UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2001
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 0-27808
HEADWATERS INCORPORATED
-----------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
- ------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
11778 South Election Road, Suite 210
Draper, Utah 84020
---------------------------------------- -----------
(Address of principal executive offices) (Zip Code)
(801) 984-9400
--------------------------------------------------
(Registrant's telephone number, including area code)
Not applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [X]
The number of shares outstanding of the Registrant's common stock as of
January 31, 2002 was 24,378,998.
HEADWATERS INCORPORATED
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS:
Condensed Consolidated Balance Sheets - As of
September 30, 2001 and December 31, 2001 ............... 3
Condensed Consolidated Statements of Income - For
the three months ended December 31, 2000 and 2001 ....... 5
Condensed Consolidated Statement of Changes in
Stockholders' Equity - For the three months ended
December 31, 2001 ....................................... 6
Condensed Consolidated Statements of Cash Flows -
For the three months ended December 31, 2000 and 2001 ... 7
Notes to Condensed Consolidated Financial Statements ...... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ................................. 11
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS .......................................... 14
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS .................. 15
ITEM 3. DEFAULTS UPON SENIOR SECURITIES ............................ 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ........ 15
ITEM 5. OTHER INFORMATION .......................................... 15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ........................... 15
SIGNATURES ............................................................... 15
Forward Looking Statements
Statements in this Form 10-Q, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Part I, Item 2 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
2
ITEM 1. FINANCIAL STATEMENTS
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
(thousands of dollars) 2001 2001
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 999 $ 2,581
Short-term investments 6,048 9,533
Trade receivables 8,887 14,019
Short-term notes and accrued interest receivable 6,857 559
Other current assets 1,257 1,307
---------------- -----------------
Total current assets 24,048 27,999
---------------- -----------------
Property, plant and equipment, net 2,680 2,755
---------------- -----------------
Other assets:
Notes and accrued interest receivable 4,000 3,820
Deferred income taxes 13,090 10,458
Intangible assets, net 10,752 10,548
Other assets 805 1,042
---------------- -----------------
Total other assets 28,647 25,868
---------------- -----------------
Total assets $ 55,375 $ 56,622
================ =================
The accompanying notes are an integral part of the consolidated financial statements.
3
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
(thousands of dollars) 2001 2001
- ------------------------------------------------------------------------------------------- ---------------- -----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 2,203 $ 2,852
Accrued personnel costs 2,777 1,095
Other accrued liabilities 4,987 5,113
Short-term borrowings 4,356 139
--------------- ----------------
Total current liabilities 14,323 9,199
--------------- ----------------
Long-term liabilities:
Notes payable, non-current 149 127
Other long-term liabilities 2,906 2,909
Deferred revenue 6,911 6,718
--------------- ----------------
Total long-term liabilities 9,966 9,754
--------------- ----------------
Total liabilities 24,289 18,953
--------------- ----------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 23,807 shares at September 30, 2001 (including 548 shares
held in treasury) and 24,358 shares at December 31, 2001 (including
546 shares held in treasury) 24 24
Capital in excess of par value 83,921 85,808
Accumulated deficit (49,399) (44,672)
Other, primarily treasury stock (3,460) (3,491)
--------------- ----------------
Total stockholders' equity 31,086 37,669
--------------- ----------------
Total liabilities and stockholders' equity $ 55,375 $ 56,622
=============== ================
The accompanying notes are an integral part of the consolidated financial statements.
4
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months Ended December 31,
------------------------------------
(thousands of dollars, except per-share data) 2000 2001
- -------------------------------------------------------------- ---------------- ------------- ----------------- ------------------
Revenue:
License fees $ 6,267 $ 5,816
Chemical reagent sales 5,521 10,343
Service revenue 328 1,539
Other 200 724
----------------- ------------------
Total revenue 12,316 18,422
----------------- ------------------
Operating costs and expenses:
Cost of chemical reagents 3,625 7,229
Cost of operations 1,101 2,407
Selling, general and administrative 1,470 1,604
----------------- ------------------
Total operating costs and expenses 6,196 11,240
----------------- ------------------
Operating income 6,120 7,182
----------------- ------------------
Other income (expense):
Interest and net investment income (loss) 222 (28)
Interest expense (86) (39)
Other, net (750) 742
----------------- ------------------
Total other income (expense), net (614) 675
----------------- ------------------
Income before income taxes 5,506 7,857
Income tax provision (100) (3,130)
----------------- ------------------
Net income $ 5,406 $ 4,727
================= ==================
Basic net income per common share $ .23 $ .20
================= ==================
Diluted net income per common share $ .22 $ .19
================= ==================
The accompanying notes are an integral part of the consolidated financial statements.
