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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2001,
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 0-27808
HEADWATERS INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11778 South Election Road, Suite 210
Draper, Utah 84020
(Address of principal executive offices) (Zip Code)
(801) 984-9400
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not 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-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of November 30, 2001 was $265,687,832 based upon the
closing price on the Nasdaq Stock Market(SM) reported for such date. This
calculation does not reflect a determination that persons whose shares are
excluded from the computation are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock as of
November 30, 2001 was 24,342,384.
---------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated herein by
reference: Portions of the registrant's definitive proxy statement to be issued
in connection with registrant's annual stockholders' meeting to be held in 2002.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS..........................................................3
ITEM 2. PROPERTIES........................................................9
ITEM 3. LEGAL PROCEEDINGS.................................................9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...............9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................10
ITEM 6. SELECTED FINANCIAL DATA..........................................12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................13
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......20
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................20
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..............................20
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............21
ITEM 11. EXECUTIVE COMPENSATION...........................................21
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.......................................................21
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K......................................................22
SIGNATURES....................................................................26
Forward Looking Statements
Statements in this Form 10-K, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Item 7 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
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PART I
ITEM 1. BUSINESS
The Company
Headwaters Incorporated is a world leader in developing and deploying
alternative energy and related technologies to the marketplace. Headwaters is
focused on converting fossil fuels such as gas, coal and heavy oils into
alternative energy products.
Company History. Headwaters was incorporated in Delaware in 1995 under
the name Covol Technologies, Inc. In September 2000, the Company's name was
changed to Headwaters Incorporated. Headwaters' stock trades under the Nasdaq
symbol HDWR. Except where the context requires otherwise, references to
"Headwaters" includes Headwaters' subsidiaries.
Business Strategy. The future of fossil fuels is at the molecular
level. Converting natural gas and refinery off-gas to liquid fuels, coal to gas
and clean transportation fuels, and heavy oils to light fuels are all examples
of changing the physical nature of the fossil fuel at the molecular level.
Broadly speaking, this is the technology that Headwaters has developed.
Headwaters has the ability to adjust the composition of the fossil fuel
molecules, converting the low value fossil fuel into a higher value product. The
conversion from low to high value products also allows Headwaters to extract
troublesome elements, like sulfur, nitrogen, and heavy metals, out of the fuel.
The result is a high value clean product.
Through its operating division, Covol Fuels, Headwaters has developed,
patented and commercialized an innovative chemical technology that interacts
with carbon based feedstock to produce a solid alternative fuel that is eligible
for federal tax credits. Since 1996, Headwaters has licensed this technology for
royalty payments and also sells its chemical reagent products to its licensees
and other customers. To date, this technology has provided Headwaters with most
of its revenue.
Additionally, Headwaters' subsidiary acquired in August 2001,
Hydrocarbon Technologies, Inc. ("HTI"), has developed catalyst and nano-catalyst
technologies to convert coal to liquid fuels, gas to liquid fuels, and
heavy/waste oils to clean light fuels. The development of nano-catalyst
technology by HTI places Headwaters at the forefront of applying advanced
molecular science to multiple energy and chemical processes.
Covol Fuels
Covol Fuels earns royalty fees from licensing its patented technology
to produce solid alternative fuel from coal. In addition, Covol Fuels earns
revenues from the sale of the chemical reagents used in producing the
alternative fuel. The chemical reagent reacts on the surface of the coal-based
feedstock to bind the materials together. The ultimate end-users of this
alternative fuel are electric utilities and steel companies.
Covol Fuels' proprietary, organic reagents are the most widely used
reagents for coal-based alternative fuel. They are competitively priced, safe,
odorless, and easy to handle. They improve combustion properties and do not
damage material handling, pulverizing or combustion equipment. They do not
increase HAP, VOC, SOx, or NOx emissions and they do not fall under any SARA,
CONEG or TCLP regulations.
Covol Fuels' hands-on field engineers are available to assist
customers. They have years of experience operating mixers, extruders, pellet
mills, briquetters, dryers and material handling equipment. They are experts in
applying Covol Fuels' reagents on multiple types of coal feedstocks. Covol Fuels
has been successful in operating facilities above minimum rated design capacity
while running multiple types of coal feedstocks. As an operator, Covol Fuels can
develop process improvements and demonstrate them in commercial facilities.
Covol Fuels designs and constructs reagent mixing and application systems and
can retrofit existing plants to use the Covol Fuels reagents. For new customers,
Covol Fuels has a mobile, skid-mounted, reagent delivery system to allow on-site
demonstration testing.
Covol Fuels has fully-equipped production and analytical laboratories.
The production laboratory includes bench-scale equipment for mixing, extruding,
pelletizing, briquetting and drying. The analytical laboratory has all of the
equipment necessary for testing chemical change, including Fourier transform
infrared spectroscopy (FTIR), thermogravimetric analysis (TGA) and full
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proximate analysis equipment. Covol Fuels has a staff of engineers with field
and laboratory experience available to analyze test results. Covol Fuels has an
agreement with Dow Chemical Company for technical support services. In addition,
Covol Fuels has a technical advisory board, made up of experts in the fields of
coal combustion and polymer chemistry, to assist in developing new reagent
technologies, analytical procedures, and combustion improvements for alternative
fuels.
Licensees. Covol Fuels derives most of its revenue from the owners of
alternative fuel facilities that have licensed Covol Fuels' technology and that
purchase chemical reagent from Covol Fuels. Covol Fuels has royalty agreements
with 28 out of the approximate 75 total solid alternative fuel facilities in the
industry. Licensees include large electrical utility companies, coal companies,
and financial institutions that pay Covol Fuels licensing fees for its
technology. An industry report estimates that Covol Fuels' licensee facilities
have total production capacity in excess of 23 million tons per year.
License and Chemical Supply Agreements. All entities that have
constructed or own facilities using the Covol Fuels technologies have entered
into a technology license and chemical reagent supply agreement with Covol
Fuels. Many license agreements provided for an initial license fee, payable upon
reaching project milestones. Covol Fuels has received most of the initial
license fees related to these facilities, which amounts are being amortized to
revenue by Covol Fuels over the life of the license agreements. In addition,
pursuant to many of the license agreements, the licensee pays a quarterly
royalty generally at a prescribed dollar amount per ton of alternative fuel sold
or a percentage of the tax credits earned by the licensee. In some cases, the
amount paid is subject to adjustment to the extent that licensees incur
operating losses on the production and sale of alternative fuel, exclusive of
the amount licensees pay as a license fee for the use of the technology.
However, the fees paid to Covol Fuels under license agreements are not based on
the sales price of the alternative fuel product but rather on the tax credits
earned. The license agreements generally have a term continuing through the
later of January 1, 2008, or the corresponding date after which tax credits may
not be claimed or are otherwise not available under Section 29 of the tax code.
Covol Fuels has also agreed, pursuant to chemical supply agreements, to
provide chemical reagent to licensees and other customers for the manufacture
and production of alternative fuel. The price for the chemical sold to licensees
and other customers falls into two categories: a fixed price, or an amount equal
to Covol Fuels' cost plus a prescribed mark-up.
Major Licensees. Approximately $8,509,000 of revenue in 2000 and
$16,044,000 in 2001 was from TECO Coal Corporation affiliated licensees;
$12,296,000 of revenue in 2000 and $5,111,000 in 2001 was from DTE Energy
Services, Inc. affiliated licensees; $1,032,000 of revenue in 1999, $15,511,000
in 2000 and $4,978,000 in 2001 was from licensees formerly affiliated with
PacifiCorp; $849,000 of revenue in 1999, $2,558,000 in 2000 and $4,675,000 in
2001 was from Pace Carbon Fuels, L.L.C. affiliated licensees; and $2,673,000 of
revenue in 1999 was from a licensee formerly affiliated with Flour Corporation.
No other single customer accounted for over 10% of total revenue in 1999, 2000
or 2001.
Licensees' Coal Feedstock. The alternative fuel facilities use coal and
coal fines as the primary feedstocks to produce alternative fuel. Licensees
secure their own supply of coal feedstocks. Many licensees that are also coal
producers utilize their own feedstock sources. Nonproducer licensees purchase
coal feedstocks to supply their facilities. While a supply of coal derivatives
is essential to the feasibility of an alternative fuel facility, such feedstocks
are available for purchase by licensees.
Supply of Chemicals. Covol Fuels purchases its patented and proprietary
chemical reagent from Dow Chemical Company pursuant to an agreement under which
Covol Fuels pays a prescribed price per pound of chemicals. Covol Fuels arranges
with Dow for the delivery of the chemical reagent from Dow's manufacturing
plants directly to each Covol Fuels customer. The reagents are manufactured in
six Dow plants throughout North America, assuring short lead-time deliveries.
Covol Fuels does not inventory any chemical material but instead arranges with
Dow for shipping of the chemical reagent directly to the facilities.
Construction and Sale of Facilities. Covol Fuels designed, constructed,
and commissioned six alternative fuel facilities between 1996 and 1998. In
transactions that closed between March 1997 and April 2000, Headwaters sold its
six alternative fuel facilities. There are no outstanding purchase payments for
Headwaters to receive in connection with these transactions. However, Headwaters
entered into technology license and chemical reagent supply agreements with the
buyers for ongoing royalties and chemical reagent sales.
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Alternative Fuel Tax Credits. The alternative fuel produced by Covol
Fuels' technology qualifies for tax credits under Section 29 of the Internal
Revenue Code. Section 29 was originally developed in 1979 to encourage the
creation of additional domestic production of fuels to decrease the United
States' dependency on foreign oil. The credit encourages the production of oil,
gas and synthetic fuels from non-conventional sources such as shale, tar sands
and coal. The Section 29 tax credit is scheduled to expire on December 31, 2007.
Congress has extended the tax credit three times in the past.
Covol Fuels' technology royalties and chemical reagent sales ultimately
derive from each customer's ability to manufacture and sell qualified fuels that
generate tax credits for the facility owner. Section 29 of the Internal Revenue
Code provides for a credit against regular federal income tax with respect to
sales of qualified fuel to an unrelated party. The Section 29 credit equates to
approximately $20.00-$28.00 per ton of alternative fuel, depending upon the
recoverable heat content.
In order to qualify as "solid synthetic fuels produced from coal" for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. In September 1995, Covol Fuels received a Private
Letter Ruling, or PLR, from the IRS in which the IRS, based on representations
made to it by Covol Fuels, ruled that Covol Fuels' alternative fuel technology
produces a significant chemical change compared to the parent feedstocks and
thus qualifies the end product for the Section 29 credit.
Because Covol Fuels currently does not sell fuel from an alternative
fuel facility, Covol Fuels does not itself claim Section 29 tax credits.
However, licensees of Covol Fuels' alternative fuel technology do claim Section
29 tax credits. At least 14 PLRs covering 19 alternative fuel facilities have
been obtained by third parties in connection with licenses of Covol Fuels'
alternative fuel technology. PLRs are only binding with respect to the specific
facts and circumstances addressed in the PLR and may only be relied on by the
party that obtained the PLR. Also, in its rulings to licensees the IRS notes
that no temporary or final regulations pertaining to one or more of the issues
addressed in the PLRs have been adopted and that the PLRs would be modified or
revoked by the adoption of temporary or final regulations to the extent the
regulations are inconsistent with any conclusions in the PLRs. The IRS notes,
however, that a PLR is not revoked or modified retroactively, except in rare and
unusual circumstances, provided that:
o there has been no misstatement or omission of material facts,
o the facts at the time of the transaction are not materially different
from the facts on which the PLR was based,
o there has been no change in the applicable law,
o the PLR was originally issued for a proposed transaction, and
o the taxpayer directly involved in the PLR acted in good faith in
relying on the PLR, and revoking the PLR retroactively would be to the
taxpayer's detriment.
The Section 29 credit is subject to a phaseout after unregulated oil
prices reach specified levels under an annually adjusted formula. The credit
would begin to phase out if the reference price for oil exceeds approximately
$48.00 per barrel. The credit is also subject to reduction insofar as an
otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state, or local governments, or from tax-exempt bond
financing.
Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, the credits are not subject to
subsequent recapture. By virtue of the various limitations and other factors
described above, there can be no assurances that any particular amount of
Section 29 credit will be allowable and usable. To qualify for the tax credit,
the alternative fuel facilities must have been constructed pursuant to a binding
written contract in effect as of December 31, 1996, and placed in service before
July 1, 1998. The Section 29 credit will, under present law, be available for
sales of qualified fuels completed before January 1, 2008.
Because of the significance of the Section 29 tax credit, constituents
have from time-to-time communicated with their congressional representatives
about the benefits and burdens of the credit. Congress periodically entertains
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legislation to further extend Section 29 deadlines, particularly in times of
heightened energy dependence awareness. The Department of the Treasury and the
IRS have ongoing oversight programs and review taxpayer use of the credit for
possible abuses, including whether there should be restrictions on the
availability of credits.
Covol Fuels pioneered work with the IRS in defining the criteria for
chemical change in coal-based synthetic fuel. Covol obtained one of the first
PLR's from the IRS for a coal-based synthetic fuel facility and assisted in
establishing record keeping and compliance procedures. Covol Fuels' reagents
have demonstrated significant chemical change as verified through independent
laboratories. Covol Fuels can tailor the reagents to maintain chemical change
across the full FTIR spectrum while enhancing chemical change on specific
absorption peaks on high rank coals. Covol Fuel's in-house personnel work
hand-in-hand with customers to achieve compliance with IRS guidelines.
Hydrocarbon Technologies, Inc. (HTI)
HTI Acquisition. On May 2, 2001, Headwaters entered into an Agreement
and Plan of Reorganization and a Share Exchange Agreement with HTI and its
shareholders, pursuant to which Headwaters has now acquired all of the stock of
HTI, in exchange for $1,394,920 and 592,952 shares of Headwaters common stock at
the closing, which occurred in August 2001 (with 10% of the cash and shares
being placed in escrow to protect Headwaters from any breaches or
misrepresentations in the representations, warranties, and covenants in the
agreements), plus the conversion of HTI options into options to purchase up to
144,285 shares of Headwaters stock. The HTI shareholders tendering their shares
under the Share Exchange Agreement are also eligible to obtain up to
approximately $1,395,000 of additional cash and approximately 593,000 additional
shares of Headwaters common stock, in the aggregate, if HTI achieves certain
business and financial milestones specified in the Share Exchange Agreement. HTI
will continue to conduct its business as a wholly-owned subsidiary of
Headwaters.
HTI is a company focused on developing and commercializing catalysts
and catalytic processes for producing chemicals and converting low-value fossil
fuels into high-value alternative fuels while improving energy efficiency and
reducing environmental risks. Initially formed in 1943 as Hydrocarbon Research,
Inc., the Company and its predecessor have a long history of developing and
commercializing leading edge chemical and energy technologies.
One of the core competencies developed by HTI is working at the
molecular level to control how atoms of precious metals catalysts are fixed on
substrate materials. Nanotechnology is one of the most significant advancements
in catalysis technology during the past 20 years, and HTI is currently
positioned to be a major player within this market through its research
expertise and increasing portfolio of patents.
HTI offers technology for producing ultra-clean liquid fuels directly
from coal. In this process, coal molecules are changed into diesel, gasoline and
other fuel molecules, and sulfur, nitrogen, ash and other impurities are
removed, leaving a very high grade of liquid fuel.
HTI has developed a patented technology to change complex heavy oil
molecules into lighter molecules. The HTI process is a novel hydrocracking
process using HTI's proprietary slurry catalyst and close-coupled hydrotreating
to produce ultra-clean diesel fuel, jet fuel, gasoline or fuel oil. The
technology can be applied in new or existing hydrocrackers.
Many used motor oils and bottom-of-the-barrel refinery residual oils
are difficult to process in existing refineries because they contain high
percentages of sulfur, ash, carbon residues and heavy metals. HTI holds the
patents to an innovative environmentally-clean process that upgrades these oils
using the carbon in scrap tires to remove impurities. All of the feed materials
are fully utilized and converted into value added products.
Commercialization of slurry-phase Fischer-Tropsch (F-T) technology is a
major objective of both government and industry to provide the nation with
adequate clean diesel fuels from indigenous fossil fuel resources. HTI has
developed a novel skeletal-iron F-T catalyst specifically designed for
slurry-phase reactors. It is stronger than conventional F-T catalysts and
delivers improved economics, making F-T technology more competitive in the
marketplace.
HTI maintains a staff of engineers, scientists and technicians with
expertise in the design and operation of high-pressure and temperature process
6
plants. The Company has invested $30 million in pilot plant and laboratory
facilities in Lawrenceville, New Jersey. The facilities meet all of the latest
environmental and safety standards and are used for providing outside services
for other companies and government agencies.
Proprietary Protection
Trademarks and Service Marks. Headwaters and its subsidiaries have
three registered trademarks issued between 1997 and 2000 and one pending
trademark application filed in 2000.
Patents. Headwaters and its subsidiaries have 23 U.S. patents that
expire between 2011 and 2020 and seven U.S. patent applications pending.
There can be no assurance as to the scope of protection afforded by the
patents. In addition, there are other technologies in use and others may
subsequently be developed, which do not, or will not, utilize processes covered
by the patents. There can be no assurance that Headwaters' patents will not be
infringed or challenged by other parties or that Headwaters will not infringe on
patents held by other parties. Because many of these patents represent new
technology, the importance of the patents to Headwaters' business will depend on
its ability to commercialize these technologies successfully, as well as its
ability to protect its technology from infringement or challenge by other
parties.
In addition to patent protection, Headwaters also relies on trade
secrets, know-how, and confidentiality agreements to protect the Headwaters
technologies. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to Headwaters' know-how, concepts, ideas, and documentation.
Since Headwaters' proprietary information is important to its business,
failure to protect ownership of its proprietary information would likely have a
material adverse effect on Headwaters. Headwaters' current revenues are
dependent upon license agreements by which licensees use the Headwaters
technologies to manufacture alternative fuel and then pay license fees, and
purchase chemical reagent products from Headwaters. Headwaters believes that its
patents, trade secrets, know-how, and confidential information are the basis
upon which Headwaters is able to obtain licensing agreements.
Other Strategic Acquisitions
Headwaters believes that it may have unique opportunities to pursue
additional acquisitions that are synergistic with Headwaters' financial and
operational objectives. Headwaters will evaluate possible acquisitions of
complementary businesses aligned to the chemical, mineral, or energy industries
in which Headwaters does business. If suitable candidates are not found in these
industries, Headwaters intends to pursue possible acquisition candidates in
other growing industries where promising financial returns exist.
Government Regulation
Covol Fuels and Licensees. Covol Fuels' and its licensees' alternative
fuel operations are subject to federal, state, and local environmental
regulations that impose limitations on the discharge of pollutants into the air
and water and establish standards for the treatment, storage, and disposal of
waste products. In order to establish and operate the alternative fuel plants,
Covol Fuels and its licensees have obtained various state and local permits.
