UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission file number 0-27808
HEADWATERS INCORPORATED
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
10653 South River Front Parkway, Suite 300
South Jordan, Utah 84095
------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(801) 984-9400
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(Registrant's telephone number, including area code)
Not applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock as of July 31,
2004 was 33,600,144.
HEADWATERS INCORPORATED
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page No.
ITEM 1. FINANCIAL STATEMENTS (Unaudited):
Condensed Consolidated Balance Sheets - As of
September 30, 2003 and June 30, 2004........................ 3
Condensed Consolidated Statements of Income - For the three
and nine months ended June 30, 2003 and 2004................ 4
Condensed Consolidated Statement of Changes in Stockholders'
Equity - For the nine months ended June 30, 2004............ 5
Condensed Consolidated Statements of Cash Flows - For the
nine months ended June 30, 2003 and 2004.................... 6
Notes to Condensed Consolidated Financial Statements.......... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......28
ITEM 4. CONTROLS AND PROCEDURES.........................................29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS..............................................29
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......................29
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................29
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............29
ITEM 5. OTHER INFORMATION..............................................29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...............................30
SIGNATURES...................................................................31
Forward-looking Statements
This Quarterly Report on Form 10-Q 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. 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 Annual Report on Form 10-K for the year ended
September 30, 2003, and the Risk Factors described in Item 5 of our Form 8-K
dated May 25, 2004 and in our Form S-3 filed on July 20, 2004. 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.
Our internet address is www.hdwtrs.com. There we make available, free of charge,
our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and any amendments to those reports, as soon as reasonably
practicable after we electronically file such material with, or furnish it to,
the Securities and Exchange Commission ("SEC"). Our reports can be accessed
through the investor relations section of our web site. The information found on
our web site is not part of this or any report we file or furnish to the SEC.
2
ITEM 1. FINANCIAL STATEMENTS
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
(in thousands, except per-share data) 2003 2004
- --------------------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 18,732 $ 10,723
Short-term trading investments 2,921 23,635
Trade receivables, net 52,399 75,247
Inventories 7,827 26,175
Other current assets 6,005 15,394
----------------------------------
Total current assets 87,884 151,174
----------------------------------
Property, plant and equipment, net 52,743 86,693
----------------------------------
Other assets:
Intangible assets, net 112,414 127,375
Goodwill 112,131 280,656
Debt issue costs and other assets 8,103 9,667
----------------------------------
Total other assets 232,648 417,698
----------------------------------
Total assets $ 373,275 $ 655,565
==================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 17,177 $ 21,410
Accrued personnel costs 8,669 14,770
Income taxes 1,561 15,672
Other accrued liabilities 14,961 24,069
Current portion of long-term debt 27,475 10,299
Current portion of unamortized non-refundable license fees 3,865 9,559
----------------------------------
Total current liabilities 73,708 95,779
----------------------------------
Long-term liabilities:
Long-term debt 104,044 219,282
Deferred income taxes 50,663 49,237
Unamortized non-refundable license fees and other long-term liabilities 4,703 5,189
----------------------------------
Total long-term liabilities 159,410 273,708
----------------------------------
Total liabilities 233,118 369,487
----------------------------------
Commitments and contingencies
Stockholders' equity:
Common stock, $0.001 par value; authorized 50,000 shares, issued and
outstanding 27,878 shares at September 30, 2003 (including 467 shares
held in treasury) and 33,591 shares at June 30, 2004 (including 423
shares held in treasury) 28 34
Capital in excess of par value 130,936 233,102
Retained earnings 12,213 56,992
Treasury stock, at cost (2,783) (2,637)
Other (237) (1,413)
----------------------------------
Total stockholders' equity 140,157 286,078
----------------------------------
Total liabilities and stockholders' equity $ 373,275 $ 655,565
==================================
See accompanying notes.
3
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------------------------------------------------
(in thousands, except per-share data) 2003 2004 2003 2004
- ------------------------------------------------------------------------------------------------------------------------------
Revenue:
Sales of chemical reagents $ 35,908 $ 35,284 $ 98,099 $ 98,393
License fees 10,120 13,444 27,846 59,276
Coal combustion products revenues 46,005 58,670 115,460 143,363
Sales of construction materials 13,257 26,780 36,041 49,961
Other revenues 1,106 140 3,712 4,315
------------------------------------------------------------------
Total revenue 106,396 134,318 281,158 355,308
------------------------------------------------------------------
Operating costs and expenses:
Cost of chemical reagents sold 25,271 23,784 66,065 66,804
Cost of coal combustion products revenues 33,217 42,089 84,635 102,835
Cost of construction materials sold 10,059 19,825 27,535 38,921
Cost of other revenues 1,186 45 3,318 362
Depreciation and amortization 3,409 4,549 9,660 11,056
Research and development 1,052 1,679 3,172 5,135
Selling, general and administrative 10,433 14,562 30,259 42,340
------------------------------------------------------------------
Total operating costs and expenses 84,627 106,533 224,644 267,453
------------------------------------------------------------------
Operating income 21,769 27,785 56,514 87,855
------------------------------------------------------------------
Other income (expense):
Interest and net investment income 188 19 359 380
Interest expense (4,205) (1,284) (12,272) (12,633)
Losses on notes receivable -- -- (2,142) (1,038)
Other, net (208) 275 (124) (1,080)
------------------------------------------------------------------
Total other income (expense), net (4,225) (990) (14,179) (14,371)
------------------------------------------------------------------
Income before income taxes 17,544 26,795 42,335 73,484
Income tax provision (7,000) (10,735) (16,950) (28,705)
------------------------------------------------------------------
Net income $ 10,544 $ 16,060 $ 25,385 $ 44,779
==================================================================
Basic earnings per share $ 0.39 $ 0.48 $ 0.94 $ 1.43
==================================================================
Diluted earnings per share $ 0.37 $ 0.47 $ 0.90 $ 1.38
==================================================================
See accompanying notes.
4
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
For the Nine Months Ended June 30, 2004
Common stock Capital in Total
-------------------- excess Retained Common stock stockholders'
(in thousands) Shares Amount of par value earnings held in treasury Other equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balances as of September 30, 2003 27,878 $28 $130,936 $12,213 $(2,783) $ (237) $140,157
Common stock issued for cash, net
of offering costs of $6,432 4,958 5 90,253 90,258
Exercise of stock options
and warrants 696 1 6,619 6,620
Tax benefit from exercise of stock
options and warrants 3,320 3,320
Issuance of restricted stock to
officers and employees 59 -- 1,381 (1,381) --
44 shares of treasury stock
transferred to employee stock
purchase plan, at cost 593 146 739
Amortization of deferred compensation
from stock options and restricted stock 205 205
Net income for the nine months
ended June 30, 2004 44,779 44,779
-----------------------------------------------------------------------------------------
Balances as of June 30, 2004 33,591 $34 $233,102 $56,992 $(2,637) $(1,413) $286,078
=========================================================================================
See accompanying notes.
5
HEADWATERS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended June 30,
--------------------------------
(in thousands) 2003 2004
- -------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 25,385 $ 44,779
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 9,660 11,636
Non cash interest expense related to amortization of debt discount and debt
issue costs 2,872 7,798
Deferred income taxes (761) (2,245)
Income tax benefit from exercise of stock options and warrants 1,650 3,320
Amortization of non-refundable license fees (884) (885)
Net loss (gain) on disposition of property, plant and equipment (260) 794
Write-downs of notes receivable and investment 2,436 1,038
Decrease (increase) in short-term trading investments 4,118 (20,714)
Other changes in operating assets and liabilities, net (3,041) 10,703
--------------------------------
Net cash provided by operating activities 41,175 56,224
--------------------------------
Cash flows from investing activities:
Payments for acquisition of VFL Technology Corporation, net of cash acquired -- (3,515)
Payments for acquisition of Eldorado Stone, LLC, net of cash acquired -- (209,770)
Purchase of property, plant and equipment (6,321) (9,869)
Proceeds from disposition of property, plant and equipment 253 53
Increase in intangible assets -- (1,045)
Net decrease (increase) in other assets (290) 30
--------------------------------
Net cash used in investing activities (6,358) (224,116)
--------------------------------
Cash flows from financing activities:
Net proceeds from issuance of common stock -- 90,258
Net proceeds from issuance of long-term debt -- 269,239
Payments on long-term debt (30,334) (206,973)
Proceeds from exercise of options and warrants 1,494 6,620
Employee stock purchases 565 739
--------------------------------
Net cash provided by (used in) financing activities (28,275) 159,883
--------------------------------
Net increase (decrease) in cash and cash equivalents 6,542 (8,009)
Cash and cash equivalents, beginning of period 7,284 18,732
--------------------------------
Cash and cash equivalents, end of period $ 13,826 $ 10,723
================================
See accompanying notes.
6
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
1. Nature of Operations and Basis of Presentation
Operations - Headwaters Incorporated is incorporated in Delaware.
Headwaters owns 100% of the following subsidiaries: Industrial Services
Group, Inc. ("ISG"), a Utah-based company acquired by Headwaters in
September 2002; Headwaters Technology Innovation Group, Inc. ("HTI")
(formerly Hydrocarbon Technologies, Inc.), a New Jersey company acquired in
August 2001; VFL Technology Corporation ("VFL"), a Pennsylvania company
acquired in April 2004; Eldorado Stone, LLC ("Eldorado"), a Delaware
company acquired in June 2004; and Southwest Concrete Products, L.P.