5
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Three Months Ended December 31, 2001
(Unaudited)
Other
-------------- ------------
Deferred Common
Common Stock Capital in compensation stock held
--------------------------- excess Accumulated related to in
(thousands of dollars and shares) Shares Amount of par value deficit stock options treasury
- ------------------------------------------------------- ------------- ----------------- ------------- -------------- ------------
Balances as of September 30, 2001 23,807 $ 24 $ 83,921 $ (49,399) $ (422) $ (3,038)
Exercise of stock options and warrants 551 -- 1,447
Tax benefit from exercise of stock options 440
Amortization of deferred compensation
related to stock options 24
Purchase of 10 shares of treasury stock,
at cost (101)
12 shares of treasury stock transferred
to employee stock purchase plan 46
Net income 4,727
------ -------- ---------- ---------- ---------- ---------
Balances as of December 31, 2001 24,358 $ 24 $ 85,808 $ (44,672) $ (398) $ (3,093)
====== ======== ========== ========== ========== =========
The accompanying notes are an integral part of the consolidated financial statements.
6
HEADWATERS INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three months Ended December 31,
---------------------------------
(thousands of dollars) 2000 2001
- -------------------------------------------------------------------------------------------- ------------------- -------------
Cash flows from operating activities:
Net income $ 5,406 $ 4,727
Adjustments to reconcile net income to net cash provided by operating activities:
Deferred income taxes -- 3,072
Recognition of deferred revenue (274) (276)
Depreciation and amortization 105 346
Net loss (gain) on disposition of property, plant and equipment (15) 15
Losses in equity investments, write-offs and provisions for unrealizable investments 692 --
Write-down of related party note receivable 88 --
Other changes in operating assets and liabilities (158) (6,318)
------------- ------------
Net cash provided by operating activities 5,844 1,566
------------- ------------
Cash flows from investing activities:
Payments on notes receivable -- 6,778
Net purchases of short-term investments -- (3,485)
Net proceeds from sale of short-term investments 740 --
Net proceeds from disposition of property, plant and equipment 15 --
Purchase of property, plant and equipment (109) (178)
Investments in and loans to non-affiliated companies (3,213) --
Net increase in other assets (53) (252)
------------- ------------
Net cash provided by (used in) investing activities (2,620) 2,863
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and other borrowings 7,448 2,056
Payments on notes payable and other borrowings (9,834) (6,295)
Proceeds from exercise of options and warrants 75 1,447
Purchase of common stock for the treasury, net of employee stock purchases (1,568) (55)
------------- ------------
Net cash used in financing activities (3,879) (2,847)
------------- ------------
Net increase (decrease) in cash and cash equivalents (655) 1,582
Cash and cash equivalents, beginning of period 983 999
------------- ------------
Cash and cash equivalents, end of period $ 328 $ 2,581
============= ============
Supplemental schedule of non-cash investing and financing activities:
Income tax benefit from exercise of stock options $ -- $ 440
Cancellation of treasury stock (1,285) --
The accompanying notes are an integral part of the consolidated financial statements.
7
HEADWATERS INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
1. Nature of Operations and Basis of Presentation
-----------------------------------------------
Operations - Headwaters Incorporated and its subsidiaries' primary business
is commercializing its chemical reagent technologies used to produce
alternative fuel from coal derivatives and to develop and deploy
alternative energy technologies. Currently, Headwaters has licensed its
technology to the owners of 28 alternative fuel facilities which are
operating at various levels of production in ten states. In August 2001,
Headwaters acquired 100% of Hydrocarbon Technologies, Inc. ("HTI"), a New
Jersey company that has significant intellectual property including
technologies to transform coal and heavy oil into ultra-clean diesel fuel,
recycle waste oil into higher value carbon products, and nano-catalyst
technology. Headwaters is interested in possible strategic acquisitions of
entities that operate in adjacent industries and that would be synergistic
with its current operations.