Covol Fuels believes that it or its licensees have obtained all required permits
to construct and operate alternative fuel facilities, and that they are in
substantial compliance with all relevant laws and regulations governing
alternative fuel operations.
Compliance with permits, regulations, and the approved processes and
procedures help protect against pollution or contamination. Acid is the only
stored raw material used in the approved alternative fuel from coal process that
is classified as hazardous. Still, the possibility exists that regulatory
noncompliance or accidental discharges, in spite of safeguards, could create an
environmental liability. Therefore, Covol Fuels' and its licensees' alternative
fuel operations entail risk of environmental damage and Covol Fuels or its
licensees could incur liabilities in the future arising from the discharge of
pollutants into the environment or from waste disposal practices.
Failure by Covol Fuels or its licensees to maintain necessary permits
to operate alternative fuel plants and to comply with permit requirements could
have a material adverse effect on Covol Fuels or its licensees. Other
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developments, such as the enactment of more stringent environmental laws and
regulations, could require Covol Fuels or its licensees to incur significant
capital expenditures. If Covol Fuels or its licensees are unable to comply with
such laws and regulations, or if compliance substantially increases production
costs, such developments could also have a material adverse effect on Covol
Fuels.
HTI. HTI's operations are also subject to federal, state, and local
environmental regulation. HTI believes that it has obtained all required permits
pertaining to its business and operations, and that it is in substantial
compliance with all applicable laws.
HTI's ordinary course of business involves using its facilities to
perform R&D activities, process and recycle oil and to research and develop
technologies involving waste coal, oil chemicals, and energy technologies,
including liquefaction of coal. As a result, petroleum and other hazardous
materials have been and are present on its property. HTI hires independent
contractors to transport and dispose of any hazardous materials generated and
sends any hazardous wastes only to federally approved, large scale, and
reputable off-site waste facilities. HTI's wholly owned subsidiary Chemsampco's
ordinary course of business involves distillation to purify products, analysis,
packaging of chemicals, and the selling, warehousing, and manufacturing of
organic chemicals in small research volumes (generally from 1 gram to 1
kilogram). As a result, hazardous materials have been and are present on
Chemsampco's leased property. HTI believes that appropriate handling and
training procedures are in effect for HTI's and Chemsampco's properties and
operations. However, the possibility still exists that regulatory noncompliance
or accidental discharges, in spite of safeguards, could create an environmental
liability. Therefore, HTI's and Chemsampco's operations entail risk of
environmental damage and HTI could incur liabilities in the future arising from
the discharge of pollutants into the environment or from waste disposal
practices.
Safety. Covol Fuels, its licensees, and HTI are also subject to federal
and state safety and health standards. Covol Fuels is committed to providing
effective management of worker safety and health protection. In addition, Covol
Fuels has developed a safety policy designed to raise and maintain safety
awareness by both management and employees. Covol Fuels has a positive,
well-established, working relationship with MSHA and has coordinated and hosted
meetings between MSHA and synthetic fuel industry participants. Failure by Covol
Fuels or its licensees to comply with safety and health standards could have a
material adverse affect on Covol Fuels. For example, a regulatory inspector
could close an alternative fuel facility until the licensee meets the required
standards.
Competition
Alternative fuels made using the Headwaters technologies compete with
other alternative fuel products as well as traditional fuels. Competitive
factors include price, quality, delivery cost, and handling costs. Headwaters
may experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce
coal-based solid alternative fuels. Competition may come in the form of the
licensing of the competing technologies to process coal derivatives, the
marketing of competitive chemical reagents, the marketing of end products
qualifying as synthetic fuel, and the development of alternative fuel projects.
Competition includes, for example, Nalco Chemical Company in the chemical
reagent sales business. Headwaters also experiences competition from traditional
coal and fuel suppliers and natural resource producers, in addition to those
companies that specialize in the recycling and upgrading of industrial waste
products. Many of these companies have greater financial, management, and other
resources than Headwaters. Headwaters believes that it will be able to compete
effectively, but there can be no assurance that it will be able to do so
successfully.
Employees
Headwaters and its subsidiaries currently employ approximately 110
persons full-time. Of these employees, approximately 50 are in alternative fuel
operations and technical support services, 14 are in corporate administration,
miscellaneous operations and project development, and 45 are employed by HTI.
None of these employees are covered by a collective bargaining agreement.
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ITEM 2. PROPERTIES
In October 2000, Headwaters leased for a five year term approximately
7,000 square-feet of office space in Draper, Utah, which houses Headwaters'
executive offices. The lease provides for a monthly rent of approximately
$8,000, with certain adjustments for inflation plus expenses.
In 1995, HTI purchased approximately six acres in Lawrenceville, New
Jersey, where its headquarters and research facilities are now located. HTI's
subsidiary Chemsampco leases real property located in Lawrence Township, New
Jersey, for $3,800 per month. The lease was entered into on July 28, 1998 and
expires on August 31, 2002.
None of Headwaters' other subsidiaries have significant interests in
real property.
ITEM 3. LEGAL PROCEEDINGS
Headwaters has ongoing litigation that it has incurred in the normal
course of business, including the items discussed herein. Headwaters intends to
vigorously defend and/or pursue its rights in these actions. Headwaters does not
currently believe that the outcome of these actions will have a material adverse
effect on the Company's financial position.
Adtech. In October 1998, Headwaters entered into a technology purchase
agreement with James G. Davidson and Adtech, Inc. The transaction transferred
certain patent and royalty rights to Headwaters related to an alternative fuel
technology invented by Davidson. (This technology is distinct from the
technology developed by Headwaters.) In September 2000, Headwaters received a
summons and complaint from the United States District Court for the Western
District of Tennessee filed by Adtech, Inc. against Davidson and Headwaters. In
the action, certain purported officers and directors of Adtech alleged that the
technology purchase transaction was an unauthorized corporate action and that
Davidson and Headwaters conspired together to effect the transfer. The complaint
asserted related causes of action and sought unspecified money damages and other
relief. In August 2001, the trial court granted Headwaters' motion to dismiss
the complaint. It is not known whether the plaintiffs will appeal. Because
resolution of the litigation is uncertain, legal counsel cannot express an
opinion as to the ultimate amount, if any, of Headwaters' liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical sale agreement with AJG Financial Services, Inc. The
agreement called for AJG to pay royalties and to purchase proprietary chemical
material from Headwaters. In October 2000, Headwaters filed a complaint in the
Fourth District Court for the State of Utah against AJG alleging that it had
failed to make payments and to perform other obligations under the agreement.
Headwaters asserts claims including breach of contract, declaratory judgment,
unjust enrichment, and accounting and seeks money damages in the amount of
$750,000 plus other damages to be proven at trial, as well as other relief.
AJG's answer to the complaint denied Headwaters' claims and asserted
counter-claims based upon allegations of misrepresentation and breach of
contract. AJG seeks unspecified compensatory damages as well as punitive
damages. Headwaters has denied the allegations of AJG's counter-claims. Because
the litigation is at an early stage and resolution is uncertain, legal counsel
cannot express an opinion as to the ultimate amount of recovery or liability.
Nalco. In October 2000, Headwaters filed a complaint in the United
States District Court for the District of Utah against Nalco Chemical Company
("Nalco"). Headwaters alleges that Nalco, by its sale and marketing of materials
for use in creating alternative fuel, breached a non-disclosure agreement,
misappropriated trade secrets, and violated patent rights of Headwaters.
Headwaters seeks by its complaint injunctive relief and damages to be proven at
trial. Because the litigation is at an early stage and resolution is uncertain,
legal counsel cannot express an opinion as to the ultimate amount, if any, that
might be recovered.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
9
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of Headwaters' common stock trade on the Nasdaq Stock
Market(SM) under the symbol "HDWR." Options on Headwaters' common stock are
traded on the Chicago Board Options Exchange under the symbol "HQK." The
following table sets forth, for the periods presented, the high and low trading
prices of Headwaters' common stock as reported by Nasdaq. The following prices
may not be considered valid indications of market value due to the limited and
sporadic trading in the shares of common stock during certain periods.
Fiscal 2000 Low High
----------- --- ----
Quarter ended December 31, 1999 $0.50 $3.25
Quarter ended March 31, 2000 0.78 2.31
Quarter ended June 30, 2000 1.25 2.13
Quarter ended September 30, 2000 2.06 4.75
Fiscal 2001
-----------
Quarter ended December 31, 2000 $2.13 $ 3.25
Quarter ended March 31, 2001 2.25 6.53
Quarter ended June 30, 2001 6.44 16.00
Quarter ended September 30, 2001 7.11 14.19
As of November 30, 2001, there were approximately 453 stockholders of
record of Headwaters' common stock. Headwaters has not paid dividends on its
common stock to date and does not intend to pay dividends on its common stock in
the foreseeable future. Headwaters intends to retain earnings to finance the
development and expansion of its business. Payment of common stock dividends in
the future will depend, among other things, upon Headwaters' ability to generate
earnings, its need for capital, investment opportunities and its overall
financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Headwaters within the
past three years without registration under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances nor were any
commissions paid in connection therewith. However, Headwaters did pay finders
fees in the form of cash, stock or warrants in connection with various
securities issuances.
Headwaters believes that the following issuances of shares of common
stock, notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Headwaters that it was accredited
as that term is defined in Regulation D and that the security was acquired for
investment purposes. However, Headwaters has effective five registration
statements filed on Form S-3. These registration statements have registered many
of the securities described in this section.
In 1996, Headwaters formed two limited partnerships, Alabama Synfuel #1
Ltd. and Utah Synfuel #1 Ltd., to assist with the financing of construction at
two alternative fuel facilities. These two facilities have been sold. On
September 9, 1998, Headwaters offered the limited partners in Utah Synfuel #1
and Alabama Synfuel #1 an exchange of Headwaters' common stock for their limited
partnership interests. The exchange ratio was based in part on an independent
valuation of the limited partnerships' assets and other factors including but
not limited to current and future expected cash flow of the partnerships and
current market values of Headwaters' common stock as quoted by Nasdaq. The
exchange ratio for Utah Synfuel #1 was 112.828 shares of common stock for each
limited partnership unit and for Alabama Synfuel #1 was 125.97 shares for each
limited partnership unit. The limited partnerships' units originally sold for
$1,000 per unit.
10
As of November 10, 1999, all of the limited partners in Utah Synfuel #1
and all of the limited partners in Alabama Synfuel #1 had agreed to exchange
their limited partnership interests for shares of Headwaters' common stock, and
accordingly Utah Synfuel #1 and Alabama Synfuel #1 became wholly-owned
subsidiaries of Headwaters.
During November 1998, Headwaters completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt, which had a twelve-month term, has been repaid. The
equity transaction consisted of the sale of a unit at a price of $5.00. A unit
consisted of one share of restricted common stock of Headwaters plus a warrant
to purchase one additional share of restricted common stock at an exercise price
of $7.50. The warrants expired on June 30, 2000 if not exercised. However,
during 2000 the exercise period for the purchase of approximately 183,000 of
these warrant shares was extended for approximately seven months. The stock and
shares issuable pursuant to the related warrants bear "piggyback" registration
rights.
During January 1999, Headwaters completed a financing transaction with
a major shareholder and lender to Headwaters, that consisted of the sale of
1,000 shares of a new series of non-voting, 7% dividend, convertible preferred
stock, designated as Series C 7% Convertible Preferred Stock. Headwaters
received approximately $900,000 in net proceeds from the issuance of this
preferred stock.
Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants were exercisable through
July 2001 at an exercise price of $6.88 per share. The exercise deadline for
certain other warrants with an exercise price of $7.00 per share held by the
shareholder were extended to June 2000 and certain additional warrants with an
exercise price of $30.00 per share were relinquished and canceled. Headwaters
granted registration rights for the restricted common shares issuable upon
conversion of the preferred stock or upon exercise of the common stock warrants.
During January 2000, all of the remaining shares of Series C preferred
stock were converted. Approximately 237,000 shares of common stock were issued
on conversion of the preferred stock and related accrued but unpaid dividends.
There are no outstanding shares of Series C preferred stock.
On March 17, 1999, Headwaters completed a financing transaction with a
large investment fund. The financing consisted of the issuance of $20,000,000
face value of convertible secured debt, issued at a 50% discount, and the
issuance of 60,000 shares of cumulative convertible preferred stock (Series D)
for $6,000,000, for total gross proceeds of $16,000,000. Warrants for the
purchase of common stock were also issued as part of the financing and were
valued at approximately $3,000,000. Net cash proceeds were used to retire
maturing short-term debt and related accrued interest, for working capital and
other general corporate purposes. This transaction is described in detail in the
Form 8-K filed March 24, 1999 and in the Form 10-Q/A for the quarterly period
ended March 31, 1999. Beginning in November 1999 and through March 2000,
Headwaters issued approximately 2,632,000 shares of common stock on conversion
of 24,369 shares of Series D preferred stock. The preferred stock was
convertible at $5.00 or 90% of market, whichever was less. By May 2000,
Headwaters had redeemed all of the investment fund's $20,000,000 face value
convertible debt and incurred early prepayment costs of approximately
$6,037,000. By March 2000, Headwaters had redeemed the investment fund's
35,631remaining Series D preferred shares for $4,454,000 including a redemption
premium of approximately $1,882,000. There are no outstanding shares of Series D
preferred stock.
In September 1999, Headwaters entered into a transaction with an
affiliate of a major shareholder and lender to Headwaters, to provide financing
of up to $4,000,000 in the form of convertible secured debt. Headwaters received
$850,000 at the time of closing, less a placement fee of 10%, and subsequent to
September 30, 1999 received a total of $1,650,000, less a placement fee of 10%.
The debt was convertible at $3.00 per share, or market, whichever is less, and
was convertible at the rate of 25% every 30 days beginning 30 days from the date
of closing, subject to certain restrictions. Headwaters could redeem all
outstanding debt at a rate of 125% of face value by providing 30 days notice.
Borrowings were due in March 2001, if not converted earlier, and interest
payments were due quarterly beginning December 1999. Headwaters assigned the
royalties to be received from a licensed alternative fuel facility as collateral
for the financing. In November and December 1999, approximately 2,532,000 shares
of common stock were issued on conversion of $1,280,000 of the convertible debt.
In January 2000, Headwaters redeemed all of the remaining convertible debt for
redemption consideration of approximately $1,300,000 plus 8,565 shares of common
stock. The agreement required the issuance of warrants to purchase Headwaters
shares equal to 40% of the shares issuable under any borrowings under this
financing arrangement. The warrants have a three-year exercise period and an
exercise price of $3.60 per share. Warrants for the purchase of a total of
approximately 350,000 shares of common stock were issued.
11
In December 1999, Headwaters placed $1,500,000 of financing less a 10%
placement fee with an investor rather than drawing the entire $4,000,000 of
funding as provided under the September financing arrangement. The terms and
conditions of this financing were similar to the September financing. The debt
was convertible at $0.73 per share, the market price at closing, or market price
on the conversion date, whichever was less. In January 2000, Headwaters redeemed
all of this convertible debt for redemption consideration of approximately
1,900,000 plus 205,435 shares of common stock. The agreement required the
issuance of warrants to purchase Headwaters shares equal to 40% of the shares
issuable under the debt agreement. Warrants for the purchase of approximately
923,000 shares were issued. The warrants have a three-year exercise period and
an exercise price of $0.88 per share.
In March 2000, Headwaters completed a private placement financing
transaction by selling to 49 investors approximately 3,629,000 shares of
restricted Headwaters common stock, $0.001 par value, at a price of $1.36 per
share, yielding to Headwaters $4,666,000, net of $270,000 in placement costs.
The investors received registration rights for the stock purchased.
In April 2000, Headwaters completed a private placement financing
transaction by selling to one of its directors and three officers a total of
approximately 379,000 shares of restricted Headwaters common stock, $0.001 par
value, at a price of $1.56 per share and warrants for the purchase of
approximately 133,000 shares of common stock, for net cash proceeds to
Headwaters of approximately $588,000. The warrants are exercisable through March
2005 at a price of $1.56 per share. The investors received registration rights
for the stock purchased and the warrant shares.
In April 2000, an investor acquired from a third party a Headwaters'
14% note due in April 2000 with an approximate $3,000,000 balance and at the
same time also acquired from the third party warrants to purchase 100,000 shares
of Headwaters' common stock. Headwaters and the investor agreed to extend for
one year the repayment date for $1,000,000 of the principal amount of the note.
Headwaters and the investor further agreed to the satisfaction of $2,000,000 of
the note in exchange for 1,185,818 shares of Headwaters restricted common stock,
$0.001 par value, and warrants to purchase 296,000 shares of Headwaters' common
stock. The warrants are exercisable through April 2005 at a price of $2.10 per
share. In July 2000, Headwaters repaid the $1,000,000 note balance which was
accruing interest at 14%. A former director of Headwaters was also a manager and
2.5% owner of the investor. The director disclaims any beneficial interest in
the investor's securities in Headwaters.
In August 2001, Headwaters completed a 100% acquisition of HTI for
total costs at closing of approximately $11,774,000, including the issuance of
approximately 593,000 shares of Headwaters restricted common stock. Former HTI
shareholders are also eligible to receive up to 593,000 additional shares of
Headwaters restricted common stock in future periods if HTI achieves certain
operating targets and other milestones. Headwaters is obligated to file a
registration statement on Form S-3 to register the restricted stock issued and
issuable to the former HTI shareholders.
During the fiscal year ended September 30, 2001, options for the
exercise of approximately 116,000 shares of Headwaters common stock were
exercised, resulting in the issuance of restricted shares of common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of Headwaters. This information should be read in
conjunction with the consolidated financial statements, related notes and other
financial information included herein. As more fully described in Notes 14 and
15 to the consolidated financial statements, in 1999 and 2000 Headwaters
recorded approximately $0 and $17,949,000, respectively, of gains on sale of
facilities and other transactions, and approximately $9,234,000 and $17,758,000,
respectively, of losses on sale of facilities, asset write-offs and other
charges. Headwaters believes these items are not directly related to its core
business and does not expect similar items in the future. As more fully
described in Note 15 to the consolidated financial statements, in 2000
Headwaters recorded an extraordinary loss on early extinguishment of debt of
$7,860,000. Additionally, as more fully described in Note 11 to the consolidated
financial statements, in 2000 and 2001, Headwaters recorded approximately
$3,000,000 and $7,470,000, respectively, of income tax benefit from the
reduction of its deferred tax asset valuation allowance. Also, as more fully
described in Notes 2 and 3 to the consolidated financial statements, in August
2001, Headwaters acquired HTI, the financial statements of which are
consolidated with Headwaters' financial statements using a one-month lag.