("SCP"), a Texas company acquired in July 2004 (see Note 2). Headwaters'
focus is on enhancing the value of energy resources in an environmentally
responsible manner; promoting the expanded use of coal combustion products
("CCPs"); and expanding Headwaters' construction materials business,
including opportunities to utilize products from other Headwaters
operations in the production of construction materials. Headwaters
currently generates revenue from licensing its chemical technologies to
produce synthetic fuel, from managing CCPs and from the sale of
construction materials. Headwaters intends to continue to expand its
business through growth of existing operations, commercialization of
technologies currently being developed, and strategic acquisitions of
entities that operate in adjacent industries.
Through its proprietary Covol Fuels process, Headwaters adds value to the
production of coal-based solid synthetic fuels primarily for use in
electric power generation plants. Headwaters currently licenses its
technologies to the owners of 28 of a company-estimated 75 coal-based solid
synthetic fuel facilities in the United States. ISG, through its
wholly-owned subsidiary ISG Resources, Inc., is the nation's largest
provider of CCP management and marketing services to the electric utility
industry, serving more than 100 coal-fired electric power generation plants
nationwide. Through its distribution network of over 110 locations, ISG is
the leading provider of high quality fly ash to the building products and
ready mix concrete industries in the United States. ISG also develops and
deploys technologies for maintaining and improving fly ash quality.
Headwaters' construction materials segment develops, manufactures and
distributes value-added bagged concrete, stucco, mortar and block products
that utilize fly ash, and with the acquisitions of Eldorado and SCP,
manufactured stone and expanded concrete block products. Headwaters,
through its wholly-owned subsidiary HTI, conducts research and development
activities directed at catalyst technologies to convert coal and heavy oil
into environmentally-friendly, high-value liquid fuels. In addition, HTI
has developed a unique process to custom design nanocatalysts that could be
used in multiple industrial applications.
Basis of Presentation - The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with the rules and
regulations of the Securities and Exchange Commission ("SEC") for quarterly
reports on Form 10-Q. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included, and
consist of normal recurring adjustments, including adjustments for the
transactions described in Notes 7 and 10. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States have been condensed or omitted. These financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto included in Headwaters' Annual Report on Form 10-K for the year
ended September 30, 2003 ("Form 10-K") and in Headwaters' Quarterly Reports
on Form 10-Q for the quarters ended December 31, 2003 and March 31, 2004.
Headwaters' fiscal year ends on September 30 and unless otherwise noted,
future references to 2003 refer to Headwaters' fiscal quarter and/or
nine-month period ended June 30, 2003, and references to 2004 refer to
Headwaters' fiscal quarter and/or nine-month period ended June 30, 2004.
The consolidated financial statements include the accounts of Headwaters
and all of its subsidiaries. All significant intercompany transactions and
accounts are eliminated in consolidation. Due to the time required to
obtain accurate financial information related to HTI's foreign contracts,
for financial reporting purposes HTI's financial statements have
historically been consolidated with Headwaters' financial statements using
a one-month lag. Effective October 1, 2003, Headwaters eliminated this
one-month lag because of the decreased significance of HTI's foreign
contracts. Accordingly, ten months of HTI's results of operations have been
included in the consolidated statement of income for the nine months ended
June 30, 2004. The results of operations for VFL and Eldorado have been
included in the consolidated results of operations from the dates of
acquisition through June 30, 2004. Due to the seasonality of the operations
of the CCP and construction materials segments and other factors,
7
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
Headwaters' consolidated results of operations for 2004 are not indicative
of the results to be expected for the full fiscal 2004 year.
Common Stock Options and Restricted Stock Grants - Headwaters has elected
to continue to apply the intrinsic value method as prescribed by APB 25 in
accounting for options and restricted stock grants to employees, officers
and directors and does not currently plan to change to the fair value
method unless required by changes in accounting standards. The alternative
fair value method of accounting prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS No. 123"), requires the use of option
valuation models that were developed for use in valuing traded stock
options, as discussed below. Under APB 25, no compensation expense is
recognized for stock option and restricted stock grants to employees,
officers and directors when the exercise price of stock options or
restricted stock equals or exceeds the market price of Headwaters' common
stock on the date of grant.
In years prior to 1998, certain options were granted with terms considered
compensatory. In addition, in April 2004, Headwaters issued restricted
stock to certain officers and employees, also with terms considered
compensatory, because the restricted stock was issued at no cost to the
recipients. In such instances, compensation cost is amortized to expense
over the applicable vesting period on a straight-line basis. If the fair
value provision of SFAS No. 123 would have been applied to all options and
restricted stock grants, net income and earnings per share would have been
changed to the pro forma amounts shown in the table below.
Three Months Ended June 30, Nine Months Ended June 30,
-------------------------------- -----------------------------
(in thousands, except per-share data) 2003 2004 2003 2004
-------------------------------------------- ---------------- --------------- ------------- ---------------
Net income - as reported $10,544 $16,060 $25,385 $44,779
Add actual amortization expense included in
reported net income 23 160 69 205
Deduct expense determined under fair value
provision of SFAS No. 123 (1,069) (905) (2,833) (2,920)
---------------- --------------- ------------- ---------------
Net income - pro forma $ 9,498 $15,315 $22,621 $42,064
==============================================================
Basic earnings per share - as reported $ 0.39 $ 0.48 $ 0.94 $ 1.43
- pro forma $ 0.35 $ 0.46 $ 0.84 $ 1.34
Diluted earnings per share - as reported $ 0.37 $ 0.47 $ 0.90 $ 1.38
- pro forma $ 0.34 $ 0.45 $ 0.80 $ 1.29
The fair values of stock option grants for 2003 and 2004 were determined
using the Black-Scholes option pricing model and the following assumptions:
expected stock price volatility of 40%, risk-free interest rates ranging
from 1.3% to 4.5%, weighted average expected option lives of 3 to 4 years,
and no dividend yield. The Black-Scholes option valuation model was
developed for use in estimating the fair value of traded options that have
no vesting restrictions and that are fully transferable. In addition,
option valuation models require the input of highly subjective assumptions
including expected stock price volatility. Because Headwaters' stock
options and restricted stock have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect their fair value, in management's
opinion, the existing models do not necessarily provide a reliable measure
of the fair value of stock options and restricted stock.
Reclassifications - Certain prior period amounts have been reclassified to
conform with the current period's presentation. The reclassifications had
no effect on net income or total assets.
Recent Accounting Pronouncements - Headwaters has reviewed all recently
issued accounting standards that have not yet been adopted in order to
determine their potential effect, if any, on the results of operations or
financial position of Headwaters. Based on that review, Headwaters does not
currently believe that any of these recent accounting pronouncements will
have a significant effect on its current or future financial position,
results of operations, cash flows or disclosures.
8
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
2. Acquisitions
As described in the following paragraphs, Headwaters completed the
acquisition of three companies in April, June and July 2004.
VFL - On April 9, 2004, Headwaters acquired 100% of the common stock of VFL
and assumed all of VFL's outstanding debt. VFL is based in West Chester,
Pennsylvania and manages approximately two million tons of CCPs annually.
In addition, VFL has operating knowledge relating to the use of low quality
ash materials in value-added applications. The acquisition of VFL broadens
the scope of services that Headwaters' CCP segment offers, as well as its
client base, principally on the East coast of the United States and in the
Ohio River Valley. VFL's results of operations have been included in
Headwaters' consolidated statement of income since April 9, 2004.
In connection with the VFL acquisition, Headwaters issued $19,000,000 of
notes payable to the VFL stockholders, $13,000,000 of which was repaid
prior to June 30, 2004 and $6,000,000 of which was repaid in July 2004.
The following table sets forth the total consideration paid for VFL.
(in thousands)
----------------------------------------------------------------------
Cash paid to VFL stockholders $ 3,326
Notes payable issued to VFL stockholders 19,000
VFL debt assumed by Headwaters 6,749
Costs directly related to acquisition 225
-----------
$29,300
===========
The following table sets forth the preliminary allocation of the total
estimated consideration to the tangible and intangible assets acquired and
liabilities assumed.
(in thousands)
----------------------------------------------------------------------
Cash $ 36
Trade receivables, net 4,287
Other assets 860
Property, plant and equipment 8,443
Intangible assets acquired - contracts 11,290
Goodwill 7,604
Accounts payable and accrued liabilities (3,220)
----------
Net assets acquired $29,300
==========
The VFL acquisition was accounted for using the purchase method of
accounting as required by SFAS No. 141, "Business Combinations." Assets
acquired and liabilities assumed were recorded at their estimated fair
values as of April 9, 2004. Approximately $11,290,000 of the purchase price
was allocated to identifiable intangible assets consisting of contracts
with utility companies, industrial clients and municipalities. This amount
is being amortized over an estimated average useful life of eight years.
The remaining purchase price not attributable to the tangible and
identifiable intangible assets was allocated to goodwill, all of which is
expected to be tax deductible. All of the intangible assets and goodwill
have been allocated to Headwaters' CCP segment. The final purchase price
and the allocation thereof will likely differ from that reflected above
after final valuations and other procedures have been completed.