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with the rules and
regulations of the Securities and Exchange Commission for quarterly reports
on Form 10-Q. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. All adjustments
consist of normal recurring adjustments. The results of operations for the
three-months ended December 31, 2001 are not necessarily indicative of the
results to be expected for the full fiscal 2002 year. Certain information
and footnote disclosures normally included in financial statements prepared
in accordance with accounting principles generally accepted in the United
States have been condensed or omitted. It is suggested that these financial
statements be read in conjunction with the consolidated financial
statements and notes thereto included in Headwaters' Annual Report on Form
10-K for the year ended September 30, 2001 ("Form 10-K").
HTI - As described in more detail in the notes to the consolidated
financial statements in the Form 10-K, HTI's financial statements are
consolidated with Headwaters' financial statements using a one-month lag.
Accordingly, HTI's November 30, 2001 balance sheet has been consolidated
with Headwaters' December 31, 2001 balance sheet, and HTI's results of
operations for the period from date of acquisition (August 28, 2001) to
November 30, 2001 have been consolidated with Headwaters' results for the
quarter ended December 31, 2001. The $559,000 short-term note receivable in
the December 31, 2001 balance sheet represents the portion of the
intercompany note receivable due from HTI not eliminated in consolidation.
HTI develops and commercializes catalysts and catalytic processes for
producing chemicals and converting low-value fossil fuels into high-value
alternative fuels. HTI's revenue consists primarily of contract services
for businesses and the US Department of Energy and is included in the
caption "Service revenue" in the consolidated statement of income for the
three months ended December 31, 2001. HTI's costs related to that service
revenue are included in cost of operations for the quarter. In accounting
for long-term contracts, HTI primarily uses the percentage of completion
method of accounting, on the basis of the relationship between effort
expended and total estimated effort for the contract. If estimates of costs
to complete a contract indicate a loss, provision is made currently for the
total anticipated loss. Included in cost of operations is approximately
$162,000 of amortization expense related to the identifiable intangible
assets recorded as of the acquisition date.
2. Borrowing Arrangements
----------------------
Unsecured Bank Line of Credit - Headwaters has an unsecured revolving line
of credit with a bank which currently has an expiration date in October
2002. Borrowings under the unsecured line of credit are limited to a
maximum amount of $10,000,000 and bear interest at prime plus .75% (5.5% at
December 31, 2001). Maximum borrowings under the line of credit during the
December 2001 quarter were approximately $956,000, but there were no
borrowings outstanding under the line as of December 31, 2001.
Short-term Borrowings with an Investment Company - Headwaters has an
arrangement with an investment company under which Headwaters can borrow up
to 90% of the value of the portfolio of Headwaters' short-term investments
with the investment company ($9,160,000 at December 31, 2001). These
investments consist primarily of government-backed securities and
collateralize any outstanding borrowings. Maximum borrowings under this
arrangement during the December 2001 quarter were approximately $5,095,000,
but there were no borrowings outstanding at December 31, 2001. Borrowings
8
under this arrangement and the bank line of credit are used for short-term
working capital needs. Interest on these borrowings totaled approximately
$10,000 during the December 2001 quarter.
3. Basic and Diluted Earnings per Share
------------------------------------
Three Months Ended December 31,
(thousands of dollars and shares, except per-share data) 2000 2001
----------------------------------------------------------------------------------- ------------------- ----------------
Numerator:
Net income $ 5,406 $ 4,727
Preferred stock dividends (undeclared) (47) --
------------------- ----------------
Numerator for basic earnings per share -- net income attributable
to common stockholders 5,359 4,727
Effect of dilutive securities - preferred stock dividends 47 --
------------------- ----------------
Numerator for diluted earnings per share -- net income attributable
to common stockholders after assumed conversions $ 5,406 $ 4,727
=================== ================
Denominator:
Denominator for basic earnings per share -- weighted-average
shares outstanding 22,979 23,592
Effect of dilutive securities:
Shares issuable upon exercise of options and warrants 700 1,621
Shares issuable upon conversion of preferred stock 443 --
------------------- ----------------
Total dilutive potential shares 1,143 1,621
------------------- ----------------
Denominator for diluted earnings per share -- weighted-average
shares outstanding after assumed exercises and conversions 24,122 25,213
=================== ================
Basic net income per share $ .23 $ .20
=================== ================
Diluted net income per share $ .22 $ .19
=================== ================
The amount of anti-dilutive securities not considered in the diluted
earnings per share calculation, consisting only of out-of-the money options
and warrants, totaled approximately 2,667,000 and 695,000 shares for the
three months ended December 31, 2000 and 2001, respectively.
