UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
August 14, 2001
----------------
Date of Report (Date of earliest event reported)
HEADWATERS INCORPORATED
------------------------
(Exact name of Registrant as specified in its charter)
Delaware 0-27808 87-0547337
-------- ------- ----------
(State or other jurisdiction of (Commission File Number) (IRS Employer
incorporation) Identification No.)
11778 South Election Road, Suite 210
Draper, UT 84020
----------------
(Address of principal executive offices)
(Zip Code)
(801) 984-9400
---------------
(Registrant's telephone number, including area code)
Not Applicable
--------------
(Former name or former address, if changed since last report.)
Certain statements 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
certain of the factors that could cause actual results to differ from
expectations, please see the information set forth under the caption entitled
"Forward-Looking Statements" in PART I, ITEM 2 of Headwaters' Quarterly Report
on Form 10-Q for the quarter ended June 30, 2001. There can be no assurance that
Headwaters' results of operations will not be adversely affected by such
factors. Headwaters 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.
Item 2. Acquisition of Hydrocarbon Technologies, Inc.
Headwaters announced on August 29, 2001 that it completed the acquisition of
Hydrocarbon Technologies, Inc., effective as of August 28, 2001. Share and
dollar amounts included in that press release were based upon reasonable
estimations made at that time. The final amounts paid to HTI varied somewhat
from those amounts although the differences are immaterial. Shares and dollars
actually paid are reflected in the pro forma information included in this Form
8-K. The complete text of the August 29, 2001 announcement follows.
Headwaters Incorporated (Nasdaq: HDWR), today announced that the acquisition of
Hydrocarbon Technologies, Inc. ("HTI") has been completed. HTI will be a wholly
owned subsidiary of Headwaters Incorporated ("Headwaters"). Consideration at
closing consists of $1.5 million in cash, assumption of $1.5 million of HTI
debt, the issuance of approximately 605,000 shares of Headwaters' common stock
and the assumption of approximately 121,000 options, now convertible into
Headwaters' stock. Up to an additional $1.5 million in cash and 605,000 shares
of Headwaters' stock is issuable upon HTI's accomplishment of certain milestones
over the next two years. These milestones are based on execution of certain
significant contracts and achievement of certain EBITDA levels. Based on the
current stock price of Headwaters, the acquisition has a total potential
purchase price of approximately $17 million.
Initially formed in 1943, HTI and its predecessor have a long history of being
in the forefront of developing catalysts and catalytic processes for energy
related applications such as Gas to Liquids, Heavy Oil Upgrading, Coal
Liquefaction, Gasification and Syngas Synthesis. According to the Department of
Energy, "Catalysis and catalytic processes are responsible for about 20% of the
U.S. gross domestic product (all goods and services), and are the keys to future
gains in energy efficiency, environmental stewardship and attendant economic
prosperity for the country." HTI offers Headwaters opportunities in ongoing
projects in China with Coal and Heavy Oil Conversion as well as opportunities in
the U.S. and throughout the world, including the introduction of
"nano-catalysis."
HTI's nano-catalysis technology can improve performance and reduce precious
metal consumption in many applications including petrochemical processes and
automotive emissions control. The technology is still early stage, but has the
potential to be deployed in a variety of commodity chemical and energy markets.
The catalysis market has a current global revenue base of over $10 billion.
Nano-technology is perhaps the single greatest advancement in catalysis in the
last 20 years and HTI is in the forefront of this development.
Kirk A. Benson, Chairman and CEO, stated, "We are pleased to complete this
acquisition and to be able to combine the resources of Headwaters and HTI for
the continued development and expansion of these catalytic processes. HTI's
technologies and accomplishments align well with Headwaters' skill at commercial
deployment of alternative fuel technology and will advance the development and
commercialization of alternative fuels, carbon based fuels and related
technologies well into the future. The completion of this acquisition marks a
major milestone for Headwaters in being able to create new opportunities for
growth and diversification."
About Headwaters Incorporated
Headwaters Incorporated is the world leader in developing and deploying
alternative fuel and related technologies. It is focused on converting fossil
fuels such as coal and heavy oils to alternative energy products. Through its
2
existing alternative fuels business, the Company earns a growing royalty stream
that provides the capital needed to acquire and expand synergistic business
opportunities. Headwaters Incorporated trades under the Nasdaq symbol HDWR.
About Hydrocarbon Technologies, Inc.
Hydrocarbon Technology, Inc. is on the forefront in the development and
commercialization of coal and heavy oil conversion, catalysis and catalytic
processes that produce alternate fuels and chemicals while improving energy
efficiency and reducing environmental risks. HTI is a wholly owned subsidiary of
Headwaters.
Certain statements contained in this document may be deemed to be
forward-looking statements under federal securities laws, and Headwaters intends
that such forward-looking statements be subject to the safe-harbor created
thereby. Such forward-looking statements relate to: i) the growth of Headwaters'
revenues, earnings, or earnings per share; ii) the ability of Headwaters to
sustain the earnings stream from its alternative fuels business; iii) the
expectation that Headwaters' stock is undervalued or will increase in value in
the future; iv) the completion of any future acquisitions and the expectation
that the value of such acquisitions will increase, v) the commercialization of
any technology acquired or developed. Headwaters cautions that these statements
are qualified by important factors that could cause actual results to differ
materially from those reflected by the forward-looking statements contained
herein. Such factors include, but are not limited to: a) the availability of tax
credits to our licensees under the tax code; b) our dependence on licensees to
use our technology; c) collection of payments outstanding; d) limitations in the
capital available to Headwaters to execute on its business plan, and the cost of
that capital; e) the ability of Headwaters to locate and close on attractive
acquisition opportunities; f) the Company's limited operating history with its
new business strategy and its ability to sustain and manage its growth under
that strategy; f) the success of the Company in replacing and growing its
financial performance before its legacy alternative fuels business declines; and
other risks as detailed in Headwaters' annual report on Form 10-K, quarterly
report on Form 10-Q, and other filings from time to time with the Securities and
Exchange Commission.
Item 5. Other Events - Restatement of Certificate of Incorporation
Headwaters restated its Certificate of Incorporation on August 14, 2001. The
restated Certificate is filed as Exhibit 3.1.9 hereto.
Item 7. Financial Statements and Exhibits
(a) The following consolidated financial statements of Hydrocarbon
Technologies, Inc. and subsidiaries are included herein:
Audited Financial Statements:
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Operations for the Years Ended
December 31, 2000 and 1999
Consolidated Statements of Stockholders' Equity (Deficit) for
the Years Ended December 31, 2000 and 1999
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2000 and 1999
Notes to Consolidated Financial Statements
Unaudited Financial Statements:
Accountants' Review Report
Consolidated Balance Sheets as of June 30, 2001 and
December 31, 2000
Consolidated Statements of Operations for the Six Months Ended
June 30, 2001 and 2000
Consolidated Statements of Stockholders' Equity (Deficit) for
the Six Months Ended June 30, 2001 and 2000
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2001 and 2000
Notes to Consolidated Financial Statements
3
(b) The following unaudited pro forma financial information is
included herein:
Introduction to Pro Forma Financial Information
Pro Forma Condensed Combined Balance Sheet as of June 30, 2001
Pro Forma Condensed Combined Statement of Income for the Year
Ended September 30, 2000
Pro Forma Condensed Combined Statement of Income for the Nine
Months Ended June 30, 2001
Notes to Pro Forma Condensed Combined Financial Information
(c) The following exhibits are included herein:
3.1.9 Restated Certificate of Incorporation of Headwaters
dated August 14, 2001
10.72.2 Amendment No. 1 to Agreement and Plan of
Reorganization between Headwaters and Hydrocarbon
Technologies, Inc. dated August 21, 2001
10.72.3 Amendment No. 1 to Share Exchange Agreement between
Headwaters and Hydrocarbon Technologies, Inc. dated
August 21, 2001
10.72.4 Certificate of Merger between Headwaters and
Hydrocarbon Technologies, Inc. dated August 29, 2001
23 Consent of Independent Auditors
23.1 Consent of Accountants
4
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
HEADWATERS INCORPORATED
-----------------------------
Registrant
Date: September 11, 2001 /s/ Kirk A. Benson
-----------------------------
Kirk A. Benson
Chief Executive Officer and
Principal Executive Officer
5
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
Consolidated Financial Statements
Years Ended December 31, 2000 and 1999
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
Table of Contents
Years Ended December 31, 2000 and 1999
Page
Number
----
INDEPENDENT AUDITORS' REPORT............................................... 1
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS........................................ 2
CONSOLIDATED STATEMENTS OF OPERATIONS ............................. 3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY.......... 4
CONSOLIDATED STATEMENTS OF CASH FLOWS ............................. 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................... 6-21
i
DRUKER, RAHL & FEIN
CERTIFIED PUBLIC ACCOUNTANTS
BUSINESS CONSULTANTS
A Member of The Mercadien Group
INDEPENDENT AUDITORS' REPORT
To The Board of Directors and Stockholders of
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
Donald F. Conway, CPA o
Conrad L. Druker, CPA We have audited the accompanying consolidated balance
Esmond S. Druker, CPA sheets of HYDROCARBON TECHNOLOGIES, INC. AND
Eugene J. Elias, CPA, RMA SUBSIDIARIES as of December 31, 2000 and 1999, and
Jack H. Fein, CPA * the related consolidated statements of operations,
Robert J. Rahl, CPA * stockholders' (deficit) equity and cash flows for the
David L. Stafford, CPA * years then ended. These consolidated financial
Richard S. Willinger, CPA statements are the responsibility of the Company's
__________________________ management. Our responsibility is to express an
Peter A. Inverso, CPA opinion on these financial statements based on our
audits.
* CPA in NJ and PA
o CPA in NY We conducted our audits in accordance with auditing
standards generally accepted in the United States of
OTHER OFFICE America. Those standards require that we plan and
86 Buck Road perform the audit to obtain reasonable assurance
Holland, PA 18966 about whether the financial statements are free of
215-355-4860 material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit
o National Associated also includes assessing the accounting principles
CPA Firms used and significant estimates made by management, as
well as evaluating the overall financial statement
o American Institute of presentation. We believe that our audits provide a
Certified Public reasonable basis for our opinion.
Accountants
In our opinion, the consolidated financial statements
o New Jersey Society of referred to above present fairly, in all material
Certified Public respects, the financial position of HYDROCARBON
Accountants TECHNOLOGIES, INC. AND SUBSIDIARIES as of December
31, 2000 and 1999, and the results of its operations
o Pennsylvania Institute ofand its cash flows for the years then ended in
Certified Public conformity with accounting principles generally
Accountants accepted in the United States of America.
o Private Companies As discussed in Note N to the financial statements,
Practice Section the Company pursuant to APB 20 Accounting Changes has
made changes to the recognition of intangibles in
o SEC Practice Section connection with an initial public distribution of
securities by a closely held company.
