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, 2000,
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
(formerly Covol Technologies, Inc.)
(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 S. Election Drive, 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. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 1, 2000 was $57,893,307 based upon the closing
price on the Nasdaq National 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
December 1, 2000 was 23,391,473.
---------------------------
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 2001.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS..........................................................3
ITEM 2. PROPERTIES........................................................9
ITEM 3. LEGAL PROCEEDINGS................................................10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................11
ITEM 6. SELECTED FINANCIAL DATA..........................................15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................16
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK........22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..............................22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............22
ITEM 11. EXECUTIVE COMPENSATION...........................................23
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...23
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.........................................................23
SIGNATURES..................................................................27
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.
2
PART I
ITEM 1. BUSINESS
The Company
Headwaters has developed an innovative chemical technology wherein
chemical reagents interact with coal based feedstock to produce an alternative
fuel. Through its existing chemical-based fuels business, Headwaters earns a
stable and growing revenue stream that provides the capital needed to develop
synergistic business opportunities.
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.
Company History
Headwaters' technologies are being used to transform coal, coal fines,
coal refuse and other coal derivatives into a special qualified fuel. The
technologies molecularly bind coal derivatives into a formed fuel through a
significant chemical reaction. The resulting product has been classified as a
"qualified fuel" within the meaning of Section 29 of the U.S. Internal Revenue
Code. Sales of the fuel therefore qualify for a significant tax credit. By
licensing its technology to owners of production facilities, Headwaters earns
royalties based upon the sale of qualified fuel. Headwaters also earns revenues
from chemical reagent sales to these producers.
Although not proven commercially, the Headwaters technologies have
broader potential applications. For example, the technologies can also be used
to transform coke dust into formed coke. Coke, which is processed metallurgical
grade coal, is primarily used in the iron making process as a reducing agent and
also as a fuel source. Coke dust, also known as "coke breeze," is a fine residue
by-product resulting from the production, handling and storage of coke. In
tests, Headwaters has successfully aggregated coke dust into briquettes designed
to withstand the weight, heat and other factors inside of metal making furnaces.
The Headwaters technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Within controlled, small scale laboratory settings, the Headwaters
technologies have been demonstrated to be capable of producing briquettes from
such steel production wastes. Such briquettes can be further processed in metal
reducing furnaces to form high grade pig iron, a common form of feed material
used in the steel industry.
Additional fuel or resource by-products to which the Headwaters
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.
Except for alternative fuel production, the Headwaters technologies
described above have not been commercially applied. No assurance can be given
that Headwaters will be able to implement these applications profitably or that
the development of these alternative applications will be the most profitable
use of Headwaters' limited financial and managerial resources.
Current and Future Business Strategy
Headwaters intends to grow its business by increasing chemical reagent
sales and maximizing royalty income. The growth of alternative fuel production
and sales by licensees results in increased royalty payments and increased
chemical sales for Headwaters. Headwaters hopes to diversify its operations in
related businesses, building on its core competencies in specialty chemicals,
energy, and in resource recovery.
3
For the past four years, Headwaters' business strategy has been focused
almost exclusively upon alternative fuels from coal derivatives. There are 28
facilities owned by unaffiliated third parties located in nine states that are
licensed to use Headwaters' alternative fuel technology.
Headwaters and its licensees are in the process of increasing
production levels and product sales. An industry report estimates that the
optimum potential production level for the Headwaters' alternative fuels
technology is 23,000,000 tons per year. Licensees' reports of alternative fuel
sales for the quarter ended September 30, 2000 yield annualized sales of
approximately 9,800,000 tons. Headwaters is working with its licensees to
optimize production levels and quality though laboratory testing and field work.
These efforts result in improved Headwaters products, services and techniques.
Feedstock supply, production, product quality and the marketing of the
alternative fuel all directly affect the amount and timing of royalties to be
received by Headwaters. Accordingly, assisting licensees to optimize the
production from these facilities is one of Headwaters' highest priorities.
Headwaters has received one-time initial license fees with respect to
most of the facilities. These initial license fees are being amortized into
revenue over the life of the license agreements. Future revenues related to such
facilities are expected to come from royalties earned from Headwaters'
licensees' ongoing production and sale of alternative fuel pursuant to existing
licensing agreements.
Headwaters also expects to generate significant revenues from future
sales of chemical reagent materials. Headwaters hopes to increase sales of its
chemical materials, first, by increased purchases by licensees as alternative
fuel production increases, and second, by marketing these chemicals to existing
non-licensee facility owners that have not used the Headwaters chemical reagent
materials before.
Headwaters has a contract to operate one alternative fuel facility
located in Pennsylvania. This operation provides Headwaters with manufacturing
experience to add to its ongoing laboratory experience. Headwaters also receives
a small operating fee for these services.
Strategic Acquisitions. Headwaters believes that it may have unique
opportunities to pursue acquisitions that are synergistic with Headwaters'
financial and operational objectives. Headwaters intends to pursue 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 fragmented, growing industries where promising financial
returns exist.
Emerging Business Investments. Headwaters has made some limited
investments in emerging businesses. These investments are in the form of secured
loans and equity purchases. As of December 1, 2000, Headwaters and its
wholly-owned subsidiary, Kwai Financial, Inc., have loaned or committed to loan
approximately $4.1 million to nine businesses. Kwai Financial normally
participates with other lenders in bridge loans with terms of approximately 120
to 180 days until equity financing is obtained, at which time the bridge loans
are repaid.
As of December 1, 2000, Headwaters has also invested approximately $5
million to purchase minority equity interests in five emerging businesses.
Headwaters' goal is to maximize the return on these investments and identify a
liquidity event for the equity investment. Headwaters does not intend to
increase the funds committed to these investment types in the future.
Alternative Fuel Tax Credits
Headwaters' technology royalties and chemical reagent sales ultimately
derive from each licensee's ability to manufacture and sell qualified fuels that
generate tax credits for the facility owner. Section 29 of the U.S. 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 Headwaters received a Private
Letter Ruling, or PLR, from the IRS in which the IRS, based on representations
made to it by Headwaters, ruled that the alternative fuel technology produces a
significant chemical change compared to the parent feedstocks and this qualifies
the end product as a solid synthetic fuel.
4
Because Headwaters currently does not sell fuel from an alternative
fuel facility, Headwaters does not claim Section 29 tax credits. However,
licensees of Headwaters' alternative fuel technology do claim Section 29 tax
credits. At least 11 PLRs covering 17 alternative fuel facilities have been
obtained by third parties in connection with licenses of Headwaters' alternative
fuel technology. All PLRs are only binding with respect to the specific projects
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:
* there has been no misstatement or omission of material facts,
* the facts at the time of the transaction are not materially different
from the facts on which the PLR was based,
* there has been no change in the applicable law,
* the PLR was originally issued for a proposed transaction and
* 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 phase out after the unregulated
oil price reaches 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. 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 communicated with their congressional representatives about the benefits
and burdens of the credit. Congress continues to periodically entertain
legislation to further extend Section 29 deadlines particularly in times of
heightened energy dependence awareness. However, the Department of the Treasury
and the IRS have ongoing oversight programs and are currently reviewing taxpayer
use of the credit for possible abuses, including whether there should be
restrictions on the availability of credits.
Licensees
Headwaters derives most of its revenue from the owners of alternative
fuel facilities who have licensed Headwaters' technology and who purchase
chemical reagent from Headwaters.
In total, Headwaters has licensed or constructed plants using the
Headwaters technologies at 24 alternative fuel facilities that operate at
various locations in the primary coal supply regions of the United States. For
all facilities, the construction agreements were entered into prior to December
31, 1996. In some instances, Headwaters entered into a construction contract
that was either fulfilled by Headwaters or later assigned to a licensee. In
certain instances, the licensees entered into their own construction contracts.
License and Chemical Supply Agreements. All entities that have
constructed or own facilities using the Headwaters technologies have entered
into a technology license and chemical reagent supply agreement with Headwaters.
Many license agreements provided for an initial license fee, payable upon
reaching project milestones.
5
Headwaters has received most of the initial license fees related to these
facilities, which amounts are being amortized into revenue by Headwaters over
the life of the license agreements. In addition, pursuant to many of the license
agreements, the licensee pays a quarterly earned license fee generally at a
prescribed dollar amount or a percentage of the tax credits earned by the
licensee. In some cases, the amount to be 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. The fees paid to Headwaters under the license agreements
are not based on the sales price of the alternative fuel product but rather 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 not otherwise available under Section 29 of
the tax code.
Headwaters has also agreed, pursuant to chemical supply agreements, to
provide chemical reagent to licensees for the manufacture and production of
alternative fuel. The price for the chemical sold to the licensees falls into
two categories: a fixed price, or an amount equal to Headwaters' cost plus a
prescribed mark-up.
The chemical reagent is currently manufactured by Dow Chemical
Corporation for Headwaters utilizing Headwaters' patented and proprietary
technology. Headwaters does not inventory any chemical material but instead
arranges with Dow for shipping of the chemical reagent directly to the
facilities.
Major Licensees. Approximately 15% of revenues in 1998, 15% of revenues
in 1999 and 34% of revenues in 2000 were from PacifiCorp affiliated licensees;
approximately 21% of revenues in 1998, 40% of revenues in 1999 and 7% of
revenues in 2000 were from a Fluor Corporation affiliated licensee; and 21% of
revenues in 1998, 13% of revenues in 1999 and 6% of revenues in 2000 were from
Pace Carbon Fuels, L.L.C. affiliated licensees. Also, in 2000 approximately 27%
of revenues were from DTE Energy Services, Inc. affiliated licensees and 19% of
revenues were from TECO Coal Corporation affiliated licensees, most of which
related to non-recurring gains on sales of facilities. No other single customer
accounted for over ten percent of total revenues in the years presented.
Licensees' Coal Feedstock. The alternative fuel facilities use coal,
coal refuse, 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. Headwaters purchases its patented and proprietary
chemical reagent from Dow Chemical Company under an agreement through 2007 under
which Headwaters pays a prescribed price per pound of chemical. Headwaters
arranges with Dow for the delivery of the chemical reagent from Dow's
manufacturing plants directly to each of the alternative fuel facilities
licensed by Headwaters.
Sale of Facilities
Headwaters has constructed and sold six alternative fuel facilities.
The following summarizes each sale:
Utah Synfuel #1. In March 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Headwaters was at the time a 64% owner and general
partner, sold the Utah alternative fuel facility to Coaltech No. 1, L.P. for
$3.5 million payable in 44 quarterly installments, all in accordance with the
Utah Project Purchase Agreement among Headwaters, Utah Synfuel #1 and Coaltech.
In June 2000, Headwaters and Coaltech negotiated a termination of the Utah
Project Purchase Agreement and a new licensee and chemical reagent purchase
agreement calling for payment to Headwaters of a specified percentage of the
ongoing net benefits received by the Coaltech partners.
Alabama Synfuel #1. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Headwaters was at the time a 74% owner and general partner,
sold its facility to Birmingham Syn Fuel, L.L.C., a wholly-owned subsidiary of
PacifiCorp Financial Services, Inc. in March 1998. The purchase price for the
Birmingport facility was $6,500,000 payable in the form of a nonrecourse
promissory note collateralized by certain portions of the Birmingport facility.
In May 2000 Headwaters and Birmingham Syn Fuel negotiated a termination of the
purchase transaction documents and replaced them with a reduced interest but
otherwise substantially similar amended and restated $6,500,000 note. At the
same time, Headwaters, Birmingham Syn Fuel and PacifiCorp negotiated four new
license and chemical reagent purchase agreements calling for payment to
Headwaters of specified ongoing royalties and chemical reagent sales.
6
River Hill. Headwaters and its subsidiaries, Commonwealth Synfuel,
L.L.C. and Synfuel Investments, Inc., sold the River Hill facility to DTE River
Hill L.L.C., an affiliate of DTE Energy Services, Inc., in August 1999. The
purchase price for the River Hill facility consisted of a cash payment to
Headwaters of $1,250,000, assumption of $5,000,000 of facility debt, completion
of capital improvements to the facility and an eight-year royalty arrangement
with both Headwaters and the construction lender, plus contingent payments based
upon facility production performance. Headwaters subsequently received all
production performance payments. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.
Carbon Synfuel. Headwaters and its subsidiaries, Carbon Synfuel, L.L.C.
and Synfuel Investments, Inc., sold the Carbon Synfuel facility for $10 million
cash to DTE Kentucky, LLC, an affiliate of DTE Energy Services, Inc., in
December 1999. Headwaters also entered into a license and chemical reagent
supply agreement which calls for ongoing royalties and chemical reagent sales.
Pocahontas Synfuel. Headwaters and its subsidiaries Pocahontas Synfuel,
L.L.C. and Synfuel Investments, Inc. sold the Pocahontas Synfuel facility for $8
million cash and an additional net payment of $2.5 million contingent upon the
buyer's placing the facility into commercial operation at a new site to Premier
Elkhorn Coal Company, an affiliate of TECO Coal Corporation in January 2000.