Accordingly, HTI's August 2001 acquisition date balance sheet has been
12
consolidated with Headwaters' September 30, 2001 balance sheet but no results of
operations of HTI have been included in Headwaters' consolidated results for any
period.
The selected financial data as of and for the years ended September 30,
1997 and 1998 and as of September 30, 1999 are derived from audited financial
statements not included herein. The selected financial data for the year ended
September 30, 1999 were derived from the financial statements of Headwaters
which have been audited by PricewaterhouseCoopers LLP included elsewhere herein.
The selected financial data as of and for the years ended September 30, 2000 and
2001 were derived from the financial statements of Headwaters which have been
audited by Arthur Andersen LLP included elsewhere herein.
Year Ended September 30,
-----------------------------------------------------------------
(thousands of dollars, except per-share data) 1997 1998 1999 2000 2001
- ------------------------------------------------- ------------ ------------ ------------ ------------ -------------
OPERATING DATA:
Total revenue $ 147 $ 2,186 $ 6,719 $45,835 $45,464
Net income (loss) (10,498) (11,308) (28,393) 3,682 21,517
Diluted net income (loss) per
common share (1.32) (1.17) (2.39) 0.15 0.87
As of September 30,
-----------------------------------------------------------------
(thousands of dollars) 1997 1998 1999 2000 2001
- ------------------------------------------------- ------------ ------------ ------------ ------------ -------------
BALANCE SHEET DATA:
Working capital (deficit) $(3,471) $ 7,497 $(1,799) $11,225 $ 9,725
Net property, plant and equipment 13,619 15,809 14,182 552 2,680
Total assets 26,590 68,061 58,095 33,441 55,375
Long-term obligations:
Long-term liabilities 3,817 14,879 18,422 5,235 3,055
Deferred revenue 1,545 8,377 7,501 10,513 6,911
Redeemable convertible preferred
stock -- -- 4,332 -- --
Total long-term obligations 5,362 23,256 30,255 15,748 9,966
Total stockholders' equity (deficit) 6,426 14,746 (1,028) 10,747 31,086
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the consolidated financial statements and notes thereto
included elsewhere herein. Headwaters' fiscal year ends on September 30 and
unless otherwise noted, all future references to years shall mean Headwaters'
fiscal year rather than a calendar year.
Year Ended September 30, 2001 Compared to Year Ended September 30, 2000
The information set forth below compares Headwaters' operating results
for 2001 with its operating results for 2000.
Revenue. There was $17,949,000 of gains on sale of facilities and other
transactions in 2000. There was no such revenue recorded in 2001 and as a
result, total revenue for 2001 decreased by $371,000 to $45,464,000 as compared
to $45,835,000 for 2000. The major components of revenue are discussed in the
sections below.
License Fees. During 2001, Headwaters recognized license fee revenue
totaling $20,765,000, an increase of $3,450,000 over $17,315,000 of license fee
revenue recognized during 2000. License fees in 2001 consisted of recurring
license fees or royalty payments of $18,750,000 and deferred revenue
amortization of $2,015,000. License fees in 2000 consisted of recurring license
fees of $16,513,000 and deferred revenue amortization of $802,000.
13
Recurring license fees in 2000 included $11,680,000 related to a single
licensee that owned four facilities. This licensee did not report and pay
certain prior period royalty obligations to Headwaters timely, resulting in some
"catch-up" revenue recognition in 2000 for royalties related to periods other
than the year ended September 30, 2000. Moreover, this licensee significantly
reduced its production and sale of alternative fuel in early 2001 and did not
operate the four facilities for most of 2001. These two factors combined
resulted in a decline in recurring license fees from the licensee of
approximately $7,982,000 in 2001 as compared to 2000. This licensee sold the
facilities in October 2001 and Headwaters expects to receive license fees from
the new owner in 2002. Due to increased alternative fuel sales, there was an
increase of approximately $10,219,000 in recurring license fees from all other
licensees in 2001 over 2000. In 2001, the largest single licensee accounted for
$6,228,000 of earned license fees.
Chemical Sales. Chemical sales during 2001 were $22,407,000 with a
corresponding direct cost of $14,524,000. Chemical sales during 2000 were
$9,757,000 with a corresponding direct cost of $6,617,000. The increase in
chemical sales in 2001 over 2000 was due to increased alternative fuel
production by Headwaters' licensees, as well as sales of chemicals to new
customers. There were no similar sales of chemicals to new customers in 2000.
Currently, Headwaters expects its future chemical sales revenue from all
licensees and other customers to be higher than the amounts reported for 2001
due to anticipated increases in alternative fuel production by licensees and
increased sales of chemicals to new customers. Headwaters currently expects
future gross profit margins to be somewhat less than the record margin
percentage for 2001 due to differing chemical formula requirements of certain
licensees and new customers.
Gains on Sale of Facilities and Other Transactions. In 1999, Headwaters
sold a facility located in Pennsylvania on which a loss of approximately
$1,839,000 was recognized. Headwaters also entered into an agreement under which
it operates this facility on behalf of the owner. In 2000, upon achieving
specified operating performance milestones, Headwaters received additional cash
payments related to the sale of this facility. These payments, net of
obligations to third parties, approximated $7,377,000. Of the net amount
received, Headwaters recognized $4,400,000 as revenue in 2000 because there were
no ongoing obligations associated with those payments. Headwaters deferred the
recognition of $2,977,000, which amount was characterized in the sales agreement
as prepaid royalties. This amount is being recognized as revenue on a
straight-line basis through December 2007.
In 2000, Headwaters sold the three remaining alternative fuel
facilities it owned plus an option to acquire a licensee facility. One of these
sold facilities was located in Utah, two of these facilities were located in
West Virginia, and the facility under option was located in Nevada. Headwaters
reported net gains on these transactions totaling approximately $12,470,000.
Headwaters also entered into its standard supply agreements with the new owners
of the facilities to sell proprietary chemical material used at the facilities
and receives ongoing royalties based upon the sale of alternative fuel from the
facilities. In 2000, Headwaters also recorded gains of approximately $1,079,000
related to the satisfaction of a $755,000 contingent contract liability and a
$324,000 gain recognized on a note receivable transaction. There were no
facility sales or gains recorded in 2001.
Cost of Operations. These costs decreased by $1,284,000 to $3,071,000
in 2001 from $4,355,000 in 2000. The decrease was primarily attributable to
elimination of operating costs associated with the three facilities owned by
Headwaters which were sold in December 1999 through April 2000. In 2000, cost of
operations included labor and other operating expenses at the owned alternative
fuel facilities and the wash plant located in Utah. There were no such costs in
2001.
Selling, General and Administrative Expenses. These expenses increased
$1,011,000 to $5,838,000 during 2001 from $4,827,000 for 2000. The increase in
2001 was due primarily to an increase in professional services expenses of
approximately $1,273,000 and an increase in compensation-related costs of
approximately $257,000. These increases were partially offset by the resolution
of certain liabilities for $175,000 less than previously recorded and a net
decrease in other cost categories of approximately $344,000. The increase in
professional services expenses was due primarily to legal costs associated with
the current legal actions Headwaters is pursuing. The increase in
compensation-related costs related primarily to an increase in marketing
department headcount.
Asset Write-offs and Other Charges. In 2000, Headwaters recorded an
impairment charge of approximately $14,804,000 related to assets located in Utah
and Alabama. This impairment charge consisted of an approximate $12,615,000
write-down to net realizable value of certain ancillary equipment which remained
on the sites when the facilities were sold and was idled, plus an approximate
$2,189,000 write-off of an intangible asset which was no longer considered
recoverable due to the relocation of a licensee facility. Headwaters also
14
recorded employee severance and other non-cash charges from incremental
amortization of deferred compensation from stock options (resulting from the
termination of employees whose stock options became fully vested upon
termination) totaling approximately $1,443,000. Other settlement charges
($979,000) and asset write-downs ($532,000) were recorded in 2000. All of these
asset write-offs and other charges totaled approximately $17,758,000. There were
no similar charges recorded in 2001.
Acquired In-process Research and Development. Approximately $2,400,000
of the HTI purchase price was allocated to purchased in-process research and
development, all of which was expensed in 2001(see "Acquisition of HTI," below).
Other Income and Expense. During 2001, Headwaters reported net other
expenses of $5,163,000 compared to net other expenses of $3,636,000 during 2000.
The increase of $1,527,000 in net other expense is primarily attributable to a
decrease in interest and investment income of approximately $1,049,000 and an
increase in equity and debt investment-related losses of approximately
$5,519,000, partially offset by a decrease of approximately $4,590,000 in
interest expense and an increase in the mark-to-market adjustment of the
carrying value of a related party note receivable of approximately $475,000.
The decrease in interest income from 2000 to 2001 primarily related to
a decrease in interest from the related party note receivable discussed below
from $515,000 in 2000 to $0 in 2001 and a decrease in the interest rate on a
$6,500,000 note receivable from a licensee. During 2000, Headwaters made several
equity investments in and loans to unrelated high-risk entities and in 2000,
Headwaters recognized approximately $746,000 of losses related to its equity
investments. During 2001, Headwaters recorded additional losses totaling
approximately $6,265,000 related to write-offs of notes receivable and losses on
equity investments, for an increase of $5,519,000 in the 2001 losses compared to
2000.
Interest expense decreased in 2001 primarily due to the significantly
lower average levels of outstanding borrowings that existed in 2001 as compared
to 2000. During 1996, Headwaters sold certain construction companies and
received as consideration a $5,000,000 note receivable. The note was "marked to
market" each period based upon the market value of Headwaters' common stock held
as collateral and was reflected in the consolidated balance sheet at the
underlying value of this collateral, $466,000 at September 30, 2000. In 2001,
Headwaters accepted as full satisfaction of the note receivable the shares of
Headwaters' stock collateralizing the note and a new note receivable which was
fully reserved. This resulted in recognition of a gain in 2001 of approximately
$541,000, representing the increase in value of the collateral from September
30, 2000 to the date the collateral was surrendered in payment of the note. The
corresponding adjustment in 2000 resulted in a write-up of $66,000 for a net
increase in the adjustment of $475,000 in 2001 compared to 2000.
Income Taxes. In 2000, Headwaters reported a net income tax benefit of
$2,900,000, consisting of the recognition of $3,000,000 of its deferred tax
asset, reduced by $100,000 of federal alternative minimum tax. In 2001,
Headwaters reported a net income tax benefit of $7,049,000, consisting of the
recognition of $7,470,000 of its deferred tax asset, reduced by $100,000 of
federal alternative minimum tax and $321,000 of current state income tax
expense.
Headwaters' valuation allowance decreased by $14,200,000 during 2001. A
valuation allowance is provided if it is more likely than not that some portion
or all of a deferred tax asset will not be realized. Based primarily on results
of operations in 2001 and expected future results of operations, Headwaters
determined that as of September 30, 2001, it is more likely than not that its
deferred tax assets will be realized and the valuation allowance was reduced. In
order to realize the entire amount of its deferred tax asset, Headwaters may
need to report in excess of $25,000,000 of pretax earnings.
Extraordinary Item. In 2000, Headwaters redeemed all of its remaining
convertible debt. The redemption consideration and early prepayment costs
included approximately $7,037,000 in cash plus the issuance of approximately
214,000 shares of common stock. The loss recognized as a result of the total
redemption consideration paid plus the acceleration of amortization of the
unamortized debt discount and debt issuance costs in excess of the debt carrying
value totaled approximately $7,860,000.
Year Ended September 30, 2000 Compared to Year Ended September 30, 1999
The information set forth below compares Headwaters' operating results
for 2000 with its operating results for 1999.
15
Revenue. Total revenue for 2000 increased by $39,116,000 to $45,835,000
as compared to $6,719,000 for 1999. The major components of this revenue are
discussed in the sections below.
License Fees. During 2000, Headwaters recognized license fees totaling
$17,315,000 while $3,526,000 of license fees were recognized during 1999. The
license fees in 2000 consisted of the straight-line amortization of one-time
non-refundable initial and prepaid license fees of $1,003,000, reduced by a
one-time adjustment of $201,000, and recurring license fees or royalty payments
of $16,513,000. License fees in 1999 consisted of the straight-line amortization
of one-time non-refundable initial license fees of $875,000 and recurring
license fees or royalty payments of $2,651,000. The increase in 2000 recurring
license fees was due primarily to a significant increase from a licensee that
owns and operates four alternative fuel facilities in addition to less
significant increases from other licensees.
Chemical Sales. Chemical sales during 2000 were $9,757,000 with a
corresponding direct cost of $6,617,000. Chemical sales during 1999 were
$2,140,000 with a corresponding direct cost of $1,695,000. The increase in
chemical sales in 2000 over 1999 was due to increased alternative fuel
production by Headwaters' licensees.
Gains on Sale of Facilities and Other Transactions. In 2000, Headwaters
recognized gains on the sale of its owned alternative fuel facilities totaling
approximately $16,870,000. Headwaters also recorded gains of approximately
$1,079,000 related to the satisfaction of a $755,000 contingent contract
liability and a $324,000 gain recognized on a note receivable transaction. There
were no facility sales or gains recorded in 1999.
Cost of Operations. These costs decreased by $8,967,000 to $4,355,000
during 2000 from $13,322,000 during 1999. During 2000, Headwaters incurred
significantly lower operating expenses in connection with the continued
refinement and implementation of the briquetting process associated with the 24
facilities placed in service during 1998, and in particular the operating costs
associated with the four facilities owned by Headwaters which were sold. In
1999, cost of operations consisted primarily of labor and operating expenses at
the owned alternative fuel facilities and the wash plant located in Utah, losses
related to the write-down of inventory purchased from Coaltech, and costs
incurred in providing assistance to Headwaters' licensees in resolving ramp-up
issues at their alternative fuel facilities.
Until October 1999, Headwaters operated an alternative fuel facility
for Coaltech, a partnership for which Headwaters was the general partner. Under
the operating agreement, Headwaters was contractually obligated to purchase all
of the alternative fuel produced at cost plus $1 per ton. Production of
alternative fuel from this facility during 1999 was not significant and
accordingly, the cost per ton was significantly in excess of the current market
value. These costs and the corresponding write-down of this inventory to its
market value are included in cost of operations. The 1999 write-down was
approximately $1,815,000. Headwaters operated the Coaltech Utah facility at a
loss because of the need to gain operating experience (it was the first
alternative fuel facility Headwaters built and operated), test alternative
production methods, maintain operational status for Section 29 qualification,
maintain the relationship with AJ Gallagher, an owner of the facility and a
major licensee and partner of Headwaters, and other related business reasons.
Selling, General and Administrative Expenses. These expenses decreased
$54,000, or 1%, to $4,827,000 during 2000 from $4,881,000 for 1999.
Asset Write-offs and Other Charges. In 2000, Headwaters recorded
impairment charges of approximately $14,804,000 related to assets located in
Utah and Alabama. Headwaters also recorded employee severance and other non-cash
charges from incremental amortization of deferred compensation from stock
options totaling approximately $1,443,000. Other settlement charges ($979,000)
and asset write-downs ($532,000) were recorded in 2000. All of these asset
write-offs and other charges totaled approximately $17,758,000.
In 1999, Headwaters sold a facility located in Pennsylvania on which a
loss of approximately $1,839,000 was recognized. Also in 1999, certain assets,
primarily consisting of leasehold improvements on the property where a small
alternative fuel facility was located, were abandoned. The carrying value of
these assets, totaling approximately $556,000, was written off during 1999.
Based on the uncertainty of recovering certain advances on coal fine inventories
paid from 1997 through May 1999, Headwaters wrote off $3,677,000 of advances on
inventories in 1999. In addition, Headwaters wrote off a $660,000 note
receivable and recorded a liability for approximately $469,000 related to a
settlement agreement with a company that had provided Headwaters with advice
with respect to the use of certain alternative fuel technology, certain
financing obtained and the sale of certain alternative facilities. Finally,
16
Headwaters recorded approximately $2,033,000 of non-cash, incremental
amortization of deferred compensation from stock options, resulting from the
termination of employees whose stock options became fully vested upon
termination. All of these 1999 losses, write-offs and provisions totaled
approximately $9,234,000, which amount is recorded as asset write-offs and other
charges in the consolidated statement of operations.
Other Income and Expense. During 2000, Headwaters reported net other
expenses of $3,636,000 compared to $5,980,000 for 1999. This decrease in net
other expense of $2,344,000 relates primarily to a decrease of $1,439,000 in
interest expense and a positive variance of $1,275,000 in the mark-to-market
adjustment of the carrying value of a related party note receivable
collateralized by Headwaters common stock, offset by $746,000 of losses recorded
in 2000 in the carrying value of equity investments.
Interest expense decreased in 2000 primarily due to the lower average
levels of outstanding borrowings which existed in 2000 as compared to 1999, most
notably as a result of the debt repayments during 2000. The adjustment to the
carrying amount of the related party note receivable (which was "marked to
market" each period based upon the market value of Headwaters' common stock held
as collateral) resulted in a write-up of $66,000 during 2000, compared to a
write-down of $1,209,000 during 1999 for a net change of $1,275,000. During
2000, Headwaters made investments in several less than 50%-owned affiliates.
During 2000, the provision for allowances totaled approximately $646,000. In
addition, Headwaters recognized approximately $100,000 of losses related to its
equity in investments accounted for using the equity method.
Income Taxes. In 2000, Headwaters reported a net income tax benefit of
$2,900,000, consisting of the recognition of $3,000,000 of its deferred tax
asset, reduced by $100,000 of federal alternative minimum tax. Headwaters had no
income tax provision or benefit in 1999 because of its net operating loss
position.
Liquidity and Capital Resources
Net cash provided by operating activities during 2001 was $18,884,000
compared to $6,608,000 during 2000. Most of the cash flow from operating
activities in 2001was attributable to net income of $21,517,000. During 2001,
investing activities consisted primarily of investments in and loans to
non-affiliated companies of approximately $4,636,000 and the acquisition of HTI
for cash of approximately $4,845,000 and the issuance of stock and stock options
valued at approximately $6,810,000. Financing activities in 2001 consisted
primarily of proceeds from borrowings of approximately $8,991,000, repayments of
borrowings of approximately $9,941,000, the purchase of treasury stock, net of
transfers to Headwaters' Employee Stock Purchase Plan, for approximately
$10,409,000, and proceeds from the exercise of stock options and warrants of
approximately $1,926,000.
In 2001, Headwaters' primary investing activity consisted of
investments in and loans to unrelated high-risk companies. During 2001,
Headwaters collected, wrote off, or sold all of the loans to such entities and
wrote off or sold all of the equity investments. Total losses recorded in 2001
were approximately $6,265,000. In September 2001, Headwaters sold all of its
remaining high-risk investments in exchange for a $4,000,000 collateral-based
note receivable from a limited liability corporation. This note is due no later
than September 2004, is collateralized by the bridge loans and equity
investments sold and is being accounted for on the cost recovery method.