4. Income Taxes
------------
In the December 2000 quarter, Headwaters recorded $100,000 of alternative
minimum tax expense. In the December 2001 quarter, Headwaters reported
$3,130,000 of income tax expense, consisting of approximately $3,070,000 of
deferred tax expense and approximately $60,000 of current tax expense. As
of December 31, 2001, Headwaters had net operating loss carryforwards of
approximately $18,000,000 which can be used to offset future taxable
income.
5. Commitments and Contingencies
-----------------------------
Commitments and contingencies as of December 31, 2001 not disclosed
elsewhere, consisting of legal and contractual matters, are as follows:
HTI Acquisition. Additional contingent consideration can be earned by the
former HTI stockholders during calendar 2002 based on certain operating
targets and other milestones. As required by generally accepted accounting
principles, a contingent liability of $2,714,000 was recorded, representing
the contingent incremental consideration for identified purchased assets in
excess of the consideration paid at closing. A contingent liability was not
recognized for the contingent incremental consideration that, if paid in
the future, would be recorded as goodwill. This amount will be adjusted in
the future if and when the actual contingent consideration is paid. If some
or all of the recorded contingent consideration is not paid, some of the
recorded asset values for assets acquired will be adjusted accordingly. If
all operating targets and other milestones are achieved, the total
additional consideration that could be issued to the former HTI
9
stockholders would consist of approximately $1,395,000 in cash and
approximately 593,000 shares of Headwaters common stock. The value of the
common shares issued in the future, if any, will be determined at the time
the shares are issued, based on the fair value of the shares at that time.
Adtech. In October 1998, Headwaters entered into a technology purchase
agreement with James G. Davidson and Adtech, Inc. The transaction
transferred certain patent and royalty rights to Headwaters related to an
alternative fuel technology invented by Davidson. (This technology is
distinct from the technology developed by Headwaters.) In September 2000,
Headwaters received a summons and complaint from the United States District
Court for the Western District of Tennessee filed by Adtech, Inc. against
Davidson and Headwaters. In the action, certain purported officers and
directors of Adtech alleged that the technology purchase transaction was an
unauthorized corporate action and that Davidson and Headwaters conspired
together to effect the transfer. The complaint asserted related causes of
action and sought unspecified money damages and other relief. In August
2001, the trial court granted Headwaters' motion to dismiss the complaint.
Plaintiffs have appealed the case to the Sixth Circuit Court of Appeals.
Because resolution of the appeal is uncertain, legal counsel cannot express
an opinion as to the ultimate amount, if any, of Headwaters' liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical reagent sale agreement with AJG Financial Services,
Inc. The agreement called for AJG to pay royalties and to purchase
proprietary chemical reagent material from Headwaters. In October 2000,
Headwaters filed a complaint in the Fourth District Court for the State of
Utah against AJG alleging that it had failed to make payments and to
perform other obligations under the agreement. Headwaters asserts claims
including breach of contract, declaratory judgment, unjust enrichment, and
accounting and seeks money damages in the amount of $750,000 plus other
damages to be proven at trial, as well as other relief. AJG's answer to the
complaint denied Headwaters' claims and asserted counter-claims based upon
allegations of misrepresentation and breach of contract. AJG seeks
unspecified compensatory damages as well as punitive damages. Headwaters
has denied the allegations of AJG's counter-claims. Because the litigation
is at an early stage and resolution is uncertain, legal counsel cannot
express an opinion as to the ultimate amount of recovery or liability.
Nalco. In October 2000, Headwaters filed a complaint in the United States
District Court for the District of Utah against Nalco Chemical Company
("Nalco"). Headwaters alleges that Nalco, by its sale and marketing of
materials for use in creating alternative fuel, breached a non-disclosure
agreement, misappropriated trade secrets, and violated patent rights of
Headwaters. Headwaters seeks by its complaint injunctive relief and damages
to be proven at trial. Nalco filed an answer denying the allegations in the
complaint and asserting counter-claims alleging patent invalidity.