Headwaters subsequently received the contingent payment. Headwaters also entered
into a license and chemical reagent supply agreement which calls for ongoing
royalties and chemical reagent sales.
Mountaineer Fuels. Headwaters and its subsidiaries Mountaineer Fuels,
L.L.C. and Synfuel Investments, Inc. sold the Mountaineer Fuels facility for
$9.7 million cash and an additional $300,000 payment contingent upon successful
reassembly at the owner's new site to DTE Kentucky, LLC, an affiliate of DTE
Energy Services, Inc., in April 2000. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.
Proprietary Protection
Trademarks and Service Marks:
United States Trademark Registration No. 2,038,742 issued February 18,
1997 for mark "Covol."
United States Trademark/Service Mark Application No. 78/018,501 filed
July 26, 2000 for mark "Headwaters."
Patents. Headwaters has eight U.S. patents that expire on January 21,
2014 and one U.S. patent that expires on August 9, 2011. 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, that Headwaters will not infringe on patents held by other
parties or that Headwaters will have the resources to enforce any proprietary
protection afforded by the patent or defend against an infringement claim.
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 and expected revenues
are dependent upon license agreements by which licensees use the Headwaters
technologies to manufacture alternative fuel and then pay license fees to
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.
7
Government Regulation
Headwaters' 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, Headwaters and its licensees obtained
various state and local permits. Headwaters believes that it or its licensees
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 the alternative fuel operations.
Compliance with permits, regulations, and the approved processes helps
protect against pollution or contamination. Acid is the only stored raw material
used in the approved 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,
Headwaters' and its licensees' alternative fuel operations entail risk of
environmental damage and Headwaters or its licensees may incur liabilities in
the future arising from the discharge of pollutants into the environment or from
waste disposal practices.
Failure by Headwaters 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 Headwaters or its licensees. Other
developments, such as the enactment of more stringent environmental laws and
regulations, could require Headwaters or its licensees to incur significant
capital expenditures. If Headwaters or its licensees do not have the financial
resources or are otherwise unable to comply with such laws and regulations, or
if compliance substantially increases production costs, these results could also
have a material adverse effect on Headwaters.
Headwaters' goal is to establish itself as the provider of technologies
that will assist others in the processing and reclamation of their wastes and
by-products, and Headwaters seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. However, the
alternative fuel manufacturing process using Headwaters' technologies typically
uses dilute acids. Headwaters and its licensees must comply with hazardous
material handling and storage regulations related to acid solutions and stored
concentrates.
Headwaters' and its licensees' alternative fuel operations are also
subject to federal and state safety and health standards. Headwaters is
committed to providing effective management of worker safety and health
protection. In addition, Headwaters has developed a safety policy designed to
raise and maintain safety awareness by both management and employees. Failure to
comply with safety and health standards could have a material adverse affect on
Headwaters. For example, a regulatory inspector could close the operation until
a 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, marketing of
competitive chemical reagents or in the marketing of end products qualifying as
synthetic fuel. Competition includes, for example, Startec in the project
development business and Nalco Chemical Company in the chemical reagent sales
business. Headwaters will also experience competition from traditional coal and
fuel suppliers and natural resource producers in addition to those companies
that specialize in the recycling of waste products generated by coal, coke,
steel and other resource production. Many of these companies have greater
financial, management and other resources than Headwaters. Headwaters believes
that it will be able to compete effectively although there can be no assurance
that it will do so successfully.
8
Employees
Headwaters and its subsidiaries currently employ 51 persons full-time.
Of these employees, 35 are in alternative fuel operations and technical support
services and 16 are in corporate administration and miscellaneous operations and
project development. None of these employees are covered by a collective
bargaining agreement.
Forward Looking Statements
Statements in this Annual Report on Form 10-K regarding Headwaters'
expectations as to the operation of facilities utilizing Headwaters'
technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of non-alternative fuel 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. 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.
ITEM 2. PROPERTIES
Headwaters leased in October 2000 for a five year term approximately
7,000 square-feet of office space in Draper, Utah, which houses its executive
offices. The lease provides for a monthly rent of approximately $8,000 with
certain adjustments for inflation plus expenses.
In October 1997, Headwaters purchased for $150,000 an 8,000 square-foot
site located in Price, Utah, on which Headwaters' prototype plant is located.
Included in the purchase was a 1,400 square-foot office and warehouse building
which houses equipment. The property is subject to a 10-year $100,000 mortgage
held by the seller. Headwaters has been leasing the property and is also
considering selling the property.
In June 1996, Headwaters entered into a land lease of approximately 12
acres in Price, Utah with a current monthly rental of $600. The lease term
commenced on June 20, 1996 and expires on December 31, 2007 but may be extended.
In 1996, Headwaters constructed a 22,000 square-foot building to house a synfuel
facility. In March 1997, this building was subleased by Headwaters to Coaltech
as part of the sale of the Utah Synfuel #1 facility. Headwaters has also
constructed a 1,650 square-foot chemical mixing plant, on the property.
In February 1997, Headwaters entered into a lease agreement with
Earthco for two contiguous parcels located in Wellington, Utah. On one 30 acre
parcel, Headwaters constructed a 3,400 square-foot wash plant. The second parcel
covers approximately 357 acres to be used as a fines recovery operation. In
September 2000, Headwaters agreed to terminate the lease agreement with Earthco
which has relinquished its rights in the property to Nevada Electric Investment
Company ("NEICO") as a part of a settlement. At the same time, Headwaters leased
the first parcel from NEICO and entered into a sublease with a third party that
wishes to use the wash plant. The lease and sublease are each for a concurrent
one year term, with the sublessee performing all of Headwaters' lease
obligations to NEICO. The sublessee has an option to purchase the wash plant at
the end of the one year sublease.
In 1997, Headwaters entered into a five-year, $850 per month sublease
with Combustion Resources, Inc. for approximately 2,400 square feet of office
and laboratory space in Provo, Utah. Headwaters is currently renegotiating this
lease.
In May 1998, Headwaters purchased approximately 80 acres of undeveloped
property near Sunnyside, Utah for $100,000. In June 1998, Headwaters entered
into a five-year lease with an option to purchase approximately 40 acres of
property with office and warehouse improvements. The lease payments are $2,500
per month, escalating to $3,500 per month over time. The leased property is
adjacent to the purchased property.
None of Headwaters' subsidiaries have significant interests in real
property.
9
ITEM 3. LEGAL PROCEEDINGS
Headwaters has ongoing litigation that it incurs in the normal course
of business including the items discussed herein. Headwaters intends to
vigorously defend and/or pursue it's 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.
NEICO/Earthco. In February 1997, Headwaters entered into a contract on
a parcel of real property located near Price, Utah, in which Headwaters obtained
certain possessory and related interests, Headwaters' primary purpose being to
obtain a source of coal fines to serve as feedstock for a nearby alternative
fuel facility. In August 1999, Headwaters alleged that Earthco had breached a
material provision of the contract because Earthco did not have title to the
property. Headwaters refused to tender its August 1999 payment because of
Earthco's breach. In addition, Headwaters contended that the quantity and/or
quality of recoverable coal fines was substantially less than what Headwaters
had understood. Earthco subsequently countered with allegations that Headwaters
had breached its obligations under the contract, including failure to make the
August 1999 payment.
In November 1999, Headwaters was served with a complaint from the
Seventh Judicial District Court of Carbon County, Utah styled Nevada Electric
Investment Company v. Earthco, et al. In the complaint, Nevada Electric
Investment Company ("NEICO") alleged that it is the lawful owner of the property
near Wellington, Utah described in Headwaters' lease from Earthco. NEICO sought
a declaratory judgement that Headwaters is not entitled to possession of the
property due to the lack of ownership by Earthco. The complaint also sought
further relief from Earthco.
Headwaters received Earthco's answer, counterclaims and cross-claim in
December 1999. Earthco's cross-claim against Headwaters alleged breach of
contract and prayed for substantial damages in an amount to be proven at trial
but alleged to be in excess of $5 million. Headwaters filed its reply and
cross-claim against Earthco in January 2000 denying Earthco's claims and
asserting claims of misrepresentation, breach of lease, unjust enrichment, and
related claims and for general and consequential damages in an amount to be
proven at trial.
NEICO, Earthco and Headwaters have settled their disputes. Earthco and
Headwaters entered into a mutual release of claims. Earthco confirmed title to
the property in NEICO. In September 2000, Headwaters entered into a one-year
lease for the wash plant parcel directly with NEICO and otherwise confirmed
title to the property in NEICO. The parties are awaiting an order of dismissal
from the court.
K-Lee Processing. In March 1997, Headwaters entered into an Amended and
Restated Supply Agreement for the purchase of coal fines from K-Lee Processing,
Inc. and Concord Coal Recovery Limited Partnership (together "K-Lee").
Headwaters periodically purchased coal fines from K-Lee throughout 1997. K-Lee
invoiced Headwaters for a total of 108,000 tons of fines and Headwaters paid for
those fines. However, K-Lee failed to deliver 11,059 tons valued at $320,716.
K-Lee has refused to refund the overpayment for non-delivered fines. In July
2000 Headwaters filed a complaint against K-Lee Processing, Inc. and Concord
Coal Recovery Limited Partnership in the United States District Court for the
Northern District of Alabama seeking damages in the amount of $320,716 for the
coal fines purchased but not delivered. 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.
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 allege that the
technology purchase transaction was an unauthorized corporate action and that
Davidson and Headwaters conspired together to effect the transfer. The complaint
asserts related causes of action in fraud, conversion, patent infringement,
conspiracy and unfair competition seeking unspecified money damages to be proven
at trial, accounting, disgorgement, recission of contracts, punitive damages,
and other relief. Headwaters denies these allegations and is asking the court to
dismiss the action. 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.
10
Levy. In March 1999, Headwaters sold convertible preferred stock,
warrants, and a convertible promissory note to OZ Master Fund, Ltd. In September
2000, Headwaters received a summons and complaint from the United States
District Court for the Southern District of New York filed by Mark Levy against
OZ Master Fund and related entities ("OZ") and Headwaters. In the action, a
purported shareholder of Headwaters alleges that OZ violated section 16(b) of
the Securities Exchange Act of 1934 by converting preferred stock into
Headwaters common stock and then selling the same within a six month period, and
further, that Headwaters' redemption of the preferred stock and the note
constituted a sale of common stock for which OZ is liable under section 16(b).
The complaint seeks on behalf of Headwaters from OZ unspecified money damages to
be proven at trial, attorney fees, and other relief. 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.
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 has
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
has answered the complaint denying Headwaters' claims and asserting
counter-claims based upon allegations of misrepresentation and breach. AJG seeks
unspecified compensatory damages as well as punitive damages. Headwaters denies
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. 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 by Headwaters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of stockholders was held on September 6, 2000.
Reference is made to Headwaters' Form 8-K filed September 19, 2000 for a
description of the matters voted on and the results of the voting.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The shares of common stock of Headwaters trade on the Nasdaq Stock
Market(SM) under the symbol "HDWR." 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.
11
Fiscal 1999 Low High
- ----------- --- ----
Quarter ended December 31, 1998 $4.25 $9.38
Quarter ended March 31, 1999 4.13 8.13
Quarter ended June 30, 1999 3.25 7.00
Quarter ended September 30, 1999 2.50 6.06
Fiscal 2000
- -----------
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
As of December 1, 2000, there were approximately 547 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 and are now
owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. 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 on 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.
As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one 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 became a wholly-owned subsidiary of
Headwaters. In November 1999, the last limited partner in Alabama Synfuel #1
exchanged its limited partnership interest as a part of a licensing agreement so
that Alabama Synfuel #1 also became a wholly-owned subsidiary 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
12
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 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, which had the following
rights and privileges:
* Dividends on the preferred stock were cumulative and accrued whether or
not they had been declared or whether Headwaters had any profits. The
dividend rate was 7% per year of the liquidation value of $1,000 per
share.
* The preferred stock was convertible into common shares in incremental
stages beginning April 1999 through July 1999, at which time all of the
outstanding shares became convertible to common stock. The number of
common shares to be received upon conversion was determined by
multiplying the number of preferred shares by $1,000 and dividing that
number by the conversion price (originally $5.50 per share, subject to
market adjustment). Upon conversion, all accrued and unpaid dividends
were to be paid or converted into shares of common stock.
* Headwaters had the option to redeem the outstanding preferred stock
beginning July 1999 for a redemption price equal to 125% of the
liquidation value plus any accrued and unpaid dividends thereon.
Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants are exercisable from
April 1999 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
13
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.
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 director of Headwaters is a manager and 2.5% owner
of the investor. The director disclaims any beneficial interest in the
investor's securities in Headwaters.
