631,000 in 1998. The decrease in selling,  general
and  administrative  expenses is attributable to management's  cost  containment
program put into effect  during the third  quarter of 1997.  Additionally,  1997
included  $276,000 to write down certain  unamortized  patent costs.  Management
plans to continue to find ways to contain,  curtail or cut overhead  expenses as
it finds opportunities to do so.

     For the year ended  December 31, 1998,  HERC's  operating loss was $157,000
compared to $2,621,000 for the same period in 1997. Additionally, net income for
1998 was $40,000  consisting of income from discontinued  operations of $571,000
offset by a loss from continuing operations of $531,000.  This compares to a net
loss for 1997 of $4,462,000  consisting of a loss from continuing  operations of
$2,634,000 and a loss from discontinued operations of $1,828,000.

     As HERC  continues  to focus on the marine  segment  and begins to sell its
services  in  other  segments  and  as it  continues  to  control  expenses,  it
anticipates  that revenues will increase in 1999 over those of 1998. This belief
is based on the results of  operations  of the fourth  quarter and the impact of
actions  taken in 1997 and 1998,  but is  subject  to change  depending  on many
factors, including continuing to provide services under the Portsmouth contract,
expanding operations to the Pacific Fleet,  securing contracts from the merchant
marine fleets and controlling costs. It also depends on many factors outside the
control of HERC, such as maintenance of its competitive  advantages  among other
things.

LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash  equivalents  were $243,000 at December 31, 1998 and $135,000
at  December  31,  1997 while  working  capital  was  $449,000  and a deficit of
$834,000 at those  respective  dates.  The increase in cash and working  capital
during 1998 is a function of the private  placement of  restricted  common stock
during the second  quarter of 1998 offset by cash used in operating  activities,
investing activities and principal payments of short and long term debt.

     As of December  31,  1998,  HERC had paid off its  $250,000  term loan from
InterEquity and had total other long-term debt of $25,000.  Additionally,  as of
December 31, 1998, HERC had no factored receivables under its factoring facility
although this credit facility is available as a source of cash if HERC needs it.
(See Note 4 to the consolidated financial statements)

     During the fourth  quarter of 1998,  HERC  concluded the sale of its wholly
owned subsidiary,  HERC Consumer Products, Inc. which marketed and sold consumer
products to wholesale and retail customers.  HERC was paid a cash  consideration
of $200,000 at the closing and will be paid a 3% royalty of the adjusted revenue
above $1 million for  certain  consumer  products  for the three years after the
closing date. All remaining  consumer  products  inventories were purchased as a
part of the transaction.

     In the second quarter of 1998,  HERC sold 3,240,000  shares of Common Stock
at $0.31 per share and received net proceeds of $999,400.

     HERC currently contracts with a few customers responsible for a majority of
HERC's  revenues,  and HERC  expects the high  concentration  levels to continue
through 1999. Thus, any material delay, cancellation or reduction of orders from
these customers could have a material adverse effect on HERC's operations.

                                                                         Page 11
<PAGE>
     Management has no plans to sell additional securities to raise cash and can
make no guarantee that it could sell additional  securities.  However,  any such
sale, if necessary,  would substantially  dilute the interest of HERC's existing
stockholders.

YEAR 2000 COMPLIANCE DISCLOSURE

     Many  existing  computer  programs  and  databases  use only two  digits to
identify  a year in the date  field  (i.e.,  99  would  represent  1999).  These
programs and  databases  were  designed and developed  without  considering  the
impact  of the  upcoming  millennium.  Consequently,  in  the  Year  2000,  date
sensitive  computer  programs  may  interpret  the date "00" as 1900 rather than
2000. If not  corrected,  many computer  systems could fail or create  erroneous
results in the Year 2000.

COMPANY'S STATE OF READINESS

     HERC is currently  assessing  all of its internal and external  systems and
processes  with respect to the Year 2000 issue.  HERC has received  notification
from its provider of financial  and  accounting  software  that such software is
structured to  accommodate  the year 2000 and beyond.  HERC plans to continue to
test all of its mission  critical  internal and external  systems and  processes
(and the associated Year 2000 "fixes") for Year 2000 compliance  during 1999. As
part of this  process,  HERC is  assessing  the  potential  impact  of Year 2000
failures  from  vendors and outside  parties  upon its business and is currently
taking steps to minimize that risk.  Based on HERC's  current state of readiness
and the steps  currently  being taken (i.e.,  installing  backup  processes  and
systems),  HERC does not believe that the Year 2000 problem will have a material
adverse effect on HERC's financial position, liquidity or operations.

COMPANY'S COSTS OF YEAR 2000 COMPLIANCE

     HERC estimates its total cost of Year 2000 compliance to be immaterial.

COMPANY'S RISKS OF YEAR 2000 ISSUES

     HERC believes that the risk of failure of its software due to the Year 2000
issue is minimal;  however, there may be latent defects of which it is not aware
that may cause disruption.  To the extent HERC's vendors, service providers, and
customers have  significant  Year 2000  failures,  HERC may be affected by their
inability to perform or from disruption in their providing services or orders.

COMPANY'S CONTINGENCY PLANS

     HERC is developing  contingency plans with respect to significant Year 2000
issues within its control. For example,  HERC is in the process of assessing and
verifying  the Year 2000  compliance of its raw material  vendors.  Verification
will be accomplished through the use of written certifications.  Any vendors not
found to be Year 2000 compliant will be replaced, if possible, with vendors that
are Year 2000 compliant.

OTHER MATTERS

     In June 1997, SFAS No. 130, "Reporting  Comprehensive Income," and SFAS No.
131, "Disclosure about Segments of an Enterprise and Related  Information," were
issued.  No.  130  specifies   presentation  of  comprehensive  income  and  its
components;  No.  131  requires  certain  additional  information  on  operating
segments,   products  and  services,   geographic  areas  and  major  customers.
Implementation  of both  statements,  which are  effective  for 1998 and  future
years, will have no material impact on HERC's financial statements.

ITEM 7. FINANCIAL STATEMENTS

     See Index to Financial Statements on page F-1 attached hereto.

                                                                         Page 12
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE

     Not Applicable

                                   PART III.

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

Name                    Age                   Position
----                    ---                   --------
S. Steven Carl          41    Chairman of the Board of Directors, Chief
                              Executive Officer and President

Michael H. Harader      31    Vice President of Finance, Chief Financial Officer

Salvatore DiMascio      59    Director

Robert M. Leopold       73    Director

Dr. Jerome H. Ludwig    65    Director

R. John Armstrong       55    Director

S. Steven Carl has been the Chief Executive Officer and a Director of HERC since
August 1995 and was  President  of HERC from August 1995 to February  28,  1996.
Effective  February 28, 1996, Mr. Carl became Chairman of the Board and resigned
as President of HERC. Mr. Carl was re-appointed  President in May 1997. From May
1992 to August 1995, Mr. Carl was the President and Chief  Executive  Officer of
CCT Corporation, a wholly owned subsidiary of HERC acquired in May 1995.

Michael H.  Harader  has been Vice  President  of Finance  since July 27,  1998.
Effective  October 27, 1998,  Mr. Harader became Chief  Financial  Officer.  Mr.
Harader  joined HERC in January 1996 and has held  positions as  Controller  and
Accounting  Manager.  From January 1992 until  February  1994,  Mr.  Harader was
Corporate Controller of 90 Clothing Company,  Inc. From April 1994 until January
1996,  Mr.  Harader was Credit  Manager of Isley's RV Service  Center,  Inc. Mr.
Harader is a Certified Public Accountant.

Salvatore  DiMascio has been a Director of HERC since  September 3, 1996.  Since
1986,  Mr.  DiMascio  has been  President  of  DiMascio  Venture  Management,  a
management  and  investment  consulting  firm.  From June 1994 to June 1997, Mr.
DiMascio was  Executive  Vice  President and Chief  Financial  Officer of Anchor
Gaming, a public company.  Among other executive level positions held during his
30-year  career,  Mr.  DiMascio was Senior Vice  President  and Chief  Financial
Officer of Conair  Corporation.  In addition,  he has  experience  in industrial
products manufacturing,  distribution and other service industries. Mr. DiMascio
is currently a Director of U.S.  Communications  Inc., Fotoball USA and Colorado
Casino Resorts,  Inc., all public companies.  Mr. DiMascio is a Certified Public
Accountant.

