UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
May 25, 2004
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Date of Report (Date of earliest event reported)
HEADWATERS INCORPORATED
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(Exact name of Registrant as specified in its charter)
Delaware 0-27808 87-0547337
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(State or other jurisdiction of (Commission File Number) (IRS Employer
incorporation) Identification No.)
10653 South River Front Parkway, Suite 300
South Jordan, UT 84095
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(Address of principal executive offices)
(Zip Code)
(801) 984-9400
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name or former address, if changed since last report)
This Current Report on Form 8-K contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995 regarding future
events and our future results that are based on current expectations, estimates,
forecasts, and projections about the industries in which we operate and the
beliefs and assumptions of our management. Forward-looking statements include
Headwaters' expectations as to the managing and marketing of coal combustion
products, operations of facilities utilizing alternative fuel technologies, the
marketing of synthetic fuels, the availability of tax credits, the availability
of feed stocks, 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, including without
limitation, our proposed Eldorado acquisition, and other information about
Headwaters. Actual results may vary materially from such expectations. Words
such as "expects," "anticipates," "targets," "goals," "projects," "believes,"
"seeks," "estimates," variations of such words and similar expressions are
intended to identify such forward-looking statements. In addition, any
statements that refer to projections of our future financial performance, our
anticipated growth and trends in our businesses, and other characterizations of
future events or circumstances, are forward-looking. For a discussion of the
factors that could cause actual results to differ from expectations, please see
the captions entitled "Forward-looking Statements" and "Risk Factors" in Item 7
of our Form 10-K for the year ended September 30, 2003 and the Risk Factors
described in Item 5 below. There can be no assurance that our results of
operations will not be adversely affected by such factors. Unless legally
required, we undertake no obligation to revise or update any forward-looking
statements for any reason. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date of the
applicable report.
Item 2: Probable Acquisition of Eldorado Stone, LLC
As described in Headwaters' Form 8-K filed on April 22, 2004, Headwaters entered
into a purchase agreement to acquire the ownership interests of Eldorado Stone,
LLC, a leading manufacturer of architectural manufactured stone based in San
Marcos, California. Eldorado Stone will become a wholly-owned subsidiary of
Headwaters, integrated into its construction materials segment. The acquisition,
which is subject to completion of financing and other customary conditions, is
expected to close in June 2004.
The total purchase price for Eldorado Stone, excluding estimated expenses of
approximately $3,500,000, is expected to be approximately $202,500,000. The
calculation of the final purchase price will vary based on certain adjustments
at the time of closing as well as total closing and transaction costs.
Headwaters will use existing cash, financing available under its new credit
facility and new financing to be obtained prior to closing to pay for the
acquisition.
Item 5: Other Events and Regulation FD Disclosure - Updated List of Risk Factors
for Outstanding Effective Forms S-3 and S-8
Headwaters currently has several outstanding effective Forms S-3 and Forms S-8.
The following list of risk factors supercedes and replaces the Risk Factors
section in the Prospectus of each of the following registration statements on
Form S-3 or Form S-8: 333-34488, 333-67371, 333-76724, 333-79385, 333-96919,
333-39674, 333-39676, 333-39678, 333-100322, and 333-103527. In addition, these
risk factors may also be incorporated into future registration statements that
we may file.
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Risk Factors
Risks relating to our proposed Eldorado Acquisition
If the Eldorado Acquisition is not completed, we may not be able to use the net
proceeds of our proposed financing in a manner that would provide benefits
similar to the intended benefits of the Eldorado Acquisition, and our results of
operations could suffer and the market price of our common stock could decline.
On April 21, 2004, we entered into an agreement to purchase all of the
outstanding equity of Eldorado Stone, LLC ("Eldorado"). Eldorado manufactures,
distributes and sells the Eldorado Stone(TM) brand of architectural manufactured
stone. The total purchase price for the acquisition of Eldorado (the "Eldorado
Acquisition") is approximately $202.5 million in cash.
The closing of the Eldorado Acquisition is conditioned upon the consummation of
financing (which is intended to be the net proceeds from a proposed offering of
$150 million of convertible senior subordinated notes due 2016 (the "Convertible
Notes"), approximately an additional $50 million in new borrowings under our
senior secured credit facility and internally generated cash), the expiration or
termination of all applicable HSR waiting periods and other customary closing
conditions. The requests of Headwaters and Eldorado for early termination of the
waiting periods applicable under HSR have been granted. While we have no reason
to believe that all other conditions to closing will not be satisfied, there can
be no assurance that we will consummate the acquisition. If the Eldorado
Acquisition is not completed, we will have incurred substantial expenses,
including those related to the financing. In addition, it is unlikely we will
have an immediate use for the net proceeds of the Convertible Notes other than
to invest such amounts in short-term marketable securities that are likely to
yield less interest than we will pay on the Convertible Notes. If we do not
complete the Eldorado Acquisition and are not able to use the net proceeds of
the offering of Convertible Notes in a manner that would provide benefits
similar to the intended benefits of the Eldorado Acquisition, our results of
operations could suffer and the market price of our common stock could decline.
In the event that the Eldorado Acquisition does not close for any reason, we
intend to use the net proceeds from the offering of Convertible Notes for
general corporate purposes, including to fund acquisitions of complementary
businesses in the chemical, energy, building products and related industries.
See "Risks Relating to Our Business-Our business strategy to grow through
acquisitions may not be successful."
If we do not successfully integrate Eldorado with our existing business, we may
not realize the expected benefits of the acquisition.
There is a significant degree of difficulty and management distraction inherent
in the process of integrating Eldorado, even though we expect that senior
management of Eldorado will continue to operate the business after closing.
These difficulties include:
-Integrating Eldorado with our construction materials business,
American Construction Materials, Inc. ("ACM"), while maintaining the
ongoing operations of each business;
-Coordinating geographically separate organizations;
-Integrating the business cultures of the companies, which may prove
to be incompatible; and
-Retaining key officers and personnel.
Eldorado has a work force of approximately 1,500 employees. The combination with
Headwaters will result in the combined company having more than 2,500 employees,
which substantially increases Headwaters' current workforce. Integration of
these additional employees, many of whom are manufacturing plant workers, could
result in integration issues, including issues related to human resource benefit
plans and an increase in EEOC claims and claims for workers compensation.
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As we integrate Eldorado into our business, we will have increased significantly
our employee base, sales and products. We cannot assure you that we can realize
our strategy to integrate the Eldorado and ACM sales forces and distribution
networks or to sell ACM products through the Eldorado Stone(TM) brand. The
integration process will require us to expand significantly our operational and
financial systems, which will increase the operating complexity of our systems.
Implementation of controls, systems and procedures may be costly and
time-consuming.
We cannot assure you that we will successfully or cost-effectively integrate the
businesses. The failure to do so could have a material adverse effect on our
business, financial condition and results of operations. The process of
integrating operations could cause an interruption of, or loss of momentum in,
the activities of Eldorado or our existing businesses. Members of Headwaters'
and ISG's senior management may be required to devote considerable amounts of
time to the integration, which could decrease the time they will have to manage
Headwaters' existing businesses, with an adverse effect on providing services to
existing customers and developing new customers and products.
If Headwaters cannot invest additional capital into Eldorado, we may not realize
the intended benefits of the acquisition.
In the year ended December 31, 2003, Eldorado made capital expenditures of
approximately $8.5 million. Such expenditures may be insufficient to continue
Eldorado's growth and Headwaters believes that additional capital will be
required for growth and other purposes, including some retrofitting of plants to
enable the use of fly ash as a replacement for cement in the construction of
manufactured stone.
Headwaters has limited manufacturing experience and may not be able to
efficiently manage Eldorado's manufacturing plants.
Eldorado has manufacturing facilities in nine locations throughout the United
States. Headwaters has limited manufacturing experience and may not be able to
resolve manufacturing issues or increase efficiencies at manufacturing plants.
In addition, Eldorado is in the process of obtaining requisite environmental
permits for its manufacturing facilities. We cannot assure you that Eldorado can
obtain such permits in a timely manner or at all, and failure to obtain such
permits may result in additional costs and/or fines.
Eldorado's market is seasonal and cyclical, and factors affecting the
residential construction market may adversely affect our business.
Eldorado's market is seasonal and cyclical. The majority of Eldorado's sales are
in the residential construction market. If there is an increase in interest
rates or any slow down in new housing starts or remodeling activities, there may
be a negative effect on Eldorado's sales and our business could be adversely
affected.
Eldorado faces significant competition.
Eldorado competes with both national and regional manufacturers and suppliers of
architectural stone veneer products. On the national level, Eldorado's primary
competitor is Cultured Stone, a division of Owens Corning. Certain of Eldorado's
competitors, including Owens Corning, may have greater financial, manufacturing
and distribution resources than Headwaters.
Eldorado is subject to ongoing litigation matters.
Eldorado is a party to some significant legal proceedings and is subject to
potential claims regarding the operation of its business. These claims include
allegations of employee harassment, unfair labor practices, retaliatory
discharge, negligence, breach of contract, and defective products. These
proceedings will require that we incur substantial costs, including attorneys'
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fees, managerial time and other personnel resources and costs in pursuing
resolution. Adverse resolution of these proceedings could have a materially
adverse effect on our business.
Risks Relating to Our Business
The profitability of Covol Fuels depends on the continued existence of tax
credits under Section 29 of the Internal Revenue Code, which is scheduled to
expire on December 31, 2007.
Covol Fuels' license fees and revenues from sales of chemical reagents depend on
the ability of our licensees and customers to manufacture and sell qualified
synthetic fuels that generate tax credits. Under current law, Section 29 tax
credits are not available for synthetic fuel sold after December 31, 2007. In
addition, there have been initiatives from time to time to consider the early
repeal or modification of Section 29. Recently, a bill has been introduced in
the United States House of Representatives that would repeal the Section 29
credit for synthetic fuel produced from coal. If Section 29 expires at the end
of 2007 or if it is repealed or adversely modified, synthetic fuel facilities
would probably either close or substantially curtail production. At this time,
given current prices of coal and costs of synthetic fuel production, we do not
believe that production of synthetic fuel will be profitable absent the tax
credits. In addition, if our licensees close their facilities or materially
reduce production activities (whether after 2007, upon earlier repeal or adverse
modification of Section 29 or for any other reason), it would have a material
adverse effect on the revenues and net income of Headwaters.
Furthermore, Section 29 tax credits are subject to phase-out after the
unregulated oil price reaches $50.14 per barrel (the trading price on May 11,
2004 was $40.08 per barrel), adjusted annually for inflation.
Ongoing financial profitability of Covol Fuels depends upon our licensees'
demand for Section 29 tax credits, which in turn depends on our licensees'
taxable income.
Covol Fuels' business depends upon the ability of our licensees and chemical
reagent customers to utilize Section 29 tax credits. Their ability to utilize
tax credits, in turn, depends upon their other taxable income. A decline in the
profitability of our licensees could reduce their ability to utilize tax
credits, and, in turn, could lead to a reduction in the production of synthetic
fuel at their facilities. Such licensees could sell their facilities to a
taxpayer with more capacity to utilize the tax credits, but any such transfer
could result in short-term or long-term disruption of operations. Accordingly,
the decline in profitability of our licensees or chemical reagent customers
could have a material adverse effect on the revenues and net income of
Headwaters.
IRS reviews under Section 29 may adversely affect our licensees' production of
synthetic fuel.
The issuance of PLRs under Section 29 by the IRS is important to the willingness
of the owners of synthetic fuel facilities to operate and to their ability to
transfer ownership of those facilities. However, PLRs may be modified or revoked
by the IRS.
The IRS has suspended the issuance of PLRs to synthetic fuel facility owners
several times in the past, and there can be no assurance that the IRS will not
suspend the issuance of PLRs in the future. Most recently, in June 2003, the IRS
stated in summary in Announcement 2003-46 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," and that
pending its review of the issue it was suspending the issuance of new PLRs
regarding significant chemical change.
The IRS release of Announcement 2003-46 caused certain of Headwaters' licensees
to reduce or cease synthetic fuel production, which resulted in a material
adverse impact on Headwaters' revenues and net income. In October 2003, the IRS
stated, in summary, in Announcement 2003-70 that it continues to question
whether the processes it had approved under its long-standing ruling practice
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produce the necessary level of chemical change required under Section 29 and
Revenue Ruling 86-100. Nonetheless, the IRS indicated that it would continue to
issue PLRs regarding chemical change under the standards set forth in Revenue
Procedures 2001-30 and 2001-34, and that the industry's chemical change test
procedures and results are scientifically valid if applied in a consistent and
unbiased manner. Although the IRS resumed its practice of issuing PLRs, it
expressed continuing concerns regarding the sampling and data/record retention
practices prevalent in the synthetic fuels industry.
The full effect that Announcement 2003-70 (or future suspensions or
pronouncements similar to Announcement 2003-46) may have on the industry is
unknown. The expression of IRS concern regarding current practices in the
industry may have a material adverse effect on the willingness of buyers to
engage in transactions or on the willingness of current owners to operate their
facilities. If current owners are unable to sell their facilities or are
unwilling to operate them, production will not be maximized, materially
adversely affecting our revenues and net income. We cannot predict whether the
IRS may conduct reviews or investigations of Section 29 tax credits in the
future, or whether the outcome of IRS audits involving licensees would be
favorable.
Senate investigation of Section 29 tax credits may adversely affect Covol Fuels.
On October 30, 2003, the Permanent Subcommittee on Investigations of the
Government Affairs Committee of the United States Senate issued a notification
of pending investigations. The notification listed, among others, the synthetic
fuel tax credit as a new item. In March 2004, the Subcommittee described its
investigation as follows:
The Subcommittee is continuing its investigation of tax credits claimed
under Section 29 of the Internal Revenue Code for the sale of
coal-based synthetic fuels. This investigation is examining the
utilization of these tax credits, the nature of the technologies and
fuels created, the use of these fuels, and others aspects of Section
29. The investigation will also address the IRS' administration of
Section 29 tax credits.
The Subcommittee is expected to hold a hearing in June 2004 regarding its
investigation of Section 29 tax credits.
The effect that the Subcommittee investigation of synthetic fuel tax credits may
have on the industry is unknown. While the investigation is pending, it may have
a material adverse effect on the willingness of buyers to engage in transactions
to purchase synthetic fuel facilities or on the willingness of current owners to
operate their facilities, and may materially adversely affect our revenues and
net income. We cannot make any assurances as to the timing or ultimate outcome
of the Subcommittee investigation, nor can we predict whether Congress or others
may conduct investigations of Section 29 tax credits in the future.
Covol Fuels' licensees are subject to audit by the IRS, and the IRS may
challenge or disallow Section 29 tax credits claimed.
Licensees are subject to audit by the IRS. The IRS may challenge whether Covol
Fuels' licensees satisfy the requirements of Section 29, or applicable PLRs, or
may attempt to disallow Section 29 tax credits for some other reason. Headwaters
understands that the IRS has recently initiated audits of certain taxpayers who
claimed Section 29 tax credits during open tax years, and the outcome of any
such audit is uncertain. In the event that tax credits are disallowed, licensees
may seek recovery from Covol Fuels for operational or other reasons, although we
believe there would be no basis for such claims. The inability of a licensee to
claim Section 29 tax credits also would reduce our future income from the
licensee. In addition, IRS audit activity may have a material adverse effect on
the willingness of buyers to engage in transactions to purchase synthetic fuel
facilities or on the willingness of current owners to operate their facilities.
If current owners are unable to sell their facilities or are unwilling to
operate them at full capacity, production will not be maximized, materially
adversely affecting our revenues and net income.
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Demand for Section 29 tax credits may be influenced by negative publicity
involving the industry or transactions principally motivated by the reduction of
taxes.
There has been public scrutiny, by the media and by policymakers, of Section 29.
Outside the Section 29 context, there has been increased public scrutiny of
transactions motivated principally by the reduction of federal income taxes. Our
licensees could determine that the risk of negative publicity or public scrutiny
associated with the Section 29 tax credits exceeds the financial benefits from
the utilization of the credits. Such licensees may seek to mitigate or eliminate
such risk by reducing or ceasing production of synthetic fuel or disposing of
their facilities, resulting in short-term or long-term disruption of operations,
in which case our revenues could be materially adversely affected.