Headwaters also has certain contract rights in excess of the $4,000,000 note
amount in certain situations relating to the collection of cash by the limited
liability company. Headwaters does not currently intend to make any significant
additional equity investments in or loans to any new unrelated entities, but
could incur additional losses if the $4,000,000 loan is not repaid. In addition
to the $4,000,000 note receivable, at September 30, 2001 Headwaters had
outstanding one other note receivable in the amount of $6,500,000. This note and
the related accrued interest was collected in October 2001. Headwaters has no
current plans to construct any additional alternative fuel facilities, but is
interested in possible strategic acquisitions of entities that operate in
adjacent industries and that would be synergistic with Headwaters' current
operations. Any future acquisitions could be funded using Headwaters' common
stock, available cash, debt, or some combination thereof.
As described in Note 6 to the consolidated financial statements,
Headwaters acquired shares of its common stock during 2001 in connection with
its stock repurchase program. The program authorizes Headwaters to purchase
stock in the open market or through negotiated block transactions. Purchases
under the plan are at the discretion of Headwaters' management. During 2001,
Headwaters purchased approximately 1,648,000 shares for approximately
$10,510,000. Headwaters continually evaluates financial alternatives to the
17
stock repurchase program and future purchases are subject to market conditions
and available cash. Headwaters currently expects repurchases during 2002 to be
below 2001 levels.
Headwaters' working capital decreased from approximately $11,225,000 at
September 30, 2000, to approximately $9,725,000 at September 30, 2001. The
primary reasons for the decline in working capital were repayment of long-term
debt, investments in and loans to non-affiliated companies, the acquisition of
HTI, and purchases of treasury stock. Cash from operations funded these working
capital requirements. Headwaters expects its operations to produce positive cash
flows in future periods. In addition to cash provided by operating activities,
Headwaters has an arrangement with an investment company under which Headwaters
can borrow up to 90% of the value of the portfolio of Headwaters' short-term
investments with the investment company. These investments consist primarily of
government-backed securities and collateralize any outstanding borrowings.
Maximum borrowings under this arrangement during 2001 were approximately
$4,095,000, which amount was outstanding at September 30, 2001. Borrowings under
this arrangement were used for short-term working capital needs, primarily for
stock repurchases, rather than liquidating the securities held as collateral.
Maximum borrowing capacity under this arrangement at November 30, 2001
approximated $8,600,000.
Headwaters also has borrowing capability under an unsecured revolving
line of credit with a bank which currently has an expiration date in October
2002. Borrowings under the line of credit are limited to a maximum amount of
$10,000,000 and bear interest at prime plus .75% (6.75% at September 30, 2001).
Maximum borrowings under the line of credit during 2001 were approximately
$4,896,000, but there were no borrowings outstanding under the line at September
30, 2001. Headwaters believes it will have sufficient cash reserves to meet its
obligations during 2002, and also believes it has the ability to raise
additional debt and equity capital from other sources if necessary.
Income Taxes. As of September 30, 2001, Headwaters had net operating
loss carryforwards of approximately $24,000,000 which can be used to offset
future taxable income. The net operating loss carryforwards expire from 2017 to
2021. Headwaters also has approximately $220,000 in research and development tax
credit carryforwards which can be used to offset future tax liabilities. The tax
credit carryforwards expire from 2007 to 2016. The utilization of HTI's
acquisition date operating loss carryforwards (totaling approximately
$2,800,000) against future taxable income is subject to an annual limitation of
approximately $800,000 due to the change in ownership of HTI. Headwaters'
valuation allowance decreased by $14,200,000 during 2001. A valuation allowance
is provided if it is more likely than not that some portion or all of a deferred
tax asset will not be realized. Based primarily on results of operations in 2001
and expected future results of operations, Headwaters determined that as of
September 30, 2001 it is more likely than not that its deferred tax assets will
be realized and the valuation allowance was reduced.
During 2002, Headwaters expects to pay some alternative minimum taxes
and some state income taxes in certain states where net operating loss
carryforwards aren't available. However, because of existing net operating loss
carryforwards for regular federal tax purposes and in many states where
Headwaters does business, and due to anticipated tax benefits from exercise of
stock options, Headwaters does not currently expect to pay significant amounts
of regular income taxes until late 2002 or early 2003.
Acquisition of HTI
In August 2001, Headwaters completed a 100% acquisition of HTI, a New
Jersey-based company that has significant intellectual property including
technologies to transform coal and heavy oil into ultra-clean diesel fuel and to
recycle waste oil into higher value carbon products, and nano-catalyst
technology. Total consideration paid at closing, including the direct costs
incurred by Headwaters to consummate the acquisition, was approximately
$11,774,000. Additional contingent consideration can be earned by the former HTI
stockholders in future periods based on operating targets and other milestones.
As required by generally accepted accounting principles, a contingent liability
of $2,714,000 was recorded, representing the contingent incremental
consideration for identified purchased assets in excess of the consideration
paid at closing. A contingent liability was not recognized for the contingent
incremental consideration that, if paid in the future, would be recorded as
goodwill. This amount will be adjusted in the future when the actual contingent
consideration is paid. If some or all of the recorded contingent consideration
is not paid in the future, some of the recorded asset values will be adjusted
accordingly.
If all operating targets and other milestones are achieved, the total
additional consideration that could be issued to the former HTI stockholders
would consist of approximately $1,395,000 in cash and approximately 593,000
shares of Headwaters common stock. The value of the common shares issued, if
any, will be determined at the time the shares are issued, based on the fair
value of the shares at that time.
18
Assets acquired and liabilities assumed were recorded at their
estimated fair values as of the acquisition date. Approximately $9,700,000 of
the purchase price was allocated to identifiable intangible assets consisting of
existing patented technology with an estimated useful life of 15 years.
Management currently plans to commercialize HTI's existing technology
domestically and in certain other countries and is currently planning to
emphasize catalytic processes and technologies to change coal and heavy oils
into other high-grade fuels.
Approximately $2,400,000 of HTI's purchase price was allocated to
purchased in-process research and development, consisting primarily of efforts
focused on developing catalysts and catalytic processes to lower the cost of
producing alternative fuels and chemicals while improving energy efficiency and
reducing environmental risks. This amount represents the estimated purchased
in-process technology for projects that have not yet reached technological
feasibility and currently have no alternative use. The valuation of the
in-process research and development included, but was not limited to, an
analysis of the market for the acquired products and technologies, the
completion costs for the projects, the expected cash flows attributed to the
projects and the risks associated with achieving such cash flows. The estimated
value of these projects was determined by estimating the costs to develop the
purchased in-process technology into commercially viable products, estimating
the resulting net cash flows from the sale of those products, and discounting
the net cash flows back to their present value. As required by generally
accepted accounting principles, Headwaters recorded a charge for this purchased
in-process research and development as of the date of acquisition, which is
included in operating costs and expenses in the consolidated statement of
operations.
Due to the time required to obtain accurate financial information
related to HTI's significant foreign operations, for financial reporting
purposes HTI's financial statements are consolidated with Headwaters' financial
statements using a one-month lag. Accordingly, HTI's August 2001 acquisition
date balance sheet has been consolidated with Headwaters' September 30, 2001
balance sheet, but no results of operations of HTI have been included in
Headwaters' consolidated statements of operations for any period. HTI's November
30, 2001 balance sheet will be consolidated with Headwaters' December 31, 2001
balance sheet and HTI's results of operations for the period from date of
acquisition to November 30, 2001 will be consolidated with Headwaters' results
for the quarter ending December 31, 2001. As of September 30, 2001, Headwaters
had loaned HTI approximately $1,060,000, of which $259,000 was not eliminated in
consolidation.
Impact of Inflation
During 2001, Headwaters' operations were not materially impacted by
inflation.
Other Items
Headwaters has reviewed all recently issued, but not yet adopted,
accounting standards in order to determine their potential effects, if any, on
the future results of operations or financial position of Headwaters. Based on
that review, Headwaters believes that full implementation of SFAS No. 142,
"Accounting for Goodwill and Intangible Assets," which pursuant to its
provisions can not be early implemented, will require certain additional
disclosures; however, Headwaters believes that neither SFAS No. 142 nor any of
the other pronouncements reviewed will have any significant effects on its
current or future financial position or results of operations.
Forward Looking Statements
Statements in this Annual Report on Form 10-K regarding Headwaters'
expectations as to the operation of facilities utilizing Headwaters' alternative
fuel technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of new technologies and other strategic business opportunities and
acquisitions and other information about Headwaters that is not purely
historical by nature, including those statements regarding Headwaters' future
business plans, the operation of facilities, the availability of tax credits,
the availability of feedstocks, the marketability of the alternative fuel, and
the financial viability of the facilities, constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Although Headwaters believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. In addition to matters affecting the alternative fuel industry
or the economy generally, factors which could cause actual results to differ
from expectations stated in these forward looking statements include, among
others, the following:
19
(1) Operating issues for licensed facilities including feedstock availability,
moisture content, Btu content, correct application of chemical reagent,
achieving significant chemical change, operability of equipment, production
capacity, product durability, resistance to water absorption, overall costs
of operations and other commercial factors surrounding the use of
Headwaters' technologies.
(2) Marketing issues relating to market acceptance and regulatory permitting of
products manufactured using Headwaters' technologies.
(3) Securing of suitable facility sites, including permits and raw materials,
for relocation and operation of facilities and product sales.
(4) The market acceptance of products manufactured with Headwaters'
technologies in the face of competition from traditional products.
(5) Dependence on licensees to successfully implement Headwaters' chemical
technologies and to make license and other payments to Headwaters.
(6) Maintenance of placed-in-service and other requirements under Section 29 of
the tax code by alternative fuel manufacturing facilities.
(7) Changes in governmental regulations or failure to comply with existing
regulations that could result in reduction or shutdown of operations of
licensee facilities.
(8) The continued availability of tax credits to licensees under the tax code
and each licensee's ability to use tax credits.
(9) The commercial feasibility of Headwaters' alternative fuel technologies
upon the expiration of tax credits.
(10) Ability to meet financial commitments under existing contractual
arrangements.
(11) Ability to meet non-financial commitments under existing contractual
arrangements.
(12) Ability to commercialize new technologies which have only been tested in
the laboratory and not in full-scale operations.
(13) Ability to commercialize the technology of HTI and to implement new
business plans which are at an early stage of investigation and investment
and which will require significant time, management, and capital
investment.
(14) Success in the face of competition by others producing alternative chemical
reagent products and other competing alternative fuel.
(15) Sufficiency of intellectual property protections.
(16) Satisfactory resolution of disputes in litigation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data required by
this Item 8 are set forth in Item 14 of this Form 10-K. All information that has
been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 19, 2000, Headwaters dismissed PricewaterhouseCoopers LLP as
its independent accountants. The Registrant's audit committee participated in
and approved the decision to change independent accountants.
The reports of PricewaterhouseCoopers LLP on the financial statements
for the two fiscal years ended September 30, 1998 and 1999 contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principle.
In connection with its audits for the two fiscal years ended September
30, 1998 and 1999 and through July 19, 2000, there were no disagreements with
PricewaterhouseCoopers LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP
would have caused them to make reference thereto in their reports on the
financial statements for such years.
20
During the two fiscal years ended September 30, 1998 and 1999 and
through July 19, 2000, there were no reportable events (as defined in Regulation
S-K Item 304(a)(1)(v)).
The Registrant requested that PricewaterhouseCoopers LLP furnish it
with a letter addressed to the Securities and Exchange Commission stating
whether or not it agrees with the above statements. A copy of such letter is
filed as Exhibit 16 to this Form 10-K.
On July 19, 2000, the audit committee appointed Arthur Andersen LLP as
Headwaters' auditors. Headwaters did not consult with Arthur Andersen LLP on any
application of accounting principles or any other matter during the two fiscal
years ended September 30, 1999 or subsequent thereto through July 19, 2000.
The appointment of Arthur Andersen LLP as independent auditors of
Headwaters for the fiscal year ended September 30, 2000 was ratified by the
stockholders at a special meeting held on September 6, 2000.
There have been no disagreements with accountants on accounting or
financial statement disclosure subsequent to the appointment of Arthur Andersen
LLP on July 19, 2000.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information to be set forth under the captions "Executive Officers"
and "Proposal No. 1: Election of Directors" in Headwaters' Proxy Statement to be
filed in January 2002 for the Annual Meeting of Stockholders to be held in 2002
(the "Proxy Statement"), is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information to be set forth under the caption "Executive
Compensation and Related Information" in the Proxy Statement is incorporated
herein by reference; provided, however, that Headwaters specifically excludes
from such incorporation by reference any information set forth under the
captions "Compensation Committee Report on Executive Compensation" and
"Stockholder Return Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security ownership of certain beneficial owners and management to be
set forth under the caption "Security Ownership of Directors, Nominees and
Principal Stockholders" in the Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information to be set forth under the caption "Transactions with
Related Parties" in the Proxy Statement is incorporated herein by reference.
21
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Consolidated Financial Statements of Headwaters Incorporated Page
Reports of Independent Public Accountants F-1
Consolidated Balance Sheets as of September 30, 2000 and 2001 F-2
Consolidated Statements of Operations
for the years ended September 30, 1999, 2000 and 2001 F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended September 30, 1999, 2000 and 2001 F-5
Consolidated Statements of Cash Flows
for the years ended September 30, 1999, 2000 and 2001 F-8
Notes to Consolidated Financial Statements F-10
2. Financial Statement Schedules
All financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.
3. Listing of Exhibits
Certain other instruments which would otherwise be required to be
listed below have not been so listed because such instruments do not authorize
securities in an amount which exceeds 10% of the total assets of Headwaters and
its subsidiaries on a consolidated basis and Headwaters agrees to furnish a copy
of any such instrument to the Commission upon request.
For convenience, the name Headwaters is used throughout this listing
although in some cases the name Covol was used in the original instrument.
Exhibit No. Description Location
----------- ----------- --------
3.1.9 Restated Certificate of Incorporation of Headwaters dated August 14, 2001 (17)
3.2 By-Laws of Headwaters (1)
3.2.1 Certificate of Amendment to Bylaws of Headwaters dated January 31, 1996 (1)
3.2.2 Certificate of Amendment to the Bylaws dated May 20, 1997 (Originally designated (3)
as Exhibit No. 3.2.1)
3.2.3 Certificate of Amendment to the Bylaws dated June 25, 1997 (Originally (3)
designated as Exhibit No. 3.2.2)
10.11.2 License Agreement dated September 10, 1996, between Headwaters and CoBon Energy, (2)
LLC
10.13.7 Note Restructure and Assumption Agreement among Gerald Larson, et. al. and *
Headwaters dated October 24, 2001
10.13.8 $250,000 Promissory Note from The Murdock Group Holding Corporation in favor of *
Headwaters dated October 24, 2001
10.13.9 $200,000 Promissory Note from The Murdock Group Holding Corporation in favor of *
Headwaters dated October 24, 2001
10.30 Lease Agreement, dated December 12, 1996, between Headwaters and UPC, Inc. (2)
regarding Price City, Utah property
10.45** License and Binder Purchase Agreement, dated December 14, 1997, between (4)
Appalachian Synfuel, LLC and Headwaters
10.47** License Agreement, dated August 5, 1997, between Pelletco Corporation and (4)
Headwaters
10.49** Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG (4)
Financial Services, Inc. and Headwaters
10.50.1** Form of Amended and Restated License and Binder Purchase Agreement dated (5)
February 3, 1998, between PC Virginia Synthetic Fuel #1, PC West Virginia Synthetic
Fuel #1, PC West Virginia Synthetic Fuel #2, PC West Virginia Synthetic Fuel #3
and Headwaters
22
10.50.1.1*** Form of First Amendment to Amended and Restated License and Binder Purchase (13)
Agreement, dated March 31, 1999, between PC Virginia Synthetic Fuel #1; PC
Virginia Synthetic Fuel #2; PC West Virginia Synthetic Fuel #3 and Headwaters
10.54 Employment Agreement effective May 1, 1998 with Steven G. Stewart (6)
10.56 Employment Agreement effective April 21, 1998 with Brent M. Cook (7)
10.60 Employment Agreement effective April 20, 1999 with Kirk A. Benson (8)
10.61 River Hill Project Purchase Agreement between DTE River Hill, L.L.C. and (16)
Headwaters dated August 27, 1999
10.61.1** License and Binder Purchase Agreement between DTE River Hill, L.L.C. and (16)
Headwaters dated August 27, 1999
10.61.2 Modification Agreement between DTE River Hill L.L.C., Fun Enterprises Pty Limited (16)
and Headwaters dated August 27, 1999
10.64*** Utah #2 Asset Purchase Agreement dated December 23, 1999 between Headwaters and (9)
DTE Kentucky, LLC
10.64.1*** License and Binder Purchase Agreement dated December 29, 1999 between Headwaters (13)
and DTE Kentucky, LLC
10.65*** Asset Purchase Agreement dated January 18, 2000 among Headwaters, Pocahontas (9)
Synfuel, L.L.C., Synfuel Investments, Inc., Premier Elkhorn Coal Company, and
TECO Coal Corporation
10.65.1*** License and Binder Purchase Agreement dated January 18, 2000 between Headwaters (13)
and Premier Elkhorn Coal Company (related to the Pocahontas facility)
10.65.2*** License and Binder Purchase Agreement dated January 21, 2000 between Headwaters (13)
and Premier Elkhorn Coal Company (related to the Mohave facility)
10.67 Mountaineer Fuels Asset Purchase Agreement dated April 17, 2000 between DTE (10)
Kentucky, LLC and Headwaters
10.67.1*** License and Binder Purchase Agreement dated April 17, 2000 between DTE Kentucky, (10)
LLC and Headwaters
10.69*** Settlement Agreement and Mutual Release dated May 25, 2000 among Headwaters and (11)
Birmingham Syn Fuel, L.L.C., PacifiCorp Syn Fuel, L.L.C., and PacifiCorp
Financial Services, Inc.