Robert M.  Leopold has been a Director of HERC since June 5, 1996.  Mr.  Leopold
has  been the  President  of  Huguenot  Associates,  a  financial  and  business
consulting firm since 1977, and the Chairman of the Board of International Asset
Management  Group,  Inc.  since 1983.  During 1997,  Huguenot  Associates  was a
consultant to HERC.  From June 1982 to December  1990,  Mr. Leopold held various
positions  with  Insituform  of North  America,  Inc.,  including  Vice Chairman
(1982-1986),  Chief  Executive  Officer  (1986-1989),  Chairman  (1986-1987) and
Advisor  to the  Chairman  (1989-1990).  Mr.  Leopold  was  also a  director  of
Insituform  Mid-America,  Inc.  Mr.  Leopold is a Director of Infodata  Systems,
Inc., Dental Services of America and Standard Security Life Insurance Company of
New York, a wholly owned subsidiary of Independence Holding Company.

                                                                         Page 13
<PAGE>
Dr.  Jerome  Ludwig has been a Director  of HERC since June 1993.  He retired in
September  1997 as  Executive  Vice  President  and  Secretary  of HERC to which
positions he was elected in June 1993.  Dr. Ludwig  continues as a consultant to
HERC.  For more  than  five  years  prior to 1993,  he  served  as a  scientific
consultant to HERC and also was engaged in  acquisition/divestiture  consulting.
Dr. Ludwig has spent over 40 years in marketing and product  development  in the
chemical,  plastics and  pharmaceutical  industries  and holds 25 United  States
patents.

R. John  Armstrong  has been a  Director  of HERC since  January  1,  1999.  Mr.
Armstrong  served eleven years in the U.S. Navy, with experience in ship design,
construction and maintenance,  with a four year tour at a SupShip (supervisor of
shipbuilding  office),  serving in quality  assurance,  contracts  and  planning
departments in addition to serving two years on the  engineering  faculty at the
Naval Academy.  Following his resignation from the Navy, Mr. Armstrong served as
a Project  Manager and,  ultimately,  Executive Vice President of a professional
services company in Washington DC, providing  engineering and computer  services
to a broad  spectrum  of  clients.  In 1986 he became the  President  of Seaward
Marine Services, Inc., engaged in international diving services.

BOARD OF DIRECTORS; COMMITTEES

     Directors   are  elected  to  serve  until  the  next  annual   meeting  of
stockholders  of HERC or until  their  successors  are  qualified  and  elected.
Officers  serve at the  discretion  of the  Board of  Directors  subject  to any
contracts of employment.

     Outside Directors elected at duly convened annual shareholder's meetings or
other  properly  convened Board  elections are  compensated by an annual Outside
Director's  Retainer in the amount of $15,000  per annum,  payable in (a) $1,500
paid in cash  semi-annually  on the first day of the second and fourth  quarters
following such election, (b) $1,000 paid in cash for personal attendance at duly
convened  quarterly  meetings  of the  Board,  and  (c)  the  issuance  of  HERC
restricted common stock payable quarterly on the first day of each quarter in an
amount  equivalent to $2,000 of market value measured on the close of trading of
the last trading day of the prior quarter, plus out-of-pocket expenses.

     The Board held five meetings during the year ended December 31, 1998.

     The  Board  of  Directors  has   established  an  Audit   Committee  and  a
Compensation Committee.

     The Audit Committee,  currently comprised of Messrs.  DiMascio and Leopold,
has been  formed  to:  (i)  recommend  annually  to the Board of  Directors  the
appointment  of  the  independent   auditors  of  HERC;  (ii)  review  with  the
independent auditors the scope of the annual audit and review their final report
relating thereto;  (iii) review with the independent auditors overall accounting
practices,  policies,  and  accounting and financial  controls of HERC;  (iv) be
available to the independent  auditors during the year for  consultation and (v)
review  related  party  transactions  by HERC on an  ongoing  basis  and  review
potential  conflicts  of  interest  situations  where  appropriate.   The  Audit
Committee held one meeting during the year ended December 31, 1998.

     The Compensation  Committee,  currently comprised of Messrs. Carl, DiMascio
and Leopold, has been formed to review overall executive compensation and review
HERC's  employee  benefit plans.  The  Compensation  Committee held two meetings
during the year ended December 31, 1998.

     HERC is obligated  through May 1999,  if so  requested by Whale  Securities
Co., L.P. ("Whale"), the underwriter of its initial public offering in May 1994,
to nominate and use its best efforts to elect Whale's  designee as a director of
HERC, or at Whale's option, as a non-voting  advisor to the Board. Whale has not
exercised its right to designate such a person.

     HERC is obligated  through  April 2001,  if so requested by GKN  Securities
Corporation ("GKN"), the placement agent of its April 1996 private placement, to
nominate and use its best efforts to elect GKN's  designee as a director of HERC
or, at GKN's option, as a non-voting adviser to the Board of Directors.  GKN has
not exercised its right to designate such a person.

                                                                         Page 14
<PAGE>
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

     Section 16(a) of the Securities Exchanges Act of 1934, as amended, requires
HERC's  directors  and officers and persons who  beneficially  own more than ten
percent  of  HERC's  Common  Stock to file  with  the  Securities  and  Exchange
Commission ("SEC") and the Boston Stock Exchange initial reports of ownership of
Common  Stock in HERC.  Officers,  directors  and  greater-than-ten  percent  of
shareholders  are required by SEC  regulation to furnish HERC with copies of all
Section 16(a) reports they filed. To HERC's knowledge, based solely on review of
the copies of such reports furnished to HERC and written  representation that no
other  reports were  required,  during the year ended  December  31, 1998,  such
persons complied with all Section 16(a) filing requirements,  with the exception
of Mr. John A. Gulick III, the Secretary of HERC,  who did not timely file Forms
3 and 4 during 1998 in respect of two warrants.

ITEM 10. EXECUTIVE COMPENSATION

     Set forth in the following  table is  information  about the salary paid or
accrued  to  each  officer  and  director  receiving  compensation  of at  least
$100,000, and the Chief Executive Officer,  (collectively,  the "Named Executive
Officers") for the three years ended December 31, 1998.

      Name & Principal Position                 Year        Salary
      -------------------------                 ----        ------
S. Steven Carl   Chairman of the Board,         1998       $ 82,100
                 Chief Executive Officer,       1997       $100,100
                 President and Director         1996       $115,500

     Other  than  the  cash  compensation  set  forth in the  table,  the  Named
Executive Officer did not receive non-cash benefits having a value exceeding 10%
of his cash compensation.

STOCK OPTION PLANS

     In 1993,  the Board of Directors of HERC adopted a Stock Option Plan ("1993
Plan")  pursuant  to which  350,000  shares of Common  Stock were  reserved  for
issuance to key employees,  including officers.  Key employees are persons whose
efforts,  knowledge and expertise are integral to the  operations and success of
HERC.  The  Board of  Directors  administers  the 1993  Plan,  but the  Board of
Directors  may appoint a committee  to act on its  behalf.  Such  options can be
incentive stock options ("ISOs") within the meaning of the Internal Revenue Code
of  1986,  as  amended,  or  options  not  qualifying  as  ISOs  ("Non-qualified
options").  The  exercise  price of any ISO cannot be less than 100% of the fair
market  value per share of Common  Stock on the date of grant (110% of such fair
market value if the grantee owns stock  possessing more than 10% of the combined
voting power of all classes of HERC's  stock).  No options may be granted  after
the year 2003.  As of December  31,  1998,  HERC had issued  under the 1993 Plan
250,000 options exercisable at prices ranging from $0.3125 to $2.50 per share.