March 20, 2001
(Except as to Note N, which is as of April 23, 2001
and Note O, which is as of August 28, 2001)
/s/ Druker, Rahl & Fein
DRUKER, RAHL & FEIN
P.O. Box 7648 o Princeton, NJ 08543-7648 o 609.689.9700 o FAX 609.689.9720
www.mercadien.com
1
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
---------------------------
2000 1999
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ASSETS
Current Assets
Cash $ 61,091 $ 92,384
Accounts receivable, net of allowance for
uncollectible accounts of $10,200 (2000) and (1999) 235,038 707,257
Unbilled costs and fees 72,055 137,657
Other receivables 40,558 19,386
Inventories 558,439 646,145
Prepaid expenses and other current assets 161,290 89,333
Prepaid income taxes 51,740 -
------------ ------------
Total Current Assets 1,180,211 1,692,162
Property, plant and equipment 1,068,639 1,242,419
Other assets 93,448 136,578
------------ ------------
Total Assets $ 2,342,298 $ 3,071,159
============ ============
LIABILITIES AND STOCKHOLDERS'(DEFICIT) EQUITY
Current Liabilities
Current portion of capitalized lease obligation $ - $ 4,060
Line of credit payable 1,000,000 450,000
Current portion of long-term debt 185,746 107,342
Accounts payable 865,396 498,764
Accrued expenses 144,229 114,095
Accumulated employee vacation 111,323 133,510
Income taxes payable 600 17,960
Deferred revenue and other current liabilities 62,504 847,874
------------ ------------
Total Current Liabilities 2,369,798 2,173,605
Long-term debt 30,295 145,969
Excess of net assets acquired over cost 386,491 436,152
------------ ------------
Total Liabilities 2,786,584 2,755,726
------------ ------------
Stockholders'(Deficit) Equity
Common stock, 10,000,000 shares authorized; 1,501,112
(2000) and 1,222,877 (1999) shares issued 15,011 12,229
Additional paid-in capital 990,415 806,777
Accumulated deficit (1,449,712) (503,573)
------------ ------------
Total Stockholders'(Deficit) Equity (444,286) 315,433
------------ ------------
Total Liabilities and Stockholders' (Deficit) Equity $ 2,342,298 $ 3,071,159
============ ============
See notes to consolidated financial statements. 2
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31,
---------------------------
2000 1999
------------ ------------
Revenue
Contract revenue $ 6,897,048 $ 7,951,640
Retail sales 240,789 212,259
------------ ------------
Total revenue 7,137,837 8,163,899
------------ ------------
Direct costs
Labor costs 1,450,663 1,403,474
Fringe benefits 550,218 577,038
Other direct costs 1,609,280 1,493,617
Applied overhead 2,289,388 2,081,800
Depreciation and amortization 186,370 203,543
------------ ------------
Total direct costs 6,085,919 5,759,472
------------ ------------
Gross profit 1,051,918 2,404,427
------------ ------------
Operating expenses
Marketing 514,626 553,342
Research and development 558,999 782,769
Bid proposal 217,054 136,269
General and administrative 671,679 733,167
------------ ------------
Total operating expenses 1,962,358 2,205,547
------------ ------------
(Loss) income from operations (910,440) 198,880
------------ ------------
Other income (expense)
Interest income 7,887 12,087
Rental income 14,976 13,431
Miscellaneous income - 11,884
Interest expense (74,334) (122,493)
Amortization of goodwill (43,130) (43,130)
Amortization of negative goodwill 49,661 49,661
------------ ------------
Total other expense (44,940) (78,560)
------------ ------------
(Loss) income before (benefit of) provision for income taxes (955,380) 120,320
(Benefit of) provision for income taxes (9,241) 50,691
------------ ------------
Net (loss) income $ (946,139) $ 69,629
============ ============
See notes to consolidated financial statements. 3
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
Common Stock $.01 Par Value
------------------------------ Additional (Accumulated
Shares Amount Paid-in Capital Deficit) Total
------------ ------------- --------------- ------------- ------------
Balance, January 1, 1999 $ 984,729 $ 9,848 $ 649,599 $ (573,202) $ 86,245
Shares repurchased from former employees (83,543) (835) (55,138) - (55,973)
Shares purchased through Employee
Stock Purchase Plan 280,391 2,803 185,058 - 187,861
Other stock subscribed during the period 41,300 413 27,258 - 27,671
Net income for the year - - - 69,629 69,629
--------- ----------- ----------- ----------- ------------
Balance, December 31, 1999 1,222,877 12,229 806,777 (503,573) 315,433
Shares repurchased from former employees (11,368) (114) (7,502) - (7,616)
Shares purchased through Employee
Stock Purchase Plan 248,115 2,481 163,757 - 166,238
Other stock subscribed during the period 41,488 415 27,383 - 27,798
Net loss for the year - - - (946,139) (946,139)
--------- ----------- ----------- ----------- ------------
Balance, December 31, 2000 1,501,112 $ 15,011 $ 990,415 $(1,449,712) $ (444,286)
========= =========== =========== =========== ============
See notes to consolidated financial statements. 4
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
2000 1999
------------ ------------
Cash Flows from Operating Activities
Net (loss) income $ (946,139) $ 69,629
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities
Depreciation and amortization 229,500 246,673
Amortization of negative goodwill (49,661) (49,661)
Allowance for uncollectible accounts - 9,000
Changes in current assets and liabilities
Accounts receivable 472,219 41,963
Unbilled costs and fees 65,602 (58,097)
Other receivables (21,172) 5,105
Inventories 87,706 119,253
Prepaid expenses and other current assets (71,957) 82,444
Prepaid income taxes (51,740) 8,298
Accounts payable 366,632 179,522
Accrued expenses 30,134 46,895
Accumulated employee vacation (22,187) 12,991
Income taxes payable (17,360) 17,960
Deferred revenue and other current liabilities (785,370) (272,412)
------------ ------------
Net cash (used in) provided by operating activities (713,793) 459,563
------------ ------------
Cash Flows from Investing Activities
Purchase of property, plant and equipment (12,590) (81,066)
------------ ------------
Cash Flows from Financing Activities
Proceeds from borrowing - notes payable 179,874 -
Proceeds from line of credit 1,000,000 450,000
Principal payments under capital lease obligations (4,060) (4,390)
Principal payments on notes payable (217,144) (1,117,710)
Principal payments on line of credit (450,000) (225,000)
Subscription and issuance of common stock 194,036 215,532
Repurchase of stock from former employees (7,616) (55,973)
------------ ------------
Net cash provided by (used in) financing activities 695,090 (737,541)
------------ ------------
Net decrease in cash (31,293) (359,044)
Cash, beginning of year 92,384 451,428
------------ ------------
Cash, end of year $ 61,091 $ 92,384
============ ============
Supplemental Disclosures of Cash Flow Information
Cash paid during the year for
Interest $ 65,642 $ 122,493
============ ============
Income taxes $ 59,768 $ 24,433
============ ============
See notes to consolidated financial statements. 5
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
The Company provides research and development services for converting,
upgrading and cleaning fossil fuels and for recycling waste organics
(plastics) for the US Department of Energy ("DOE") as well as other
commercial customers. The Company's commercial customer base,
predominantly within the oil and gas industry, is throughout the United
States.
Organization and Basis of Consolidation
The consolidated financial statements include the accounts of Hydrocarbon
Technologies Canada, Inc. incorporated on December 19, 1995 for purposes
of performing joint research and development activities utilizing
intellectual property with a university in Canada. The Company also has
established a wholly owned subsidiary, Hydrocarbon Environmental
Technology, Inc. for the purpose of performing research into converting
scrap tires and waste oil into a more refined oil and carbon based solid
material. The Company also has a wholly owned subsidiary which was
established during 1998, Chemsampco, Inc., which is also based in New
Jersey. This subsidiary is a chemical manufacturer and supplier. All
intercompany transactions have been eliminated.
Ownership
The Company is owned entirely by its employees. The initial stockholders
were the Company's president, vice-president, treasurer, and secretary.
As discussed in the Employee Stock Purchase Plan note, the Company
subsequently developed the plan in which all the Company's employees may
purchase at their option, shares in the Company's stock. Currently,
substantially all of the employees are participating in this plan.
Cash
For the purpose of the statements of cash flows, cash includes time
deposits and all highly liquid debt instruments with original maturities
of three months or less.
Inventories
Inventories consist of custom repair parts for the equipment used and the
supplies consumed in the various tests the Company performs. Since
substantially all of this inventory is repair parts, consumable supplies
and chemicals, they are valued at their specific historical cost and are
not for resale to customers. There are no raw materials or work in
process.
The inventory related to the subsidiary Chemsampco, Inc. is comprised of
reagent chemicals of varying degrees of purity and is available for
resale to customers.
Inventory maintained by the subsidiary is valued at the lower of cost
(determined on a first in first out basis) or market.
Research and Development Costs
Current operations are charged with all internal research and development
expenses, (including overhead allocations), which amounted to $558,999
and $782,769 for the years ended December 31, 2000 and 1999,
respectively.
6
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and Equipment and Depreciation
Property and equipment is stated at cost and is depreciated for financial
reporting purposes on a straight-line basis over the estimated useful
lives of the respective assets which lives range from three to thirty
nine and one-half years. Building improvements are depreciated over their
estimated useful lives. Repairs and maintenance expenditures which do not
extend the useful lives of the related assets are expensed as incurred.
Excess of Net Assets Acquired Over Cost (Negative Goodwill)
Effective January 17, 1995 (the transaction was completed on April 17,
1995, retroactively effective to January 17, 1995), the Company purchased
the location, the existing equipment, inventory, DOE contracts and other
assets from Husky Oil, Ltd. of Canada ("Husky"). (This purchase was
arranged since Husky was planning to close the facility.) The Company
agreed to purchase the assets and assume various liabilities from Husky
in exchange for the funds Husky estimated it would need to expend for the
site closing.
In accordance with accounting principles generally accepted in the United
States of America requirements related to below market value business
combinations, the non-current assets (land, building, equipment, and
customer list) have been written down to the lower of their proportionate
share of the purchase price or zero. As a result, a credit balance in
goodwill (negative goodwill) resulted. The figure is being amortized into
income over 15 years using the straight-line method and amounted to
$49,661 for both years ended December 31, 2000 and 1999.
Goodwill
Effective March 1998, the Company purchased the assets of another entity
and created a wholly owned subsidiary, Chemsampco, Inc. Goodwill
represents the excess of the purchase price of the assets purchased over
the fair market value at the date of acquisition and is being amortized
on the straight line method over 60 months and is included in other
assets. Amortization expense charged to operations was $43,130 for both
years ended December 31, 2000 and 1999.
Income Taxes
In February 1992, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 109, Accounting for
Income Taxes. Under the asset and liability method of Statement No. 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax basis and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. Under Statement No. 109, the
effect on deferred tax assets and liabilities of a change in the tax
rates is recognized in income in the period that includes the enactment
date.
7
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes (Continued)
The Company also qualifies as a "Personal Service Corporation" (PSC) as
defined in the Internal Revenue Service Regulations. Accordingly, for
income tax purposes, the Company is entitled to report its income and
expenses using the cash receipts and disbursements method of accounting
instead of the accrual method (Generally Accepted Accounting Principles)
used for financial statement reporting.
The Company has elected to file a consolidated federal tax return
including its Canadian subsidiary as if it was a domestic corporation.
Major Customers
The Company generally extends unsecured credit in connection with its
testing sales, however a significant portion of the business (7% and 16%
for 2000 and 1999, respectively) is from the DOE. The Company has made,
in its opinion, appropriate estimated provisions (which are $10,200 at
December 31, 2000 and 1999) for credit losses on accounts receivable from
commercial customers based upon information currently available. The
Company, like other governmental contractors, is subject to annual
appropriations by Congress to continue funding for these programs.
A significant portion of the Company's revenue (67% and 71% for 2000 and
1999, respectively) is from one commercial customer. Included in accounts
receivable and unbilled costs and fees is $22,875 and $493,831 at
December 31, 2000 and 1999, respectively.
Revenue Recognition
Revenue from cost reimbursement contracts is recorded as the costs
associated with that revenue are incurred. During 2000 and 1999, the
Company used provisional rates when invoicing for overhead and general
and administrative expenses under its DOE contracts. These provisional
rates are based on the Company's budget for the respective year.
Adjustments to these rates are made monthly when the actual rates can be
calculated after allowing for anticipated unallowable expenses. Final
adjustments will be made after year end rates are approved by the Defense
Contract Audit Agency "DCAA" (usually one to two years after the close of
the fiscal year). All of these rates are subject to audit by various
government authorities, principally the DCAA.
Revenue from other contracts (fixed price) is also recognized as the
costs associated with that revenue are incurred. Estimated losses will be
accrued when the facts indicating that a loss will occur become known.
The Company has a liquification process contract which will also produce
approximately 317,000 pounds of material. Revenue recognition applicable
to this contract is based upon the percentage of completion method of
accounting. Accordingly, income is recognized in the ratio that labor
hours incurred bears to estimated total labor hours. Adjustments to labor
hour estimates are made periodically, and losses expected to be incurred
on contracts in progress are charged to operations in the period such
losses are determined.
8
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition (continued)
The Company reflects earnings in excess of billings as unbilled costs and
fees in the consolidated balance sheet as a current asset. Conversely,
billings in excess of earnings are reflected as deferred revenue in the
consolidated balance sheet as a current liability.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
the Company to make estimates and assumptions that affect certain
reported amounts and disclosures. Accordingly, actual results could
differ from those estimates.
B. CONCENTRATIONS OF CREDIT RISK
The Company maintains cash balances which may exceed federally insured
limits. The Company historically has not experienced any related cash in
bank losses. The Company provides credit in the normal course of business
to its customers and performs ongoing credit evaluations of its customers,
historical trends and other information.
C. PENSION PLAN
The Company sponsors a 401(k) retirement plan for its employees that allows
the employees to contribute a portion of their salary to their retirement.
The Company currently matches the employees' contribution up to 5% of the
employees' compensation. The board of directors also has the option of
making discretionary contributions (in addition to the matching
contributions) in any amount subject to Internal Revenue limitations. For
2000 and 1999, the Company's total contribution was $164,181 and $144,953,
respectively.
D. PROPERTY , PLANT AND EQUIPMENT
Property, plant and equipment, which is stated at cost less accumulated
depreciation and amortization, is summarized as follows:
December 31,
-----------=---------------
2000 1999
------------ ------------
Machinery and equipment $ 997,250 $ 984,660
Building improvements 652,626 652,626
Equipment under capital leases 56,076 56,076
------------ ------------
Subtotal 1,705,952 1,693,362
Less accumulated depreciation and amortization 637,313 450,943
------------ ------------
$ 1,068,639 $ 1,242,419
============ ============
Depreciation and amortization expense aggregated $186,370 and $203,543 for
the years ended December 31, 2000 and 1999, respectively.
9
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
E. OTHER RECEIVABLES
As discussed previously, the Company purchased its facility from Husky. The
facility has various environmental problems that are in various stages of
remediation under the supervision of the New Jersey Department of
Environmental Protection (NJ DEP). A former owner of the facility is
responsible for the clean up of the site (for contamination prior to the
purchase by Husky) and has invested over $4,000,000 to date in the clean up
project. Part of the terms of the sale of the facility to the Company is
that the former owner of the site remain fully responsible, and further,
that Husky guarantee the former owner's continuing compliance with the
terms of its environmental remediation plan agreed to with the NJ DEP. The
Company has from time to time needed to expend funds in order to maintain
the remediation program and is seeking reimbursement from the former owner.
Accordingly, $34,026 and $6,640 is due from the former owner as of December
31, 2000 and 1999, respectively. This amount is included in the current
assets section under the caption "Other receivables."
F. DEBT
Credit line payable consist of the following:
December 31,
---------------------------
2000 1999
------------ ------------
A $1,000,000 credit line for general corporate and
working capital purposes as well as other debt
paydown, with interest at prime plus 1% and
expires May 31, 2001. Prime at December 31, 2000
was 9.5%. The bank has a security interest in all
assets of the Company and a junior lien on the
inventory of the subsidiary, Chemsampco, Inc.