10.69.3*** License and Binder Purchase Agreement dated May 25, 2000 between Birmingham Syn (11)
Fuel, L.L.C. and Headwaters
10.69.4*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (11)
Fuel, L.L.C. and Headwaters (related to the Brookwood facility)
10.69.5*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (11)
Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #1 facility)
10.69.6*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (11)
Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #2 facility)
10.70*** Settlement Agreement and Release dated June 26, 2000 among Headwaters, Utah (11)
Synfuel #1, Ltd., Coaltech No. 1, L.P., AJG Financial Services, Inc. and Square D
Company
10.70.1*** License and Binder Supply Agreement dated June 26, 2000 among Coaltech No.1 L.P., (11)
Utah Synfuel #1 Ltd, and Headwaters
10.71 Loan Agreement dated October 18, 2000 between Headwaters and Zions First National (13)
Bank
10.71.2 First Amendment to Loan Agreement dated February 1, 2001 between Headwaters and (14)
Zions First National Bank
10.71.3 Promissory Note dated February 1, 2001 between Headwaters as borrower and Zions (14)
First National Bank as lender
10.71.4 Second Amendment to Loan Agreement dated September 26, 2001 between Headwaters *
and Zions First National Bank
10.72 Agreement and Plan of Reorganization between Headwaters and Hydrocarbon (15)
Technologies, Inc. dated May 2, 2001
10.72.1 Share Exchange Agreement between Headwaters and Hydrocarbon Technologies, Inc. (15)
dated May 2, 2001
10.72.2 Amendment No. 1 to Agreement and Plan of Reorganization between Headwaters and (17)
Hydrocarbon Technologies, Inc. dated August 21, 2001
10.72.3 Amendment No. 1 to Share Exchange Agreement between Headwaters and Hydrocarbon (17)
Technologies, Inc. dated August 21, 2001
10.72.4 Certificate of Merger between Headwaters and Hydrocarbon Technologies, Inc. dated (17)
August 29, 2001
10.73 Contribution and Subscription Agreement among Headwaters and Avintaquin Capital, *
LLC dated September 24, 2001
10.73.1 Promissory Note from Avintaquin Capital, LLC in favor of Headwaters dated *
September 24, 2001
16 Letter regarding change in certifying accountant (12)
23
21.1 List of Subsidiaries of Headwaters *
23.1 Consent of Arthur Andersen LLP *
23.2 Consent of PricewaterhouseCoopers LLP *
99.1 Amended 2000 Employee Stock Purchase Plan (originally designated as Exhibit No. (15)
99.2)
99.2 1995 Stock Option Plan (originally designated as Exhibit No. 10.5) (1)
99.2.1 First Amendment to the 1995 Stock Option Plan (originally designated as Exhibit (1)
10.5.1)
99.3 Headwaters Incentive Bonus Plan dated May 25, 2000 (13)
-----------------------
* Filed herewith.
** Confidential treatment has been granted to certain portions of
this exhibit, which portions have been deleted and filed
separately with the Securities and Exchange Commission.
*** This exhibit contains confidential material that has been
omitted pursuant to a Confidential Treatment Request. The
omitted information has been filed separately with the
Securities and Exchange Commission.
Unless another exhibit number is indicated as the exhibit number for the exhibit
as "originally filed," the exhibit number in the filing in which any exhibit was
originally filed and to which reference is made hereby is the same as the
exhibit number assigned herein to the exhibit.
(1) Incorporated by reference to the indicated exhibit filed with Headwaters'
Registration Statement on Form 10, filed February 26, 1996.
(2) Incorporated by reference to the indicated exhibit filed with Headwaters'
Annual Report on Form 10-K for the fiscal year ended September 30, 1996.
(3) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1997.
(4) Incorporated by reference to the indicated exhibit filed with Headwaters'
Annual Report on Form 10-K for the fiscal year ended September 30, 1997.
(5) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1998.
(6) Incorporated by reference to the indicated exhibit filed with Headwaters'
Annual Report on Form 10-K, for the fiscal year ended September 30, 1998.
(7) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q, for the quarterly period ended December 31,
1998.
(8) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q for the quarter ended June 30, 1999.
(9) Incorporated by reference to the indicated exhibit filed with Headwaters'
Current Report on Form 8-K/A, for the event dated December 31, 1999, filed
March 16, 2000.
(10) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q for the quarter ended March 31, 2000.
(11) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000.
(12) Incorporated by reference to the indicated exhibit filed with Headwaters'
Current Report on Form 8-K/A, for the event dated July 19, 2000, filed July
28, 2000.
(13) Incorporated by reference to the indicated exhibit filed with Headwaters'
Annual Report on Form 10-K for the fiscal year ended September 30, 2000.
(14) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q, for the quarter ended March 31, 2001.
(15) Incorporated by reference to the indicated exhibit filed with Headwaters'
Quarterly Report on Form 10-Q, for the quarter ended June 30, 2001.
(16) Incorporated by reference to the indicated exhibit filed with Headwaters'
Current Report on Form 8-K/A, for an event dated August 27, 1999, filed
August 15, 2001.
(17) Incorporated by reference to the indicated exhibit filed with Headwaters'
Current Report on Form 8-K, for events dated August 14, 2001 and August 28,
2001, filed September 12, 2001.
24
Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
September 30, 2001:
o Form 8-K/A filed on August 15, 2001, for an event dated August 27, 1999
(Sale of alternative fuel facility).
o Form 8-K filed on September 12, 2001 for events dated August 14, 2001
(Restatement of Certificate of Incorporation) and August 28, 2001
(Acquisition of Hydrocarbon Technologies, Inc.). The following
financial statements of Hydrocarbon Technologies, Inc. and subsidiaries
and unaudited pro forma financial information were filed with this Form
8-K:
Audited Financial Statements of HTI:
------------------------------------
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Operations for the Years Ended
December 31, 2000 and 1999
Consolidated Statements of Stockholders' Equity (Deficit) for
the Years Ended December 31, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000 and 1999
Notes to Consolidated Financial Statements
Unaudited Financial Statements of HTI:
--------------------------------------
Accountants' Review Report
Consolidated Balance Sheets as of June 30, 2001 and
December 31, 2000
Consolidated Statements of Operations for the Six Months Ended
June 30, 2001 and 2000
Consolidated Statements of Stockholders' Equity (Deficit) for
the Six Months Ended June 30, 2001 and 2000
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2001 and 2000
Notes to Consolidated Financial Statements
Unaudited pro forma financial information:
------------------------------------------
Introduction to Pro Forma Financial Information
Pro Forma Condensed Combined Balance Sheet as of June 30, 2001
Pro Forma Condensed Combined Statement of Income for the Year
Ended September 30, 2000
Pro Forma Condensed Combined Statement of Income for the Nine
Months Ended June 30, 2001
Notes to Pro Forma Condensed Combined Financial Information
Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 3 above.
Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 2 above.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HEADWATERS INCORPORATED
By:/s/ Kirk A. Benson
---------------------------
Kirk A. Benson
Chief Executive Officer and
Principal Executive Officer
By:/s/ Steven G. Stewart
---------------------------
Steven G. Stewart
Chief Financial Officer and
Principal Financial Officer
Date: December 21, 2001
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.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Kirk A. Benson Chief Executive Officer December 21, 2001
- ------------------------- (Principal Executive Officer)
Kirk A. Benson and Director
/s/ Steven G. Stewart Chief Financial Officer December 21, 2001
- ------------------------- (Principal Financial and
Steven G. Stewart Accounting Officer)
/s/ Brent M. Cook President and Director December 21, 2001
- -------------------------
Brent M. Cook
/s/ DeLance W. Squire Director December 21, 2001
- -------------------------
DeLance W. Squire
/s/ James A. Herickhoff Director December 21, 2001
- -------------------------
James A. Herickhoff
/s/ Raymond J. Weller Director December 21, 2001
- -------------------------
Raymond J. Weller
/s/ Ronald S. Tanner Director December 21, 2001
- -------------------------
Ronald S. Tanner
/s/ Alfred G. Comolli Director December 21, 2001
- -------------------------
Alfred G. Comolli
/s/ L.K. (Theo) Lee Director December 21, 2001
- -------------------------
L.K. (Theo) Lee
26
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Headwaters Incorporated:
We have audited the accompanying consolidated balance sheets of Headwaters
Incorporated (a Delaware corporation) and subsidiaries as of September 30, 2000
and 2001, and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for the years 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Headwaters Incorporated and
subsidiaries as of September 30, 2000 and 2001, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
October 17, 2001
Report of Independent Accountants
To the Board of Directors
Headwaters Incorporated and Subsidiaries
In our opinion, the accompanying consolidated statements of operations, changes
in stockholders' equity, and cash flows for the year ended September 30, 1999,
present fairly, in all material respects, the consolidated results of operations
and cash flows of Headwaters Incorporated and Subsidiaries for the year ended
September 30, 1999, in conformity with accounting principles generally accepted
in the United States of America. 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
of these statements in accordance with auditing standards generally accepted in
the United States of America which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Salt Lake City, Utah
January 13, 2000
F-1
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 30,
(thousands of dollars) 2000 2001
- ---------------------------------------------------------------------------------- --------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 983 $ 999
Short-term investments 6,973 6,048
Trade receivables, net 7,298 8,887
Short-term notes and accrued interest receivable 2,530 6,857
Other current assets 387 1,257
--------------- ----------------
Total current assets 18,171 24,048
--------------- ----------------
Property, plant and equipment, net 552 2,680
--------------- ----------------
Other assets:
Notes and accrued interest receivable 6,598 4,000
Equity investments, net 3,259 --
Deferred income taxes 3,000 13,090
Intangible assets, net 1,221 10,752
Other assets 640 805
--------------- ----------------
Total other assets 14,718 28,647
--------------- ----------------
Total assets $ 33,441 $ 55,375
=============== ================
The accompanying notes are an integral
part of the consolidated financial statements.
F-2
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
As of September 30,
(thousands of dollars and shares) 2000 2001
- ------------------------------------------------------------------------------------ -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 698 $ 2,203
Accrued personnel costs 2,254 2,777
Other accrued liabilities 3,786 4,987
Short-term borrowings 208 4,356
-------------- ----------------
Total current liabilities 6,946 14,323
-------------- ----------------
Long-term liabilities:
Notes payable, non-current 5,055 149
Other long-term liabilities 180 2,906
Deferred revenue 10,513 6,911
-------------- ----------------
Total long-term liabilities 15,748 9,966
-------------- ----------------
Total liabilities 22,694 24,289
-------------- ----------------
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 17 shares at September 30, 2000 and 0 shares at
September 30, 2001 1 --
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 23,341 shares at September 30, 2000 (including 214 shares
held in treasury) and 23,807 shares at September 30, 2001 (including 548
shares held in treasury) 23 24
Capital in excess of par value 82,659 83,921
Accumulated deficit (70,221) (49,399)
Treasury stock (734) (3,038)
Other (981) (422)
-------------- ----------------
Total stockholders' equity 10,747 31,086
-------------- ----------------
Total liabilities and stockholders' equity $ 33,441 $ 55,375
============== ================
The accompanying notes are an integral
part of the consolidated financial statements.
F-3
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
(thousands of dollars, except per-share data) 1999 2000 2001
- --------------------------------------------------------------------- ----------------- ------------------ ------------------
Revenue:
License fees $ 3,526 $ 17,315 $ 20,765
Chemical sales 2,140 9,757 22,407
Gains on sale of facilities and other transactions -- 17,949 --
Alternative fuel sales 767 149 --
Other 286 665 2,292
----------------- ------------------ ------------------
Total revenue 6,719 45,835 45,464
----------------- ------------------ ------------------
Operating costs and expenses:
Cost of chemical 1,695 6,617 14,524
Cost of operations 13,322 4,355 3,071
Selling, general and administrative 4,881 4,827 5,838
Acquired in-process research and development -- -- 2,400
Asset write-offs and other charges 9,234 17,758 --
----------------- ------------------ ------------------
Total operating costs and expenses 29,132 33,557 25,833
----------------- ------------------ ------------------
Operating income (loss) (22,413) 12,278 19,631
----------------- ------------------ ------------------
Other income (expense):
Interest and net investment income 1,586 1,775 726
Interest expense (6,253) (4,814) (224)
Losses on notes receivable and equity investments -- (746) (6,265)
Other, net (1,313) 149 600
----------------- ------------------ ------------------
Total other expense, net (5,980) (3,636) (5,163)
----------------- ------------------ ------------------
Income (loss) before income taxes and extraordinary item (28,393) 8,642 14,468
Income tax benefit -- 2,900 7,049
----------------- ------------------ ------------------
Income (loss) before extraordinary item (28,393) 11,542 21,517
Extraordinary loss on early extinguishment of debt -- (7,860) --
----------------- ------------------ ------------------
Net income (loss) $ (28,393) $ 3,682 $ 21,517
================= ================== ==================
Basic net income (loss) per common share $ (2.39) $ 0.17 $ 0.94
================= ================== ==================
Diluted net income (loss) per common share $ (2.39) $ 0.15 $ 0.87
================= ================== ==================
The accompanying notes are an integral
part of the consolidated financial statements.
F-4
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Other
-----------------------------------------
Notes and
interest
receivable
- related
parties, from
Convertible issuance of,
Preferred or Deferred
Stock Common Stock Capital in collateralized compensation Common stock
(thousands of dollars -------------------------------- excess of par Accumulated by, common from stock held in
and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
Balances as of October 1, 1998 316 $1 11,272 $11 $69,284 $(43,002) $(7,773) $(3,775) $ --
Common stock issued to purchase
minority interests in
subsidiaries 70 -- 519
Common stock and warrants to
purchase common stock
issued for cash, including
exercise of stock options 776 1 3,774
Value of common stock warrants
issued under terms of existing
debt agreement and in
connection with extension of
note payable due date -- -- 453
Common stock issued for rights
to technology 60 -- 375
Common stock issued on
conversion of preferred stock
and in payment of dividends (300) -- 602 1 194 (195)
Return of previously issued
common stock by a director (14) -- --
Value of common stock options
and warrants issued in
connection with debt financing -- -- 323
Preferred stock and warrants to
purchase common stock issued
for cash, net of offering costs 1 -- 899
Value of common stock warrants
issued in connection with
redeemable convertible preferred
stock and convertible debt 2,435
Value of extended and repriced
warrants issued in connection
with satisfaction of notes
payable -- -- 201
Preferred stock cash dividends (123)
Write-down of related party
note receivable 1,209
Amortization of deferred
compensation from stock options 2,553
Net loss for the year ended
September 30, 1999 (28,393)
---------------------------------------------------------------------------------------------------
Balances as of September 30, 1999 17 1 12,766 13 78,457 (71,713) (6,564) (1,222) --
---------------------------------------------------------------------------------------------------
The accompanying notes are an integral
part of the consolidated financial statements.
F-5
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued
Other
-----------------------------------------
Notes and
interest
receivable
- related
parties, from
Convertible issuance of,
Preferred or Deferred
Stock Common Stock Capital in collateralized compensation Common stock
(thousands of dollars -------------------------------- excess of par Accumulated by, common from stock held in
and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
Preferred stock cash dividends $(297)
Reclassification of redeemable
convertible preferred
stock to convertible preferred
stock 38 $-- $ 2,710
Common stock issued on conversion
of convertible preferred stock
and in payment of dividends (2) -- 2,812 $ 3 1,631 (11)
Redemption of convertible
preferred stock (36) -- (2,572) (1,882)
Common stock issued for cash 4,008 4 5,250
Common stock issued on conversion
of debt 3,726 3 2,961
Common stock issued in connection
with redemption of debt 214 -- 256
Common stock issued in connection
with cash and cashless exercises
of warrants and options 985 1 658
Value of common stock warrants
and options issued in connection
with convertible debt financing
and debt extension -- -- 538
Purchase and cancellation of
warrants (149)
Cancellation of related party
notes receivable and common
stock collateralizing the notes (812) (1) (5,944) $6,164
Write-up of related party note
receivable (66)
Amortization of deferred
compensation from stock options $707
Purchase of 586 shares of
treasury stock, at cost $(1,897)
14 shares of treasury stock
transferred to employee stock
purchase plan 26
Cancellation of 358 shares of
treasury stock (358) -- (1,137) 1,137
Net income for the year ended
September 30, 2000 3,682
---------------------------------------------------------------------------------------------------
Balances as of September 30, 2000 17 1 23,341 23 82,659 (70,221) (466) (515) (734)
---------------------------------------------------------------------------------------------------
The accompanying notes are an integral
part of the consolidated financial statements.
F-6
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued
Other
-----------------------------------------
Notes and
interest
receivable
- related
parties, from
Convertible issuance of,
Preferred or Deferred
Stock Common Stock Capital in collateralized compensation Common stock
(thousands of dollars -------------------------------- excess of par Accumulated by, common from stock held in
and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
Common stock issued on conversion
of convertible preferred stock (17) $(1) 443 $-- $ --
Preferred stock cash dividends $ (695)
Exercise of stock options and
warrants 860 1 1,925
Common stock issued in connection
with purchase of Hydrocarbon
Technologies, Inc., net of
estimated registration costs 593 1 5,434
Common stock options issued in
connection with purchase of
Hydrocarbon Technologies, Inc. 1,325
Tax benefit from exercise of
stock options 1,690
Write-up of related party note
receivable to collateral value $(541)
Cancellation of related party
note receivable and transfer of
collateral shares to treasury
stock 1,007 $(1,007)
Amortization of deferred
compensation from stock options $93
Purchase of 1,648 shares of
treasury stock, at cost (10,510)
34 shares of treasury stock
transferred to employee stock
purchase plan 101
Cancellation of 1,430 shares of
treasury stock (1,430) (1) (9,112) 9,112
Net income for the year ended
September 30, 2001 21,517
---------------------------------------------------------------------------------------------------
Balances as of September 30, 2001 -- $-- 23,807 $24 $83,921 $(49,399) $ -- $(422) $(3,038)
===================================================================================================
The accompanying notes are an integral
part of the consolidated financial statements.
F-7
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
(thousands of dollars) 1999 2000 2001
- ----------------------------------------------------------------------------------------- ----------- ------------- ------------
Cash flows from operating activities:
Net income (loss) $(28,393) $ 3,682 $ 21,517
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Deferred income tax benefit -- (3,000) (7,470)
Recognition of deferred revenue (875) (802) (2,015)
Depreciation and amortization 2,570 1,021 263
Amortization of deferred compensation from stock options 2,553 707 93
Interest expense related to amortization of debt discount and debt
issuance costs 2,075 3,034 79
Net losses (gains) on sale of facilities, property, plant and equipment 1,979 (16,894) (42)
Losses in equity investments, write-offs and provisions for unrealizable
investments -- 746 3,018
Write-down of notes receivable and related accrued interest -- -- 3,200
Write-down (write-up) of related party note receivable 1,209 (66) (541)
Acquired in-process research and development -- -- 2,400
Gains on other transactions -- (1,079) --
Non-cash portion of asset write-offs and other charges 5,362 15,485 --
Extraordinary loss on early extinguishment of debt -- 7,860 --
Other changes in operating assets and liabilities, net of effect of
acquisition of Hydrocarbon Technologies, Inc.:
Receivables (2,837) (3,968) (987)
Other current assets 107 161 26
Accounts payable and accrued liabilities (993) (1,804) 958
Deferred revenue -- 1,587 (1,587)
Other, net (273) (62) (28)
----------- ------------- ------------
Net cash provided by (used in) operating activities (17,516) 6,608 18,884
----------- ------------- ------------
Cash flows from investing activities:
Payments for acquisition of Hydrocarbon Technologies, Inc., net of cash
acquired -- -- (4,845)
Net proceeds from sale of short-term investments -- -- 925
Net purchases of short-term investments -- (6,973) --
Investments in and loans to non-affiliated companies -- (4,005) (4,636)
Purchase of facilities held for sale and equipment (861) (403) (170)
Proceeds from sale of facilities, property, plant and equipment 1,433 42,334 168
Net decrease (increase) in restricted assets (95) 843 (85)
Proceeds from facility transferred under note receivable arrangement 525 -- --
Other, net (127) (9) (95)
----------- ------------- ------------
Net cash provided by (used in) investing activities 875 31,787 (8,738)
----------- ------------- ------------
Cash flows from financing activities:
Net proceeds from issuance of notes payable, warrants and other borrowings 11,193 6,980 8,991
Payments on notes payable, including redemption premiums, and other borrowings (4,690) (43,995) (9,941)
Purchase of common stock for the treasury, net of employee stock purchases -- (1,871) (10,409)
Proceeds from exercise of options and warrants -- 659 1,926
Preferred stock dividends (123) (297) (695)
Net proceeds from issuance of common stock and warrants 3,775 5,254 --
Net proceeds from issuance of preferred stock and warrants 6,367 -- --
Preferred stock redemptions -- (4,454) --
Other, net (147) (149) (2)
----------- ------------- ------------
Net cash provided by (used in) financing activities 16,375 (37,873) (10,130)
----------- ------------- ------------
Net increase (decrease) in cash and cash equivalents (266) 522 16
Cash and cash equivalents, beginning of year 727 461 983
----------- ------------- ------------
Cash and cash equivalents, end of year $ 461 $ 983 $ 999
============ ============= ============
The accompanying notes are an integral
part of the consolidated financial statements.