Eldorado - On June 2, 2004, Headwaters acquired 100% of the ownership
interests of Eldorado and paid off all of Eldorado's outstanding debt.
Eldorado is based in San Marcos, California and is a leading manufacturer
of architectural manufactured stone. With over 1,600 distributors, Eldorado
provides Headwaters with a national platform for expanded marketing of
"green" building products, such as mortar and stucco made with reclaimed
fly ash from coal combustion. Headwaters expects Eldorado, which will be
integrated into its construction materials segment, to provide critical
mass and improved margins in Headwaters' efforts to expand the use of fly
ash in building products. Eldorado's results of operations have been
included in Headwaters' consolidated statement of income since June 2,
2004.
9
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
In connection with the Eldorado acquisition, Headwaters issued $172,500,000
of new convertible senior subordinated debt and also borrowed funds under
its senior secured revolving credit arrangement and an arrangement with an
investment company, the latter two of which were repaid prior to June 30,
2004, all as explained in more detail in Note 7.
The following table sets forth the total consideration paid for Eldorado.
(in thousands)
-----------------------------------------------------------------------
Cash paid to Eldorado owners $136,982
Cash paid to retire Eldorado debt and related
accrued interest 69,650
Costs directly related to acquisition 3,800
------------
$210,432
============
The following table sets forth the preliminary allocation of the total
estimated consideration to the tangible and intangible assets acquired and
liabilities assumed.
(in thousands)
-----------------------------------------------------------------------
Cash $ 662
Trade receivables, net 16,051
Inventory 17,209
Other assets 3,069
Property, plant and equipment 23,040
Intangible assets acquired 8,153
Goodwill 160,921
Accounts payable and accrued liabilities (18,673)
-----------
Net assets acquired $210,432
===========
The Eldorado acquisition was accounted for using the purchase method of
accounting. Assets acquired and liabilities assumed were recorded at their
estimated fair values as of June 2, 2004. Approximately $8,153,000 of the
purchase price was allocated to identifiable intangible assets, consisting
primarily of non-compete agreements. The intangible assets are being
amortized over estimated useful lives ranging from three to ten years. The
remaining purchase price not attributable to the tangible and identifiable
intangible assets was allocated to goodwill, most of which is expected to
be tax deductible. All of the intangible assets and goodwill have been
allocated to Headwaters' construction materials segment. The final purchase
price and the allocation thereof will likely differ from that reflected
above after final valuations and other procedures have been completed.
Pro Forma Information - The following unaudited pro forma financial
information for 2003 and 2004 assumes the VFL and Eldorado acquisitions
occurred as of the beginning of the respective periods. The pro forma
combined results combine Headwaters' historical results for the periods
presented with VFL's and Eldorado's historical results for the same
periods, after giving effect to certain adjustments, including interest
expense and the amortization of intangible assets.
Unaudited Pro Forma Results
--------------------------------------------------------------
Three Months Ended June 30, Nine Months Ended June 30,
-------------------------------- -----------------------------
(in thousands, except per-share data) 2003 2004 2003 2004
-------------------------------------------- ---------------- --------------- ------------- ---------------
Total revenue $140,675 $156,874 $368,782 $448,624
Net income 11,883 17,050 26,328 46,387
Basic earnings per common share 0.44 0.51 0.98 1.48
Diluted earnings per common share 0.42 0.50 0.93 1.43
The pro forma results have been prepared for illustrative purposes only.
Such information does not purport to be indicative of the results of
operations which actually would have resulted had the acquisitions occurred
on the dates indicated, nor is it indicative of the results that may be
expected in future periods.
10
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
SCP - On July 2, 2004, Headwaters acquired certain assets of SCP and
assumed all of SCP's outstanding debt. SCP is based in Alleyton, Texas and
is a leading manufacturer of concrete blocks in South Texas, complementing
Headwaters' similar operations in Dallas and East Texas. SCP provides
Headwaters with modern concrete-based manufacturing facilities and the
opportunity to increase the use of CCPs in the manufacture of block and
brick. SCP also has an experienced management team, with the President of
SCP assuming responsibility for all of Headwaters' construction materials
operations in Texas. SCP's results of operations will be included in
Headwaters' consolidated statement of income beginning July 2, 2004.
Total consideration paid for SCP is currently estimated to be approximately
$36,000,000, consisting of cash and the assumption of approximately
$10,000,000 of debt. Headwaters also agreed to pay an earn-out to the
sellers if certain earnings targets are exceeded during the 12 months
ending December 31, 2005.
The SCP acquisition will be accounted for using the purchase method of
accounting. Assets acquired and liabilities assumed will be recorded at
their estimated fair values as of July 2, 2004. Some portion of the
purchase price is currently expected to be allocated to identifiable
intangible assets, which amounts will be amortized over the assets'
estimated useful lives. The remaining purchase price not attributable to
the tangible and identifiable intangible assets will be allocated to
goodwill, most of which is expected to be tax deductible. All of the
intangible assets and goodwill will be allocated to Headwaters'
construction materials segment.
Deferred Acquisition Costs - In the March 2004 quarter, Headwaters expensed
approximately $829,000 of deferred acquisition costs related to acquisition
projects that were abandoned.
3. Segment Reporting
The following segment information has been prepared in accordance with SFAS
No. 131, "Disclosure about Segments of an Enterprise and Related
Information," all as explained in more detail in the notes to the financial
statements in Headwaters' Form 10-K. Performance of the segments is
evaluated primarily on operating income. Intersegment sales are immaterial.
Segment costs and expenses considered in deriving segment operating income
include cost of revenues, depreciation and amortization, research and
development, and segment-specific selling, general and administrative
expenses. Amounts included in the "Corporate" column represent expenses not
specifically attributable to any segment and include administrative
departmental costs and general corporate overheads. Segment assets reflect
those specifically attributable to individual segments and primarily
include accounts receivable, inventories, property, plant and equipment,
intangible assets and goodwill. Other assets are included in the
"Corporate" column. Segment information for the 2004 periods includes VFL
results for three months (included in the CCP segment) and Eldorado results
for one month (included in the construction materials segment).
Alternative Construction
(in thousands) Energy CCPs Materials Corporate Totals
---------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2003
Segment revenue $ 47,134 $ 46,005 $ 13,257 $ -- $ 106,396
====================================================================
Depreciation and amortization $ (312) $ (2,876) $ (151) $ (70) $ (3,409)
====================================================================
Operating income (loss) $ 18,214 $ 6,104 $ 1,270 $ (3,819) $ 21,769
========================================================
Net interest expense (4,017)
Other income (expense), net (208)
Income tax provision (7,000)
-----------
Net income $ 10,544
===========
Capital expenditures $ 6 $ 3,124 $ 64 $ 217 $ 3,411
====================================================================
11
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
Alternative Construction
(in thousands) Energy CCPs Materials Corporate Totals
---------------------------------------------------------------------------------------------------------------
Three Months Ended June 30, 2004
Segment revenue $ 48,868 $ 58,670 $ 26,780 $ -- $ 134,318
====================================================================
Depreciation and amortization $ (391) $ (3,669) $ (977) $ (92) $ (5,129)
====================================================================
Operating income (loss) $ 20,362 $ 8,691 $ 3,374 $ (4,642) $ 27,785
========================================================
Net interest expense (1,265)
Other income (expense), net 275
Income tax provision (10,735)
-----------
Net income $ 16,060
===========
Capital expenditures $ 108 $ 2,831 $ 1,982 $ 58 $ 4,979
====================================================================
Nine Months Ended June 30, 2003
Segment revenue $ 129,657 $ 115,460 $ 36,041 $ -- $ 281,158
============= ============ ================ ============ ===========
Depreciation and amortization $ (952) $ (8,053) $ (449) $ (206) $ (9,660)
====================================================================
Operating income (loss) $ 52,006 $ 12,051 $ 3,204 $ (10,747) $ 56,514
========================================================
Net interest expense (11,913)
Other income (expense), net (2,266)
Income tax provision (16,950)
-----------
Net income $ 25,385
===========
Capital expenditures $ 135 $ 5,481 $ 464 $ 241 $ 6,321
====================================================================
Nine Months Ended June 30, 2004
Segment revenue $ 161,984 $ 143,363 $ 49,961 $ -- $ 355,308
====================================================================
Depreciation and amortization $ (1,051) $ (9,061) $ (1,306) $ (218) $ (11,636)
====================================================================
Operating income (loss) $ 79,791 $ 19,828 $ 3,208 $ (14,972) $ 87,855
========================================================
Net interest expense (12,253)
Other income (expense), net (2,118)
Income tax provision (28,705)
-----------
Net income $ 44,779
===========
Capital expenditures $ 420 $ 7,267 $ 2,093 $ 89 $ 9,869
====================================================================
Segment Assets as of June 30, 2004 $ 36,488 $ 314,877 $ 252,916 $ 51,284 $ 655,565
====================================================================
4. Issuance of Equity Securities
Issuance of Common Stock - Headwaters has an effective universal shelf
registration statement on file with the SEC that can be used for the sale
of common stock, preferred stock, convertible debt and other securities. In
December 2003, Headwaters filed a prospectus supplement to the shelf
registration statement and issued 4,750,000 shares of common stock under
this shelf registration statement in an underwritten public offering. In
January 2004, an additional 208,457 shares of common stock were issued upon
exercise of the underwriters' over-allotment option. In total, proceeds of
$90,258,000 were received, net of offering costs of $6,432,000. Following
these issuances of common stock, approximately $53,000,000 remains
available for future offerings of securities under the shelf registration
statement. A prospectus supplement describing the terms of any additional
securities to be issued is required to be filed before any future offering
would commence under the registration statement.