14
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. In 1996, Headwaters sold its construction
subsidiaries. All construction - related operations were reflected as
discontinued operations in the 1996 financial statements. The note receivable
received by Headwaters as consideration for the sale is "marked to market" each
quarter based on the market value of Headwaters' stock held as collateral, and
the resulting adjustments are reflected in Headwaters' statement of operations.
As more fully described in Notes 14 and 15 to the consolidated financial
statements, in 1998, 1999 and 2000, Headwaters recorded approximately $200,000,
$0 and $17,949,000, respectively, of gains on sale of facilities and other
non-recurring transactions, and approximately $218,000, $9,234,000 and
$17,758,000, respectively, of losses on sale of facilities, asset write-offs and
other non-recurring charges. Additionally, as more fully described in Note 5 to
the consolidated financial statements, in 2000 Headwaters recorded an
extraordinary loss on early extinguishment of debt of $7,860,000.
The selected financial data as of and for the years ended September 30,
1996 and 1997 and as of September 30, 1998 are derived from audited financial
statements not included herein. The selected financial data for the year ended
September 30, 1998, and as of and 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 year ended September 30, 2000 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) 1996 1997 1998 1999 2000
- ------------------------------------------------- ------------ ------------- ------------ ------------- ------------
OPERATING DATA:
Total revenue $ 295 $ 147 $ 2,186 $ 6,719 $45,835
Income (loss) from continuing operations (12,955) (10,498) (11,308) (28,393) 3,682
Net income (loss) (13,836) (10,498) (11,308) (28,393) 3,682
Diluted net income (loss) per
common share:
Income (loss) per share from
continuing operations (1.86) (1.32) (1.17) (2.39) .15
Net income (loss) per share (1.99) (1.32) (1.17) (2.39) .15
As of September 30,
-------------------------------------------------------------------
(thousands of dollars) 1996 1997 1998 1999 2000
- ------------------------------------------------ ------------- ------------- ------------ ------------- ------------
BALANCE SHEET DATA:
Working capital (deficit) $(3,482) $(3,471) $ 7,497 $(1,799) $11,225
Net property, plant and equipment 7,125 13,619 15,809 14,182 552
Total assets 8,072 26,590 68,061 58,095 33,441
Long-term obligations:
Long-term liabilities 364 3,817 14,879 18,422 5,235
Deferred revenue -- 1,545 8,377 7,501 10,513
Redeemable convertible preferred
stock -- -- -- 4,332 --
Total long-term obligations 364 5,362 23,256 30,255 15,748
Total stockholders' equity (deficit) (233) 6,426 14,746 (1,028) 10,747
15
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.
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.
Revenues. Total revenue for the year ended September 30, 2000 ("2000")
increased by $39,116,000 to $45,835,000 as compared to $6,719,000 for the year
ended September 30, 1999 ("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 earned 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. Initial license fees
were normally received when construction of the related alternative fuel
facility began, when construction was completed, or when certain construction
milestones or other conditions were met. These license fees are recognized on a
straight-line basis over the period covered by Headwaters' license agreements
with licensees. Recurring earned license fees or royalty payments are due
quarterly based upon alternative fuel produced and sold as reported to
Headwaters by its licensees. The increase in 2000 earned 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. Headwaters provides chemical reagent to its licensees
either at a fixed price or at Headwaters' cost plus a contracted markup.
Headwaters purchases the chemical materials under a long-term contract with a
large chemical company. 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. 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. 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.
Headwaters also receives ongoing royalties based upon the sale of alternative
fuel from the facilities.
Gains on Non-recurring Transactions. In 2000, Headwaters recorded
non-recurring 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.
Cost of Operations decreased by $9,258,000 to $3,821,000 during 2000
from $13,079,000 during 1999. During 2000, Headwaters incurred significantly
lower operating expenses in connection with the continued
16
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 have now been
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. Headwaters expects future
costs of operations to remain significantly below 1999 levels.
Selling, General and Administrative Expenses increased $237,000, or 5%,
to $5,361,000 during 2000 from $5,124,000 for 1999. The increase in expenses in
2000 is due to an increase in payroll and other compensation-related costs,
partially offset by decreases in nearly all other cost categories.
Asset Write-offs and Other Non-recurring 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 non-recurring settlement
charges ($979,000) and asset write-downs ($532,000) were recorded in 2000. All
of these asset write-offs and non-recurring charges totaled approximately
$17,758,000.
Other Income and Expense. During 2000, Headwaters reported net other
expenses of $3,636,000 compared to $5,980,000 for 1999. This decrease 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. Interest expense is
expected to significantly decrease in the future as a result of repayment of
debt related to the sale of Company-owned facilities and the complete redemption
of outstanding convertible debt in 2000.
During 1996, Headwaters sold certain construction companies and
received as consideration a $5,000,000 note receivable ("Note"). The Note is
"marked to market" each quarter based upon the market value of Headwaters'
common stock held as collateral and is reflected in the consolidated balance
sheet at the underlying value of this collateral, $466,000 at September 30,
2000. This adjustment 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. Allowances are provided, on a case-by-case basis, when management
determines that the investment or equity in earnings is not realizable. During
2000, the provision for such 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 an 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 alternative minimum tax. Headwaters believes it is
more likely than not that the portion of the total deferred tax asset recognized
in 2000 will be realized as a result of income to be recognized from the
amortization of deferred revenue in subsequent periods.
Extraordinary Item. In January 2000, Headwaters redeemed all of the
convertible debt issued from September 1999 through December 1999 not previously
converted into common stock. The redemption consideration given included
approximately $1,000,000 in redemption premiums plus approximately 214,000
shares of common stock. The loss recognized as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs totaled approximately $1,823,000. This loss is
reflected as an extraordinary item in the consolidated statements of operations.
Also in 2000, Headwaters redeemed all of the $20,000,000 face value convertible
debt issued in March 1999. Early prepayment costs of approximately $6,037,000
were recognized as an extraordinary item as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs in excess of the debt carrying value.
17
Net Income. For 2000, net income of $3,682,000 represents an
improvement of $32,075,000 from the net loss of $28,393,000 in 1999. This is
primarily due to substantially increased revenue, including gains on the sale of
facilities, and decreased cost of operations, partially offset by increased
asset write-offs and other non-recurring charges and an extraordinary loss.
Year Ended September 30, 1999 Compared to Year Ended September 30, 1998
The information set forth below compares Headwaters' operating results
for 1999 with its operating results for 1998.
Revenues. Total revenue for the year ended September 30, 1999 ("1999")
increased by $4,533,000 to $6,719,000 as compared to $2,186,000 for the year
ended September 30, 1998 ("1998"). The major components of this revenue are
discussed in the sections below.
License Fees. During 1999, Headwaters recognized license fees totaling
$3,526,000, while $860,000 of license fees were recognized during 1998. The
license fees in 1999 consisted of the straight-line amortization of one-time
non-refundable initial license fees of $875,000 and recurring earned license
fees or royalty payments of $2,651,000. License fees in 1998 consisted of the
straight-line amortization of one-time non-refundable initial license fees of
$654,000 and recurring license fees or royalty payments of $206,000.
Chemical Sales. Total chemical sales during 1999 were $2,140,000 with a
corresponding direct cost to Headwaters of $1,695,000. Total chemical sales
during 1998 were $994,000 with a corresponding direct cost to Headwaters of
$642,000. Alternative fuel sales were $767,000 in 1999 compared to $32,000 in
1998 and represent the sale of product from Headwaters-owned facilities.
Headwaters sold six chemical mixing plants to licensees during 1998 for
$1,088,000, generating a gross profit of $200,000. There were no sales of
chemical mixing plants during 1999.
Cost of Operations increased $6,878,000 from $6,201,000 during 1998 to
$13,079,000 during 1999. During 1999, Headwaters incurred significantly higher
operating expenses in connection with the continued refinement and
implementation of the briquetting process in connection with the 24 facilities
placed in service during 1998, and in particular the operating costs of the four
facilities owned by Headwaters which were held for sale. These expenses
primarily related to labor and operating expenses at the four Headwaters-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 one of the alternative fuel
facilities 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 and 1998 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 the cost of operations. The
write-down was approximately $1,815,000 during 1999 and $1,400,000 during 1998.
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 Utah facility who is a major licensee and partner of
Headwaters, and other related business reasons.
Selling, General and Administrative Expenses increased $385,000, or 8%,
to $5,124,000 during 1999 from $4,739,000 for 1998. The largest components of
selling, general and administrative expenses for both 1999 and 1998 were
payroll, professional services and travel expenses. Payroll-related costs
increased approximately $540,000, due primarily to increased headcount, salary
costs and amortization of deferred compensation from stock options; professional
services increased approximately $20,000; and travel decreased approximately
$50,000 from 1998 to 1999. Also, there was approximately $250,000 of commissions
incurred in connection with the placement of alternative fuel license agreements
in 1998 while there were no such commissions in 1999. Changes in the other
categories from year to year were not material.
18
Asset Write-offs and Other Non-recurring 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, in 1999 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 fuel manufacturing
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 total approximately
$7,395,000, which amount is recorded as asset write-offs and other non-recurring
charges in the consolidated statement of operations.
Loss on Sale of Facility. In March 1998, Headwaters sold an alternative
fuel facility located in Alabama on which a loss of $218,000 was recognized. The
sales price was $6,500,000 payable in the form of a nonrecourse promissory note
collateralized by the facility. In 1999, Headwaters sold a facility located in
Pennsylvania on which a loss of approximately $1,839,000 was recognized. As more
fully described in Note 14 to the consolidated financial statements, Headwaters
received additional cash payments in 2000, some of which were recognized as
revenue in 2000, related to the 1999 facility sale.
Other Income and Expense. During 1999, Headwaters had net other
expenses of $5,980,000 compared to $1,694,000 for 1998. This increase of
$4,286,000 relates primarily to an increase in interest expense of $3,508,000, a
change between periods of $1,228,000 in the mark-to-market adjustment of the
carrying value of the related party note receivable collateralized by common
stock, and a decrease in minority interest in losses of consolidated
subsidiaries of $401,000, partially offset by an increase in interest income of
$1,006,000.
A $515,000 payment on the related party note receivable during 1999 was
included in interest income for 1999, while no interest income on the note was
recognized in 1998. Another reason for the increase in interest income in 1999
over 1998 relates to a full year's interest being recognized on the $6,500,000
note receivable from the sale of the Alabama facility in March 1998.
Interest expense in 1998 of $2,745,000 consisted primarily of
amortization of the discount incurred upon the issuance of convertible debt and
warrants at a discount. Interest expense of $6,253,000 in 1999 consisted of
interest accrued on notes payable used to finance the construction of
alternative fuel facilities held for sale and for operating needs and $2,075,000
of amortization of debt discount and debt issue costs. Interest expense
increased significantly as a result of the debt issued during March 1999.
During September 1998, Headwaters offered the limited partners of Utah
Synfuel #1 and Alabama Synfuel #1 common stock of Headwaters in exchange for
their limited partnership interests. These exchanges, most of which were
accounted for in September 1998, were substantially completed by November 1998,
at which time Utah Synfuel #1 became a wholly-owned subsidiary of Headwaters and
Alabama Synfuel #1 became a 98%-owned subsidiary of Headwaters. As a result of
these exchanges, minority interest in the losses of consolidated subsidiaries
decreased from approximately $392,000 in 1998 to $0 in 1999.
Net Loss. For 1999, the net loss of $28,393,000 represents an increase
of $17,085,000 from the net loss of $11,308,000 in 1998. This is primarily due
to the increase in cost of operations, the asset write-offs and other
non-recurring charges, and the increase in interest expense. Headwaters did not
recognize any income tax benefit in 1999 or 1998 since the realization of its
deferred tax asset of approximately $21,800,000, consisting primarily of net
operating loss carryforwards, was dependent on generation of future taxable
income.
Liquidity and Capital Resources
Liquidity. During 1998, Headwaters and its licensees completed the
construction of and began operations at 24 alternative fuel facilities.
Headwaters owned four facilities which were sold during 1999 and 2000. Proceeds
from the sale of facilities were used primarily to retire debt that was incurred
in connection with the construction and operation of the facilities, and to a
lesser extent, for working capital needs.
19
Net cash provided by operating activities during the year ended
September 30, 2000 was $6,608,000 compared to $17,516,000 of cash used during
the year ended September 30, 1999. Most of this change in cash flow from
operating activities is attributable to the 2000 net income of $3,682,000 as
compared to the 1999 net loss of $28,393,000, augmented by the non-cash nature
of some of the material expenses included in results of operations for 2000.
During 2000, proceeds from the sale of facilities were approximately
$42,334,000, net proceeds from the issuance of notes payable and related common
stock warrants totaled approximately $6,980,000, and net proceeds from the
issuance of common stock and related common stock warrants totaled approximately
$5,254,000. Approximately $43,995,000 of notes payable were repaid during 2000
and approximately $4,454,000 of cash was used for preferred stock redemptions.