F-8
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
Year ended September 30,
(thousands of dollars) 1999 2000 2001
- ----------------------------------------------------------------------------------------- ----------- ----------- -------------
Supplemental schedule of non-cash investing and financing activities:
Common stock issued in connection with purchase of Hydrocarbon Technologies, Inc. $ -- $ -- $ 5,435
Common stock options issued in connection with purchase of Hydrocarbon
Technologies, Inc. -- -- 1,325
Exchange of equity investments in and loans to non-affiliated companies for
long-term note receivable from non-affiliate -- -- 4,000
Common stock issued on conversion of convertible preferred stock and in
payment of dividends 2,761 1,634 3,100
Cancellation of treasury stock -- (1,137) (9,112)
Tax benefit from exercise of stock options -- -- 1,690
Cancellation of related party note receivable and transfer of collateral shares
to treasury stock -- -- 1,007
Cancellation of notes receivable - related parties and common stock
collateralizing the notes -- 6,164 --
Common stock issued on conversion of convertible debt, debt and related accrued
interest -- 2,964 --
Reclassification of redeemable convertible preferred stock to convertible
preferred stock -- 2,710 --
Reduction of note payable upon sale of facility held for sale 5,800 -- --
Notes payable issued for equipment and rights to technology 850 -- --
Common stock issued to purchase minority interests in subsidiaries 519 -- --
Common stock issued for rights to technology 375 -- --
Property, plant and equipment acquired through reduction of accounts receivable 413 -- --
Supplemental disclosure of cash flow information:
Cash paid for interest $ 3,646 $ 10,458 $ 269
Cash paid for income taxes -- -- 283
The accompanying notes are an integral
part of the consolidated financial statements.
F-9
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Description of Business
Headwaters Incorporated was incorporated in Delaware in 1995. Headwaters
owns 100% of Hydrocarbon Technologies, Inc. ("HTI"), a New Jersey company
formed in 1995 and acquired by Headwaters in August 2001. In September
2001, Headwaters disposed of its 100% interest in Kwai Financial, Inc.
("Kwai"), a Delaware company formed in 2000. Headwaters is also the general
partner and the sole limited partner in two limited partnerships, Utah
Synfuel #1 Ltd. and Alabama Synfuel #1 Ltd., which were formed in 1996 (see
Note 13). Headwaters' fiscal year ends on September 30 and unless otherwise
noted, all future references to years shall mean Headwaters' fiscal year
rather than a calendar year.
Headwaters Incorporated and its subsidiaries' primary business is
commercializing its chemical technologies used to produce alternative fuel
from coal derivatives and to develop and deploy alternative energy
technologies. Currently, Headwaters has licensed its technology to the
owners of 28 alternative fuel facilities which are operating at various
levels of production in ten states. During 1999 and 2000, Headwaters
consummated the sale of its four owned facilities and licensed its
technology to the owners. One of the facilities was sold in 1999 and three
of the facilities were sold in 2000 (see Note 14). Headwaters has no
current plans to construct any additional alternative fuel facilities.
During 2000, Headwaters began evaluating and pursuing investment
alternatives. Headwaters invested excess cash in high-grade
government-backed securities and made several equity investments in and
loans to unrelated high-risk entities. Headwaters continues to invest in
government-backed securities, but does not currently intend to make any
additional equity investments in or loans to any new unrelated entities.
Headwaters is interested in possible strategic acquisitions of entities
that operate in adjacent industries and that would be synergistic with its
current operations.
2. Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include
the accounts of Headwaters and its four subsidiaries, HTI, Kwai, Utah
Synfuel #1 and Alabama Synfuel #1. All significant intercompany
transactions and accounts are eliminated in consolidation. Due to the time
required to obtain accurate financial information related to HTI's
significant foreign operations, for financial reporting purposes HTI's
financial statements are consolidated with Headwaters' financial statements
using a one-month lag. Accordingly, HTI's August 2001 acquisition date
balance sheet has been consolidated with Headwaters' September 30, 2001
balance sheet, but no results of operations of HTI have been included in
the accompanying consolidated statements of operations for any period.
HTI's November 30, 2001 balance sheet will be consolidated with Headwaters'
December 31, 2001 balance sheet and HTI's results of operations for the
period from date of acquisition to November 30, 2001 will be consolidated
with Headwaters' results for the quarter ending December 31, 2001.
Revenue Recognition - There are 28 alternative fuel facilities that
currently utilize Headwaters' patented technology and from which Headwaters
earns license fees and/or profits from the sale of chemical reagent.
Non-refundable advance license fees and royalty payments have been received
from certain licensees under various terms and conditions. These
non-refundable license fees and royalties have been deferred and are being
recognized on a straight-line basis over the period covered by the related
license and royalty agreements, generally through calendar 2007. Recurring
license fees or royalty payments are recognized in the period when earned
which coincides with the sale of alternative fuel by Headwaters' licensees.
Revenues from the sale of chemical reagent are recognized upon delivery of
product to the licensee or non-licensee customer. In certain instances,
Headwaters is required to pay to third parties a portion of license fees
received or cash proceeds from the sale of chemical reagent. In such cases,
Headwaters records the net proceeds as revenue.
Segment Reporting, Major Customers and Concentrations of Risk - Headwaters
operates in the alternative energy industry and reports as a single
industry segment. Approximately $8,509,000 of revenue in 2000 and
$16,044,000 in 2001 was from a single licensee; $12,296,000 of revenue in
2000 and $5,111,000 in 2001 was from a second licensee; $1,032,000 of
revenue in 1999, $15,511,000 in 2000 and $4,978,000 in 2001 was from a
third licensee; $849,000 of revenue in 1999, $2,558,000 in 2000 and
$4,675,000 in 2001 was from a fourth licensee; and $2,673,000 of revenue in
1999 was from a fifth licensee. No other single customer accounted for over
10% of total revenue in any year presented. All of the above customers are
energy companies operating in the United States. Headwaters had trade
receivable balances from these five customers totaling approximately
$5,275,000 at September 30, 2001. Headwaters purchases all of the chemical
reagent that is sold to licensees and other customers from a single large
international chemical company. Management believes that if necessary, the
chemical reagent could be obtained from other suppliers. Headwaters has no
other unusual credit risks or concentrations.
Cash and Cash Equivalents - Headwaters considers all highly liquid debt
instruments with an original maturity of three months or less to be cash
equivalents. Cash and cash equivalents are deposited with financial
institutions and at times may exceed insured depository limits.
F-10
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
2. Summary of Significant Accounting Policies, continued
Short-term Investments - Short-term investments consist primarily of
mortgage- and other asset-backed securities, corporate bonds, U.S.
government securities, and equity securities. By policy, Headwaters invests
primarily in high-grade marketable securities. All investments are defined
as trading securities and are stated at market value as determined by the
most recently traded price of each security at the balance sheet date.
Unrealized gains and losses are included in earnings. Approximately
$100,000 of investment income in 2000 and $16,000 of investment losses in
2001 related to securities held at September 30, 2000 and 2001,
respectively.
Receivables - Allowances are provided for uncollectible accounts when
appropriate. Such allowances are based on a receivable-by-receivable
analysis of collectibility or impairment and totaled approximately $121,000
at September 30, 2000 and $0 at September 30, 2001 for trade receivables
and $0 at September 30, 2000 and 2001 for notes receivable. Collateral is
not required for trade receivables. Collateral, generally consisting of
most or all assets of the debtor, is required for notes receivable. Total
losses recognized on notes receivable were $0 in 1999 and 2000 and
approximately $3,658,000 in 2001. These losses are included in other
expense in the consolidated statement of operations.
Property, Plant and Equipment - Property, plant and equipment are recorded
at cost and depreciated using the straight-line method over the estimated
useful lives of the assets. Maintenance, repairs and minor replacements are
charged to expense as incurred. Upon the sale or retirement of property,
plant and equipment, any gain or loss on disposition is reflected in the
results of operations, and the related asset cost and accumulated
depreciation are removed from the respective accounts.
Equity Investments - Equity investments in less-than-50% owned affiliates
are accounted for at cost when Headwaters does not have the ability to
exercise significant influence over operating and financial policies of an
investee. When Headwaters does have the ability to exercise significant
influence, either through its ownership of voting securities or
contractually provided rights to board seats, the equity method of
accounting is used, whereby the investment is carried at cost plus
Headwaters' portion of undistributed earnings or losses subsequent to the
date of acquisition. As of September 30, 2000, Headwaters owned from 1% to
27% of the voting securities of five non-public high-risk investee
companies. There were no equity investments at September 30, 2001.
Allowances are provided, on a case-by-case basis, when management
determines that the carrying value of the investment is not realizable. At
September 30, 2000, such allowances totaled approximately $646,000. In
addition, in 2000 Headwaters recognized approximately $100,000 of losses
related to its equity in investments accounted for using the equity method.
In 2001, Headwaters recognized approximately $2,607,000 of total losses
related to its investments accounted for using the equity method. These
losses are included in other expense in the consolidated statements of
operations.
Intangible Assets - Intangible assets consist of (i) identifiable
intangible assets, comprised of existing patented technology, obtained in
connection with the acquisition of HTI (see Note 3); (ii) rights to
technology, consisting of a coal-based alternative fuel technology and
related licensing and patent rights; and (iii) the excess of the value of
the consideration paid for the purchase of certain limited partners'
interests in subsidiaries over the fair values of the related assets, which
fair values approximated their carrying cost (see Note 13). These
intangible assets are being amortized on the straight-line method over
their estimated useful lives, which range from nine to fifteen years.
Accumulated amortization of intangible assets was $302,000 as of September
30, 2000 and $470,000 as of September 30, 2001. As described in more detail
in Note 15, Headwaters wrote off approximately $2,189,000 of intangible
assets during 2000. Headwaters has implemented SFAS No. 142, "Accounting
for Goodwill and Intangible Assets," with the exception of certain
additional disclosures which can not be early implemented.
Valuation of Long-Lived Assets - Headwaters periodically evaluates the
carrying value of long-lived assets, including intangible assets, when
events and circumstances warrant such a review. The carrying value of a
long-lived asset is considered impaired when the anticipated cumulative
undiscounted cash flow from that asset is less than its carrying value. In
that event, a loss is recognized based on the amount by which the carrying
value exceeds the fair market value of the long-lived asset.
Impairment-related losses recognized in Headwaters' consolidated financial
statements for 1999 and 2000 are more fully described in Note 15.
Income Taxes - Headwaters accounts for income taxes using the asset and
liability approach. Headwaters recognizes deferred income tax assets or
liabilities for the expected future tax consequences of events that have
been recognized in the financial statements or income tax returns. Deferred
income tax assets or liabilities are determined based upon the differences
between the financial statement and tax bases of assets and liabilities
using enacted tax rates expected to apply when the differences are expected
to be settled or realized. Deferred income tax assets are reviewed
periodically for recoverability and valuation allowances are provided as
necessary. Headwaters files a consolidated tax return with its
subsidiaries.
F-11
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
2. Summary of Significant Accounting Policies, continued
Common Stock, Options and Warrants - Common stock issued for services is
accounted for using the fair value of the shares of common stock,
determined at the time the services are provided and the liability is
incurred. The measurement date used to value non-employee option grants is
the earlier of the option grant date or the date at which the recipient's
performance is complete. Such options, as well as warrants issued in
connection with debt and equity financings, including repricings and
extensions of option and warrant expiration dates, are valued using the
Black-Scholes model. If modifications to existing options or warrants
relating to debt securities occur, the incremental value of the modified
options or warrants is capitalized and amortized to interest expense over
the remaining life of the related debt.
Income Per Share Calculation - Income per share has been computed based on
the weighted-average number of common shares outstanding. Diluted income
per share computations reflect the increase in weighted-average common
shares outstanding that would result from the assumed exercise of
outstanding stock options and warrants, calculated using the treasury stock
method, and the assumed conversion of convertible securities, using the
if-converted method, where such options, warrants, and convertible
securities are dilutive.
Use of Estimates - The preparation of financial statements in conformity
with accounting principles generally accepted in the United States 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 revenue and expenses during the reporting period. Actual results
could differ materially from those estimates.
Reclassifications - Certain prior year amounts have been reclassified to
conform with the current year's presentation. The reclassifications had no
effect on net income (loss) or total assets.
3. Acquisition of HTI
In August 2001, Headwaters completed a 100% acquisition of HTI, a New
Jersey-based company that has significant intellectual property including
technologies to transform coal and heavy oil into ultra-clean diesel fuel
and to recycle waste oil into higher value carbon products, and
nano-catalyst technology. Total consideration at closing, including the
direct costs incurred by Headwaters to consummate the acquisition, was
approximately $11,774,000. The following table sets forth the consideration
paid:
(thousands of dollars and shares, except per-share amount)
-------------------------------------------------------------- ------------
Fair value of Headwaters stock (593 shares at $9.25 per
share) $ 5,485
Fair value of options to purchase 144 shares of Headwaters'
common stock issued in exchange for 152 outstanding vested
HTI options 1,325
Cash paid to HTI stockholders 1,395
Cash paid to retire HTI note payable to a bank, plus
pre-acquisition loans by Headwaters to HTI 2,560
Costs directly related to acquisition 1,009
------------
Total consideration $11,774
============
The value of the 593,000 shares of Headwaters common stock issued to the
former HTI stockholders was determined using the average market price of
Headwaters' stock over a three-day period, consisting of the day the terms
of acquisition were agreed to and one day prior to and one day subsequent
to that day ($9.25). For purposes of computing the estimated fair value of
the Headwaters stock options issued in exchange for outstanding HTI
options, the Black-Scholes model was used with the following assumptions:
expected stock price volatility of 90%, risk free interest rates of 3.5% to
4.0%, weighted average expected option lives of one to three years, no
dividend yield, and a fair value of Headwaters' stock of $9.25 per share.
Additional contingent consideration can be earned by the former HTI
stockholders during calendar 2001 and calendar 2002 based on certain
operating targets and other milestones. As required by generally accepted
accounting principles, a contingent liability of $2,714,000 was recorded,
representing the contingent incremental consideration for identified
purchased assets in excess of the consideration paid at closing. A
contingent liability was not recognized for the contingent incremental
consideration that, if paid in the future, would be recorded as goodwill.
This amount will be adjusted in the future if and when the actual
contingent consideration is paid. If some or all of the recorded contingent
consideration is not paid, some of the recorded asset values, as shown in
the following table, will be adjusted accordingly. If all operating targets
and other milestones are achieved, the total additional consideration that
could be issued to the former HTI stockholders would consist of
approximately $1,395,000 in cash and approximately 593,000 shares of
Headwaters common stock. The value of the common shares issued in the
future, if any, will be determined at the time the shares are issued, based
on the fair value of the shares at that time.
F-12
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
3. Acquisition of HTI, continued
The following table sets forth the allocation to the tangible and
intangible assets acquired and liabilities assumed, of the total
consideration at closing:
(thousands of dollars)
-------------------------------------------------------------- ------------
Tangible assets acquired, net of liabilities assumed $ 1,388
Intangible assets acquired:
Existing patented technology 9,700
Acquired in-process research and development 2,400
Deferred income taxes related to HTI acquisition date tax
net operating losses which can be utilized in future
periods 1,000
Contingent liability for purchased assets in excess of
consideration paid at closing (2,714)
------------
Net assets acquired $11,774
============
The HTI acquisition has been accounted for using the purchase method of
accounting as required by SFAS No. 141, "Business Combinations." Assets
acquired and liabilities assumed have been recorded at their estimated fair
values as of the acquisition date. Approximately $9,700,000 of the purchase
price was allocated to identifiable intangible assets consisting of
existing patented technology with an estimated useful life of 15 years.
Approximately $2,400,000 of the purchase price was allocated to purchased
in-process research and development, consisting primarily of efforts
focused on developing catalysts and catalytic processes to lower the cost
of producing alternative fuels and chemicals while improving energy
efficiency and reducing environmental risks. This amount represents the
estimated purchased in-process technology for projects that have not yet
reached technological feasibility and currently have no alternative use.
Further development of the in-process technology is currently expected to
take at least three years and to cost approximately $5,000,000. The
valuation of the in-process research and development included, but was not
limited to, an analysis of the market for the acquired products and
technologies, the completion costs for the projects, the expected cash
flows attributed to the projects and the risks associated with achieving
such cash flows. The estimated value of these projects was determined by
estimating the costs to develop the purchased in-process technology into
commercially viable products, estimating the resulting net cash flows from
the sale of those products, and discounting the net cash flows back to
their present value. As required by generally accepted accounting
principles, Headwaters recorded a charge for this purchased in-process
research and development as of the date of acquisition, which is included
in operating costs and expenses in the 2001 consolidated statement of
operations.
The following unaudited pro forma financial information for 2000 and 2001
assumes the HTI acquisition occurred as of the beginning of the respective
years. The pro forma combined results for 2000 combine Headwaters'
historical results for the year ended September 30, 2000 with HTI's
historical results for the twelve months ended June 30, 2000, after giving
effect to certain adjustments, including the amortization of acquired
intangible assets. The pro forma combined results for 2001 combine
Headwaters' historical results for the year ended September 30, 2001 with
HTI's historical results for the twelve months ended June 30, 2001, after
giving effect to necessary adjustments. The pro forma results have been
prepared for illustrative purposes only. Such information does not purport
to be indicative of the results of operations which actually would have
resulted had the acquisition occurred on the dates indicated, nor is it
indicative of the results that may be expected in future periods.