     In 1996, the Board of Directors of HERC adopted the 1996 Equity Performance
Plan ("1996  Plan")  pursuant  to which  1,000,000  shares of Common  Stock were
reserved for issuance to key employees,  officers,  directors and consultants of
HERC and its  subsidiaries,  as both ISOs and  non-qualified  options  and other
equity  based  awards.  Holders  of these  awards  are  persons  whose  efforts,
knowledge and expertise are integral to the  operations and success of HERC. The
Board of Directors  administers  the 1996 Plan,  but the Board of Directors  may
appoint a committee to act on its behalf.  The exercise  price of any ISO cannot
be less than 100% of the fair market value per share of Common Stock on the last
trading  day before  the date of grant  (110% of such fair  market  value if the
grantee owns stock  possessing  more than 10% of the total combined voting power
of all classes of HERC's stock).  The exercise price of a  Non-qualified  Option
may not be less  than  100% of the fair  market  value on the last  trading  day
before the date of grant.  No options may be granted  after the year 2006. As of
December 31, 1998 HERC had issued options under the 1996 Plan to acquire 567,500
shares of Common Stock,  exercisable at prices ranging from $0.3125 to $1.75 per
share.

                                                                         Page 15
<PAGE>
OTHER OPTIONS AND WARRANTS

     In addition to the options under the 1993 Plan and the 1996 Plan,  HERC has
outstanding  the  following  options and warrants as of December  31, 1998:  (i)
warrants to purchase  85,000 shares of Common Stock at $3.00 per share issued to
Perrin,  Holden & Davenport  Capital  Corporation in connection with its private
placement in December 1996,  (ii) warrants to purchase an aggregate of 3,214,902
shares of Common  Stock at $2.00 per share issued to investors in the April 1996
private  placement,  (iii) an  option  to  purchase  171,490  units,  each  unit
consisting of one share of Common Stock and one warrant to purchase one share of
Common Stock at $2.00 per share,  issued to GKN and its  designees in connection
with the private  placement  in April  1996,  (iv)  warrants  issued to original
insiders and a consultant  to purchase an aggregate of 100,000  shares of Common
Stock at $5.00 per share,  (v)  warrants  to purchase  an  aggregate  of 130,000
shares of Common Stock at $6.50 per share issued to Whale,  the  underwriter  of
HERC's  initial  public  offering,  (vi)  warrants  issued  to  original  bridge
financing  investors and consultants to purchase  605,000 shares of Common Stock
at prices  ranging from $1.06 to $2.75 per share,  (vii) other options issued to
employees and a former  director to purchase  490,000  shares of Common Stock at
prices  ranging  from  $0.31 to $4.00 per share,  (viii)  warrants  to  purchase
300,000  shares of Common Stock at prices ranging from $1.31 to $2.00 per share,
issued to GKN and its designees in connection with the exercise of 150,000 units
in June 1997 and (ix)  warrants to purchase  125,000  shares of Common  Stock at
prices ranging from $1.18 to $1.47 issued to InterEquity in connection  with the
term loan in September  1997. All of the foregoing  securities  are  exercisable
into an aggregate of 6,210,382 shares of Common Stock.

     The following charts set forth certain  information with respect to options
granted to the Named Executive Officers:

Options Granted in Last Fiscal Year

                               % of Total Options
                   Options    Granted to Employees  Exercise   Date   Expiration
Name             Granted (1)     In Fiscal Year      Price    Vested     Date
--------------   -----------  --------------------  --------  ------     ----
S. Steven Carl     100,000             46%          $0.3125    1998      2003

Aggregate Year-End Option Values

                           Number of                         Value of
                      Unexercised Options             Unexercised in-the-money
                      At December 31, 1998          Options at December 31, 1998
                 ----------------------------       ----------------------------
Name             Exercisable    Unexercisable       Exercisable    Unexercisable
--------------   -----------    -------------       -----------    -------------
S. Steven Carl     177,500         72,500               0(2)            0(2)

(1)  During 1998, S. Steven Carl had 150,000 options repriced to $0.3125.
(2)  The market value at December 31, 1998 of the Common  Stock  underlying  the
     options  was $0.2344 per share.  The options are  exercisable  at prices of
     $0.3125 or more.

                                                                         Page 16
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The following  table sets forth as of January 31, 1999 certain  information
regarding the beneficial  ownership of shares of Common Stock by (i) each person
who is known by HERC to beneficially own 5% or more of the outstanding shares of
Common Stock;  (ii) each of HERC's directors;  and (iii) all executive  officers
and directors of HERC as a group.

                                                                 Percentage of
                                       Amount and Nature of       Outstanding
                                            Beneficial        Common Stock Owned
Name and Address of Beneficial Owner       Ownership (1)         Beneficially
------------------------------------       -------------         ------------
S. Steven Carl (2)(3)                          994,851                8.25
Jerome H. Ludwig (2)(5)                        177,225                1.52
Robert M. Leopold (2)(6)                        61,644                   *
R. John Armstrong (2)                           48,533                   *
Salvatore T. DiMascio (2)(7)                    35,644                   *
Lance Laifer and Laifer Capital
  Management, Inc. (2)                       3,410,000               29.59
Norman H. Pessin(2)                            867,500                7.53
Shelby A. Carl(2)(4)                           823,653                6.98
All executive officers and directors
  as a group (8) (six persons)                 1,340,597             10.91

* Less than 1.

(1)  A person is deemed to be the  beneficial  owner of  securities  that can be
     acquired  by such  person  within 60 days from  January  31,  1999 upon the
     exercise of options and warrants or conversion of  convertible  securities.
     Each beneficial owner's percentage ownership is determined by assuming that
     options,  warrants and convertible  securities that are held by such person
     (but not held by any other person) and that are  exercisable or convertible
     within 60 days from  January 31,  1999 have been  exercised  or  converted.
     Except as otherwise indicated, and subject to applicable community property
     and similar laws,  each of the persons named has sole voting and investment
     power with respect to the shares shown as beneficially owned.

(2)  The address for Messrs.  S. Steven Carl, Shelby A. Carl,  Leopold,  Ludwig,
     Armstrong and DiMascio is c/o H.E.R.C. Products, Incorporated, 2202 W. Lone
     Cactus Drive #15, Phoenix,  Arizona 85027. The address for Norman H. Pessin
     is c/o Neuberger & Berman,  LLC, 605 Third Avenue,  New York, NY 10158. The
     address for Lance Laifer is c/o Laifer  Capital  management,  Inc., 45 West
     43rd Street, 9th Floor, New York, NY 10036.

(3)  Includes  530,442  shares  issuable  pursuant  to  immediately  exercisable
     options and  warrants.  Excludes  72,500  shares  issuable on options  that
     become exercisable in the future.

(4)  Includes (i) 226,771 shares  issuable  pursuant to immediately  exercisable
     options and warrants,  (ii) 288,553 shares owned of record by the Shelby A.
     Carl Trust,  the trustee of which is Mr.  Shelby A. Carl for the benefit of
     his wife, Mrs.  Margaret Carl, (iii) 5,623 shares owned of record by Shelby
     A. Carl IRA for the benefit of Mr.  Shelby A. Carl and (iv)  29,412  shares
     owned of record and 29,412 shares  issuable  upon  exercise of  immediately
     exercisable  warrants  owned by  Margaret  Carl Sep IRA for the  benefit of
     Margaret  Carl,  the wife of Mr.  Shelby A. Carl.  Excludes  20,000  shares
     issuable on warrants that become exercisable in the future.

(5)  Includes  160,083  shares  issuable  pursuant  to  immediately  exercisable
     options and warrants.

(6)  Includes 45,000 shares issuable pursuant to immediately exercisable options
     and warrants.

(7)  Includes  20,000  shares  issuable  pursuant  to  immediately   exercisable
     options.

(8)  Includes  shares  referred to as being  included in notes (3), (5), (6) and
     (7),  14,700  additional  shares  and 8,000  shares  issuable  pursuant  to
     immediately  exercisable  options.  Excludes  shares  referred  to as being
     excluded  in note (3) and 42,000  shares  issuable  on options  that become
     exercisable in the future.

                                                                         Page 17
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     None

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

Exhibit No:                         Exhibit
-----------                         -------

(3)(1)   Certificate of Incorporation of HERC, filed as Exhibit 3.1 to
         HERC's Registration Statement (No. 33-75166).

(3)(2)   By-Laws of HERC, filed as Exhibit 3.2 to HERC's Registration  Statement
         (No. 33-75166).