Capital Resources. In addition to the sale of facilities in 2000,
Headwaters' investing activities consisted of the purchase of short-term
investments and investments in non-affiliated companies. Headwaters has no
current plans to construct additional synthetic fuel facilities or to incur
significant costs to acquire property, plant and equipment, but may increase its
strategic investments and lending activities as opportunities arise. As of
September 30, 2000, Headwaters owns from 1% to 27% of the voting securities of
five non-public high-risk investee companies. Current investments range from
approximately $130,000 to $1,400,000. Through December 1, 2000, Headwaters made
additional equity investments of approximately $1,558,000 under the same general
terms as the investments made in fiscal 2000. Headwaters also has notes
receivable representing short-term loans to nine private, emerging growth
companies in order to bridge the period between seed funding and the close of
first and second rounds of equity financing. Notes receivable from these
companies range from $200,000 to $500,000 each. From October 1, 2000 to December
1, 2000, Headwaters made additional loans of approximately $1,050,000 under the
same general terms as the loans made in fiscal 2000. Headwaters does not intend
to increase the funds committed to these investment types in the future, but
could incur losses if the loans are not repaid or if the investments are not
recoverable.
As described in Note 5 to the consolidated financial statements,
Headwaters began acquiring shares of its common stock in connection with a stock
repurchase plan announced during 2000. The program authorizes Headwaters to
purchase stock in the open market or through negotiated transactions referred to
as block trades. Purchases under the plan are at the discretion of Headwaters'
management. Through September 30, 2000, Headwaters purchased approximately
586,000 shares for approximately $1,897,000, and continues to purchase stock
subsequent to September 30, 2000. Headwaters continually evaluates financial
alternatives to the stock repurchase program but currently expects the program
to continue through fiscal 2001 subject to market conditions and available cash.
Headwaters' working capital improved from a deficit position of
approximately $1,799,000 at September 30, 1999 to a positive working capital
position of approximately $11,225,000 as of September 30, 2000. Several factors
caused this change, most notably an increase in cash from the sale of facilities
and increased revenue. The most significant changes in working capital, in
addition to the increase in cash and short-term investments, were the reduction
of approximately $19,883,000 in facilities and equipment held for sale and the
reduction of approximately $20,418,000 in current notes payable. Both of these
changes resulted primarily from the sales of alternative fuel facilities in
2000.
Headwaters expects its operations to produce positive cash flows in
future periods. In addition to cash provided by operating activities, Headwaters
has borrowing capability under a revolving line of credit with a bank which was
obtained in October 2000. Borrowings under this line of credit, which expires
January 2002, were used to repay a $3,000,000 note payable to this bank which
was outstanding at September 30, 2000 and to repay a $1,838,000 note payable to
a corporation (see Notes 5 and 6 to the consolidated financial statements).
Subsequently, the line of credit was paid down and at October 31, 2000, there
were no outstanding borrowings under the line of credit. Borrowings under this
revolving line bear interest at prime plus 1% and are limited to the lesser of
$8,000,000 or the "borrowing base," as defined. At October 31, 2000, Headwaters'
notes payable totaled less than $500,000. Headwaters believes it will have
sufficient cash reserves to meet its obligations during the foreseeable future,
and also believes it has the ability to raise additional debt and equity capital
from other sources if necessary.
Forward Looking Statements
Statements in this Management's Discussion and Analysis regarding
Headwaters' expectations as to the operation of facilities utilizing Headwaters'
technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of non-alternative fuel
20
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 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) The commercial success of Headwaters' technologies.
(2) Operating issues for licensed facilities including feedstock
availability, moisture content, Btu content, correct application of
chemical reagent, significant chemical change, operability of
equipment, production capacity, product durability, resistance to water
absorption and overall costs of operations.
(3) Marketing issues relating to market acceptance of products manufactured
using Headwaters' technologies, including control of moisture content,
hardness, special handling requirements and other characteristics of
the alternative fuel product which affect its marketability and its
sales price.
(4) Securing of suitable facility sites, including permits and raw
materials, for relocation and operation of facilities and product
sales.
(5) The market acceptance of products manufactured with Headwaters'
technologies in the face of competition from traditional products.
(6) Dependence on licensees to successfully implement Headwaters' chemical
technologies and making license and other payments to Headwaters.
(7) Maintenance of placed-in-service requirements under Section 29 of the
tax code by alternative fuel manufacturing facilities.
(8) Changes in governmental regulations or failure to comply with existing
regulations that may result in operational shutdowns of licensee
facilities.
(9) The continued availability of tax credits to licensees under the tax
code.
(10) The commercial feasibility of Headwaters' alternative fuel technologies
upon the expiration of tax credits.
(11) Ability to meet financial commitments under existing contractual
arrangements.
(12) Ability to meet non-financial commitments under existing contractual
arrangements.
(13) Ability to commercialize the non-alternative fuel chemical technologies
which have only been tested in the laboratory and not in full-scale
operations.
(14) Ability to commercialize the technology of others and to implement
non-technology based business plans which are at an early stage of
investigation and investment and which will require significant time,
management, and capital investment.
(15) Success in the face of competition by others producing alternative fuel
and other products.
(16) Sufficiency of intellectual property protections.
Impact of Inflation
During 2000, cost increases to Headwaters 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 effects, if any, on the results
of operations or financial position of Headwaters. Based on that review,
Headwaters believes that none of these pronouncements will have any significant
effects on current or future financial position or results of operations.
21
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 which
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.
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," "Section 16(a) Beneficial Ownership Reporting Compliance" and
"Proposal No. 1: Election of Directors" in Headwaters' Proxy Statement to be
filed in January 2001 for the Annual Meeting of Stockholders to be held in 2001
(the "Proxy Statement"), are incorporated herein by reference.
22
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.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Consolidated Financial Statements of Headwaters Incorporated
Reports of Independent Public Accountants F-1
Consolidated Balance Sheets as of September 30, 1999 and 2000 F-2
Consolidated Statements of Operations
for the years ended September 30, 1998, 1999 and 2000 F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended September 30, 1998, 1999 and 2000 F-5
Consolidated Statements of Cash Flows
for the years ended September 30, 1998, 1999 and 2000 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.
There is included a restated financial data schedule for the years
ended September 30, 1998 and 1999.
For convenience, the name Headwaters is used throughout this listing
although in some cases the name Covol was used in the original instrument.
23
Exhibit No. Description Location
3.1 Certificate of Incorporation of Headwaters (1)
3.1.1 Certificate of Amendment of the Certificate of Incorporation of Headwaters dated (1)
January 22, 1996
3.1.2 Certificate of Amendment of the Certificate of Incorporation dated June 25, 1997 (3)
3.1.3 Certificate of Designation, Number, Voting Powers, Preferences and Rights of (4)
Headwaters' Series A 6% Convertible Preferred Stock dated August 18, 1997
(originally designated as Exhibit No. 3.1.2)
3.1.4 Certificate of Designation, Number, Voting Powers, Preferences and Rights of (5)
Headwaters' Series B Convertible Preferred Stock dated September 18, 1997
(originally designated as Exhibit No. 3.1.3)
3.1.7 Certificate of Amendment of the Certificate of Incorporation dated March 1, 2000 (14)
3.1.8 Certificate of Amendment of the Certificate of Incorporation dated September 6, (19)
2000
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)
9.1 Special Powers of Attorney Coupled With an Interest dated February 1, 1996 (1)
between Headwaters, Gerald Larson and Michael McEwan
10.8 Lease Agreement, dated May 31, 1994, between Headwaters and Byrleen Hansen (1)
regarding Carbon County, Utah property
10.11.2 License Agreement dated September 10, 1996, between Headwaters and CoBon Energy, (2)
LLC
10.13.1 Promissory Noted dated August 1996 in favor of Headwaters from Michael McEwan and *
Gerald Larson
10.13.2 Unlimited Guaranty of Gerald Larson and release of Michael McEwan dated April 29, *
1998
10.16.1 Stock Option Agreement dated June 1, 1996 with Brent M. Cook (2)
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 (6)
Appalachian Synfuel, LLC and Headwaters
10.47** License Agreement, dated August 5, 1997, between Pelletco Corporation and (6)
Headwaters
10.49** Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG (6)
Financial Services, Inc. and Headwaters
10.50.1** Form of Amended and Restated License and Binder Purchase Agreement dated February (7)
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
10.50.1.1*** Form of First Amendment to Amended and Restated License and Binder Purchase *
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 (8)
10.56 Employment Agreement effective April 21, 1998 with Brent M. Cook (9)
10.58.8 Series E Warrant in favor of Leeds Group dated March 17, 1999 (10)
10.58.9 Series E Warrant in favor of Howard L. Schwartz dated March 17, 1999 (10)
10.58.10 Series E Warrant in favor of Jack A. Schwebel dated March 17, 1999 (10)
10.58.11 Series E Warrant in favor of Brent M. Lockwood dated March 17, 1999 (10)
10.60 Employment Agreement effective April 20, 1999 with Kirk A. Benson (11)
10.61*** Purchase Agreement dated August 27, 1999 relating to the sale of the River Hill (12)
Project
10.61.1*** License and Binder Purchase Agreement dated August 27, 1999 relating to the River (12)
Hill Project
10.61.2*** Modification Agreement dated August 27, 1999 between the Purchaser of the River (12)
Hill Project, Fun Enterprises Pty Limited and Headwaters
10.64*** Utah #2 Asset Purchase Agreement dated December 23, 1999 between Headwaters and (13)
DTE Kentucky, LLC
10.64.1*** License and Binder Purchase Agreement dated December 29, 1999 between Headwaters *
and DTE Kentucky, LLC
10.65*** Asset Purchase Agreement dated January 18, 2000 among Headwaters, Pocahontas (13)
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 and *
Premier Elkhorn Coal Company (related to the Pocahontas facility)
24
10.65.2*** License and Binder Purchase Agreement dated January 21, 2000 between Headwaters and *
Premier Elkhorn Coal Company (related to the Mohave facility)
10.67 Mountaineer Fuels Asset Purchase Agreement dated April 17, 2000 between DTE (15)
Kentucky, LLC and Headwaters
10.67.1*** License and Binder Purchase Agreement dated April 17, 2000 between DTE Kentucky, (15)
LLC and Headwaters
10.69*** Settlement Agreement and Mutual Release dated May 25, 2000 among Headwaters and (17)
Birmingham Syn Fuel, L.L.C., PacifiCorp Syn Fuel, L.L.C., and PacifiCorp
Financial Services, Inc.
10.69.1 Amended and Restated Promissory Note dated May 25, 2000 in favor of Headwaters, (17)
executed by Birmingham Syn Fuel, L.L.C. as debtor
10.69.2 Amended and Restated Security Agreement dated May 25, 2000 between Headwaters and (17)
Birmingham Syn Fuel, L.L.C.
10.69.3*** License and Binder Purchase Agreement dated May 25, 2000 between Birmingham Syn (17)
Fuel, L.L.C. and Headwaters
10.69.4*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (17)
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 (17)
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 (17)
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 (17)
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., (17)
Utah Synfuel #1 Ltd, and Headwaters
10.71 Loan Agreement dated October 18, 2000 between Headwaters and Zions First National *
Bank
10.71.1 Promissory Note dated October 18, 2000 between Headwaters as borrower and Zions *
First National Bank as lender
10.72 Employment Agreement effective as of January 1, 1999 with Kenneth R. Frailey *
10.73.1 Stock Purchase Agreement dated July 7, 2000 between StyleU4EA.com, Inc. and *
Headwaters
10.73.2 Loan Agreement dated October 6, 2000 between StyleU4EA.com, Inc. and Headwaters *
10.73.3 Stock Purchase Agreement dated October 16, 2000 between StyleU4EA.com, Inc. and *
Headwaters
10.73.4 Loan Agreement dated November 29, 2000 between NextStep Broadband Corporation and *
Headwaters
10.74 Credit Agreement dated October 20, 2000 between The H.B. Group, Inc. and *
Headwaters
10.74.1 Amendment to Credit Agreement dated October 20, 2000 between The H.B. Group, Inc. *
and Headwaters
10.74.2 Second Amendment to Credit Agreement dated December 1, 2000 between The H.B. *
Group, Inc. and Headwaters
16 Letter regarding change in certifying accountant (18)
21.1 List of Subsidiaries of Headwaters *
23.1 Consent of Arthur Andersen LLP *
23.2 Consent of PricewaterhouseCoopers LLP *
27.1 Financial Data Schedule for the fiscal year ended September 30, 2000 *
27.2 Restated Financial Data Schedule for the fiscal years ended September 30, 1998 *
and 1999
99.1 2000 Employee Stock Purchase Plan (16)
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 *
- -----------------------
* 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.
25
(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' Current Report on Form 8-K, dated March 10, 1997.
(4) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, dated August 19, 1997.
(5) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for event dated September 18,
1997, filed October 28, 1997.
