UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
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)
10653 South River Front Parkway, Suite 300
South Jordan, Utah 84095
- ------------------------------------------- -----------
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock as of July 31,
2003 was 27,788,530.
HEADWATERS INCORPORATED
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page
No.
ITEM 1. FINANCIAL STATEMENTS (Unaudited):
Condensed Consolidated Balance Sheets - As of
September 30, 2002 and June 30, 2003 ....................... 3
Condensed Consolidated Statements of Income - For the
three and nine months ended June 30, 2002 and 2003 ......... 5
Condensed Consolidated Statement of Changes in Stockholders'
Equity - For the nine months ended June 30, 2003............ 6
Condensed Consolidated Statements of Cash Flows - For the
nine months ended June 30, 2002 and 2003.................... 7
Notes to Condensed Consolidated Financial Statements ......... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS..................................... 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 23
ITEM 4. CONTROLS AND PROCEDURES....................................... 24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS ............................................ 24
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS .................... 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES .............................. 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......... 24
ITEM 5. OTHER INFORMATION............................................. 24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K ............................. 25
SIGNATURES.................................................................. 26
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. The 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.
Availability of SEC Filings
Headwaters makes available free of charge through its website (www.hdwtrs.com),
its Forms 10-K, 10-Q and 8-K, as well as its registration statements, as soon as
reasonably practicable after those reports are electronically filed with the
SEC.
2
ITEM 1. FINANCIAL STATEMENTS
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
(thousands of dollars) 2002 2003
- --------------------------------------------------------------------------------------- ----------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents $ 7,284 $ 13,826
Short-term investments 5,907 1,789
Trade receivables, net 50,331 53,987
Inventories 8,442 9,266
Deferred income taxes 1,814 670
Other current assets 4,155 6,527
------------ ------------
Total current assets 77,933 86,065
------------ ------------
Property, plant and equipment, net 50,549 53,463
------------ ------------
Other assets:
Notes and accrued interest receivable 4,593 1,989
Intangible assets, net 118,918 114,040
Goodwill 113,367 112,131
Debt issue costs and other assets 7,497 6,135
------------ ------------
Total other assets 244,375 234,295
------------ ------------
Total assets $ 372,857 $ 373,823
============ ============
See accompanying notes.
3
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, June 30,
(thousands of dollars and shares, except per-share data) 2002 2003
- --------------------------------------------------------------------------------------- ----------------- ---------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 20,773 $ 21,164
Accrued personnel costs 7,293 5,476
Accrued interest 394 2,521
Income taxes 1,244 2,646
Other accrued liabilities 13,250 10,756
Current portion of long-term debt 15,578 23,640
Current portion of unamortized non-refundable license fees 4,378 6,552
------------ ------------
Total current liabilities 62,910 72,755
------------ ------------
Long-term liabilities:
Long-term debt 154,552 117,387
Deferred income taxes 51,357 50,739
Unamortized non-refundable license fees 5,010 4,126
Other long-term liabilities 432 1,121
------------ ------------
Total long-term liabilities 211,351 173,373
------------ ------------
Total liabilities 274,261 246,128
------------ ------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value; authorized 50,000 shares,
issued and outstanding 27,327 shares at September 30, 2002
(including 526 shares held in treasury) and 27,779 shares
at June 30, 2003 (including 479 shares held in treasury) 27 28
Capital in excess of par value 126,265 129,786
Retained earnings (accumulated deficit) (24,418) 967
Treasury stock, at cost (3,013) (2,826)
Other (265) (260)
------------ ------------
Total stockholders' equity 98,596 127,695
------------ ------------
Total liabilities and stockholders' equity $ 372,857 $ 373,823
============ ============
See accompanying notes.
4
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended June 30, Nine Months Ended June 30,
----------------------------------- --------------------------------
(thousands of dollars, except per-share data) 2002 2003 2002 2003
- --------------------------------------------------------- ----------------- ----------------- ---------------- ---------------
Revenue:
Chemical reagent sales $ 22,234 $ 35,908 $ 49,521 $ 98,099
License fees 8,822 10,120 21,263 27,846
Coal combustion products revenues -- 46,005 -- 115,460
Manufactured products sales -- 13,257 -- 36,041
Other revenues 912 1,106 4,862 3,712
----------- ----------- ----------- -----------
Total revenue 31,968 106,396 75,646 281,158
----------- ----------- ----------- -----------
Operating costs and expenses:
Cost of chemical reagents 14,880 25,271 33,749 66,065
Cost of coal combustion products revenues -- 33,217 -- 84,635
Cost of manufactured products -- 10,059 -- 27,535
Cost of other revenues 1,334 1,186 4,256 3,318
Depreciation and amortization 336 3,409 1,000 9,660
Research and development 598 1,052 1,727 3,172
Selling, general and administrative 3,905 10,433 9,383 30,259
----------- ----------- ----------- -----------
Total operating costs and expenses 21,053 84,627 50,115 224,644
----------- ----------- ----------- -----------
Operating income 10,915 21,769 25,531 56,514
----------- ----------- ----------- -----------
Other income (expense):
Interest and net investment income 429 188 432 359
Interest expense (12) (4,205) (68) (12,272)
Other, net (46) (208) 2,047 (2,266)
----------- ----------- ----------- -----------
Total other income (expense), net 371 (4,225) 2,411 (14,179)
----------- ----------- ----------- -----------
Income before income taxes 11,286 17,544 27,942 42,335
Income tax provision (4,550) (7,000) (11,020) (16,950)
----------- ----------- ----------- -----------
Net income $ 6,736 $ 10,544 $ 16,922 $ 25,385
=========== =========== =========== ===========
Basic net income per common share $ 0.27 $ 0.39 $ 0.70 $ 0.94
=========== =========== =========== ===========
Diluted net income per common share $ 0.26 $ 0.37 $ 0.66 $ 0.90
=========== =========== =========== ===========
See accompanying notes.
5
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Nine Months Ended June 30, 2003
Retained
Common Stock Capital in earnings Common stock
------------------- excess of (accumulated held in
(thousands of dollars and shares) Shares Amount par value deficit) treasury Other
- ---------------------------------------------------------------------------------------------------------------------------------
Balances as of September 30, 2002 27,327 $ 27 $ 126,265 $ (24,418) $ (3,013) $ (265)
Exercise of stock options and warrants 452 1 1,493
Tax benefit from exercise of stock options 1,650
47 shares of treasury stock transferred to employee stock
purchase plan, at cost 378 187
Other 5
Net income 25,385
------ ------ --------- --------- -------- ------
Balances as of June 30, 2003 27,779 $ 28 $ 129,786 $ 967 $ (2,826) $ (260)
====== ====== ========= ========= ======== ======
See accompanying notes.
6
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended June 30,
--------------------------------
(thousands of dollars) 2002 2003
- ------------------------------------------------------------------------------------------- --------------- ----------------
Cash flows from operating activities:
Net income $ 16,922 $ 25,385
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,000 9,660
Interest expense related to amortization of debt discount and debt issue costs 44 2,872
Deferred income taxes 8,131 (761)
Income tax benefit from exercise of stock options 2,680 1,650
Amortization of non-refundable license fees (848) (884)
Net gain on disposition of property, plant and equipment (1,283) (260)
Write-downs of note receivable and investment -- 2,436
Other changes in operating assets and liabilities (25,843) 1,077
---------- ----------
Net cash provided by operating activities 803 41,175
---------- ----------
Cash flows from investing activities:
Purchase of property, plant and equipment (457) (6,321)
Proceeds from disposition of property, plant and equipment 115 253
Collections on notes receivable 6,877 54
Additional cash payment for acquisition of Hydrocarbon Technologies, Inc. (419) --
Net increase in other assets (3,418) (344)
---------- ----------
Net cash provided by (used in) investing activities 2,698 (6,358)
---------- ----------
Cash flows from financing activities:
Payments on long-term debt and short-term borrowings (6,392) (30,334)
Proceeds from exercise of options and warrants 5,097 1,494
Employee stock purchases 263 565
Proceeds from issuance of short-term borrowings 2,056 --
Purchase of common stock for the treasury (1,188) --
---------- ----------
Net cash used in financing activities (164) (28,275)
---------- ----------
Net increase in cash and cash equivalents 3,337 6,542
Cash and cash equivalents, beginning of period 999 7,284
---------- ----------
Cash and cash equivalents, end of period $ 4,336 $ 13,826
========== ==========
See accompanying notes.
7
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
1. Nature of Operations and Basis of Presentation
Operations - Headwaters Incorporated creates value through
environmentally responsible energy, chemical products and services, and
by developing innovative value-added opportunities for customers.