12
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
2003 Stock Incentive Plan Awards - In March 2004, Headwaters' stockholders
approved an increase in the number of shares available for award grants
under Headwaters' 2003 Stock Incentive Plan by 1,500,000. During the
quarter ended June 30, 2004, Headwaters granted to officers and employees
options to purchase approximately 496,000 shares of common stock and issued
approximately 60,000 shares of restricted common stock, all under terms of
the 2003 Stock Incentive Plan. The stock options vest over five years and
have exercise prices ranging from $21.29 to $23.79 per share, the fair
market value of Headwaters' common stock on the grant dates. The restricted
stock was issued at no cost to the recipients and also vests over five
years.
5. Inventories
Inventories consisted of the following at:
September 30, June 30,
(in thousands) 2003 2004
------------------------------------------------------------------
Raw materials $1,059 $ 2,677
Work in process -- 239
Finished goods 6,768 23,259
------------------------------
$7,827 $26,175
==============================
6. Intangible Assets
Intangible Assets - Headwaters has no intangible assets that are not being
amortized. The following table summarizes the gross carrying amounts and
the related accumulated amortization of all amortizable intangible assets
as of:
September 30, 2003 June 30, 2004
-----------------------------------------------------------------
Gross Gross
Estimated Carrying Accumulated Carrying Accumulated
(in thousands) useful lives Amount Amortization Amount Amortization
--------------------------------------------------------------------------------------------------------------
CCP contracts 8 - 20 years $106,400 $5,499 $117,690 $ 9,849
HTI patented technologies 15 years 9,700 1,293 9,700 1,832
Non-compete agreements 3 - 3 1/2 years -- -- 6,252 165
Patents 7 1/2 years 2,764 373 2,764 649
Other 5 - 17 years 1,522 807 4,468 1,004
-----------------------------------------------------------------
$120,386 $7,972 $140,874 $13,499
=================================================================
Total amortization expense related to intangible assets was approximately
$1,626,000 and $2,189,000 for the three months ended June 30, 2003 and
2004, respectively, and approximately $4,878,000 and $5,527,000 for the
nine months ended June 30, 2003 and 2004, respectively. Total estimated
annual amortization expense, not including amortization of any intangible
assets related to the SCP acquisition, is as follows for the fiscal years
presented.
Year ending September 30, (in thousands)
----------------------------------------------
2004 $ 8,048
2005 10,291
2006 10,291
2007 9,825
2008 8,277
2009 8,064
13
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
7. Long-term Debt
Long-term debt consisted of the following at:
September 30, June 30,
(in thousands) 2003 2004
--------------------------------------------------------------- ---------------- --------------
Senior secured debt $ -- $ 48,750
Convertible senior subordinated notes -- 172,500
Notes payable to former VFL stockholders -- 6,000
Senior secured debt with a face amount totaling $114,851 111,766 --
Senior subordinated debentures with a face amount totaling 19,682 --
$20,000
Other 71 2,331
-------------------------------
131,519 229,581
Less: current portion (27,475) (10,299)
-------------------------------
Total long-term debt $ 104,044 $ 219,282
===============================
New Senior Secured Credit Agreement - In March 2004, Headwaters entered
into a credit agreement with a syndication of lenders under which a total
of $50,000,000 was borrowed under a term loan arrangement and which, as
amended in June 2004, provides for an additional $75,000,000 to be borrowed
under a revolving credit arrangement. The initial $50,000,000 of proceeds
were used to repay in full the remaining balance due under Headwaters'
former Term B senior secured credit agreement.
The current $48,750,000 term loan is secured by all assets of Headwaters,
bears interest at a variable rate (approximately 3.6% at June 30, 2004),
and is repayable in quarterly installments of $1,250,000 through September
2007. The remaining principal at that time of $32,500,000 is repayable in
November 2007, the termination date of the credit agreement. Optional
prepayments of the term loan can be made at Headwaters' discretion, subject
to certain minimum amount requirements specified in the credit agreement.
Beginning December 31, 2004 and continuing each year thereafter, Headwaters
must make mandatory prepayments to the extent of 50% of Headwaters' fiscal
year "excess cash flows," as defined. Once repaid in full or in part, no
further borrowings under the term loan arrangement can be made.
The credit agreement contains restrictions and covenants common to such
agreements, including limitations on the incurrence of additional debt,
investments, merger and acquisition activity, asset liens, capital
expenditures in excess of $26,000,000 in any fiscal year and the payment of
dividends, among others. In addition, Headwaters must meet minimum net
worth requirements and maintain certain financial ratios, including
leverage ratios and a fixed charge coverage ratio, as those terms are
defined in the credit agreement. The initial net worth requirement is
$200,308,000 and is increased by 50% of Headwaters' consolidated net income
earned subsequent to March 31, 2004. Headwaters must maintain a total
leverage ratio of 2.5:1.0 or less and a senior debt leverage ratio of
1.5:1.0 or less. Headwaters is in compliance with all debt covenants as of
June 30, 2004.
Borrowing terms under the revolving credit arrangement are generally the
same as those described in the preceding paragraphs except that
reborrowings of any available portion of the $75,000,000 revolver can be
made at any time. Finally, the credit agreement allows for the issuance of
letters of credit, provided there is capacity under the revolving credit
arrangement. Currently, two letters of credit totaling $1,970,000 are
outstanding, with expiration dates in November 2004 and June 2005. In
connection with the purchase of Eldorado in June 2004, a total of
$44,000,000 was borrowed under the revolving credit arrangement, all of
which was repaid prior to June 30, 2004. In connection with the purchase of
SCP in July 2004, a total of $20,000,000 was borrowed under the revolving
credit arrangement, which remains outstanding currently. Headwaters
currently pays a fee of 0.375% on the unused portion of the revolving
credit arrangement.
Former Senior Secured Credit Agreement - In connection with the ISG
acquisition in 2002, Headwaters entered into a $175,000,000 senior secured
credit agreement with a syndication of lenders, under which a total of
14
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
$155,000,000 was borrowed as a term loan on the acquisition date. The
credit agreement also allowed up to $20,000,000 to be borrowed under a
revolving credit arrangement. The debt was issued at a 3% discount and
Headwaters received net cash proceeds of $150,350,000. The original issue
discount was accreted using the effective interest method and the accretion
was recorded as interest expense. The debt was secured by all assets of
Headwaters, bore interest at a variable rate and was repayable in quarterly
installments through August 30, 2007.
During the quarter ended December 31, 2003, principal repayments totaling
$39,714,000 were made, including $33,471,000 of optional prepayments.
During the quarter ended March 31, 2004, the remaining balance was repaid
in full using available cash and $50,000,000 of proceeds from the new
senior debt facility described above. In connection with the full repayment
of this debt, non cash interest expense totaling approximately $5,023,000
was recognized in the March 2004 quarter, representing amortization of all
of the remaining debt discount and debt issue costs related to this debt.
Senior Subordinated Debentures - In connection with the ISG acquisition,
Headwaters also entered into a $20,000,000 subordinated loan agreement,
under which senior subordinated debentures were issued at a 2% discount,
with Headwaters receiving net cash proceeds of $19,600,000. The original
issue discount was accreted using the effective interest method and the
accretion was recorded as interest expense. ISG management participated in
one-half, or $10,000,000, of the $20,000,000 of debt issued. The other half
was issued to a corporation. The debentures were due in 2007; however, in
December 2003, the debentures were repaid in full, including a 4%, or
$400,000, prepayment charge paid to the corporation holding $10,000,000 of
the debentures. This charge, along with all remaining unamortized debt
discount and debt issue costs, is included in interest expense in the
consolidated statement of income.
Convertible Senior Subordinated Notes - In connection with the Eldorado
acquisition, Headwaters issued $172,500,000 of 2 ?% convertible senior
subordinated notes due 2016. Holders of the notes may convert the notes
into shares of Headwaters' common stock at a conversion rate of 33.3333
shares per $1,000 principal amount ($30 conversion price), or approximately
5,750,000 aggregate shares of common stock, contingent upon certain events.
The conversion rate adjusts for events related to Headwaters' common stock,
including common stock issued as a dividend, rights or warrants to purchase
common stock issued to all holders of Headwaters' common stock, and other
similar rights or events that apply to all holders of common stock.