(6) Incorporated by reference to the indicated exhibit filed with
Headwaters' Annual Report on Form 10-K for the fiscal year ended
September 30, 1997.
(7) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
ended March 31, 1998.
(8) Incorporated by reference to the indicated exhibit filed with
Headwaters' Annual Report on Form 10-K, for the fiscal year ended
September 30, 1998.
(9) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
ended December 31, 1998.
(10) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated March 17,
1999, filed March 24, 1999.
(11) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
30, 1999.
(12) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K/A, for event dated August 27,
1999, filed September 28, 1999.
(13) 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.
(14) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated February
29, 2000, filed March 2, 2000.
(15) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended March
31, 2000.
(16) Incorporated by reference to the indicated exhibit filed with
Headwaters' Registration Statement on Form S-8 (SEC file no.
333-39674), filed June 20, 2000.
(17) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
30, 2000.
(18) 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.
(19) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated September
6, 2000, filed September 19, 2000.
Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
September 30, 2000:
* Form 8-K filed on July 19, 2000, amended on July 28, 2000, for an event
dated July 19, 2000 (Change in Certifying Accountant).
* Form 8-K filed on September 19, 2000 for an event dated September 6,
2000 (Special Meeting of Stockholders).
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.
26
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 20, 2000
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 20, 2000
- --------------------- (Principal Executive Officer) and
Kirk A. Benson Director
/s/ Steven G. Stewart Chief Financial Officer December 20, 2000
- ------------------------ (Principal Financial and
Steven G. Stewart Accounting Officer)
/s/ Brent M. Cook President and Director December 20, 2000
- -----------------------
Brent M. Cook
/s/ DeLance W. Squire Director December 20, 2000
- -----------------------
DeLance W. Squire
/s/ James A. Herickhoff Director December 20, 2000
- -------------------------
James A. Herickhoff
/s/ Raymond J. Weller Director December 20, 2000
- -----------------------
Raymond J. Weller
/s/ John P. Hill, Jr. Director December 20, 2000
- -----------------------
John P. Hill, Jr.
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Headwaters Incorporated:
We have audited the accompanying consolidated balance sheet of Headwaters
Incorporated (formerly Covol Technologies, Inc.) and subsidiaries as of
September 30, 2000, and the related consolidated statements of operations,
changes in stockholders' equity (deficit) and cash flows for the year then
ended. The financial statements of the Company as of September 30, 1999 and for
the years ended September 30, 1999 and 1998 were audited by other auditors whose
report dated January 13, 2000, expressed an unqualified opinion on those
statements. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with 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 audit provides 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 the results of their operations and
their cash flows for the year then ended in conformity with accounting
principles generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Salt Lake City, Utah
November 1, 2000
Report of Independent Accountants
To the Board of Directors
Headwaters Incorporated (formerly Covol Technologies, Inc.) and Subsidiaries
In our opinion, the accompanying consolidated balance sheet as of September 30,
1999 and the related consolidated statements of operations, stockholders' equity
(deficit), and cash flows for each of the two years in the period ended
September 30, 1999, present fairly, in all material respects, the consolidated
financial position, results of operations and cash flows of Headwaters
Incorporated (formerly Covol Technologies, Inc.) and Subsidiaries at September
30, 1999 and for the two years in the period ended September 30, 1999, in
conformity with accounting principles generally accepted in the United States.
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 of these statements in accordance with
auditing standards generally accepted in the United States 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 audits provide a reasonable basis
for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Salt Lake City, Utah
January 13, 2000
F-1
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 30,
(thousands of dollars) 1999 2000
- ---------------------------------------------------------------------------------- --------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 461 $ 983
Short-term investments -- 6,973
Trade receivables, net 3,155 7,298
Notes receivable -- 2,530
Facilities and equipment held for sale 20,139 256
Due from related party 2,722 --
Inventories 573 --
Other current assets 19 131
--------------- ----------------
Total current assets 27,069 18,171
--------------- ----------------
Property, plant and equipment, net of accumulated depreciation 14,182 552
--------------- ----------------
Other assets:
Facility-dependent note and accrued interest receivable 7,879 6,598
Equity investments, net -- 3,259
Deferred income taxes -- 3,000
Intangible assets, net of accumulated amortization 3,647 1,221
Facility transferred under note receivable arrangement 2,641 --
Restricted assets 843 --
Other assets 1,834 640
--------------- ----------------
Total other assets 16,844 14,718
--------------- ----------------
Total assets $58,095 $33,441
=============== ================
(continued)
The accompanying notes are an integral
part of the consolidated financial statements.
F-2
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
As of September 30,
(thousands of dollars and shares) 1999 2000
- ------------------------------------------------------------------------------------ -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,179 $ 698
Accrued personnel costs 356 2,254
Accrued interest payable 1,452 132
Other accrued liabilities 2,549 3,654
Due to related party 2,706 --
Notes payable, current 20,626 208
-------------- ----------------
Total current liabilities 28,868 6,946
-------------- ----------------
Long-term liabilities:
Notes payable, non-current 17,887 5,055
Other long-term liabilities 535 180
Deferred revenue 7,501 10,513
-------------- ----------------
Total long-term liabilities 25,923 15,748
-------------- ----------------
Total liabilities 54,791 22,694
-------------- ----------------
Commitments and contingencies
Redeemable convertible preferred stock, $0.001 par value, issued and outstanding
60 shares at September 30, 1999 and 0 shares at September 30, 2000 4,332 --
Stockholders' equity (deficit):
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 17 shares at September 30, 1999 and 2000 (aggregate
liquidation preference of $3,682 at September 30, 2000) 1 1
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 12,766 shares at September 30, 1999 and 23,341 shares,
including 214 shares held in treasury, at September 30, 2000 13 23
Capital in excess of par value 78,457 82,659
Accumulated deficit (71,713) (70,221)
Other, including treasury stock (7,786) (1,715)
-------------- ----------------
Total stockholders' equity (deficit) (1,028) 10,747
-------------- ----------------
Total liabilities and stockholders' equity (deficit) $58,095 $33,441
============== ================
The accompanying notes are an integral
part of the consolidated financial statements.
F-3
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.)
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
(thousands of dollars, except per-share data) 1998 1999 2000
- --------------------------------------------------------------------- ----------------- ------------------ ------------------
Revenue:
License fees $ 860 $ 3,526 $17,315
Chemical sales 994 2,140 9,757
Gains on sales of facilities -- -- 16,870
Gains on non-recurring transactions 200 -- 1,079
Alternative fuel sales 32 767 149
Other 100 286 665
----------------- ------------------ ------------------
Total revenue 2,186 6,719 45,835
----------------- ------------------ ------------------
Operating costs and expenses:
Cost of chemical 642 1,695 6,617
Cost of operations 6,201 13,079 3,821
Selling, general and administrative 4,739 5,124 5,361
Asset write-offs and other non-recurring charges -- 7,395 17,758
Loss on sale of facilities 218 1,839 --
----------------- ------------------ ------------------
Total operating costs and expenses 11,800 29,132 33,557
----------------- ------------------ ------------------
Operating income (loss) (9,614) (22,413) 12,278
----------------- ------------------ ------------------
Other income (expense):
Interest and investment income 580 1,586 1,775
Interest expense (2,745) (6,253) (4,814)
Other, net 471 (1,313) (597)
----------------- ------------------ ------------------
Total other expense, net (1,694) (5,980) (3,636)
----------------- ------------------ ------------------
Income (loss) before income taxes and extraordinary item (11,308) (28,393) 8,642
Income tax benefit -- -- 2,900
----------------- ------------------ ------------------
Income (loss) before extraordinary item (11,308) (28,393) 11,542
Extraordinary loss on early extinguishment of debt -- -- (7,860)
----------------- ------------------ ------------------
Net income (loss) $(11,308) $(28,393) $ 3,682
================= ================== ==================
Basic net income (loss) per common share $(1.17) $(2.39) $.17
================= ================== ==================
Diluted net income (loss) per common share $(1.17) $(2.39) $.15
================= ================== ==================
The accompanying notes are an integral
part of the consolidated financial statements.
F-4
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
Other
------------------------------------------
Notes and
interest
receivable
-related
parties, from
issuance of,
Convertible or Deferred
Preferred Stock Common Stock Capital in collateralized compensation Common stock
(thousands of -------------------------------------- excess of par Accumulated by, common from stock held in
dollars and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at
October 1, 1997 303 $1 9,089 $9 $50,203 $(31,694) $(7,411) $(4,683) $--
Common stock issued
to purchase minority
interests in
subsidiaries 540 1 5,383
Common stock
issued for cash,
including exercise
of stock options 533 -- 3,257
Preferred stock
issued for cash,
net of offering
costs 13 -- 90
Common stock issued
on conversion of
notes payable and
accrued interest
to common stock 1,107 1 8,178
Interest expense
related to
issuance of
convertible debt
at a discount 2,046
Payment received
on notes
receivable -
related parties 329
Amortization of
deferred
compensation from
stock options 908
Write-up of
related party
note receivable (19)
Compensation expense
related to issuance
of stock options for
services 3 -- 127
Reclassification of
notes receivable -
related parties (672)
Net loss for the
year ended September
30, 1998 (11,308)
--------------------------------------------------------------------------------------------------------------
Balances at
September 30, 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
The accompanying notes are an integral
part of the consolidated financial statements.
F-5
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued
Other
------------------------------------------
Notes and
interest
receivable
-related
parties, from
issuance of,
Convertible or Deferred
Preferred Stock Common Stock Capital in collateralized compensation Common stock
(thousands of -------------------------------------- excess of par Accumulated by, common from stock held in
dollars and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
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 at
September 30, 1999 17 1 12,766 13 78,457 (71,713) (6,564) (1,222) --
--------------------------------------------------------------------------------------------------------------
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)
The accompanying notes are an integral
part of the consolidated financial statements.
F-6
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT), continued
Other
------------------------------------------
Notes and
interest
receivable
-related
parties, from
issuance of,
Convertible or Deferred
Preferred Stock Common Stock Capital in collateralized compensation Common stock
(thousands of -------------------------------------- excess of par Accumulated by, common from stock held in
dollars and shares) Shares Amount Shares Amount value deficit stock options treasury
- ------------------------------------------------------------------------------------------------------------------------------------
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 treasury
stock, at cost (1,897)
Treasury stock
transferred to
employee stock
purchase plan 26
Cancellation of
treasury stock (358) -- (1,137) 1,137
Net income for the
year ended September
30, 2000 3,682
--------------------------------------------------------------------------------------------------------------
Balances at
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-7
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
(thousands of dollars) 1998 1999 2000
- ----------------------------------------------------------------------------------------- ----------- ------------- ------------
Cash flows from operating activities:
Net income (loss) $(11,308) $(28,393) $ 3,682
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 523 2,570 1,021
Recognition of deferred revenue (654) (876) (801)
Deferred income tax benefit -- -- (3,000)
Equity in losses of investees and provision for unrealizable investments -- -- 746
Net losses (gains) on sales of facilities and disposition of equipment 218 1,979 (16,894)
Gains on non-recurring transactions -- -- (1,079)
Non-cash portion of asset write-offs and other non-recurring charges -- 5,362 15,485
Amortization of deferred compensation from stock options 1,035 2,553 707
Interest expense related to amortization of debt discount and debt
issuance costs -- 2,075 3,034
Extraordinary loss on early extinguishment of debt -- -- 7,860
Write-down (write-up) of related party note receivable (19) 1,209 (66)
Interest expense related to issuance of convertible debt at a discount 2,046 -- --
Minority interest in net income (losses) of consolidated subsidiaries (392) 9 --
Other changes in operating assets and liabilities:
Receivables (4,176) (2,837) (3,968)
Other current assets (1,570) 107 161
Accounts payable and accrued liabilities 1,297 (993) (1,804)
Deferred revenue 7,486 -- 1,586
Other, net 148 (281) (62)
----------- ------------- ------------
Net cash provided by (used in) operating activities (5,366) (17,516) 6,608
----------- ------------- ------------
Cash flows from investing activities:
Proceeds from sale of facilities and equipment -- 1,433 42,334
Purchase of property, plant and equipment and facilities held for sale (36,963) (861) (403)
Net purchase of short-term investments -- -- (6,973)
Investments in non-affiliated companies (340) -- (4,005)
Decrease (increase) in restricted assets (748) (95) 843
Proceeds from facility transferred under note receivable arrangement 647 525 --
Issuance of note receivable (660) -- --
Other -- (127) (9)
----------- ------------- ------------
Net cash provided by (used in) investing activities (38,064) 875 31,787
----------- ------------- ------------
Cash flows from financing activities:
Net proceeds from issuance of notes payable and warrants 35,454 11,193 6,980
Payments on notes payable, including redemption premiums (330) (4,690) (43,995)
Net proceeds from issuance of common stock and warrants 3,257 3,775 5,254
Net proceeds from issuance of preferred stock and warrants 90 6,367 --
Preferred stock redemptions -- -- (4,454)
Preferred stock dividends -- (123) (297)
Purchase of common stock for the treasury -- -- (1,871)
Proceeds from exercise of warrants and options -- -- 659
Proceeds from stock subscription and related party receivables 906 -- --
Other -- (147) (149)
----------- ------------- ------------
Net cash provided by (used in) financing activities 39,377 16,375 (37,873)
----------- ------------- ------------
Net increase (decrease) in cash and cash equivalents (4,053) (266) 522
Cash and cash equivalents, beginning of year 4,780 727 461
----------- ------------- ------------
Cash and cash equivalents, end of year $ 727 $ 461 $ 983
============ ============= ============
(continued)
The accompanying notes are an integral
part of the consolidated financial statements.