Headwaters denies the counter-claims; however, if Nalco prevails on its
counter-claims, the result could have a material adverse effect on
Headwaters' business. Because the litigation is at an early stage and
resolution is uncertain, legal counsel cannot express an opinion as to the
ultimate amount, if any, that might be recovered.
Headwaters is also involved in other legal proceedings that have arisen in
the normal course of business. Management believes that many of these other
claims are without merit and in all cases intends to vigorously defend its
position. Management does not believe that the outcome of these activities
will have a significant adverse effect upon the operations or the financial
position of Headwaters; however, it is possible that a change in
management's estimates of probable liability could occur and the change
could be significant.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
Three Months Ended December 31, 2001 Compared to Three Months Ended
December 31, 2000
The information set forth below compares Headwaters' operating results
for the three months ended December 31, 2001 ("2001") with operating results for
the three months ended December 31, 2000 ("2000").
Revenue. Total revenue for 2001 increased by $6,106,000 to $18,422,000
as compared to $12,316,000 for 2000. The major components of revenue are
discussed in the sections below.
License Fees. During 2001, Headwaters recognized license fee revenue
totaling $5,816,000, a decrease of $451,000 from $6,267,000 of license fee
revenue recognized during 2000. License fees in 2000 included $2,888,000 related
to a single licensee that owned four facilities. This licensee significantly
reduced its production and sale of alternative fuel in early calendar 2001 and
did not operate the four facilities for most of calendar 2001. This licensee
sold the facilities in October 2001 and while Headwaters expects to receive
license fees from the new owner in calendar 2002, there were no license fees
earned from these four facilities in 2001. Due to increased alternative fuel
sales by other licensees, there was a net increase of approximately $2,437,000
in license fees from all other licensees in 2001 over 2000. In 2001, the largest
single licensee accounted for $2,115,000, or 36%, of total license fees and
there were two additional licensees who each accounted for more than 10% of
license fee revenue.
Chemical Reagent Sales and Cost of Chemical Reagents. Chemical reagent
sales during 2001 were $10,343,000 with a corresponding direct cost of
$7,229,000. Chemical reagent sales during 2000 were $5,521,000 with a
corresponding direct cost of $3,625,000. The increase in chemical reagent sales
in 2001 over 2000 was due to increased alternative fuel production by
Headwaters' licensees, as well as sales of chemical reagents to new customers.
Headwaters expects future chemical reagent sales revenue from all licensees and
other customers to be higher in fiscal 2002 than the amounts reported for fiscal
2001 due to anticipated increases in alternative fuel production by licensees
and increases in sales of chemical reagents to new customers. The gross profit
margin decreased in 2001 from 2000 due to differing chemical reagent formula
requirements of certain licensees and new customers. Headwaters expects future
gross profit margins to be somewhat less than the margin percentages realized in
fiscal 2001 for the same reasons.
Service and Other Revenue. Service revenue for 2001 includes $1,174,000
of HTI revenue and $365,000 of fees for operating two alternative fuel
facilities for a licensee. Since HTI was acquired in August 2001, there is no
service revenue for HTI for 2000. In 2001, other revenue includes $500,000 of
one-time development services revenue related to work performed for a licensee.
Cost of Operations. These costs increased by $1,306,000 to $2,407,000
in 2001 from $1,101,000 in 2000. The increase from 2000 to 2001 was primarily
attributable to HTI costs of $1,661,000, partially offset by one-time accruals
in 2000 for certain construction-related costs of approximately $220,000 and a
decrease in personnel costs of approximately $160,000. Included in HTI's costs
is a projected loss of approximately $253,000 on a portion of a foreign contract
and approximately $162,000 of amortization expense related to the identifiable
intangible assets recorded as part of the HTI acquisition.
Selling, General and Administrative Expenses. These expenses increased
$134,000 to $1,604,000 in 2001 from $1,470,000 in 2000. The increase was due
primarily to an increase in professional services expense of approximately
$210,000, partially offset by a decrease in personnel costs of approximately
$110,000. The increase in professional services expense was due primarily to
legal costs associated with current legal matters with which Headwaters is
engaged.