There are financial covenants relating to tangible
net worth and minimum debt service coverage which
commence December 31, 2000, for which waivers have
been obtained. The credit line is personally
guaranteed by the three original
officers/stockholders of the Company up to 62% of
the credit line. $ 1,000,000 $ 450,000
------------ ------------
Total $ 1,000,000 $ 450,000
============ ============
In March 1998, the Company purchased certain assets of another entity and
created a wholly owned subsidiary named Chemsampco, Inc. and signed a
$400,000 promissory note. This note is subordinate to the line of credit
although the seller has a security interest in the inventory, machinery and
equipment, manufacturing procedures and production records, trade name and
goodwill acquired in the asset purchase. HTI (parent) as surety, has
guaranteed to the Seller that the value of the inventory purchased shall be
equal to or greater than the principal outstanding on the promissory note.
10
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F. DEBT (CONTINUED)
The line of credit contains covenants pertaining to tangible net worth and
minimum debt service coverage which commence December 31, 2000. The Company
is required to maintain minimum tangible net worth as defined, of $750,000
as of December 31, 2000. The Company is also required to maintain a minimum
debt service coverage ratio as defined, of 1.15. The Company's tangible net
worth and debt service coverage ratio are negative as of December 31, 2000.
The bank has waived these covenant violations as of and for the year ended
December 31, 2000.
Debt is comprised of the following:
December 31,
---------------------------
2000 1999
------------ ------------
Insurance premium note payable in monthly
installments of $6,509 inclusive of interest at
11.95% commencing May 2000 through October 2001.
The note is secured by the unused portion of the
underlying policies. $ 61,664 $ -
Insurance premium note payable in monthly
installments of $8,481 inclusive of interest at
10.50% commencing May 2000 through January 2001.
The note is secured by the unused portion of the
underlying policies. 8,407 -
Promissory note payable in equal monthly
installments of $10,225 inclusive of interest at
7.5% through April 2002. The note is secured by
certain assets of the Company. 145,970 253,311
------------ ------------
Total 216,041 253,311
Less current portion 185,746 107,342
------------ ------------
Debt, net of current portion $ 30,295 $ 145,969
============ =============
Total maturities of debt are as follows:
Year Ending December 31,
2001 $ 185,746
2002 30,295
------------
$ 216,041
============
G. INCOME TAXES
As previously discussed, the Company follows FASB Statement No. 109 for the
accounting for income taxes and for income tax purposes, reports its income
and expenses on the cash receipts and disbursements method of accounting.
Therefore, the Company has significant deferred tax assets and liabilities
resulting from the different methods of income recognition.
11
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
G. INCOME TAXES (CONTINUED)
Components of income tax (benefit) expense for 2000 and 1999 are as
follows:
Year Ended December 31, 2000 Federal State Total
------------ ------------ ------------
Current $ (14,396) $ 5,155 $ (9,241)
Deferred - - -
------------ ------------ ------------
Total $ (14,396) $ 5,155 $ (9,241)
============ ============ ============
Year Ended December 31, 1999 Federal State Total
------------ ------------ ------------
Current $ 27,572 $ 23,119 $ 50,691
Deferred - - -
------------ ------------ ------------
Total $ 27,572 $ 23,119 $ 50,691
============ ============ ============
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2000 and 1999 are presented below:
December 31,
---------------------------
2000 1999
------------ ------------
Deferred tax assets:
Tax effect of realization of
Accounts payable $ 292,000 $ 158,634
Accrued expenses 78,000 65,830
Deferred revenue 21,300 271,319
Net operating loss 342,000 -
------------ ------------
Subtotal 733,300 495,783
Less valuation allowance (567,800) (194,900)
------------ ------------
Total deferred tax assets 165,500 300,883
------------ ------------
Deferred tax liabilities:
Tax effect of realization of
Accounts receivable (109,600) (264,107)
Prepaid expenses (55,900) (36,776)
------------ ------------
Total deferred tax liabilities (165,500) (300,883)
------------ ------------
Net deferred tax asset $ - $ -
============ ============
12
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
G. INCOME TAXES (CONTINUED)
As discussed in the "Summary of Significant Accounting Policies," the
Company uses the cash receipts and disbursements method of accounting for
income tax purposes. Management has deemed a valuation allowance necessary
since anticipated profits in future years cannot be predicted.
As of December 31, 2000, the Company has net operating loss carryforwards
of approximately $1,000,000 and $1,500,000 for federal and state purposes,
respectively. The losses expire beginning in 2020 and 2005 for federal and
state purposes, respectively. Federal and state tax laws impose significant
restrictions on the utilization of net operating loss carryforwards in the
event of a change in ownership as defined by the Internal Revenue Service
Code Section 382.
H. EMPLOYEE STOCK PURCHASE PLAN
As previously discussed, the Company is owned by its employees. Each
employee has the option of allocating up to 15% of their payroll to
purchase shares of stock in the Company at a price set by the board of
directors. At the end of a six month period (June 30 and December 31), the
Company will apply the withheld funds to the purchase of the shares and
issue the shares. As of December 31, 2000 and 1999, substantially all the
employees participated in this plan. As a result, during the year ended
December 31, 2000, 248,115 shares of stock with a par value of $2,481 and
an additional paid in capital of $163,757 were subscribed under this plan.
During the year ended December 31, 1999, 280,391 shares of stock with a par
value of $2,803 and an additional paid in capital of $185,058 were
subscribed under this plan. Further, the board of directors may extend the
Employees Stock Purchase Plan and announce new enrollment periods.
I. STOCK OPTION PLAN
In September 1997, the shareholders of the Company approved the adoption of
the Company 1997 Stock Option Plan and the reservation of 500,000 shares of
Common Stock for issuance upon the exercise of options granted.
The Company granted 6,500 stock options to two employees with an exercise
price of $0.67 per option, the fair market value of the stock as of
December 31, 1996. The Company also granted 150,000 stock options to three
officers/shareholders with an exercise price of $0.01 per option.
The Company granted 15,000 stock options to three employees with an
exercise price of $0.67 per option on January 14, 2000. During May 2000,
the Company admitted five new Advisory Board members whose compensation for
each meeting attended would be $1,000 plus expenses plus 500 options to
purchase stock at $.67 per share.
13
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
The Company currently accounts for its stock based compensation plans using
the accounting method prescribed by Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees. Since the Company is not
required to adopt the fair value based recognition provisions prescribed
under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, it has elected only to comply with the disclosure
requirements set forth in the Statement, which includes disclosing pro
forma net income as if the fair value based method of accounting had been
applied.
The Company granted stock options to two employees as follows:
Options granted 6,500
Option exercise date February 27, 1997
Option exercise price $0.67 per option
Option term 3 years
Vesting One month from date of grant
Weighted-average remaining contractual life None
The Company granted stock options to three employees as follows:
Options granted 15,000
Option exercise date January 14, 2000
Option exercise price $0.67 per option
Option term 3 years
Vesting One month from date of grant
Weighted-average remaining contractual life 2 years
The Company granted stock options to three officers/shareholders
as follows:
Options granted 150,000
Option exercise date December 15, 1997
Option exercise price $0.01 per option
Option term 10 years
Vesting Immediately
Weighted-average remaining contractual life 7 years
14
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
The Company granted stock options to five Advisory Board members as
follows:
Options granted 2,500
Option exercise date September 12, 2000
Option exercise price $0.67 per option
Option term 10 years from date of grant
Vesting Immediately
Weighted-average remaining contractual life 9 years 3 months
The fair value of each option grant is estimated on the grant date using an
option-pricing model (Black-Scholes) with the following weighted-average
assumptions used for the 1997 and 2000 grants: dividend yield of 0%,
risk-free interest of 5.98%, and expected lives of the options of 3 and 10
years, respectively and future stock volatility of 0% since the Company is
not publicly traded.
A summary of the status of the Company's stock option plan as of December
31, 2000 and 1999, and the changes during the years then ended is presented
below:
Options granted to two employees:
Weighted-
Average
Number of Exercise
Shares Price
---------- -------------
Outstanding at January 1, 1999 6,500 $ 0.67
Granted - -
Exercised - -
Forfeited - -
---------- -------------
Outstanding at December 31, 1999 6,500 0.67
Granted - -
Exercised - -
Expired 6,500 0.67
Forfeited - -
---------- -------------
Outstanding at December 31, 2000 - $ -
========== =============
Exercisable at December 31, 2000 - $ -
========== =============
15
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
Options granted to officers/shareholders:
Weighted-
Average
Number of Exercise
Shares Price
---------- -------------
Outstanding at January 1, 1999 139,500 $ 0.01
Granted - -
Exercised - -
Forfeited - -
---------- -------------
Outstanding at December 31, 1999 139,500 0.01
Granted - -
Exercised - -
Forfeited - -
---------- -------------
Outstanding at December 31, 2000 139,500 $ 0.01
========== =============
Exercisable at December 31, 2000 139,500 $ 0.01
========== =============
Options granted to three employees:
Weighted-
Average
Number of Exercise
Shares Price
---------- -------------
Outstanding at January 1, 2000 - $ -
Granted 15,000 0.67
Exercised - -
Expired - -
Forfeited 5,000 0.67
---------- -------------
Outstanding at December 31, 2000 10,000 $ 0.67
========== =============
Exercisable at December 31, 2000 10,000 $ 0.67
========== =============
Weighted-average fair value of
options granted during the year ended
December 31, 2000 $ 0.11
==========
Options granted to Advisory Board members:
Weighted-
Average
Number of Exercise
Shares Price
---------- -------------
Outstanding at January 1, 2000 - $ -
Granted 2,500 0.67
Exercised - -
Expired - -
Forfeited - -
---------- -------------
Outstanding at December 31, 2000 2,500 $ 0.67
========== =============
Exercisable at December 31, 2000 2,500 $ 0.67
========== =============
Weighted-average fair value of options
granted during the year ended
December 31, 2000 $ 0.30
==========
16
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
J. CAPITAL LEASES PAYABLE
During 1996, the Company entered into a capital lease arrangement where
they would lease equipment for sixty months for $386 a month. Amortization
of assets under the capital lease is included in depreciation expense and
aggregated $3,724 and $11,215 for years ended December 31, 2000 and 1999,
respectively.
Capitalized lease payable consists of the following:
December 31,
---------------------
2000 1999
-------- ----------
Total capital lease $ - $ 4,275
Less amounts representing interest - 215
-------- ----------
Total obligation under capital lease - 4,060
Less current portion of lease obligation - 4,060
-------- ----------
Lease obligation, long-term $ - $ -
======== ==========
The interest rate on the capital lease is based upon the lessor's implicit
rate of return of 8.9%. Interest expense under the capital lease
approximated $215 and $590 for the years ended December 31, 2000 and 1999,
respectively.
K. PURCHASE OF SITE
Effective January 17, 1995 (the transaction was completed on April 17,
1995, retroactive to January 17, 1995), the Company purchased the location,
the existing equipment, inventory, DOE contracts, and other assets from
Husky Oil, Ltd. of Canada. (This purchase was arranged since Husky was
planning to close the facility.) The Company agreed to purchase the assets
and assume various liabilities from Husky in exchange for the funds Husky
estimated it would need to expend for the site closing. The major terms of
the purchase agreement were that the Company would purchase the site,
equipment, real estate, and liability to perform certain DOE contracts
Husky had entered into, for $150,000 (fair market value is approximately
$2,500,000) and Husky would provide $760,000 in cash (the estimated cost to
close the facility) in order to fund the initial operations and the Company
would assume a portion of the DCAA rate adjustments for prior years.
APB No. 13 indicates that assets purchased for below market value should be
recorded at the actual cost of the non current assets or zero if the
current assets' fair market value exceeds the purchase price. Accordingly,
the initial cost of the site, equipment, etc. is not reflected on the books
since they have been written down to zero. As a result, a credit balance in
goodwill (negative goodwill) of $817,517 resulted as of December 31, 1995.
The figure is being amortized into income over 15 years using the
straight-line method.
17
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
K. PURCHASE OF SITE (CONTINUED)
The DCAA has completed its audit of the billing rates used for 1992, 1993
and 1994 which resulted in an adjustment higher than estimated at the time
of purchase. Since this adjustment was a function of the purchase of the
business and not the result of the Company's operations, management reduced
goodwill for the excess of the final DOE adjustment over the estimated
provision made in 1995. The adjustment amounts to $54,601 at December 31,
1998. The net balance in negative goodwill will be amortized over its
estimated remaining life (13 years).
At December 31, 2000 and 1999 the balance in the negative goodwill account
was as follows:
December 31,
-----------------------
2000 1999
---------- ----------
Negative goodwill $ 744,923 $ 744,923
Less accumulated amortization and adjustment 358,432 308,771
---------- ----------
Negative goodwill, net $ 386,491 $ 436,152
========== ==========
Amortization of negative goodwill aggregated $49,661 for both years ended
December 31, 2000 and 1999.
L. COMMITMENTS AND OPERATING LEASES
On January 23, 1996, the Company entered into an agreement with a Canadian
enterprise to acquire certain chemical process technology and related
intellectual property. The technology represents interesting concepts but
considerable development and research work remains to be done in order for
them to be commercially viable. In the event the technology is viable, the
Company is obligated to pay royalty fees to the interested parties based on
future revenue generated by the specific technology. The amount of
liability cannot be reasonably estimated as of December 31, 2000 and 1999.
During 1998, the Board of Directors authorized the issuance of one year
warrants to purchase common stock to all holders of common stock as of June
30, 1998 for 25% of the common shares outstanding as of that date, at an
exercise price of $0.67 per share. These warrants expired on September 23,
1999 and were extended until March 31, 2000. On March 22, 2000 the Board of
Directors unanimously approved an extension on these warrants until October
31, 2000.