F-8
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
Year ended September 30,
(thousands of dollars) 1998 1999 2000
- ----------------------------------------------------------------------------------------- ----------- ----------- -------------
Supplemental schedule of non-cash investing and financing activities:
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 8,179 -- 2,964
Reclassification of redeemable convertible preferred stock to convertible
preferred stock -- -- 2,710
Common stock issued on conversion of convertible preferred stock and in
payment of dividends -- 2,761 1,634
Cancellation of treasury stock -- -- (1,137)
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 5,384 519 --
Common stock issued for rights to technology -- 375 --
Property, plant and equipment acquired through reduction of accounts receivable -- 413 --
Facility-dependent note receivable issued for sale of facility 6,500 -- --
Accounts payable for facilities held for sale 588 -- --
Supplemental disclosure of cash flow information - cash paid for interest, net of
amount capitalized in 1998 $49 $3,646 $10,458
The accompanying notes are an integral
part of the consolidated financial statements.
F-9
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-----------
1. Organization and Nature of Operations
Headwaters Incorporated (formerly Covol Technologies, Inc.) was incorporated
in Delaware in 1995. The name change to Headwaters Incorporated occurred in
September 2000. Headwaters owns 100% of Kwai Financial, Inc., which was
incorporated in fiscal 2000 ("2000"), and is 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' primary business is to commercialize its chemical technologies
used to recycle otherwise unusable materials from the coal and other
industries into marketable fuel and resources. Currently, Headwaters has
licensed its technology to the owners of 28 alternative fuel facilities at
various levels of production in approximately 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
August 1999 and three of the facilities were sold in 2000 (see Note 14).
Headwaters has no current plans to construct or acquire any additional
alternative fuel facilities. During 2000, Headwaters began evaluating and
pursuing investment alternatives for the cash generated from operations.
Headwaters has invested a major portion of this available cash flow in
high-grade government secured securities and has made several equity
investments in and loans to unrelated entities.
2. Summary of Significant Accounting Policies
Principles of Consolidation - The consolidated financial statements include
the accounts of Headwaters and three subsidiaries, Kwai Financial, Inc., Utah
Synfuel #1 and Alabama Synfuel #1. All significant intercompany transactions
and accounts are eliminated in consolidation. During 1997, Headwaters became
a 1% general partner of Coaltech No. 1 L.P., a limited partnership.
Headwaters abandoned its interest in Coaltech in October 1999. Based upon
Headwaters' lack of effective control over Coaltech and the limited partners'
financial responsibility for its operations, Headwaters' investment in
Coaltech was accounted for using the equity method of accounting with
proportional elimination of intercompany revenues and expenses.
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 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 2007. Recurring license fees or royalty payments are
recognized in the period when earned which coincides with the sale and
reporting of alternative fuel by Headwaters' licensees.
Segment Reporting, Major Customers and Concentrations of Risk - Headwaters
operates and reports as a single industry segment. Approximately $325,000 of
revenue in 1998, $1,032,000 in 1999 and $15,511,000 in 2000 was from a single
licensee; $469,000 of revenue in 1998, $2,673,000 in 1999 and $3,138,000 in
2000 was from a second licensee; and $463,000 of revenue in 1998, $849,000 in
1999 and $2,558,000 in 2000 was from a third licensee. Also, approximately
$12,296,000 and $8,509,000 of revenue in 2000 was from two other licensees,
most of which related to non-recurring gains on sales of facilities. 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 $6,906,000 at September 30, 2000. Headwaters purchases all
of the chemical reagent that is sold to licensees from a single large
international chemical company. If necessary, the chemical reagent could
easily 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.
Short-term Investments - Short-term investments consist primarily of
mortgage- and other asset-backed securities, corporate bonds, and U.S.
government 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
related to securities held at September 30, 2000.
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 ($0 at September 30, 1999) for trade receivables and $0
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, which consist of short-term notes and interest
receivable. Due from / to related party consisted of amounts due from / to
Coaltech for operating expenses or purchases from Coaltech of alternative
fuel.
F-10
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
2. Summary of Significant Accounting Policies, continued
Facilities and Equipment Held for Sale - At September 30, 1999, facilities
and equipment held for sale consisted of three alternative fuel facilities
which were sold in 2000 (see Note 14). The facilities and equipment held for
sale at September 30, 2000 are stated at the lower of cost or estimated net
realizable value. Headwaters recognizes a gain or loss on facilities and
equipment held for sale when the sale is consummated. The gain or loss
represents the difference between the sales price and the carrying value and
is reflected as a component of revenue or expenses.
Inventories - Inventories are stated at the lower of cost or market, with
cost determined using an average cost method, and consisted primarily of coal
fines and alternative fuel available for sale.
Property, Plant and Equipment - Property, plant and equipment are recorded at
cost, including where applicable interest on funds borrowed during the
construction period (see Note 6), and is 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 statement 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 owns from 1% to 27% of the voting securities of five
non-public high-risk investee companies. Current investments range from
approximately $130,000 to $1,400,000. 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 the investments
accounted for using the equity method.
Intangible Assets - Intangible assets consist of (i) 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); and (ii) rights
to technology, consisting of a coal-based alternative fuel technology and
related licensing and patent rights. These intangible assets are being
amortized on the straight-line method over approximately ten- and nine-year
periods, respectively. Accumulated amortization of intangible assets was
$410,000 as of September 30, 1999 and $302,000 as of September 30, 2000. As
described in more detail in Note 15, Headwaters wrote off approximately
$2,189,000 of intangible assets during 2000.
Restricted Assets - Restricted assets consisted primarily of highly liquid
interest bearing deposits held as collateral for certain Headwaters
obligations and cash restricted by agreement for payment to one of
Headwaters' major vendors.
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 in accordance with Statement of Financial Accounting
Standards (SFAS) No. 109, "Accounting for Income Taxes." Headwaters files a
consolidated tax return with its 100% owned subsidiary. The wholly-owned
limited partnerships file separate tax returns, as required.
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 option grant
date. 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.
F-11
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
2. Summary of Significant Accounting Policies, continued
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 the 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 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 loss or total assets.
3. Property, Plant and Equipment
Property, plant and equipment consisted of the following at September 30:
(thousands of dollars) Range of estimated useful lives 1999 2000
--------------------------------------------------------------- ------------------------------- -------------- --------------
Land $ 204 $224
Buildings and improvements 15 years 12,235 96
Machinery and equipment 5 - 7 years 4,757 370
-------------- --------------
17,196 690
Less accumulated depreciation (3,014) (138)
-------------- --------------
Net property, plant and equipment $14,182 $552
============== ==============
As described in more detail in Note 15, Headwaters recorded approximately
$12,615,000 of expense related to impaired assets during 2000. Depreciation
expense was $474,000 in 1998, $1,988,000 in 1999, and $784,000 in 2000.
4. Notes Receivable
Notes receivable, all of which were recorded initially at their fair value,
consist of the following at September 30:
(thousands of dollars) 1999 2000
---------------------------------------------------------------------------------------------- -------------- --------------
Notes Receivable
Notes receivable representing bridge loans to nine companies, primarily in
the start-up phase, for amounts ranging from $200 to $500 each and with due
dates of 120 days or less from note origination. These notes are
collateralized by most or all assets of the debtors. $-- $2,530
============== ==============
Facility-dependent Note and Accrued Interest Receivable
Note receivable from a corporation, bearing interest at 6%, interest due
quarterly and principal due February 2003, collateralized by an alternative
fuel facility in Alabama sold by Headwaters in 1998. This note receivable is
recorded at an amount which does not exceed its fair value. $6,500 $6,500
Accrued interest receivable from the above corporation 1,379 98
-------------- --------------
$7,879 $6,598
============== ==============
Facility Transferred under Note Receivable Arrangement
Facility transferred under note receivable arrangement with Coaltech. In
2000, this receivable was accepted by a creditor as partial payment on debt
owed by Headwaters to the creditor. This creditor was a limited partner in
Coaltech (see Note 5). $2,641 $--
============== ==============
F-12
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
5. Financing Transactions
During and subsequent to fiscal 2000, Headwaters entered into several
financing transactions, including the following:
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. The redemption consideration given included approximately
$1,000,000 in redemption premiums plus approximately 214,000 shares of common
stock. The loss recognized as a result of the redemption consideration paid
plus the acceleration of amortization of the unamortized debt discount and
debt issuance costs totaled approximately $1,823,000. This loss is reflected
as an extraordinary item in the consolidated statement of operations.
Also in 2000, Headwaters redeemed all of the $20,000,000 face value
convertible debt. Early prepayment costs of approximately $6,037,000 were
recognized as an extraordinary item as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized
debt discount and debt issuance costs in excess of the debt carrying value.
Also, Headwaters redeemed, concurrent with the debt redemption, all of the
preferred stock held by this entity (see Preferred Stock below).
Note Payable to a Bank - During 2000, Headwaters entered into a note payable
arrangement with a bank under which Headwaters borrowed $4,000,000. Prior to
September 30, 2000, $1,000,000 of this amount was repaid. In October 2000,
the remaining $3,000,000 was repaid with proceeds from a revolving line of
credit with the same bank, which line of credit expires in January 2002.
Funds from this line of credit were also used to repay the $1,838,000 note
payable described in Note 6. Borrowings under the line of credit bear
interest at prime plus 1%, are limited to the lesser of $8,000,000 or the
"borrowing base," as defined, and are collateralized by license fees payable
to Headwaters from the sale of alternative fuel from four alternative fuel
facilities and by a $6,500,000 note receivable due to Headwaters. The line of
credit agreement contains certain operating covenants and restrictions common
for such loans, including minimum monthly royalty revenue of $850,000 and
quarterly earnings, as defined, of $2,000,000.
Other Notes Payable - In February 2000, Headwaters restructured outstanding
debt associated with the construction of a wash plant (see Note 6). The
creditor, which is a limited partner of Coaltech, agreed to accept
Headwaters' note receivable from Coaltech (classified as "Facility
transferred under note receivable arrangement" in the consolidated balance
sheet) as partial payment on the debt. The outstanding principal and accrued
interest, totaling approximately $4,927,000, was reduced to a remaining
balance of approximately $1,962,000 ($1,838,000 at September 30, 2000) and
the due date of the restructured note was extended to October 31, 2000. A
gain of approximately $324,000 was recognized on this transaction, which
amount represents the interest on the note receivable that had not been
previously recognized. In October 2000, the debt was repaid with proceeds
from the revolving line of credit.
In April 2000, the holder of the 14% note payable described in Note 6
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.
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 (classified as redeemable convertible preferred
stock until the provisions allowing the holder to require Headwaters to
redeem the preferred stock were eliminated) 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. As of September 30, 2000, there were no outstanding
shares of Series C and Series D preferred stock.
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.
F-13
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
5. Financing Transactions, continued
Treasury Stock - During 2000, Headwaters began acquiring shares of its common
stock in connection with a stock repurchase plan announced during the year.
The program authorizes Headwaters to purchase stock in the open market or
through negotiated block transactions. Through September 30, 2000, Headwaters
purchased approximately 586,000 shares for approximately $1,897,000, of which
approximately 358,000 shares were cancelled and approximately 14,000 shares
were transferred to Headwaters' employee stock purchase plan. Subsequent to
September 30, 2000 through November 9, 2000, Headwaters purchased
approximately 100,000 additional shares for approximately $278,000.
Warrants and Options - In addition to the issuance of warrants described
previously, the terms of existing warrants for the purchase of approximately
183,000 shares of common stock at an exercise price of $7.50 per share were
amended in 2000 to extend the exercise periods for approximately seven
months. Also the terms of existing options for the purchase of approximately
60,000 shares of common stock were amended to reduce the exercise price from
$8.58 per share to $2.93 per share. These extended warrants and repriced
options were valued at approximately $70,000, which value was amortized as
interest over the term of the related debt.
Also during 2000, existing warrants for the purchase of approximately
2,750,000 shares of common stock at exercise prices ranging from $3.50 to
$12.00 per share were exchanged for warrants for the purchase of
approximately 620,000 shares of common stock with exercise prices of $1.32
per share. In 2000, Headwaters purchased and cancelled warrants for the
purchase of approximately 79,000 shares of common stock for a cash payment of
approximately $149,000.