Headwaters is focused on providing services to energy companies,
converting fossil fuels into alternative energy products, and generally
adding value to energy. Headwaters generates revenue from managing coal
combustion products ("CCPs") and from licensing its innovative chemical
technologies to produce alternative fuel. Headwaters intends to expand
its business through growth of existing operations, commercialization
of technologies currently being developed, and strategic acquisitions
of entities that operate in adjacent industries.
Through its proprietary Covol Fuels process, Headwaters adds value to
the production of coal-based solid alternative fuels primarily for use
in electric power generation plants. Headwaters has licensed its
technologies to the owners of 28 alternative fuel facilities that are
operating at various levels of production in ten states.
Headwaters owns 100% of Industrial Services Group, Inc. ("ISG"), a
Utah-based company formed in 1997 and acquired by Headwaters in
September 2002 (see Note 2). ISG, through its wholly-owned subsidiary
ISG Resources, Inc., is the nation's largest provider of CCP management
and marketing services to the electric power industry, serving more
than 100 coal-fired electric power generation plants nationwide.
Through its distribution network of over 130 locations, ISG is the
leading provider of high quality fly ash to the building products and
ready mixed concrete industries in the United States. ISG's
manufactured products division develops, manufactures and distributes
value-added fly ash-based bagged concrete, stucco, mortar and block
products. ISG also develops and deploys technologies for maintaining
and improving fly ash quality.
Headwaters also owns 100% of Hydrocarbon Technologies, Inc. ("HTI"), a
New Jersey company formed in 1995 and acquired by Headwaters in August
2001. HTI's research and development activities are directed at
catalyst and nano-catalyst technologies used to convert coal and heavy
oils into environment-friendly, higher-value liquid fuels.
Basis of Presentation - The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with
the rules and regulations of the Securities and Exchange Commission
("SEC") for quarterly reports on Form 10-Q. In the opinion of
management, all adjustments considered necessary for a fair
presentation have been included, and consist of normal recurring
adjustments (including the write-down in March 2003 of a note
receivable in the amount of approximately $2,142,000). Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States have been condensed or omitted. These
financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in
Headwaters' Annual Report on Form 10-K for the year ended September 30,
2002 ("Form 10-K") and in Headwaters' Quarterly Reports on Form 10-Q
for the quarters ended December 31, 2002 and March 31, 2003. Certain
prior period amounts have been reclassified to conform to the current
periods' presentation. The reclassifications had no effect on net
income or total assets.
Headwaters' fiscal year ends on September 30 and unless otherwise
noted, future references to 2002 refer to Headwaters' fiscal quarter
and/or the nine month period ended June 30, 2002, and references to
2003 refer to Headwaters' fiscal quarter and/or the nine month period
ended June 30, 2003.
ISG's results of operations for the three- and nine-month periods ended
June 30, 2003 are consolidated with Headwaters' 2003 results. ISG's
results of operations for periods prior to the September 2002
acquisition date have not been consolidated with Headwaters' 2002
results. Due to the seasonality of ISG's business and other factors,
Headwaters' consolidated results of operations for 2003 are not
indicative of the results to be expected for the full fiscal 2003 year.
2. ISG Acquisition
On September 19, 2002, Headwaters acquired 100% of the common stock of
ISG, assumed or paid off all of ISG's outstanding debt and redeemed all
of ISG's outstanding preferred stock. As described in more detail in
8
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
the notes to the consolidated financial statements included in the Form
10-K, the ISG acquisition was accounted for using the purchase method
of accounting as required by Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations." Assets acquired
and liabilities assumed were recorded at their estimated fair values as
of September 19, 2002. An adjusted allocation of the purchase price,
which is not materially different from the preliminary allocation
reflected in the Form 10-K, was completed during the quarter ended June
30, 2003. The adjustments made relate primarily to the completion of
property, plant and equipment valuations, income tax returns for ISG
for the period ended September 18, 2002 and certain valuations of other
liabilities acquired. The following table sets forth the current
allocation of the total consideration paid to the tangible and
intangible assets acquired and liabilities assumed:
(thousands of dollars)
----------------------------------------------- -------------
Cash $ 19,238
Trade receivables 33,820
Inventory and other assets 11,794
Net property, plant and equipment 48,981
Intangible assets acquired:
Contracts 106,400
Patents 2,764
Goodwill 107,873
Accounts payable and accrued liabilities (24,294)
Net deferred income tax liabilities (48,720)
-------------
Net assets acquired $257,856
=============
3. Segment Reporting
Until Headwaters acquired ISG in September 2002, Headwaters operated in
and reported as a single industry segment, alternative energy. With the
acquisition of ISG, Headwaters now operates in three business segments:
alternative energy, CCPs, and manufactured products.
The following segment information for 2003 has been prepared in
accordance with SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." Performance of the segments is
evaluated on several factors, including (i) operating income, and (ii)
earnings before interest, taxes, depreciation and amortization, and
other income/expense items ("EBITDA"). Intersegment sales are
immaterial. Amounts included in the "Corporate" column represent costs
not specifically attributable to any segment and include administrative
departmental costs, general corporate overhead and research and
development expenses. Segment assets reflect those specifically
attributable to individual segments and primarily include accounts
receivable, inventories, property, plant and equipment, intangible
assets and goodwill. Other assets are included in the "Corporate"
column.
Alternative Manufactured
(thousands of dollars) Energy CCPs Products Corporate Totals
------------------------------------------ ------------- ------------ ---------------- ------------ -----------
Three Months ended June 30, 2003
Segment revenue $ 47,134 $ 46,005 $ 13,257 $ -- $ 106,396
---------- ---------- ---------- ---------- ---------
EBITDA $ 19,684 $ 9,937 $ 1,421 $ (5,864) $ 25,178
Depreciation and amortization (279) (2,824) (151) (155) (3,409)
---------- ---------- ---------- ---------- ---------
Operating income $ 19,405 $ 7,113 $ 1,270 $ (6,019) 21,769
========== ========== ========== ==========
Net interest expense (4,017)
Other income (expense), net (208)
Income tax provision (7,000)
---------
Net income $ 10,544
=========
Capital expenditures $ 6 $ 3,124 $ 64 $ 217 $ 3,411
========== ========== ========== ========== =========
9
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
Alternative Manufactured
(thousands of dollars) Energy CCPs Products Corporate Totals
------------------------------------------ ------------- ------------ ---------------- ------------ -----------
Nine Months ended June 30, 2003
Segment revenue $ 129,657 $ 115,460 $ 36,041 $ -- $ 281,158
========== ========== ========== ========== =========
EBITDA $ 57,109 $ 22,714 $ 3,653 $ (17,302) $ 66,174
Depreciation and amortization (853) (7,906) (449) (452) (9,660)
---------- ---------- ---------- ---------- ---------
Operating income $ 56,256 $ 14,808 $ 3,204 $ (17,754) 56,514
========== ========== ========== ==========
Net interest expense (11,913)
Other income (expense), net (2,266)
Income tax provision (16,950)
---------
Net income $ 25,385
=========
Capital expenditures $ 135 $ 5,481 $ 464 $ 241 $ 6,321
========== ========== ========== ========== =========
Segment assets as of June 30, 2003 $ 37,271 $ 285,265 $ 21,145 $ 30,142 $ 373,823
========== ========== ========== ========== =========
4. Inventories
Inventories consisted of the following at:
September 30, June 30,
(thousands of dollars) 2002 2003
------------------------------- --------------- ----------------
Raw materials $ 1,198 $ 1,102
Finished goods 7,244 8,164
----------- -----------
$ 8,442 $ 9,266
=========== ===========
5. Intangible Assets and Goodwill
Intangible Assets - As more fully described in the notes to the
consolidated financial statements in the Form 10-K, with the exception
of certain disclosures which could not be early implemented, Headwaters
implemented SFAS No. 142, "Accounting for Goodwill and Intangible
Assets," effective with the acquisitions of HTI in August 2001 and ISG
in September 2002. Effective October 1, 2002, Headwaters fully
implemented SFAS No. 142, which mandates the following disclosures.
Headwaters has no intangible assets that are not being amortized. The
following table summarizes the gross carrying amounts and the related
accumulated amortization of all amortizable intangible assets as of:
September 30, 2002 June 30, 2003
-------------------------------- --------------------------------
Gross Gross
Estimated Carrying Accumulated Carrying Accumulated
(thousands of dollars) useful lives Amount Amortization Amount Amortization
----------------------------- -------------- --------------- ---------------- --------------- ----------------
ISG contracts 20 years $106,400 $179 $106,400 $4,169
HTI patented technology 15 years 9,700 647 9,700 1,132
ISG patents 7 1/2 years 2,764 4 2,764 281
Other 9 - 10 years 1,522 638 1,522 764
-------- ------ -------- ------
$120,386 $1,468 $120,386 $6,346
======== ====== ======== ======
Total amortization expense related to intangible assets was
approximately $204,000 and $1,626,000 for the three months ended June
30, 2002 and 2003, respectively, and $611,000 and $4,878,000 for the
nine months ended June 30, 2002 and 2003, respectively. Total estimated
annual amortization expense for fiscal years 2003 through 2007 is
approximately $6,500,000 per year.