Ongoing financial profitability of Covol Fuels depends on a small number of
licensees.
Covol Fuels has licensed its coal-based solid synthetic fuel technology to a
limited number of licensees. Under current law, facilities must have been placed
into service prior to July 1, 1998 to be eligible for Section 29 tax credits, so
Covol Fuels' business primarily depends on existing licensees and chemical
reagent customers. If any of Covol Fuels' significant licensees or chemical
reagent customers shuts down its facilities, operates its facilities at low
production levels or sells its facilities resulting in short-term or long-term
disruption of operations, our revenues and net income could be materially
adversely affected. Covol Fuels' licensees must address all operational issues
including, but not limited to, feedstock availability, cost, moisture content,
Btu content, correct chemical reagent formulation and application, operability
of equipment, product durability and overall costs of operations. In some cases,
licensees may be forced to relocate plants and enter into new strategic
contracts to address marketing and operational issues. Licensee plant
relocations disrupt production and delay generation of license fees paid to us.
The growth of Covol Fuels' revenues has depended in part on increased production
over time of coal-based solid synthetic fuel by its licensees. While to date
efficiencies in production and improvements in equipment and processes used at
facilities have allowed increased production, capacity is ultimately finite for
the specific facilities and could ultimately limit future growth.
Covol Fuels must be able to develop and improve synthetic fuel technologies.
For Covol Fuels to remain competitive, we must be able to develop or refine our
technologies to keep up with future synthetic fuel requirements. As licensees
develop and modify their operations and choices of coal feedstocks, we will need
to modify existing methods or find new methods, know-how, additives and other
techniques to meet licensee and customer demands, such as demands for improved
efficiencies, lower costs and improvements in synthetic fuel products, including
chemical change and improved combustion characteristics. If we are unable to
develop or refine our technologies, the revenues and business of Covol Fuels
could be materially harmed.
ISG's growth is dependent upon increased use and market acceptance of fly ash.
ISG's growth has been and continues to be dependent upon the increased use of
fly ash in the production of concrete. ISG's marketing initiatives emphasize the
environmental, cost and performance advantages of replacing portland cement with
fly ash in the production of concrete. If ISG's marketing initiatives are not
successful, ISG may not be able to sustain its growth.
ISG's business is dependent upon the price and supply of fly ash alternatives.
A significant portion of ISG's business is based on the use of fly ash as a
replacement for portland cement in concrete products. There is currently an
overcapacity of cement in the world market, causing potential price decreases.
The markets for ISG's products are regional, in part because of the costs in
transporting CCPs, and ISG's business is affected by the availability and cost
of competing products in the specific regions where it conducts business. If
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competing products become available at more competitive costs, ISG's sales,
revenue and net income could decrease.
ISG's business could be adversely affected by fluctuations in weather and
construction cycles.
ISG manages and markets CCPs and uses CCPs to produce construction materials.
Utilities produce CCPs year-round. In comparison, sales of CCPs are generally
keyed to construction market demands that tend to follow national trends in
construction with predictable increases during temperate seasons. ISG's CCP
sales have historically reflected these seasonal trends, with the largest
percentage of total annual revenues being realized in the quarters ended June 30
and September 30. Low seasonal demand normally results in reduced shipments and
revenues in the quarter ended March 31.
The CCP industry is cyclical because of its dependence on building construction
and highway construction, including infrastructure repair, and is affected by
changes in general and local economic conditions. State construction budgets are
affected adversely by economic downturns. A downturn in the economy in one or
more markets that ISG serves could have a material adverse effect on ISG's
sales.
If ISG's coal-fired electric utility industry suppliers fail to provide ISG with
high quality CCPs on a timely basis, ISG's costs could increase and our growth
could be hindered.
ISG relies on the production of CCPs by coal-fired electric utilities. ISG has
occasionally experienced delays and other problems in obtaining high quality
CCPs from its suppliers and may in the future be unable to obtain high quality
CCPs on the scale and within the time frames required by ISG to meet its
customers' needs. If ISG is unable to obtain CCPs or if it experiences a delay
in the delivery of high quality CCPs, ISG may be forced to incur significant
unanticipated expenses to secure alternative sources or to otherwise maintain
supply to its customers. Moreover, its revenues could be adversely affected if
these customers choose to find alternatives to ISG products.
HTI's technologies may not be commercially developed and marketed profitably.
Although HTI has developed and patented several technologies, commercialization
of these technologies is in initial stages. Market acceptance of these
technologies will depend on our ability to enter into agreements with licensees
or joint venturers to further develop and provide adequate funding to
commercialize the technologies. We can give no assurance that we will be able to
enter into these agreements or that adequate funding will be available to fully
develop and successfully commercialize its technologies or that they can be
marketed profitably.
HTI will conduct business in China, where intellectual property and other laws,
as well as business conditions, could create risks.
HTI has entered into agreements with Shenhua Group, the largest coal company in
the People's Republic of China, to license its direct coal liquefaction
technology for use in a plant in China. We have entered into a preliminary joint
venture agreement for fuel cell technology development and commercialization
with the Dalian Institute of Chemical Physics in China, using our
nanotechnology. In addition, other HTI activities are likely to involve
licensing of other technologies in China. There is the risk that foreign
intellectual property laws will not protect our intellectual property to the
same extent as under United States laws, leaving us vulnerable to competitors
who may attempt to copy our products, processes or technologies. Further, the
legal system of China is based on statutory law. Under this system, prior court
decisions may be cited as persuasive authority but do not have binding
precedential effect. Since 1979, the Chinese government has been developing a
comprehensive system of commercial laws and considerable progress has been made
in the promulgation of laws and regulations dealing with economic matters, such
as corporate organization and governance, foreign investment, commerce, taxation
and trade. As these laws, regulations and legal requirements are relatively new
and because of the limited volume of published case law and judicial
8
interpretations and the non-binding nature of prior court decisions, the
interpretation and enforcement of these laws, regulations and legal requirements
involve some uncertainty. These uncertainties could limit the legal protection
or recourse available to us. In addition, dependence on foreign licenses and
conducting foreign operations may subject us to increased risk from political
change, ownership issues or repatriation or currency exchange concerns.
Environmental regulations could adversely affect our business.
Our operations and those of our suppliers and customers involved in coal-based
energy generation, primarily utilities, are subject to federal, state and local
environmental regulation. The coal-based solid synthetic fuel operations of
Headwaters and its licensees are subject to federal, state and local
environmental regulations that impose limitations on the discharge of pollutants
into the air and water and establish standards for the treatment, storage and
disposal of waste products. In order to establish and operate the synthetic fuel
plants, power plants and operations to collect and transport CCPs and bottom
ash, we, our licensees and customers have obtained various state and local
permits and must comply with processes and procedures that have been approved by
regulatory authorities. Compliance with permits, regulations and the approved
processes and procedures help protect against pollution and contamination, and
are critical to our business. Although we believe that we and our licensees and
customers are in substantial compliance with environmental regulations, permits
and approved processes and procedures, any failure to comply could result in the
issuance of substantial fines and penalties and cause us to incur environmental
liabilities.
The federal Clean Air Act of 1970 and subsequent amendments (particularly the
Clean Air Act Amendments of 1990), and corresponding state laws, regulate the
emissions of materials into the air, and in certain circumstances require
installation of emission control technologies that affect the operation of
coal-fired utility power plants. Current and future emission regulations may
have an adverse impact on the quantity and quality of CCPs produced by utilities
and may add to the costs of operating a power plant. Because ISG manages and
markets CCPs produced by coal-fired utilities, regulations that restrict
coal-burning, make it more expensive or affect the quantity and quality of CCPs
produced by utilities could adversely affect ISG's business.
Materials sold by ISG vary in chemical composition. While CCPs generally have
been excluded from regulation as "hazardous wastes," the EPA is planning to
publish proposed rules for CCPs generated by commercial electric power producers
in August 2004 and for management of CCPs at mine facilities in July 2005 which
will address, among other things, state and regional solid waste plans for CCPs
disposed of in landfills or surface impoundments, or used to fill surface or
underground mines. These proposed rules could make coal burning more expensive
or less attractive to ISG's utility clients. ISG manages a number of landfill
and pond operations that may be affected by EPA's proposed regulations. ISG is
engaged in providing services at one landfill operation that is permitted and
managed as a hazardous waste landfill. ISG provides the services necessary to
landfill the client's hazardous wastes and operates certain in-plant equipment
and systems for the client. Accordingly, there can be no assurance that ISG will
not be named in any third-party claims relating to the project.
CCPs contain small concentrations of metals that are considered as "hazardous
substances" under the Comprehensive Environmental Response Compensation and
Liability Act ("CERCLA"). Land application of CCPs is regulated by a variety of
federal and state statutes, which impose testing and management requirements to
ensure environmental protection. Under certain circumstances, mismanagement of
CCPs could give rise to CERCLA liability.
HTI's ordinary course of business requires using its facilities to perform
research and development activities involving coal, oil, chemicals and energy
technologies, including liquefaction of coal. As a result, petroleum and other
hazardous materials have been and are present in and on HTI's properties.
Regulatory noncompliance or accidental discharges, in spite of safeguards, could
create an environmental liability. Therefore our operations entail risk of
environmental damage, and we could incur liabilities in the future arising from
the discharge of pollutants into the environment or from waste disposal
practices.
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We are involved in significant litigation and are subject to potential claims
relating to our business.
We are a party to some significant legal proceedings and are subject to
potential claims regarding operation of our business. Headwaters was recently
notified of a potential claim involving its recently-acquired VFL Technology
Corp. subsidiary relating to an automobile accident allegedly caused by one of
VFL's employees. The accident involved a fatality and many severe injuries. No
litigation has yet ensued against VFL, and Headwaters is reviewing the potential
allegations of liability and insurance coverage. These proceedings will require
that we incur substantial costs, including attorneys' fees, managerial time and
other personnel resources and costs in pursuing resolution. Adverse resolution
of these proceedings could have a materially negative effect on our business.
We have significant competition.
Headwaters experiences competition from traditional coal and fuel suppliers and
companies involved with natural resources, in addition to those companies that
specialize in the use and upgrading of industrial byproducts. Many of these
companies have greater financial, management and other resources than Headwaters
and may be able to take advantage of acquisitions and other opportunities more
readily. There can be no assurance that Headwaters will be able to do so
successfully.
Coal-based solid synthetic fuels made using Covol Fuels' technologies, from
which Covol Fuels derives license revenues and revenues from sales of chemical
reagents, compete with other synthetic fuel products, as well as traditional
fuels. Covol Fuels' competition includes the marketing of competitive chemical
reagents and the marketing of end products qualifying as synthetic fuel. Covol
Fuels competes with other companies possessing technologies to produce
coal-based solid synthetic fuels and companies that produce chemical reagents
such as Nalco Chemical Company and Accretion Technologies, LLC.
Covol Fuels also experiences competition from traditional coal and fuel
suppliers and companies involved with natural resources, in addition to those
companies that specialize in the use and upgrading of industrial byproducts.
These companies may have greater financial, management and other resources than
Headwaters has. Further, many industrial coal users are limited in the amount of
synthetic fuel product they can purchase from Covol Fuels' licensees because
they have committed to purchase a substantial portion of their coal requirements
through long-term contracts for standard coal.
Synthetic fuel technology and the use of CCPs are the subject of extensive
research and development by our competitors. If competitive technologies are
developed that greatly increase the demand for CCPs or reduce the costs of
synthetic fuels or other resources, the economic viability of our technologies
and business could be adversely affected.
Generally, the business of marketing traditional CCPs and construction materials
is intensely competitive. ISG has substantial competition in three main areas:
obtaining CCP management contracts with utility and other industrial companies;
marketing CCPs and related industrial materials; and marketing its construction
materials. ISG has a presence in every region in the United States, but because
the market for the management of CCPs is highly fragmented and because the costs
of transportation are high relative to sales prices, most of the competition in
the CCP management industry is regional. There are many local, regional and
national companies that compete for market share in these areas with similar
products and with numerous other substitute products. Although ISG typically has
long-term CCP management contracts with its clients, some of such contracts
provide for the termination of such contract at the convenience of the utility
company upon a minimum 90-day notice. Moreover, certain of ISG's most
significant regional CCP competitors appear to be seeking a broader national
presence. These competitors include Lafarge North America Inc., Boral Material
Technologies Inc. and Cemex. Construction materials are produced and sold
regionally by the numerous owners and operators of concrete ready-mix plants.
Producers with sand and gravel sources near growing metropolitan areas have
important transportation advantages. In Texas, ISG's most important construction
materials market, Featherlite Building Products is among ISG's competitors.
10
Certain of these competitors have substantially greater resources than
Headwaters and ISG. If they were to begin to compete in the national market, or
in regions where they currently do not have operations, ISG's business may be
materially adversely affected.
Many of the world's major chemical companies are devoting significant resources
to researching and developing nanocatalysts and catalytic processes. These
companies have greater financial, management and other resources than Headwaters
has. Headwaters' strategy is to enter into license agreements or joint ventures
with major chemical companies for the further development and commercialization
of Headwaters' nanocatalyst technologies.
Our business strategy to grow through acquisitions may not be successful.
An important business strategy of Headwaters is growth through acquisitions. Our
ability to successfully implement our strategy is subject to a number of risks,
including difficulties in identifying acceptable acquisition candidates,
consummating acquisitions on favorable terms and obtaining adequate financing,
which may adversely affect our ability to develop new products and services and
to compete in our rapidly changing marketplace. In addition, if we consummate
acquisitions through an exchange of our securities, our existing stockholders
could suffer dilution. Successful management and integration of acquisitions are
subject to a number of risks, including difficulties in assimilating acquired
operations, including loss of key employees, diversion of management's attention
from core business operations, assumption of contingent liabilities and
incurrence of potentially significant write-offs. There can be no assurance that
we will be successful in implementing our acquisition strategy, that such
strategy will improve our operating results or that these activities will not
have a dilutive effect on existing stockholders.
If we are unable to manage the growth of our business successfully, our revenues
and business prospects could suffer.
We have experienced significant growth recently, both internally and through
acquisitions. We may not be able to successfully manage the increased scope of
our operations or a significantly larger and more geographically diverse
workforce as we expand. Any failure to successfully manage growth could harm our
business and financial results. Additionally, growth increases the demands on
our management, our internal systems, procedures and controls. To successfully
manage growth, we must add administrative staff and periodically update and
strengthen our operating, financial and other systems, procedures and controls,
which will increase our costs and may reduce our profitability. We may be unable
to successfully implement improvements to our information and control systems in
an efficient or timely manner and may discover deficiencies in existing systems
and controls.
Our business could be harmed if we are unable to protect our proprietary
intellectual property.
We rely primarily on a combination of trade secrets, patents, copyright and
trademark laws and confidentiality procedures to protect our intellectual
property. Despite these precautions, unauthorized third parties may
misappropriate, infringe upon, copy or reverse engineer portions of our
technology. We do not know if current or future patent applications will be
issued with the scope of the claims sought, if at all, or whether any patents
issued will be challenged or invalidated. Our business could be harmed if we
infringe upon the intellectual property rights of others. We have been, and may
be in the future, notified that we may be infringing intellectual property
rights possessed by third parties. If any such claims are asserted against us,
we may seek to enter into royalty or licensing arrangements. There is a risk in
these situations that no license will be available or that a license will not be
available on reasonable terms, precluding our use of the applicable technology.
Alternatively, we may decide to litigate such claims or attempt to design around
the patented technology. These actions could be costly and would divert the
efforts and attention of our management and technical personnel. As a result,
any infringement claims by third parties or claims for indemnification by
customers resulting from infringement claims, whether or not proven to be true,
may materially harm our business and prospects.
11
We have significant debt service requirements.