Other Income and Expense. During 2001, Headwaters reported net other
income of $675,000 compared to net other expense of $614,000 during 2000. The
difference of $1,289,000 in net other income / expense is primarily attributable
to a net increase in gains associated with a related party note receivable of
approximately $840,000 and a decrease in equity investment losses of
approximately $690,000, partially offset by a decrease in interest and net
investment income of approximately $250,000.
11
In 1996, Headwaters sold certain construction companies and received as
consideration a note receivable. The note was "marked to market" each period
based upon the market value of Headwaters' common stock held as collateral and
was reflected in Headwaters' financial statements at the underlying value of
that collateral. In 2000, Headwaters recorded a "mark to market" loss of
approximately $90,000 on the note receivable. In January 2001, Headwaters
accepted as full satisfaction of the note receivable the shares of Headwaters'
stock collateralizing the note plus a new note receivable which was fully
reserved. In October 2001, Headwaters collected $750,000 on the fully reserved
note.
During fiscal 2000 and early fiscal 2001, Headwaters made several
equity investments in and loans to unrelated high-risk entities. In 2000,
Headwaters recognized approximately $690,000 of losses related to its equity
investments. There were no such losses in 2001.
Interest and net investment loss was $28,000 in 2001, which compares to
$222,000 of interest and net investment income in 2000. The difference of
$250,000 was primarily attributable to the recording in 2001 of a mark-to-market
loss adjustment of approximately $150,000 related to certain short-term
government securities classified as trading securities, and a decrease in
interest income of approximately $80,000 related to a $6,500,000 note receivable
that was collected in October 2001.
Income Taxes. As of September 30, 2001, Headwaters determined that it
was more likely than not that it would realize the benefit of its net operating
loss carryforwards and recorded a deferred tax asset totaling approximately
$10,470,000. The December 2001 quarter is the first period in which Headwaters
has recorded a full tax provision. In 2001, Headwaters reported $3,130,000 of
income tax expense, consisting of a reduction in the deferred tax asset of
approximately $3,070,000, and approximately $60,000 of current tax expense. In
2000, Headwaters utilized its net operating loss carryforwards and reported only
$100,000 of alternative minimum tax expense.
Liquidity and Capital Resources
Net cash provided by operating activities during 2001 was $1,566,000
compared to $5,844,000 during 2000. Most of the cash flow from operating
activities in 2001was attributable to net income before income taxes of
$7,857,000, largely offset by an increase in trade receivables of $5,132,000.
During 2001, investing activities consisted primarily of the collection on notes
receivable of approximately $6,778,000 and net purchases of short-term
investments of approximately $3,485,000. Financing activities in 2001 consisted
primarily of net repayments of short-term borrowings of approximately $4,239,000
and proceeds from the exercise of stock options and warrants of approximately
$1,447,000.
Operating Activities. Headwaters reported net income in 2001 of
$4,727,000; however, substantially all of the reported income tax expense of
$3,130,000 was deferred tax expense which did not require the use of cash.
Headwaters' trade receivables increased substantially during 2001 due primarily
to the substantial increase in revenue in the December 2001 quarter compared to
the September 2001 quarter (totaling approximately $5,727,000). Headwaters has
no allowance for doubtful accounts at December 31, 2001.
Investing and Financing Activities. In September 2001, Headwaters sold
all of its remaining high-risk investments in exchange for a $4,000,000
collateral-based note receivable from a limited liability corporation. This note
is due no later than September 2004, is collateralized by the bridge loans and
equity investments sold and is being accounted for on the cost recovery method.
Headwaters also has certain contract rights in excess of the $4,000,000 note
amount relating to the collection of cash by the limited liability corporation.
Headwaters does not currently intend to make any significant additional equity
investments in or loans to any new unrelated entities, but could incur
additional losses if the $4,000,000 loan is not repaid. During the December 2001
quarter, Headwaters collected $180,000 on this note. At September 30, 2001, in
addition to the $4,000,000 note receivable, Headwaters had outstanding one other
note receivable in the amount of $6,500,000. This note and the related accrued
interest was collected in October 2001.
Headwaters is interested in possible strategic acquisitions of entities
that operate in adjacent industries and that would be synergistic with its
current operations. Any future acquisitions could be funded using Headwaters'
available cash, common stock, debt, or some combination thereof.
