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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
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)
Not applicable
---------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 [ ]
The number of shares outstanding of the Registrant's common stock as of July 31,
2002 was 25,181,296.
HEADWATERS INCORPORATED
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (Unaudited):
Condensed Consolidated Balance Sheets - As of
September 30, 2001 and June 30, 2002 ...........................3
Condensed Consolidated Statements of Income - For the
three and nine months ended June 30, 2001 and 2002 .............5
Condensed Consolidated Statement of Changes in
Stockholders' Equity - For the nine months ended
June 30, 2002...................................................6
Condensed Consolidated Statements of Cash Flows - For the
nine months ended June 30, 2001 and 2002........................7
Notes to Condensed Consolidated Financial Statements ............8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.............................14
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......19
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ..............................................19
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS ......................19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ................................20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ............20
ITEM 5. OTHER INFORMATION...............................................20
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ...............................20
SIGNATURES....................................................................22
Forward Looking Statements
Statements in this Form 10-Q, 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 Part I, Item 2 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.
2
ITEM 1. FINANCIAL STATEMENTS
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
(thousands of dollars) 2001 2002
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 999 $ 4,336
Short-term investments 6,048 24,894
Trade receivables, net 8,887 21,650
Short-term notes and accrued interest receivable 6,857 501
Other current assets 1,257 1,719
---------------- -----------------
Total current assets 24,048 53,100
---------------- -----------------
Property, plant and equipment, net 2,680 2,798
---------------- -----------------
Other assets:
Notes and accrued interest receivable 4,000 5,584
Intangible assets, net 10,752 14,399
Deferred income taxes 13,090 1,049
Other assets 805 4,179
---------------- -----------------
Total other assets 28,647 25,211
---------------- -----------------
Total assets $ 55,375 $ 81,109
================ =================
The accompanying notes are an integral
part of the consolidated financial statements.
3
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, June 30,
(thousands of dollars and shares, except per-share data) 2001 2002
- -------------------------------------------------------------------------------------------- --------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,203 $ 2,772
Accrued personnel costs 2,777 4,314
Other accrued liabilities 4,987 7,633
Current portion of unamortized non-refundable license fees 1,106 2,866
Notes payable, current and other short-term borrowings 4,356 81
--------------- ----------------
Total current liabilities 15,429 17,666
--------------- ----------------
Long-term liabilities:
Notes payable, non-current 149 88
Other long-term liabilities 2,906 297
Unamortized non-refundable license fees 5,805 5,305
--------------- ----------------
Total long-term liabilities 8,860 5,690
--------------- ----------------
Total liabilities 24,289 23,356
--------------- ----------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 23,807 shares at September 30, 2001 (including 548 shares
held in treasury) and 25,177 shares at June 30, 2002 (including 533 shares
held in treasury) 24 25
Capital in excess of par value 83,226 92,902
Accumulated deficit (48,704) (31,782)
Other, primarily treasury stock (3,460) (3,392)
--------------- ----------------
Total stockholders' equity 31,086 57,753
--------------- ----------------
Total liabilities and stockholders' equity $ 55,375 $ 81,109
=============== ================
The accompanying notes are an integral
part of the consolidated financial statements.
4
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended June 30, Nine Months Ended June 30,
--------------------------------- --------------------------------
(thousands of dollars, except per-share data) 2001 2002 2001 2002
- --------------------------------------------------------------- ----------------- --------------- ---------------- ---------------
Revenue:
License fees $ 4,336 $ 8,822 $ 15,770 $ 21,263
Chemical reagent sales 5,777 22,234 15,432 49,521
Service revenue 267 559 763 3,758
Other 319 353 803 1,104
----------------- --------------- ---------------- ---------------
Total revenue 10,699 31,968 32,768 75,646
----------------- --------------- ---------------- ---------------
Operating costs and expenses:
Cost of chemical reagents 3,610 14,880 9,889 33,749
Cost of operations 489 2,817 2,446 7,972
Research and development -- 630 -- 1,828
Selling, general and administrative 730 2,726 3,828 6,566
----------------- --------------- ---------------- ---------------
Total operating costs and expenses 4,829 21,053 16,163 50,115
----------------- --------------- ---------------- ---------------
Operating income 5,870 10,915 16,605 25,531
----------------- --------------- ---------------- ---------------
Other income (expense):
Interest and net investment income 170 429 511 432
Interest expense (33) (12) (179) (68)
Other, net (1,033) (46) (1,859) 2,047
----------------- --------------- ---------------- ---------------
Total other income (expense), net (896) 371 (1,527) 2,411
----------------- --------------- ---------------- ---------------
Income before income taxes 4,974 11,286 15,078 27,942
Income tax provision (18) (4,550) (140) (11,020)
----------------- --------------- ---------------- ---------------
Net income $ 4,956 $ 6,736 $ 14,938 $ 16,922
================= =============== ================ ===============
Basic net income per common share $ .22 $ .27 $ .65 $ .70
================= =============== ================ ===============
Diluted net income per common share $ .20 $ .26 $ .61 $ .66
================= =============== ================ ===============
The accompanying notes are an integral
part of the consolidated financial statements.
5
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended June 30, 2002 (Unaudited)
Other
----------------------------
Deferred Common
Common Stock Capital in compensation stock held
------------------- excess Accumulated related to in
(thousands of dollars and shares) Shares Amount of par value deficit stock options treasury
- -------------------------------------------------------------- ------------------------- ------------- -------------- -------------
Balances as of September 30, 2001 23,807 $24 $83,226 $(48,704) $(422) $(3,038)
Exercise of stock options and warrants 1,265 1 5,096
Tax benefit from exercise of stock options 2,680
Common stock issued in connection with purchase of
Hydrocarbon Technologies, Inc. 178 -- 2,823
Amortization of deferred compensation related to
stock options 70
Purchase of 83 shares of treasury stock, at cost (1,188)
26 shares of treasury stock transferred to employee
stock purchase plan 164 99
Cancellation of 73 shares of treasury stock (73) (1,087) 1,087
Net income 16,922
--------------------------------------------------------------------------------
Balances as of June 30, 2002 25,177 $25 $92,902 $(31,782) $(352) $(3,040)
================================================================================
The accompanying notes are an integral
part of the consolidated financial statements.