(3)(3)   Certificate  of   Designations,   Preferences   and  Other  Rights  and
         Qualifications  of the Class A Preferred  Stock,  as amended,  filed as
         Exhibit 99.1 to Form 8-K dated December 17, 1996.

(4)(1)   Specimen of Common Stock  certificate  (reference  also made to exhibit
         3.1 and 3.2),  filed as Exhibit  4.1 to HERC's  Registration  Statement
         (No. 33-75166).

(4)(2)   Form of Underwriter's Warrant Agreement and Warrant Certificate,  filed
         as Exhibit 4.2 to HERC's Registration Statement (No. 33-75166).

(4)(3)   Form of Warrant Agreement issued to Perrin,  Holden & Davenport Capital
         Corporation  dated December 17, 1996,  filed as Exhibit 4.2 of Form 8-K
         dated December 17, 1996.

(4)(4)   Form of Agency  Agreement  between HERC and Perrin,  Holden & Davenport
         Capital Corporation dated as of November 15, 1996, as amended, filed as
         Exhibit 4.3 of Form 8-K dated December 17, 1996.

(4)(5)   Form of Warrant  Agreement  between HERC and GKN Securities Corp. dated
         November 19, 1996,  filed as Exhibit 4.5 of Registration  Statement No.
         333-19361.

(4)(6)   Form of Warrant and Registration  Rights Agreement between HERC and the
         Equity  Group,  dated  September  27,  1996,  filed as  Exhibit  4.6 of
         Registration Statement No. 333-19361.

(10)(1)  1993 Incentive Stock Option Plan, as amended,  filed as Exhibit 10.3 to
         HERC's Registration Statement No. 33-75166.

(10)(2)  Agency  Agreement  between HERC and GKN  Securities  Corporation  dated
         March 4, 1996,  filed as Exhibit 10.8 to HERC's  Annual  Report on Form
         10K-SB for the fiscal year ended December 31, 1995

(10)(3)  Form of Purchase  Option issued to GKN Securities  Corporation and its'
         designees, filed as Exhibit 10.9 to HERC's Annual Report on Form 10K-SB
         for the fiscal year ended December 31, 1995

(10)(4)  Form of Warrant  Agreement  issued to investors on April 3, 1996, filed
         as Exhibit  10.10 to HERC's Annual Report on Form 10K-SB for the fiscal
         year ended December 31, 1995

(10)(5)  Form of Subscription  Agreement  between HERC and investors dated April
         3, 1996,  filed as Exhibit 10.11 to HERC's Annual Report on Form 10K-SB
         for the fiscal year ended December 31, 1995

(10)(6)  1996  Performance  Equity  Plan,  filed  as  Annex  A to  HERC's  Proxy
         Statement dated June 11, 1996.

(10)(7)  Form of Purchase  Option issued to GKN Securities  Corporation  and its
         designees  dated June 18, 1997,  filed as Exhibit  10.15 to HERC's Form
         10-KSB for the year ended December 31, 1997.

(10)(8)  Loan Agreement by and between HERC and  InterEquity  Capital  Partners,
         LLP dated  September  15,  1997 filed as Exhibit  10.18 to HERC's  Form
         10-KSB for the year ended December 31, 1997.

(10)(9)  Account Transfer and Purchase  Agreement by and between HERC,  H.E.R.C.
         Consumer Products, Inc., and KBK Financial Incorporated dated September
         22,  1997 filed as  Exhibit  10.19 to HERC's  Form  10-KSB for the year
         ended December 31, 1997.

(10)(10) Agreement  by and between  HERC and the U.S.  Navy dated August 8, 1997
         filed as  Exhibit  10.20  to  HERC's  Form  10-KSB  for the year  ended
         December 31, 1997.

                                                                         Page 18
<PAGE>
(10)(11) Lease by and between HERC and Roger Buttrum dated May 14, 1996 filed as
         Exhibit  10.21 to HERC's  Form 10-KSB for the year ended  December  31,
         1997.

(10)(12) Form of Warrant  Agreement between HERC and Jerry Ludwig and Associates
         dated  September  3, 1997 filed as Exhibit  10.22 to HERC's Form 10-KSB
         for the year ended December 31, 1997.

(10)(13) Form of Warrant  Agreement between HERC and Shelby Carl dated September
         3, 1997 filed as Exhibit 10.23 to HERC's Form 10-KSB for the year ended
         December 31, 1997.

(10)(14) Amendment to Stock Option  Agreement by and between Gary S. Glatter and
         HERC dated March 23, 1995 filed as Exhibit  10.24 to HERC's Form 10-KSB
         for the year ended December 31, 1997.

(10)(15) Amendment  Number two to Stock Option  Agreement by and between Gary S.
         Glatter  and HERC dated  February  1, 1997  filed as  Exhibit  10.25 to
         HERC's Form 10-KSB for the year ended December 31, 1997.

                                                          Sequential Page Number
                                                          ----------------------

(21)     Subsidiaries                                               40

(22)(1)  Consent of Independent Certified Public
         Accountants (BDO Seidman, LLP)                             41

(23)(2)  Consent of Independent Public
         Accountants (Arthur Andersen LLP)                          42

(27)     Financial Data Schedule                                    43

(99)(1)   Risk Factors                                              44

(b)      Reports on Form 8-K:   None.

                                                                         Page 19
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED

                   Index to Consolidated Financial Statements

                                                                        Page No.
                                                                        --------
    Reports of Independent Public Accountants                             F-2
    Financial Statements:
         Consolidated Balance Sheet
                  December 31, 1998                                       F-4
         Consolidated Statements of Operations
                  Years Ended December 31, 1998 and 1997                  F-5
         Consolidated Statements of Stockholders' Equity
                  Years Ended December 31, 1998 and 1997                  F-6
         Consolidated Statements of Cash Flows
                  Years Ended December 31, 1998 and 1997                  F-7

         Notes to Consolidated Financial Statements                       F-8


                                                                             F-1
<PAGE>
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the Board of Directors and Stockholders of
H.E.R.C. Products Incorporated:


We have audited the accompanying consolidated balance sheet of H.E.R.C. PRODUCTS
INCORPORATED  AND  SUBSIDIARIES  as  of  December  31,  1998,  and  the  related
consolidated  statements of operations,  stockholders' equity and cash flows for
the year then ended.  These financial  statements are the  responsibility of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements based on our audit. The financial statements of the Company
as of December  31,  1997,  were  audited by other  auditors  whose report dated
January 31,  1998,  expressed an  unqualified  opinion on those  statements  and
included an explanatory  paragraph  concerning the Company's ability to continue
as a going concern.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material respects,  the financial  position of H.E.R.C.  Products
Incorporated  as of December 31, 1998,  and the results of their  operations and
their cash flows for the year then ended, in conformity with generally  accepted
accounting principles.

                                                        Arthur Andersen LLP

Phoenix, Arizona,
   February 5, 1999.

                                                                             F-2
<PAGE>



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors
H.E.R.C. Products Incorporated
Phoenix, Arizona

We  have  audited  the  accompanying   consolidated  statements  of  operations,
stockholders'  equity  and cash  flows of  H.E.R.C.  Products  Incorporated  and
subsidiaries  for the year ended December 31, 1997.  These financial  statements
are the  responsibility of the Company's  management.  Our  responsibility is to
express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit to obtain reasonable
assurance   about  whether  the  financial   statements  are  free  of  material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the results of operations and cash flows of
H.E.R.C.  Products Incorporated and subsidiaries for the year ended December 31,
1997, in conformity with generally accepted accounting principles.

The accompanying  consolidated  financial statements have been prepared assuming
that the Company will continue as a going concern.  The Company has  experienced
recurring losses from operations and had a net working capital  deficiency as of
December 31, 1997. These conditions raise  substantial doubt about the Company's
ability to continue as a going concern. The consolidated financial statements do
not  include  any  adjustments  that  might  result  from  the  outcome  of this
uncertainty.