18
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS AND OPERATING LEASES (CONTINUED)
A summary of the status of the warrants as of December 31, 2000 and 1999
and the changes during the years then ended is presented below.
2000 1999
------------------------- -----------------------
Weighted- Weighted-
Average Average
Number of Exercise Number of Exercise
Shares Price Shares Price
--------- ----------- --------- -----------
Outstanding at beginning
of year 187,978 $ 0.67 229,278 $ 0.67
Granted - - - -
Exercised 86,232 0.67 41,300 0.67
Expired 101,746 0.67 - -
------- --------- ------- ---------
Outstanding at end of year - $ - 187,978 $ 0.67
======= ========= ======= =========
The Company entered into a four year lease agreement commencing September
1, 1998 for space applicable to the subsidiary Chemsampco. The rent under
this agreement is $3,800 per month plus utilities. The lease contains a
contingent rental payment based upon increases in taxes, as well as, a
renewal option for an additional two years.
The following is a schedule of future minimum rental payments required
under an operating lease that has initial or remaining non-cancelable lease
terms in excess of one year as of December 31, 2000:
Year Ending December 31,
2001 $ 45,600
2002 30,400
------------
Total minimum future rental payments $ 76,000
============
Rent expense aggregated $45,600 for both years ended December 31, 2000 and
1999.
On July 1, 1998, one of the Company's subsidiaries entered into an
agreement with a vendor to market certain scrap tire and waste oil
technology which involves the conversion of scrap tire and waste oil into a
more refined oil and carbon based solid material. Under the terms of the
agreement, the Company is obligated to pay $9,250 per month, of which
$2,250 per month is deferred until the contract is completed or terminates
on December 31, 2000. At the end of this agreement the vendor has the
option to accept the deferred cash or convert the cash to common stock of
the Company's subsidiary.
During June 1999, the Company terminated the agreement and the subsidiary
will pay to the vendor the unpaid portion of the consulting fee through the
date of termination and the deferred portion of the consulting fee will be
paid in cash. The termination was in accordance with the agreement. The
deferred portion included in accrued expenses at December 31, 2000 and 1999
is $0 and $4,500, respectively.
19
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS AND OPERATING LEASES (CONTINUED)
During 2000, the Company entered into an agreement with a foreign entity to
sell a 15% interest in HTI's Coal Process Technology for $750,000. A
separate agreement for a feasibility study relating to the technology was
signed for $1,600,000 along with a Licensing Agreement in Principle for
$8,200,000. The formal Licensing Agreement is to be signed at the
conclusion of the feasibility study, with 85% of the licensing fee
applicable to HTI. The licensing fee is to be paid out over several years
based on obtaining specific milestones as stated in the Agreement in
Principle. The first payment approximates $2,000,000 and is payable upon
signing of the Licensing Agreement. HTI received payment of $1,300,000
subsequent to December 31, 2000 towards the feasibility agreement.
M. CONTINGENCY
During October 2000, the Board of Directors approved a measure whereby
terminated employees of the Company could elect to retain their stock in
the Company for a period of up to five years after termination. The measure
provides that the Company will purchase the shares from the former
employees at the greater of $0.67 per share or the fair market value of the
shares at the repurchase date. As of December 31, 2000, the number of
shares held by former employees of the Company was 133,812.
N. SUBSEQUENT EVENTS
During April 2001, the Company entered into an agreement with an unrelated
entity to enter into a business combination transaction whereby this
unrelated entity will acquire substantially all of the issued and
outstanding shares of stock of HTI and subsidiaries for cash and stock in
the acquirer. In addition, the acquirer will repay the line of credit
outstanding as of December 31, 2000 in the amount of $1,000,000 and an
additional line of credit, which was obtained from the same bank during
April 2001 in the amount of $500,000.
The Company in order to effect the aforementioned business combination has
decided to restate the financial statements to reflect the acquirer's
accounting principles. The Company has written off Intellectual Property
and Organization Costs, which the Company had previously capitalized and
amortized over a period of time. The restatement is effective December 31,
1998. The cost of the intangible assets and the related accumulated
amortization as of December 31, 1998 have been removed from the Company's
balance sheet and is summarized as follows:
December 31, 1998
-----------------
Intellectual Property $ 175,000
Less accumulated amortization 52,500
---------------
$ 122,500
===============
Organization costs $ 127,022
Less accumulated amortization 29,770
---------------
$ 97,252
===============
20
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
N. SUBSEQUENT EVENTS (CONTINUED)
The Company has also recorded a valuation allowance applicable to the
deferred tax asset which amounted to $176,500 as of December 31, 1998.
The Company has also restated inventory in relation to the acquisition of
Chemsampco, Inc. and has reclassified $210,428 from inventory to goodwill.
The restatement is as of December 31, 1998 and the restated goodwill will
be amortized over a sixty month period.
The cumulative effect of the above restatements for each of the three years
ended December 31, 2000, 1999 and 1998 is as follows:
2000 1999 1998
----------- ----------- -----------
Net (loss) income as originally reported $ (935,491) $ 98,677 $ (730,681)
Adjustment for effect of a change in
accounting principle that is applied
retroactively (10,648) (29,048) (431,322)
----------- ----------- -----------
Net (loss) income as adjusted $ (946,139) $ 69,629 $(1,162,003)
=========== =========== ===========
HTI and the subsidiary HETI became a 53% member in a limited liability
company and entered into an exclusive sublicensing agreement to
commercialize the Company's waste oil and waste tire processing technology.
O. SALE OF COMPANY
The aforementioned business combination was consummated on August 28, 2001
whereby all of the shares issued and outstanding were acquired by an
unrelated entity. It is the intention of the acquirer to provide ongoing
financial support to HTI and subsidiaries.
21
HYDROCARBON TECHNOLOGIES INC.
AND SUBSIDIARIES
Consolidated Financial Statements
Six Months Ended
June 30, 2001 and 2000
HYDROCARBON TECHNOLOGIES INC. AND SUBSIDIARIES
Table of Contents
Six Months Ended June 30, 2001 and 2000
Page
Number
------
ACCOUNTANTS' REPORT.........................................................1
FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS .............................................2
CONSOLIDATED STATEMENTS OF OPERATIONS....................................3
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY ...............4
CONSOLIDATED STATEMENTS OF CASH FLOWS...................................5-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .............................7-23
DRUKER, RAHL & FEIN
CERTIFIED PUBLIC ACCOUNTANTS
BUSINESS CONSULTANTS
A Member of The Mercadien Group
To The Board of Directors and Stockholders of
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
Donald F. Conway, CPA o We have reviewed the accompanying consolidated
Conrad L. Druker, CPA balance sheet of HYDROCARBON TECHNOLOGIES, INC. AND
Esmond S. Druker, CPA SUBSIDIARIES as of June 30, 2001 and the related
Eugene J. Elias, CPA, RMA consolidated statements of operations, stockholders'
Jack H. Fein, CPA * (deficit) equity, and cash flows for the six months
Robert J. Rahl, CPA * ended June 30, 2001 and 2000, in accordance with
David L. Stafford, CPA * Statements on Standards for Accounting and Review
Richard S. Willinger, CPA Services issued by the American Institute of
__________________________ Certified Public Accountants. All information
Peter A. Inverso, CPA included in these financial statements is the
representation of the management of HYDROCARBON
* CPA in NJ and PA TECHNOLOGIES, INC. AND SUBSIDIARIES.
o CPA in NY
OTHER OFFICE A review consists principally of inquiries of Company
86 Buck Road personnel and analytical procedures applied to
Holland, PA 18966 financial data. It is substantially less in scope
215-355-4860 than an audit in accordance with auditing standards
generally accepted in the United States of America,
o National Associated the objective of which is the expression of an
CPA Firms opinion regarding the consolidated financial
statements taken as a whole. Accordingly, we do not
o American Institute of express such an opinion.
Certified Public
Accountants Based on our reviews, we are not aware of any
material modifications that should be made to the
o New Jersey Society of accompanying consolidated financial statements in
Certified Public order for them to be in conformity with accounting
Accountants principles generally accepted in the United States of
America.
o Pennsylvania Institute of
Certified Public The consolidated balance sheet as of December 31,
Accountants 2000 was audited by us, and we expressed an
unqualified opinion on it in our report dated March
o Private Companies 20, 2001, but we have not performed any auditing
Practice Section procedures since that date.
o SEC Practice Section July 17, 2001
(Except as to Note P, which is as of August 28, 2001)
/s/ Druker, Rahl & Fein
DRUKER, RAHL & FEIN
P.O. Box 7648 o Princeton, NJ 08543-7648 o 609.689.9700 o FAX 609.689.9720
www.mercadien.com
1
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2001 2000
(Reviewed) (Audited)
------------ ------------
ASSETS
Current Assets
Cash $ 103,699 $ 61,091
Accounts receivable, net of allowance for uncollectible
accounts of $10,200 (2001) and (2000) 184,522 235,038
Unbilled costs and fees 22,875 72,055
Other receivables 18,142 40,558
Inventories 522,972 558,439
Prepaid expenses and other current assets 257,245 161,290
Prepaid income taxes 51,740 51,740
------------ ------------
Total Current Assets 1,161,195 1,180,211
Property, plant and equipment 1,069,165 1,068,639
Other assets 71,883 93,448
------------ ------------
Total Assets $ 2,302,243 $ 2,342,298
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities
Current portion of capitalized lease obligation $ 18,597 $ -
Credit lines payable 1,450,000 1,000,000
Current portion of long-term debt 419,587 185,746
Accounts payable 974,242 865,396
Accrued expenses 139,683 144,229
Accumulated employee vacation 139,510 111,323
Deferred revenue and other current liabilities 878,114 62,504
Income taxes payable 160 600
------------ ------------
Total Current Liabilities 4,019,893 2,369,798
------------ ------------
Obligation under capital lease 15,000 -
Long-term debt - 30,295
Excess of net assets acquired over cost 361,660 386,491
------------ ------------
Total Liabilities 4,396,553 2,786,584
------------ ------------
Stockholders' Deficit:
Common stock, 10,000,000 shares authorized; 1,599,611
(2001) and 1,501,112 (2000) shares issued 15,996 15,011
Additional paid in capital 1,055,424 990,415
Accumulated deficit (3,165,730) (1,449,712)
------------ ------------
Total Stockholders' Deficit (2,094,310) (444,286)
------------ ------------
Total Liabilities and Stockholders' Deficit $ 2,302,243 $ 2,342,298
============ ============
See notes to consolidated financial statements and accountants' report. 2
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Six Month Ended June 30,
----------------------------------
2001 2000
------------ ------------
Revenue
Contract revenue $ 1,905,970 $ 4,542,463
Retail sales 123,678 127,865
------------ ------------
Total revenue 2,029,648 4,670,328
------------ ------------
Direct costs
Labor costs 735,546 835,967
Fringe benefits 317,968 302,637
Other direct costs 312,650 989,020
Applied overhead 1,073,388 1,044,634
Depreciation and amortization 93,681 93,753
------------ ------------
Total direct costs 2,533,233 3,266,011
------------ ------------
Gross (loss) profit (503,585) 1,404,317
------------ ------------
Operating Expenses
Marketing 191,887 285,917
Research and development 131,109 315,211
Bid proposal 62,064 124,797
General and administrative 340,887 341,444
------------ ------------
Total operating expenses 725,947 1,067,369
------------ ------------
(Loss) income from operations (1,229,532) 336,948
------------ ------------
Other income (expense)
Interest income 3,099 4,437
Rental income 7,037 7,999
Costs incurred and accrued in connection with merger (449,474) -
Interest expense (50,414) (33,770)
Amortization of goodwill (21,565) (21,565)
Amortization of negative goodwill 24,831 24,831
------------ ------------
Total other expenses (486,486) (18,068)
------------ ------------
(Loss) income before provision for income taxes (1,716,018) 318,880
Provision for income taxes - 27,439
------------ ------------
Net (loss) income $ (1,716,018) $ 291,441
============ ============
See notes to consolidated financial statements and accountants' report. 3
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
Six Months Ended June 30, 2001 and 2000
Common Stock $.01 Par Value Additional Accumulated
Shares Amount Paid In Capital Deficit Total
------ ------ --------------- ------- -----
Balance January 1, 2000 1,222,877 $ 12,229 $ 806,777 $ (503,573) $ 315,433
Shares purchased through Employee
Stock Purchase Plan 135,906 1,359 89,698 - 91,057
Other stock subscribed during the period 15,712 157 10,371 - 10,528
Stock repurchased during the period (11,368) (114) (7,502) - (7,616)
Net income for the period - - - 291,441 291,441
---------- --------- ------------ ----------- ------------
Balance June 30, 2000 1,363,127 $ 13,631 $ 899,344 $ (212,132) $ 700,843
========== ========= ============ =========== ============
Balance January 1, 2001 1,501,112 $ 15,011 $ 990,415 $(1,449,712) $ (444,286)
Shares purchased through Employee
Stock Purchase Plan 108,812 1,088 71,816 - 72,904
Other stock subscribed during the period - - - - -
Stock repurchased during the period (10,313) (103) (6,807) - (6,910)
Net loss for the period - - - (1,716,018) (1,716,018)
---------- --------- ------------ ----------- ------------
Balance June 30, 2001 1,599,611 $ 15,996 $ 1,055,424 $(3,165,730) $ (2,094,310)
========== ========= ============ =========== ============
See notes to consolidated financial statements and accountants' report. 4
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30,
--------------------------------
2001 2000
------------ ------------
Cash Flows from Operating Activities
Net (loss) income $ (1,716,018) $ 291,441
Adjustments to reconcile net (loss) income to net cash
(used in) provided by operating activities
Depreciation and amortization 115,246 115,318
Amortization of negative goodwill (24,831) (24,831)
Changes in current assets and liabilities
Accounts receivable 50,516 (677,008)
Unbilled costs and fees 49,180 76,309
Other receivables 22,416 (56,170)
Inventories 35,467 11,172
Prepaid expenses and other current assets (95,955) (152,249)
Accounts payable 108,846 (88,771)
Accrued expenses (4,546) (32,406)
Accumulated employee vacation 28,187 25,871
Income taxes payable (440) (15,050)
Deferred revenue and other current liabilities 815,610 570,132
------------ ------------
Net cash (used in) provided by operating activities (616,322) 43,758
------------ ------------
Cash Flows from Investing Activities
Purchase of property and equipment (60,610) -
------------ ------------
Cash Flows from Financing Activities
Proceeds from borrowing - notes payable 334,112 179,874
Proceeds from borrowing - credit line 450,000 -
Principal payments under capital lease obligation - (2,095)
Principal payments on notes payable (130,566) (79,365)
Principal payments on line of credit - (250,000)
Subscription and issuance of common stock 72,904 101,585
Repurchase of stock from former employees (6,910) (7,616)
------------ ------------
Net cash provided by (used in) financing activities 719,540 (57,617)
------------ ------------
Net increase (decrease) in cash 42,608 (13,859)
Cash, beginning of period 61,091 92,384
------------ ------------
Cash, end of period $ 103,699 $ 78,525
============ ============
See notes to consolidated financial statements and accountants' report. 5
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Six Months Ended June 30,
--------------------------------
2001 2000
------------ ------------
Supplemental Disclosures of Cash Flow Information
Cash paid during the period for
Interest $ 43,584 $ 33,770
============ ============
Income taxes $ 440 $ 42,490
============ ============
Supplemental Schedule of Non-Cash Investing and
Financing Activities
Capitalized lease obligation incurred for purchase
of equipment $ 33,597 $ -
============ ============
See notes to consolidated financial statements and accountants' report. 6
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
The Company provides research and development services for converting,
upgrading and cleaning fossil fuels and for recycling waste organics
(plastics) for the US Department of Energy ("DOE") as well as other
commercial customers. The Company's commercial customer base,
predominantly within the oil and gas industry, is throughout the United
States.