6
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended June 30,
----------------------------
(thousands of dollars) 2001 2002
- ------------------------------------------------------------------------------------------------- -------------- -------------
Cash flows from operating activities:
Net income $ 14,938 $ 16,922
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes -- 10,811
Amortization of non-refundable license fees (1,739) (848)
Depreciation and amortization 196 1,000
Net gain on disposition of property, plant and equipment (42) (1,283)
Losses in equity investments, write-offs and provisions for unrealizable investments 1,428 --
Write-down of note receivable and related accrued interest 1,025 --
Write-up of related party note receivable (541) --
Other changes in operating assets and liabilities (1,317) (6,953)
-------------- -------------
Net cash provided by operating activities 13,948 19,649
-------------- -------------
Cash flows from investing activities:
Additional cash payment for acquisition of Hydrocarbon Technologies, Inc. -- (419)
Payments on notes receivable -- 6,877
Net purchases of short-term investments -- (18,846)
Net proceeds from sale of short-term investments 1,766 --
Net proceeds from disposition of property, plant and equipment 42 115
Purchase of property, plant and equipment (148) (457)
Investments in and loans to non-affiliated companies (4,562) --
Net increase in other assets (527) (3,418)
-------------- -------------
Net cash used in investing activities (3,429) (16,148)
-------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and other borrowings 8,148 2,056
Payments on notes payable and other borrowings (12,650) (6,392)
Proceeds from exercise of options and warrants 1,708 5,097
Purchase of common stock for the treasury, net of employee stock purchases (7,795) (925)
Preferred stock dividends (695) --
-------------- -------------
Net cash used in financing activities (11,284) (164)
-------------- -------------
Net increase (decrease) in cash and cash equivalents (765) 3,337
Cash and cash equivalents, beginning of period 983 999
-------------- -------------
Cash and cash equivalents, end of period $ 218 $ 4,336
============== =============
Supplemental schedule of non-cash investing and financing activities:
Additional shares of common stock issued in connection with acquisition of
Hydrocarbon Technologies, Inc. $ -- $ 2,823
Income tax benefit from exercise of stock options -- 2,680
Cancellation of treasury stock (5,846) (1,087)
Common stock issued on conversion of convertible preferred stock and in
payment of dividends 3,100 --
The accompanying notes are an integral
part of the consolidated financial statements.
7
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
1. Nature of Operations and Basis of Presentation
-----------------------------------------------
Operations - Headwaters Incorporated through its subsidiaries is a world
leader in commercializing technologies that enhance the fuel value of coal,
gas and oil. Operations currently focus on the application of proprietary
technologies in the production of a coal-based solid alternative fuel.
Headwaters currently has royalty agreements with 28 alternative fuel
facilities which are operating at various levels of production in ten
states. In addition to royalty revenues, Headwaters also sells its
proprietary chemical reagents essential to the production of solid
alternative fuels both to its licensee plants and to other customers.
Technology development activities focus primarily on converting coal, gas
and heavy oils into ultra-clean liquid fuels. In August 2001, Headwaters
acquired 100% of Hydrocarbon Technologies, Inc. ("HTI"), a New Jersey
company that has significant intellectual property, including technologies
to transform coal and heavy oil into ultra-clean diesel fuel, recycle waste
oil into higher value carbon products, and nano-catalyst technology.
Headwaters seeks to identify and analyze acquisition opportunities that
strengthen and fortify its position as a leading value enhancer to energy.
As more fully described in Note 7, in July 2002, Headwaters announced that
it has agreed to acquire Industrial Services Group, Inc. ("ISG"), including
its subsidiary ISG Resources, Inc. ISG is the largest manager and marketer
of coal combustion products, particularly high quality fly ash, a
substitute for cement in the production of concrete, in the United States.
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with the rules and
regulations of the Securities and Exchange Commission ("SEC") for quarterly
reports on Form 10-Q. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included, and except
for the transactions disclosed in Note 2, consist of normal recurring
adjustments. During the nine-month period ended June 30, 2002, a gain was
recorded on the sale of a 50% interest in one of Headwaters' original
alternative fuel facilities. This gain was $1,342,000 and is included in
other income in the consolidated statement of income.
The results of operations for the three- and nine-month periods ended June
30, 2002 are not necessarily indicative of the results to be expected for
the full fiscal 2002 year. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in Headwaters' Annual Report on Form 10-K/A for the year ended
September 30, 2001 ("Form 10-K") and in Headwaters' Quarterly Reports on
Form 10-Q for the quarters ended December 31, 2001 and March 31, 2002.
HTI - As more fully described in the notes to the consolidated financial
statements in the Form 10-K, HTI's financial statements are consolidated
with Headwaters' financial statements using a one-month lag. Accordingly,
HTI's May 31, 2002 balance sheet has been consolidated with Headwaters'
June 30, 2002 balance sheet, and HTI's results of operations for the period
from date of acquisition (August 28, 2001) to May 31, 2002 have been
consolidated with Headwaters' results for the nine months ended June 30,
2002. The $501,000 short-term note receivable in the June 30, 2002 balance
sheet represents the portion of the intercompany note receivable due from
HTI not eliminated in consolidation.
HTI develops and commercializes catalysts and catalytic processes for
producing chemicals and converting low-value fossil fuels into high-value
alternative fuels. HTI's revenue consists primarily of contract services
for businesses and the US Department of Energy and is included in the
caption "Service revenue" in the consolidated statements of income for the
three- and nine-month periods ended June 30, 2002. HTI's costs related to
service revenue are included in cost of operations for the respective
periods. In accounting for long-term contracts, HTI primarily uses the
percentage of completion method of accounting, on the basis of the
relationship between effort expended and total estimated effort for the
contract. If estimates of costs to complete a contract indicate a loss, a
provision is made for the total anticipated loss. Included in cost of
operations for the three- and nine-month periods ended June 30, 2002 is
$162,000 and $485,000, respectively, of amortization expense related to the
identifiable intangible assets recorded as part of the HTI acquisition.
8
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
2. HTI Transactions Subsequent to Acquisition
------------------------------------------
Adjustment to Purchase Price Allocation - During the quarter ended March
31, 2002, in connection with the preparation of Headwaters' and HTI's
consolidated income tax returns for the year ended September 30, 2001,
Headwaters finalized its analysis of HTI's differences between book and tax
reporting and HTI's net operating loss carryforwards as of the acquisition
date. Based on this analysis, Headwaters adjusted the HTI purchase price
allocation to record additional deferred tax assets of $510,000 and
additional deferred tax liabilities of $4,240,000, eliminated a $2,714,000
contingent liability and recorded goodwill of $1,016,000.