Unaudited Pro Forma
Results
---------------------------
(thousands of dollars, except per-share data) 2000 2001
---------------------------------------------- ------------- -------------
Total revenue $54,504 $49,961
Income before extraordinary item 11,058 17,802
Net income 3,198 17,802
Basic income per common share before
extraordinary item 0.55 0.78
Diluted income per common share before
extraordinary item 0.48 0.72
Basic net income per common share 0.14 0.78
Diluted net income per common share 0.13 0.72
F-13
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
4. Property, Plant and Equipment
Property, plant and equipment consisted of the following at September 30:
Estimated useful
(thousands of dollars) lives 2000 2001
---------------------------------- ---------------- --------- ----------
Land $ 224 $ 379
Buildings and improvements 15 years 96 624
Machinery and equipment 3 - 8 years 370 1,885
--------- ----------
690 2,888
Less accumulated depreciation (138) (208)
--------- ----------
Net property, plant and equipment $ 552 $2,680
========= ==========
Depreciation expense was approximately $1,988,000 in 1999, $784,000 in 2000
and $93,000 in 2001. As described in more detail in Note 15, Headwaters
recorded approximately $12,615,000 of expense related to impaired assets
during 2000.
5. Notes Receivable
Notes receivable consisted of the following at September 30:
(thousands of dollars) 2000 2001
--------------------------------------------------------- -------- --------
Short-term Notes and Accrued Interest Receivable
Facility-dependent note receivable from a corporation,
bearing interest at 6% paid quarterly, collateralized
by an alternative fuel facility in Alabama sold by
Headwaters in 1998. This note receivable was
collected in October 2001. $ -- $6,500
Accrued interest receivable from the above corporation,
collected in October 2001 -- 98
Portion of intercompany note receivable and accrued
interest due from HTI not eliminated in consolidation
(see Note 3) -- 259
Notes receivable representing bridge loans to nine
companies, primarily in the start-up phase, for
amounts ranging from $200 to $500 each, with due
dates of 120 days or less from note origination.
These notes were collateralized by most or all assets
of the debtors and were collected, written off or
sold in 2001. 2,530 --
-------------------
Total $2,530 $6,857
===================
Notes and Accrued Interest Receivable
Collateral-dependent note receivable from a limited
liability corporation, bearing interest at LIBOR plus
0.9% interest (3.7% at September 30, 2001) payable
quarterly, with principal due no later than September
2004. This note is collateralized by certain bridge
loans and equity investments sold by Headwaters to
this entity in September 2001. This note is being
accounted for on the cost recovery basis. $ -- $4,000
Facility-dependent note receivable described above,
collected in October 2001. 6,500 --
Accrued interest receivable from the above corporation 98 --
-------------------
Total $6,598 $4,000
===================
F-14
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
6. Financing and Other Equity Transactions
During 2000 and 2001 and subsequent to 2001, Headwaters entered into
several transactions, including the following:
Unsecured Bank Line of Credit - In October 2000, the remaining balance of
$3,000,000 due under a note payable to a bank (see Note 7) was repaid with
proceeds from a revolving line of credit with the same bank, which line of
credit has an expiration date in October 2002. Funds from this line of
credit were also used to repay the $1,838,000 note payable described in
Note 7. Borrowings under the unsecured line of credit are limited to a
maximum amount of $10,000,000 and bear interest at prime plus .75% (6.75%
at September 30, 2001). Maximum borrowings under the line of credit during
2001 were approximately $4,896,000, but there were no borrowings
outstanding under the line as of September 30, 2001. The line of credit
agreement contains certain covenants and restrictions common for such
loans, including minimum required stockholders' equity and quarterly
earnings. Headwaters was in compliance with the covenants and restrictions
at September 30, 2001.
Short-term Borrowings with an Investment Company - Headwaters has an
arrangement with an investment company under which Headwaters can borrow up
to 90% of the value of the portfolio of Headwaters' short-term investments
with the investment company (see Note 7). These investments consist
primarily of government-backed securities and collateralize any outstanding
borrowings. Maximum borrowings under this arrangement during 2001 were
approximately $4,095,000, which amount was outstanding at September 30,
2001. Borrowings under this arrangement were used for short-term working
capital needs, primarily for stock repurchases, rather than liquidating the
securities held as collateral.
Convertible Debt - In 2000, Headwaters issued convertible secured debt and
warrants to purchase approximately 1,172,000 shares of common stock, in two
unrelated transactions, for total net proceeds of approximately $2,800,000.
The warrants had exercise prices ranging from $.88 to $3.60 per share, with
expiration dates ranging from September 2002 to December 2002 and were
assigned a value of approximately $562,000. This debt, along with the
convertible debt issued to one of the same debt holders in September 1999,
was convertible into common stock at market rates. During 2000, convertible
debt with a face amount of approximately $1,280,000 and a carrying value of
approximately $970,000 was converted into approximately 2,540,000 shares of
common stock. In January 2000, Headwaters redeemed all of the remaining
convertible debt.
In April 2000, the holder of a $4,000,000 note payable converted $2,000,000
of principal into approximately 1,186,000 shares of common stock and
warrants for the purchase of approximately 296,000 shares of common stock.
The warrants are exercisable through April 2005 at a price of $2.10 per
share.
Convertible Preferred Stock - During 2000, 200 shares of Series C preferred
stock, along with related accumulated but undeclared dividends, were
converted into approximately 180,000 shares of common stock, and 24,369
shares of Series D convertible preferred stock were converted into
approximately 2,632,000 shares of common stock. Also in 2000, Headwaters
redeemed the remaining 35,631 shares of Series D preferred stock. The total
amount paid to redeem the preferred stock was approximately $4,454,000,
including a redemption premium of approximately $1,882,000, which was
charged directly to stockholders' equity. In 2001, all of the outstanding
shares of preferred stock, consisting of 3,000 shares of Series A and
14,310 shares of Series B, were converted into a total of approximately
443,000 shares of common stock, representing a conversion price of $7.00
per common share. Headwaters paid the accrued but undeclared dividends of
approximately $695,000 in cash rather than allowing conversion into common
stock at a price below market.
Common Stock - In 2000, Headwaters issued approximately 3,629,000 shares of
common stock in a private placement for cash proceeds of approximately
$4,666,000, net of costs of approximately $270,000. In another transaction,
Headwaters issued approximately 379,000 shares of common stock and warrants
for the purchase of approximately 133,000 shares of common stock to certain
officers and directors for net cash proceeds of approximately $588,000. The
warrants are exercisable through March 2005 at a price of $1.56 per share.
Treasury Stock - During 2001, Headwaters acquired shares of its common
stock in connection with the stock repurchase program announced in May 2000
and expanded in June 2001. The program, as revised, authorizes Headwaters
to purchase stock in the open market or through negotiated block
transactions up to an aggregate of 20% of the outstanding common stock, or
$15,000,000, whichever is greater. During 2001, Headwaters purchased
approximately 1,648,000 shares for approximately $10,510,000. Also during
2001, approximately 1,430,000 shares of treasury stock were cancelled.
F-15
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
6. Financing and Other Equity Transactions, continued
Related Party Note Receivable Collateralized by Common Stock - In January
2001, Headwaters accepted from a stockholder as full satisfaction of a
collateral-based note receivable, i) 150,000 shares of Headwaters stock and
options to acquire 25,000 shares of Headwaters common stock for $1.50 per
share that collateralized the note, both of which were cancelled, and ii) a
new 6% collateralized promissory note receivable in the principal amount of
$1,750,000. Prior to this transaction, the original note receivable was
being carried at the value of the underlying collateral. Headwaters
recognized a gain of approximately $541,000 representing the increase in
value of that collateral from September 30, 2000 to the date the collateral
was surrendered by the stockholder in payment of the note. Headwaters
recorded an allowance against the full amount of the new note receivable
and related accrued interest due to substantial uncertainty of both the
collectibility of the new note and the value of the new collateral. In
October 2001, a $750,000 payment was received on the new promissory note,
which amount, along with certain other assets, was accepted as full
satisfaction of the new promissory note. The $750,000 gain on this
transaction will be recognized in the December 2001 quarter. Due to
substantial uncertainty regarding both value and realization, Headwaters
recorded the other assets obtained in that transaction at $0.
7. Liabilities
Other Accrued Liabilities - Other accrued liabilities consisted of the
following at September 30:
(thousands of dollars) 2000 2001
-------------------------------------------------------------------------------------------------------
Chemical costs not yet invoiced $ 552 $ 877
Accrued costs related to HTI acquisition -- 777
Accrued royalties due to third parties 215 725
Commitment to a feed stock supplier for a licensee's alternative fuel
facility 784 576
Contingent liability arising from the 1999 sale of an alternative fuel
facility 800 --
Estimated costs to settle long-term contractual obligations 407 --
Other 1,028 2,032
-------------------------
$3,786 $ 4,987
=========================
Notes Payable and Other Short-term Borrowings - Notes payable and other
borrowings consist of the following at September 30:
(thousands of dollars) 2000 2001
-------------------------------------------------------------------------------------------------------
Short-term borrowings from an investment company, bearing interest
at a floating rate (4.1% at September 30, 2001), collateralized by
investments with the investment company with a carrying value of
approximately $5,700. $ -- $ 4,095
Note payable to a bank, bearing interest at prime plus 2%, repaid with
proceeds from a line of credit with this bank obtained in October 2000
(see Note 6). 3,000 --
Note payable to a corporation, bearing interest at 6%, repaid with proceeds
from a bank line of credit obtained in October 2000 (see Note 6). 1,838 --
Other 425 410
-------------------------
5,263 4,505
Less: current portion (208) (4,356)
-------------------------
Total non-current $5,055 $ 149
=========================
F-16
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
7. Liabilities, continued
Interest Rates and Debt Maturities - The weighted-average interest rate on
notes payable and other short-term borrowings was 9.7% at September 30,
2000 and 4.7% at September 30, 2001. Future maturities of notes payable and
short-term borrowings as of September 30, 2001 are as follows:
(thousands of
Year ending September 30, dollars)
-------------------------- ---------------------
2002 $4,356
2003 78
2004 30
2005 12
2006 13
Thereafter 16
---------------------
Total $4,505
=====================
Interest Costs - During 1999, Headwaters incurred total interest costs of
approximately $6,253,000, including approximately $2,075,000 of non-cash
interest expense resulting from amortization of debt discount and debt
issuance costs. During 2000, Headwaters incurred total interest costs of
approximately $4,814,000, including approximately $3,034,000 of non-cash
interest expense resulting from amortization of debt discount and debt
issuance costs. During 2001, Headwaters incurred total interest costs of
approximately $224,000, including approximately $79,000 of non-cash
interest expense resulting from amortization of debt discount and debt
issuance costs. No interest costs were capitalized in any of these years.
8. Notes and Interest Receivable - Related Parties, Collateralized by Common
Stock
As of September 30, 2000, notes and interest receivable - related parties,
collateralized by common stock, consisted of a collateral-based note
receivable from a stockholder with a carrying value of approximately
$466,000 and a $5,000,000 face amount, bearing interest at 6%. The note was
collateralized by 150,000 shares of Headwaters' common stock and options to
acquire 25,000 shares of Headwaters' common stock, which collateral, along
with a new note receivable, was accepted as satisfaction of the note in
2001, all as described in more detail in Note 6. Interest income of
approximately $515,000 was recognized in both 1999 and 2000 based on cash
payments received. No interest income was recognized in 2001.
In 2000, Headwaters entered into termination agreements with certain then
current and former officers and employees having notes and interest payable
to Headwaters totaling approximately $6,164,000. The agreements called for
the cancellation of the outstanding balances under the notes, including
interest, in exchange for the surrender and cancellation of the outstanding
shares of common stock collateralizing the notes. These transactions
resulted in the cancellation of approximately 812,000 shares of common
stock and the recognition of a loss of approximately $219,000, which amount
represents the interest recognized on the notes in prior periods.
9. Stock Options and Warrants
Stock Options - As of September 30, 2001, Headwaters had one stock option
plan (the "Option Plan") under which 2,400,000 shares of common stock are
reserved for ultimate issuance. As of September 30, 2001 options for
approximately 150,000 shares of common stock can be granted under the Plan.
A committee of Headwaters' Board of Directors, or in its absence the Board
(the "Committee"), administers and interprets the Option Plan. This
Committee is authorized to grant options and other awards both under the
terms of the Option Plan and outside the Option Plan to eligible employees,
officers, directors, and consultants of Headwaters. The Option Plan
provides for the granting of both incentive stock options and non-statutory
stock options. Terms of options granted under the Option Plan, including
vesting requirements, are determined by the Committee. Options granted
under the Option Plan vest over periods ranging up to ten years, expire ten
years from the date of grant and are not transferable other than by will or
by the laws of descent and distribution. Incentive stock option grants must
meet the requirements of the Internal Revenue Code.
Headwaters has elected to continue to apply Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related interpretations in accounting for options granted to employees and
directors. The alternative fair value method of accounting prescribed by
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"),
requires the use of option valuation models that were not developed for use
in valuing employee stock options, as discussed below. Under APB 25, no
compensation expense is recognized for stock option grants to employees,
officers and directors when the exercise price of stock options equals or
exceeds the market price of Headwaters' common stock on the date of grant.
F-17
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
9. Stock Options and Warrants, continued
When options are issued with terms considered compensatory, the related
compensation expense is amortized to expense over the specified vesting
period on a straight-line basis. There was no deferred compensation related
to options granted in 1999, 2000 or 2001. The amortized compensation
expense related to compensatory options granted in prior years was
approximately $2,553,000, $707,000 and $93,000 for 1999, 2000 and 2001,
respectively.
If Headwaters had elected to account for options granted based on their
fair value, as prescribed by SFAS 123, net income (loss) and income (loss)
per share would have been changed to the pro forma amounts shown in the
table below:
(thousands of dollars, except per-share data) 1999 2000 2001
-------------------------------------------------- --------- -------- ---------
Net income (loss) attributable to
common stockholders -- reported (29,704) $3,246 $21,404
-- pro forma (32,969) 1,532 18,944
Basic income (loss) per share -- reported (2.39) 0.17 0.94
-- pro forma (2.65) 0.08 0.83
Diluted income (loss) per share -- reported (2.39) 0.15 0.87
-- pro forma (2.65) 0.08 0.77
The fair value of each stock option grant was determined using the
Black-Scholes option pricing model and the following assumptions: expected
stock price volatility of 50% to 85%, risk-free interest rates ranging from
3.8% to 7.8%, weighted average expected option lives of 2 to 10 years and
no dividend yield. The Black-Scholes option valuation model was developed
for use in estimating the fair value of traded options which have no
vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions
including expected stock price volatility. Because Headwaters' stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair value, in management's opinion, the existing
models do not necessarily provide a reliable measure of the fair value of
stock options.
The following table is a summary of activity for all of Headwaters' stock
options, including options not granted under the Option Plan, for the years
ended September 30:
----------------------- ---------------------- -----------------------
1999 2000 2001
----------------------- ---------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(thousands of shares) Shares Price Shares Price Shares Price
---------------------------------------- ----------- ----------- ---------- ----------- ----------- -----------
Outstanding at beginning of year 2,370 $6.29 2,971 $6.18 3,822 $5.16
Granted 667 5.40 1,112 3.31 251 9.15
Granted in exchange for HTI options -- -- -- -- 144 0.07
Exercised (30) 1.50 (42) 1.50 (822) 2.42
Canceled (36) 2.34 (219) 10.37 (112) 8.42
----------- ----------- ---------- ----------- ----------- -----------
Outstanding at end of the year 2,971 $6.18 3,822 $5.16 3,283 $5.80
=========== =========== ========== =========== =========== ===========
Exercisable at end of year 1,801 $5.23 2,201 $5.29 2,171 $5.70
=========== =========== ========== =========== =========== ===========
Weighted average fair value of
options granted during the year
below market none none $9.18
Weighted average fair value of options
granted during the year at market $2.94 $1.09 $5.20
Weighted average fair value of options
granted during the year above market $0.67 $1.19 none
F-18
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
9. Stock Options and Warrants, continued
The following table summarizes information about all stock options
outstanding at September 30, 2001:
(thousands of shares) Options Outstanding Options Exercisable
---------------------- ----------------------------------------------- -----------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable at Average
Range of Exercise September 30, Contractual Life Exercise September 30, Exercise
Prices 2001 in Years Price 2001 Price
---------------------- ----------------- ----------------- ----------- --------------- -------------
$0.01 to $1.50 779 4.3 $ 1.23 568 $ 1.14
$2.00 to $5.88 1,435 5.2 4.28 930 4.28
$8.00 to $9.09 442 6.6 8.71 200 8.25
$11.00 to $13.56 627 6.3 12.89 473 12.93
----------------- ---------------
3,283 2,171
================= ===============
Common Stock Warrants - As of September 30, 2001, there were warrants
outstanding for the purchase of approximately 684,000 shares of common
stock at prices ranging from $1.32 to $3.84 per share and with expiration
dates ranging from October 2001 to April 2005. All of these warrants were
issued in connection with private placements of common and preferred stock
or debt during 1999 and 2000.
10. Fair Value of Financial Instruments
Substantially all of Headwaters' financial instruments (consisting of cash
and cash equivalents, short-term investments, trade and notes receivable,
accounts payable, and notes payable) are either carried at fair value as of
the balance sheet date or are of a short-term nature. Accordingly, while
the fair values of some of the individual financial instruments vary
somewhat from their carrying values, the aggregate carrying values as
reflected in the consolidated financial statements for 2000 and 2001
approximated fair value.
11. Income Taxes
Headwaters had no income tax provision or benefit in 1999 because of its
net operating loss position. In 2000, Headwaters reported a net income tax
benefit of $2,900,000, consisting of the recognition of $3,000,000 of its
deferred tax asset, reduced by $100,000 of federal alternative minimum tax.
In 2001, Headwaters reported a net income tax benefit of $7,049,000,
consisting of the recognition of $7,470,000 of its deferred tax asset,
reduced by $100,000 of federal alternative minimum tax and $321,000 of
current state income tax expense.
As of September 30, 2001, Headwaters had net operating loss carryforwards
of approximately $24,000,000 which can be used to offset future taxable
income. The net operating loss carryforwards expire from 2017 to 2021.
Headwaters also has approximately $220,000 in research and development tax
credit carryforwards which can be used to offset future tax liabilities.
The tax credit carryforwards expire from 2007 to 2016. The utilization of
HTI's acquisition date operating loss carryforwards (totaling approximately
$2,800,000) against future taxable income is subject to an annual
limitation of approximately $800,000 due to the change in ownership of HTI.