Organization and Basis of Consolidation
The consolidated financial statements include the accounts of Hydrocarbon
Technologies Canada, Inc. incorporated on December 19, 1995 for purposes
of performing joint research and development activities utilizing
intellectual property with a university in Canada. The Company also has
established a wholly owned subsidiary, Hydrocarbon Environmental
Technology, Inc. for the purpose of performing research into converting
scrap tires and waste oil into a more refined oil and carbon based solid
material. The Company also has a wholly owned subsidiary which was
established during 1998, Chemsampco, Inc., which is also based in New
Jersey. This subsidiary is a chemical manufacturer and supplier. All
intercompany transactions have been eliminated.
Ownership
The Company is owned entirely by its employees. The initial stockholders
were the Company's president, vice-president, treasurer, and secretary. As
discussed in the Employee Stock Purchase Plan note, the Company
subsequently developed the plan in which all the Company's employees may
purchase at their option, shares in the Company's stock. Currently,
substantially all of the employees are participating in this plan.
Cash
For the purpose of the statements of cash flows, cash includes time
deposits, certificates of deposit and all highly liquid debt instruments
with original maturities of three months or less.
Inventories
Inventories consist of custom repair parts for the equipment used and the
supplies consumed in the various tests the Company performs. Since
substantially all of this inventory is repair parts, consumable supplies
and chemicals, they are valued at their specific historical cost and are
not for resale to customers. There are no raw materials or work in
process.
The inventory related to the subsidiary Chemsampco, Inc. is comprised of
reagent chemicals of varying degrees of purity and is available for resale
to customers.
Inventory maintained by the subsidiary is valued at the lower of cost
(determined on a first in first out basis) or market.
Research and Development Costs
Current operations are charged with all internal research and development
expenses, (including overhead allocations), which amounted to $131,109 and
$315,211 for the six months ended June 30, 2001 and 2000, respectively.
See notes to consolidated financial statements and accountants' report. 7
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Property and Equipment and Depreciation
Property and equipment is stated at cost and is depreciated for financial
reporting purposes on a straight-line basis over the estimated useful
lives of the respective assets ranging from three to thirty nine and
one-half years. Building improvements are depreciated over their estimated
useful lives. Repairs and maintenance expenditures that do not extend the
useful lives of the related assets are expensed as incurred.
Excess of Net Assets Acquired Over Cost (Negative Goodwill)
Effective January 17, 1995 (the transaction was completed on April 17,
1995, retroactively effective to January 17, 1995), the Company purchased
the location, the existing equipment, inventory, DOE contracts and other
assets from Husky Oil, Ltd. of Canada ("Husky"). (This purchase was
arranged since Husky was planning to close the facility.) The Company
agreed to purchase the assets and assume various liabilities from Husky in
exchange for the funds Husky estimated it would need to expend for the
site closing.
In accordance with accounting principles generally accepted in the United
States of America requirements related to below market value business
combinations, the non-current assets (land, building, equipment, and
customer list) have been written down to the lower of their proportionate
share of the purchase price or zero. As a result, a credit balance in
goodwill (negative goodwill) resulted. The figure is being amortized into
income over 15 years using the straight-line method and amounted to
$24,831 for both six months ended June 30, 2001 and 2000.
Goodwill
Effective March 1998, the Company purchased the assets of another entity
and created a wholly owned subsidiary, Chemsampco, Inc. Goodwill
represents the excess of the purchase price of the assets purchased over
the fair market value at the date of acquisition and is being amortized on
a straight line method over 60 months and is included in other assets.
Amortization expense charged to operations was $21,565 for both six months
ended June 30, 2001 and 2000.
Income Taxes
In February 1992, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 109, Accounting for Income
Taxes. Under the asset and liability method of Statement No. 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax basis
and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are
expected to be recovered or settled. Under Statement No. 109, the effect
on deferred tax assets and liabilities of a change in the tax rates is
recognized in income in the period that includes the enactment date.
The Company also qualifies as a "Personal Service Corporation" (PSC) as
defined in the Internal Revenue Service Regulations. Accordingly, for
income tax purposes, the Company is entitled to
See accountants' report on the consolidated financial statements. 8
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes (Continued)
report its income and expenses using the cash receipts and disbursements
method of accounting instead of the accrual method (Generally Accepted
Accounting Principles) used for financial statement reporting.
The Company has elected to file a consolidated tax return including its
Canadian subsidiary as if it was a domestic corporation.
Major Customers
The Company generally extends unsecured credit in connection with its
testing sales, and a portion of the business (6% and 4% for the six months
ended June 30, 2001 and 2000, respectively) is from the DOE. The Company
has made, in its opinion, appropriate estimated provisions (which are
$10,200 at June 30, 2001 and December 31, 2000) for credit losses on
accounts receivable from commercial contracts based upon information
currently available. The Company, like other governmental contractors, is
subject to annual appropriations by Congress to continue funding for these
programs.
A significant portion of the Company's revenue, 68% for the six months
ended June 30, 2001 is from two commercial customers and 73% of the
Company's revenue for the six months ended June 30, 2000 is from one
commercial customer. Included in accounts receivable and unbilled costs
and fees is $22,875 at both June 30, 2001 and December 31, 2000.
Revenue Recognition
Revenue from cost reimbursement contracts is recorded as the costs
associated with that revenue are incurred. During 2001 and 2000, the
Company used provisional rates when invoicing for overhead and general and
administrative expenses under its DOE contracts. These provisional rates
are based on the Company's budget for the respective year. Adjustments to
these rates are made monthly when the actual rates can be calculated after
allowing for anticipated unallowable expenses. Final adjustments will be
made after year end rates are approved by the Defense Contract Audit
Agency "DCAA" (usually one to two years after the close of the fiscal
year). All of these rates are subject to audit by various government
authorities, principally the DCAA.
Revenue from other contracts (fixed price) is also recognized as the costs
associated with that revenue are incurred. Estimated losses will be
accrued when the facts indicating that a loss will occur become known.
The Company has a liquification process contract which will also produce
approximately 317,000 pounds of material. Revenue recognition applicable
to this contract is based upon the percentage of completion method of
accounting. Accordingly, income is recognized in the ratio that labor
hours incurred bears to estimated total labor hours. Adjustments to labor
hour estimates are made periodically, and losses expected to be incurred
on contracts in progress are charged to operations in the period such
losses are determined.
The Company reflects revenue in excess of billings as unbilled costs and
fees in the consolidated balance sheet as a current asset. Conversely,
billings in excess of revenue are reflected as deferred revenue in the
consolidated balance sheets as a current liability.
See accountants' report on the consolidated financial statements. 9
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires the
Company to make estimates and assumptions that affect certain reported
amounts and disclosures. Accordingly, actual results could differ from
those estimates.
Interim Reporting
The consolidated financial statements reflect all adjustments which are,
in the opinion of management, necessary for a fair presentation of the
results of the six months ended June 30, 2001 and 2000.
B. CONCENTRATION OF CREDIT RISK
The Company maintains cash in bank balances which may exceed federally
insured limits. The Company historically has not experienced any cash in bank
losses. The Company provides credit in the normal course of business to its
customers and performs ongoing credit evaluations of its customers and
maintains allowances for uncollectible accounts based on factors surrounding
the credit risk of specific customers, historical trends and other
information.
C. PENSION PLAN
The Company sponsors a 401(k) retirement plan for its employees that allows
the employees to contribute a portion of their salary to their retirement.
The Company currently matches the employees' contribution up to 5% of the
employees' compensation. The board of directors also has the option of making
discretionary contributions (in addition to the matching contributions) in
any amount subject to Internal Revenue limitations. For the six months ended
June 30, 2001 and 2000, the Company's total contribution was $71,607 and
$88,014, respectively.
D. PROPERTY AND EQUIPMENT
Property, plant and equipment, which is stated at cost less accumulated
depreciation and amortization, is summarized as follows:
June 30, December 31,
2001 2000
------------ ------------
Machinery and equipment $ 1,038,266 $ 997,250
Building improvements 652,626 652,626
Equipment under capital lease 109,267 56,076
------------ ------------
Subtotal 1,800,159 1,705,952
Less accumulated depreciation and amortization 730,994 637,313
------------ ------------
$ 1,069,165 $ 1,068,639
============ ============
Depreciation and amortization expense aggregated $93,681 and $93,753 for the
six months ended June 30, 2001 and 2000, respectively.
See accountants' report on the consolidated financial statements. 10
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
E. OTHER RECEIVABLES
As discussed previously, the Company purchased its facility from Husky. The
facility has various environmental problems that are in various stages of
remediation under the supervision of the New Jersey Department of
Environmental Protection (NJ DEP). A former owner of the facility is
responsible for the clean up of the site (for contamination prior to the
purchase by Husky) and has invested over $4,000,000 to date in the clean up
project. Part of the terms of the sale of the facility to the Company is that
the former owner of the site remain fully responsible, and further, that
Husky guarantee the former owner's continuing compliance with the terms of
its environmental remediation plan agreed to with the NJ DEP. The Company has
from time to time needed to expend funds in order to maintain the remediation
program and is seeking reimbursement from the former owner. Accordingly, $0
and $34,026 is due from the former owner as of June 30, 2001 and December 31,
2000, respectively. This amount is included in the current assets section
under the caption "Other receivables".
F. DEBT
Credit lines payable consist of the following:
June 30, December 31,
2001 2000
---------- ------------
A $1,000,000 credit line for general
corporate and working capital purposes as
well as other debt paydown, with interest
at prime plus 1% expired May 31, 2001 but
was extended until May 31, 2002. Prime at
June 30, 2001 was 7%. The bank has a
security interest in all assets of the
Company and a junior lien on the inventory
of the subsidiary, Chemsampco, Inc. There
are financial covenants relating to
tangible net worth and minimum debt service
coverage which commence December 31, 2000,
for which waivers have been obtained. The
credit line is personally guaranteed by the
three original officers/ stockholders of
the Company up to 62% of the credit line. $ 950,000 $ 1,000,000
---------- ------------
A $500,000 credit line for general
corporate and working capital purposes,
with interest at prime plus 1% and expires
October 31, 2001. Prime at June 30, 2001
was 7%. The bank has a security interest in
all assets of the Company and a junior lien
on the inventory of the subsidiary,
Chemsampco, Inc. The aforementioned
financial covenants are also applicable to
this credit line. The credit line is
personally guaranteed by the three original
officers/ stockholders of the Company up to
62% of the credit line. 500,000 -
---------- ------------
Total $1,450,000 $ 1,000,000
========== ============
See accountants' report on the consolidated financial statements. 11
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
F. DEBT (CONTINUED)
In March 1998, the Company purchased certain assets of another entity and
created a wholly owned subsidiary named Chemsampco, Inc. and signed a
$400,000 promissory note. This note is subordinate to the line of credit
although the seller has a security interest in the inventory, machinery and
equipment, manufacturing procedures and production records, trade name and
goodwill acquired in the asset purchase. HTI (parent) as surety, has
guaranteed to the Seller that the value of the inventory purchased shall be
equal to or greater than the principal outstanding on the promissory note.
The line of credit contains covenants pertaining to tangible net worth and
minimum debt service coverage which commenced December 31, 2000. The Company
is required to maintain minimum tangible net worth as defined, of $750,000 as
of December 31, 2000. The Company is also required to maintain a minimum debt
service coverage ratio as defined of 1.15. The Company's tangible net worth
and debt service coverage ratio are negative as of June 30, 2001 and December
31, 2000. The bank has waived these covenant violations as of June 30, 2001
and December 31, 2000 and for the periods then ended.