As of March 31, 2004, we had approximately $50 million of total debt
outstanding. We intend to borrow approximately an additional $50 million of
senior indebtedness under our senior secured credit facility for financing the
Eldorado Acquisition in addition to the proposed offering of $150 million of
Convertible Notes. Subject to restrictions in our senior secured credit
facility, following the closing of the Eldorado Acquisition we may also incur
significant amounts of additional debt for working capital, capital expenditures
and other purposes. Our combined debt total could have important consequences
for our company, including the following:
o we may have difficulty borrowing money for working capital,
capital expenditures, acquisitions or other purposes;
o we will need to use a large portion of our cash flow to pay
interest and the required principal payments on borrowings
under our senior secured credit facility and Convertible
Notes, which will reduce the amount of money available to
finance our operations, capital expenditures and other
activities;
o our senior debt has a variable rate of interest, which exposes
us to the risk of increased interest rates;
o borrowings under our senior secured credit facility are
secured by all our assets;
o we may be more vulnerable to economic downturns and adverse
developments in our business;
o we may be less flexible in responding to changing business and
economic conditions, including increased competition and
demand for new products and services; and
o we may not be able to implement our business plans.
Our ability to make scheduled payments of the principal of, to pay interest on
or to refinance our indebtedness depends on our future performance, which to a
certain extent is subject to economic, financial, competitive and other factors
beyond our control. There can be no assurance that our business will continue to
generate cash flow from operations in the future sufficient to service our debt
and make necessary capital expenditures. If unable to generate such cash flow,
we may be required to adopt one or more alternatives, such as selling assets,
restructuring debt or obtaining additional equity capital. There can be no
assurance that any of these strategies could be effected on satisfactory terms
or without substantial additional expense to us. Significant acquisitions may be
funded with additional indebtedness, which would increase debt service
requirements. These and other factors could have a material adverse effect on
our results of operations, liquidity and financial condition.
Covenant restrictions under our senior secured credit facility may limit our
ability to operate our business.
Our senior secured credit facility, which includes a term loan facility,
contains, among other things, covenants that may restrict our ability to finance
future operations or capital needs, to acquire additional businesses or to
engage in other business activities. The senior secured credit facility requires
approval for acquisitions, other than the Eldorado Acquisition, funded with
aggregate cash consideration in excess of $50 million. In addition, our senior
secured credit facility sets forth covenants requiring us to maintain specified
financial ratios and satisfy certain financial condition tests which may require
that we take action to reduce our debt or to act in a manner contrary to our
business objectives. A breach of any of these covenants could result in a
default under our senior secured credit facility, in which event our lenders
could elect to declare all amounts outstanding to be immediately due and
payable, which could materially and adversely affect our financial condition and
results of operations. The offering of Convertible Notes and the Eldorado
Acquisition are permitted by the terms of our senior secured credit facility.
The indenture for the Convertible Notes does not restrict the amount of
indebtedness, including senior indebtedness, that we may incur.
12
We may not have the ability to raise the funds necessary to finance the
repurchase of the Convertible Notes or may otherwise be restricted from making
such repurchase if required by holders pursuant to the indenture.
Assuming that the offering of the Convertible Notes is completed, in 2011, or in
the event of a "designated event" under the indenture, holders may require us to
repurchase their notes at a price of 100% of the principal amount of the notes,
plus accrued and unpaid interest, including liquidated damages, if any, to, but
excluding, the repurchase date. However, it is possible that we will not have
sufficient funds available at such time to make the required repurchase of
notes. Our failure to repurchase tendered notes would constitute an event of
default under the indenture, which might constitute a default under the terms of
our other indebtedness, causing much or all of our indebtedness to become due
simultaneously when we are unable to pay it.
Risks relating to our common stock
Our stock price has been and could remain volatile.
The market price for our common stock has been and may continue to be volatile
and subject to significant price and volume fluctuations in response to market
and other factors, including the following, some of which are beyond our
control:
o variations in our quarterly operating results from our
expectations or those of securities analysts or investors;
o downward revisions in securities analysts' estimates or
changes in general market conditions;
o IRS or other governmental actions, including Congressional
hearings and investigations relating to Section 29 tax credits
and media coverage relating thereto;
o announcement by us or our competitors of significant
acquisitions, strategic partnerships, joint ventures or
capital commitments;
o additions or departures of key personnel;
o insider selling or buying;
o regulatory developments affecting our industry;
o general technological or economic trends; and
o other matters discussed in "Risk Factors."
In the past, following periods of volatility in the market price of their stock,
many companies have been the subject of securities class action litigation. If
we became involved in securities class action litigation in the future, it could
result in substantial costs and diversion of our management's attention and
resources and could harm our stock price, business, prospects, results of
operations and financial condition.
Conversion of the Convertible Notes will dilute the ownership interest of
existing stockholders, including holders who had previously converted their
notes.
Assuming closing of the offering of Convertible Notes, the conversion of some or
all of the notes will dilute the ownership interests of existing stockholders.
Any sales in the public market of the common stock issuable upon such conversion
could adversely affect prevailing market prices of our common stock. In
addition, the existence of the Convertible Notes may encourage short selling by
market participants because the conversion of the notes could depress the price
of our common stock.
13
We have never paid dividends and do not anticipate paying any dividends on our
common stock in the future, so any short-term return on your investment will
depend on the market price of our capital stock.
We currently intend to retain any earnings to finance our operations and growth.
The terms and conditions of our senior secured credit facility restrict and
limit payments or distributions in respect of our capital stock.
Delaware law and our charter documents may impede or discourage a takeover,
which could cause the market price of our shares to decline.
We are a Delaware corporation, and the anti-takeover provisions of Delaware law
impose various impediments to the ability of a third party to acquire control of
us, even if a change in control would be beneficial to our existing
stockholders. In addition, our board of directors has the power, without
stockholder approval, to designate the terms of one or more series of preferred
stock and issue shares of preferred stock, including the adoption of a "poison
pill," which could be used defensively if a takeover is threatened. The ability
of our board of directors to create and issue a new series of preferred stock
and certain provisions of Delaware law and our certificate of incorporation and
bylaws could impede a merger, takeover or other business combination involving
us or discourage a potential acquirer from making a tender offer for our common
stock, which, under certain circumstances, could reduce the market price of our
common stock.
Item 7: Financial Statements and Exhibits.
(a) The following consolidated financial statements of Eldorado Stone
LLC are included herein:
Consolidated Financial Statements for 2001:
Report of Independent Public Accountants
Consolidated Balance Sheet as of December 31, 2001
Consolidated Statement of Operations for the Year Ended
December 31, 2001
Consolidated Statement of Members' Deficit for the Year
Ended December 31, 2001
Consolidated Statement of Cash Flows for the Year Ended
December 31, 2001
Notes to Consolidated Financial Statements
Consolidated Financial Statements for 2002 and 2003:
Report of KPMG LLP, Independent Auditors for 2002 and 2003
Consolidated Balance Sheets as of December 31, 2002 and
2003 and Unaudited Consolidated Balance Sheet as of
March 31, 2004
Consolidated Statements of Operations for the Years Ended
December 31, 2002 and 2003 and Unaudited Three Months
Ended March 31, 2003 and 2004
Consolidated Statements of Members' Deficit for the Years
Ended December 31, 2002 and 2003 and Unaudited Three
Months Ended March 31, 2004
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2002 and 2003 and Unaudited Three Months
Ended March 31, 2003 and 2004
Notes to Consolidated Financial Statements
14
(b) The following unaudited pro forma financial information for
Headwaters Incorporated is included herein:
Introduction to Pro Forma Financial Information
Pro Forma Condensed Combined Balance Sheet as of
March 31, 2004
Pro Forma Condensed Combined Statement of Income for the
Year Ended September 30, 2003
Pro Forma Condensed Combined Statement of Income for the
Six Months Ended March 31, 2004
Notes to Pro Forma Condensed Combined Financial Information
15
Eldorado Stone LLC and Subsidiaries
Consolidated financial statements
As of December 31, 2001
Together with auditors' report
16
Report of independent public accountants
To the members of Eldorado Stone LLC:
We have audited the accompanying consolidated balance sheet of Eldorado Stone
LLC (a Delaware limited liability company) and subsidiaries as of December 31,
2001, and the related consolidated statements of operations, members' deficit,
and cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eldorado Stone LLC
and subsidiaries as of December 31, 2001, and the results of their operations
and their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States.
Arthur Andersen LLP
Philadelphia, Pennsylvania
March 29, 2002
Note: This is a copy of the audit report previously issued by Arthur Andersen
LLP in connection with Eldorado Stone LLC and Subsidiaries' financial statements
for the year ended December 31, 2001. This audit report has not been reissued by
Arthur Andersen LLP in connection with this filing.
17
Eldorado Stone LLC and Subsidiaries
Table of contents
Consolidated balance sheet
As of December 31, 2001................................................
Consolidated statement of operations
For the year ended December 31, 2001 ..................................
Consolidated statement of members' deficit
For the year ended December 31, 2001 ..................................
Consolidated statement of cash flows
For the year ended December 31, 2001 ..................................
Notes to consolidated financial statements
December 31, 2001......................................................
18
Eldorado Stone LLC and Subsidiaries
Consolidated balance sheet
As of December 31, 2001
(in thousands, except unit amounts)
Assets
Current assets:
Cash $ 367
Accounts receivable, net of allowances of $524 7,032
Due from affiliate 145
Inventories, net of reserves of $300 5,601
Prepaid expenses and other 493
---------------
13,638
---------------
Property, plant, and equipment, net 15,960
---------------
Other assets:
Goodwill and intangibles 17,001
Deferred financing costs 2,247
Prepaid management fees and other 1,207
---------------
Total other assets 20,455
---------------
$ 50,053
===============
Liabilities and members' deficit
Current liabilities:
Line of credit $ 1,369
Accounts payable 2,656
Accrued expenses and other 2,072
Current portion of capital lease obligations and long-term debt 3,158
---------------
9,255
Capital lease obligations and long-term debt, net of current portion 47,693
---------------
56,948
---------------
Commitments and contingencies (Note 9)
Members' deficit:
Capital, 100,000 units issued and outstanding 29,632
Retained deficit (36,711)
Accumulated other comprehensive income 184
---------------
(6,895)
---------------
$ 50,053
===============
The accompanying notes are an integral part of this consolidated financial statement.
19
Eldorado Stone LLC and Subsidiaries
Consolidated statement of operations
For the year ended December 31, 2001
(in thousands)
Net sales $ 49,165
Cost of sales 29,772
---------------
Gross profit 19,393
---------------
Operating expenses:
Sales and marketing 3,759
General and administrative 9,088
---------------
12,847
---------------
Operating income 6,546
Interest expense 3,717
---------------
Net income $ 2,829
===============
The accompanying notes are an integral part of this consolidated financial statement.
20
Eldorado Stone LLC and Subsidiaries
Consolidated statement of members' deficit
For the year ended December 31, 2001
(in thousands)
Accumulated other
Retained comprehensive
Capital deficit income Total
----------- ----------- ------------------ -----------
Balance, January 1, 2001 $ 8,000 $ 19,839 $ - $ 27,839
Net income - 2,829 2,829
Net gain on derivative instruments - - 238 238
Reclassification of net gains
on derivative instruments - - (54) (54)
-----------
Total comprehensive income 3,013
-----------
Recapitalization 21,632 (59,379) - (37,747)
----------- ----------- ----------- -----------
Balance, December 31, 2001 $ 29,632 $ (36,711) $ 184 $ (6,895)
=========== =========== =========== ===========
The accompanying notes are an integral part of this consolidated financial statement.
21
Eldorado Stone LLC and Subsidiaries
Consolidated statement of cash flows
For the year ended December 31, 2001
(in thousands)
Cash flows from operating activities:
Net income $ 2,829
Adjustments to reconcile net income to net cash provided by operating
activities -
Depreciation and amortization 6,969
Changes in noncash working capital:
Accounts receivable (10)
Inventories (1,789)
Prepaid expenses and other assets (1,553)
Accounts payable (401)
Accrued expenses (290)
------------
Net cash provided by operating activities 5,755
------------
Cash flows from investing activities:
Payments for acquisitions (10,077)
Purchases of property, plant, and equipment (4,961)
------------
Net cash used in investing activities (15,038)
------------
Cash flows from financing activities:
Net proceeds from borrowings on line of credit 1,119
Proceeds from principal borrowings on long-term debt (including deferred 49,836
financing costs)
Principal repayments of long-term debt (4,879)
Issuance of membership units 21,632
Repurchase of ownership interests (59,379)
------------
Net cash provided by financing activities 8,329
------------
Net decrease in cash (954)
Cash, beginning of year 1,321
------------
Cash, end of year $ 367
============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 3,214
============
The accompanying notes are an integral part of this consolidated financial statement.
22
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
1. Business, recapitalization and acquisition:
Business
Eldorado Stone LLC (the Company) and subsidiaries, a Delaware limited liability
company, manufactures and distributes the Eldorado Stone(R) brand of artificial
or pre-cast stone products to customers primarily located throughout the United
States. The Company also franchises the production of Eldorado Stone(R) products
to regional manufacturers located In the United States and other countries.
These products include interior and exterior veneer and decorative and
functional landscape materials, as well as the molds used in the manufacture of
these products.
Effective July 1, 2000, the Company was formed to own and manage the operations
of four newly-formed limited liability companies. Each of these new limited
liability companies were formed from the contribution of substantially all of
the respective operating assets and liabilities of four predecessor operating
companies. This transaction was accounted for as a purchase business
combination, with StoneCraft Industries' LLC as the acquirer and Eldorado Stone
Operations LLC, Northwest Stone & Brick Company LLC, and Northwest Properties
LLC as the acquired subsidiaries.
Recapitalization
On February 20, 2001, an investor group acquired a controlling interest in the
Company through a leveraged recapitalization (the Recapitalization) after which
the Company continued to use its historical cost basis and the new investor
group's basis was not "pushed down" to the Company.
The principal elements of the Recapitalization include (1) the redemption of
stock of unit holding companies for $13.9 million, (ii) the purchase of stock of
unit holding companies for $5.9 million, (iii) the purchase of units for $28.7
million, (iv) repayment of existing Company debt of $4.3 million, and (v) a
transfer of $3.4 million into escrow which will be distributed to the sellers
when certain conditions are achieved.
The Company incurred approximately $7.2 million in transaction costs related to
the Recapitalization. Costs of approximately $1.6 million associated with the
credit facilities to effect the recapitalization were deferred. Costs of $2.4
million directly related to the sale and redemption of stock, as well as the
payment of the sellers transaction expenses of $3.2 million have been charged to
equity as costs of completing such transactions. These funds were provided by
capital contributions of $21.6 million, borrowings of $17.0 million under the
Term A loan, borrowings of $16.0 million under the Term B loan, and borrowings
of $9.0 million under subordinated promissory notes.
23
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
Following the Recapitalization the investor group and the historical members of
the limited liability company had ownership interests of approximately 72.9
percent and 27.1 percent, respectively.
Acquisition
On August 1, 2001, the Company purchased significantly all of the assets and
assumed significantly all of the liabilities of L&S Stone, Inc. The results of
the acquired company's operations have been included in the consolidated
financial statements since that date. L&S Stone, Inc. was a franchisee of a
subsidiary of the Company. The transaction was accounted for as a purchase
business combination under Statement of Financial Accounting Standards (SFAS)
No. 141, "Business Combinations."
The purchase price of the acquisition was $10.1 million. The following table
summarizes the estimated fair values of the assets acquired and liabilities
assumed at the date of acquisition (in thousands):
Current assets $ 4,921
Property, plant, and equipment 3,708
Acquired intangible assets 3,635
------------
Total assets acquired 12,264
Total liabilities assumed (2,187)
------------
Net assets acquired $ 10,077
============
The $3.6 million of acquired intangible assets was allocated to the territorial
exclusivity of the franchisee and its access to the technology and manufacturing
expertise related to the tooling used in the production of Eldorado Stone(R)
brand products. This amount is being amortized on a straight-line basis over
five years.
2. Summary of significant accounting policies:
Principles of consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All significant intercompany balances and transactions have
been eliminated.
Cash and cash equivalents
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out (FIFO) method.