Financing activities in 2001 consisted primarily of net repayments of
short-term borrowings of approximately $4,239,000 and proceeds from the exercise
of stock options and warrants of approximately $1,447,000. Other than operating
leases for certain equipment and real estate, which are not material, Headwaters
has no off-balance sheet transactions, derivatives, or similar instruments and
has no involvement with any special purpose entities of any kind. Headwaters is
not a guarantor of any other entities' debt or other financial obligations.
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Working Capital. Headwaters' working capital increased from
approximately $9,725,000 at September 30, 2001, to approximately $18,800,000 at
December 31, 2001. The primary reasons for this increase in working capital were
the significant increase in trade receivables, resulting from increased revenue,
and the reduction of outstanding short-term borrowings during the December 2001
quarter. Headwaters expects operations to produce positive cash flows in future
periods, which, combined with current working capital, will be sufficient for
Headwaters' needs for the next 12 months.
Borrowing Arrangements. Headwaters has an unsecured revolving line of
credit with a bank which currently has an expiration date in October 2002.
Borrowings under the unsecured line of credit are limited to a maximum amount of
$10,000,000 and bear interest at prime plus .75% (5.5% at December 31, 2001).
Maximum borrowings under the line of credit during the December 2001 quarter
were approximately $956,000, but there were no borrowings outstanding under the
line as of December 31, 2001. Headwaters also has an arrangement with an
investment company under which Headwaters can borrow up to 90% of the value of
the portfolio of Headwaters' short-term investments with the investment company
($9,160,000 at December 31, 2001). These investments consist primarily of
government-backed securities and collateralize any outstanding borrowings.
Maximum borrowings under this arrangement during the December 2001 quarter were
approximately $5,095,000, but there were no borrowings outstanding at December
31, 2001. Borrowings under this arrangement and the bank line of credit are used
for short-term working capital needs.
Income Taxes. As of December 31, 2001, Headwaters had net operating
loss carryforwards of approximately $18,000,000 which can be used to offset
future taxable income. The net operating loss carryforwards expire from 2017 to
2021. Headwaters also has approximately $220,000 in research and development tax
credit carryforwards which can be used to offset future tax liabilities. The tax
credit carryforwards expire from 2007 to 2016. The utilization of HTI's
acquisition date operating loss carryforwards (totaling approximately
$2,800,000) against future taxable income is subject to an annual limitation of
approximately $800,000 due to the change in ownership of HTI.
During 2002, Headwaters expects to pay some alternative minimum taxes
and some state income taxes in certain states where net operating loss
carryforwards aren't available. However, because of existing net operating loss
carryforwards for regular federal tax purposes and in many states where
Headwaters does business, and due to anticipated tax benefits from exercise of
stock options, Headwaters does not currently expect to pay significant amounts
of regular income taxes until late fiscal 2002 or early fiscal 2003.
Acquisition of HTI
In August 2001, Headwaters completed the acquisition of HTI. Total
consideration paid at closing, including the direct costs incurred by Headwaters
to consummate the acquisition, was approximately $11,774,000. Additional
contingent consideration can be earned by the former HTI stockholders during
calendar 2002 based on certain operating targets and other milestones. As
required by generally accepted accounting principles, a contingent liability of
$2,714,000 was recorded, representing the contingent incremental consideration
for identified purchased assets in excess of the consideration paid at closing.
A contingent liability was not recognized for the contingent incremental
consideration that, if paid in the future, would be recorded as goodwill. This
amount will be adjusted in the future if and when the actual contingent
consideration is paid. If some or all of the recorded contingent consideration
is not paid, some of the recorded asset values for assets acquired will be
adjusted accordingly. If all operating targets and other milestones are
achieved, the total additional consideration that could be issued to the former
HTI stockholders would consist of approximately $1,395,000 in cash and
approximately 593,000 shares of Headwaters common stock. The value of the common
shares issued in the future, if any, will be determined at the time the shares
are issued, based on the fair value of the shares at that time.
Assets acquired and liabilities assumed were recorded at their
estimated fair values as of the acquisition date. Approximately $9,700,000 of
the purchase price was allocated to identifiable intangible assets consisting of
existing patented technology with an estimated useful life of 15 years.
Management expects to commercialize HTI's existing technology domestically and
in certain other countries and is emphasizing catalytic processes and
technologies to change coal and heavy oils into higher value fuels.
As of December 31, 2001, Headwaters had loaned HTI approximately
$4,255,000, of which $559,000 was not eliminated in consolidation.