The notes are convertible if any of the following five criteria are met: 1)
satisfaction of a market price condition which becomes operative if the
common stock trading price reaches $39 per share for a certain period of
time prior to June 1, 2011 and at any time after that date; 2) a credit
rating, if any, assigned to the notes is three or more rating subcategories
below the initial rating, if any; 3) the notes trade at 98% of the product
of the common stock trading price and the number of shares of common stock
issuable upon conversion of $1,000 principal amount of the notes, except
this provision is not available if the closing common stock price is
between 100% and 130% of the current conversion price of the notes; 4)
Headwaters calls the notes for redemption; and 5) certain corporate
transactions occur, including distribution of rights or warrants to all
common stock holders entitling them to purchase common stock at less than
the current market price or distribution of common stock, cash or other
assets, debt securities or certain rights to purchase securities where the
distribution has a per share value exceeding 5% of the closing common stock
price on the day immediately preceding the declaration date for such
distribution. In addition, the notes are convertible if Headwaters enters
into an agreement pursuant to which Headwaters' common stock would be
converted into cash, securities or other property.
Headwaters may call the notes for redemption at any time on or after June
1, 2007 and prior to June 4, 2011 if the closing common stock price exceeds
130% of the conversion price for 20 trading days in any consecutive 30-day
trading period (in which case Headwaters must provide a "make whole"
payment of the present value of all remaining interest payments on the
redeemed notes through June 1, 2011). In addition, the holder of the notes
has the right to require Headwaters to repurchase all or a portion of the
notes on June 1, 2011 or if a fundamental change in common stock has
occurred, including termination of trading. Subsequent to June 1, 2011, the
notes require an additional interest payment equal to 0.40% of the average
trading price of the notes if the trading price equals 120% or more of the
principal amount of the notes.
15
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
Headwaters has not included the additional shares of common stock
contingently issuable under the notes in diluted earnings per share as none
of the contingencies have been met. Had Headwaters included the shares in
the June 30, 2004 calculation using the if-converted method, diluted
earnings per share would have been reduced by $0.02 per share to $0.45 and
$1.36 for the three- and nine-month periods ended June 30, 2004,
respectively.
Notes Payable to Former VFL Stockholders - In connection with the VFL
acquisition, Headwaters issued $19,000,000 of notes payable to the VFL
stockholders, $13,000,000 of which was repaid prior to June 30, 2004 and
$6,000,000 of which was repaid in July 2004. The interest rate on
$16,000,000 of the notes was 9%. The interest rate on the remaining
$3,000,000 of notes was a variable rate (approximately 3.6% at June 30,
2004).
Short-term Borrowings with an Investment Bank - Headwaters has an
arrangement with an investment bank under which Headwaters can borrow up to
90% of the value of the portfolio of Headwaters' short-term investments
with the investment bank, limited to a maximum amount of $20,000,000.
Headwaters borrowed $10,000,000 under this arrangement during June 2004,
all of which was repaid prior to June 30, 2004. In July, Headwaters
borrowed $6,000,000 under this arrangement, which was repaid prior to July
31, 2004.
Interest Costs - During the three- and nine-month periods ended June 30,
2004, Headwaters incurred total interest costs of approximately $1,355,000
and $12,978,000, respectively, including approximately $167,000 and
$7,798,000, respectively, of non-cash interest expense and approximately
$71,000 and $345,000, respectively, of interest costs that were
capitalized. During the three- and nine-month periods ended June 30, 2003,
Headwaters incurred total interest costs of approximately $4,278,000 and
$12,390,000, respectively, including approximately $1,268,000 and
$2,872,000, respectively, of non-cash interest expense and approximately
$73,000 and $118,000, respectively, of interest costs that were
capitalized. The weighted-average interest rate on the face amount of
outstanding long-term debt, disregarding amortization of debt issue costs
and debt discount, was approximately 7.2% at September 30, 2003 and 3.1% at
June 30, 2004.
8. Income Taxes
The income tax provision consisted of the following:
Three Months Ended June 30, Nine Months Ended June 30,
---------------------------------------------------------------
(in thousands) 2003 2004 2003 2004
-----------------------------------------------------------------------------------------------------------
Current tax provision:
Federal $ 6,870 $ 12,565 $ 15,383 $ 28,758
State 1,213 1,158 2,328 2,192
---------------------------------------------------------------
Total current tax provision 8,083 13,723 17,711 30,950
Deferred tax provision:
Federal (976) (2,851) (677) (2,141)
State (107) (137) (84) (104)
---------------------------------------------------------------
Total deferred tax provision (1,083) (2,988) (761) (2,245)
---------------------------------------------------------------
Total income tax provision $ 7,000 $ 10,735 $ 16,950 $ 28,705
===============================================================
16
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
9. Earnings per Share
Three Months Ended June 30, Nine Months Ended June 30,
(in thousands, except per-share data) 2003 2004 2003 2004
-----------------------------------------------------------------------------------------------------------
Numerator - Net income $ 10,544 $ 16,060 $ 25,385 $ 44,779
===============================================================
Denominator:
Denominator for basic earnings per share
- weighted-average shares outstanding 27,192 33,118 27,003 31,287
Effect of dilutive securities - shares
issuable upon exercise of options and
warrants 1,107 1,200 1,185 1,214
----------------- -------------- -------------- ---------------
Denominator for diluted earnings per
share - weighted-average shares
outstanding after assumed exercises 28,299 34,318 28,188 32,501
===============================================================
Basic earnings per share $ 0.39 $ 0.48 $ 0.94 $ 1.43
===============================================================
Diluted earnings per share $ 0.37 $ 0.47 $ 0.90 $ 1.38
===============================================================
Anti-dilutive securities not considered in the diluted earnings per share
calculation, consisting of out-of-the money options, totaled approximately
740,000 and 0 shares for the three months ended June 30, 2003 and 2004,
respectively, and 510,000 and 10,000 shares for the nine months ended June
30, 2003 and 2004, respectively.
10. Commitments and Contingencies
Commitments and contingencies as of June 30, 2004 not disclosed elsewhere,
are as follows:
Purchase Commitments - Certain ISG contracts with its suppliers require ISG
to make minimum purchases. During the quarter ended December 31, 2003, one
of ISG's minimum purchase contracts was amended. The amendment decreased
the annual purchase commitment and also extended the term of the contract
for several years. Due to the extended life of the contract, ISG's total
future minimum purchase requirements increased by approximately $17,925,000
during 2004 through 2011.
Medical Insurance - Effective January 1, 2003, Headwaters adopted a
self-insured medical insurance plan for its employees and the employees of
all of its subsidiaries. Currently, this plan has stop-loss coverage for
amounts in excess of $100,000 per individual and approximately $7,500,000
in the aggregate for the plan year ending December 31, 2004. Headwaters has
contracted with a third-party administrator to assist in the payment and
administration of claims. Insurance claims are recognized as expenses when
incurred and include an estimate of costs for claims incurred but not
reported at the balance sheet date. As of June 30, 2004, approximately
$1,394,000 is accrued for claims incurred from January through June 30,
2004 that have not been paid or reported.
Incentive Agreements with ISG Principals - In January 2003, Headwaters
executed incentive agreements with three of the former stockholders and
officers of ISG, all of whom were officers of either Headwaters or ISG
following the ISG acquisition. The agreements called for contingent
payments totaling up to $5,000,000 in the event of (i) a change in control,
as defined, or (ii) continuing employment through September 2004 and an
average stock price for Headwaters' common stock for any calendar quarter
exceeding $20 per share. The maximum payments would be required if there
were a change in control prior to October 2004, or if the officers remain
employed through September 2004 and the average stock price for any
calendar quarter reaches $25 per share or more. During the quarter ended
December 31, 2003, two of the three officers resigned their positions. As a
result, the maximum payment to the remaining officer that could be required
under the remaining incentive agreement is $1,500,000. During the nine
months ended June 30, 2004, Headwaters recorded an expense of approximately
$1,231,000 related to this obligation.
17
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
Property, Plant and Equipment - As of June 30, 2004, Headwaters was
committed to spend approximately $7,000,000 to complete capital projects
that were in various stages of completion. Legal or Contractual Matters -
Headwaters has ongoing litigation and claims incurred during the normal
course of business, including the items discussed below. Headwaters intends
to vigorously defend and pursue its rights in these actions. Management
does not currently believe that the outcome of these actions will have a
material adverse effect on Headwaters' operations, cash flows or financial
position; however, it is possible that a change in the estimates of
probable liability could occur, and the changes could be significant.
Additionally, as with any litigation, these proceedings may require that
Headwaters incur substantial costs, including attorneys' fees, managerial
time, and other personnel resources and costs in pursuing resolution.
Boynton. In October 1998, Headwaters entered into a technology purchase
agreement with James G. Davidson and Adtech, Inc. The transaction
transferred certain patent and royalty rights to Headwaters related to a
synthetic fuel technology invented by Davidson. (This technology is
distinct from the technology developed by Headwaters.) This action is
factually related to an earlier action brought by certain purported
officers and directors of Adtech, Inc. That action was dismissed by the
United States District Court for the Western District of Tennessee and the
District Court's order of dismissal was affirmed on appeal. In the current
action, the allegations arise from the same facts, but the claims are
asserted by certain purported stockholders of Adtech. In June 2002,
Headwaters received a summons and complaint from the United States District
Court for the Western District of Tennessee alleging, among other things,
fraud, conspiracy, constructive trust, conversion, patent infringement and
interference with contract arising out of the 1998 technology purchase
agreement entered into between Davidson and Adtech on the one hand, and
Headwaters on the other. The complaint seeks declaratory relief and
compensatory and punitive damages. The District Court has dismissed all
claims against Headwaters except conspiracy and constructive trust and has
scheduled trial for November 2004. Because the resolution of the litigation
is uncertain, legal counsel cannot express an opinion as to the ultimate
amount, if any, of Headwaters' liability.