                                                            BDO SEIDMAN, LLP

Chicago, Illinois
January 31, 1998
                                                                             F-3
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED

                           Consolidated Balance Sheet

                                December 31, 1998

ASSETS
CURRENT ASSETS
     Cash and cash equivalents                                     $    242,867
     Trade accounts receivable, net of allowance for
           doubtful accounts of $11,630                                 616,356
     Inventories                                                         19,430
     Net assets of discontinued operations (Note 2)                     114,192
     Costs in excess of billings                                         13,993
     Other receivables                                                    4,255
     Prepaid expenses                                                    62,832
                                                                   ------------
           Total Current Assets                                       1,073,925
                                                                   ------------
PROPERTY AND EQUIPMENT
     Property and equipment                                             958,736
     Less accumulated depreciation                                      322,311
                                                                   ------------
           Net Property and Equipment                                   636,425
                                                                   ------------
OTHER ASSETS
     Patents, net of accumulated amortization of $95,407
       (Note 1)                                                          64,971
     Patents pending                                                     95,182
     Refundable deposits and other assets                                76,993
                                                                   ------------
            Total Other Assets                                          237,146
                                                                   ------------
                                                                   $  1,947,496
                                                                   ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
     Accounts payable                                              $    155,650
     Accrued wages                                                       42,030
     Billings in excess of costs                                         42,447
     Current portion of notes payable (Note 4)                           66,109
     Liabilities of discontinued operation (Note 2)                     154,506
     Other accrued expenses                                             164,042
                                                                   ------------
            Total Current Liabilities                                   624,784
                                                                   ------------
LONG-TERM LIABILITIES
     Notes payable, net of current portion (Note 4)                      25,147
                                                                   ------------
            Total Liabilities                                           649,931
                                                                   ------------
COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY (NOTES 4, 5 AND 6)
     Common Stock, $0.01 par value; authorized 40,000,000
       shares; issued and outstanding 11,491,921                        114,919
     Additional paid-in capital                                      13,923,793
     Accumulated deficit                                            (12,741,147)
                                                                   ------------
            Total Stockholders' Equity                                1,297,565
                                                                   ------------
                                                                   $  1,947,496
                                                                   ============

The accompanying notes are an integral part of this consolidated balance sheet

                                                                            F-4
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED

                      Consolidated Statements of Operations

                                                       Years Ended December 31,
                                                     ---------------------------
                                                          1998          1997
                                                          ----          ----
SALES                                                $  3,168,955   $ 1,404,641
COST OF SALES                                           1,327,782     1,117,550
                                                     ------------   -----------
GROSS PROFIT                                            1,841,173       287,091
SELLING EXPENSES                                          366,946       421,567
GENERAL AND ADMINISTRATIVE EXPENSES                     1,630,966     2,486,780
                                                     ------------   -----------
OPERATING LOSS                                           (156,739)   (2,621,256)
                                                     ------------   -----------
OTHER INCOME (EXPENSE)
   Interest expense                                       (85,760)      (35,614)
   Loss on sale or disposal of equipment                 (265,222)       (5,032)
   Miscellaneous                                           18,760        27,750
   Expenses relating to settlement of lawsuits           (120,000)           --
   Gain on sale of patent                                  77,597            --
                                                     ------------   -----------
         Total Other Income (Expense)                    (374,625)      (12,896)
                                                     ------------   -----------

LOSS FROM CONTINUING OPERATIONS                          (531,364)   (2,634,152)
DISCONTINUED OPERATIONS (NOTE 2):
   Income (Loss) from Operations of
     Discontinued Segments                                256,792       (87,713)
   Income (Loss) from Disposition of
     Discontinued Segments                                315,002    (1,740,000)
                                                     ------------   -----------
         Income (Loss) from Discontinued
           Operations                                     571,794    (1,827,713)
                                                     ------------   -----------
NET INCOME (LOSS)                                          40,430    (4,461,865)
NON-CASH DIVIDEND ON PREFERRED STOCK (NOTE 5)                  --        62,842
                                                     ------------   -----------
NET INCOME (LOSS) ALLOCABLE TO COMMON
  STOCKHOLDERS                                       $     40,430   $(4,524,707)
                                                     ============   ===========

EARNINGS (LOSS) PER COMMON SHARE - BASIC
  AND DILUTED

LOSS FROM CONTINUING OPERATIONS                      $      (0.05)  $     (0.35)

INCOME (LOSS) FROM DISCONTINUED OPERATIONS                   0.05         (0.23)
                                                     ------------   -----------
NET INCOME (LOSS) PER COMMON SHARE                   $       0.00   $     (0.58)

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

BASIC                                                  10,391,936     7,773,951
                                                     ============   ===========

DILUTED                                                10,392,616     7,773,951
                                                     ============   ===========

The accompanying notes are an integral part of these consolidated statements

                                                                             F-5
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED

                 Consolidated Statement of Stockholders' Equity
<TABLE>
<CAPTION>
                                Preferred Stock           Common Stock       Additional
                              -------------------       ----------------      Paid-in     Accumulated
                              Shares       Amount       Shares    Amount      Capital       Deficit          Total
                              ------       ------       ------    ------      -------       -------          -----
<S>                           <C>       <C>            <C>        <C>       <C>            <C>            <C>
BALANCE,
DECEMBER 31, 1996             170,000   $ 1,480,000    6,356,487  $ 63,565  $11,223,593   $ (8,256,870)  $ 4,510,288

Net Loss                           --            --           --        --           --     (4,461,865)   (4,461,865)
Conversion of Preferred
Stock to Common Stock
 (Note 5)                     (170,000)   (1,480,000)   1,714,101    17,141    1,462,859             --            --
Exercise of stock options
 (Note 5)                          --            --       10,000       100       19,275             --        19,375
Exercise of warrant (Note 5)       --            --      150,000     1,500      138,750             --       140,250
Costs associated with
Preferred Stock                    --            --           --        --      (34,813)            --       (34,813)
Warrants issued to prepay
 future year's expenses
 (Note 5)                          --            --           --        --       74,900             --        74,900
Dividend on Preferred Stock
  payable in Common
Stock upon conversion
  (Notes 1 and 5)                  --            --           --        --       62,842        (62,842)           --
                             --------   -----------  -----------  --------  -----------   ------------   -----------
BALANCE,
DECEMBER 31, 1997                  --            --    8,230,588    82,306   12,947,406    (12,781,577)      248,135
                             --------   -----------  -----------  --------  -----------   ------------   -----------
Net Income                         --            --           --        --           --         40,430        40,430
Warrants issued for
 services                          --            --           --        --        3,600             --         3,600
Issuance of shares of
 Common Stock                      --            --    3,261,333    32,613      972,787             --     1,005,400
                             --------   -----------  -----------  --------  -----------   ------------   -----------
BALANCE,
DECEMBER 31, 1998                  --   $        --  $11,491,921  $114,919  $13,923,793   $(12,741,147)  $ 1,297,565
                             ========   ===========  ===========  ========  ===========   ============   ===========
</TABLE>

The accompanying notes are an integral part of this consolidated balance sheet

                                                                             F-6
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED

                      Consolidated Statements of Cash Flows

                                                       Years Ended December 31,
                                                       ------------------------
                                                          1998          1997
                                                          ----          ----
CASH FLOWS FROM OPERATING ACTIVITIES
  Net Income (Loss)                                    $  40,430    $(4,461,865)
  Adjustments to reconcile net income (loss)
    to net cash used in operating activities
     Depreciation and amortization                       311,234        524,152
     Provision for loss on discontinued operation             --      1,740,000
     Expenses paid by stockholders and Common Stock
       and warrants issued for services                    6,000         34,592
     Loss on sale or disposal of equipment               265,222          5,032
     (Increase) decrease in assets
       Trade accounts receivable                        (605,852)        59,175
       Inventories                                           946         73,194
       Costs in excess of billings                       (13,993)            --
       Other receivables                                   7,708         10,104
       Prepaid expenses                                  (16,875)        14,241
       Other assets                                      (60,578)       (44,108)
     Increase (decrease) in liabilities
       Accounts payable                                 (174,070)       305,268
       Accrued expenses                                   11,676          8,969
       Billings in excess of costs                        42,447             --
       Change in net liabilities of discontinued
         operations                                     (167,707)       404,890
                                                       ---------    -----------