10
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
Goodwill - In accordance with the requirements of SFAS No. 142,
Headwaters does not amortize goodwill, all of which relates to the
acquisitions of ISG and HTI. In connection with the final allocation of
the purchase price for ISG, goodwill decreased approximately $1,236,000
during the quarter ended June 30, 2003 (see Note 2). SFAS No. 142
requires Headwaters to periodically perform tests for goodwill
impairment. Step 1 of the initial impairment test was required to be
performed no later than March 31, 2003; thereafter impairment testing
is required to be performed no less often than annually, or sooner if
evidence of possible impairment arises. Impairment testing is performed
at the reporting unit level and Headwaters has identified four
reporting units: (i) the Covol Fuels division and (ii) HTI (which
together comprise the alternative energy segment), (iii) CCPs and (iv)
Manufactured Products. Currently, goodwill exists only in the CCPs and
HTI reporting units.
Step 1 of impairment testing consists of determining and comparing the
fair values of the reporting units to the carrying values of those
reporting units. If step 1 is failed for either the CCPs or HTI
reporting units, indicating a potential impairment, Headwaters would be
required to complete step 2, which is a more detailed test to calculate
the implied fair value of goodwill, and compare that value to the
carrying value of the goodwill.
During the quarter ended March 31, 2003, Headwaters performed step 1
impairment tests of the recorded goodwill in the CCPs and HTI reporting
units as of October 1, 2002, the beginning of its fiscal year 2003.
During the quarter ended June 30, 2003 Headwaters performed its annual,
recurring tests for potential impairment using the date of June 30,
2003. The tests indicated that the fair values of the reporting units
exceeded their carrying values as of both October 1, 2002 and June 30,
2003. Accordingly, step 2 of the impairment tests was not required to
be performed and no impairment charge was recorded.
6. Long-term Debt
Long-term debt consisted of the following at:
September 30, June 30,
(thousands of dollars) 2002 2003
--------------------------------------------------------------- ----------------- ---------------
Senior secured debt with a face amount totaling $155,000 at
September 30, 2002 and $124,722 at June 30, 2003 $150,378 $121,278
Senior subordinated debentures with a face amount totaling 19,603 19,662
$20,000
Other 149 87
-------- --------
170,130 141,027
Less: current portion (15,578) (23,640)
-------- --------
Total long-term debt $154,552 $117,387
======== ========
Senior Secured Credit Agreement - In connection with the ISG
acquisition, Headwaters entered into a $175,000,000 senior secured
credit agreement with a syndication of lenders, under which a total of
$155,000,000 was borrowed on the acquisition date. The credit agreement
also allows up to $20,000,000 to be borrowed under a revolving credit
arrangement. The debt was issued at a 3% discount and Headwaters
received net cash proceeds of $150,350,000. The original issue discount
is being accreted using the effective interest method and the accretion
is recorded as interest expense. The debt is secured by all assets of
Headwaters, bears interest at a variable rate (approximately 5.6% at
June 30, 2003), and is repayable in quarterly installments through
August 2007.
In the December 2002 quarter, principal repayments totaling $9,875,000
were made, which included a $6,000,000 optional early repayment. In the
March 2003 quarter, principal repayments totaling $5,221,000 were made,
which included a $1,500,000 optional early repayment. In the June 2003
quarter, principal repayments totaling $15,182,000 were made, which
included $11,500,000 of optional early repayments. When optional
prepayments are made, required principal repayments for all future
periods are reduced and as of June 30, 2003 totaled approximately
$3,371,000 for the remainder of fiscal 2003, approximately $26,967,000
in fiscal years 2004, 2005 and 2006, and approximately $40,450,000 in
fiscal 2007. In certain situations, for example when Headwaters
receives "excess cash flow," as defined, mandatory prepayments, in
11
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
excess of the scheduled payments, are required. Mandatory prepayments
are calculated as a percentage of "excess cash flow," ranging up to
100%, which percentage is based on Headwaters' "leverage ratio."
The credit agreement contains restrictions and covenants common to such
agreements, including limitations on the incurrence of additional debt,
investments, merger and acquisition activity, asset liens, capital
expenditures in excess of $15,000,000 in any fiscal year, and the
payment of dividends, among others. In addition, Headwaters must
maintain certain financial ratios, including leverage ratios and
interest coverage, as those terms are defined in the credit agreement.
As of June 30, 2003, Headwaters must maintain a total leverage ratio of
2.5:1.0 or less. The maximum ratio declines over time until June 2004,
at which time the ratio must remain at 2.0:1.0 or less. There is a
similar leverage ratio requirement for the senior debt alone, which at
June 30, 2003 must be 2.0:1.0 or less, declining over time through June
2004, at which time it must be maintained at 1.5:1.0 or less. The
interest coverage requirement at June 30, 2003 was 4.0:1.0 or more and
does not change until December 2003, at which time the ratio must be
maintained at a level of 5.0:1.0 or more. Headwaters was in compliance
with all debt covenants as of June 30, 2003.
Under the terms of the senior secured credit agreement, Headwaters may
borrow up to a total of $175,000,000; provided, however, that, except
for the initial $20,000,000 of available revolving credit, the maximum
borrowing limit is permanently reduced by the amount of any repayments
of the initial $155,000,000 borrowed in September 2002. Terms of any
additional borrowings under the credit agreement are generally the same
as those described in the preceding paragraphs. Finally, the credit
agreement allows for the issuance of letters of credit, provided there
is capacity under the available revolving credit arrangement. Currently
two letters of credit totaling $2,970,000 are outstanding, with
expiration dates in November 2003 and March 2004. No other borrowings
have been drawn or letters of credit issued. Headwaters pays a fee of
5/8% on the unused portion of the revolving credit arrangement.
Senior Subordinated Debentures - In connection with the ISG
acquisition, Headwaters also entered into a $20,000,000 subordinated
loan agreement, under which senior subordinated debentures were issued
at a 2% discount, with Headwaters receiving net cash proceeds of
$19,600,000. The original issue discount is being accreted using the
effective interest method and the accretion is recorded as interest
expense. ISG management participated in one-half, or $10,000,000, of
the $20,000,000 of debt issued. The other half was issued to a
corporation. The debt is not secured, bears interest at an 18% rate
payable quarterly, and is repayable in September 2007. It is senior to
all other debt except the senior secured debt described above. The debt
agreement allows for optional prepayments. Any prepayments paid to the
corporation are subject to a prepayment charge which ranges from 5% of
the principal prepaid in the first year to 1% of the principal prepaid
in the last year of the five-year term of the debt agreement.
The loan agreement contains restrictions and covenants common to such
agreements, and these are generally consistent with those described
above for the senior secured debt. As of June 30, 2003, Headwaters must
maintain a total leverage ratio of 2.75:1.0 or less. The maximum ratio
declines over time until June 2004, at which time the ratio must remain
at 2.25:1.0 or less. The interest coverage requirement at June 30, 2003
was 3.75:1.0 or more and does not change until December 2003, at which
time the ratio must be maintained at a level of 4.75:1.0 or more.
Headwaters was in compliance with all debt covenants as of June 30,
2003.
Interest Costs - As a result of the early repayments of principal
totaling $11,500,000 and $19,000,000 in the quarter and nine months
ended June 30, 2003, respectively, additional non-cash interest expense
of approximately $654,000 and $1,109,000, respectively, was incurred,
representing accelerated amortization of debt discount and debt issue
costs associated with those principal amounts.
During the quarter ended June 30, 2003, Headwaters incurred total
interest costs of approximately $4,278,000, including approximately
$1,268,000 of non-cash interest expense and approximately $73,000 of
interest costs that were capitalized. During the nine months ended June
30, 2003, Headwaters incurred total interest costs of approximately
$12,390,000, including approximately $2,872,000 of non-cash interest
expense and approximately $118,000 of interest costs that were
capitalized. During the three- and nine-month periods ended June 30,
2002, Headwaters incurred total interest costs of approximately $12,000
and $68,000, respectively, including approximately $14,000 and $44,000,
respectively, of non-cash interest expense. No interest costs were
12
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
capitalized in the 2002 periods. The weighted-average interest rate on
the face amount of outstanding long-term debt, disregarding
amortization of debt issue costs and debt discount, was approximately
7.3% at September 30, 2002 and June 30, 2003.