24
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
Property, plant, and equipment
Property, plant, and equipment are recorded at cost. Expenditures for major
renewals and betterments are capitalized and normal maintenance and repairs are
expensed as incurred.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets as follows:
Buildings 15 - 40 years
Machinery and equipment 5 - 10 years
Molds 3 years
Leasehold improvements Lesser of 10 years
or life of lease
Furniture, fixtures, and office equipment 3 - 10 years
Vehicles 5 years
Gains and losses on disposal are recognized in the year of the disposition.
Goodwill
Goodwill of $806,000, which represents the excess of cost over fair value of net
assets of acquired businesses, is being amortized on a straight-line basis over
15 years. The Company develops operating income projections and evaluates the
recoverability and amortization period of goodwill using these projections.
Based upon management's current assessment, the estimated remaining amortization
period of goodwill is appropriate and the remaining balance is fully
recoverable. Total amortization expense related to goodwill for 2001 was $54,000
and accumulated amortization as of December 31, 2001 was $81,000.
Intangible assets
Intangible assets of $20,985,000 consist of value assigned to manufacturing
expertise and technology related the tooling used in the production of Eldorado
Stone(R) brand products and the territorial exclusivity of franchisees and their
access to this technology. These intangible assets are being amortized on a
straight-line basis over the estimated life of current tooling technology and
the terms of the franchise agreements which are five to seven years. The Company
develops operating income projections and evaluates the recoverability and
amortization period of intangibles using these projections. Based upon
management's current assessment, the estimated remaining amortization period of
the intangibles are appropriate and the remaining balance is fully recoverable.
Total amortization expense related to intangible assets for 2001 was $3,251,000
and accumulated amortization as of December 31, 2001 was $4,709,000.
25
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
Other assets
Other assets consist principally of deferred financing fees paid in connection
with the Recapitalization and acquisition transactions and prepaid management
fees (see Note 8). These amounts are being amortized on a straight-line basis
over the following periods:
Deferred financing costs 6 years Prepaid management fees 5 years Total
amortization expense related to these assets was approximately $563,000 for the
year ended December 31, 2001.
Revenue recognition
Revenue is recognized upon shipment of products, net of allowances for estimated
discounts and returns which are provided at the time of sale based on the
Company's discount policies and historical experience.
Income taxes
The Company is a limited liability company and is not subject to federal and
state income taxes. The taxable income is reported by its members as allocated
under the terms of the Limited Liability Company Agreement.
Shipping and handling fees
The Company accounts for shipping and handling fees In accordance with the
provisions of Emerging Issues Task Force (EITF) Issue No. 00-10, "Accounting for
Shipping and Handling Fees and Costs," which requires amounts billed to
customers for shipping and handling be classified as net sales. Costs associated
with shipping and handling are included in cost of sales in the consolidated
statement of operations.
Use of estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Long-lived assets
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of," requires review of the carrying value of
long-lived assets and certain intangibles for impairment when events or changes
in circumstances indicate that the carrying amount of the asset may not be
recoverable. The Company assesses at each balance sheet date whether there has
been a permanent impairment in the value of these assets. This assessment
26
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
includes such factors as obsolescence, demand, new technology, competition, and
other pertinent economic factors and trends that may have an impact on the value
of remaining lives of these assets. The measurement of possible impairment is
based on the ability to recover the balance of these assets from expected future
operating cash flows on an undiscounted basis. There was no impairment of assets
recorded during the year ended December 31, 2001.
Accounting for derivative instruments and hedging activities
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended, on January 1, 2001, at which time there was no
effect on the consolidated financial statements. Effective with the adoption of
this pronouncement, the Company recognizes all derivatives on the balance sheet
at fair value. On the date the derivative instrument is entered into, the
Company generally designates the derivative as either (1) a hedge of the fair
value of a recognized asset or liability or of an unrecognized firm commitment
(fair value hedge) or (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability (cash flow hedge). Changes in the fair value of a derivative that
is designated as, and meets all the required criteria for, a fair value hedge,
along with the gain or loss on the hedged asset or liability that is
attributable to the hedged risk, are recorded in current period earnings.
Changes in the fair value of a derivative that is designated as, and meets all
the required criteria for, a cash flow hedge are recorded in accumulated other
comprehensive income and reclassified into earnings as the underlying hedged
item affects earnings. The portion of the change in fair value of a derivative
associated with hedge ineffectiveness or the component of a derivative
instrument excluded from the assessment of hedge effectiveness is recorded
currently in earnings. Also, changes in the entire fair value of a derivative
that is not designated as a hedge are recorded immediately in earnings. The
Company formally documents all relationships between hedging instruments and
hedged items, as well as its risk-management objective and strategy for
undertaking various hedge transactions. This process includes relating all
derivatives that are designated as fair value or cash flow hedges to specific
assets and liabilities on the balance sheet or to specific firm commitments or
forecasted transactions.
During October 2001, the Company entered into an interest rate swap agreement,
which is outstanding at December 31, 2001 to effectively convert LIBOR-based
variable rate debt to fixed rate debt. At December 31, 2001, the notional amount
of the contract was $37,875,000. The notional amount of the swap will decrease
throughout the life of the swap to a final notional amount of $26,437,500 on
October 29, 2004. The contract matures on October 31, 2004. The Company will
receive variable rate payments based on LIBOR from third parties and is
obligated to pay fixed interest rate payments (equal to 3.72 percent) to the
third parties during the term of the contract.
During 2001, the Company reclassified $54,000 of net gains on derivative
instruments into earnings. In addition, the change in fair value of the
derivative instruments during 2001 was a gain of $238,000. At December 31, 2001,
the net unrealized gain on the interest rate swaps was $184,000 and is reflect
as an asset on the balance sheet and in accumulated other comprehensive income.
In 2001, the net gain resulting from cash flow hedge ineffectiveness was not
significant.
27
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
3. Fair value of financial instruments:
The Company's financial instruments consist primarily of cash, accounts
receivable, accounts payable, and debt. Carrying amounts of cash, accounts
receivable, and accounts payable approximate their fair values because of the
short-term maturity of such instruments. The carrying values of long-term debt
instruments approximate their fair value because interest rates on such debt are
periodically adjusted and approximate current market rates. The interest rate
swap is recorded at fair value in the consolidating balance sheet.
4. New accounting standards:
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
142, "Goodwill and Other Intangible Assets." SFAS No. 142 addresses financial
accounting and reporting for acquired goodwill and other intangible assets. The
Statement provides that goodwill and some intangibles will no longer be
amortized on a recurring basis. Goodwill and intangible assets with an
indefinite life will be subject to an initial impairment test within six months
of adoption of SFAS No. 142 and annually thereafter. The Statement also requires
disclosure of certain information about goodwill and other intangible assets
subsequent to their acquisition. The Company will adopt SFAS No. 142 in 2002.
During 2001, total goodwill amortized was $54,000. The Company is currently
evaluating the impact of adopting this pronouncement.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." The statement supersedes SFAS No. 121. The
statement also supersedes Accounting Principles Board Opinion (APB) No. 30
provisions related to the accounting and reporting for the disposal of a segment
of a business. This statement establishes a single accounting model, based on
the framework established in SFAS No. 121, for long-lived assets to be disposed
of by sale. The statement retains most of the requirements in SFAS No. 121
related to the recognition of impairment of long-lived assets to be held and
used. The statement is effective for fiscal years beginning after December 15,
2001, with earlier adoption encouraged. The Company is currently evaluating the
impact of adopting this pronouncement
5. Inventories:
Inventories consist of the following (in thousands):
Raw materials $ 647
Finished goods 5,254
Less - Reserves (300)
------------
$ 5,601
============
At December 31, 2001, approximately $155,000 of inventories were located with a
related entity in Mexico (see Note 8).
28
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
6. Property, plant and equipment:
Property, plant, and equipment, net consists of the following (in thousands):
Land $ 1,210
Buildings 4,340
Machinery and equipment 6,465
Office equipment, furniture, and fixtures 555
Auto equipment 1,196
Molds, tooling, and plugs 7,991
Leasehold improvements 2,031
Property held for investment 15
Less-Accumulated depreciation (7,843)
------------
$ 15,960
============
Molds and tooling are used to manufacture stone products while plugs are used to
produce the molds. Depreciation expense was $3,101,000 for the year ended
December 31, 2001.
At December 31, 2001, the Company had approximately $122,000 of property and
equipment, net, located with a related entity in Mexico (see Note 8).
7. Long-term debt:
Long-term debt consists of the following (in thousands):
Term A loan, due February 20, 2006 $ 19,500
Term B loan, due February 20, 2007 22,000
Subordinated promissory notes, due February 20, 2008 9,000
------------
50,500
Less-Current portion 3,000
------------
$ 47,500
============
In connection with the Recapitalization, the Company entered into a senior
credit agreement (the Credit Agreement) dated February 20, 2001, with various
financial institutions (the Lenders). Pursuant to the terms of the Credit
Agreement, the Company obtained from the Lenders a Term A loan, a Term B loan, a
Line of Credit, and also entered into four subordinated promissory notes (the
Notes), as described below. The Company amended the Credit Agreement in
connection with the acquisition of L&S Stone, Inc. (see Note 1).
The Credit Agreement places restrictions on the activities of the Company and
requires the maintenance of certain financial ratios, including subordinated
debt to EBITDA, total debt to EBITDA and interest coverage ratios, among other
29
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
restrictions. As of December 31, 2001, the Company was in compliance with all
covenants included in the Credit Agreement. The Credit Agreement is
collateralized by certain assets of the Company.
The Company has two term loans totaling $41,500,000-Term A loan for $19,500,000
and Term B loan for $22,000,000. Term A loan has a maturity date of February 20,
2006, and requires quarterly repayments beginning on June 30, 2001. These
repayments vary and gradually increase through the loan period. Principal
amounts outstanding under Term A loan accrue interest at a rate ranging from
LIBOR plus 250 basis points to LIBOR plus 350 basis points, depending on the
Company's total debt to EBITDA ratio (4.91 percent at December 31, 2001) and are
payable on a quarterly basis. Term B loan has a maturity date of February 20,
2007 and requires quarterly repayments of $5,500,000 on March 31, 2006, June 30,
2006, September 30, 2006 and February 20, 2007. Principal amounts outstanding
under Term B loan accrue interest at LIBOR plus 400 basis points (5.91 percent
at December 31, 2001) and are payable on a quarterly basis.
The Company entered into the Notes also on February 20, 2001, which have
principal amounts totaling $9,000,000. The Notes bear interest on the principal
amount at the rate of 13 percent per annum and have a maturity date of February
20, 2008. In connection with the Notes, the Company issued warrants to the
lenders to acquire 4,987 units of the Company.
The Line of Credit, which matures on February 20, 2006, accrues interest at
rates ranging from Prime plus 150 basis points to Prime plus 250 basis points.
The interest rate on borrowings under the Line of Credit at December 31, 2001
was 6.75 percent. The average amount outstanding under the Line of Credit was
approximately $704,000 during the year-ended December 31, 2001. The maximum
amount outstanding during the period was $2,187,000. The Company pays a
commitment fee equal to 1/2 of 1 percent on the average daily unused borrowings
under the Credit Facility.
Scheduled maturities of long-term debt are as follows (in thousands):
2002 $ 3,000
2003 5,000
2004 5,500
2005 4,500
2006 18,000
Thereafter 14,500
------------
$ 50,500
============
30
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
8. Related-party transactions:
Note receivable from member
A note receivable from a member of $43,000 is included in prepaid expenses and
other on the accompanying consolidated balance sheet. It is unsecured,
noninterest-bearing and does not contain specific repayment terms.
Mexico operations
The Company uses the services of a manufacturing subcontractor related through
common ownership. The Company advances amounts to this entity on a regular basis
to assist with operations. Charges incurred for materials purchased and services
provided were approximately $3,176,000 for the year ended December 31, 2001 and
are included in cost of sales. A net amount due of $145,000 from this entity is
included in due from affiliate on the accompanying consolidated balance sheet.
Prepaid management fee
In connection with the Recapitalization, the Company prepaid $1.4 million in
management fees to an investor for future management services that will be
provided to the Company over the next five years.
9. Commitments and contingencies:
Franchise agreements
A subsidiary of the Company franchises the production of Eldorado Stone(R)
products to various regional manufacturers, including the other subsidiaries of
the Company. In connection with granting exclusive manufacturing rights in a
given area, the subsidiary agrees to provide informal training, marketing
information, assistance with openings of plants, and new and replacement molds
at mutually agreed upon prices. Total franchise fees and royalty income to
franchisees other than the other subsidiaries of the Company was $888,000 and
sales of molds to franchisees other than the other subsidiaries of the Company
was $2,429,000 for the year ended December 31, 2001.
Operating leases
The Company leases certain of its office and warehouse facilities as well as
certain equipment under noncancellable operating leases. Rent expense under
these leases was approximately $675,000 in 2001.
The future minimum rental payments under noncancellable operating leases are as
follows (in thousands):
31
Eldorado Stone LLC and Subsidiaries
Notes to consolidated financial statements
December 31, 2001
2002 $ 893
2003 781
2004 453
2005 200
2006 197
Capital leases obligations
Annual payments due under capital lease obligations
are as follows (in thousands):
2002 $ 175
2003 115
2004 57
2005 33
2006 and thereafter 11
------------
Total payments 391
Amount representing interest (40)
------------
Present value of payments 351
Current portion (158)
------------
Long-term portion $ 193
============
Legal claims
The Company is subject to certain legal proceedings and claims arising in the
ordinary course of business. Management believes that the disposition of these
matters will not have a material adverse affect on the Company's consolidated
financial position or results of operations.
10. Concentration of credit risk:
Financial instruments which potentially subject the Company to concentrations of
credit risk consist principally of trade receivables from wholesale
distributors, dealers, and franchisees located throughout the United States,
Japan, Canada and Mexico. The Company performs ongoing credit evaluations of its
customers' financial condition and, to date, has not experienced any material
losses.
32
Independent Auditors' Report
The Members
Eldorado Stone LLC:
We have audited the accompanying consolidated balance sheets of Eldorado Stone
LLC and subsidiaries as of December 31, 2002 and 2003, and the related
consolidated statements of operations, members' deficit, and cash flows for the
years then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eldorado Stone LLC
and subsidiaries as of December 31, 2002 and 2003, and the results of their
operations and their cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
San Diego, California
March 5, 2004
33
ELDORADO STONE LLC AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except unit amounts)
December 31, March 31,
--------------------------------- --------------
Assets 2002 2003 2004
-------------- -------------- --------------
(unaudited)
Current assets:
Cash and cash equivalents $ 992 $ - $ -
Accounts receivable, net of allowances of $643, $732 and $799,
respectively 10,988 14,530 16,173
Inventories 9,655 13,078 17,155
Prepaid expenses and other current assets 924 1,393 1,553
-------------- -------------- --------------
Total current assets 22,559 29,001 34,881
-------------- -------------- --------------
Property, plant, and equipment, net 18,544 21,035 22,017
-------------- -------------- --------------
Other assets:
Intangibles, net 22,102 17,789 16,327
Goodwill 725 725 725
Deferred financing costs, net 1,923 1,454 1,432
Prepaid management fees and other assets 1,094 603 534
Due from affiliate 399 399 399
-------------- -------------- --------------
Total other assets 26,243 20,970 19,417
-------------- -------------- --------------
$ 67,346 $ 71,006 $ 76,315
============== ============== ==============
Liabilities and Members' Deficit
Current liabilities:
Accounts payable $ 6,674 $ 8,075 $ 9,215
Accrued expenses and other current liabilities 2,607 3,741 3,985
Current portion of obligations under noncompete agreements 600 700 700
Current portion of long-term debt 5,000 5,500 5,500
Current portion of capital lease obligations and other
long-term debt 74 53 53
-------------- -------------- --------------
Total current liabilities 14,955 18,069 19,453
Obligations under noncompete agreements 2,400 2,100 2,000
Unrealized loss on derivative instruments 2,257 1,156 844
Line of credit 3,140 9,225 9,300
Long-term debt, net of current portion 52,500 47,000 51,625
Capital lease obligations and long-term debt, net of current portion 123 38 26
-------------- -------------- --------------
Total liabilities 75,375 77,588 83,248
-------------- -------------- --------------
Commitments and contingencies (note 11)
Members' deficit:
Capital, authorized 117,861, issued and outstanding 100,000 units 29,632 29,632 29,632
Accumulated deficit (35,404) (35,058) (35,721)
Accumulated other comprehensive loss (2,257) (1,156) (844)
-------------- -------------- --------------
Total members' deficit (8,029) (6,582) (6,933)
-------------- -------------- --------------
$ 67,346 $ 71,006 $ 76,315
============== ============== ==============
See accompanying notes to consolidated financial statements.