6. Liabilities
Other Accrued Liabilities - Other accrued liabilities consist of the
following at September 30:
(thousands of dollars) 1999 2000
---------------------------------------------------------------------------------------------- -------------- --------------
Contingent liability arising from the sale of an alternative fuel facility $800 $800
Commitment to a feed stock supplier for a licensee's alternative fuel facility -- 784
Chemical costs not yet invoiced -- 552
Estimated costs to settle long-term contractual obligations 755 407
Other 994 1,111
-------------- --------------
$2,549 $3,654
============== ==============
Notes Payable - Notes payable consist of the following at September 30:
(thousands of dollars) 1999 2000
--------------------------------------------------------------------------------------------------- ----------- -------------
Note payable to a bank, bearing interest at prime plus 2% (11.5% at September
30, 2000), collateralized by license fees payable to Headwaters from the sale
of alternative fuel from four alternative fuel facilities and by a $6,500
note receivable due to Headwaters, repaid with proceeds from a long-term line
of credit with this bank obtained in October 2000 (see Note 5). $ -- $3,000
Note payable to a corporation, bearing interest at 6%, collateralized by a
coal wash plant with a carrying value of $0, repaid in October 2000 with
funds obtained from a long-term bank line of credit obtained in October 2000
(see Note 5). 4,313 1,838
Note payable to the same corporation referred to in the preceding paragraph,
bearing interest at prime, repaid in December 1999. 2,900 --
Note payable to the same corporation referred to in the preceding two
paragraphs, bearing interest at 6%, repaid in January 2000. 6,500 --
Note payable to a limited liability company, bearing interest at 10%, repaid
in April 2000. 9,191 --
Convertible secured note payable with an investment company, issued at a
discount, bearing a stated interest rate of 2.5% on the $20,000 face amount,
redeemed in May 2000 (see Note 5). 10,265 --
F-14
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
6. Liabilities, continued
Convertible secured note payable to a Headwaters shareholder, issued at a
discount, bearing a stated interest rate of 8%. This note, which increased in
amount in October 1999, along with another convertible note payable to an
unrelated entity issued in December 1999, were redeemed by Headwaters in
January 2000. 622 --
Note payable to a corporation bearing interest at 14%. In 2000, a total of
$2,000 of principal was repaid and $2,000 of principal was converted into
shares of common stock and warrants for the purchase of common stock. A
member of Headwaters' Board of Directors is affiliated with this corporation. 4,000 --
Other 722 425
----------- -------------
38,513 5,263
Less: current portion (20,626) (208)
----------- -------------
Total non-current $17,887 $5,055
=========== =============
Interest Rates and Debt Maturities - The weighted-average interest rate on
notes payable, excluding note discounts, was 7.9% at September 30, 1999 and
9.7% at September 30, 2000. Future maturities of notes payable as of
September 30, 2000 are as follows:
Year ending September 30, (thousands of dollars)
--------------------------- ---------------------
2001 $208
2002 4,921
2003 63
2004 30
2005 12
Thereafter 29
---------------------
Total $5,263
=====================
Interest Costs - During 1998, Headwaters incurred total interest costs of
approximately $4,135,000 (including approximately $2,046,000 of non-cash
interest expense resulting from issuance of convertible debt at a discount),
of which approximately $1,390,000 was capitalized. 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). No interest
costs were capitalized in 1999 or 2000.
Deferred Compensation - In 1993, Headwaters assumed a liability to pay a
stockholder of Headwaters $40,000 per year for seven years beginning February
1999. The present value of the unpaid portion of this liability ($180,000 at
September 30, 2000), discounted at approximately 5%, is included in other
long-term liabilities in the consolidated balance sheet.
7. Preferred Stock
As of September 30, 2000, Headwaters had shares outstanding under two series
of non-voting preferred stock. There were 3,000 shares of Series A preferred
stock issued and outstanding and 14,310 shares of Series B preferred stock
issued and outstanding. Holders are entitled to cumulative dividends at the
rate of 6% per year of the liquidation value of $1,000 per share for Series A
and approximately 7% per year of the liquidation value of $7 per share for
Series B. These dividends accumulate whether or not they have been declared
or whether Headwaters has any profits. Additional shares of preferred stock
may be issued in lieu of cash to pay accumulated dividends on both series.
Accumulated dividends on the Series B shares may be converted by Headwaters
into common stock at a conversion price of $7.00 per share.
Upon the liquidation of Headwaters, holders are entitled to receive $1,000
per share for Series A and $7 per share for Series B, together with all
accumulated and unpaid dividends, if any. Holders are entitled to convert
their preferred shares to common shares at any time. The number of common
shares to be received upon conversion of the Series A shares is determined by
multiplying the number of preferred shares by $1,000 and dividing by the
conversion price of $7.00 per share. The number of common shares to be
received upon conversion of the Series B shares is equal to the number of
preferred shares converted. Headwaters has the right to require any holder of
the Series A preferred shares to convert their shares into common stock. No
dividends have been declared on either series through September 30, 2000.
Dividends in arrears at September 30, 2000 totaled approximately $561,000, or
$187 per share for Series A, and approximately $21,000, or $1.50 per share
for Series B.
F-15
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
8. Notes and Interest Receivable - Related Parties, Collateralized by Common
Stock
Notes and interest receivable - related parties, collateralized by common
stock, consist of the following at September 30:
(thousands of dollars and shares) 1999 2000
---------------------------------------------------------------------------------------------- ------------- --------------
Note receivable from a stockholder, $5,000 face amount, bearing interest at
6%, renegotiated in November 1997, principal and interest of $515 due in
annual installments beginning January 1999 through January 2004, with
remaining balances due January 2005. The note is collateralized by 150 shares
of Headwaters' common stock and options expiring in January 2006 to acquire
25 shares of Headwaters' common stock and is personally guaranteed by the
stockholder. The carrying value is equal to the fair value of the 150 shares
and options and is net of an unamortized discount of $1,281 based upon an
imputed rate of 10.25%, and an allowance for impairment of $3,319 in 1999 and
$3,253 in 2000. No interest income was recognized in 1998. Interest income of
$515 was recognized in both 1999 and 2000 based on cash payments received. $400 $466
Notes and interest receivable from 16 current and former officers and
employees, issued upon exercise of options to purchase common stock of
Headwaters and collateralized by the shares of Headwaters' common stock
purchased. These notes were cancelled in 2000, as described below. No
interest income was recognized during 1998, 1999 or 2000. 5,492 --
Notes receivable from seven former officers of Headwaters, originally
collateralized by partnership interests which were subsequently exchanged for
shares of Headwaters' common stock (see Note 13). These notes were cancelled
in 2000, as described below. No interest income was recognized during 1998,
1999 or 2000. 672 --
------------- --------------
$6,564 $466
============= ==============
In 2000, Headwaters entered into termination agreements with the 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 (see Note 15), which amount represents the interest
recognized on the notes in prior periods.
9. Fair Value of Financial Instruments
SFAS No. 107 requires that the fair market value of certain financial
instruments be disclosed in the financial statements. Headwaters has the
following financial instruments that are subject to the provisions of SFAS
No. 107:
* Cash and cash equivalents
* Short-term investments
* Trade and notes receivable
* Facility-dependent note receivable
* Notes payable
* Note receivable - related party, collateralized by common stock
Substantially all of Headwaters' financial instruments 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 1999 and
2000 approximated fair value, with the exception of the notes payable in 1999
totaling approximately $38,500,000 for which the aggregate market value
approximated $42,300,000 at September 30, 1999.
F-16
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
10. Stock Options and Warrants
Stock Options - At September 30, 2000, Headwaters had one stock option plan
(the "Option Plan") under which 2,400,000 shares of common stock are reserved
for ultimate issuance. 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. 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. Accordingly, under APB 25, no compensation expense has been 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.
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 1998, 1999 and 2000. The amortized compensation expense
related to compensatory options granted in prior years was approximately
$908,000, $2,553,000 and $707,000 for 1998, 1999 and 2000, respectively.
Compensation expense related to options that vested immediately was
approximately $127,000 for 1998 and $0 for 1999 and 2000.
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) 1998 1999 2000
--------------------------------------------------------------------------- ---------------- --------------- ---------------
Net income (loss) attributed to common stockholders -- reported $(11,645) $(29,704) $3,246
-- pro forma (14,567) (32,969) 1,532
Basic income (loss) per share -- reported (1.17) (2.39) .17
-- pro forma (1.46) (2.65) .08
Diluted income (loss) per share -- reported (1.17) (2.39) .15
-- pro forma (1.46) (2.65) .08
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 .70, risk-free interest rates ranging from
4.4% to 7.8%, weighted average expected option lives of 4 to 10 years and no
dividends. 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 single measure of the fair value of stock options.
F-17
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
10. Stock Options and Warrants, continued
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:
1998 1999 2000
--------------------------- ------------------------- --------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(thousands of shares) Shares Price Shares Price Shares Price
------------------------------------------- ------------- ------------- ------------ ------------ ------------ -------------
Outstanding at beginning of year 1,614 $ 2.85 2,370 $6.29 2,971 $6.18
Granted 850 12.34 667 5.40 1,112 3.31
Exercised (94) 1.93 (30) 1.50 (42) 1.50
Canceled -- -- (36) 2.34 (219) 10.37
------------- ------------- ------------ ------------ ------------ -------------
Outstanding at end of the year 2,370 $ 6.29 2,971 $6.18 3,822 $5.16
============= ============= ============ ============ ============ =============
Exercisable at end of year 1,038 $5.23 1,801 $5.23 2,201 $5.29
============= ============= ============ ============ ============ =============
Weighted average fair value of options
granted during the year below market $10.21 none none
Weighted average fair value of options
granted during the year at market $9.91 $2.93 $1.92
Weighted average fair value of options
granted during the year above market none $2.92 $3.98
The following table summarizes information about all stock options
outstanding at September 30, 2000:
(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 2000 in Years Price 2000 Price
------------------------ ---------------------- ------------------- ------------------ ------------------ -----------------
$1.50 to $3.00 1,728 4.9 $ 1.85 1,136 $ 1.68
$4.00 to $9.00 1,441 6.6 5.62 652 6.73
$11.00 to $13.56 653 7.2 12.92 413 12.96
---------------------- ------------------
3,822 2,201
====================== ==================
Common Stock Warrants - As of September 30, 2000, there were warrants
outstanding for the purchase of approximately 724,000 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 notes
payable during 1999 and 2000 (see Note 5).
F-18
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
11. Basic and Diluted Income Per Share
(thousands of dollars and shares, except per-share data) 1998 1999 2000
---------------------------------------------------------- -------------- --------------- --------------- ---------------
Numerator:
Income (loss) before extraordinary item $(11,308) $(28,393) $11,542
Extraordinary item -- -- (7,860)
--------------- --------------- ---------------
Net income (loss) (11,308) (28,393) 3,682
Preferred stock dividends (undeclared) (337) (466) (378)
Imputed preferred stock dividends -- (845) (58)
--------------- --------------- ---------------
Numerator for basic earnings per share -- net income
(loss) attributable to common stockholders (11,645) (29,704) 3,246
Effect of dilutive securities - preferred stock dividends -- -- 139
--------------- --------------- ---------------
Numerator for diluted earnings per share -- net income
(loss) attributable to common stockholders after assumed
conversions $(11,645) $(29,704) $ 3,385
=============== =============== ===============
Denominator:
Denominator for basic earnings per share --
weighted-average shares outstanding 9,969 12,418 19,468
Effect of dilutive securities:
Shares issuable upon exercise of options and warrants -- -- 391
Shares issuable upon conversion of preferred stock -- -- 2,376
--------------- --------------- ---------------
Total dilutive potential shares -- -- 2,767
--------------- --------------- ---------------
Denominator for diluted earnings per share -- weighted- average shares
outstanding after assumed exercises and conversions 9,969 12,418 22,235
=============== =============== ===============
Basic earnings per share:
Income (loss) before extraordinary item $(1.17) $(2.39) $.57
Extraordinary item -- -- (.40)
--------------- --------------- ---------------
Net income (loss) per common share $(1.17) $(2.39) $.17
=============== =============== ===============
Diluted earnings per share:
Income (loss) before extraordinary item $(1.17) $(2.39) $.50
Extraordinary item -- -- (.35)
--------------- --------------- ---------------
Net income (loss) per common share $(1.17) $(2.39) $.15
=============== =============== ===============
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 both 1998 and 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, most of which was redeemed
in April and May 2000 (see Note 5), were dilutive; all other potentially
dilutive securities (for the purchase of or conversion into a total of
approximately 5,000,000 shares of common stock) were anti-dilutive (exercise
price exceeded market price) and were not considered in the calculation.
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.
12. Income Taxes
Headwaters had no income tax provision or benefit in 1998 or 1999 because of
its net operating loss position. In 2000, Headwaters reported an 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 alternative minimum tax.