AGTC. In March 1996, Headwaters entered into an agreement with AGTC and its
associates for certain services related to the identification and selection
of synthetic fuel projects. In March 2002, AGTC filed an arbitration demand
in Salt Lake City, Utah claiming that it is owed commissions under the 1996
agreement for 8% of the revenues received by Headwaters from the Port
Hodder project. Headwaters asserts that AGTC did not perform under the
agreement and that the agreement was terminated and the disputes were
settled in July 1996. Headwaters filed an answer in the arbitration,
denying AGTC's claims and asserting counterclaims against AGTC. The
arbitrator is conducting a hearing that will continue through August 2004.
Because the resolution of the arbitration is uncertain, legal counsel
cannot express an opinion as to the ultimate amount, if any, of Headwaters'
liability.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical reagent sale agreement with AJG Financial Services,
Inc. The agreement called for AJG to pay royalties and to purchase
proprietary chemical reagent material from Headwaters. In October 2000,
Headwaters filed a complaint in the Fourth District Court for the State of
Utah against AJG alleging that it had failed to make payments and to
perform other obligations under the agreement. Headwaters asserts claims
including breach of contract, declaratory judgment, unjust enrichment and
accounting and seeks money damages as well as other relief. AJG's answer to
the complaint denied Headwaters' claims and asserted counter-claims based
upon allegations of misrepresentation and breach of contract. AJG seeks
compensatory damages as well as punitive damages. Headwaters has denied the
allegations of AJG's counter-claims. The court has scheduled trial for
January 2005. Because the resolution of the litigation is uncertain, legal
counsel cannot express an opinion as to the ultimate amount of recovery or
liability.
McEwan. In 1995, Headwaters granted stock options to a member of its board
of directors, Lloyd McEwan. The director resigned from the board in 1996.
Headwaters has declined McEwan's attempts to exercise most of the options
on grounds that the options terminated. In June 2004, McEwan filed a
complaint in the Fourth District Court for the State of Utah against
Headwaters alleging breach of contract, breach of implied covenant of good
faith and fair dealing, fraud, and misrepresentation. McEwan seeks
declaratory relief as well as compensatory and punitive damages. Headwaters
has filed an answer denying McEwan's claims and has asserted counterclaims
against McEwan. The case is at an early stage. Because resolution of the
litigation is uncertain, legal counsel cannot express an opinion as to the
ultimate amount of liability or recovery.
18
HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
ISG Matters. There is litigation and pending and threatened claims made
against certain subsidiaries of ISG with respect to several types of
exterior stucco finish systems manufactured and sold by its subsidiaries
for application by contractors, developers and owners on residential and
commercial buildings. This litigation and these claims are controlled by
such subsidiaries' insurance carriers. The plaintiffs or claimants in these
matters have alleged that due to some failure of the stucco system itself
or its application, the buildings have suffered damage due to the
progressive, latent effects of water penetration through the building's
exterior. The most prevalent type of claim involves alleged defects
associated with an artificial stucco system manufactured by one of ISG's
subsidiaries, Best Masonry. Best Masonry continued to manufacture this
system through 1997, and there is a 10-year projected claim period
following discontinuation of the product.
Typically, the claims cite damages for alleged personal injuries and
punitive damages for alleged unfair business practices in addition to
asserting more conventional damage claims for alleged economic loss and
damage to property. To date, claims made against such subsidiaries have
been paid by their insurers, with the exception of minor deductibles,
although such insurance carriers typically have issued "reservation of
rights" letters to ISG. None of the cases has gone to trial, and while two
such cases involve 100 and 800 homes, respectively, none of the cases
includes any claims formally asserted on behalf of a class. While, to date,
none of these proceedings have required that ISG incur substantial costs,
there is no guarantee of insurance coverage or continuing coverage. These
and future proceedings may result in substantial costs to ISG, including
attorneys' fees, managerial time and other personnel resources and costs.
Adverse resolution of these proceedings could have a materially negative
effect on ISG's business, financial condition and results of operation, and
its ability to meet its financial obligations. Although ISG carries general
and product liability insurance, ISG cannot assure that such insurance
coverage will remain available, that ISG's insurance carrier will remain
viable or that the insured amounts will cover all future claims in excess
of ISG's uninsured retention. Future rate increases may also make such
insurance uneconomical for ISG to maintain. In addition, the insurance
policies maintained by ISG exclude claims for damages resulting from
exterior insulating finish systems, or EIFS, that have manifested after
March 2003. Because resolution of the litigation and claims is uncertain,
legal counsel cannot express an opinion as to the ultimate amount, if any,
of Headwaters' liability.
Other. Headwaters and its subsidiaries are also involved in other legal
proceedings that have arisen in the normal course of business.
Section 29 Matters - Covol Fuels' license fees and revenues from sales of
chemical reagents depend on the ability of licensees and customers to
manufacture and sell qualified synthetic fuels that generate tax credits.
From time to time, issues arise as to the availability of tax credits,
including the items discussed below.
Legislation. Under current law, Section 29 tax credits for synthetic fuel
produced from coal expire on December 31, 2007. In addition, there have
been initiatives from time to time to consider the early repeal or
modification of Section 29. This year, a bill was 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,
Headwaters does not believe that production of synthetic fuel will be
profitable absent the tax credits. In addition, if Headwaters' 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 annual average unregulated oil price
reaches $50.14 per barrel (the NYMEX one-day trading price on August 9,
2004 was $44.84 per barrel), adjusted annually for inflation, with tax
credits fully phased out at $62.94 per barrel.
IRS Audits. Licensees are subject to audit by the IRS. The IRS may
challenge whether Covol Fuels' licensees satisfy the requirements of
Section 29, or applicable Private Letter Rulings, including
placed-in-service requirements, or may attempt to disallow Section 29 tax
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HEADWATERS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004
(Unaudited)
credits for some other reason. The IRS has initiated audits of certain
licensee-taxpayers who claimed Section 29 tax credits, and the outcome of
any such audit is uncertain. Recently, a licensee announced that IRS field
auditors have issued a notice of proposed adjustment challenging the
placed-in-service date of three of its synthetic fuel facilities. The
licensee believes that the facilities meet the placed-in-service
requirement, however, the matter is at an early stage and the timing and
final results of the audit are unknown. The inability of a licensee to
claim Section 29 tax credits would reduce Headwaters' future income from
the licensee.
Senate Permanent Subcommittee on Investigations. On October 29, 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 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 other aspects of Section 29. The investigation will
also address the IRS' administration 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 Headwaters' revenues and net income. The
Subcommittee has not scheduled a hearing as of this report. Headwaters
cannot make any assurances as to the timing or ultimate outcome of the
Subcommittee investigation, nor can Headwaters predict whether Congress or
others may conduct investigations of Section 29 tax credits in the future.
License Fees - Pursuant to the contractual terms of an agreement with a
certain licensee, the license fees owed to Headwaters, which accumulated
during a period of approximately two and a half years, were placed in
escrow for the benefit of Headwaters, pending resolution of an audit of the
licensee by the IRS. As of March 31, 2004, the escrowed license fees and
earned interest, net of the amount Headwaters is required to pay to a third
party, were approximately $28,000,000. Approximately $3,000,000 of this
amount related to revenue recorded in the March 2004 quarter and
approximately $25,000,000 was recorded as revenue related to prior periods.
Prior to December 31, 2003, certain accounting rules governing revenue
recognition, requiring that the seller's price to the buyer be "fixed or
determinable" as well as reasonably certain of collection, appeared to
preclude revenue recognition for the amounts placed in escrow because they
were potentially subject to adjustment based on the outcome of the IRS
audit. Accordingly, none of the escrowed amounts were recognized as revenue
in the consolidated statements of income through December 31, 2003. During
the March 2004 quarter, the fieldwork for the tax audit of the licensee was
completed and there were no proposed adjustments to the tax credits claimed
by the licensee. As a result, in March 2004 Headwaters recognized revenue
relating to the funds deposited in the escrow account totaling
approximately $27,900,000. Interest income of approximately $164,000 was
also recognized. During the June 2004 quarter, the IRS completed its
administrative review of the licensee's tax audit and the escrowed amounts
were disbursed from the escrow account and paid to Headwaters.
In addition to the escrowed amounts, this same licensee has also set aside
substantial amounts for working capital and other operational contingencies
as provided for in the contractual agreements. These amounts may eventually
be paid out to various parties having an interest in the cash flows from
the licensee's operations, including Headwaters, if they are not used for
working capital and other operational contingencies. As a result,
Headwaters currently expects to receive at some future date a portion of
those reserves, the amount of which is not currently determinable and
therefore, not recognizable.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto included elsewhere herein. Headwaters' fiscal year ends on September 30
and unless otherwise noted, future references to 2003 refer to Headwaters'
fiscal quarter and/or nine-month period ended June 30, 2003, and references to
2004 refer to Headwaters' fiscal quarter and/or nine-month period ended June 30,
2004.