34
ELDORADO STONE LLC AND SUBSIDIARIES
Consolidated Statements of Operations
(In thousands)
For the years ended For the three months
December 31, ended March 31,
--------------------------- ----------------------
2002 2003 2003 2004
-------- --------- -------- --------
(unaudited) (unaudited)
Net sales . . . . . . . . . . . . . . $ 76,786 $ 103,659 $ 19,494 $ 27,763
Cost of sales . . . . . . . . . . . . 48,673 72,059 14,280 19,586
-------- --------- -------- --------
Gross profit . . . . . . . . . 28,113 31,600 5,214 8,177
Operating expenses: . . . . . . . . .
Sales and marketing . . . . . . . 6,519 8,280 2,087 2,657
General and administrative . . . . 12,340 15,306 3,379 4,287
-------- --------- -------- --------
Operating income (loss) . . . . 9,254 8,014 (252) 1,233
Interest expense . . . . . . . . . . . 4,969 5,349 1,365 1,380
-------- --------- -------- --------
Net income (loss) . . . . . . . $ 4,285 $ 2,665 $ (1,617) $ (147)
======== ========= ======== ========
See accompanying notes to consolidated financial statements.
35
ELDORADO STONE LLC AND SUBSIDIARIES
Consolidated Statements of Members' Deficit
(In thousands)
Accumulated
Accumulated/ other
retained comprehensive
Units Capital deficit income (loss) Total
--------- ------------ ------------ ------------ ------------
Balance, December 31, 2001 100,000 $ 29,632 $ (36,711) $ 184 $ (6,895)
Comprehensive income:
Net income - - 4,285 - 4,285
Net unrealized loss on derivative instruments - - - (3,110) (3,110)
Reclassification of net losses on
derivative instruments - - - 669 669
--------- ------------ ------------ ------------ ------------
Total comprehensive income 1,844
Dividend distributions - - (2,978) - (2,978)
--------- ------------ ------------ ------------ ------------
Balance, December 31, 2002 100,000 29,632 (35,404) (2,257) (8,029)
Comprehensive income:
Net income - - 2,665 - 2,665
Unrealized net gain on derivative instruments - - - 271 271
Reclassification of net losses on
derivative instruments - - - 830 830
--------- ------------ ------------ ------------ ------------
Total comprehensive income 3,766
Dividend distributions - - (2,319) - (2,319)
--------- ------------ ------------ ------------ ------------
Balance, December 31, 2003 100,000 29,632 (35,058) (1,156) (6,582)
Comprehensive income:
Net income (unaudited) - - (147) - (147)
Unrealized net gain on derivative
instruments (unaudited) - - - 117 117
Reclassification of net losses on
derivative instruments (unaudited) - - - 195 195
--------- ------------ ------------ ------------ ------------
Total comprehensive income (unaudited) 165
Dividend distributions (unaudited) - - (516) - (516)
--------- ------------ ------------ ------------ ------------
Balance, March 31, 2004 (unaudited) 100,000 $ 29,632 $ (35,721) $ (844) $ (6,933)
========= ============ ============ ============ ============
See accompanying notes to consolidated financial statements.
36
ELDORADO STONE LLC AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)
For the years ended For the three months
December 31, ended March 31,
------------------------------- ----------------------------
2002 2003 2003 2004
------------ ------------ ------------ ------------
(unaudited) (unaudited)
Cash flows from operating activities:
Net income (loss) $ 4,285 $ 2,665 $ (1,617) $ (147)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 9,676 13,972 3,758 3,503
Changes in noncash working capital,
net of acquisitions:
Accounts receivable, net (3,785) (3,478) (925) (1,643)
Inventories, net (3,616) (3,212) (2,667) (4,077)
Prepaid expenses and other current assets (592) (465) (605) (160)
Prepaid management fees and other assets (320) 128 (57) (26)
Accounts payable 3,940 1,354 (560) 1,140
Accrued expenses and other current
liabilities 159 434 505 244
------------ ------------ ------------ ------------
Net cash provided by (used in)
operating activities 9,747 11,398 (2,168) (1,166)
------------ ------------ ------------ ------------
Cash flows from investing activities:
Cash paid for acquisitions (8,792) (1,843) (750) (19)
Purchases of property, plant, and equipment (5,965) (8,492) (2,475) (2,752)
------------ ------------ ------------ ------------
Net cash used in investing activities (14,757) (10,335) (3,225) (2,771)
------------ ------------ ------------ ------------
Cash flows from financing activities:
Net proceeds from borrowings on line of credit 1,771 6,085 6,900 75
Principal repayments on capital lease obligations (158) (112) (19) (12)
Principal repayments on noncompete obligations - (600) - (100)
Repayments of notes payable (3,000) (4,993) (1,250) (1,375)
Payment of debt financing costs - (116) - (135)
Proceeds from principal borrowings on long-term debt 10,000 - - 6,000
Dividend distributions (2,978) (2,319) (846) (516)
------------ ------------ ------------ ------------
Net cash provided by (used in)
financing activities 5,635 (2,055) 4,785 3,937
------------ ------------ ------------ ------------
Net increase (decrease) in cash
and cash equivalents 625 (992) (608) -
Cash and cash equivalents, beginning of period 367 992 992 -
------------ ------------ ------------ ------------
Cash and cash equivalents, end of period $ 992 $ - $ 384 $ -
============ ============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 4,103 $ 4,713 $ 987 $ 1,177
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
37
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Information as of March 31, 2004 and for the three months ended March
31, 2003 and 2004 is unaudited)
(1) Business and Acquisitions
(a) Business
Eldorado Stone LLC (the Company) and subsidiaries, a Delaware limited
liability company, manufactures and distributes the Eldorado Stone(R)
brand of artificial or pre-cast stone products to customers primarily
located throughout the United States. The Company also franchises the
production of Eldorado Stone(R) products to regional manufacturers
located in the United States and other countries. These products
include interior and exterior veneer and decorative and functional
landscape materials, as well as the molds used in the manufacture of
these products.
Effective July 1, 2000, the Company was formed to own and manage the
operations of four newly-formed limited liability companies. Each of
these new limited liability companies was formed from the contribution
of substantially all of the respective operating assets and
liabilities of four predecessor operating companies. This transaction
was accounted for as a purchase business combination, with StoneCraft
Industries LLC as the acquirer and Eldorado Stone Operations LLC,
Northwest Stone & Brick Company LLC, and Northwest Properties LLC as
the acquired subsidiaries.
(b) Recapitalization
On February 20, 2001, an investor group acquired a controlling
interest in the Company through a recapitalization (the
Recapitalization) after which the Company continued to use its
historical cost basis and the new investor group's basis was not
"pushed down" to the Company.
The principal elements of the Recapitalization included (i) the
redemption of stock of unit holding companies for $13.9 million, (ii)
the purchase of stock of unit holding companies for $5.9 million,
(iii) the purchase of units for $28.7 million, (iv) repayment of
existing Company debt of $4.3 million, and (v) a transfer of $3.4
million into escrow which was distributed to the sellers when certain
conditions were achieved.
The Company incurred approximately $7.2 million in transaction costs
related to the Recapitalization. Costs of approximately $1.6 million
associated with the debt facilities to effect the Recapitalization
were deferred. Costs of $2.4 million directly related to the sale and
redemption of stock, as well as the payment of the sellers'
transaction expenses of $3.2 million have been charged to equity as
costs of completing such transactions. These funds were provided by
capital contributions of $21.6 million, borrowings of $17.0 million
under the Term A loan, borrowings of $16.0 million under the Term B
loan, and borrowings of $9.0 million under subordinated promissory
notes.
Following the Recapitalization the investor group and senior
management had ownership interests of approximately 72.9 percent and
27.1 percent, respectively.
38
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(c) Acquisitions
L&S Stone, Inc.
On August 1, 2001, the Company purchased significantly all of the
assets and assumed significantly all of the liabilities of L&S Stone,
Inc., a manufacturer and distributor of the Eldorado Stone(R) brand of
artificial or pre-cast stone products. The results of the acquired
company's operations have been included in the consolidated financial
statements since that date. The transaction was accounted for as a
purchase business combination.
The purchase price of the acquisition was $10.1 million. The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in thousands):
Current assets $ 4,921
------------
Property, plant, and equipment 3,708
Acquired intangible assets 3,635
------------
12,264
Total liabilities assumed (2,187)
------------
Net assets acquired $ 10,077
============
The $3.6 million of acquired intangible assets was allocated to the
territorial exclusivity of the franchisee and its access to the
technology and manufacturing expertise related to the tooling used in
the production of Eldorado Stone(R) brand products. This amount is
being amortized on a straight-line basis over five years.
Tempe Stone LLC
On April 30, 2002, the Company purchased significantly all of the
assets and assumed significantly all of the liabilities of Tempe Stone
LLC, a manufacturer and distributor of the Eldorado Stone(R) brand of
artificial or pre-cast stone products. The results of the acquired
company's operations have been included in the consolidated financial
statements since that date. The transaction was accounted for as a
purchase business combination.
The purchase price of the acquisition was $4.3 million. The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in thousands):
Current assets $ 173
Property, plant, and equipment 700
Acquired intangible assets 3,400
----------
Net assets acquired $ 4,273
==========
The $3.4 million of acquired intangible assets were allocated to the
territorial exclusivity of the franchise and its access to the
technology and manufacturing expertise related to the tooling used in
the production of its products. This amount is being amortized on a
straight-line basis over five years.
In conjunction with the acquisition, an agreement to not compete for
five years was entered into by the seller of Tempe Stone LLC with the
Company. As part of this agreement, the Company will pay the seller
$200,000 per year for five years, totaling $1,000,000.
L-B Stone, Inc.
On December 31, 2002, the Company purchased significantly all of the
assets and assumed significantly all of the liabilities of L-B Stone,
Inc., a manufacturer and distributor of the Eldorado Stone(R) brand of
artificial or pre-cast stone products. The results of the acquired
company's operations have been included in the consolidated financial
statements since that date. The transaction was accounted for as a
purchase business combination.
The purchase price of the acquisition was $7.8 million. The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in thousands):
Current assets $ 715
Property, plant, and equipment 835
Acquired intangible assets 6,425
----------
Total assets acquired 7,975
Total liabilities assumed (180)
----------
Net assets acquired $ 7,795
==========
The $6.4 million of acquired intangible assets was allocated to the
territorial exclusivity of the franchise and its access to the
technology and manufacturing expertise related to the tooling used in
the production of its products. This amount is being amortized on a
straight-line basis over five years.
In conjunction with the acquisition, an agreement to not compete for
five years was entered into by the seller of L-B Stone, Inc. As part
of this agreement, the Company will pay the seller $400,000 per year
for five years, totaling $2,000,000.
Eagle Stone & Brick LLC
On January 3, 2003, the Company purchased significantly all of the
assets and assumed significantly all of the liabilities of Eagle Stone
& Brick LLC, a manufacturer and distributor of the Eldorado Stone(R)
brand of artificial or pre-cast stone products. The results of the
acquired company's operations have been included in the consolidated
financial statements since that date. The transaction was accounted
for as a purchase business combination.
39
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The purchase price of the acquisition was $1.3 million. The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in thousands):
Current assets $ 222
Property, plant, and equipment 298
Acquired intangible assets 811
---------
1,331
Total liabilities assumed (63)
---------
Net assets acquired $ 1,268
=========
The $811,000 of acquired intangible assets were allocated to the
territorial exclusivity of the franchise and its access to the
technology and manufacturing expertise related to the tooling used in
the production of its products. This amount is being amortized on a
straight-line basis over five years.
In conjunction with the acquisition, an agreement to not compete for
five years was entered into by the seller of Eagle Stone & Brick LLC
with the Company. As part of this agreement, the Company will pay the
seller $100,000 per year for five years, totaling $500,000.
Impamerica, S.A. de C.V.
On September 8, 2003, the Company purchased certain of the assets of
Impamerica, S.A. de C.V., a manufacturer and distributor of the
Eldorado Stone(R) brand of artificial or pre-cast stone products. The
transaction was accounted for as a purchase business combination.
The purchase price of the acquisition was $642,000. The following
table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in thousands):
Current assets $ 59
Property, plant, and equipment 397
Acquired intangible assets 186
--------
Net assets acquired $ 642
========
The $186,000 of acquired intangible assets was allocated to the
territorial exclusivity of the franchise and its access to the
technology and manufacturing expertise related to the tooling used in
the production of its products. This amount is being amortized on a
straight-line basis over five years.
Earn out Consideration
In connection with the L&S Stone, Inc., the Tempe Stone LLC and the
Eagle Stone & Brick LLC acquisitions, the Company agreed to make
additional future payments to sellers that are contingent upon the
acquired entities' achievement of specific performance-based
milestones. Pursuant to the provisions of SFAS No. 141, Business
Combinations, such contingent liabilities are recognized by the
Company when the contingency is determinable beyond a reasonable doubt
40
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and, hence, the additional consideration becomes payable. During the
years ended as of December 31, 2002 and 2003, $275,000 and $363,000,
respectively, of earn out consideration was recognized. These amounts
are an adjustment to the purchase price of the acquired company, and
were recorded as an intangible asset and are being amortized on a
straight-line basis over the term of the remaining life of the
intangibles. The Company considered the guidance in Emerging Issues
Task Force Issue No. 95-8 in determining that the earn out
consideration was additional purchase price of the acquisition.
Additional payments of up to $7,115,000 may be earned under these
arrangements through 2006.
(2) Summary of Significant Accounting Policies
(a) Unaudited Interim Financial Information
The accompanying unaudited consolidated balance sheet as of March 31,
2004, the consolidated statements of operations and cash flows for the
three months ended March 31, 2003 and 2004, and the consolidated
statements of members' deficit for the three months ended March 31,
2004, are unaudited. The unaudited interim consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles. In the opinion of the Company's management, the
unaudited interim consolidated financial statements have been prepared
on the same basis as the audited consolidated financial statements and
include all adjustments, consisting only of normal recurring
adjustments, necessary for the fair presentation of the Company's
financial position as of March 31, 2004 and its results of operations
and cash flows for the three months ended March 31, 2003 and 2004. The
results for the three months ended March 31, 2004, are not necessarily
indicative of the results to be expected for the full year.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
(c) Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
(d) Accounts Receivable
Accounts receivable are recorded at the invoiced amount and do not
bear interest. The allowance for doubtful accounts is the Company's
best estimate of the amount of probable credit losses in the Company's
existing accounts receivable. The Company determines the allowance
based on historical write-off experience by industry.
(e) Inventories
Inventories are stated at the lower of cost or market. Cost,
consisting primarily of materials, labor and overhead, is determined
by the first-in, first-out (FIFO) method.
(f) Property, Plant, and Equipment
Property, plant, and equipment are recorded at cost. Expenditures for
major renewals and betterments are capitalized and normal maintenance
and repairs are expensed as incurred. Plant and equipment under
capital leases are stated at the lower of their fair value or the
present value of the related minimum lease payments.
41
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Depreciation and amortization are computed using the straight-line
method over the estimated useful lives of the assets as follows:
Buildings 15 to 40 years
Machinery and equipment 5 to 10 years
Molds 3 years
Leasehold improvements Lesser of 10 years
or life of lease
Furniture, fixtures, and office equipment 3 to 10 years
Vehicles 5 years
Gains and losses on disposal are recognized in the year of the
disposition.