Contingent Consideration - In accordance with the original HTI acquisition
agreements, additional contingent consideration could be earned by the
former HTI stockholders during calendar 2002 based on the attainment of
certain operating targets and other milestones. In April 2002, Headwaters
and the former HTI stockholders agreed to an amendment of the acquisition
agreements and reached a final settlement of all outstanding contingent
payments. Headwaters paid the former HTI stockholders additional
consideration with a value totaling $3,242,000. The consideration consisted
of cash of $419,000 and the issuance of approximately 178,000 shares of
Headwaters common stock valued at $2,823,000. This transaction resulted in
an increase in goodwill by the total value of the consideration of
$3,242,000. The value of the 178,000 shares of 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
settlement was reached and one day prior to and one day subsequent to that
day.
Goodwill and Intangible Assets - Full implementation of SFAS No. 142,
"Accounting for Goodwill and Intangible Assets," will require certain
additional disclosures regarding HTI's identified intangible assets and
goodwill beginning October 1, 2002. In addition, SFAS No. 142, when fully
implemented in fiscal 2003, will require Headwaters to review for
impairment those intangible assets and goodwill in accordance with the
requirements of SFAS No. 142 instead of following the existing rules for
impairment testing. The new rules require, among other things, that
goodwill be tested for impairment at least annually using a two-step
process that begins with an estimation of the fair value of the reporting
unit giving rise to the goodwill. Headwaters currently believes the
HTI-related identifiable assets and goodwill are not impaired under either
the existing rules for testing impairment, nor under the new rules required
by SFAS No. 142. In addition, Headwaters believes the original estimated
useful life of 15 years assigned to HTI's identified intangible assets is
appropriate.
Restructuring - In March 2002, $500,000 of HTI restructuring costs were
accrued. These costs are related to a cost reduction plan approved in March
2002 and implemented during March and early April 2002. The plan calls for,
among other cost cutting measures, a reduction in personnel from a cross
section of HTI's departments. All of the identified employees, comprising
approximately 25% of HTI's total workforce prior to implementation of the
plan, were terminated effective April 4, 2002. Actual costs paid to
implement the cost reduction plan through July 31, 2002 total approximately
$325,000, with an estimated $175,000 of costs to be paid during the
remainder of calendar 2002.
3. Basic and Diluted Earnings per Share
------------------------------------
Three Months Ended June 30, Nine Months Ended June 30,
(thousands of dollars and shares, except per-share data) 2001 2002 2001 2002
-------------------------------------------------------------- --------------- -------------- -------------- --------------
Numerator:
Net income $ 4,956 $ 6,736 $ 14,938 $ 16,922
Preferred stock dividends (undeclared) (19) -- (113) --
--------------- -------------- -------------- --------------
Numerator for basic earnings per share -- net income
attributable to common stockholders 4,937 6,736 14,825 16,922
Effect of dilutive securities - preferred stock dividends 19 -- 113 --
--------------- -------------- -------------- --------------
Numerator for diluted earnings per share -- net income
attributable to common stockholders after assumed conversions $ 4,956 $ 6,736 $ 14,938 $ 16,922
=============== ============== ============== ==============
9
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
Denominator:
Denominator for basic earnings per share -- weighted-average
shares outstanding 22,730 24,506 22,723 24,007
Effect of dilutive securities:
Shares issuable upon exercise of options and warrants 2,220 1,512 1,445 1,555
Shares issuable upon conversion of preferred stock 187 -- 357 --
--------------- -------------- -------------- --------------
Total dilutive potential shares 2,407 1,512 1,802 1,555
--------------- -------------- -------------- --------------
Denominator for diluted earnings per share -- weighted-average
shares outstanding after assumed exercises and conversions 25,137 26,018 24,525 25,562
=============== ============== ============== ==============
Basic net income per share $ 0.22 $ 0.27 $ 0.65 $ 0.70
=============== ============== ============== ==============
Diluted net income per share $ 0.20 $ 0.26 $ 0.61 $ 0.66
=============== ============== ============== ==============
The amount of anti-dilutive securities not considered in the diluted
earnings per share calculation, consisting of out-of-the money options and
warrants, totaled approximately 690,000 and 0 shares for the three months
ended June 30, 2001 and 2002, respectively, and 1,600,000 and 270,000
shares for the nine months ended June 30, 2001 and 2002, respectively.
4. Borrowing Arrangements
----------------------
Bank Line of Credit - Headwaters has a 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 0.75% (5.5% at June 30, 2002). Maximum borrowings
under the line of credit during the quarter ended December 31, 2001 were
$956,000, but there were no borrowings outstanding under the line at
December 31, 2001 nor at any time during the six months ended June 30,
2002.
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, which portfolio value was approximately
$18,800,000 at June 30, 2002. These investments consist primarily of
government-backed securities and collateralize any outstanding borrowings.
Maximum borrowings under this arrangement during the quarter ended December
31, 2001 were $5,095,000, but there were no borrowings outstanding at
December 31, 2001 nor at any time during the six months ended June 30,
2002. Borrowings under this arrangement and the bank line of credit are
used for short-term working capital needs. Interest on these borrowings
totaled $10,000 during the quarter ended December 31, 2001.
5. Income Taxes
------------
Headwaters recorded $18,000 of current state income tax expense in the
quarter ended June 30, 2001. In addition, Headwaters recorded $100,000 of
current alternative minimum federal tax expense and $22,000 of current
state income tax expense for the six months ended March 31, 2001, for total
income tax expense of $140,000 for the nine months ended June 30, 2001.
Headwaters recorded $4,550,000 and $11,020,000, respectively, of income tax
expense in the quarter and nine months ended June 30, 2002. For the June
30, 2002 quarter, total income tax expense consisted of approximately
$4,310,000 of deferred federal and state tax expense and approximately
$240,000 of current state tax expense. For the nine months ended June 30,
2002, total income tax expense consisted of approximately $10,810,000 of
deferred federal and state tax expense and approximately $610,000 of
current state tax expense, offset by approximately $400,000 of current
federal tax credits. As of June 30, 2002, Headwaters had net operating loss
("NOL") carryforwards for tax purposes of approximately $12,000,000 and
does not anticipate actually paying any substantial amounts of federal
income taxes until these NOL carryforwards are fully used.