         Total adjustments                              (393,842)     3,135,509
                                                       ---------    -----------
           Net cash used in operating activities        (353,412)    (1,326,356)
                                                       ---------    -----------
CASH FLOWS FROM INVESTING ACTIVITIES
  Capital expenditures                                  (232,276)      (311,645)
  Cash received from the sale of equipment                 5,974         12,969
  Expenditures related to patents and patents pending    (48,677)       (99,021)
                                                       ---------    -----------
           Net cash used in investing activities        (274,979)      (397,697)
                                                       ---------    -----------
CASH FLOWS FROM FINANCING ACTIVITIES
  Proceeds from issuance of Common Stock                 999,400             --
  Expenses from issuance of Preferred Stock                   --        (34,813)
  Proceeds from exercise of stock options                     --         19,375
  Proceeds from exercise of warrant                           --        140,250
  Proceeds from issuance of notes payable
    and long-term debt                                   137,431        393,583
  Principal payments under notes payable                (400,969)       (28,789)
                                                       ---------    -----------
          Net cash provided by financing activities      735,862        489,606
                                                       ---------    -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS     107,471     (1,234,447)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD         135,396      1,369,843
                                                       ---------    -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD             $ 242,867    $   135,396
                                                       =========    ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

Cash paid during the period for interest               $  85,760    $    35,919
Capital lease obligations incurred                     $  31,484    $   134,057

The accompanying notes are an integral part of this consolidated balance sheet

                                                                             F-7
<PAGE>
                         H.E.R.C. PRODUCTS INCORPORATED
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 1998 AND 1997


1.  NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

H.E.R.C.   Products   Incorporated  (the  "Company")   provides  water  pipeline
rehabilitation  services for marine, fire protection and municipal water systems
and manufactures and sells water treatment chemicals. The Company's wholly owned
subsidiaries,   CCT  Corporation  ("CCT")  which  manufactured  and  distributed
proprietary agricultural products and HERC Consumer Products, Inc. ("HCP") which
marketed consumer products toward wholesale and retail customers,  are accounted
for as discontinued operations (Note 2).

PRINCIPLES OF CONSOLIDATION AND PREPARATION OF FINANCIAL STATEMENTS

The accompanying  consolidated  financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant intercompany accounts
and  transactions  have  been  eliminated  in  consolidation.  CCT  and  HCP are
accounted for as  discontinued  operations  (Note 2).  Certain 1997 amounts have
been restated to conform to 1998 presentation.

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the  reported  amounts of revenues  and expenses  during the  reporting  period.
Actual results could differ from those estimates.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH AND CASH EQUIVALENTS

For purposes of the statements of cash flows,  cash equivalents  include cash on
hand,   bank  checking  and  money  market  accounts  and  other  highly  liquid
investments with original maturities of 90 days or less.

INVENTORIES

Inventories  consist  primarily of raw  materials and are stated at the lower of
cost or market (net  realizable  value).  Cost is determined by various  methods
that approximate first-in, first-out.

                                      F-8
<PAGE>
PROPERTY, EQUIPMENT AND DEPRECIATION

Property and  equipment  are stated at cost.  Depreciation  is computed over the
estimated useful lives of the assets by the  straight-line  method for financial
reporting and by accelerated methods for income taxes.

Property and equipment for continuing operations at December 31, 1998 are:

         Equipment                           $ 841,869
         Office furniture and fixtures         116,867
                                               958,736
         Less accumulated depreciation        (322,311)
                                             ---------
         Net property and equipment          $ 636,425
                                             =========

The useful lives of property and equipment for computing depreciation range from
three to ten years.

PATENTS AND PATENTS PENDING

Patents issued are stated at cost and amortized on the straight-line  basis over
10 years.  Costs for patents pending are amortized when the patents are awarded.
Unamortized costs for patents that are denied or have no continuing  application
to the Company's  ongoing product base are expensed.  Such expenses  amounted to
$4,000 and $276,000 for the years ended 1998 and 1997, respectively.

REVENUE RECOGNITION

The Company  recognizes  revenue when  products  are  shipped.  The Company also
performs pipe-cleaning services, which are recorded when the work is complete.

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

During 1997, 1,714,101 shares of Common Stock were issued upon the conversion of
170,000 shares of Preferred Stock. During 1997, certain adjustments were made to
assets and liabilities  acquired in the purchase of the 50% interest of H.E.R.C.
Consumer  Products  Company  and, as a result,  goodwill was reduced by $22,673.
During 1997, inventory with a value of $211,685 was reclassified to property and
equipment.  During 1998 and 1997,  the value  attributed  to warrants  issued to
prepay future expenses was $3,600 and $74,900, respectively.

EARNINGS (LOSS) PER SHARE

     During 1997, the Company adopted SFAS No. 128, EARNINGS PER SHARE. Pursuant
to SFAS No. 128,  basic  earnings  per common share are computed by dividing net
income  (loss)  by the  weighted  average  number  of  shares  of  common  stock
outstanding during the year. For the year ended December 31, 1997, regarding the
computation of diluted loss per common share, no outstanding options or warrants
were assumed to be exercised for purposes of calculating  diluted loss per share
as their effect was anti-dilutive.

                                      F-9
<PAGE>
The  preferred  stock  dividend in 1997 was paid in common  stock at the time of
conversion of the preferred  stock and was  determined  according to the formula
set forth in Note 5.

RECENTLY ADOPTED ACCOUNTING STANDARDS

In 1998, the Company  adopted  Statement of Financial  Accounting  Standards No.
131,  DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED  INFORMATION.  The
new rules  establish  revised  standards  for public  companies  relating to the
reporting  of  financial  and  descriptive  information  about  their  operating
segments in financial  statements.  The Company  adopted SFAS No. 131 and all of
the required disclosures (Note 7).

2.  DISCONTINUED OPERATIONS

During the fourth  quarter of 1997, the Company  discontinued  operations of its
agricultural  business,  CCT, which is accounted for as a discontinued operation
in the accompanying financial statements. During the fourth quarter of 1998, the
Company  concluded the sale of its wholly owned  subsidiary  HCP,  which is also
accounted  for  as  a  discontinued  operation  in  the  accompanying  financial
statements.   In  connection   with  this  sale,   the  Company   received  cash
consideration of $200,000,  plus a 3% royalty of future adjusted  revenues above
$1 million on certain  consumer  products  for a period of three  years from the
closing date. All remaining  consumer  products  inventories were purchased as a
part of the transaction.  Accordingly the  Consolidated  Statement of Operations
for the year ended December 31,1997 is reclassified.

CCT Operating Results were:
                                                       Years Ended December 31,
                                                      --------------------------
                                                         1998           1997
                                                         ----           ----

Sales                                                 $ 341,965      $1,662,318
Expenses                                                203,588       1,756,391
                                                      ---------      -----------
Income (loss) from discontinued operation ($0.01
 and $0.01 per Common Share respectively)             $ 138,377      $ ( 94,073)
                                                      =========      ==========

                                                                            F-10
<PAGE>
HCP Operating Results were:

                                                       Years Ended December 31,
                                                      --------------------------
                                                         1998           1997
                                                         ----           ----
Sales                                                $1,171,556       $1,758,205
Expenses                                              1,053,141        1,751,845
                                                     ----------       ----------
Income from discontinued operation ($0.01
 and $0.00 per Common Share respectively)            $  118,415       $    6,360
                                                     ==========       ==========

Liabilities  of CCT and HCP at December 31, 1998  consist of trade  payables and
miscellaneous accrued expenses.  The loss from the disposition of CCT in 1997 is
comprised of a write off of goodwill of $1,478,000  and other wind down expenses
of $262,000.

3.  INCOME TAXES

The Company has adopted  Statement of Financial  Accounting  Standards  No. 109,
ACCOUNTING  FOR  INCOME  TAXES.  SFAS No.  109  requires  the use of an asset or
liability  approach in  accounting  for income  taxes.  Deferred  tax assets and
liabilities  are  recorded  based  on  the  differences  between  the  financial
statement  and tax bases of assets and  liabilities  and the tax rates in effect
when these differences are expected to reverse.