(g) Goodwill and Intangibles
Goodwill represents the excess of costs over fair value of assets of
businesses acquired. The remaining goodwill balance at December 31,
2002 and 2003, and March 31, 2004 (unaudited) was $725,000. The
Company adopted the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets, as of January 1, 2002. Goodwill acquired in a
purchase business combination is not amortized, but instead tested for
impairment at least annually in accordance with the provisions of SFAS
No. 142. SFAS No. 142 also requires definite-lived intangible assets
to be amortized over their respective estimated useful lives to their
estimated residual values, and reviewed for impairment in accordance
with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived
Assets.
In connection with the SFAS No. 142 transitional goodwill impairment
test, the Company performed an assessment of whether there was an
indication that goodwill is impaired as of the date of adoption. To
accomplish this, the Company identified its reporting units, which the
Company determined there to be one. The Company determined the fair
value of the reporting unit and compared it to the carrying amount of
the reporting unit within six months of January 1, 2002. Since the
fair value of the reporting unit exceeded the carrying amount of the
reporting unit, it was not necessary for the Company to perform the
second step of the transitional impairment test, which is a more
detailed test to calculate the implied fair value of goodwill and
ultimately determine any impairment.
Prior to the adoption of SFAS No. 142, goodwill was amortized on a
straight-line basis over the expected periods to be benefited, which
was 15 years, and assessed for recoverability by determining whether
the amortization of the goodwill balance over its remaining life could
be recovered through undiscounted future operating cash flows of the
acquired operation. The amount of goodwill impairment, if any, was
measured based on projected discounted future operating cash flows
using a discount rate reflecting the Company's average cost of funds.
Intangible assets of $30,923,000 and $32,488,000 at December 31, 2002
and 2003, respectively, consist of value assigned to manufacturing
expertise and technology related to the tooling used in the production
of stone products and the territorial exclusivity of a franchise, and
their access to this technology and trademarks. These intangible
assets were $32,531,000 as of March 31, 2004 (unaudited). These
intangible assets are being amortized on a straight-line basis over
the estimated life of current tooling technology and the terms of the
franchise agreements, which are five to seven years. Based upon
management's current assessment, the estimated remaining amortization
period of the intangibles is appropriate and the remaining balance is
fully recoverable. Total amortization expense related to intangible
assets for the years ended 2002 and 2003, was $4,031,000 and
42
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
$5,878,000, respectively. Total amortization expense related to
intangible assets for the three months ended March 31, 2003
(unaudited) and 2004 (unaudited) was $1,434,000 and $1,505,000,
respectively. Accumulated amortization for intangible assets as of
December 31, 2002 and 2003 was $8,821,000 and $14,699,000,
respectively. Accumulated amortization for intangible assets as of
March 31, 2004 (unaudited) was $16,204,000.
The following table summarizes estimated annual amortization expense
for amortizable intangibles for fiscal years ending:
2004 $ 6,021
2005 5,270
2006 3,856
2007 2,530
2008 and thereafter 112
-----------
$ 17,789
===========
(h) Other Assets
Other assets consist principally of deferred financing fees paid in
connection with the debt obligation and prepaid management fees (note
10). These amounts are being amortized on a straight-line basis over
five years.
Total amortization expense related to these assets was approximately
$876,000 and $861,000, for the years ended December 31, 2002 and 2003,
respectively. Accumulated amortization for these assets was $1,422,000
and $2,303,000 at December 31, 2002 and 2003, respectively. Total
amortization expense related to these assets was approximately
$209,000 and $228,000 for the three months ended March 31, 2003
(unaudited) and 2004 (unaudited), respectively, and accumulated
amortization for these assets was $2,531,000 at March 31, 2004
(unaudited). Amortization of deferred financing fees of $519,000 and
$584,000 has been recorded as interest expense in 2002 and 2003,
respectively. Amortization of deferred financing fees of $143,000 and
$157,000 has been recorded as interest expense for the three months
ended March 31, 2003 (unaudited) and 2004 (unaudited), respectively.
(i) Revenue Recognition
Revenue is recognized when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the relevant
receivable is reasonably assured, persuasive evidence of an
arrangement exists, and the sales price is fixed or determinable, net
of allowances for estimated discounts and returns which are provided
at the time of sale based on the Company's discount policies and
historical experience. Royalties are recognized when product is sold
by the franchisee based on square footage of product sold.
(j) Income Taxes
The Company is a limited liability company and is not subject to
federal and state income taxes. Taxable income is reported by its
members under the terms of the Limited Liability Company Agreement.
43
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(k) Shipping and Handling Fees
The Company accounts for shipping and handling fees in accordance with
the provisions of Emerging Issues Task Force (EITF) Issue No. 00-10,
Accounting for Shipping and Handling Fees and Costs, which requires
amounts billed to customers for shipping and handling be classified as
net sales. Costs associated with shipping and handling are included in
cost of sales in the consolidated statements of operations.
(l) Advertising Costs
The Company expenses advertising costs as incurred, except for certain
product collateral materials, which are capitalized and amortized to
expense as the materials are distributed. Approximately $23,000 and
$629,000 of advertising was capitalized in prepaid expenses and other
at December 31, 2002 and 2003, respectively. Advertising expenses
totaled approximately $2,136,000 and $2,709,000 for the years ended
December 31, 2002 and 2003, respectively.
(m) Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements
and the reported amounts of sales and expenses during the reporting
period. Significant items subject to such estimates and assumptions
include the carrying amount of property, plant, and equipment and
valuation allowances for receivables, inventories, and warranties.
Actual results could differ from those estimates.
(n) Impairment of Long-Lived Assets
The Company adopted SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, on January 1, 2002. The adoption of
SFAS No. 144 did not affect the Company's financial statements.
In accordance with SFAS No. 144, long-lived assets, such as property,
plant, and equipment, and purchased intangibles subject to
amortization, are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of an asset to
estimated undiscounted future cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated
future cash flows, an impairment charge is recognized for the amount
by which the carrying amount of the asset exceeds the fair value of
the asset. Assets to be disposed of would be separately presented in
the balance sheet and reported at the lower of the carrying amount or
fair value less costs to sell, and are no longer depreciated. The
assets and liabilities of a disposed group classified as held for sale
would be presented separately in the appropriate asset and liability
sections of the consolidated balance sheets.
Prior to the adoption of SFAS No. 144, the Company accounted for
long-lived assets in accordance with SFAS No. 121, Accounting for
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of.
44
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(o) Accounting for Derivative Instruments and Hedging Activities
The Company follows the provisions of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended. Under the
provisions of this pronouncement, the Company recognizes all
derivatives on the balance sheet at fair value. On the date the
derivative instrument is entered into, the Company generally
designates the derivative as either (1) a hedge of the fair value of a
recognized asset or liability or of an unrecognized firm commitment
(fair value hedge) or (2) a hedge of a forecasted transaction or of
the variability of cash flows to be received or paid related to a
recognized asset or liability (cash flow hedge). Changes in the fair
value of a derivative that is designated as, and meets all the
required criteria for, a fair value hedge, along with the gain or loss
on the hedged asset or liability that is attributable to the hedged
risk, are recorded in current period earnings. Changes in the fair
value of a derivative that is designated as, and meets all the
required criteria for, a cash flow hedge are recorded in accumulated
other comprehensive income and reclassified into earnings as the
underlying hedged item affects earnings. The portion of the change in
fair value of a derivative associated with hedge ineffectiveness or
the component of a derivative instrument excluded from the assessment
of hedge effectiveness is recorded currently in earnings. Also,
changes in the entire fair value of a derivative that is not
designated as a hedge are recorded immediately in earnings. The
Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objective
and strategy for undertaking various hedge transactions. This process
includes relating all derivatives that are designated as fair value or
cash flow hedges to specific assets and liabilities on the balance
sheet or to specific firm commitments or forecasted transactions.
During October 2001, the Company entered into an interest rate swap
agreement, which is outstanding at December 31, 2003, to effectively
convert LIBOR-based variable rate debt to fixed rate debt. At December
31, 2002 and 2003, the notional amount of the contract was $37,875,000
and $31,275,000, respectively. At March 31, 2004 (unaudited), the
notional amount of the contract was $30,150,000. The notional amount
of the swap will decrease throughout the life of the swap to a final
notional amount of $26,437,500 on October 29, 2004. The contract
matures on October 31, 2004. The Company will receive variable rate
payments based on LIBOR from third parties and is obligated to pay
fixed interest rate payments (equal to 3.72%) to the third parties
during the term of the contract.
During 2002, the Company reclassified $669,000 of net losses on
derivative instruments into earnings. In addition, the change in fair
value of the derivative instruments during 2002 was a loss of
$3,110,000. During 2003, the Company recognized $830,000 of previously
deferred net losses on derivative instruments into earnings. In
addition, the unrealized gains on the derivative instruments during
2003 was $271,000, which was recorded to accumulated other
comprehensive income (loss) in the statement of members' equity. At
December 31, 2002 and 2003, the net unrealized loss on the interest
rate swaps was and $2,257,000 and $1,156,000, respectively, and is
reflected as a liability on the consolidated balance sheets and in
accumulated other comprehensive income. During the three months ended
March 31, 2004 (unaudited), the Company recognized $195,000 of
previously deferred net losses on derivative instruments into
earnings. In addition, the unrealized gains on the derivative
instruments during the three months ended March 31, 2004 (unaudited),
was $117,000, which was recorded to accumulated other comprehensive
income (loss) in the statement of members' equity. At March 31, 2004
(unaudited), the net unrealized loss on the interest rate swaps was
$844,000 and is reflected as a liability on the consolidated balance
sheets and in accumulated other comprehensive income.
45
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(p) Unit Option Plan
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations
to account for its fixed-plan unit options. Under this method,
compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise
price. The Company applies variable accounting to account for its
options that vest according to performance criteria as defined in the
option agreement. The Company did not record any compensation expense
related to performance-based options as the amounts are not material
to the consolidated financial statements.
For purposes of pro forma disclosure, the Company considered the
alternative fair value method of accounting prescribed by SFAS No.
123, Accounting for Stock-Based Compensation. The Company used the
minimum value method to determine the fair value of unit options
granted in 2002 using the following assumptions: expected volatility
of 0%, risk free interest rate of 4%, weighted average option life of
10 years, and expected dividend yield of 8.9%. Based on the estimated
fair value of the unit options, had the Company applied the fair value
method, the pro forma difference in net income would be less than
$15,000 for each period presented.
(3) Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, accounts receivable, accounts payable, and debt. Carrying
amounts of cash and cash equivalents, accounts receivable, and accounts
payable approximate their fair values because of the short-term maturity of
such instruments. The carrying values of long-term debt instruments
approximate their fair value because interest rates on such debt are
periodically adjusted and approximate current market rates. The interest
rate swap is recorded at fair value in the accompanying consolidated
balance sheets.
(4) Recently Issued Accounting Standards
In December 2003, FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights, and,
accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, which
was issued in January 2003. The Company will be required to apply FIN 46R
to variable interest in VIEs created after December 31, 2003. For variable
interest in VIEs created before January 1, 2004, the interpretation will be
applied beginning January 1, 2005. For any VIEs that must be consolidated
under FIN 46R that were created before January 1, 2004, the assets,
liabilities, and noncontrolling interests of the VIE initially would be
measured at their carrying amounts with any difference between the net
amount added to the balance sheet and any previously recognized interest
being recognized as the cumulative effect of any accounting change. If
determining the carrying amounts is not practicable, fair value at the date
FIN 46R first applies may be used to measure the assets, liabilities, and
noncontrolling interest of the VIE. The Company has not yet determined the
impact of the adoption of FIN 46R on the Company's consolidated financial
statements.
46
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(5) Inventories
Inventories consist of the following (in thousands):
December 31,
---------------------------- March 31,
2002 2003 2004
----------- ----------- -----------
(unaudited)
Raw materials $ 974 $ 1,595 $ 1,568
Finished goods 8,681 11,483 15,587
----------- ----------- -----------
$ 9,655 $ 13,078 $ 17,155
=========== =========== ===========
At December 31, 2002 and 2003, approximately $319,000 and $247,000,
respectively, of inventories were located with a related entity in Mexico.
At March 31, 2004 (unaudited), approximately $321,000 of inventories were
located with this related entity in Mexico.
(6) Property, Plant, and Equipment
Property, plant, and equipment, net, consists of the following (in
thousands):
December 31,
---------------------- March 31,
2002 2003 2004
--------- --------- ---------
(unaudited)
Land $ 1,209 $ 1,209 $ 1,209
Buildings 4,799 4,776 4,776
Machinery and equipment 6,334 7,801 7,429
Office equipment, furniture,
and fixtures 967 1,337 1,479
Auto equipment 1,445 1,321 1,220
Molds, tooling, and plugs 14,780 21,370 23,978
Leasehold improvements 2,049 2,475 2,516
Less accumulated depreciation and
amortization (13,039) (19,254) (20,590)
--------- --------- ---------
$ 18,544 $ 21,035 $ 22,017
========= ========= =========
Molds and tooling are used to manufacture stone products while plugs are
used to produce the molds. Depreciation expense was $4,769,000 and
$7,233,000, for the years ended December 31, 2002 and 2003, respectively.
Depreciation expense was $2,112,000 and $1,770,000 for the three months
ended March 31, 2003 (unaudited) and 2004 (unaudited), respectively.
At December 31, 2002 and 2003, the Company had approximately $343,000 and
$209,000, respectively, of property and equipment, net, located with a
related entity in Mexico. At March 31, 2004 (unaudited), the Company had
approximately $178,000 of property and equipment, net, located with this
related entity in Mexico.
47
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(7) Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consists of the following
(in thousands):
December 31,
------------------------ March 31,
2002 2003 2004
---------- ---------- ----------
(unaudited)
Accrued personnel costs $ 1,132 $ 1,693 $ 1,696
Warranty 348 220 220
Earnout consideration 275 363 363
Other current liabilities 852 1,465 1,706
---------- ---------- ----------
$ 2,607 $ 3,741 $ 3,985
========== ========== ==========
(8) Long-Term Debt
Long-term debt consists of the following (in thousands):
December 31,
------------------------ March 31,
2002 2003 2004
---------- ---------- ----------
(unaudited)
Term A loan, due February 20, 2006 $ 16,500 $ 11,500 $ 10,125
Term B loan, due February 20, 2007 32,000 32,000 38,000
Subordinated promissory notes,
due February 20, 2008 9,000 9,000 9,000
Line of credit, due February 20, 2006 3,140 9,225 9,300
Other borrowings 60 15 14
Capital lease obligations 137 76 65
---------- ---------- ----------
60,837 61,816 66,504
Less current portion (5,074) (5,553) (5,553)
---------- ---------- ----------
$ 55,763 $ 56,263 $ 60,951
========== ========== ==========
The Company entered into a senior credit agreement (the Credit Agreement)
dated February 20, 2001, with various financial institutions (the Lenders).
Pursuant to the terms of the Credit Agreement, the Company obtained from
the Lenders a Term A loan, a Term B loan, a Line of Credit, and also
entered into four subordinated promissory notes (the Notes), as described
below. The Company amended the Credit Agreement during 2002 to increase the
total of the Term B loan by $10,000,000 to $32,000,000 and amended the
Credit Agreement during the three months ended March 31, 2004 (unaudited),
to increase the total of the Term B loan by $6,000,000 to $38,000,000.
The Credit Agreement places restrictions on the activities of the Company
and requires the maintenance of certain financial ratios, including
subordinated debt to EBITDA, total debt to EBITDA, and interest coverage
ratios, among other restrictions. As of December 31, 2002 and 2003 and
48
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
March 31, 2004 the Company was in compliance with all covenants included in
the Credit Agreement. The Credit Agreement is collateralized by certain
assets of the Company.
The Company has two term loans totaling $43,500,000 at December 31, 2003.
These term loans totaled $48,125,000 at March 31, 2004 (unaudited). Term A
loan has a maturity date of February 20, 2006, and requires quarterly
repayments beginning on June 30, 2001. These repayments vary and gradually
increase through the loan period. Principal amounts outstanding under Term
A loan accrue interest at a rate ranging from LIBOR plus 250 basis points
to LIBOR plus 350 basis points, depending on the Company's total debt to
EBITDA ratio (3.64% and 3.59% at December 31, 2003 and March 31, 2004
(unaudited), respectively) and are payable on a quarterly basis. Term B
loan has a maturity date of February 20, 2007 and requires quarterly
repayments of $8,000,000 on March 31, 2006, June 30, 2006, September 30,
2006, and February 20, 2007. Principal amounts outstanding under Term B
loan accrue interest at LIBOR plus 400 basis points (5.14% and 5.09% at
December 31, 2003 and March 31, 2004, respectively) and are payable on a
quarterly basis.