7. Stock Options
Headwaters has elected to continue to apply the intrinsic value method
as prescribed by APB 25 in accounting for options granted to employees,
officers and directors and does not currently plan to change to the
fair value method. The alternative fair value method of accounting
prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), as amended by SFAS No. 148, requires the use of option
valuation models that were not developed for use in valuing employee
stock options, as discussed below. Under APB 25, no compensation
expense is recognized for stock option grants to employees, officers
and directors when the exercise price of stock options equals or
exceeds the market price of Headwaters' common stock on the date of
grant.
In years prior to 1998, certain options were granted with terms
considered compensatory. In such instances, the related compensation
cost is amortized to expense over the applicable vesting period on a
straight-line basis. Amortized compensation expense related to
compensatory options granted in prior years was approximately $23,000
for each of the three-month periods ended June 30, 2002 and 2003 and
approximately $69,000 for each of the nine-month periods ended June 30,
2002 and 2003. If the fair value provisions of SFAS No. 123 would have
been applied to all options granted, compensation expense would have
been approximately $550,000 and $1,070,000, respectively, for the
three-month periods ended June 30, 2002 and 2003, and approximately
$1,710,000 and $2,830,000, respectively, for the nine-month periods
ended June 30, 2002 and 2003.
If Headwaters had elected to account for options granted based on their
fair values, as prescribed by SFAS 123, net income and income per share
for 2002 and 2003 would have been changed to the pro forma amounts
shown in the table below.
Three Months Ended June 30, Nine Months Ended June 30,
------------------------------- ------------------------------
(thousands of dollars, except per-share data) 2002 2003 2002 2003
--------------------------------------------- ---------------- -------------- -------------- ---------------
Net income - as reported $6,736 $10,544 $16,922 $25,385
Pro forma additional compensation expense (526) (1,046) (1,645) (2,764)
------ ------- ------- -------
Net income - pro forma $6,210 $ 9,498 $15,277 $22,621
====== ======= ======= =======
Basic income per share - as reported $ 0.27 $ 0.39 $ 0.70 $ 0.94
- pro forma $ 0.25 $ 0.35 $ 0.64 $ 0.84
Diluted income per share - as reported $ 0.26 $ 0.37 $ 0.66 $ 0.90
- pro forma $ 0.24 $ 0.34 $ 0.60 $ 0.80
The fair values of the 2002 and 2003 option grants were determined
using the Black-Scholes option pricing model and the following
assumptions: expected stock price volatility of 40% to 60%, risk-free
interest rates ranging from 1.7% to 4.0%, weighted average expected
option lives of five years, and no dividend yield. The Black-Scholes
option valuation model was developed for use in estimating the fair
value of traded options that have no vesting restrictions and that are
fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including expected stock price
volatility. Because Headwaters' stock options have characteristics
significantly different from those of traded options, and because
changes in the subjective input assumptions can materially affect their
fair value, in management's opinion, the existing models do not
necessarily provide a reliable measure of the fair value of stock
options.
During the quarter ended June 30, 2003, Headwaters granted to employees
and officers options to purchase approximately 390,000 shares of common
stock. These options have an exercise price of $16.89 per share, the
fair market value of Headwaters' common stock on the date of grant.
Subsequent to June 30, 2003, Headwaters granted to certain employees
and an officer options to purchase a total of approximately 180,000
shares of common stock with exercise prices ranging from $14.70 to
$15.48 per share, the fair market value of Headwaters' common stock on
the dates of grant.
13
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
8. Income Taxes
The income tax provision consisted of the following:
Three Months Ended June 30, Nine Months Ended June 30,
-------------------------------- ------------------------------
(thousands of dollars) 2002 2003 2002 2003
------------------------------------------- ----------------- -------------- -------------- ---------------
Current tax provision:
Federal $1,180 $6,870 $ 2,051 $15,383
State 350 1,213 838 2,328
------ ------ ------- -------
Total current tax provision 1,530 8,083 2,889 17,711
Deferred tax provision (benefit):
Federal 2,763 (976) 7,440 (677)
State 257 (107) 691 (84)
------ ------ ------- -------
Total deferred tax provision (benefit) 3,020 (1,083) 8,131 (761)
------ ------ ------- -------
Total income tax provision $4,550 $7,000 $11,020 $16,950
====== ====== ======= =======
9. Earnings per Share
(thousands of dollars and shares, Three Months Ended June 30, Nine Months Ended June 30,
-------------------------------- ------------------------------
except per-share data) 2002 2003 2002 2003
------------------------------------------- ----------------- -------------- -------------- ---------------
Numerator - Net income $6,736 $10,544 $16,922 $25,385
====== ======= ======= =======
Denominator:
Denominator for basic earnings per share
- weighted-average shares outstanding 24,506 27,192 24,007 27,003
Effect of dilutive securities - shares
issuable upon exercise of options and warrants 1,512 1,107 1,555 1,185
------ ------- ------- -------
Denominator for diluted earnings per
share - weighted-average shares
outstanding after assumed exercises 26,018 28,299 25,562 28,188
====== ======= ======= =======
Basic net income per share $ 0.27 $ 0.39 $ 0.70 $ 0.94
====== ======= ======= =======
Diluted net income per share $ 0.26 $ 0.37 $ 0.66 $ 0.90
====== ======= ======= =======
Anti-dilutive securities not considered in the diluted earnings per
share calculations, consisting of out-of-the money options, totaled
approximately 0 and 740,000 shares for the quarters ended June 30, 2002
and 2003, respectively, and 270,000 and 510,000 shares for the
nine-month periods ended June 30, 2002 and 2003, respectively.
10. Commitments and Contingencies
Commitments and contingencies as of June 30, 2003 not disclosed
elsewhere, are as follows:
Medical Insurance - Effective January 1, 2003, Headwaters adopted a
self-insured medical insurance plan for employees of all of its
subsidiaries. This plan has stop-loss coverage for amounts in excess of
$75,000 per individual and approximately $6,000,000 in the aggregate
for the plan year ending December 31, 2003. Headwaters has contracted
with a third-party administrator to assist in the payment and
administration of claims. Insurance claims are recognized as expenses
when incurred and include an estimate of costs for claims incurred but
not reported at the balance sheet date. As of June 30, 2003,
approximately $863,000 is accrued for claims incurred from January
though June 2003. For calendar year 2002, ISG maintained a self-insured
medical insurance plan for its employees. No liability for 2002 claims
remains as of June 30, 2003.
14
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
Property, Plant and Equipment - As of June 30, 2003, Headwaters was
committed to spend approximately $6,000,000 to complete capital
projects that were in various stages of completion.
Legal or Contractual Matters - Adtech. In October 1998, Headwaters
entered into a technology purchase agreement with James G. Davidson and
Adtech, Inc. The transaction transferred certain patent and royalty
rights to Headwaters related to an alternative fuel technology invented
by Davidson. (This technology is distinct from the technology developed
by Headwaters.) In September 2000, Headwaters received a summons and
complaint from the United States District Court for the Western
District of Tennessee filed by Adtech, Inc. against Davidson and
Headwaters. In the action, certain purported officers and directors of
Adtech alleged that the technology purchase transaction was an
unauthorized corporate action and that Davidson and Headwaters
conspired together to affect the transfer. In August 2001, the trial
court granted Headwaters' motion to dismiss the complaint. Plaintiffs
appealed the case to the Sixth Circuit Court of Appeals. In 2002, the
Sixth Circuit Court of Appeals issued an order i) affirming the
District Court's judgment and order of dismissal, and ii) transferring
to the Federal Circuit Court of Appeals plaintiff's appeal of the
District Court's order denying the motion for relief from judgment. The
Federal Circuit Court of Appeals has affirmed the District Court's
order denying the motion for relief from judgment and the case is now
fully at its end.
Boynton. This action is factually related to the Adtech matter. In the
Adtech case, the alleged claims are asserted by certain purported
officers and directors of Adtech, Inc. In the Boynton action, the
allegations arise from the same facts, but the claims are asserted by
certain purported stockholders of Adtech. In June 2002, Headwaters
received a summons and complaint from the United States District Court
for the Western District of Tennessee alleging, inter alia, fraud,
conspiracy, constructive trust, conversion, patent infringement, and
interference with contract arising out of the 1998 technology purchase
agreement entered into between Davidson and Adtech on the one hand, and
Headwaters on the other. The complaint seeks declaratory relief and
compensatory and punitive damages. Because the litigation is at an
early stage and resolution is uncertain, legal counsel cannot express
an opinion as to the ultimate amount, if any, of Headwaters' liability.