The provision (benefit) for income taxes consists of the following:

                                                       Years Ended December 31,
                                                      --------------------------
                                                        1998           1997
                                                        ----           ----
          Current                                      $     --      $      --
          Deferred                                           --             --
                                                       --------      ---------
                                                       $     --      $      --
                                                       ========      =========

The components of deferred taxes as of December 31, 1998, are as follows:

         Current deferred tax assets:
           Accruals not currently deductible for tax                $    46,466
           Current portion of valuation allowance                       (46,466)
                                                                    -----------
                                                                    $        --
                                                                    ===========
         Noncurrent deferred tax assets:
           Book amortization in excess of tax amortization          $    35,695
           Patent reserve                                                71,220
           Net operating loss carryforwards                           4,106,157
           Book depreciation in excess of tax depreciation               43,287
           Noncurrent portion of valuation allowance                 (4,256,359)
                                                                    -----------
                                                                    $        --
                                                                    ===========

                                                                            F-11
<PAGE>
The Company was in a consolidated tax loss position for the years ended December
31, 1998 and 1997, and therefore had no federal income tax expense. Deferred tax
assets of  approximately  $4,106,000 as of December 31, 1998  ($2,600,000  as of
December 31,  1997),  from loss  carryforward  benefits  have not been  recorded
because of the uncertainty of realizing such benefits.

A reconciliation of the U.S. Federal  statutory rate to the Company's  effective
tax rate is as follows:

                                                        1998
                                                        ----
                  Statutory federal rate                 34%
                  Effect of state taxes                   6%
                                                         40%

Net operating loss carryforwards for federal tax purposes totaled  approximately
$10,265,000  at December 31, 1998.  These losses are available for  carryforward
against future years' taxable income, subject to certain limitations, and expire
in various years through 2018.

4.  LONG TERM DEBT AND OTHER FINANCING ARRANGEMENTS

Long term debt and other  financing  arrangements  consist of the  following  at
December 31, 1998:

                  Equipment financing                   $ 69,649
                  Insurance and other financing           21,607
                                                        --------
                  Total financing                         91,256
                  Less current portion                   (66,109)
                                                        --------
                  Total long term debt                  $ 25,147
                                                        ========

In  September  1997 the  Company  closed on a five-year  term loan and  borrowed
$250,000.  Interest  was  payable  monthly at an annual  rate of 14%;  principal
repayments were over 54 months and began 6 months after takedown.  In connection
with the  closing,  the  Company  issued two  warrants  to the  lender,  each to
purchase  62,500  shares of Common Stock at $1.18  (market price at closing) and
$1.475 (25%  premium over market  price at  closing),  respectively.  During the
fourth quarter of 1998, the Company paid off the term loan in full.

Equipment  financings are payable in monthly  installments  over varying periods
through  November  2001.  Interest  rates  range from 11.5% to 22.4%.  Principal
payments are $66,109 in 1999, $20,261 in 2000 and $4,886 in 2001.

                                                                            F-12
<PAGE>
In October 1997, the Company  concluded an arrangement for a factoring  facility
whereby  the factor  purchases  eligible  receivables  and  advances  80% of the
purchased amount to the Company.  Purchased  receivables may not exceed $600,000
at any one time.  The  arrangement  may be canceled by either party with 30 days
notice.  If the Company cancels,  certain penalties apply. At December 31, 1998,
there were no factored receivables.  This arrangement is accounted for as a sale
of receivables on which the factor has recourse to the 20% residual of aggregate
receivables purchased and outstanding.

5.  STOCKHOLDERS' EQUITY

CONVERTIBLE PREFERRED STOCK

In December  1996 the Company  completed  a private  equity  offering of 170,000
shares of Class A  Preferred  Stock  ("Preferred  Stock")  for $10 per share and
received net proceeds of  $1,480,000.  The Preferred  Stock had a par and stated
value of $.01 and $10, respectively.

The holders of the Preferred Stock were entitled to receive  dividends of 10% of
the stated  value per annum from the date of issuance  through  the  "Conversion
Date," as defined,  payable solely in shares of the Company's  Common Stock. The
Preferred Stock and accrued  dividends thereon through the Conversion Date, were
converted  into  1,714,101  shares of Common  Stock  during the first and second
quarters of 1997.  Such amount was  determined  by dividing the aggregate of the
stated value of the  Preferred  Stock plus accrued  dividends by 75% of the five
day average closing bid price of the shares of Common Stock immediately prior to
conversion.

COMMON STOCK

In April 1996, the Company completed the private placement of 3,214,902 units at
a price of $.85 per unit and received net proceeds of approximately  $2,277,000.
Each unit consisted of one share of Common Stock and one warrant, which entitles
the  holder to  purchase  one share of Common  Stock at a price of $2 per share,
subject to adjustment,  until April 3, 1999.  The placement  agent was granted a
warrant to acquire 321,490 units at .935 per unit which consists of one share of
Common  Stock and one warrant to acquire one share of Common  Stock at $2.00 per
share.  In May 1997,  the placement  agent  partially  exercised the warrant and
acquired 150,000 warrants. The remaining 171,490 units are currently exercisable
and expire April 3, 2001. In connection with the partial  exercise,  the Company
granted warrants for purchase of an aggregate  150,000 shares of Common Stock at
$1.3125  per  share  to  the  placement  agent.   Such  warrants  are  currently
exercisable and expire on June 18, 2002.

Included in the April 1996 private  placement  were 382,353 units to satisfy the
Company's  obligation to S. Steven Carl and his father,  the Chairman  Emeritus,
who had advanced $325,000 to the Company.

                                                                            F-13
<PAGE>
During 1997,  employee stock options were exercised to purchase 10,000 shares of
Common Stock at $1.9375 per share.

During  1998,  the Company  sold  3,240,000  shares of Common Stock at $0.31 per
share and received net proceeds of $999,400.

During 1998,  the Company  issued  21,333  shares of Common Stock to its outside
directors as a part of their annual compensation.

WARRANTS

In May and September  1993 and January  1994,  the Company  issued  warrants for
600,000 shares of Common Stock.  The warrants became  exercisable in May 1994 at
$2.50 per share and expire at various  dates  through 1999. At December 31, 1998
such warrants for 212,500 shares of Common Stock remain  outstanding  and expire
in 1999.

In  connection  with the public  offering of its Common  Stock in May 1994,  the
Company was required to reduce the existing  number of shares of its outstanding
Common Stock to no more than 950,000 shares.  As consideration for the reduction
of  shares,  the  stockholders  were  granted  warrants,   which  are  currently
exercisable  until  December 31, 1999, to acquire 50,000 shares of the Company's
Common Stock at $5.00 per share.

In 1994, the underwriter of the Company's  public offering  acquired,  for $130,
warrants for the  purchase of 130,000  shares of the Common Stock of the Company
at $6.50 per share.  The warrants are currently  exercisable  and expire May 10,
1999.

As of December 31, 1998,  outstanding warrants issued for the purchase of shares
of Common Stock to various  consultants at exercise prices ranging from $0.22 to
$5.00 per share  totaled  442,500.  Of the  warrants  outstanding,  425,000  are
currently  exercisable  within the above price range and expire at various dates
through September 2004.

In 1996, the placement  agent for the 1996 private  offering of Preferred  Stock
was  granted a warrant to  acquire  85,000  shares of Common  Stock at $3.00 per
share. The warrants are currently exercisable and expire December 2001.

Warrants for the purchase of 125,000 shares were issued to a lender in September
1997 (Note 4). Such warrants are exercisable September 1998 through August 2003.

                                                                            F-14
<PAGE>
6. STOCK BASED COMPENSATION

In October 1993, the Company  adopted an incentive stock option plan for 350,000
shares of Common Stock that may be granted to employees.  The Company adopted an
additional  plan in 1996 for  1,000,000  shares  of  Common  Stock  for grant to
employees,  officers,  directors and  consultants  of the Company and its wholly
owned  subsidiaries.  The exercise price per share may not be less than the fair
market value per share on the date the options are granted.  Generally,  options
granted  vest over a period up to five years and  expire  over  varying  periods
through 2007.