Debt is comprised of the following:
June 30, December 31,
2001 2000
---------- ------------
Promissory note payable in equal monthly
installments of $10,225 inclusive of
interest at 7.5% through April 2002. The
note is secured by certain assets of the
Company. $ 89,214 $ 145,970
Insurance premium note payable in monthly
installments of $8,481 inclusive of
interest at 10.5% commencing May 2000
through January 2001. The note was secured
by the unused portion of the underlying
policies. - 8,407
Insurance premium note payable in monthly
installments of $6,509 inclusive of
interest at 11.95% commencing May 2000
through October 2001. The note is secured
by the unused portion of the underlying
policies. 25,401 61,664
Insurance premium note payable in monthly
installments of $15,437 inclusive of
interest at 8.54% commencing April 2001
through January 2002. The note is secured
by the unused portion of the underlying
policies. 104,972 -
Promissory note payable from acquirer with
interest at 8.5%. The note has a
subordinated security interest to the lines
of credit and is due May 2, 2002. 200,000 -
---------- ------------
Total 419,587 216,041
Less current portion 419,587 185,746
---------- ------------
Debt, net of current portion $ - $ 30,295
========== ============
See accountants' report on the consolidated financial statements. 12
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
G. INCOME TAXES
As previously discussed, the Company follows FASB Statement No. 109 for the
accounting of income taxes and for income tax purposes, reports its income
and expenses on the cash receipts and disbursements method of accounting.
Therefore the Company has significant deferred tax assets and liabilities
resulting from the different methods of income recognition.
Components of income tax expense for the six months ended June 30, 2001 and
2000 are as follows:
2001 2000
---------- ----------
Current:
Federal $ - $ 16,520
State - 2,700
---------- ----------
- 19,220
---------- ----------
Deferred:
Federal - 2,518
State - 5,701
---------- ----------
- 8,219
---------- ----------
Total provision for income taxes $ - $ 27,439
========== ==========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax asset and deferred tax liability at June 30,
2001 and December 31, 2000 are presented below:
June 30, December 31,
2001 2000
----------- -----------
Deferred tax asset:
Tax effect of realization of
Accounts payable $ 331,300 $ 292,000
Accrued expenses 94,900 78,000
Deferred revenues 298,600 21,300
Net operating loss 306,000 342,000
----------- -----------
Subtotal 1,030,800 733,300
Less valuation allowance (849,000) (567,800)
----------- -----------
Total deferred tax asset 181,800 165,500
----------- -----------
Deferred tax liabilities:
Tax effect of realization of
Accounts receivable 76,700 (109,600)
Prepaid expenses 105,100 (55,900)
----------- -----------
Total deferred tax liability 181,800 (165,500)
----------- -----------
Net deferred tax asset $ - $ -
=========== ===========
As discussed in the "Summary of Significant Accounting Policies," the Company
uses the cash receipts and disbursements method of accounting for income tax
purposes. Management has deemed a valuation allowance necessary since
anticipated profits in future years cannot be predicted.
See accountants' report on the consolidated financial statements. 13
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
G. INCOME TAXES (CONTINUED)
As of June 30, 2001, the Company has net operating loss carryforwards of
approximately $1,000,000 and $1,500,000 for federal and state purposes,
respectively. The losses expire beginning in 2020 and 2005 for federal and
state purposes, respectively. Federal and state tax laws impose significant
restrictions on the utilization of net operating loss carryforwards in the
event of a change in ownership as defined by the Internal Revenue Service
Code Section 382.
H. EMPLOYEE STOCK PURCHASE PLAN
As previously discussed, the Company is owned by its employees. Each employee
has the option of allocating up to 15% of their payroll to purchase shares of
stock in the Company at a price set by the board of directors. At the end of
a six month period (June 30 and December 31), the Company will apply the
withheld funds to the purchase of the shares and issue the shares. As of June
30, 2001 and 2000, substantially all the employees participated in this plan.
As a result, during the six month period ended June 30, 2001, 108,812 shares
of stock with a par value of $1,088 and an additional paid in capital of
$71,816 were subscribed under this plan. During the six month period ended
June 30, 2000, 135,906 shares of stock with a par value of $1,359 and an
additional paid in capital of $89,698 were subscribed under this plan. As of
April 26, 2001 the Board discontinued further contributions to the Employees
Stock Purchase Plan.
I. STOCK OPTION PLAN
In September 1997, the stockholders of the Company approved the adoption of
the Company's 1997 Stock Option Plan and the reservation of 500,000 shares of
Common Stock for issuance upon the exercise of options granted.
The Company granted 6,500 stock options to two employees with an exercise
price of $.67 per option, the fair market value of the stock as of December
31, 1996. The Company also granted 150,000 stock options to three
officers/shareholders with an exercise price of $.01 per option.
The Company granted 15,000 stock options to three employees with an exercise
price of $.67 per option on January 14, 2000. During May 2000, the Company
admitted five new Advisory Board members whose compensation for each meeting
attended would be $1,000 plus expenses plus 500 options to purchase stock at
$.67 per share.
The Company currently accounts for its stock based compensation plans using
the accounting method prescribed by Accounting Principals Board Opinion No.
25, Accounting for Stock Issued to Employees. Since the Company is not
required to adopt the fair value based recognition provisions prescribed
under Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation, it has elected only to comply with the disclosure
requirements set forth in the Statement, which includes disclosing proforma
net income as if the fair value based method of accounting had been applied.
See accountants' report on the consolidated financial statements. 14
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
The Company granted stock options to two employees as follows:
Options granted 6,500
Option exercise date February 27, 1997
Option exercise price $ .67 per option
Option term 3 years
Vesting One month from date of grant
Weighted-average remaining contractual life None
The Company granted stock options to three employees as follows:
Options granted 15,000
Option exercise date January 14, 2000
Option exercise price $ .67 per option
Option term 3 years
Vesting One month from date of grant
Weighted-average remaining contractual life 1 year, 6 months
The Company granted stock options to three officers/shareholders as follows:
Options granted 150,000
Option exercise date December 15, 1997
Option exercise price $ .01 per option
Option term 10 years
Vesting Immediately
Weighted-average remaining contractual life 6 years, 6 months
The Company granted stock options to five Advisory Board members as follows:
Options granted 2,500
Option exercise date September 12, 2000
Option exercise price $ .67 per option
Option term 10 years from date of grant
Vesting Immediately
Weighted-average remaining contractual life 8 years, 9 months
The fair value of the options granted is estimated on the grant date using an
option-pricing model (Black-Scholes) with the following weighted average
assumptions used for the 1997 and 2000 grants: dividend yield 0%, risk free
interest of 5.98%, expected lives of the options of 3 and 10 years,
respectively and future stock volatility of 0% since the Company is not
publicly traded.
See accountants' report on the consolidated financial statements. 15
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
A summary of the status of the Company's stock option plan as of June 30,
2001 and June 30, 2000 and the changes during the periods then ended is
presented below.
Options granted to two employees:
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2001 - $ -
Granted - -
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2001 - $ -
========= ============
Exercisable at June 30, 2001 - $ -
========= ============
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2000 6,500 $ 0.67
Granted - -
Exercised - -
Expired 6,500 0.67
Forfeited - -
--------- ------------
Outstanding at June 30, 2000 - $ -
========= ============
Exercisable at June 30, 2000 - $ -
========= ============
Options granted to three employees:
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2001 15,000 $ 0.67
Granted - -
Exercised - -
Expired - -
Forfeited 5,000 0.67
--------- ------------
Outstanding at June 30, 2001 10,000 $ 0.67
========= ============
Exercisable at June 30, 2001 10,000 $ 0.67
========= ============
See accountants' report on the consolidated financial statements. 16
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
Options granted to three employees (Continued):
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2000 - $ -
Granted 15,000 0.67
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2000 15,000 $ 0.67
========= ============
Exercisable at June 30, 2000 15,000 $ 0.67
========= ============
Weighted-average fair value of options
granted during the period ended
June 30, 2000 $ 0.11
=========
Options granted to officers/shareholders:
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2001 139,500 $ 0.01
Granted - -
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2001 139,500 $ 0.01
========= ============
Exercisable at June 30, 2001 139,500 $ 0.01
========= ============
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2000 139,500 $ 0.01
Granted - -
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2000 139,500 $ 0.01
========= ============
Exercisable at June 30, 2000 139,500 $ 0.01
========= ============
See accountants' report on the consolidated financial statements. 17
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
I. STOCK OPTION PLAN (CONTINUED)
Options granted to five Advisory Board members:
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2001 2,500 $ 0.67
Granted - -
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2001 2,500 $ 0.67
========= ============
Exercisable at June 30, 2001 2,500 $ 0.67
========= ============
Weighted-
Number of Average
Shares Exercise Price
------------- --------------
Outstanding at January 1, 2000 - $ -
Granted - -
Exercised - -
Expired - -
Forfeited - -
--------- ------------
Outstanding at June 30, 2000 - $ -
========= ============
Exercisable at June 30, 2000 - $ -
========= ============
J. CAPITAL LEASE PAYABLE
The Company leases certain equipment under capital leases expiring in 2000
and 2003. The assets and liabilities under the capital leases are recorded at
the lower of the present value of the minimum lease payments or the fair
value of the asset at the inception of the lease. The assets are amortized
over the lower of their related lease terms or their estimated productive
lives. Amortization of assets under the capital leases is included in
depreciation and amortization expense and amounted to $1,772 and $1,862 for
the six months ended June 30, 2001 and 2000, respectively.
Properties held under capital leases are included in property and equipment
are as follows:
June 30, December 31,
2001 2000
------------- ------------
Warehouse equipment $ 18,622 $ 18,622
Office equipment 37,482 37,482
Analytical equipment 53,163 -
------------- ------------
Subtotal 109,267 56,104
Less accumulated amortization 57,853 56,104
------------- ------------
Total $ 51,414 $ -
============= ============
See accountants' report on the consolidated financial statements. 18
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
J. CAPITAL LEASE PAYABLE (CONTINUED)
Minimum lease payments due under capital leases for the period ending:
June 30,
-----------------------
2002 $ 19,968
2003 $ 16,720
--------
Total net minimum capital lease payments 36,688
Less amounts representing interest 3,091
--------
Present value of net minimum capital lease payments 33,597
Less current maturities of capital lease obligations 18,597
--------
Obligations under capital leases, excluding current maturities $ 15,000
========
The interest rates on capitalized leases vary from 8.9% to 11.3% and are
based on the lessor's implicit rate of return. Interest expense under the
capital lease approximated $0 and $58 for six months ended June 30, 2001 and
2000, respectively.
K. PURCHASE OF SITE
Effective January 17, 1995 (the transaction was completed on April 17, 1995,
retroactive to January 17, 1995), the Company purchased the location, the
existing equipment, inventory, DOE contracts, and other assets from Husky
Oil, Ltd. of Canada. (This purchase was arranged since Husky was planning to
close the facility.) The Company agreed to purchase the assets and assume
various liabilities from Husky in exchange for the funds Husky estimated it
would need to expend for the site closing. The major terms of the purchase
agreement were that the Company would purchase the site, equipment, real
estate, and liability to perform certain DOE contracts Husky had entered
into, for $150,000 (fair market value is approximately $2,500,000) and Husky
would provide $760,000 in cash (the estimated cost to close the facility) in
order to fund the initial operations and the Company would assume a portion
of the DCAA rate adjustments for prior years.
APB No. 13 indicates that assets purchased for below market value should be
recorded at the actual cost of the non current assets or zero if the current
assets' fair market value exceeds the purchase price. Accordingly, the
initial cost of the site, equipment, etc. are not reflected on the books
since they have been written down to zero. As a result, a credit balance in
goodwill (negative goodwill) of $817,517 resulted as of December 31, 1995.
The figure is being amortized into income over 15 years using the
straight-line method.
The DCAA has completed its audit of the billing rates used for 1992, 1993 and
1994 which resulted in an adjustment higher than estimated at the time of
purchase. Since this adjustment was a function of the purchase of the
business and not the result of the Company's operations, management reduced
goodwill for the excess of the final DOE adjustment over the estimated
provision made in 1995. The adjustment amounts to $54,601 at December 31,
1998. The net balance in negative goodwill will be amortized over its
estimated remaining life (13 years).
See accountants' report on the consolidated financial statements. 19
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
K. PURCHASE OF SITE (CONTINUED)
At June 30, 2001 and December 31, 2000 the balance in the negative goodwill
account was as follows:
2001 2000
---------- ----------
Negative goodwill $ 744,923 $ 744,923
Less accumulated amortization and adjustment 383,263 358,432
---------- ----------
Negative goodwill, net $ 361,660 $ 386,491
========== ==========
Amortization of negative goodwill aggregated $24,831 for both six months
ended June 30, 2001 and June 30, 2000.
L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS
On January 23, 1996, the Company entered into an agreement with a Canadian
enterprise to acquire certain chemical process technology and related
intellectual property. The technology represents interesting concepts but
considerable development and research work remains to be done in order for
them to be commercially viable. In the event the technology is viable, the
Company is obligated to pay royalty fees to the interested parties based on
future revenue generated by the specific technology. The amount of liability
cannot be reasonably estimated as of June 30, 2001 and December 31, 2000.
During 1998, the Board of Directors authorized the issuance of one year
warrants to purchase common stock to all holders of common stock as of June
30, 1998 for 25% of the common shares outstanding as of that date, at an
exercise price of $.67 per share. These warrants expired on September 23,
2000 and were extended until June 30, 2000. On March 22, 2000 the Board of
Directors unanimously approved an extension on these warrants until October
31, 2000.