10
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
Headwaters' effective tax rate was 40% and 39%, respectively, for the
quarter and nine months ended June 30, 2002. The effective tax rate was 40%
for the quarter ended December 31, 2001 and was lower for the quarter ended
March 31, 2002 due primarily to the enactment in March 2002 of the Job
Creation and Worker Assistance Act of 2002. This law allows Headwaters' NOL
carryforwards to offset 100% (instead of only 90%) of the alternative
minimum tax liability for fiscal years 2001 and 2002 only. As a result, a
tax refund receivable was recorded for $200,000 representing the recovery
of alternative minimum taxes expensed and paid in 2001.
6. Commitments and Contingencies
-----------------------------
Commitments and contingencies as of June 30, 2002 not disclosed elsewhere,
are as follows:
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. Plaintiffs appealed the case to the Sixth Circuit
Court of Appeals. In June 2002, the Sixth Circuit Court of Appeals issued
an order i) affirming the District Court's judgment and order of dismissal,
and ii) transferring to the Federal Circuit Court of Appeals plaintiff's
appeal of the District Court's order denying rule 60(b) motion for relief
from judgment. Because resolution of the appeal is uncertain, legal counsel
cannot express an opinion as to the ultimate amount, if any, of Headwaters'
liability.
Boynton. This action is factually related to the Adtech matter. In the
Adtech case, the alleged claims are asserted by certain purported officers
and directors of Adtech, Inc. In the Boynton action, the allegations arise
from the same facts, but the claims are asserted by certain purported
stockholders of Adtech. In June 2002, Headwaters received a summons and
complaint from the United States District Court for the Western District of
Tennessee alleging, inter alia, fraud, conspiracy, constructive trust,
conversion, patent infringement, and interference with contract arising out
of the 1998 technology purchase agreement entered into between Davidson and
Adtech on the one hand, and Headwaters on the other. The complaint seeks
declaratory relief and compensatory and punitive damages. 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, of Headwaters'
liability.
AGTC. In March 1996, Headwaters entered into an agreement with AGTC and its
associates for certain services related to the identification and selection
of alternative fuel projects. In March 2002, AGTC filed an arbitration
demand claiming that it is owed a commission under the 1996 agreement for
eight percent of the monetized price of the Port Hodder project. Headwaters
asserts that AGTC did not perform under the agreement and that the
agreement was terminated and the disputes were settled in July 1996.
Headwaters has filed an answer in the arbitration, denying AGTC's claims
and has asserted counterclaims against AGTC. Because the arbitration is at
an early stage and resolution is uncertain, legal counsel cannot express an
opinion as to the ultimate amount of recovery or liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical reagent sale agreement with AJG Financial Services,
Inc. The agreement called for AJG to pay royalties and to purchase
proprietary chemical reagent 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.
11
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
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. Nalco filed an answer denying the allegations in the
complaint and asserting counter-claims alleging patent invalidity.
Headwaters denies the counter-claims; however, if Nalco prevails on its
counter-claims, the result could have a material adverse effect on
Headwaters' business. 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.
License Fees. Pursuant to the contractual terms of the agreement with a
licensee, the net license fees earned by Headwaters, totaling approximately
$4,000,000 as of June 30, 2002, have been placed in escrow for the benefit
of Headwaters. Headwaters currently expects the escrowed amounts to
increase and that most, if not all, of such amounts will be recognized as
revenue at some future date. Certain accounting rules governing revenue
recognition require the seller's price to the buyer be "fixed or
determinable" and in this situation appear to currently preclude revenue
recognition. Accordingly, none of the escrowed amounts have been recognized
as revenue in the consolidated statements of income.
Other. Headwaters is also involved in other legal proceedings that have
arisen in the normal course of business. Management believes that
Headwaters has meritorious defenses to many of these other claims and in
all cases intends to vigorously defend its position. Management does not
believe that the outcome of these activities will have a significant
adverse 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.
Deferred Acquisition Costs - Headwaters seeks to identify and analyze
acquisition opportunities that strengthen and fortify its position as a
leading value enhancer to energy. Any future acquisitions could be funded
using Headwaters' available cash, issuance of common or preferred stock,
debt, or some combination thereof. As of June 30, 2002, Headwaters has
capitalized approximately $3,460,000 of costs associated with potential
future acquisitions and related projects that it is currently pursuing. If
Headwaters were to discontinue its acquisition pursuits or these potential
acquisitions and related projects are not ultimately consummated, the
respective capitalized costs will be expensed.
7. Events Subsequent to June 30, 2002
----------------------------------
Settlement Agreement - In July 2002, Headwaters reached a settlement
agreement with a third-party entity with which Headwaters had a dispute
regarding an ongoing commitment to pay a portion of the license fees
Headwaters receives from a licensee. Under the terms of the agreement, in
recognition of full settlement of amounts due, Headwaters agreed to pay
this entity approximately 30% of the amount Headwaters had received from
the licensee. Of the total amount paid of approximately $1,100,000,
approximately $350,000 related to license fees applicable to the year ended
September 30, 2001, for which a liability of approximately $100,000 already
had been recorded in accordance with SFAS No. 5, "Accounting for
Contingencies." The balance of the amount paid represents the settlement of
liabilities arising subsequent to September 30, 2001.
Probable Acquisition - In July 2002, Headwaters announced that it has
agreed to acquire Industrial Services Group, Inc. ("ISG"), including its
subsidiary ISG Resources, Inc. ISG is the largest manager and marketer of
coal combustion products, particularly high quality fly ash, a substitute
for cement in the production of concrete, in the United States. Under the
terms of the agreement, Headwaters has agreed to issue 2,000,000 shares of
Headwaters common stock and pay $31,000,000 in cash to acquire 100% of the
stock of ISG. Headwaters will also assume approximately $181,000,000 of ISG
debt, to be refinanced using a new senior bank credit facility. The
acquisition is expected to close in calendar 2002 and is subject to
standard closing conditions, including Headwaters' completion of the
proposed bank financing and obtaining regulatory approvals.
12
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
In connection with the acquisition, Headwaters has received a funding
commitment for a bank credit facility totaling $245,000,000 consisting of a
five-year amortizing senior secured term loan for $220,000,000, which will
be used to fund the acquisition of ISG and other costs and expenses related
to the acquisition, and an additional $25,000,000 available under a
three-year revolving line of credit, that will not be drawn at closing, but
will be available for working capital and general corporate purposes.