Other Items
Headwaters has reviewed all recently issued, but not yet adopted,
accounting standards in order to determine their potential effects, if any, on
the future results of operations or financial position of Headwaters. Based on
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that review, Headwaters believes that full implementation of SFAS No. 142,
"Accounting for Goodwill and Intangible Assets," will require certain additional
disclosures beginning October 1, 2002; however, Headwaters believes that neither
SFAS No. 142 nor any of the other pronouncements reviewed will have any
significant effects on its current or future financial position or results of
operations.
Forward Looking Statements
Statements in this Quarterly Report on Form 10-Q regarding Headwaters'
expectations as to the operation of facilities utilizing Headwaters' alternative
fuel technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of new technologies and other strategic business opportunities and
acquisitions and other information about Headwaters that is not purely
historical by nature, including those statements regarding Headwaters' future
business plans, the operation of facilities, the availability of tax credits,
the availability of feedstocks, the marketability of the alternative fuel, and
the financial viability of the facilities, constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Although Headwaters believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. In addition to matters affecting the alternative fuel industry
or the economy generally, factors which could cause actual results to differ
from expectations stated in these forward looking statements include, among
others, the following:
(1) Operating issues for licensed facilities including feedstock
availability, moisture content, Btu content, correct application of
chemical reagent, achieving significant chemical change, operability of
equipment, production capacity, product durability, resistance to water
absorption, overall costs of operations and other commercial factors
surrounding the use of Headwaters' technologies.
(2) Marketing issues relating to market acceptance and regulatory permitting
of products manufactured using Headwaters' technologies.
(3) Securing of suitable facility sites, including permits and raw materials,
for relocation and operation of facilities and product sales.
(4) The market acceptance of products manufactured with Headwaters'
technologies in the face of competition from traditional products.
(5) Dependence on licensees to successfully implement Headwaters' chemical
reagent technologies and to make license and other payments to
Headwaters.
(6) Maintenance of placed-in-service and other requirements under Section 29
of the tax code by alternative fuel manufacturing facilities.
(7) Changes in governmental regulations or failure to comply with existing
regulations that could result in reduction or shutdown of operations of
licensee facilities.
(8) The continued availability of tax credits to licensees under the tax code
and each licensee's ability to use tax credits.
(9) The commercial feasibility of Headwaters' alternative fuel technologies
upon the expiration of tax credits.
(10) Ability to meet financial commitments under existing contractual
arrangements.
(11) Ability to meet non-financial commitments under existing contractual
arrangements.
(12) Ability to commercialize new technologies which have only been tested in
the laboratory and not in full-scale operations.
(13) Ability to commercialize the technology of HTI and to implement new
business plans which are at an early stage of investigation and
investment and which will require significant time, management, and
capital investment.
(14) Success in the face of competition by others producing alternative
chemical reagent products and other competing alternative fuel.
(15) Sufficiency of intellectual property protections.
(16) Satisfactory resolution of disputes in litigation.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "ITEM 3: LEGAL PROCEEDINGS" in Headwaters' Annual Report on Form
10-K for the year ended September 30, 2001 for descriptions of current legal
proceedings. There have been no material changes with respect to those matters
since that report was filed.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
Other than 18,475 shares of restricted common stock issued upon
exercise of options and 429,958 shares of restricted common stock issued upon
exercise of warrants, there have been no securities issued by Headwaters within
the past fiscal quarter without registration under the Securities Act of 1933,
as amended. As of December 31, 2001, Headwaters had five effective registration
statements filed on Form S-3 and three effective registration statements filed
on Form S-8. One or more of these registration statements have registered all
except 475 shares issued during the quarter.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibit is included herein:
99.1 Amended 2000 Employee Stock Purchase Plan
(b) The following report was filed on Form 8-K during the quarter
ended December 31, 2001:
o Form 8-K filed on December 27, 2001, for an event dated
December 27, 2001 (Risk factors updated for effective Forms
S-3 and Forms S-8)
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEADWATERS INCORPORATED
Date: February 8, 2002 By: /s/ Kirk A. Benson
----------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: February 8, 2002 By: /s/ Steven G. Stewart
-------------------------------------------
Steven G. Stewart, Chief Financial Officer
and Principal Financial Officer
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