A summary of the status of the warrants as of June 30, 2001 and December 31,
2000 and the changes during the periods then ended is presented below.
2001 2000
-------------------------- ---------------------------
Weighted- Weighted-
Average Average
Number of Exercise Number of Exercise
Shares price Shares price
----------- ----------- ----------- ------------
Outstanding at
beginning of period - $ - 187,978 $ 0.67
Granted - - - -
Exercised - - 86,232 0.67
Expired - - 101,746 0.67
----------- ----------- ----------- ------------
Outstanding at end
of period - $ - - $ -
=========== =========== =========== ============
See accountants' report on the consolidated financial statements. 20
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS (CONTINUED)
The Company entered into a four year lease agreement commencing September 1,
1998 for space applicable to the subsidiary Chemsampco. The rent under this
agreement is $3,800 per month plus utilities. The lease contains a contingent
rental payment based upon increases in taxes, as well as a renewal option for
an additional two years.
The following is a schedule of the future minimum rental payments required
under this operating lease which has an initial or remaining non-cancelable
lease term in excess of one year as of June 30, 2001:
Period ending June 30,
2002 $ 45,600
2003 7,600
-----------
$ 53,200
===========
Rent expense aggregated $22,800 for both six months ended June 30, 2001 and
2000.
On July 1, 1998, one of the Company's subsidiaries entered into an agreement
with a vendor to market certain scrap tire and waste oil technology which
involves the conversion of scrap tire and waste oil into a more refined oil
and carbon based solid material. Under the terms of the agreement, the
Company is obligated to pay $9,250 per month, of which $2,250 per month is
deferred until the contract is completed or terminates on December 31, 2000.
At the end of this agreement the vendor has the option to accept the deferred
cash or convert the cash to common stock of the Company's subsidiary.
During June 1999, the Company terminated the agreement and the subsidiary
will pay to the vendor the unpaid portion of the consulting fee through the
date of termination and the deferred portion of the consulting fee will be
paid in cash. The termination was in accordance with the agreement. The
deferred portion included in accrued expenses is $0 at both June 30, 2001 and
December 31, 2000.
During 2000, the Company entered into an agreement with a foreign entity to
sell a 15% interest in HTI's Coal Process Technology for $750,000. A separate
agreement for a feasibility study relating to the technology was signed for
$1,600,000 along with a Licensing Agreement in Principle for $8,200,000. The
formal Licensing Agreement is to be signed at the conclusion of the
feasibility study, with 85% of the licensing fee applicable to HTI. The
licensing fee is to be paid out over several years based upon obtaining
specific milestones as stated in the Agreement in Principle. The first
payment approximates $2,000,000 and is payable upon signing of the Licensing
Agreement. HTI received payment of $1,300,000 applicable to the feasibility
study during the six months ended June 30, 2001.
During May 2001, the Company entered into an agreement with an unrelated
entity to enter into a business combination transaction whereby this
unrelated entity will acquire substantially all of the issued and outstanding
shares of stock of HTI and subsidiaries for cash and stock in the acquirer.
In addition, the acquirer will repay the two lines of credit outstanding as
of June 30, 2001 in the amount of $1,450,000.
See accountants' report on the consolidated financial statements. 21
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS (CONTINUED)
During May 2001, the aforementioned acquirer loaned the Company $200,000 with
interest at 8.5% and is due May 2, 2002. The Company has accrued interest on
the loan in the amount of $1,422 as of June 30, 2001.
The Company has incurred and accrued costs associated with the aforementioned
business combination which is comprised of legal, accounting and consulting
fees amounting to $449,474 for the six months ended June 30, 2001.
During the period ended June 30, 2001, the Company became a 53% equity member
in a limited liability company, Carborex LLC ("LLC") and entered into an
exclusive sublicensing agreement to commercialize the Company's waste oil and
waste tire processing technology. The Company plans to record this investment
under the equity method, that is the investment is recorded at cost and is
adjusted periodically to recognize the LLC's share of earnings and losses.
The Company anticipates that its equity membership in the LLC will be
approximately 47% at December 31, 2001, therefore this LLC is not included in
the consolidated financial statements of the Company at June 30, 2001. The
Company's share of the LLC's losses for the period ended June 30, 2001
approximated $78,000. The Company has not guaranteed any obligations and is
not committed to provide financial support to the LLC therefore the Company's
investment and share of the LLC's loss have not been recorded in the
accompanying consolidated financial statements.
The Company received $205,000 from the LLC (a related party) during the
period ended June 30, 2001, of which $147,600 is included in contract revenue
and the balance which totals $57,400 is included in deferred revenue and
other current liabilities as of June 30, 2001.
M. CONTINGENCY
During October 2000, the Board of Directors approved a measure whereby
terminated employees of the Company could elect to retain their stock in the
Company for a period of up to five years after termination. The measure
provides that the Company will purchase the shares from the former employees
at the greater of $0.67 per share or the fair market value of the shares at
the repurchase date. As of June 30, 2001 and December 31, 2000, the number of
shares held by former employees of the Company was 115,612 and 133,812,
respectively.
N. RESTATEMENT
The Company in order to effect the aforementioned business combination has
decided to restate the financial statements to reflect the acquirer's
accounting principles. The Company has written off Intellectual Property and
Organization Costs, which the Company had previously capitalized and
amortized over a period of time. The restatement is effective December 31,
1998. The cost of the intangible assets and the related accumulated
amortization as of December 31, 1998 have been removed from the Company's
balance sheet and is summarized as follows:
See accountants' report on the consolidated financial statements. 22
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
N. RESTATEMENT (CONTINUED)
December 31, 1998
-----------------
Intellectual Property $ 175,000
Less accumulated amortization 52,500
---------------
$ 122,500
===============
Organization costs $ 127,022
Less accumulated amortization 29,770
---------------
$ 97,252
===============
The Company has also recorded a valuation allowance applicable to the
deferred tax asset which amounted to $176,500 as of December 31, 1998.
The Company has also restated inventory in relation to the acquisition of
Chemsampco, Inc. and has reclassified $210,428 from inventory to goodwill.
The restatement is as of December 31, 1998 and the restated goodwill will be
amortized over a sixty month period.
The cumulative effect of the above restatements for the periods ended is as
follows:
Six Months Ended Year Ended
June 30, December 31,
---------------- ------------
2000 1998
----------- -----------
Net income (loss) as originally reported $ 198,865 $ (730,681)
Adjustment for effect of a change in
accounting principle that is applied
retroactively 92,576 (431,322)
----------- -----------
Net income (loss) as adjusted $ 291,441 $(1,162,003)
=========== ===========
O. SUBSEQUENT EVENT
During July and August 2001, the acquirer loaned an additional $850,000 to
the Company with interest at 8.5% and is due May 2, 2002.
P. SALE OF COMPANY
The aforementioned business combination was consummated on August 28, 2001
whereby all of the shares issued and outstanding were acquired by an
unrelated entity. It is the intention of the acquirer to provide ongoing
financial support to HTI and subsidiaries.
See accountants' report on the consolidated financial statements. 23
HEADWATERS INCORPORATED AND
HYDROCARBON TECHNOLOGIES, INC.
INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
(amounts in thousands of dollars and shares)
On August 28, 2001, Headwaters completed a 100% acquisition of Hydrocarbon
Technologies, Inc. ("HTI"). HTI has significant intellectual property that
includes the technology to transform coal and heavy oil into ultra-clean diesel
fuel, recycle waste oil into valuable carbon products, and nano-catalyst
technology. Total consideration at closing is currently estimated to be
approximately $10,618 and consists of cash of $1,447, direct costs incurred by
Headwaters to consummate the acquisition of $860, the issuance of 593 shares of
Headwaters common stock valued at $5,485, options to purchase 144 shares of
Headwaters' common stock issued in exchange for outstanding vested HTI options
valued at $1,325, plus the assumption and retirement of $1,501 of HTI debt.
The value of Headwaters 593 shares of common stock issued was determined using
the average market price of Headwaters' stock over a three-day period,
consisting of the day the terms of acquisition were agreed to and one day prior
to and one day subsequent to that day ($9.25). For purposes of computing the
estimated fair value of the Headwaters stock options, the Black-Scholes option
pricing model was used with the following assumptions: expected stock price
volatility of .90, risk free interest rates of 3.5% to 4.0%, weighted average
expected option lives of one to three years, no dividends, and a fair value of
Headwaters' common stock of $9.25 per share.
Additional contingent consideration can be earned by HTI's stockholders in
future periods based on EBITDA targets and other milestones. As required by
generally accepted accounting principles, a contingent liability of $2,287 was
recorded representing the contingent incremental consideration for identified
purchased assets in excess of the consideration paid at closing. A contingent
liability was not recognized for the contingent incremental consideration that,
if paid in the future, would be recorded as goodwill. These amounts will be
adjusted in the future when the actual contingent consideration is known.
The HTI acquisition has been accounted for using the purchase method of
accounting as required by Statement of Financial Accounting Standards No.141,
"Business Combinations." Assets acquired and liabilities assumed have been
recorded at their estimated fair values as of the acquisition date.
Approximately $9,700 of the purchase price was allocated to identifiable
intangible assets consisting of existing patented technology with an estimated
useful life of 15 years.
Approximately $2,400 of the purchase price was allocated to purchased in-process
research and development. This amount represents the estimated purchased
in-process technology for projects that have not yet reached technological
feasibility and have no alternative future use. The value of these projects was
determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from the sale of those products, and discounting the net cash flows back
to their present value. Headwaters recorded a non-recurring charge for this
purchased in-process research and development as of the closing date of
acquisition.
1
The following pro forma combined balance sheet gives effect to the acquisition
of HTI as if it had been completed as of June 30, 2001 and combines the
historical June 30, 2001 balance sheets for both Headwaters and HTI. The pro
forma combined statements of operations for the year ended September 30, 2000
and the nine months ended June 30, 2001 give effect to the acquisition as if it
had occurred on October 1, 1999. The pro forma combined statement of operations
for the year ended September 30, 2000 combines Headwaters' historical results
for the year ended September 30, 2000 with HTI's historical results for the year
ended December 31, 2000. Headwaters' historical consolidated statement of income
for the year ended September 30, 2000 reflects the elimination of an
extraordinary item for the early extinguishment of debt in the amount of $7,860.
The pro forma combined statement of operations for the nine months ended June
30, 2001 combines both Headwaters' and HTI's historical results for that
nine-month period. Accordingly, HTI's historical results for the three-month
period from October 1, 2000 to December 31, 2000 are included in both the pro
forma combined statement of operations for the year ended September 30, 2000 and
the pro forma combined statement of operations for the nine months ended June
30, 2001.
The pro forma combined financial statements are presented for illustrative
purposes only. Such information does not purport to be indicative of the results
of operations or financial position which actually would have resulted had the
acquisition occurred on the dates indicated, nor is it indicative of the results
that may be expected in future periods. The pro forma adjustments are based upon
information and assumptions available at the time of filing this Form 8-K. The
pro forma information should be read in conjunction with the accompanying notes
thereto.
2
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
as of June 30, 2001
Historical
-------------------------- Pro Forma Pro Forma
(thousands of dollars) Headwaters HTI Adjustments Combined
- ---------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 218 $ 104 $ 322
Short-term investments 5,207 $(2,948) [A] 2,259
Trade receivables, net 6,542 185 6,727
Short-term notes and accrued interest receivable 1,180 (201) [B] 979
Other current assets 401 872 1,273
--------------------------------------- -----------
Total current assets 13,548 1,161 (3,149) 11,560
--------------------------------------- -----------
Property, plant and equipment, net of accumulated depreciation 631 1,069 1,109 [C] 2,809
--------------------------------------- -----------
Other assets:
Notes and accrued interest receivable 8,716 8,716
Equity investments, net 4,210 4,210
Deferred income taxes 3,000 3,000
Intangible assets, net of accumulated amortization 1,094 9,700 [D] 10,794
Other assets 1,175 72 (860) [E]
(72) [F] 315
--------------------------------------- -----------
Total other assets 18,195 72 8,768 27,035
--------------------------------------- -----------
Total assets $32,374 $2,302 $ 6,728 $41,404
======================================= ===========
(continued)
See accompanying notes. 3
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET, continued
as of June 30, 2001
Historical
-------------------------- Pro Forma Pro Forma
(thousands of dollars) Headwaters HTI Adjustments Combined
- ---------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY)
Current liabilities:
Accounts payable $ 1,025 $ 974 $ 1,999
Accrued personnel costs 1,681 140 1,821
Other accrued liabilities 3,140 1,018 $ (1) [B] 4,157
Short-term borrowings 612 1,888 (1,501) [G]
(200) [B] 799
-------------------------------------- -----------
Total current liabilities 6,458 4,020 (1,702) 8,776
-------------------------------------- -----------
Long-term liabilities:
Notes payable, non-current 149 15 164
Other long-term liabilities 149 362 2,287 [H]
(362) [I] 2,436
Deferred revenue 7,187 7,187
-------------------------------------- -----------
Total long-term liabilities 7,485 377 1,925 9,787
-------------------------------------- -----------
Total liabilities 13,943 4,397 223 18,563
-------------------------------------- -----------
Stockholders' equity (net capital deficiency):
Common stock 23 16 1 [J]
(16) [K] 24
Capital in excess of par value 78,521 1,055 (1,055) [K]
5,484 [J]
1,325 [L] 85,330
Accumulated deficit (55,978) (3,166) 3,166 [M]
(2,400) [N] (58,378)
Other, primarily treasury stock (4,135) (4,135)
-------------------------------------- -----------
Total stockholders' equity (net capital deficiency) 18,431 (2,095) 6,505 22,841
-------------------------------------- -----------
Total liabilities and stockholders' equity (net
capital deficiency) $ 32,374 $ 2,302 $ 6,728 $ 41,404
====================================== ===========
See accompanying notes. 4
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
For the year ended September 30, 2000
Historical
--------------------------------------- Pro Forma Pro Forma
(thousands of dollars and shares, except per share amounts) Headwaters HTI Adjustments Combined
- ------------------------------------------------------------------------------------------------------------------------------------
(Year ended (Year ended
September 30, 2000) December 31, 2000)
Revenue:
License fees $17,315 $17,315
Chemical sales 9,757 9,757
Contract revenue $6,897 6,897
Gains on non-recurring transactions 17,949 17,949
Other 814 241 1,055
------------------------------------------------- -------------
Total revenue 45,835 7,138 52,973
------------------------------------------------- -------------
Operating costs and expenses:
Cost of chemical 6,617 6,617
Cost of operations 3,821 6,086 $ 86 [O]
647 [P] 10,640
Selling, general and administrative 5,361 1,403 6,764
Asset write-offs and other non-recurring charges 17,758 17,758
Research and development 559 559
------------------------------------------------- -------------
Total operating costs and expenses 33,557 8,048 733 42,338
------------------------------------------------- -------------
Operating income (loss) 12,278 (910) (733) 10,635
------------------------------------------------- -------------
Other income (expense):
Interest and investment income 1,775 8 1,783
Interest expense (4,814) (74) (4,888)
Other, net (597) 21 (7) [Q] (583)
------------------------------------------------- -------------
Total other expense, net (3,636) (45) (7) (3,688)
------------------------------------------------- -------------
Income (loss) before income taxes 8,642 (955) (740) 6,947
Income tax benefit 2,900 9 2,909
------------------------------------------------- -------------
Net income (loss) before extraordinary item $11,542 $ (946) $(740) $9,856
================================================= =============
Basic net income per common share before extraordinary item $ 0.57 $ 0.47
=============== ==========
Diluted net income per common share before extraordinary item $ 0.50 $ 0.42
=============== ==========
Weighted-average shares outstanding:
Basic 19,468 593 [R] 20,061
=============== ================= ==========
Diluted 22,235 736 [R] 22,971
=============== ================= ==========
See accompanying notes. 5
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC.