AGTC. In March 1996, Headwaters entered into an agreement with AGTC and
its associates for certain services related to the identification and
selection of alternative fuel projects. In March 2002, AGTC filed an
arbitration demand claiming that it is owed a commission under the 1996
agreement of eight percent of the revenues received by Headwaters from
the Port Hodder project. Headwaters asserts that AGTC did not perform
under the agreement and that the agreement was terminated and the
disputes were settled in July 1996. Headwaters has filed an answer in
the arbitration, denying AGTC's claims and has asserted counterclaims
against AGTC. Because the arbitration is at an early stage and
resolution is uncertain, legal counsel cannot express an opinion as to
the ultimate amount of recovery or liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical reagent sale agreement with AJG Financial
Services, Inc. The agreement called for AJG to pay royalties and to
purchase proprietary chemical reagent material from Headwaters. In
October 2000, Headwaters filed a complaint in the Fourth District Court
for the State of Utah against AJG alleging that it had failed to make
payments and to perform other obligations under the agreement.
Headwaters asserts claims including breach of contract, declaratory
judgment, unjust enrichment, and accounting and seeks money damages 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 alleged 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. Nalco filed an answer denying the
allegations in the complaint and asserting counter-claims alleging
patent invalidity, antitrust violations, and interference with economic
relations. Headwaters denied the counter-claims. The parties have
settled the dispute and the case was dismissed. There was no material
effect on Headwaters' financial statements as a result of the
settlement.
Former Director. Headwaters granted stock options to a member of its
board of directors in 1995. The director resigned from the board in
1996. The former director recently claimed that he is entitled to
exercise the options. Headwaters believes that most of the former
director's options terminated unexercised, but is investigating the
former director's claim. Because the investigation is at an early stage
and resolution is uncertain, legal counsel cannot express an opinion as
to the ultimate amount, if any, of Headwaters' liability.
15
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
License Fees. Pursuant to the contractual terms of an agreement with a
certain licensee, the cumulative net license fees owed to Headwaters,
totaling approximately $10,000,000 as of June 30, 2003, have been
placed in escrow for the benefit of Headwaters. Headwaters currently
expects the escrowed amounts to increase as additional license fees are
generated and that most, if not all, of such amounts will be recognized
as revenue at some future date. Certain accounting rules governing
revenue recognition require that the seller's price to the buyer be
"fixed or determinable" as well as reasonably certain of collection. In
this situation, those rules appear to currently preclude revenue
recognition. Accordingly, none of the escrowed amounts have been
recognized as revenue in the consolidated statements of income.
Other. Headwaters and its subsidiaries are also involved in other legal
proceedings that have arisen in the normal course of business. For
example, certain subsidiaries of ISG are involved in legal proceedings
involving allegations of breach of warranty and sales of defective
building products applied by third parties to building exteriors. Many
claims are covered by insurance. Generally, ISG denies and defends such
allegations or resolves such matters as appropriate. Management does
not believe that the outcome of these matters 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.
Incentive Agreements with ISG Principals. In January 2003, Headwaters
executed incentive agreements, with an effective date of November 2002,
with three of the former stockholders and officers of ISG, all of whom
are current officers of either Headwaters or ISG. The agreements call
for contingent payments totaling up to $5,000,000 in the event of (i) a
change in control, as defined, or (ii) continuing employment through
September 2004 and an increase in the average stock price for
Headwaters' common stock for any calendar quarter exceeding $20 per
share. The maximum payments would be required if there were a change in
control prior to October 2004, or if the officers remain employed
through September 2004 and the average stock price for any calendar
quarter reaches $25 per share or more.
IRS Announcement. An essential element for the production of qualified
solid alternative fuel under section 29 of the Internal Revenue Code
requires that coal undergo significant chemical change. In June 2003,
the IRS in a general announcement, stated that it "has had reason to
question the scientific validity of test procedures and results that
have been presented as evidence that fuel underwent a significant
chemical change, and is currently reviewing information regarding these
test procedures and results." At the same time, the IRS announced that
private letter rulings ("PLRs") on the question of significant chemical
change would be suspended for requests relying on the procedures and
results being reviewed. In addition, the IRS indicated that it may
revoke PLRs that have relied on the procedures and results under review
if it determines that those test procedures and results do not
demonstrate that a significant chemical change has occurred. PLRs from
the IRS are requested by taxpayers to gain assurance that the tax
treatment proposed by the taxpayer is acceptable to the IRS.
Section 29 tax credits have been considered and discussed on several
occasions in the past among Treasury, the IRS, industry participants,
and members of Congress. The IRS has previously suspended the issuance
of PLRs, most recently in late 2000 through the first half of 2001.
Each time that the IRS has suspended the making of rulings, the issues
raised by the IRS ultimately were satisfactorily resolved, and the IRS
resumed rulings. Headwaters is participating in industry groups that
are seeking additional information from the IRS in order to address its
concerns. At this time, however, Headwaters cannot predict the outcome
of the IRS's review, when the review will be completed, or the ultimate
impact of the review on Headwaters.
The ability to generate and use tax credits by Headwaters' licensees is
critical to their continued alternative fuel production. If the ability
to use credits is diminished or the production of the solid alternative
fuel does not qualify for the credits, a licensee may choose to sell
its interest in an alternative fuel facility or curtail production.
16
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)
_______________
Several facility sales have occurred in the past year, but the sale of
a facility normally requires a new PLR. Until the IRS resumes its
rulings on the question of significant chemical change, the transfer of
facilities will be delayed. If a licensee cannot use credits generated
by the facility and cannot sell the facility, the licensee may elect to
reduce or suspend production of alternative fuel. Headwaters' license
fee revenue and chemical reagent sales have been negatively affected by
one licensee's decision to limit production until the IRS's position on
chemical change is clarified and rulings on that issue are again
available. Headwaters cannot predict whether other customers and
licensees may elect to reduce or suspend production of alternative
fuel.
11. SEC Shelf Registration
In July 2002, Headwaters filed a $250,000,000 universal shelf
registration statement with the SEC that can be used for the sale of
common stock, preferred stock, convertible debt and other securities,
should Headwaters so choose. The SEC declared this registration
statement effective in August 2002. In July 2003, Headwaters filed an
amendment to the registration statement for the purpose of
deregistering $100,000,000 of the originally registered securities,
thereby decreasing the maximum amount of securities that can be sold
thereunder to $150,000,000. A prospectus supplement describing the
terms of any securities to be issued is required to be filed before any
offering would commence under the shelf registration. The most likely
use of proceeds from securities offered under the shelf registration
would be to reduce long-term debt; however, proceeds could also be used
for working capital and other general corporate purposes.
12. Recent Accounting Pronouncements
In January 2003, Financial Accounting Interpretation No. 46,
"Consolidation of Variable Interest Entities," ("FIN No. 46") was
issued. This interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," addresses consolidation by
business enterprises of variable interest entities that have certain
characteristics. FIN No. 46 was required to be implemented by
Headwaters immediately for any variable interests in variable interest
entities created after January 31, 2003; and no later than July 1, 2003
for any variable interests in variable interest entities created before
February 1, 2003. Headwaters has reviewed this interpretation and all
other recently issued accounting standards which have not yet been
adopted in order to determine their potential effect, if any, on the
results of operations or financial position of Headwaters. Based on
that review, Headwaters does not currently believe that any of these
recent accounting pronouncements will have a significant effect on its
current or future financial position or results of operations.
17
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.
Acquisition of ISG and Segments
The consolidated financial statements include the accounts of
Headwaters and all of its subsidiaries, only two of which have significant
operations, ISG and HTI. As more fully described in Note 2 to the consolidated
financial statements, Headwaters acquired ISG on September 19, 2002.
Accordingly, ISG's results of operations for the three- and nine-month periods
ended June 30, 2003 are consolidated with Headwaters' 2003 results. ISG's
results of operations for periods prior to the September 2002 acquisition date
have not been consolidated with Headwaters' 2002 results. ISG's business is
seasonal; its strongest quarter is typically the September quarter, followed by
the June quarter and then the December quarter. The slowest quarter for ISG is
the March quarter. Due to the seasonality of ISG's business and other factors,
Headwaters' consolidated results of operations for 2003 are not indicative of
the results to be expected for the full fiscal 2003 year.
Until Headwaters acquired ISG in September 2002, Headwaters operated in
and reported as a single industry segment, alternative energy. With the
acquisition of ISG in September 2002, Headwaters now operates in three business
segments: alternative energy, CCPs, and manufactured products. These segments
are managed and evaluated separately by management based on fundamental
differences in their operations, products and services.
The alternative energy segment includes Headwaters' traditional
coal-based solid alternative fuel business and HTI's research and development
activities directed at catalyst and nano-catalyst technologies used to convert
coal and heavy oils into environment-friendly, higher-value liquid fuels.
Revenues for this segment include primarily sales of chemical reagents and
license fees.
The CCP segment includes ISG's business of supplying post-combustion
services and technologies to the coal-fired electric utility industry. This
segment markets and manages coal combustion products such as fly ash and bottom
ash, known as CCPs. ISG has long-term contracts, primarily with coal-fired
electric generating utilities, pursuant to which it manages the post-combustion
operations for the utilities. ISG markets these CCPs to replace manufactured or
mined materials, such as portland cement, lime, agricultural gypsum, fired
lightweight aggregate, granite aggregate and limestone. CCP revenues consist
primarily of the sale of products, along with a small percentage of service
revenue.