The Company entered into the Notes on February 20, 2001, which has
principal amounts totaling $9,000,000. The Notes bear interest on the
principal amount at the rate of 13% per annum and have a maturity date of
February 20, 2008. In connection with the Notes, the Company issued 4,987
warrants to the lenders. The Company's operating agreement provides for the
authorization and issuance of additional units upon the exercise of
warrants. The fair value of the warrants was not material to the financial
statements.
The Line of Credit, which matures on February 20, 2006, accrues interest at
rates ranging from Prime plus 150 basis points to Prime plus 250 basis
points. The interest rate on borrowings under the Line of Credit at
December 31, 2002 and 2003, was 5.75% and 5.5%, respectively. The interest
rate on such borrowing at March 31, 2004 (unaudited) was 5.5%. The average
amount outstanding under the Line of Credit was approximately $5,233,000
and $7,273,000 and the maximum amount outstanding was $8,552,000 and
$10,041,000 during the years ended December 31, 2002 and 2003,
respectively. The average amount outstanding under the Line of Credit was
approximately $8,872,000 and the maximum amount outstanding was $11,475,000
during the three months ended March 31, 2004 (unaudited). The Company pays
a commitment fee equal to 1/2 of 1% on the average daily unused borrowings
under the Credit Facility. The Company had $5,775,000 available under the
Line of Credit at December 31, 2003. The Company had $5,700,000 available
under the Line of Credit at March 31, 2004 (unaudited).
The Company had other borrowings for the purchase of vehicles in the amount
of $60,000 and $15,000 December 31, 2002 and 2003, respectively, which are
reported in other long-term debt in the accompanying consolidated balance
sheets. The other borrowings for the purchase of vehicles at March 31, 2004
(unaudited) was $14,000.
Scheduled maturities of long-term debt as of December 31, 2003 are as
follows (in thousands):
2004 $ 5,553
2005 4,528
2006 34,735
2007 8,000
2008 9,000
------------
$ 61,816
============
49
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company has obligations under noncompete agreements, net of current
portion, totaling $2,400,000 and $2,100,000 at December 31, 2002 and 2003,
respectively, representing the long-term portion of amounts due to the
sellers of Tempe Stone LLC, Eagle Stone & Brick LLC, and L-B Stone, Inc. to
not compete for five years. These obligations totaled $2,000,000 at March
31, 2004 (unaudited). The current portion due to the sellers, of $600,000
and $700,000 at December 31, 2002 and 2003, respectively, is included in
the accompanying consolidated balance sheet. The current portion due to the
sellers of $700,000 at March 31, 2004 (unaudited) is included in the
accompanying consolidated balance sheet.
(9) Unit Option Plan
During 2002, the Company adopted a unit option plan (the Plan) authorizing
a maximum of 12,874 units. The Plan provides that unit options may be
granted to officers and key employees of the Company. The Company's
operating agreement provides for the authorization and issuance of
additional units upon the option exercise. During 2002, the Company granted
5,640 unit options, which have a ten-year life and are exercisable at a
price of $296.32 per unit. Of these unit options, 3,040 have time-vesting
provisions (Time-based Options) that primarily vest ratably over a
four-year period, while the remaining 2,600 unit options (Performance-based
Options) vest according to performance criteria as defined in the agreement
primarily over a three-year period. During 2003, 150 of the Time-based
Options and 150 of the Performance-based Options were cancelled.
On the date of the grant of the unit options, the exercise price of the
unit options was equal to a member unit's fair value on the grant dates.
Expense related to the Performance-based Options is determined by the
amount that the member unit's fair value at the end of the year exceeds the
exercise price of the Performance-based option, while considering the
amount of Performance-based Options that are vested and earned as of the
end of the year, based on the performance criteria as defined in the option
agreement. No Performance-based Options were vested at December 31, 2002
and 2003 and March 31, 2004 (unaudited).
The following table is a summary of the activity for all unit actions
granted under the Unit Option Plan.
For the years ended December 31, For the three months
----------------------------------------------------- ended March 31,
2002 2003 2004
------------------------- ------------------------ --------------------------
(unaudited)
Exercise Exercise Exercise
Units Price Units Price Units Price
---------- ---------- ---------- ---------- ----------- ----------
Outstanding at beginning of period.... - $ - 5,640 $ 296.32 5,340 $ 296.32
Granted............................ 5,640 296.32 - - - -
Cancelled.......................... - - (300) - - -
---------- ---------- ---------- ---------- ----------- ----------
Outstanding at end of period.......... 5,640 296.32 5,340 296.32 5,340 296.32
Exercisable at end of period.......... 819 $ 296.32 1,532 $ 296.32 1,829 $ 296.32
---------- ---------- ---------- ---------- ----------- ----------
50
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(10) Related-Party Transactions--Information as December 31, 2002 and 2003 and
for the years ended 2002 and 2003.
(a) Employee Relationship
During 2003, the Company had sales totaling $190,000 with a customer
that is owned by an employee of the Company. Accounts receivable from
this customer totaled approximately $12,000 at December 31, 2003.
Additionally, on January 3, 2003, the Company entered into a lease
agreement with the employee for a manufacturing facility used by the
Company. During 2003, the Company made payments totaling $55,000 in
accordance with the lease.
(b) Employee Mortgage Assistance and Severance
On May 17, 2002, the Company entered into a mortgage assistance
program with an employee in which the Company made payments as
advances on behalf of the employee during 2002 and 2003 in the amount
of $12,000 and $20,000, respectively.
In October 2003, the Company entered into a severance agreement with
the employee that obligated the Company to pay the employee $101,000,
cancel the employee's unit options, and forgive the $32,000 balance
receivable under the mortgage assistance program. The entire amount of
$133,000 was expensed in 2003.
(c) Mexico Operations
The Company uses the services of a manufacturing subcontractor related
through common ownership. The Company advances amounts to this entity
on a regular basis to assist with operations. Charges incurred for
materials purchased and services provided were approximately
$5,295,000 and $5,063,000 for the years ended December 31, 2002 and
2003, respectively, and are included in cost of sales. A net amount
due of $399,000 in both 2002 and 2003, respectively, from this entity
is included in due from affiliate on the accompanying consolidated
balance sheets. The net amount due is collateralized by the assets of
the entity and repayments will occur on an unspecified payment plan or
through the transfer of inventory.
(d) Supply and Services Agreement
On May 2, 2002, the Company entered into an agreement with a customer,
owned by an employee of the Company, for the sale of product at a
fixed price for the first year of the agreement and then at the lowest
distributor pricing, as defined, thereafter through April 30, 2006.
During 2002 and 2003, the Company had sales with this customer
totaling $2,059,424, and $3,543,000, respectively. At December 31,
2002 and 2003, accounts receivable from this customer totaled
approximately $478,000 and $1,157,000, respectively.
Also on May 2, 2002, the Company entered into a services agreement,
which has an initial term of one year and is renewable for successive
six month terms, with this customer in which the Company provides
space at one of its facilities and pays various expenses on the
customer's behalf. Through 2003, the Company paid the customer $20,000
per month in return for the customer providing certain services to the
Company including administrative and accounting support. Additionally,
on May 2, 2002, the Company entered into a lease agreement with this
employee for a manufacturing facility used by the Company. During 2002
and 2003, the Company made payments totaling $53,000 and $80,000,
respectively, in accordance with the lease.
51
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(e) Member Unit Holders
The Company prepaid $1.4 million in management fees to an investor for
management services to be provided to the Company over five years
beginning February 20, 2001. These management services included
assistance in the coordination of due diligence and closing procedures
for follow-on acquisitions, negotiations related to the expansion of
the debt facilities, and ongoing operational consulting services
related to the Company's manufacturing processes. The $1.4 million was
recorded as a prepaid asset on the accompanying consolidated balance
sheets and is amortized over a five-year period.
Additionally, the Company reimbursed the investor for certain general
and administrative expenses totaling $196,000 and $400,000 in 2002 and
2003, respectively. The Company had payables to the investor totaling
approximately $81,000 and $0 at December 31, 2002 and 2003,
respectively, that are included in accounts payable in the
accompanying balance sheets.
(f) Employee Advances
Employee advances of approximately $13,000 and $68,000 at December 31,
2002 and 2003, respectively, are included in prepaid expenses and
other on the accompanying balance sheets. These advances are unsecured
and non-interest bearing.
(11) Commitments and Contingencies--Information as December 31, 2002 and 2003
and for the years ended 2002 and 2003 except for item (d) below.
(a) Franchise Agreements
A subsidiary of the Company franchises the production of Eldorado
Stone(R) products to various regional manufacturers, including the
other subsidiaries of the Company. In connection with granting
exclusive manufacturing rights in a given area, the subsidiary agrees
to provide informal training, marketing information, assistance with
openings of plants, and new and replacement molds at mutually agreed
upon prices. Total franchise fees and royalty income from franchisees
other than the other subsidiaries of the Company was approximately
$350,000 and $72,000, and sales of molds to franchisees other than to
the subsidiaries of the Company was approximately $2,100,000 and
$1,500,000 for the years ended December 31, 2002 and 2003,
respectively.
(b) Operating Leases
The Company leases certain of its office and warehouse facilities as
well as certain equipment under noncancelable operating leases. Rent
expense under these leases was approximately $1,188,000 and $2,101,000
in 2002, and 2003, respectively.
52
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The future minimum rental payments under noncancelable operating
leases are as follows (in thousands):
2004 $ 1,751
2005 1,194
2006 799
2007 382
2008 380
-----------
$ 4,506
===========
(c) Capital Lease Obligations
Future minimum capital lease payments as of December 31, 2003 are as
follows (in thousands):
2004 $ 41
2005 30
2006 10
------
Total minimum lease payments 81
Less amount representing interest (5)
------
Present value of payments 76
Less current portion 38
------
Long-term portion $ 38
======
(d) Warranty Liabilities
The Company provides a limited warranty on its product for a period of
50 years. The Company analyzes warranty claims and determines the
warranty liability based upon historical data and known warranty
claims outstanding. The Company's liability associated with their
warranty is reflected in accrued expenses and other current
liabilities in the accompanying consolidated balance sheets. The
change in warranty liabilities from December 31, 2001 through March
31, 2004 is as follows (in thousands):
Balance, December 31, 2001....................... $ 400
Changes in the liability for warranties.......... 165
Payments related to warranties................... (217)
-----------
Balance, December 31, 2002....................... $ 348
Changes in the liability for warranties.......... 129
Payments related to warranties................... (257)
-----------
Balance, December 31, 2003....................... $ 220
Changes in the liability for warranties (unaudited) 19
Payments related to warranties (unaudited)....... (19)
-----------
Balance, March 31, 2004 (unaudited).............. $ 220
===========
53
ELDORADO STONE LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(e) Legal Claims
The Company is subject to certain legal proceedings and claims arising
in the ordinary course of business. Management believes that the
disposition of these matters will not have a material adverse effect
on the Company's consolidated financial position or results of
operations.
(f) Other
On July 9, 2002, the Company entered into an agreement with an entity,
which provides for the entity to manufacture and sell product to the
Company at defined prices over the five-year and ninety-day initial
term of the agreement. The agreement includes minimum purchase
requirements aggregating $2,237,000 over the remaining portion of the
initial term. Prices paid under the agreement are determined based on
achievement of specified annual purchase levels. Amounts purchased
under the agreement totaled approximately $68,000 in 2003. No
purchases were made in 2002. In connection with the agreement, the
Company is required to supply the entity with replacement molds, which
the Company retains title to, over the term of the agreement. At
December 31, 2002 and 2003, the Company had approximately $118,000 and
$96,000 respectively, of molds, net, at the entity's location.
In addition, the agreement includes a buy-out option, which allows for
the Company to purchase all, but not less than all, of the interests
in the entity, at a purchase price as calculated based on the terms of
the agreement. The buy-out option is exercisable when the entity
achieves certain sales thresholds, as defined. Achievement has not yet
occurred.
The agreement also includes a put-option, which allows the entity to
sell 70% of its interests to the Company, if the Company elects not to
renew the agreement after the initial term or at the end of the first
or second renewal terms, as defined in the agreement. The purchase
price is calculated based on the terms included in the agreement.
(12) Concentration of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade receivables from
wholesale distributors, dealers, and franchisees located throughout the
United States, Japan, Canada, and Mexico. The Company performs ongoing
credit evaluations of its customers' financial condition and, to date, has
not experienced any material losses.
(13) Subsequent Events
On April 21, 2004, Headwaters Incorporated entered into a purchase
agreement to purchase all of the outstanding equity of the Company. The
total purchase price is approximately $202.5 million in cash, subject to
adjustment for changes in the Company's working capital, and includes the
repayment at closing of indebtedness under Eldorado's bank credit agreement
and senior subordinated notes at closing.
54
HEADWATERS INCORPORATED
INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL INFORMATION
(dollar and share amounts in thousands)
On April 21, 2004, Headwaters entered into a definitive agreement to purchase
all of the outstanding equity of Eldorado Stone LLC ("Eldorado"). Eldorado is
headquartered in San Marcos, California and is engaged primarily in the
production and sale of architectural manufactured stone throughout the United
States. At the closing of the Eldorado acquisition, Headwaters will pay
consideration which is currently estimated to consist of cash payments to the
owners of Eldorado of approximately $135,800, cash payments of approximately
$66,700 to retire Eldorado debt and related accrued interest for an aggregate
purchase price of $202,500, which, together with estimated expenses incurred by
Headwaters to consummate the Eldorado acquisition of approximately $3,500,
constitutes total consideration of approximately $206,000.
In order to obtain the cash necessary to acquire Eldorado and retire the
Eldorado debt, the pro forma financial information assumes that Headwaters will
issue $200,000 of debt consisting of $50,000 of senior secured debt under
Headwaters' existing credit facility, with a three and one-half-year term and a
floating interest rate, and $150,000 of new convertible senior subordinated debt
with an effective seven-year term and a fixed interest rate. Headwaters expects
to incur approximately $5,250 of debt issuance costs in connection with issuance
of the new convertible debt, which is assumed to have a weighted-average
effective interest rate of approximately 3.0%.
The Eldorado acquisition will be accounted for using the purchase method of
accounting as required by Statement of Financial Accounting Standards No.141,
"Business Combinations." Assets acquired and liabilities assumed will be
recorded at their estimated fair values as of the actual acquisition date. For
purposes of the accompanying pro forma information, approximately $10,000 of the
estimated purchase price was allocated to identifiable intangible assets
consisting primarily of non-compete agreements, manufacturing and mold
technology and franchise contracts with existing franchisees. Intangible assets
have an estimated combined average useful life of five years. The remaining
purchase price not attributable to the tangible or identifiable intangible
assets will be allocated to goodwill. The actual consideration as well as the
allocation of the amount of such consideration will likely differ from that
reflected in these unaudited pro forma condensed combined financial statements
after final valuations and other procedures have been completed.
55
The pro forma condensed combined balance sheet gives effect to the Eldorado
acquisition as if it had been completed as of March 31, 2004 and combines the
historical March 31, 2004 balance sheets for both Headwaters and Eldorado. The
pro forma condensed combined statements of income for the year ended September
30, 2003 and the six months ended March 31, 2004 give effect to the Eldorado
acquisition as if it had occurred on October 1, 2002. The pro forma condensed
combined statement of income for the year ended September 30, 2003 combines
Headwaters' historical results for the year ended September 30, 2003 with
Eldorado's historical results for the year ended December 31, 2003. The pro
forma combined statement of income for the six months ended March 31, 2004
combines both Headwaters' and Eldorado's historical results for that six month
period. Accordingly, Eldorado's historical results for the three-month period
from October 1, 2003 to December 31, 2003 are included in both the pro forma
combined statement of income for the year ended September 30, 2003 and the pro
forma combined statement of income for the six months ended March 31, 2004.