In addition to the above plans, the Company granted:

a.   an  officer/director  options to purchase 250,000 shares of Common Stock at
     an exercise price of $1.75 per share. The options are currently exercisable
     and expire not later than December 31, 2005.

b.   a former  Director  options to purchase  100,000  shares of Common Stock at
     exercise prices ranging from $2.50 to $4.00 per share. The options, granted
     in 1995, are currently exercisable and expire in December 1999.

c.   various key employees'  options to purchase  290,000 shares of Common Stock
     at exercise  prices  ranging  from $0.31 to $2.50 per share.  The  options,
     granted  through  1997,  are  exercisable  from 1997 to 2001 and  expire in
     various  years  through  2001.  At December 31, 1998,  140,000  options are
     outstanding of which 130,000 are exercisable.

                                                                            F-15
<PAGE>
Overall activity in the Company's stock options:

                                               Years Ended December 31,
                                 -----------------------------------------------
                                         1998                       1997
                                 --------------------       --------------------
                                            Weighted-                  Weighted-
                                             Average                    Average
                                             Exercise                   Exercise
                                 Shares       Price         Shares       Price
                                 ------       -----         ------       -----
Outstanding, at beginning
  of year                       1,351,400    $ 1.79        1,547,000    $ 2.54
Granted (including repriced
  options)                        763,500      0.31        1,042,500      1.34
Exercised                              --        --          (10,000)     1.94
Canceled (including options
  cancelled due to repricing)    (807,400)     0.65       (1,228,100)     2.35
                                ---------                 ----------

Outstanding at end of year      1,307,500      0.95        1,351,400      1.79
                                =========                 ==========
Exercisable at end of year      1,078,700      1.07          889,000      1.52
                                =========                 ==========

Details regarding the options outstanding at December 31, 1998:

                  Outstanding                               Exercisable
 ------------------------------------------------      ---------------------
                             Weighted    Weighted                   Weighted
    Exercise                  Average    Average                    Average
     Price                   Remaining   Exercise                   Exercise
     Range         Number      Life       Price           Number     Price
     -----         ------      ----       -----           ------     -----
 $0.31 - $0.41     755,500     4.27       $ 0.31          538,700    $ 0.31
 $0.41 - $5.00     552,000     3.15         1.82          540,000      1.82
                 ---------                              ---------
                 1,307,500                              1,078,700
                 =========                              =========
                                                 
                                                                            F-16
<PAGE>
The weighted-average grant-date fair value of stock options granted to employees
during  the  year  and the  weighted  average  significant  assumptions  used to
determine those fair values using a modified Black-Scholes option pricing model,
and the pro forma  effect on  earnings  of the fair value  accounting  for stock
options under SFAS No. 123 are:

                                                      Years Ended December 31,
                                                   -----------------------------
                                                      1998              1997
                                                      ----              ----
Grant-date fair value per options                  $    0.23        $      1.42

Significant assumptions (weighted average)
     Risk-free interest rate at grant date               5.6%              5.51%
     Expected stock price volatility                    87.8%               134%
     Expected dividend payout                             --                 --
     Expected option life                            5 years          1.2 years
Net Income (loss)
     As reported                                   $  40,430        $(4,461,865)
     Pro forma                                      (207,789)        (5,279,252)
Net loss per share of Common Stock
     As reported                                   $      --        $     (0.58)
     Pro forma                                         (0.02)             (0.69)

The expected  option life  considers  historical  option  exercise  patterns and
future changes to those exercise patterns anticipated at the date of grant.

7.  SEGMENT INFORMATION

For the year ended  December 31, 1998,  the Company's  major  business  segments
included in continuing  operations are pipeline  rehabilitation  services in the
marine and municipal markets and sales of industrial chemicals.

Segment  information  for  agricultural  products and consumer  products are not
provided since CCT and HCP are accounted for as  discontinued  operations in the
accompanying consolidated financial statements.

Information by segment for the year ended December 31, 1998:
<TABLE>
<CAPTION>
                                                                  Industrial
                                             Marine   Municipal   Chemicals    Corporate   Consolidated
                                             ------   ---------   ---------    ---------   ------------
<S>                                       <C>         <C>         <C>        <C>            <C>
Sales to unaffiliated customers           $2,746,003  $ 173,013   $249,939   $        --    $ 3,168,955
Income (loss) from continuing operations   1,063,785   (159,802)    91,325    (1,526,672)      (531,364)
Total assets                               1,055,381    287,168    100,559       504,388      1,947,496
Depreciation and amortization                 88,397     39,744         --       183,093        311,234
Capital expenditures                         127,023     81,210         --        24,043        232,276
</TABLE>

                                                                            F-17
<PAGE>
Information by segment for the year ended December 31, 1997:

                                       Industrial
                                        Products      Corporate     Consolidated
                                        --------      ---------     ------------
Sales to unaffiliated customers       $ 1,404,641             --    $ 1,404,641
Income (loss) from continuing
  operations                             (668,176)   $(1,965,976)    (2,634,152)
Total assets                              894,381        755,769      1,650,150
Depreciation and amortization             366,978        152,307        519,285
Capital expenditures                      294,600         17,045        311,645

During 1997,  the Company  monitored its pipe cleaning and  industrial  chemical
segments  in the  industrial  products  segment.  In  1998,  the  Company  split
industrial  products into three  segments  consisting  of marine,  municipal and
industrial chemicals.

The Company's  strategy  involves  concentrating  its efforts on providing water
rehabilitation  services to a diverse group of  customers.  The company has been
undertaking  substantial  efforts to diversify  its customer base and expand its
markets. In 1997 and 1998, sales to the U.S. Navy under the five year Portsmouth
contract were 34% and 66%,  respectively,  of consolidated sales from continuing
operations.  The aggregate revenues from the servicing of United States vessels,
which  includes  sales  from  cleaning  of  vessels  outside  of the  Portsmouth
Contract,  represented  50%  and  87%  of  consolidated  sales  from  continuing
operations for the fiscal years ended December 31, 1997 and 1998, respectively.

8.  COMMITMENTS AND CONTINGENCIES

LITIGATION

The Company is a defendant in various legal  actions and claims  incident to the
conduct of its  business.  Although the ultimate  resolution of these matters is
not known,  management and its legal counsel believe the Company has meritorious
defenses and the outcome will have no material effect on the Company's financial
position.

ENVIRONMENTAL MATTERS

Management  believes  the  Company  is in  compliance  with  federal  and  state
environmental regulations that pertain to the sale and use of its products.

                                                                            F-18
<PAGE>
LEASE COMMITMENTS

The  Company  has  operating  leases,  expiring  through  2001,  for  office and
warehouse  facilities  in Phoenix,  Arizona,  Portsmouth,  Virginia and National
City,  California and for office equipment.  Rental expense  associated with all
operating  leases of  continuing  operations  was  $166,995 and $167,761 for the
years ended December 31, 1998 and 1997, respectively.

Future minimum payments under operating leases as of December 31, 1998 are:

            Years Ending
            December 31,                             Amount
            ------------                             ------
            1999                                    $  153,187
            2000                                       123,837
            2001                                        75,878
            2002                                           443
                                                    ----------
                                                       353,345
                                                    ==========

                                                                            F-19
<PAGE>
                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, H.E.R.C. Products Incorporated has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.


                         H.E.R.C. PRODUCTS INCORPORATED


                                            By: /s/ S. Steven Carl
                                                -----------------------
Dated:  March 26, 1999                          S. Steven Carl, President and
                                                Chief Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
Registrant and in the capacities and on the dates indicated.

Name                                   Title                           Date
----                                   -----                           ----
/s/ S. Steven Carl              Chairman of the Board,            March 26, 1999
------------------------        Chief Executive Officer
S. Steven Carl                  and President

/s/ Jerome H. Ludwig            Director                          March 26, 1999
------------------------
Jerome H. Ludwig

/s/ Robert M. Leopold           Director                          March 26, 1999
------------------------
Robert M. Leopold

/s/ Salvatore Dimascio          Director                          March 26, 1999
------------------------
Salvatore DiMascio

/s/ R. John Armstrong           Director                          March 26, 1999
------------------------
R. John Armstrong

/s/ Michael H. Harader          Chief Financial Officer           March 26, 1999
------------------------        (Principal Financial and
Michael H. Harader              Accounting Officer)


                                                                         Page 39