Headwaters believes it is more likely than not that the portion of the total
deferred tax asset recognized in 2000 will be realized as a result of income
to be recognized from the amortization of deferred revenue in subsequent
periods.
F-19
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
12. Income Taxes, continued
As of September 30, 2000, Headwaters has net operating loss carryforwards of
approximately $39,700,000 which can be used to offset future taxable income.
The net operating loss carryforwards expire from 2010 to 2019. Headwaters
also has approximately $200,000 in research and development tax credit
carryforwards which can be used to offset future tax liabilities. The tax
credit carryforwards expire from 2007 to 2011. The utilization of these
carryforwards against future taxable income may become subject to an annual
limitation due to changes in ownership of Headwaters' common stock.
The provision for income taxes for the years ended September 30, 1998, 1999
and 2000 differs from the statutory federal income tax rate due to the
following:
(thousands of dollars) 1998 1999 2000
--------------------------------------------------------------------------- ------------- --------------- --------------
Tax provision (benefit) at statutory rate $(3,844) $(9,653) $1,252
Alternative minimum tax -- -- 100
Change in valuation allowance 4,200 10,600 (3,600)
State income taxes, net of federal tax effect (373) (936) 122
Net operating loss carryforwards -- -- (1,100)
Other, including redetermination of prior years' tax estimates 17 (11) 326
----------------------------------------------
Federal income tax provision (credit) $ 0 $ 0 $(2,900)
=============== =============== ==============
The components of the net deferred tax asset as of September 30, 1999 and
2000 are as follows:
(thousands of dollars ) 1999 2000
------------------------------------------------------------------------------------------- -------------- ---------------
Net operating loss carryforwards $16,300 $14,800
Research and development tax credit carryforwards 200 200
License fee revenue recognition 3,200 3,900
Compensation expense related to common stock options 3,000 3,300
Write-down of related party note receivable 1,200 1,100
Estimated liabilities 300 300
Depreciation 400 --
Other -- 400
------------------------------
Total deferred tax assets 24,600 24,000
Valuation allowance (24,600) (21,000)
------------------------------
Net deferred tax asset $ 0 $ 3,000
==============================
The valuation allowance increased by $4,200,000 during 1998 and by
$10,600,000 during 1999. The valuation allowance decreased by $3,600,000
during 2000, representing the decreased amount of deferred tax assets at
September 30, 2000 not considered recoverable through the reversal of taxable
temporary differences or the generation of future taxable income. SFAS No.
109 requires that a valuation allowance be provided if it is more likely than
not that some portion or all of a deferred tax asset will not be realized.
Headwaters' ability to realize the benefit of its deferred tax assets will
depend on the generation of future taxable income through its continuing
operations. Because Headwaters has not generated significant operating income
to date, Headwaters believes that a valuation allowance of $21,000,000 should
be provided as of September 30, 2000. This estimate may change in the near
term depending on the level of earned license fees received in 2001.
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
$2,786,000 at September 30, 1999 and approximately $464,000 at September 30,
2000 (see Note 15).
F-20
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
14. Sale of Facilities
Headwaters' business plan 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 1998, Headwaters sold
an alternative fuel facility located in Alabama on which a loss of $218,000
was recognized. The sales price was $6,500,000 payable in the form of a
nonrecourse promissory note collateralized by the facility. 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 liability has been recorded in
other accrued liabilities (see Note 6). 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. Headwaters also receives ongoing royalties based upon the sale of
alternative fuel from the facilities.
15. Gains on Non-recurring Transactions and Asset Write-offs and Other
Non-recurring Charges
Gains on Non-recurring Transactions - In fiscal 1998, Headwaters recorded net
gains on sales of chemical plants of $200,000. During 2000, Headwaters
recorded non-recurring gains of approximately $1,079,000 related to the
satisfaction of a contingent contract liability ($755,000) and the gain
recognized on the Coaltech note receivable transaction described in Note 5.
1999 Asset Write-offs and Other Non-recurring Charges - In fiscal 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, in 1999
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 fuel manufacturing 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 total approximately $7,395,000, which
amount is recorded as asset write-offs and other non-recurring charges in the
consolidated statement of operations. Of this amount, approximately
$5,362,000 represented non-cash expenses.
2000 Asset Write-offs and Other Non-recurring Charges - In fiscal 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 non-recurring settlement charges ($979,000) and asset
write-downs ($532,000) were recorded in 2000. All of these asset write-offs
and non-recurring charges totaled approximately $17,758,000. Of this amount,
approximately $15,485,000 represented non-cash expenses.
16. Commitments and Contingencies
Commitments and contingencies as of September 30, 2000 not disclosed
elsewhere, are as follows:
Leases - Rental expense was approximately $480,000 in 1998, $1,309,000 in
1999 and $255,000 in 2000. Headwaters has noncancellable operating leases for
equipment and for real estate. At September 30, 2000, minimum rental payments
due under these leases are as follows:
F-21
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
16. Commitments and Contingencies, continued
Year ending September 30: (thousands of dollars)
----------------------------- -----------------------
2001 $143
2002 170
2003 147
2004 116
2005 119
Thereafter 44
-----------------------
$739
=======================
Employee Benefit Plans - In 2000, Headwaters' Board of Directors approved
three employee benefit plans, the Headwaters Technologies 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 to the Plan of up to
15% of their compensation, subject to statutory limitations. Headwaters may
elect to match employee contributions up to a specified maximum rate, which
matching contributions, if made, vest over a four-year period. Headwaters is
not required to have net income in order to make a matching contribution.
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 calendar-month 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 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 than other measurements of performance.
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
operation of an alternative fuel facility owned by a licensee, are eligible
to participate in the Incentive Bonus Plan. The total amount charged to
operations in 2000 for all of the above plans was approximately $1,768,000.
Legal or Contractual Matters - NEICO/Earthco. In February 1997, Headwaters
entered into a contract on a parcel of real property located near Price,
Utah, in which Headwaters obtained certain possessory and related interests,
Headwaters' primary purpose being to obtain a source of coal fines to serve
as feedstock for a nearby alternative fuel facility. In August 1999,
Headwaters alleged that Earthco had breached a material provision of the
contract because Earthco did not have title to the property. Headwaters
refused to tender its August 1999 payment because of Earthco's breach. In
addition, Headwaters contended that the quantity and/or quality of
recoverable coal fines was substantially less than what Headwaters had
understood. Earthco subsequently countered with allegations that Headwaters
had breached its obligations under the contract, including failure to make
the August 1999 payment.
In November 1999, Headwaters was served with a complaint from the Seventh
Judicial District Court of Carbon County, Utah styled Nevada Electric
Investment Company v. Earthco, et al. In the complaint, Nevada Electric
Investment Company ("NEICO") alleged that it is the lawful owner of the
property near Wellington, Utah described in Headwaters' lease from Earthco.
NEICO sought a declaratory judgement that Headwaters is not entitled to
possession of the property due to the lack of ownership by Earthco. The
complaint also sought further relief from Earthco.
F-22
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
16. Commitments and Contingencies, continued
Headwaters received Earthco's answer, counterclaims and cross-claim in
December 1999. Earthco's cross-claim against Headwaters alleged breach of
contract and prayed for substantial damages in an amount to be proven at
trial but alleged to be in excess of $5 million. Headwaters filed its reply
and cross-claim against Earthco in January 2000 denying Earthco's claims and
asserting claims of misrepresentation, breach of lease, unjust enrichment,
and related claims and for general and consequential damages in an amount to
be proven at trial.
NEICO, Earthco and Headwaters have settled their disputes. Earthco and
Headwaters entered into a mutual release of claims. Earthco confirmed title
to the property in NEICO. In September 2000 Headwaters entered into a one
year lease for the wash plant parcel directly with NEICO and otherwise
confirmed title to the property in NEICO. The parties are awaiting an order
of dismissal from the court.
K-Lee Processing. In March 1997, Headwaters entered into an Amended and
Restated Supply Agreement for the purchase of coal fines from K-Lee
Processing, Inc. and Concord Coal Recovery Limited Partnership (together
"K-Lee"). Headwaters periodically purchased coal fines from K-Lee throughout
1997. K-Lee invoiced Headwaters for a total of 108,000 tons of fines and
Headwaters paid for those fines. However, K-Lee failed to deliver 11,059 tons
valued at $320,716. K-Lee has refused to refund the overpayment for
non-delivered fines. In July 2000 Headwaters filed a complaint against K-Lee
Processing, Inc. and Concord Coal Recovery Limited Partnership in the United
States District Court for the Northern District of Alabama seeking damages in
the amount of $320,716 for the coal fines purchased but not delivered.
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.
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. 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 allege that
the technology purchase transaction was an unauthorized corporate action and
that Davidson and Headwaters conspired together to effect the transfer. The
complaint asserts related causes of action in fraud, conversion, patent
infringement, conspiracy and unfair competition seeking unspecified money
damages to be proven at trial, accounting, disgorgement, recission of
contracts, punitive damages, and other relief. Headwaters denies these
allegations and is asking the court to dismiss the action. 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.
Levy. In March 1999, Headwaters sold convertible preferred stock, warrants,
and a convertible promissory note to OZ Master Fund, Ltd. In September 2000,
Headwaters received a summons and complaint from the United States District
Court for the Southern District of New York filed by Mark Levy against OZ
Master Fund and related entities ("OZ") and Headwaters. In the action, a
purported shareholder of Headwaters alleges that OZ violated section 16(b) of
the Securities Exchange Act of 1934 by converting preferred stock into
Headwaters common stock and then selling the same within a six month period,
and further, that Headwaters' redemption of the preferred stock and the note
constituted a sale of common stock for which OZ is liable under section
16(b). The complaint seeks on behalf of Headwaters from OZ unspecified money
damages to be proven at trial, attorney fees, and other relief. 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.
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 has 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 has answered the complaint denying Headwaters'
claims and asserting counter-claims based upon allegations of
misrepresentation and breach. AJG seeks unspecified compensatory damages as
well as punitive damages. Headwaters denies 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.
F-23
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
16. Commitments and Contingencies, continued
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 by Headwaters.
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 Contracts - Headwaters has entered into employment agreements with
the Chief Executive Officer, President, Chief Financial Officer and others.
The agreements generally are renewable by Headwaters and have terms of one to
three years. They provide for annual salaries and benefits ranging from
approximately $132,000 to $250,000 annually per officer or employee,
currently totaling approximately $1,142,000 for all officers and employees
combined. All agreements provide for termination benefits, generally
consisting of at least one-year's salary.
17. Events Subsequent to September 30, 2000
Events subsequent to September 30, 2000, not disclosed elsewhere, include the
following.
From October 1, 2000 through December 1, 2000, Headwaters made additional
finance loans of approximately $1,050,000 and additional equity investments
of approximately $1,558,000 under the same general terms as the loans and
investments made in fiscal 2000.
18. Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for 1999 and 2000 is as follows:
1999
------------------------------------------------------------------
First Second Third Fourth
(thousands of dollars) Quarter Quarter Quarter Quarter Full Year
- ------------------------------------------------- ------------ ------------- ------------ ------------- ------------
Net revenue $ 1,382 $ 1,143 $ 1,577 $2,617 $6,719
Gross loss (2,640) (1,684) (1,741) (1,990) (8,055)
Net loss (4,558) (5,057) (5,527) (13,251) (28,393)
Non-recurring asset write-offs and
other non-recurring charges included in
net loss (1) -- (556) -- (6,839) (7,395)
Non-recurring loss on sale of facility
included in net loss (1) -- -- -- (1,839) (1,839)
Basic net loss per common share (2) (.39) (.41) (.48) (1.09) (2.39)
Diluted net loss per common share (2) (.39) (.41) (.48) (1.09) (2.39)
F-24
HEADWATERS INCORPORATED (FORMERLY COVOL TECHNOLOGIES, INC.) AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
-----------
18. Quarterly Financial Data (Unaudited), continued
2000
------------------------------------------------------------------
First Second Third Fourth
(thousands of dollars) Quarter Quarter Quarter Quarter Full Year
- ------------------------------------------------- ------------ ------------- ------------ -------------- -----------
Net revenue $11,049 $7,899 $15,000 $11,887 $45,835
Non-recurring gains (losses) on sales
of facilities included in net revenue(1) 5,341 (598) 8,527 3,600 16,870
Other non-recurring gains included in
net revenue (1) -- 1,079 -- -- 1,079
Gross profit 8,600 5,832 12,363 8,602 35,397
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
Non-recurring asset write-offs and
other non-recurring charges included in
net income (loss) (1) (11,021) (841) (1,559) (4,337) (17,758)
Basic net income (loss) per common share(2) (.16) .01 .09 .13 .17
Diluted net income (loss) per common share(2) (.16) .01 .09 .12 .15
(1) The non-recurring gains and losses on sales of facilities, other
non-recurring gains, and asset write-offs and other non-recurring 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.
F-25