Interest rates on the loans will be based on LIBOR, and principal amounts
outstanding may be repaid at any time without penalty.
SEC Registration Statement - Also in July 2002, Headwaters filed a
$250,000,000 universal shelf registration statement with the SEC that can
be used for the sale of common stock, preferred stock, convertible debt and
other securities, should Headwaters so choose. This filing provides
increased flexibility with respect to Headwaters' financing alternatives.
This registration statement was declared effective by the SEC as of August
5, 2002; however, a prospectus supplement describing the terms of any
securities will be filed before any offering would commence under the
registration statement. Headwaters could use the proceeds from securities
offered under the shelf registration to reduce borrowings from the bank
credit facility, or for working capital and other general corporate
purposes.
8. Recent Accounting Pronouncements
The implications of full implementation of SFAS No. 142, "Accounting for
Goodwill and Intangible Assets," are more fully described in Note 2. In
April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was issued.
SFAS No. 145, in rescinding SFAS No. 4, will require that the loss on early
extinguishment of debt, classified as an extraordinary item in fiscal 2000,
no longer be classified as extraordinary, but rather as interest expense.
SFAS No. 145 is required to be implemented by Headwaters in fiscal 2003 and
therefore will have no material effect on Headwaters' future financial
position or results of operations.
Headwaters has reviewed all other recently issued, but not yet adopted,
accounting standards in order to determine their potential effect, if any,
on the future results of operations or financial position of Headwaters.
Based on that review, Headwaters does not currently believe there are any
other recent accounting pronouncements that will have a significant effect
on its current or future financial position or results of operations.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001
The information set forth below compares Headwaters' operating results
for the three months ended June 30, 2002 ("2002") with operating results for the
three months ended June 30, 2001 ("2001").
Revenue. Total revenue for 2002 increased by $21,269,000 to $31,968,000
as compared to $10,699,000 for 2001. The major components of revenue are
discussed below.
License Fees. During 2002, Headwaters recognized license fee revenue
totaling $8,822,000, an increase of $4,486,000 from $4,336,000 of license fee
revenue recognized during 2001. The increase in license fee revenue is due to
licensee facilities being relocated or, where a change in ownership has
occurred, a resumption of the production and sale of alternative fuel by the new
owners, as well as from increased alternative fuel sales by other Headwaters'
licensees.
Chemical Reagent Sales and Cost of Chemical Reagents. Chemical reagent
sales during 2002 were $22,234,000 with a corresponding direct cost of
$14,880,000. Chemical reagent sales during 2001 were $5,777,000 with a
corresponding direct cost of $3,610,000. The increase in chemical reagent sales
in 2002 over 2001 was due to increased alternative fuel production by
Headwaters' licensees, as well as sales of chemical reagents to new customers.
The gross profit margin decreased in 2002 from 2001 due primarily to increased
sales of a new chemical reagent formula, for certain licensees and new
customers, which has a higher sales price and a lower gross margin. Headwaters
expects future gross profit margins to be lower than the margin percentages
realized in fiscal 2001 for the same reason, but expects the gross margin for
the remainder of fiscal 2002 to be relatively consistent with the gross margin
achieved in 2002.
Cost of Operations. These costs increased by $2,328,000 to $2,817,000
in 2002 from $489,000 in 2001. The increase from 2001 to 2002 was primarily
attributable to costs incurred by HTI of $1,547,000, an increase in personnel
costs of approximately $410,000, and lower 2001 costs as a result of the
resolution of certain contingent liabilities for amounts less than previously
recorded. Included in HTI's costs is $162,000 of amortization expense related to
the identifiable intangible assets recorded as part of the HTI acquisition.
Research and Development. Substantially all of the research and
development costs for 2002 represent the costs of research and development
incurred by HTI. Since HTI was acquired in August 2001, there were no research
and development costs for 2001.
Selling, General and Administrative Expenses. These expenses increased
$1,996,000 to $2,726,000 in 2002 from $730,000 in 2001. The increase was due
primarily to increases of approximately $1,290,000 in personnel costs,
approximately $490,000 in settlement costs and approximately $140,000 in
professional services expense. The increase in personnel costs relates primarily
to the improvement in Headwaters' operations and its impact on accruals for
incentive-based compensation.
Other Income and Expense. During 2002, Headwaters reported net other
income of $371,000 compared to net other expense of $896,000 during 2001. The
difference of $1,267,000 in net other income / expense is primarily attributable
to an increase in interest and net investment income of $260,000 and a decrease
in equity and debt investment-related losses of approximately $1,040,000.
Interest and net investment income increased from $170,000 in 2001 to
$429,000 in 2002. The $259,000 increase was primarily due to substantially
higher average balances of short-term investments in 2002, partially offset by
lower investment returns, as compared to 2001.
During fiscal 2000 and early fiscal 2001, Headwaters made several
equity investments in and loans to unrelated high-risk entities. In 2001,
Headwaters recognized $1,040,000 of losses related to those investments. There
were no such losses in 2002.
14
Income Taxes. As of September 30, 2001, Headwaters determined that it
was more likely than not that it would realize the benefit of its net operating
loss ("NOL") carryforwards and recorded a deferred tax asset totaling
approximately $10,470,000. Headwaters then began recording a full tax provision
beginning with the quarter ended December 31, 2001.
Headwaters recorded $4,550,000 of income tax expense in 2002, which
consisted of approximately $4,310,000 of deferred federal and state tax expense
and approximately $240,000 of current state tax expense. In 2001, Headwaters
utilized its NOL carryforwards and recorded only $18,000 of current state income
tax. Headwaters' effective tax rate was 40% in 2002, which is consistent with
the expected effective tax rate for fiscal 2002.
Nine Months Ended June 30, 2002 Compared to Nine Months Ended June 30, 2001
The information set forth below compares Headwaters' operating results
for the nine months ended June 30, 2002 ("2002") with operating results for the
nine months ended June 30, 2001 ("2001").
Revenue. Total revenue for 2002 increased by $42,878,000 to $75,646,000
as compared to $32,768,000 for 2001. The major components of revenue are
discussed below.