The manufactured products segment produces and sells standard masonry
and stucco construction materials and supplies, packaged products and blocks, as
well as some of ISG's value-added technology products. ISG continually seeks to
increase the volumes of CCPs used as ingredients in the mortars, stuccos and
blocks that the manufactured products segment produces.
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002
The information set forth below compares Headwaters' operating results
for the three months ended June 30, 2003 ("2003") with operating results for the
three months ended June 30, 2002 ("2002").
Revenue. Total revenue for 2003 increased by $74.4 million or 233% to
$106.4 million as compared to $32.0 million for 2002. The major components of
revenue are discussed in the sections below.
Chemical Reagent Sales. Chemical reagent sales during 2003 were $35.9
million with a corresponding direct cost of $25.3 million. Chemical reagent
sales during 2002 were $22.2 million with a corresponding direct cost of $14.9
million. The increase in chemical reagent sales during 2003 was due to increased
alternative fuel production by Headwaters' licensees, as well as sales of
chemical reagents to new customers. In June 2003, one of Headwaters' licensees
significantly reduced production of alternative fuel, and as a result chemical
reagent sales from this licensee could decrease by as much as $3.5 million in
the September 2003 quarter as compared to the June 2003 quarter (See "IRS
Announcement" in Note 10 to the consolidated financial statements). The gross
margin percentage decreased in 2003 from 2002 due primarily to higher chemical
reagent costs and differing chemical reagent formula margins. Headwaters
currently expects its per unit chemical reagent costs to decrease slightly
during the September 2003 quarter and into early fiscal 2004; however, actual
future gross margin percentages will depend on several factors, including which
chemical reagent formulas customers use and in what quantities.
License Fees. As more fully described in Headwaters Form 10-K, "ITEM 1:
BUSINESS, Covol Fuels," Headwaters earns license fees from the owners of
facilities which use Headwaters' proprietary technology to produce solid
alternative fuel. This alternative fuel, when sold, is eligible for federal tax
credits under Section 29 of the Internal Revenue Code, currently through
December 31, 2007, subject to changes in laws or regulations. During 2003,
18
Headwaters recognized license fee revenue totaling $10.1 million, an increase of
$1.3 million or 15% over $8.8 million of license fee revenue recognized during
2002. License fees in 2003 consisted of recurring license fees or royalty
payments of $9.8 million and deferred revenue amortization of $0.3 million.
License fees in 2002 consisted of recurring license fees of $8.5 million and
deferred revenue amortization of $0.3 million. The increase in license fee
revenue in 2003 is largely attributable to one licensee that significantly
increased its production of alternative fuel. This same licensee significantly
decreased its production of alternative fuel in June 2003 and it is not
currently known at what levels it will operate its facilities during the
September 2003 quarter and beyond. Headwaters recognized approximately $2.0
million of license fee revenue from this licensee during the June 2003 quarter
(See "IRS Announcement" in Note 10 to the consolidated financial statements).
Pursuant to the contractual terms of an agreement with a certain
licensee, the cumulative net license fees owed to Headwaters, totaling
approximately $10,000,000 as of June 30, 2003, have been placed in escrow for
the benefit of Headwaters. Headwaters currently expects the escrowed amounts to
increase as additional license fees are generated and that most, if not all, of
such amounts will be recognized as revenue at some future date. Certain
accounting rules governing revenue recognition require that the seller's price
to the buyer be "fixed or determinable" as well as reasonably certain of
collection. In this situation, those rules appear to currently preclude revenue
recognition. Accordingly, none of the escrowed amounts have been recognized as
revenue in the consolidated statements of income.
ISG Revenues and Cost of Revenues. Coal combustion products revenues
and manufactured products sales and the related cost of revenue captions
represent ISG's revenues and cost of revenues for 2003. There were no comparable
revenues and cost of revenues for ISG included in the 2002 results.
Depreciation and Amortization. These costs increased by $3.1 million to
$3.4 million in 2003 from $0.3 million in 2002. The increase was primarily
attributable to depreciation and amortization of the tangible and intangible
assets related to the ISG acquisition. Depreciation and amortization expense in
subsequent quarters should be comparable to 2003, but will increase
substantially in fiscal 2003 over the respective 2002 periods as a result of the
ISG acquisition.
Research and Development. Research and development expenses increased
by $0.5 million to $1.1 million in 2003 from $0.6 million in 2002. The increase
was primarily attributable to the inclusion of additional costs relating to
ISG's research and development activities. In 2002, research and development
expenses primarily represent costs related to HTI's activities.
Selling, General and Administrative Expenses. These expenses increased
$6.5 million or 167% to $10.4 million for 2003 from $3.9 million for 2002. The
increase in 2003 was due primarily to the inclusion of ISG's costs.
Other Income and Expense. During 2003, Headwaters reported net other
expense of $4.2 million compared to net other income of $0.4 million during
2002. The change of $4.6 million is primarily attributable to an increase in
interest expense of $4.2 million, $0.7 million of which resulted from the early
repayments of debt principal which accelerated the amortization of debt discount
and debt issue costs related to the principal that was repaid. Interest expense
increased in 2003 due to the substantial increase in debt incurred in September
2002 to finance the acquisition of ISG. Interest expense will be significantly
higher in fiscal 2003 compared to the respective fiscal 2002 periods as a result
of this debt. Any future early repayments of debt principal will accelerate the
amortization of debt discount and debt issue costs.
Income Tax Provision. In both 2003 and 2002, Headwaters recorded an
income tax provision at an effective tax rate of approximately 40%.
Nine Months Ended June 30, 2003 Compared to Nine Months Ended June 30, 2002
The information set forth below compares Headwaters' operating results
for the nine months ended June 30, 2003 ("2003") with operating results for the
nine months ended June 30, 2002 ("2002").
Revenue. Total revenue for 2003 increased by $205.6 million or 272% to
$281.2 million as compared to $75.6 million for 2002. The major components of
revenue are discussed in the sections below.
Chemical Reagent Sales. Chemical reagent sales during 2003 were $98.1
million with a corresponding direct cost of $66.1 million. Chemical reagent
sales during 2002 were $49.5 million with a corresponding direct cost of $33.7
million. The increase in chemical reagent sales during 2003 was due to increased
alternative fuel production by Headwaters' licensees, as well as sales of
chemical reagents to new customers.
License Fees. During 2003, Headwaters recognized license fee revenue
totaling $27.8 million, an increase of $6.5 million or 31% over $21.3 million of
license fee revenue recognized during 2002. License fees in 2003 consisted of
recurring license fees or royalty payments of $26.9 million and deferred revenue
amortization of $0.9 million. License fees in 2002 consisted of recurring
license fees of $20.1 million and deferred revenue amortization of $1.2 million.
There were two primary reasons for the increase in license fee revenue in 2003
compared to 2002. A major licensee that purchased four facilities from a former
19
licensee in October 2001 did not begin operating those facilities until early
calendar 2002. Headwaters earned approximately $8.6 million in license fees from
this licensee in 2003 and $4.2 million in 2002. Also, another licensee
significantly increased its production of alternative fuel in 2003. This same
licensee significantly decreased its production of alternative fuel in June 2003
and it is not currently known at what levels it will operate its facilities
during the September 2003 quarter and beyond. Headwaters has recognized $5.0
million of revenue from this licensee in 2003.
ISG Revenues and Cost of Revenues. Coal combustion products revenues
and manufactured products sales and the related cost of revenue captions
represent ISG's revenues and cost of revenues for 2003. There were no comparable
revenues and cost of revenues for ISG included in the 2002 results.
Depreciation and Amortization. These costs increased by $8.7 million to
$9.7 million in 2003 from $1.0 million in 2002. The increase was primarily
attributable to depreciation and amortization of the tangible and intangible
assets related to the ISG acquisition.
Research and Development. Research and development expenses increased
by $1.5 million to $3.2 million in 2003 from $1.7 million in 2002. The increase
was primarily attributable to the inclusion of additional costs relating to
ISG's research and development activities. In 2002, research and development
expenses primarily represent costs related to HTI's activities.
Selling, General and Administrative Expenses. These expenses increased
$20.9 million or 222% to $30.3 million for 2003 from $9.4 million for 2002. The
increase in 2003 was due primarily to the inclusion of ISG's costs, and to a
lesser extent, an increase in professional services expenses of approximately
$1.1 million related to legal actions Headwaters is currently pursuing.
Other Income and Expense. During 2003, Headwaters reported net other
expense of $14.2 million compared to net other income of $2.4 million during
2002. The change of $16.6 million is primarily attributable to an increase in
interest expense of $12.2 million, gains in 2002 for $1.3 million related to the
sale of an interest in an alternative fuel facility and $0.8 million related to
the collection of a note receivable that had previously been written off, and a
$2.1 million write-down of a note receivable in 2003.