Eldorado revenues and net income for the three-month period ended December 31,
2003 which were included in both of these periods were $28,173 and $894,
respectively.
The pro forma condensed combined information is presented for illustrative
purposes only. Such information does not purport to be indicative of the results
of operations and financial position which actually would have resulted had the
Eldorado acquisition occurred on the dates indicated, nor is it indicative of
the results that may be expected in future periods. The pro forma adjustments
are based upon information and assumptions available at the time of filing this
Form 8-K.
56
HEADWATERS INCORPORATED
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
as of March 31, 2004
Historical
--------------------------- Pro Forma Pro Forma
(thousands of dollars) Headwaters Eldorado Adjustments Combined
- -------------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,535 $ 200,000 A
(135,784) B
(66,716) C
(3,500) D
(5,250) E
8,750 F $ 2,035
Short-term trading investments 33,568 (8,750) F 24,818
Trade receivables, net 87,024 $ 16,173 103,197
Inventories 9,924 17,155 27,079
Other current assets 5,957 1,553 7,510
--------------------------------------------- -------------
Total current assets 141,008 34,881 (11,250) 164,639
--------------------------------------------- -------------
Property, plant and equipment, net 53,747 22,017 75,764
--------------------------------------------- -------------
Other assets:
Intangible assets, net of accumulated amortization 110,121 16,327 (16,327) G
10,000 H 120,121
Goodwill 112,131 725 (725) I
154,357 J 266,488
Debt issue costs and other assets 4,703 2,365 (667) K
(1,265) L
5,250 M 10,386
--------------------------------------------- -------------
Total other assets 226,955 19,417 150,623 396,995
--------------------------------------------- -------------
Total assets $ 421,710 $ 76,315 $ 139,373 $ 637,398
============================================= =============
(continued)
See accompanying notes.
57
HEADWATERS INCORPORATED
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET, continued
as of March 31, 2004
Historical
--------------------------- Pro Forma Pro Forma
(thousands of dollars) Headwaters Eldorado Adjustments Combined
- -------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,957 $ 9,215 $ 20,172
Accrued personnel costs 11,919 1,829 13,748
Other accrued liabilities 23,936 2,909 $ (291) N 26,554
Current portion of long-term debt 5,012 5,500 (5,500) O
5,000 P 10,012
Current portion of unamortized non-refundable
license fees 2,066 2,066
--------------------------------------------- -------------
Total current liabilities 53,890 19,453 (791) 72,552
--------------------------------------------- -------------
Long-term liabilities:
Long-term debt 45,035 60,925 (60,925) Q
150,000 R
45,000 S 240,035
Deferred income taxes 51,273 51,273
Unamortized non-refundable license fees and other
long-term liabilities 3,860 2,870 (844) T 5,886
--------------------------------------------- -------------
Total long-term liabilities 100,168 63,795 133,231 297,194
--------------------------------------------- -------------
Total liabilities 154,058 83,248 132,440 369,746
--------------------------------------------- -------------
Stockholders' equity (deficit):
Common stock 33 33
Capital in excess of par value 229,562 29,632 (29,632) U 229,562
Retained earnings (accumulated deficit) 40,932 (35,721) 35,721 V 40,932
Treasury stock, at cost (2,683) (2,683)
Other (192) (844) 844 W (192)
--------------------------------------------- -------------
Total stockholders' equity (deficit) 267,652 (6,933) 6,933 267,652
--------------------------------------------- -------------
Total liabilities and stockholders'
equity (deficit) $ 421,710 $ 76,315 $ 139,373 $ 637,398
============================================= =============
See accompanying notes.
58
HEADWATERS INCORPORATED
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
For the year ended September 30, 2003
Historical
--------------------------------- Pro Forma Pro Forma
(thousands of dollars and shares, except per share amounts) Headwaters Eldorado Adjustments Combined
- -------------------------------------------------------------------------------------------------------------------------------
(Year ended (Year ended
September 30, 2003) December 31, 2003)
Revenue:
Sales of chemical reagents $ 128,375 $ 128,375
License fees 35,726 35,726
Coal combustion products revenues 169,938 169,938
Sales of construction materials 49,350 $ 103,659 153,009
Other revenues 4,241 4,241
---------------------------------------------- ------------
Total revenue 387,630 103,659 491,289
---------------------------------------------- ------------
Operating costs and expenses:
Cost of chemical reagents sold 87,386 87,386
Cost of coal combustion products revenues 123,146 123,146
Cost of construction materials sold 37,689 65,198 102,887
Cost of other revenues 3,919 3,919
Depreciation and amortization 12,982 13,388 $ (5,881) X
2,000 Y 22,489
Research and development 4,674 4,674
Selling, general and administrative 40,715 17,059 57,774
---------------------------------------------- ------------
Total operating costs and expenses 310,511 95,645 (3,881) 402,275
---------------------------------------------- ------------
Operating income 77,119 8,014 3,881 89,014
---------------------------------------------- ------------
Other income (expense):
Interest and net investment income 310 310
Interest expense (15,687) (5,349) 4,765 Z
584 AA
(750) BB
(1,680) CC
(4,500) DD (22,617)
Losses on notes receivable and investments (2,436) (2,436)
Other, net 775 775
---------------------------------------------- ------------
Total other expense, net (17,038) (5,349) (1,581) (23,968)
---------------------------------------------- ------------
Income before income taxes 60,081 2,665 2,300 65,046
Income tax provision (23,450) (1,936) EE (25,386)
---------------------------------------------- ------------
Net income $ 36,631 $ 2,665 $ 364 $ 39,660
============================================== ============
Basic earnings per common share $ 1.35 $ 1.46
============= ============
Diluted earnings per common share $ 1.30 $ 1.41
============= ============
Weighted-average shares outstanding:
Basic 27,083 27,083
============= ============
Diluted 28,195 28,195
============= ============
See accompanying notes.
59
HEADWATERS INCORPORATED
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
For the six months ended March 31, 2004
Historical
--------------------------------- Pro Forma Pro Forma
(thousands of dollars and shares, except per share amounts) Headwaters Eldorado Adjustments Combined
- -------------------------------------------------------------------------------------------------------------------------------
Revenue:
Sales of chemical reagents $ 63,109 $ 63,109
License fees 45,832 45,832
Coal combustion products revenues 84,692 84,692
Sales of construction materials 23,181 $ 55,936 79,117
Other revenues 4,175 4,175
---------------------------------------------- ------------
Total revenue 220,989 55,936 276,925
---------------------------------------------- ------------
Operating costs and expenses:
Cost of chemical reagents sold 43,019 43,019
Cost of coal combustion products revenues 60,746 60,746
Cost of construction materials sold 19,256 36,310 55,566
Cost of other revenues 317 317
Depreciation and amortization 6,507 6,691 $ (2,975) X
1,000 Y 11,223
Research and development 3,456 3,456
Selling, general and administrative 27,617 9,507 37,124
---------------------------------------------- ------------
Total operating costs and expenses 160,918 52,508 (1,975) 211,451
---------------------------------------------- ------------
Operating income 60,071 3,428 1,975 65,474
---------------------------------------------- ------------
Other income (expense):
Interest and net investment income 362 362
Interest expense (11,350) (2,681) 2,372 Z
309 AA
(375) BB
(840) CC
(2,250) DD (14,815)
Loss on note receivable (1,038) (1,038)
Other, net (1,356) - (1,356)
---------------------------------------------- ------------
Total other expense, net (13,382) (2,681) (784) (16,847)
---------------------------------------------- ------------
Income before income taxes 46,689 747 1,191 48,627
Income tax provision (17,970) (756) EE (18,726)
---------------------------------------------- ------------
Net income $ 28,719 $ 747 $ 435 $ 29,901
============================================== ============
Basic earnings per common share $ 0.95 $ 0.98
============= ============
Diluted earnings per common share $ 0.91 $ 0.95
============= ============
Weighted-average shares outstanding:
Basic 30,371 30,371
============= ============
Diluted 31,593 31,593
============= ============
See accompanying notes.
60
HEADWATERS INCORPORATED
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL STATEMENTS
(dollar and share amounts in thousands)
1. Basis of Presentation
The pro forma condensed combined financial statements included herein have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and certain footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations; however, management believes
that the disclosures are adequate to make the information presented not
misleading.
2. Probable Acquisition of Eldorado Stone LLC
On April 21, 2004, Headwaters entered into a definitive agreement to purchase
all of the outstanding equity of Eldorado Stone LLC ("Eldorado"). Eldorado is
headquartered in San Marcos, California and is engaged primarily in the
production and sale of architectural manufactured stone throughout the United
States. At the closing of the Eldorado acquisition, Headwaters will pay
consideration which is currently estimated to consist of cash payments to the
owners of Eldorado of approximately $135,800, cash payments of approximately
$66,700 to retire Eldorado debt and related accrued interest for an aggregate
purchase price of $202,500, which, together with estimated expenses incurred by
Headwaters to consummate the Eldorado acquisition of approximately $3,500,
constitutes total consideration of approximately $206,000.
In order to obtain the cash necessary to acquire Eldorado and retire the
Eldorado debt, the pro forma financial information assumes that Headwaters will
issue $200,000 of debt consisting of $50,000 of senior secured debt under
Headwaters' existing credit facility, with a three and one-half-year term and a
floating interest rate, and $150,000 of new convertible senior subordinated debt
with an effective seven-year term and a fixed interest rate. Headwaters expects
to incur approximately $5,250 of debt issuance costs in connection with issuance
of the new convertible debt, which is assumed to have a weighted-average
effective interest rate of approximately 3.0%.
The following table sets forth the estimated consideration to be exchanged at
closing to acquire Eldorado:
Estimated consideration at closing:
Cash to be paid to Eldorado stockholders $135,784
Cash to be paid to retire Eldorado debt and
related accrued interest 66,716
Estimated direct costs 3,500
--------
Total $206,000
========
The following table sets forth a preliminary allocation of the total estimated
consideration to the tangible and intangible assets to be acquired and
liabilities to be assumed:
Preliminary purchase price allocation:
Tangible assets acquired, net of liabilities assumed $ 41,643
Intangible assets acquired:
Intangible assets 10,000
Goodwill 154,357
--------
Total estimated consideration at closing $206,000
========
61
HEADWATERS INCORPORATED
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL STATEMENTS
(dollar and share amounts in thousands)
The Eldorado acquisition will be accounted for using the purchase method of
accounting as required by Statement of Financial Accounting Standards No. 141,
"Business Combinations." Assets acquired and liabilities assumed will be
recorded at their estimated fair values as of the actual acquisition date. The
fair value of tangible assets primarily consists of property, plant and
equipment of $22,000 and trade receivables and inventory, net of trade payables
and accrued liabilities, of $20,000. For purposes of the accompanying pro forma
information, approximately $10,000 of the estimated purchase price was allocated
to identifiable intangible assets consisting primarily of non-compete
agreements, manufacturing and mold technology and franchise contracts with
existing franchisees. Intangible assets have an estimated combined average
useful life of five years. The remaining purchase price not attributable to the
tangible or identifiable intangible assets will be allocated to goodwill. The
actual consideration as well as the allocation of the amount of such
consideration will likely differ from that reflected in these unaudited pro
forma condensed combined financial statements after final valuations and other
procedures have been completed.
3. Pro Forma Financial Statements and Adjustments
The pro forma condensed combined balance sheet gives effect to the Eldorado
acquisition as if it had been completed as of March 31, 2004 and combines the
historical March 31, 2004 balance sheets for both Headwaters and Eldorado. The
pro forma combined statements of income for the year ended September 30, 2003,
and the six months ended March 31, 2004, give effect to the acquisition as if it
had occurred on October 1, 2002. The pro forma combined statement of income for
the year ended September 30, 2003 combines Headwaters' historical results for
the year ended September 30, 2003 with Eldorado's historical results for the
year ended December 31, 2003. The pro forma combined statement of income for the
six months ended March 31, 2004 combines both Headwaters' and Eldorado's
historical results for that six month period. Accordingly, Eldorado's historical
results for the three-month period from October 1, 2003 to December 31, 2003 are
included in both the pro forma combined statement of income for the year ended
September 30, 2003 and the pro forma combined statement of income for the six
months ended March 31, 2004. Eldorado revenues and net income for the
three-month period ended December 31, 2003 which were included in both of these
periods were $28,173 and $894, respectively.
The pro forma combined financial statements are presented for illustrative
purposes only. Such information does not purport to be indicative of the results
of operations or financial position which actually would have resulted had the
acquisition occurred on the dates indicated, nor is it indicative of the results
that may be expected in future periods. The pro forma adjustments are based upon
information and assumptions available at the time of filing this Form 8-K.
The pro forma condensed combined financial statements give effect to the
following pro forma adjustments:
A Cash proceeds from new issuances of long-term debt by Headwaters.
B Cash to be paid at closing to previous Eldorado owners.
C Cash to be paid at closing to retire Eldorado debt and related accrued
interest.
62
HEADWATERS INCORPORATED
NOTES TO UNAUDITED PRO FORMA CONDENSED
COMBINED FINANCIAL STATEMENTS
(dollar and share amounts in thousands)
D Cash paid for estimated expenses incurred by Headwaters for the
acquisition.
E Cash paid for estimated debt issuance costs related to the convertible
senior subordinated debt of $150,000 borrowed for the acquisition.
F Cash from sale of short-term trading investments to pay expenses
incurred by Headwaters for the acquisition and debt issuance costs
related to the convertible senior subordinated debt of $150,000.
G Elimination of Eldorado's historical intangible assets.
H Adjustment to record new intangible assets, primarily non-compete
agreements, manufacturing and mold technology and franchise contracts
with existing franchisees.
I Elimination of Eldorado's historical goodwill.
J Adjustment to record new goodwill, based on estimated fair values of
Eldorado assets acquired and liabilities assumed.
K Elimination of Eldorado's historical prepaid management fees and
capitalized trademark costs.
L Elimination of Eldorado's debt issuance costs.
M Capitalization of estimated debt issuance costs related to new
issuance of convertible senior subordinated debt for $150,000.
N Payment of Eldorado accrued interest.
O Retirement of current portion of Eldorado pre-acquisition debt.
P Current portion of $50,000 senior debt borrowed for the acquisition.
Q Retirement of long-term portion of Eldorado pre-acquisition debt.
R Convertible subordinated debt of $150,000 borrowed for the
acquisition.
S Long-term portion of $50,000 senior debt borrowed for the acquisition.
T Elimination of Eldorado's long-term liability for unrealized losses on
derivative instruments, primarily interest rate swaps.
U Elimination of Eldorado's historical capital.
V Elimination of Eldorado's historical accumulated deficit.
W Elimination of Eldorado's historical other equity.
63
X Elimination of Eldorado's historical amortization of intangibles and
trademark costs.
Y Adjustment to amortize new intangibles, estimated at $10,000, over an
estimated average life of five years. New intangibles primarily
include non-compete agreements, manufacturing mold technology and
franchise contracts with existing franchisees.
Z Elimination of Eldorado's interest on pre-acquisition debt retired by
Headwaters at closing.
AA Elimination of Eldorado's historical amortization of deferred
financing costs.
BB Adjustment to record interest for amortization of new debt issuance
costs of $5,250 on issuance of $150,000 of convertible senior
subordinated debt using an effective seven-year life.
CC Adjustment to record interest on new $50,000 long-term senior debt
using a 3.36% effective interest rate. The effect of a 1/8% change in
the effective interest rate would be approximately $62.5 per year.
DD Adjustment to record interest on new $150,000 long-term convertible
senior subordinated debt using a 3.0% effective interest rate. The
effect of a 1/8% change in the effective interest rate would be
approximately $187.5 per year.
EE Combined income tax effect of Eldorado's historical net income plus
the profit and loss-related pro forma adjustments, calculated using
a combined effective federal and state income tax rate of
approximately 39%.
64
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
HEADWATERS INCORPORATED
Registrant
Date: May 25, 2004 /s/ Kirk A. Benson
-------------------------------
Kirk A. Benson
Chief Executive Officer
(Principal Executive Officer)
65