The provision for income taxes differs from the statutory federal income
tax rate due to the following:
(thousands of dollars) 1999 2000 2001
--------------------------------------------------------- ------------- ------------- -------------
Tax provision (benefit) at statutory rate $(9,653) $ 274 $ 5,064
Change in valuation allowance 10,600 (10,400) (14,200)
Alternative minimum tax -- 100 100
State income taxes, net of federal tax effect (936) 25 470
Acquired in-process research and development -- -- 918
Other, primarily redetermination of prior years' tax estimates (11) 7,101 599
------------- ------------- -------------
Income tax provision (benefit) $ 0 $(2,900) $(7,049)
============= ============= =============
F-19
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
11. Income Taxes, continued
The components of the net deferred tax assets were as follows as of
September 30:
(thousands of dollars ) 2000 2001
----------------------------------------------------------------------- ------------ --------------
Net operating loss carryforwards $ 11,300 $ 9,120
Research and development tax credit carryforwards 200 220
License fee revenue recognition 3,900 2,640
Write-down of related party note receivable 1,100 720
Estimated liabilities 300 410
Other, net 400 50
------------ --------------
Total deferred tax assets 17,200 13,160
Valuation allowance (14,200) --
------------ --------------
Net deferred tax assets $ 3,000 $13,160
============ ==============
The valuation allowance increased by $10,600,000 during 1999, decreased by
$10,400,000 during 2000, and decreased by $14,200,000 during 2001. A
valuation allowance is provided if it is more likely than not that some
portion or all of a deferred tax asset will not be realized. Based
primarily on results of operations in 2001 and expected future results of
operations, Headwaters determined that as of September 30, 2001, it is more
likely than not that its deferred tax assets will be realized and the
valuation allowance was reduced.
12. Basic and Diluted Income Per Share
The following table sets forth the computation of basic and diluted income
(loss) per share.
(thousands of dollars and shares, except per-share data) 1999 2000 2001
---------------------------------------------------------- ------------- ------------ ------------
Numerator:
Income (loss) before extraordinary item $(28,393) $11,542 $21,517
Extraordinary item -- (7,860) --
------------- ------------ ------------
Net income (loss) (28,393) 3,682 21,517
Preferred stock dividends (undeclared) (466) (378) (113)
Imputed preferred stock dividends (845) (58) --
------------- ------------ ------------
Numerator for basic earnings per share -- net income
(loss) attributable to common stockholders (29,704) 3,246 21,404
Effect of dilutive securities - preferred stock dividends -- 139 113
------------- ------------ ------------
Numerator for diluted earnings per share - net income
(loss) attributable to common stockholders after assumed
conversions $(29,704) $ 3,385 $21,517
============= ============ ============
Denominator:
Denominator for basic earnings per share -
weighted-average shares outstanding 12,418 19,468 22,787
Effect of dilutive securities:
Shares issuable upon exercise of options and warrants -- 391 1,582
Shares issuable upon conversion of preferred stock -- 2,376 268
------------- ------------ ------------
Total dilutive potential shares -- 2,767 1,850
------------- ------------ ------------
Denominator for diluted earnings per share -- weighted
- average shares outstanding after assumed exercises
and conversions 12,418 22,235 24,637
============= ============ ============
Basic earnings per share:
Income (loss) before extraordinary item $ (2.39) $ 0.57 $ 0.94
Extraordinary item -- (0.40) --
------------- ------------ ------------
Net income (loss) per common share $ (2.39) $ 0.17 $ 0.94
============= ============ ============
Diluted earnings per share:
Income (loss) before extraordinary item $ (2.39) $ 0.50 $ 0.87
Extraordinary item -- (0.35) --
------------- ------------ ------------
Net income (loss) per common share $ (2.39) $ 0.15 $ 0.87
============= ============ ============
F-20
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
12. Basic and Diluted Income Per Share, continued
During the periods presented, Headwaters' potentially dilutive securities
consisted of options and warrants for the purchase of common stock,
convertible debt and convertible preferred stock. For 1999, all potentially
dilutive securities were anti-dilutive and were not considered in the
calculation of diluted earnings per share. For 2000, some options and
warrants and certain convertible preferred stock were dilutive, but all
other potentially dilutive securities were anti-dilutive and were not
considered in the calculation. For 2001, most options and warrants and all
of the then outstanding preferred stock were dilutive and were considered
in the calculation. Anti-dilutive securities not considered in the diluted
earnings per share calculation totaled approximately 6,750,000 shares in
2000 and approximately 1,375,000 shares in 2001. Imputed preferred stock
dividends were calculated based upon the amount by which the price of
Headwaters' common stock exceeded the conversion price at the date
convertible preferred shares were issued.
13. Purchase of Limited Partners' Interests in Subsidiaries
In September 1998, Headwaters formally offered the limited partners in its
two consolidated subsidiaries, Utah Synfuel #1 and Alabama Synfuel #1, an
exchange of Headwaters' common stock for their limited partnership
interests. During September through November 1998, all but one of the
limited partners exchanged their interests and Utah Synfuel #1 became a
wholly-owned subsidiary of Headwaters and Alabama Synfuel #1 became a
98%-owned subsidiary of Headwaters. Approximately 610,000 shares of common
stock were issued in these transactions. In 2000, Headwaters reached an
agreement settling several outstanding issues with the remaining limited
partner of Alabama Synfuel #1 following which Alabama Synfuel #1 became a
wholly-owned subsidiary of Headwaters. The carrying value of the intangible
assets recorded in the exchange transactions, net of accumulated
amortization, was approximately $464,000 at September 30, 2000 and
approximately $400,000 at September 30, 2001 (see Note 15).
14. Sale of Facilities
Headwaters' business plan through 2000 called for the construction and sale
of alternative fuel manufacturing facilities and the licensing of
Headwaters' technology to facility purchasers to generate ongoing
royalties. In 1999, Headwaters sold a facility located in Pennsylvania on
which a loss of approximately $1,839,000 was recognized. Headwaters
remained contingently liable for $800,000 of the facility debt which
contingent liability was originally recorded in other accrued liabilities
(see Note 7), but which was recognized as income in 2001 due to the
elimination of the contingency. Headwaters also entered into an agreement
under which it operates this facility on behalf of the owner. In 2000, upon
achieving specified operating performance milestones, Headwaters received
additional cash payments related to the sale of this facility. The cash
proceeds from these payments, net of obligations to third parties,
approximated $7,377,000. Of the net amount received, Headwaters recognized
$4,400,000 as revenue because there were no ongoing obligations associated
with those payments. Headwaters deferred the recognition of $2,977,000,
which amount was characterized as prepaid royalties. This amount is being
recognized as revenue on a straight-line basis through December 2007.
In 2000, Headwaters sold the three remaining alternative fuel facilities it
owned plus an option to acquire a licensee facility. One of these sold
facilities was located in Utah, two of these facilities were located in
West Virginia, and the facility under option was located in Nevada.
Headwaters reported net gains on these transactions totaling approximately
$12,470,000. Headwaters also entered into its standard supply agreements
with the new owners of the facilities to sell proprietary chemical material
used at the facilities and receives ongoing royalties based upon the sale
of alternative fuel from the facilities.
15. Gains on Other Transactions, Asset Write-offs and Other Charges, and
Extraordinary Item
Gains on Other Transactions - During 2000, Headwaters recorded other gains
of approximately $1,079,000 related to the satisfaction of a contingent
contract liability ($755,000) and the gain recognized on a note receivable
transaction.
1999 Asset Write-offs and Other Charges - In 1999, certain assets,
primarily consisting of leasehold improvements on the property where a
small alternative fuel facility was located, were abandoned. The carrying
value of these assets, totaling approximately $556,000, was written off
during 1999. Based on the uncertainty of recovering certain advances on
coal fine inventories paid from 1997 through May 1999, Headwaters wrote off
$3,677,000 of advances on inventories in 1999. In addition, Headwaters
wrote off a $660,000 note receivable and recorded a liability for
approximately $469,000 related to a settlement agreement with a company
that had provided Headwaters with advice with respect to the use of certain
alternative fuel technology, certain financing obtained and the sale of
certain alternative facilities. Finally, Headwaters recorded approximately
$2,033,000 of non-cash, incremental amortization of deferred compensation
from stock options, resulting from the termination of employees whose stock
options became fully vested upon termination. All of these 1999 write-offs
and provisions totaled approximately $7,395,000, which amount is recorded
as asset write-offs and other charges in the consolidated statement of
operations. Of this amount, approximately $5,362,000 represented non-cash
expenses.
F-21
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
15. Gains on Other Transactions, Asset Write-offs and Other Charges, and
Extraordinary Item, continued
2000 Asset Write-offs and Other Charges - In 2000, Headwaters recorded an
impairment charge of approximately $14,804,000 related to assets located in
Utah and Alabama. This impairment charge consisted of an approximate
$12,615,000 write-down to net realizable value of certain plant and
equipment which remained on the sites when the facilities were sold and was
idled, plus an approximate $2,189,000 write-off of an intangible asset
which was no longer considered recoverable due to the relocation of a
licensee facility. Headwaters also recorded employee severance and other
non-cash charges from incremental amortization of deferred compensation
from stock options (resulting from the termination of employees whose stock
options became fully vested upon termination) totaling approximately
$1,443,000. Other settlement charges ($979,000) and asset write-downs
($532,000) were recorded in 2000. All of these asset write-offs and other
charges totaled approximately $17,758,000. Of this amount, approximately
$15,485,000 represented non-cash expenses.
Extraordinary Loss - In 2000, Headwaters redeemed all of its remaining
convertible debt. The redemption consideration and early prepayment costs
included approximately $7,037,000 in cash plus the issuance of
approximately 214,000 shares of common stock. The loss recognized as a
result of the total redemption consideration paid plus the acceleration of
amortization of the unamortized debt discount and debt issuance costs in
excess of the debt carrying value totaled approximately $7,860,000. This
loss is reflected as an extraordinary item in the consolidated statement of
operations.
16. Commitments and Contingencies
Commitments and contingencies as of September 30, 2001 not disclosed
elsewhere, are as follows:
Leases - Rental expense was approximately $1,309,000 in 1999, $255,000 in
2000 and $204,000 in 2001. Headwaters has noncancellable operating leases
for equipment and for real estate. At September 30, 2001, minimum rental
payments due under these leases are as follows:
Year ending September 30: (thousands of dollars)
----------------------------- -----------------------
2002 $221
2003 179
2004 139
2005 137
2006 44
Thereafter 12
-----------------------
$732
=======================
Employee Benefit Plans - In 2000, Headwaters' Board of Directors approved
three employee benefit plans, the Headwaters Incorporated 401(k) Profit
Sharing Plan, the 2000 Employee Stock Purchase Plan, and the Headwaters
Incorporated Incentive Bonus Plan. Under the terms of the 401(k) Plan,
employees may elect to make tax-deferred contributions of up to 15% of
their compensation, subject to statutory limitations. Headwaters matches
employee contributions up to a specified maximum rate, which matching
contributions vest over a three-year period. Headwaters is not required to
be profitable in order to make matching contributions.
The 2000 Employee Stock Purchase Plan provides eligible employees with an
opportunity to increase their proprietary interest in the success of
Headwaters by purchasing stock in Headwaters on favorable terms and to pay
for such purchases through payroll deductions. A total of 500,000 shares of
common stock are reserved for issuance under the Plan. Under the Plan,
employees purchase shares of stock directly from Headwaters, which shares
are made available primarily from treasury shares repurchased on the open
market or from authorized but unissued shares, if necessary. Headwaters'
current intent is to use shares being purchased on the open market to meet
these requirements. The Plan is intended to comply with Section 423 of the
Internal Revenue Code, but is not subject to the requirements of ERISA.
Employees purchase stock through payroll deductions of from 1% to 10% of
cash compensation, subject to certain limitations. The stock is purchased
in a series of quarterly offerings. The cost per share to the employee is
85% of the lesser of the fair market value at the beginning of the offering
period or the end of the offering period.
The Incentive Bonus Plan, approved annually by the compensation committee
of the board of directors, provides for annual cash bonuses to be paid if
Headwaters accomplishes certain financial goals and if employees meet
individual goals. A participant's cash bonus is based on Headwaters'
success in meeting or exceeding specified financial performance targets
established by the compensation committee, the employee's base pay, and
individual performance during the year. Headwaters' financial goals are
based upon an economic value added concept ("EVA") which purports to more
closely align with a company's share price performance than other
measurements of performance.
F-22
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
16. Commitments and Contingencies, continued
Substantially all employees of Headwaters are eligible to participate in
the 401(k) and Stock Purchase Plans after meeting certain age and length of
employment requirements. All employees, except those directly involved in
the operations of alternative fuel facilities owned by a licensee, are
eligible to participate in the Incentive Bonus Plan. Total expense for all
of the above plans was approximately $1,768,000 in 2000 and $2,082,000 in
2001.
Legal or Contractual Matters - Adtech. In October 1998, Headwaters entered
into a technology purchase agreement with James G. Davidson and Adtech,
Inc. The transaction transferred certain patent and royalty rights to
Headwaters related to an alternative fuel technology invented by Davidson.
(This technology is distinct from the technology developed by Headwaters.)
In September 2000, Headwaters received a summons and complaint from the
United States District Court for the Western District of Tennessee filed by
Adtech, Inc. against Davidson and Headwaters. In the action, certain
purported officers and directors of Adtech alleged that the technology
purchase transaction was an unauthorized corporate action and that Davidson
and Headwaters conspired together to effect the transfer. The complaint
asserted related causes of action and sought unspecified money damages and
other relief. In August 2001, the trial court granted Headwaters' motion to
dismiss the complaint. It is not known whether the plaintiffs will appeal.
Because resolution of the litigation is uncertain, legal counsel cannot
express an opinion as to the ultimate amount, if any, of Headwaters'
liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical sale agreement with AJG Financial Services, Inc. The
agreement called for AJG to pay royalties and to purchase proprietary
chemical material from Headwaters. In October 2000, Headwaters filed a
complaint in the Fourth District Court for the State of Utah against AJG
alleging that it had failed to make payments and to perform other
obligations under the agreement. Headwaters asserts claims including breach
of contract, declaratory judgment, unjust enrichment, and accounting and
seeks money damages in the amount of $750,000 plus other damages to be
proven at trial, as well as other relief. AJG's answer to the complaint
denied Headwaters' claims and asserted counter-claims based upon
allegations of misrepresentation and breach of contract. AJG seeks
unspecified compensatory damages as well as punitive damages. Headwaters
has denied the allegations of AJG's counter-claims. Because the litigation
is at an early stage and resolution is uncertain, legal counsel cannot
express an opinion as to the ultimate amount of recovery or liability.
Nalco. In October 2000, Headwaters filed a complaint in the United States
District Court for the District of Utah against Nalco Chemical Company
("Nalco"). Headwaters alleges that Nalco, by its sale and marketing of
materials for use in creating alternative fuel, breached a non-disclosure
agreement, misappropriated trade secrets, and violated patent rights of
Headwaters. Headwaters seeks by its complaint injunctive relief and damages
to be proven at trial. Because the litigation is at an early stage and
resolution is uncertain, legal counsel cannot express an opinion as to the
ultimate amount, if any, that might be recovered.
Headwaters is also involved in other legal proceedings that have arisen out
of the normal course of business. Management believes that many of these
other claims are without merit and in all cases intends to vigorously
defend its position. Management does not believe that the outcome of these
activities will have a significant effect upon the operations or the
financial position of Headwaters; however, it is possible that a change in
management's estimates of probable liability could occur and the change
could be significant.
Employment and Severance Agreements - Headwaters has entered into
employment agreements with its Chief Executive Officer and six other
officers, including three HTI officers. The agreements generally are
renewable by Headwaters and have original terms ranging from three to five
years. They provide for annual salaries and benefits ranging from
approximately $143,000 to $257,000 annually per officer. The annual
commitment under all Headwaters and HTI agreements combined is currently
approximately $1,278,000. All agreements provide for termination benefits,
ranging from at least six-month's salary, up to a maximum period equal to
the remaining term of the agreement. In addition to these employment
agreements, in connection with the acquisition of HTI and in accordance
with HTI's Change in Control Severance Plan, substantially all of HTI's
employees could potentially be eligible to receive continuation of salary
for certain periods of time following termination without cause, if such
termination occurs within six months after a change in control. Headwaters
does not currently expect to make any material payments under the terms of
this HTI plan.
17. Related Party Transactions
In addition to related party transactions disclosed elsewhere, Headwaters
purchases certain insurance benefits for its employees from various
companies for which a director of Headwaters acts as a broker or agent.
Gross payments to those insurance companies totaled approximately $374,000
in 1999, $361,000 in 2000 and $381,000 in 2001.
F-23
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
18. Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for 2000 and 2001 is as follows:
2000
----------------------------------------------------------------
First Second Third Fourth
(thousands of dollars, except per-share data) Quarter Quarter Quarter Quarter Full Year
---------------------------------------------- ----------- ------------ ------------ -------------- -----------
Net revenue $11,049 $7,899 $15,000 $11,887 $45,835
Gains on other transactions
included in net revenue (1) 5,341 481 8,527 3,600 17,949
Gross profit 8,533 5,761 12,157 8,412 34,863
Income (loss) before extraordinary item (1,926) 2,137 8,259 3,072 11,542
Net income (loss) (1,926) 314 2,222 3,072 3,682
Asset write-offs and other charges
included in net income (loss) (1) (11,021) (841) (1,559) (4,337) (17,758)
Basic net income (loss) per common share (2) (0.16) 0.01 0.09 0.13 0.17
Diluted net income (loss) per common share (2) (0.16) 0.01 0.09 0.12 0.15
2001
----------------------------------------------------------------
First Second Third Fourth
(thousands of dollars, except per-share data) Quarter Quarter Quarter Quarter (3) Full Year
---------------------------------------------- ----------- ------------ ------------ -------------- -----------
Net revenue $12,316 $9,754 $10,699 $12,695 $45,464
Gross profit 7,590 6,245 6,600 7,434 27,869
Net income (3) 5,406 4,576 4,956 6,579 21,517
Basic net income per common share 0.23 0.20 0.22 0.29 0.94
Diluted net income per common share 0.22 0.19 0.20 0.26 0.87
(1) Gains on other transactions and asset write-offs and other charges are more
fully described in Notes 14 and 15.
(2) In accordance with SFAS No. 128, "Earnings Per Share," net income (loss) per
common share is computed independently for each of the quarters presented
and the sum of the quarterly computations does not equal the total computed
for the year.
(3) In the fourth quarter of 2001, Headwaters recognized approximately
$7,470,000 of its deferred tax asset (see Note 11), recorded losses totaling
approximately $3,812,000 related to write-offs of notes receivable and
losses on equity investments (see Note 2), and recorded $2,400,000 of
expense related to in-process research and development purchased in the HTI
acquisition (see Note 3).
F-24