License Fees. During 2002, Headwaters recognized license fee revenue
totaling $21,263,000, an increase of $5,493,000 from $15,770,000 of license fee
revenue recognized during 2001. The increase in license fee revenue is due to
licensee facilities being relocated or, where a change in ownership has
occurred, a resumption of the production and sale of alternative fuel by the new
owners, as well as from increased alternative fuel sales by other Headwaters'
licensees.
Chemical Reagent Sales and Cost of Chemical Reagents. Chemical reagent
sales during 2002 were $49,521,000 with a corresponding direct cost of
$33,749,000. Chemical reagent sales during 2001 were $15,770,000 with a
corresponding direct cost of $9,889,000. The increase in chemical reagent sales
in 2002 over 2001 was due to increased alternative fuel production by
Headwaters' licensees, as well as sales of chemical reagents to new customers.
The gross profit margin decreased in 2002 from 2001 due to increased sales of a
new chemical reagent formula, for certain licensees and new customers, which has
a higher sales price and a lower gross margin.
Service and Other Revenue. Service revenue for 2002 includes $2,340,000
of HTI revenue and $1,418,000 of fees for operating two alternative fuel
facilities for a licensee. Since HTI was acquired in August 2001, there was no
service revenue for HTI for 2001. Headwaters operated only one alternative fuel
facility in 2001 for which it received $763,000 in fees. In 2002, other revenue
includes $500,000 of one-time development services revenue related to work
performed for a licensee.
Cost of Operations. These costs increased by $5,526,000 to $7,972,000
in 2002 from $2,446,000 in 2001. The increase from 2001 to 2002 was primarily
attributable to costs incurred by HTI of $4,885,000 and an increase in personnel
costs of approximately $450,000. Restructuring costs of $500,000 are included in
HTI's costs. These costs are related to a cost reduction plan approved in March
2002 and implemented during March and early April 2002. The plan calls for,
among other cost cutting measures, a reduction in personnel comprising
approximately 25% of HTI's total workforce. Also included in HTI's costs is
$485,000 of amortization expense related to the identifiable intangible assets
recorded as part of the HTI acquisition.
Research and Development. Substantially all of the research and
development costs for 2002 represent the costs of research and development
incurred by HTI. Since HTI was acquired in August 2001, there were no research
and development costs for 2001.
Selling, General and Administrative Expenses. These expenses increased
$2,738,000 to $6,566,000 in 2002 from $3,828,000 in 2001. The increase was due
primarily to increases of approximately $1,490,000 in personnel costs,
approximately $680,000 in professional services expense, and approximately
$490,000 in settlement costs. The increase in personnel costs relates primarily
to the improvement in Headwaters' operations and its impact on accruals for
incentive-based compensation. The increase in professional services expense was
due primarily to consulting costs related to strategic planning.
Other Income and Expense. During 2002, Headwaters reported net other
income of $2,411,000 compared to net other expense of $1,527,000 during 2001.
The difference of $3,938,000 in net other income / expense is primarily
attributable to a decrease in equity and debt investment-related losses of
approximately $2,450,000 and a gain on sale of an interest in an alternative
fuel facility of $1,342,000 in 2002.
15
During fiscal 2000 and early fiscal 2001, Headwaters made several
equity investments in and loans to unrelated high-risk entities. In 2001,
Headwaters recognized approximately $2,450,000 of losses related to those
investments. There were no such losses in 2002. In 2002, Headwaters sold a 50%
interest in one its original alternative fuel facilities. The gain on the sale
of this interest was $1,342,000. There were no other material asset sales in
either 2002 or 2001.
Interest and net investment income decreased from $511,000 in 2001 to
$432,000 in 2002. The $79,000 decrease was primarily due to a decrease of
approximately $275,000 in interest income related to a $6,500,000 note
receivable partially offset by an increase of approximately $160,000 in the
return on short-term investments. The $6,500,000 note receivable was collected
in October 2001 and accordingly, there was little interest income on this note
in 2002. In 2001, Headwaters recognized net investment income of approximately
$190,000 while in 2002 net investment income of approximately $350,000 was
recognized. The $160,000 increase was primarily due to substantially higher
average balances of short-term investments in 2002, partially offset by lower
investment returns, as compared to 2001.
Income Taxes. Headwaters recorded $11,020,000 of income tax expense in
2002, which consisted of approximately $10,810,000 of deferred federal and state
tax expense and approximately $610,000 of current state tax expense, offset by
approximately $400,000 of current federal tax credits. In 2001, Headwaters
utilized its net operating loss carryforwards and recorded only $100,000 of
current alternative minimum federal tax expense and $40,000 of current state
income tax. Headwaters' effective tax rate was 39% in 2002.
Liquidity and Capital Resources
Net cash provided by operating activities during the nine months ended
June 30, 2002 ("2002") was $19,649,000 compared to $13,948,000 during the nine
months ended June 30, 2001 ("2001"). Most of the cash flow from operating
activities in both periods was attributable to net income. During 2002,
investing activities consisted primarily of net purchases of short-term
investments of $18,846,000, the collection on notes receivable of $6,877,000,
and costs related to potential future acquisitions and related projects totaling
approximately $3,460,000. Financing activities in 2002 consisted primarily of
net repayments of short-term borrowings of $4,336,000 and proceeds from the
exercise of stock options and warrants of $5,097,000.
Operating Activities. Headwaters reported net income in 2002 of
$16,922,000. Moreover, most of Headwaters' reported income tax expense of
$11,020,000 represents realization of deferred income taxes which did not
require the use of cash. In 2002, the cash provided from operations was reduced
by a significant increase in trade receivables approximating $12,763,000. This
increase in trade receivables was due to the significant increase in revenues
during 2002. Headwaters has no allowance for doubtful accounts at June 30, 2002.