Consolidation, Acquisitions and Segments
Consolidation. The consolidated financial statements include the
accounts of Headwaters and all of its subsidiaries. All significant intercompany
transactions and accounts are eliminated in consolidation. Due to the time
required to obtain accurate financial information related to HTI's foreign
contracts, for financial reporting purposes HTI's financial statements have
historically been consolidated with Headwaters' financial statements using a
one-month lag. Effective October 1, 2003, Headwaters eliminated this one-month
lag because of the decreased significance of HTI's foreign contracts.
Accordingly, ten months of HTI's results of operations have been included in the
consolidated statement of income for the nine months ended June 30, 2004. The
results of operations for VFL and Eldorado have been included in the
consolidated results of operations from the dates of acquisition (April 9, 2004
and June 2, 2004, respectively) through June 30, 2004.
VFL Acquisition. On April 9, 2004, Headwaters acquired 100% of the
common stock of VFL and assumed all of VFL's outstanding debt, for a total
purchase price of approximately $29.3 million. VFL is based in West Chester,
Pennsylvania and manages approximately two million tons of CCPs annually. In
addition, VFL has operating knowledge relating to the use of low quality ash
materials in value-added applications. The acquisition of VFL broadens the scope
of services that Headwaters' CCP segment offers, as well as its client base,
principally on the East coast of the United States and in the Ohio River Valley.
In connection with the VFL acquisition, Headwaters issued $19.0 million of notes
payable to the VFL stockholders, $13.0 million of which was repaid prior to June
30, 2004 and $6.0 million of which was repaid in July 2004.
The VFL acquisition was accounted for using the purchase method of
accounting as required by SFAS No.141, "Business Combinations." Assets acquired
and liabilities assumed were recorded at their estimated fair values as of April
9, 2004. Approximately $11.3 million of the purchase price was allocated to
identifiable intangible assets consisting of contracts with utility companies,
industrial clients and municipalities. This amount is being amortized over an
estimated average useful life of eight years. The remaining purchase price not
attributable to the tangible and identifiable intangible assets was allocated to
goodwill, all of which is expected to be tax deductible. All of the intangible
assets and goodwill have been allocated to Headwaters' CCP segment.
Eldorado Acquisition. On June 2, 2004, Headwaters acquired 100% of the
ownership interests of Eldorado and paid off all of Eldorado's outstanding debt,
for a total purchase price of approximately $210.4 million. Eldorado is based in
San Marcos, California and is a leading manufacturer of architectural
manufactured stone. With over 1,600 distributors, Eldorado provides Headwaters
with a national platform for expanded marketing of "green" building products,
such as mortar and stucco made with reclaimed fly ash from coal combustion.
Headwaters expects Eldorado, which will be integrated into its construction
materials segment, to provide critical mass and improved margins in Headwaters'
efforts to expand the use of fly ash in building products. In connection with
the Eldorado acquisition, Headwaters issued $172.5 million of new convertible
senior subordinated debt and also borrowed funds under its senior secured
revolving credit arrangement and an arrangement with an investment company, the
latter two of which were repaid prior to June 30, 2004, all as explained in more
detail in Note 7 to the consolidated financial statements.
The Eldorado acquisition was accounted for using the purchase method of
accounting. Assets acquired and liabilities assumed were recorded at their
estimated fair values as of June 2, 2004. Approximately $8.2 million of the
purchase price was allocated to identifiable intangible assets, consisting
primarily of non-compete agreements. The intangible assets are being amortized
over estimated useful lives ranging from three to ten years. The remaining
purchase price not attributable to the tangible and identifiable intangible
assets was allocated to goodwill, most of which is expected to be tax
deductible. All of the intangible assets and goodwill have been allocated to
Headwaters' construction materials segment.
Segments. Headwaters operates in three business segments, alternative
energy, CCPs, and construction materials. These segments are managed and
evaluated separately by management based on fundamental differences in their
operations, products and services.
The alternative energy segment includes Headwaters' traditional
coal-based solid synthetic fuels business and HTI's business of developing
catalyst technologies to convert coal and heavy oil into
21
environmentally-friendly, higher-value liquid fuels as well as nanocatalyst
processes and applications. Revenues for this segment primarily include sales of
chemical reagents and license fees.
The CCP segment includes ISG's business of providing fly ash to the
building products and ready mix concrete industries. This segment markets coal
combustion products such as fly ash and bottom ash, known as CCPs. ISG has
long-term contracts, primarily with coal-fired electric power generation plants,
pursuant to which it manages the post-combustion operations for the utilities.
ISG markets CCPs to replace manufactured or mined materials, such as portland
cement, lime, agricultural gypsum, fired lightweight aggregate, granite
aggregate and limestone. CCP revenues consist primarily of the sale of products,
with a small amount of service revenue. VFL has been included in Headwaters' CCP
segment since its acquisition in April 2004.
The construction materials segment manufactures and distributes
value-added bagged concrete, stucco, mortar and block products, and since the
acquisition of Eldorado, architectural manufactured stone. ISG has introduced
high volumes of CCPs as substitute ingredients in the products the construction
materials segment produces. Eldorado has been included in Headwaters'
construction materials segment since its acquisition in June 2004.
Due to the seasonality of the operations of the CCP and construction
materials segments, the VFL and Eldorado acquisitions in 2004, and other
factors, Headwaters' consolidated results of operations for 2004 are not
indicative of the results to be expected for the full fiscal 2004 year.
Three Months Ended June 30, 2004 Compared to Three Months Ended June 30, 2003
The information set forth below compares Headwaters' operating results
for the three months ended June 30, 2004 ("2004") with operating results for the
three months ended June 30, 2003 ("2003").
Revenue. Total revenue for 2004 increased by $27.9 million or 26% to
$134.3 million as compared to $106.4 million for 2003. The major components of
revenue are discussed in the sections below.
Sales of Chemical Reagents. Chemical reagent sales during 2004 were
$35.3 million with a corresponding direct cost of $23.8 million. Chemical
reagent sales during 2003 were $35.9 million with a corresponding direct cost of
$25.3 million. The decrease in chemical reagent sales during 2004 was due
primarily to decreased synthetic fuel production by customers with which
Headwaters does not have a license agreement, largely offset by increased
synthetic fuel production by Headwaters' licensees. The gross margin percentage
increased 3% from 2003 to 2004 due primarily to a general price increase
effective in 2004.
License Fees. During 2004, Headwaters recognized license fee revenue
totaling $13.4 million, an increase of $3.3 million or 33% over $10.1 million of
license fee revenue recognized during 2003. The primary reason for the increase
in license fee revenue in 2004 compared to 2003 was the recognition in 2004 of
approximately $5.0 million of revenue relating to the licensee whose IRS audit
was finalized recently for which 2003 license fees were escrowed (see Note 10 to
the consolidated financial statements), partially offset by a decrease in
license fees of approximately $1.8 million from another licensee which curtailed
production of synthetic fuel at two facilities in 2004.
The licensee described in Note 10 to the consolidated financial
statements has set aside substantial amounts for working capital and other
operational contingencies as provided for in the contractual agreements. These
amounts may eventually be paid out to various parties having an interest in the
cash flows from the licensee's operations, including Headwaters, if they are not
used for working capital and other operational contingencies. As a result,
Headwaters currently expects to receive at some future date a portion of those
reserves, the amount of which is not currently determinable and therefore, not
recognizable.
CCP Revenues. CCP revenues for 2004 were $58.7 million with a
corresponding direct cost of $42.1 million. CCP revenues for 2003 were $46.0
million with a corresponding direct cost of $33.2 million. The increase in CCP
revenues during 2004 was due primarily to increased demand for high quality fly
ash products and the acquisition of VFL in April 2004. VFL's revenues for 2004
totaled $7.7 million.
Sales of Construction Materials. Sales of construction materials during
2004 were $26.8 million with a corresponding direct cost of $19.8 million. Sales
of construction materials during 2003 were $13.3 million with a corresponding
direct cost of $10.1 million. The increase in sales of construction materials
during 2004 was due primarily to the acquisition of Eldorado in June 2004.
Eldorado's revenues for 2004 totaled $13.6 million.
Depreciation and Amortization. These costs increased from $3.4 million
in 2003 to $4.5 million in 2004, due primarily to the acquisitions of VFL and
Eldorado and the resulting increases in depreciable property, plant and
equipment and amortizable intangible assets (see Notes 2 and 6 to the
consolidated financial statements).
22
Research and Development. Research and development expenses increased
by $0.6 million to $1.7 million in 2004 from $1.1 million in 2003. The increase
was primarily attributable to increased HTI research and development activities.
Management currently expects fiscal 2004 research and development expenses to
outpace the level of expenses for 2003 as a result of continued emphasis on
HTI's activities.
Selling, General and Administrative Expenses. These expenses increased
$4.2 million to $14.6 million for 2004 from $10.4 million for 2003. The increase
in 2004 was due primarily to the acquisitions of VFL and Eldorado ($2.8 million)
and increased incentive pay expenses, along with certain increases in various
other costs incidental to growth, such as payroll-related costs and professional
services. The increase in incentive pay expenses was the result of obligations
arising from Headwaters' bonus plans, due in turn to improved operating results
in 2004 compared to 2003.