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
For the nine months ended June 30, 2001
Historical
---------------------------------------- Pro Forma Pro Forma
(thousands of dollars and shares, except per share amounts) Headwaters HTI Adjustments Combined
- ------------------------------------------------------------------------------------------------------------------------------------
(Nine months ended (Nine months ended
June 30, 2001) June 30, 2001)
Revenue:
License fees $15,770 $15,770
Chemical sales 15,432 15,432
Contract revenue $ 2,403 2,403
Other 1,566 185 1,751
---------------------------------------------------- ------------
Total revenue 32,768 2,588 35,356
---------------------------------------------------- ------------
Operating costs and expenses:
Cost of chemical 9,889 9,889
Cost of operations 2,446 3,682 $ 65 [O]
485 [P] 6,678
Selling, general and administrative 3,828 970 4,798
Research and development 283 283
---------------------------------------------------- ------------
Total operating costs and expenses 16,163 4,935 550 21,648
---------------------------------------------------- ------------
Operating income (loss) 16,605 (2,347) (550) 13,708
---------------------------------------------------- ------------
Other income (expense):
Interest and investment income 511 4 (1) [S] 514
Interest expense (179) (84) 1 [S] (262)
Other, net (1,859) (433) (5) [Q]
450 [T] (1,847)
---------------------------------------------------- ------------
Total other income (expense), net (1,527) (513) 445 (1,595)
---------------------------------------------------- ------------
Income (loss) before income taxes 15,078 (2,860) (105) 12,113
Income tax benefit (expense) (140) 37 (103)
---------------------------------------------------- ------------
Net income (loss) $14,938 $(2,823) $(105) $12,010
==================================================== ============
Basic net income per common share $ 0.65 $ 0.51
============= ============
Diluted net income per common share $ 0.61 $ 0.48
============= ============
Weighted-average shares outstanding:
Basic 22,723 593 [R] 23,316
============= ================= ============
Diluted 24,525 736 [R] 25,261
============= ================= ============
See accompanying notes. 6
HEADWATERS INCORPORATED AND
HYDROCARBON TECHNOLOGIES, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL STATEMENTS
(dollars and shares in thousands, except per share amounts)
1. Basis of Presentation
The pro forma condensed combined financial statements included herein have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and certain footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations; however, management believes
that the disclosures are adequate to make the information presented not
misleading.
2. Acquisition of Hydrocarbon Technologies, Inc.
On August 28, 2001, Headwaters completed a 100% acquisition of Hydrocarbon
Technologies, Inc. ("HTI"). HTI has significant intellectual property that
includes the technology to transform coal and heavy oil into ultra-clean diesel
fuel, recycle waste oil into valuable carbon products, and nano-catalyst
technology. Total consideration at closing is currently estimated to be
approximately $10,618 and includes direct costs incurred by Headwaters to
consummate the acquisition. The following table sets forth the estimated
consideration paid at closing to acquire HTI:
Estimated consideration at closing:
Fair value of Headwaters stock (593 shares at
$9.25 per share) $ 5,485
Fair value of options to purchase 144 shares of
Headwaters' common stock issued in exchange for
152 outstanding vested HTI options 1,325
Cash paid to HTI stockholders 1,447
Cash paid to retire HTI note payable to bank 1,501
Estimated direct costs 860
---------
Total $ 10,618
---------
The value of Headwaters 593 shares of common stock issued was determined using
the average market price of Headwaters' stock over a three-day period,
consisting of the day the terms of acquisition were agreed to and one day prior
to and one day subsequent to that day ($9.25). For purposes of computing the
estimated fair value of the Headwaters stock options, the Black-Scholes option
pricing model was used with the following assumptions: expected stock price
volatility of .90, risk free interest rates of 3.5% to 4.0%, weighted average
expected option lives of one to three years, no dividends, and a fair value of
Headwaters' stock of $9.25 per share.
Additional contingent consideration can be earned by HTI's stockholders in
future periods based on EBITDA targets and other milestones. As required by
generally accepted accounting principles, a contingent liability of $2,287 was
recorded representing the contingent incremental consideration for identified
purchased assets in excess of the consideration paid at closing. A contingent
liability was not recognized for the contingent incremental consideration that,
if paid in the future, would be recorded as goodwill. These amounts will be
adjusted in the future when the actual contingent consideration is known.
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The following table sets forth the allocation of the total estimated
consideration at closing to the tangible and intangible assets acquired and
liabilities assumed:
Purchase price allocation:
Tangible assets acquired, net of liabilities assumed $ 805
Intangible assets acquired:
Existing patented technology 9,700
Acquired in-process research and development 2,400
Contingent liability for purchased assets in excess
of consideration paid at closing (2,287)
---------
Total consideration at closing $ 10,618
---------
The HTI acquisition has been accounted for using the purchase method of
accounting as required by Statement of Financial Accounting Standards No.141,
"Business Combinations." Assets acquired and liabilities assumed have been
recorded at their estimated fair values as of the acquisition date.
Approximately $9,700 of the purchase price was allocated to identifiable
intangible assets consisting of existing patented technology with an estimated
useful life of 15 years.
Approximately $2,400 of the purchase price was allocated to purchased in-process
research and development. This amount represents the estimated purchased
in-process technology for projects that have not yet reached technological
feasibility and have no alternative future use. The valuation of the in-process
research and development included, but was not limited to, an analysis of the
market for the acquired products and technologies, the completion costs for the
projects, the expected cash flows attributed to the projects and the risks
associated with achieving such cash flows. The estimated value of these projects
was determined by estimating the costs to develop the purchased in-process
technology into commercially viable products, estimating the resulting net cash
flows from the sale of those products, and discounting the net cash flows back
to their present value. The assumptions used in valuing the in-process research
and development were based upon assumptions management believes to be
reasonable, but which are inherently uncertain and unpredictable. For these
reasons, actual results may vary from the estimated results. Headwaters recorded
a non-recurring charge for this purchased in-process research and development as
of the date of acquisition. Management believes that the acquired in-process
research and development will be successfully developed; however, these
technologies may not achieve commercial viability.
HTI's current development efforts are focused primarily on three projects: the
hydrogen peroxide project, the nano particle precious metal catalyst project and
the acrylic acid project. Developing and enhancing these products is
time-consuming, costly, and complex. There is a risk that the development will
not produce commercially viable products.
The hydrogen peroxide project, which is believed to represent a significant
technical advancement in the production of hydrogen peroxide directly from
hydrogen and oxygen, has been under development since 1997. To date, a lab-scale
test has been successfully completed which led to a patent on the process that
was received in January 2001. Presently, a continuous pilot test unit is under
construction. When the pilot test unit is completed, a stability and
optimization test will commence which is expected to take one year to complete.
If the pilot test is successful, a commercial demonstration test will be
undertaken. This test will also require approximately one year to complete.
Total costs to complete the project are currently estimated to range from $500
to $1,000.
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The nano particle precious metal catalyst project is a method of dispersing
nano-sized particles over the surface of support material. Such a catalyst can
improve performance and reduce precious metal consumption in numerous
applications. This project is in the lab test stage. This stage is expected to
take approximately one year to complete at a cost of about $500. It is
anticipated the lab test stage will result in the development of multiple nano
catalyst processes. At the completion of the lab test, each identified nano
catalyst process will require approximately two years for both a pilot test and
a commercial demonstration test. The cost for each nano catalyst process that
completes the final two stages is expected to be approximately $1,000.
The acrylic acid project is a one-step process for the production of acrylic
acid. This project has completed the lab test stage and the pilot test stage. As
a result of the pilot test, some additional refinements which will make the
process more competitive need to be done before advancing to the next
development stage. Current expectations are that this additional testing will
take six months and cost approximately $150. If successful refinements are made,
the project would then proceed to a commercial demonstration test. That test is
estimated to take a year to complete at a cost of approximately $400.
3. Pro Forma Financial Statements and Adjustments
The pro forma combined balance sheet gives effect to the acquisition of HTI as
if it had been completed as of June 30, 2001 and combines the historical June
30, 2001 balance sheets for both Headwaters and HTI. The pro forma combined
statements of operations for the year ended September 30, 2000 and the nine
months ended June 30, 2001 give effect to the acquisition as if it had occurred
on October 1, 1999. The pro forma combined statement of operations for the year
ended September 30, 2000 combines Headwaters' historical results for the year
ended September 30, 2000 with HTI's historical results for the year ended
December 31, 2000. Headwaters' historical consolidated statement of income for
the year ended September 30, 2000 reflects the elimination of an extraordinary
item for the early extinguishment of debt in the amount of $7,860. The pro forma
combined statement of operations for the nine months ended June 30, 2001
combines both Headwaters' and HTI's historical results for that nine-month
period. Accordingly, HTI's historical results for the three-month period from
October 1, 2000 to December 31, 2000 are included in both the pro forma combined
statement of operations for the year ended September 30, 2000 and the pro forma
combined statement of operations for the nine months ended June 30, 2001.
The pro forma combined financial statements are presented for illustrative
purposes only. Such information does not purport to be indicative of the results
of operations or financial position which actually would have resulted had the
acquisition occurred on the dates indicated, nor is it indicative of the results
that may be expected in future periods. The pro forma adjustments are based upon
information and assumptions available at the time of filing this Form 8-K.
The pro forma condensed combined financial statements give effect to the
following pro forma adjustments:
A Cash component of purchase price paid at closing ($1,447), plus cash
paid to retire HTI note payable to a bank assumed in the acquisition
($1,501).
B Elimination of a note receivable and accrued interest due to Headwaters
from HTI.
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C Adjustment to increase HTI property, plant and equipment to fair value
at acquisition date.
D Identifiable intangible assets of HTI based on estimated fair value at
acquisition date.
E Reclassification of direct costs incurred by Headwaters to consummate
acquisition of HTI.
F Elimination of HTI goodwill.
G Elimination of HTI's note payable to a bank which was assumed and
retired by Headwaters at acquisition date.
H Contingent liability recorded to reflect contingent incremental
consideration for identified purchased assets in excess of
consideration paid at closing.
I Elimination of HTI negative goodwill.
J Headwaters common stock issued at closing.
K Elimination of HTI's capital accounts.
L Fair value of options to acquire Headwaters common stock issued in
exchange for outstanding vested HTI options.
M Elimination of HTI's accumulated deficit.
N Recognition of purchased in-process research and development.
O Depreciation on increase in value of HTI buildings and equipment ($86
for the year ended September 30, 2000 and $65 for the nine months ended
June 30, 2001).
P Amortization of HTI identifiable intangible assets ($647 for the year
ended September 30, 2000 and $485 for the nine months ended June 30,
2001).
Q Elimination of HTI's historical amortization of goodwill and negative
goodwill.
R The pro forma combined net income per share amounts are based on (i)
Headwaters' historical weighted-average number of common shares
outstanding, plus (ii) the shares issued at the acquisition date (593)
and, for the diluted per-share computation, (iii) the effect of the
shares issuable upon exercise of the options to acquire Headwaters
common stock issued in exchange for outstanding vested HTI options,
using the treasury stock method (143).
S Elimination of interest income and interest expense on note receivable
due to Headwaters from HTI.
T Elimination of HTI's non-recurring acquisition-related direct costs.
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