Investing and Financing Activities. In September 2001, Headwaters sold
all of its remaining high-risk investments in exchange for a $4,000,000 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. Following payment
of the note principal, Headwaters has the right to receive the first $1,000,000
plus 20% of any additional cash received by the limited liability corporation
related to the assets sold by Headwaters. Headwaters does not currently intend
to make any significant additional equity investments in or loans to any new
unrelated high-risk entities, but could incur additional losses if the
$4,000,000 loan is not repaid. During 2002, Headwaters collected $279,000 on
this note. At September 30, 2001, in addition to the $4,000,000 note receivable,
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 seeks to identify and analyze acquisition opportunities that
strengthen and fortify its position as a leading value enhancer to energy. Any
future acquisitions could be funded using Headwaters' available cash, issuance
of common or preferred stock, debt, or some combination thereof. As of June 30,
2002, Headwaters has capitalized approximately $3,460,000 of costs associated
with potential future acquisitions and related projects that it is currently
pursuing. If Headwaters were to discontinue its acquisition pursuits or these
potential acquisitions and related projects are not ultimately consummated, the
respective capitalized costs will be expensed. As more fully described below,
Headwaters announced that it has agreed to acquire Industrial Services Group,
Inc. ("ISG"), including its subsidiary ISG Resources, Inc. ISG is the largest
manager and marketer of coal combustion products, particularly high quality fly
ash, a substitute for cement in the production of concrete, in the United
States.
The majority of Headwaters' short-term investments consist of
fixed-rate U.S. government securities, and accordingly, changes in interest
rates can affect the market value of these investments. These investments are
carried at market value in the consolidated balance sheet and the periodic
adjustments to reflect changes in market value are included in interest and net
investment income in the consolidated statements of operations.
16
Financing activities in 2002 consisted primarily of net repayments of
short-term borrowings of $4,336,000 and proceeds from the exercise of stock
options and warrants of $5,097,000. Other than operating leases for certain
equipment and real estate, which are not material, Headwaters has no off-balance
sheet transactions, derivatives, or similar instruments and is not a guarantor
of any other entities' debt or other financial obligations.
Working Capital. Headwaters' working capital increased from $8,619,000
at September 30, 2001, to $35,434,000 at June 30, 2002. The primary reasons for
this increase in working capital were the significant increases in cash and cash
equivalents, short-term investments and trade receivables, all resulting from
increased revenue, profitability and realization of deferred income taxes.
Headwaters expects operations to produce positive cash flows in future periods,
which, combined with current working capital, will be sufficient for Headwaters'
operating needs for the next 12 months. Working capital could be used to help
fund future strategic acquisitions. Assuming the closing of the ISG transaction,
including the related bank financing (which is expected to include a $25,000,000
three-year revolving line of credit to be available for general corporate
purposes), Headwaters expects to have working capital sufficient for the needs
of the combined company.
Borrowing Arrangements. Headwaters has a 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 0.75% (5.5% at June 30, 2002). Maximum borrowings under
the line of credit during the quarter ended December 31, 2001 were $956,000, but
there were no borrowings outstanding under the line at December 31, 2001 nor at
any time during the six months ended June 30, 2002. Headwaters also 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, which portfolio value was approximately $18,800,000 at June
30, 2002. These investments consist primarily of government-backed securities
and collateralize any outstanding borrowings. Maximum borrowings under this
arrangement during the quarter ended December 31, 2001 were $5,095,000, but
there were no borrowings outstanding at December 31, 2001 nor at any time during
the six months ended June 30, 2002. Borrowings under this arrangement and the
bank line of credit are used for short-term working capital needs.
Income Taxes. As of June 30, 2002, Headwaters had net operating loss
("NOL") carryforwards for tax purposes of approximately $12,000,000 and does not
anticipate actually paying any substantial amounts of income taxes until these
NOL carryforwards are fully used. The NOL carryforwards expire from 2017 to
2021. Headwaters also has approximately $220,000 of 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 NOL
carryforwards (totaling approximately $2,400,000) against future taxable income
is subject to an annual limitation of approximately $800,000 due to the change
in ownership of HTI.
During 2002, Headwaters made estimated payments for alternative minimum
taxes and for certain state income taxes in states where NOL carryforwards are
not available. Due to the passage in March 2002 of the Job Creation and Worker
Assistance Act of 2002 (the "Act"), Headwaters filed for a refund of the
alternative minimum taxes paid in fiscal 2001 and filed for refunds related to
the carryback of HTI's 2000 and 2001 losses, which pursuant to the Act can be
carried back for five years instead of the statutory two-year period. Refunds
expected to be received in fiscal 2002 total approximately $400,000. Because of
existing NOL carryforwards for regular federal tax purposes and in many states
where Headwaters does business, the provisions of the Act allowing Headwaters'
NOL carryforwards to offset 100% of the alternative minimum tax liability for
fiscal 2002, and due to tax benefits from the exercise of stock options,
Headwaters does not currently expect to pay significant amounts of income taxes
until late fiscal 2002 or early fiscal 2003.
Probable Acquisition of ISG
In July 2002, Headwaters announced that it has agreed to acquire
Industrial Services Group, Inc. ("ISG"), including its subsidiary ISG Resources,
Inc. ISG is the largest manager and marketer of coal combustion products,
particularly high quality fly ash, a substitute for cement in the production of
concrete, in the United States. Under the terms of the agreement, Headwaters has
agreed to issue 2,000,000 shares of Headwaters common stock and pay $31,000,000
in cash to acquire 100% of the stock of ISG. Headwaters will also assume
approximately $181,000,000 of ISG debt, to be refinanced using a new senior bank
credit facility. The acquisition is expected to close in calendar 2002 and is
subject to standard closing conditions, including Headwaters' completion of the
proposed bank financing and obtaining regulatory approvals.
In connection with the acquisition, Headwaters has received a funding
commitment for a bank credit facility totaling $245,000,000 consisting of a
five-year amortizing senior secured term loan for $220,000,000, which will be
used to fund the acquisition of ISG and other costs and expenses related to the
acquisition, and an additional $25,000,000 available under a three-year
revolving line of credit, that will not be drawn at closing, but will be
available for working capital and general corporate purposes. Interest rates on
the loans will be based on LIBOR, and principal amounts outstanding may be
repaid at any time without penalty.
17
SEC Registration Statement
In July 2002, Headwaters filed a $250,000,000 universal shelf
registration statement with the SEC that can be used for the sale of common
stock, preferred stock, convertible debt and other securities, should Headwaters
so choose. This filing provides increased flexibility with respect to
Headwaters' financing alternatives. This registration statement was declared
effective by the SEC as of August 5, 2002; however, a prospectus supplement
describing the terms of any securities will be filed before any offering would
commence under the registration statement. Headwaters could use the proceeds
from securities offered under the shelf registration to reduce borrowings from
the bank credit facility, or for working capital and other general corporate
purposes.