Interest expense increased in 2003 due to the substantial increase in
debt incurred in September 2002 to finance the acquisition of ISG. Interest
expense in 2003 also includes $1.1 million related to accelerated amortization
of debt discount and debt issue costs associated with $19.0 million of early
repayments of senior debt principal.
Income Tax Provision. In 2003, Headwaters recorded an income tax
provision at an effective tax rate of approximately 40%. In 2002, the effective
tax rate was approximately 39%.
Liquidity and Capital Resources
Net cash provided by operations during the nine months ended June 30,
2003 ("2003") was $41.2 million compared to $0.8 million of net cash provided by
operations during the nine months ended June 30, 2002 ("2002"). Most of the
positive cash flow from operating activities in both periods was attributable to
net income; however in 2002, due to large cash expenditures for short-term
investments ($18.8 million) and the significant growth in Headwaters' business,
operating activities resulted in a low amount of net cash inflow. During 2003,
investing activities consisted primarily of payments for the purchase of
property, plant and equipment. Investing activities in 2002 consisted primarily
of the collection of a $6.5 million note receivable and an increase in other
assets, primarily costs associated with potential acquisitions and related
projects. Financing activities in both 2003 and 2002 consisted primarily of
repayments of long-term debt and short-term borrowings, proceeds from exercise
of options and warrants and employee stock purchases. More details about these
activities are provided in the following paragraphs.
Operating Activities. Cash provided from operations in 2003 of $41.2
million primarily resulted from net income of $25.4 million plus depreciation
and amortization of $9.7 million.
Investing Activities. In 2003, payments for the purchase of property,
plant and equipment totaled $6.3 million. These capital expenditures primarily
related to ISG's business, in particular the CCP segment. Capital expenditures
are currently expected to total approximately $10.0 million in fiscal 2003.
In September 2001, Headwaters sold all of its remaining high-risk
investments in exchange for a $4.0 million 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. In March 2003, Headwaters recorded a
$2.1 million write-down of this note and as of June 30, 2003, this note has a
carrying value of $0.5 million. Headwaters could incur additional losses if the
remaining balance on the note is not repaid. At September 30, 2001, Headwaters
had outstanding one other note receivable in the amount of $6.5 million. This
note and the related accrued interest were collected in October 2001. Also in
2002, Headwaters capitalized over $3.0 million of costs associated with
potential acquisitions and related projects.
20
Financing Activities. Headwaters acquired ISG in September 2002. In
order to obtain the cash necessary to acquire ISG and retire ISG's debt,
Headwaters issued $175.0 million of new debt consisting of $155.0 million of
senior secured debt and $20.0 million of subordinated debt (see Note 6 to the
consolidated financial statements). During 2003, principal repayments of the
senior debt totaling $30.3 million were made, which included $19.0 million of
optional early repayments. When optional prepayments are made, required
principal repayments for all future periods are reduced. Currently, the
remaining required fiscal 2003 principal repayment is $3.4 million. Headwaters
may, in the future, make additional optional early repayments of the senior debt
depending on actual cash flows, Headwaters' current and expected cash
requirements and other factors deemed significant by management.
In 2003, cash proceeds from employee stock purchases and from the
exercise of options and warrants totaled $2.1 million, compared to $5.4 million
in 2002. Option and warrant exercise activity is largely dependent on
Headwaters' stock price and is not predictable. To the extent non-qualified
stock options are exercised, or there are disqualifying dispositions of shares
obtained upon the exercise of incentive stock options, Headwaters receives a tax
benefit generally equal to the income recognized by the optionee. Such amounts,
reflected in cash flows from operations in the consolidated statements of cash
flows, were $2.7 million in 2002 and $1.7 million in 2003.
Headwaters intends to expand its business through growth of existing
operations, commercialization of technologies currently being developed, and
strategic acquisitions of entities that operate in adjacent industries.
Acquisitions over a certain size require the approval of the senior debt
holders.
In July 2002, Headwaters filed a $250.0 million universal shelf
registration statement with the SEC that can be used for the sale of common
stock, preferred stock, convertible debt and other securities, should Headwaters
so choose. The SEC declared this registration statement effective in August
2002. In July 2003, Headwaters filed an amendment to the registration statement
for the purpose of deregistering $100.0 million of the originally registered
securities, thereby decreasing the maximum amount of securities that can be sold
thereunder to $150.0 million. A prospectus supplement describing the terms of
any securities to be issued is required to be filed before any offering would
commence under the shelf registration. The most likely use of proceeds from
securities offered under the shelf registration would be to reduce long-term
debt; however, proceeds could also be used for working capital and other general
corporate purposes.
Working Capital. Headwaters' working capital decreased by $1.7 million
from September 30, 2002, to $13.3 million as of June 30, 2003. The most
significant change in the components of working capital was an increase of $8.1
million in the current portion of long-term debt, reflecting senior debt
repayment obligations which are higher for fiscal 2004 than for fiscal 2003.
Headwaters expects operations to produce positive cash flows in future periods,
which, combined with current working capital and the $20.0 million revolving
line of credit described below, is expected to be sufficient for operating needs
for the next 12 months.
Long-term Debt. In connection with the ISG acquisition, Headwaters
entered into a $175.0 million senior secured credit agreement with a syndication
of lenders, under which a total of $155.0 million was borrowed on the
acquisition date. The credit agreement also allows up to $20.0 million to be
borrowed under a revolving credit arrangement. The debt is secured by all assets
of Headwaters, bears interest at a variable rate (approximately 5.6% at June 30,
2003), and is repayable in quarterly installments through August 2007. Future
required principal repayments for all future periods currently total
approximately $3.4 million for the remainder of fiscal 2003, approximately $27.0
million in fiscal years 2004, 2005, and 2006, and approximately $40.4 million in
fiscal 2007. In certain situations, for example when Headwaters receives "excess
cash flow," as defined, mandatory prepayments, in excess of the scheduled
payments, are required. Mandatory prepayments are calculated as a percentage of
"excess cash flow," ranging up to 100%, which percentage is based on Headwaters'
"leverage ratio."
The credit agreement contains restrictions and covenants common to such
agreements, including limitations on the incurrence of additional debt,
investments, merger and acquisition activity, asset liens, capital expenditures
in excess of $15.0 million in any fiscal year, and the payment of dividends,
among others. In addition, Headwaters must maintain certain financial ratios,
including leverage ratios and interest coverage, as those terms are defined in
the credit agreement. As of June 30, 2003, Headwaters must maintain a total
leverage ratio of 2.5:1.0 or less. The maximum ratio declines over time until
June 2004, at which time the ratio must remain at 2.0:1.0 or less. There is a
similar leverage ratio requirement for the senior debt alone, which at June 30,
2003 must be 2.0:1.0 or less, declining over time through June 2004, at which
time it must be maintained at 1.5:1.0 or less. The interest coverage requirement
at June 30, 2003 was 4.0:1.0 or more and does not change until December 2003, at
which time the ratio must be maintained at a level of 5.0:1.0 or more.
Headwaters was in compliance with all debt covenants as of June 30, 2003.
Under the terms of the senior secured credit agreement, Headwaters may
borrow up to a total of $175.0 million; provided, however, that, except for the
initial $20.0 million of available revolving credit, the maximum borrowing limit
is permanently reduced by the amount of any repayments of the initial $155.0
million borrowed in September 2002. Terms of any additional borrowings under the
credit agreement are generally the same as described in the preceding
paragraphs. Finally, the credit agreement allows for the issuance of letters of
credit, provided there is capacity under the available revolving credit
arrangement. Currently two letters of credit totaling $3.0 million are
outstanding, with expiration dates in November 2003 and March 2004. No other
borrowings have been drawn or letters of credit issued. Headwaters pays a fee of
5/8% on the unused portion of the revolving credit arrangement.
In connection with the ISG acquisition, Headwaters also entered into a
$20.0 million subordinated loan agreement. ISG management participated in
one-half, or $10.0 million, of the $20.0 million of debt issued. The other half
was issued to a corporation. The debt is not secured, bears interest at an 18%
rate payable quarterly, and is repayable in September 2007. It is senior to all
other debt except the senior secured debt described above. The debt agreement
allows for optional prepayments. Any prepayments paid to the corporation are
subject to a prepayment charge which ranges from 5% of the principal prepaid in
the first year to 1% of the principal prepaid in the last year of the five-year
term of the debt agreement.