Acquisition of HTI
Headwaters completed the acquisition of HTI in August 2001. Total
consideration paid at closing, including the direct costs incurred by Headwaters
to consummate the acquisition, was approximately $11,774,000. During 2002, in
connection with the preparation of Headwaters' and HTI's consolidated income tax
returns for the year ended September 30, 2001, Headwaters finalized its analysis
of all of HTI's differences between book and tax reporting and HTI's net
operating loss carryforwards as of the acquisition date. Based on this analysis,
Headwaters adjusted the purchase price allocation to record additional deferred
tax assets of $510,000 and additional deferred tax liabilities of $4,240,000,
eliminated a $2,714,000 contingent liability and recorded goodwill of
$1,016,000.
In accordance with the original HTI acquisition agreements, additional
contingent consideration could be earned by the former HTI stockholders during
calendar 2002 based on the attainment of certain operating targets and other
milestones. In April 2002, Headwaters and the former HTI stockholders agreed to
an amendment of the acquisition agreements and reached a final settlement of all
outstanding contingent payments. Headwaters paid the former HTI stockholders
additional consideration with a value totaling $3,242,000. The consideration
consisted of cash of $419,000 and the issuance of approximately 178,000 shares
of Headwaters common stock valued at $2,823,000. This transaction resulted in an
increase in goodwill by the total value of the consideration of $3,242,000. The
value of the 178,000 shares of 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 settlement was reached and
one day prior to and one day subsequent to that day.
As of June 30, 2002, Headwaters had loaned HTI approximately
$7,500,000, of which $501,000 was not eliminated in consolidation because HTI's
financial statements are consolidated with Headwaters' financial statements
using a one-month lag.
Recent Accounting Pronouncements
The implications of full implementation of SFAS No. 142, "Accounting
for Goodwill and Intangible Assets," are more fully described in Note 2 to the
consolidated financial statements. In April 2002, SFAS No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections," was issued. SFAS No. 145, in rescinding SFAS No. 4, will
require that the loss on early extinguishment of debt classified as an
extraordinary item in fiscal 2000 no longer be classified as extraordinary. SFAS
No. 145 is required to be implemented by Headwaters in fiscal 2003 and therefore
will have no material effect on Headwaters' future financial position or results
of operations.
Headwaters has reviewed all other recently issued, but not yet adopted,
accounting standards in order to determine their potential effect, if any, on
the future results of operations or financial position of Headwaters. Based on
that review, Headwaters does not currently believe there are any other recent
accounting pronouncements that will have a significant effect on its current or
future financial position or results of operations.
18
Forward Looking Statements
Statements in this Quarterly Report on Form 10-Q 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:
(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
reagent 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "ITEM 3: LEGAL PROCEEDINGS" in Headwaters' Annual Report on Form
10-K/A for the year ended September 30, 2001 for descriptions of current legal
proceedings. Other than the June 2002 activity for Adtech and the Boynton and
AGTC matters described in Note 6 to the consolidated financial statements, there
have been no material changes with respect to legal proceedings as they are
described in the Form 10-K/A.
19
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
Other than 148,529 shares of restricted common stock issued upon
exercise of options and warrants and 177,893 shares of restricted common stock
issued to the former stockholders of HTI, there were no securities issued by
Headwaters within the past fiscal quarter without registration under the
Securities Act of 1933, as amended. As of June 30, 2002, Headwaters had five
effective registration statements filed on Form S-3 and three effective
registration statements filed on Form S-8. One or more of these registration
statements have registered all except 5,386 of the shares issued during the
quarter.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
99.4 Headwaters 2002 Stock Incentive Plan
99.5 Certification of Chief Executive Officer
99.6 Certification of Chief Financial Officer
(b) No reports were filed on Form 8-K during the quarter ended
June 30, 2002. However, there were two Forms 8-K filed in July
2002, as follows:
o Form 8-K filed July 18, 2002 for an event dated July
15, 2002 (Probable acquisition of Industrial Services
Group, Inc. ("ISG")). The following financial
statements of ISG and unaudited pro forma financial
information were filed with this Form 8-K:
Audited Financial Statements of ISG:
Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 2001
and 2000
Consolidated Statements of Operations for the Years Ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Comprehensive Loss for the
Years Ended December 31, 2001, 2000 and 1999
Consolidated Statements of Shareholders' Equity (Deficit)
for the Years Ended December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999
Notes to Consolidated Financial Statements
Unaudited Financial Statements of ISG :
Condensed Consolidated Balance Sheets as of March 31, 2002
and December 31, 2001
Condensed Consolidated Statements of Operations for the
Three Months Ended March 31, 2002 and 2001
Condensed Consolidated Statements of Comprehensive Loss
for the Three Months Ended March 31, 2002 and 2001
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended March 31, 2002 and 2001
Notes to Condensed Consolidated Financial Statements
Note: Industrial Services Group, Inc. is not an SEC
registrant. ISG Resources, Inc., a wholly-owned
subsidiary of Industrial Services Group, Inc., has
been and is an SEC registrant. As such, ISG
Resources, Inc. has made various filings in
accordance with the rules and regulations of the SEC.
The consolidated financial statements of Industrial
Services Group, Inc. included in the Form 8-K include
ISG Resources, Inc., but are not comparable to the
consolidated financial statements of ISG Resources,
Inc. included in previous SEC filings.
20
Unaudited pro forma financial information:
Introduction to Pro Forma Financial Information
Pro Forma Condensed Combined Balance Sheet as of
March 31, 2002
Pro Forma Condensed Combined Statement of Income for the
Year Ended September 30, 2001
Pro Forma Condensed Combined Statement of Income for the
Six Months Ended March 31, 2002
Notes to Pro Forma Condensed Combined Financial
Information
o Form 8-K filed July 22, 2002 for an event dated
August 28, 2001 (Updated pro forma financial
information with respect to Headwaters' August 28,
2001 acquisition of Hydrocarbon Technologies, Inc.).
The following unaudited pro forma financial
information was filed with the Form 8-K:
Introduction to Pro Forma Financial Information
Pro Forma Condensed Combined Statement of Income for the
Year Ended September 30, 2001
Notes to Pro Forma Condensed Combined Statement of Income
21
SIGNATURES
Pursuant to the requirements 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
Date: August 6, 2002 By: /s/ Kirk A. Benson
---------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: August 6, 2002 By: /s/ Steven G. Stewart
---------------------------------------
Steven G. Stewart, Chief Financial Officer
and Principal Financial Officer
22