The loan agreement contains restrictions and covenants common to such
agreements, and these are generally consistent with those described above for
the senior secured debt. As of June 30, 2003, Headwaters must maintain a total
leverage ratio of 2.75:1.0 or less. The maximum ratio declines over time until
June 2004, at which time the ratio must remain at 2.25:1.0 or less. The interest
21
coverage requirement at June 30, 2003 was 3.75:1.0 or more and does not change
until December 2003, at which time the ratio must be maintained at a level of
4.75:1.0 or more. Headwaters was in compliance with all debt covenants as of
June 30, 2003.
Income Taxes. In fiscal 2002, Headwaters' cash requirements for income
taxes were not significant due to the availability and utilization of net
operating loss carryforwards ("NOLs"). Although Headwaters currently has some
NOLs in certain states, remaining NOLs for federal tax purposes are not
material. Accordingly, Headwaters' cash requirements for income taxes in fiscal
2003 are expected to approximate the income tax provision, with some lag due to
the seasonality of operations and because estimated income tax payments are
typically based on annualizing the fiscal year's income based on year-to-date
results. In 2003, payments totaling approximately $12.1 million have been made.
Summary of Future Cash Requirements. Significant future cash needs, in
addition to operational working capital requirements, are currently expected to
consist primarily of debt service payments on outstanding long-term debt, income
taxes, and capital expenditures.
IRS Announcement
As more fully described in "IRS Announcement" in Note 10 to the
consolidated financial statements, the IRS is reviewing test procedures and
results regarding chemical change as it relates to the production of solid
alternative fuel under section 29 of the Internal Revenue Code. The ability to
generate and use tax credits by Headwaters' licensees is critical to their
continued alternative fuel production. Headwaters' license fee revenue and
chemical reagent sales have been negatively affected by one licensee's decision
to limit production until the IRS's position on chemical change is clarified and
rulings on that issue are again available. Headwaters cannot predict whether
other customers and licensees may elect to reduce or suspend production of
alternative fuel.
Recent Accounting Pronouncements
In January 2003, Financial Accounting Interpretation No. 46,
"Consolidation of Variable Interest Entities," ("FIN No. 46") was issued. This
interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements," addresses consolidation by business enterprises of variable
interest entities that have certain characteristics. FIN No. 46 was required to
be implemented by Headwaters immediately for any variable interests in variable
interest entities created after January 31, 2003, and no later than July 1, 2003
for any variable interests in variable interest entities created before February
1, 2003. Headwaters has reviewed this interpretation and all other recently
issued accounting standards which have not yet been adopted in order to
determine their potential effect, if any, on the results of operations or
financial position of Headwaters. Based on that review, Headwaters does not
currently believe that any of these recent accounting pronouncements will have a
significant effect 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 managing and marketing of coal combustion products,
operation of facilities utilizing alternative fuel technologies, the marketing
of alternative fuels, 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, and the marketability of the coal combustion products and
alternative fuel, 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
22
assurance that actual results will not differ materially from its expectations.
In addition to matters affecting the coal combustion products and alternative
fuel industries 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) Ability to repay our substantial debt obligations, including significant
interest payments, under our senior secured credit facility and senior
subordinated debentures.
(2) Restrictions on our ability to operate the businesses because of
covenants in the senior secured credit facility and senior subordinated
debentures.
(3) Satisfactory resolution of several significant disputes in litigation.
(4) Increased use and market acceptance of fly ash.
(5) Fluctuations in the price and sales of cement and concrete products
markets in which ISG competes.
(6) Clean Air Act Amendments and regulations that could adversely impact coal
consumption or the quality and quantity of coal combustion products.
(7) Potential property damage claims and the availability of insurance
coverage for claims related to ISG's stucco and other building products.
(8) Liabilities in excess of Headwaters' insurance limits, not covered by
insurance, or for which insurance is not available.
(9) Operating issues for licensed alternative fuel 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 Covol Fuels' technologies.
(10) Marketing issues relating to acceptance and regulatory permitting of
alternative fuels manufactured using Covol Fuels' technologies.
(11) Securing of suitable alternative fuel facility sites, including permits
and raw materials, for relocation and operation of alternative fuel
facilities and product sales.
(12) The market acceptance of products manufactured with Headwaters'
technologies in the face of competition from traditional products.
(13) Dependence on licensees to successfully implement Covol Fuels'
technologies and to make license and other payments to Covol Fuels.
(14) Maintenance of placed-in-service and other requirements under Section 29
of the tax code by alternative fuel manufacturing facilities.
(15) Changes in governmental regulations or failure to comply with existing
regulations that could result in reduction or shutdown of operations of
licensee alternative fuel facilities.
(16) The continued availability of tax credits to licensees under the tax code
and each licensee's ability to use tax credits, including satisfactory
resolution of the IRS's position on chemical change.
(17) The commercial feasibility of Covol Fuels' alternative fuel technologies
upon the expiration of tax credits.
(18) Ability to commercialize new technologies which have only been tested in
the laboratory and not in full-scale operations.
(19) 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.
(20) Success of HTI in conducting business in China.
(21) Success in the face of competition by others producing coal combustion
products or alternative chemical reagent products.
(22) Sufficiency of intellectual property protections.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Headwaters is exposed to financial market risks, primarily related to
changes in interest rates. Headwaters does not use derivative financial
instruments for speculative or trading purposes, and no significant derivative
financial instruments were outstanding as of June 30, 2003 or subsequent
thereto.
The majority of Headwaters' short-term investments, all of which are
classified as trading securities, consist of fixed-rate U.S. government
securities or securities backed by the U.S. government. Changes in interest
rates can affect the market value of these investments, which are carried at
market value in the consolidated balance sheets. The periodic adjustments to
reflect changes in market value are included in interest and net investment
income in the consolidated statements of income. Based on the current amount of
short-term investments and expected near-term changes in the amount of
short-term investments, Headwaters does not expect any material near-term
investment losses to result from changes in interest rates.
23
As described in more detail in Note 6 to the unaudited consolidated
financial statements, Headwaters has outstanding $124.7 million of variable-rate
long-term debt as of June 30, 2003, which is repayable through August 2007. The
interest rate on this debt as of June 30, 2003 was approximately 5.6%, which
rate changed in July 2003 to approximately 5.5%. At that time, Headwaters locked
in a rate for three months. In October 2003, Headwaters can lock in a new rate
for one, three, or six months. A change in the interest rate of 1% would change
interest expense by approximately $1.2 million during the next 12 months,
considering required principal repayments.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure controls are procedures that are designed with an objective
of ensuring that information required to be disclosed in Headwaters' periodic
reports filed with the SEC, such as this Quarterly Report on Form 10-Q, is
recorded, processed, summarized and reported within the time periods specified
by the SEC. Disclosure controls are also designed with an objective of ensuring
that such information is accumulated and communicated to Headwaters' management,
including the Chief Executive Officer ("CEO") and the Chief Financial Officer
("CFO"), in order to allow timely consideration regarding required disclosures.
The evaluation of Headwaters' disclosure controls by the CEO and CFO
included a review of the controls' objectives and design, the operation of the
controls, and the effect of the controls on the information presented in this
Quarterly Report. Headwaters' management, including the CEO and CFO, does not
expect that disclosure controls can or will prevent or detect all errors and all
fraud, if any. A control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Also, projections of any evaluation of the disclosure
controls and procedures to future periods are subject to the risk that the
disclosure controls and procedures may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
Based on their review and evaluation as of June 30, 2003, and subject
to the inherent limitations as described above, Headwaters' CEO and CFO have
concluded that Headwaters' disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective. In addition, they are not aware of any change in Headwaters' internal
control over financial reporting during the quarter ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, Headwaters'
internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Legal or Contractual Matters" in Note 10 to the consolidated
financial statements for a description of current legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the quarter ended June 30, 2003, pursuant to the exercise of
options and warrants, approximately 104,000 shares of Headwaters restricted
common stock were issued. Headwaters has several outstanding effective
registration statements filed on Forms S-3 and Forms S-8. All of the shares of
restricted common stock issued during the quarter have been registered under one
of these registration statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
10.60.0 Amendment to Employment Agreement with *
Kirk A. Benson dated July 9, 2003
12 Computation of ratio of earnings to *
combined fixed charges and preferred
stock dividends
31 Section 302 Certification of Chief *
Executive Officer
31.1 Section 302 Certification of Chief *
Financial Officer
32 Section 906 Certifications of Chief *
Executive Officer and Chief Financial
Officer
_______________________
* Filed herewith.
(b) The following Form 8-K was furnished to the SEC during the
quarter ended June 30, 2003:
Form 8-K dated April 24, 2003 announcing Headwaters' results
for the quarter ended March 31, 2003.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEADWATERS INCORPORATED
Date: August 8, 2003 By: /s/ Kirk A. Benson
------------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: August 8, 2003 By: /s/ Steven G. Stewart
------------------------------------------
Steven G. Stewart, Chief Financial Officer
and Principal Financial Officer
26