Other Income and Expense. During 2004, Headwaters reported net other
expense of $1.0 million compared to net other expense of $4.2 million during
2003. The change of $3.2 million was primarily attributable to a decrease in
interest expense of $2.9 million in 2004.
Interest expense decreased from $4.2 million in 2003 to $1.3 million in
2004 due primarily to lower average levels of outstanding debt in 2004 and the
substantial reduction in the weighted-average interest rate on outstanding debt
in 2004.
In 2004, a gain of $0.3 million was recorded on a note receivable
previously written off, and in 2003, a $0.3 million loss was recorded on an
investment.
Income Tax Provision. In 2004, Headwaters recorded an income tax
provision at an effective tax rate of approximately 40.0%, compared to 39.9% in
2003.
Nine Months Ended June 30, 2004 Compared to Nine Months Ended June 30, 2003
The information set forth below compares Headwaters' operating results
for the nine months ended June 30, 2004 ("2004") with operating results for the
nine months ended June 30, 2003 ("2003").
Revenue. Total revenue for 2004 increased by $74.1 million or 26% to
$355.3 million as compared to $281.2 million for 2003. The major components of
revenue are discussed in the sections below.
Sales of Chemical Reagents. Chemical reagent sales during 2004 were
$98.4 million with a corresponding direct cost of $66.8 million. Chemical
reagent sales during 2003 were $98.1 million with a corresponding direct cost of
$66.1 million. The increase in chemical reagent sales during 2004 was due
primarily to significantly increased synthetic fuel production by Headwaters'
licensees, largely offset by decreased synthetic fuel production by customers
with which Headwaters does not have a license agreement. The gross margin
percentage decreased 1% from 2003 to 2004 due primarily to differing chemical
reagent formula requirements of certain licensees and other customers.
License Fees. During 2004, Headwaters recognized license fee revenue
totaling $59.3 million, an increase of $31.5 million or 113% over $27.8 million
of license fee revenue recognized during 2003. The primary reason for the
increase in license fee revenue in 2004 compared to 2003 was the recognition in
March 2004 of $24.9 million of net revenue relating to funds previously
deposited in an escrow account by one of Headwaters' licensees relating to funds
deposited prior to December 31, 2003, plus approximately $8.0 million of net
revenue relating to the March and June 2004 quarters.
CCP Revenues. CCP revenues for 2004 were $143.4 million with a
corresponding direct cost of $102.8 million. CCP revenues for 2003 were $115.5
million with a corresponding direct cost of $84.6 million. The increase in CCP
revenues during 2004 was due primarily to increased demand for high quality fly
ash products, the acquisition of VFL in April 2004, and the renegotiation of
certain service agreements. VFL's revenues for 2004 totaled $7.7 million. The
gross margin percentage increased from 2003 to 2004 due primarily to benefits
realized from the renegotiation of the service agreements.
Sales of Construction Materials. Sales of construction materials during
2004 were $50.0 million with a corresponding direct cost of $38.9 million. Sales
of construction materials during 2003 were $36.0 million with a corresponding
direct cost of $27.5 million. The increase in sales of construction materials
during 2004 was due primarily to the acquisition of Eldorado in June 2004.
Eldorado's revenues for 2004 totaled $13.6 million. The decrease in gross margin
percentage from 2003 to 2004 was due primarily to certain inventory and other
balance sheet adjustments, some of which related to original purchase price
allocations, partially offset by higher margins from Eldorado for the month of
June.
Depreciation and Amortization. These costs increased by $1.4 million to
$11.1 million in 2004 from $9.7 million in 2003. The increase was primarily
attributable to the acquisitions of VFL and Eldorado and the resulting increases
in depreciable property, plant and equipment and amortizable intangible assets,
and an extra month of depreciation and amortization of HTI's tangible and
intangible assets in 2004.
23
Research and Development. Research and development expenses increased
by $1.9 million to $5.1 million in 2004 from $3.2 million in 2003. The increase
was primarily attributable to increased HTI research and development activities
and an extra month of HTI expenses in 2004.
Selling, General and Administrative Expenses. These expenses increased
$12.0 million to $42.3 million for 2004 from $30.3 million for 2003. The
increase in 2004 was due primarily to increased incentive pay expenses, along
with certain increases in various other costs incidental to growth, primarily
payroll-related costs, as well as the acquisitions of VFL and Eldorado. The
increase in incentive pay expenses was the result of obligations arising from
Headwaters' bonus plans, due in turn to improved operating results in 2004
compared to 2003, a significant portion of which related to revenue recognized
from escrowed funds in March 2004, as previously discussed.
Other Income and Expense. During 2004, Headwaters reported net other
expense of $14.4 million compared to net other expense of $14.2 million during
2003. The change of $0.2 million was primarily attributable to an increase in
interest expense of $0.3 million in 2004, the write-off of $0.8 million of
deferred acquisition costs related to projects that were abandoned in 2004,
partially offset by a reduction of $1.1 million in note receivable losses.
Interest expense increased from $12.3 million in 2003 to $12.6 million
in 2004 due primarily to accelerated non-cash interest expense related to the
substantial increase in debt repayments that were made in 2004 compared to 2003.
In 2004, debt repayments totaled approximately $207.0 million, which consisted
largely of early repayments. In 2003, debt repayments totaled approximately
$30.3 million. As a result of the increase in repayments in 2004, non-cash
interest expense, representing amortization of debt discount and debt issue
costs, increased from $2.9 million in 2003 to $7.8 million in 2004. Partially
offsetting this large increase in non-cash interest expense was a decrease in
cash interest expense in 2004 due to the lower average levels of outstanding
long-term debt in 2004 compared to 2003, and a reduction in the weighted-average
interest rate on outstanding debt.
Losses of $1.0 million were recorded on notes receivable in 2004
compared to a loss on a note receivable of $2.1 million in 2003.
Income Tax Provision. In 2004, Headwaters recorded an income tax
provision at an effective tax rate of approximately 39.1%. In 2003, the
effective tax rate was approximately 40.0%. The primary reason for the decrease
in the effective tax rate was decreased state income taxes due to tax planning
strategies implemented for fiscal year 2004.
Liquidity and Capital Resources
Summary of Cash Flow Activities. Net cash provided by operating
activities during the nine months ended June 30, 2004 ("2004") was $56.2 million
compared to $41.2 million of net cash provided by operations during the nine
months ended June 30, 2003 ("2003"). The change was primarily attributable to an
increase in net income in 2004 compared to 2003.
In 2004, Headwaters issued 5.0 million shares of common stock under an
effective shelf registration statement for net cash proceeds of $90.3 million.
Headwaters used $50.0 million of the cash generated from the issuance of common
stock to repay debt and the remaining proceeds were temporarily invested in
short-term trading investments. During 2004, a total of $207.0 million of debt
was repaid, which amount includes $50.0 million of cash obtained from the
refinancing of Headwaters' senior debt. New debt issuances in 2004 totaled
$269.2 million, net of debt issuance costs, and included $172.5 million of
convertible senior subordinated notes and $94.0 million of senior debt (of which
$45.25 million was repaid prior to June 30, 2004). Most of the new debt
issuances were in connection with the Eldorado acquisition in June 2004. During
2004, investing activities consisted primarily of payments for acquisitions,
including approximately $209.8 million for Eldorado, and the purchase of
property, plant and equipment. More details about Headwaters' investing and
financing activities are provided in the following paragraphs.
Investing Activities. As described in more detail in Note 2 to the
consolidated financial statements, Headwaters acquired VFL and Eldorado during
the quarter ended June 30, 2004. These acquisitions required net payments of
cash totaling approximately $213.3 million, most of which was obtained from the
issuance of $172.5 million of convertible senior subordinated notes and $44.0
million of borrowings under Headwaters' revolving credit arrangement. In
addition, in July 2004, Headwaters acquired SCP for total cash payments of
approximately $26.0 million and the assumption of approximately $10.0 million of
debt.
Headwaters intends to continue to expand its business through growth of
existing operations, commercialization of technologies currently being
developed, and strategic acquisitions of entities that operate in adjacent
industries. It is possible that some portion of cash and cash equivalents and
short-term trading investments will be used to fund acquisitions of
complementary businesses in the chemical, energy, building products and related
industries. Acquisitions are an important part of Headwaters' business strategy
and to that end, Headwaters routinely reviews complementary acquisitions,
including those in the areas of CCP marketing and construction materials, and
coal and catalyst technologies. The new senior secured credit agreement
24
generally requires approval for acquisitions funded with cash in excess of $30.0
million individually or in excess of $50.0 million in the aggregate. Approval is
required for aggregate acquisitions in excess of $20.0 million not funded with
cash. These limits apply to acquisitions in any single fiscal year. Approvals
from the lenders for the acquisitions of VFL, Eldorado and SCP were obtained
when the new credit agreement was executed. In 2004, Headwaters expensed
approximately $0.8 million of deferred acquisition costs related to acquisition
projects that were abandoned.
In 2004, payments for the purchase of property, plant and equipment
totaled $9.9 million. These capital expenditures primarily related to the CCP
segment. Total capital expenditures for fiscal year 2004 are expected to be
higher than for fiscal year 2003, due primarily to the 2004 acquisitions.
Headwaters had two notes receivable with a combined carrying value of
approximately $2.5 million at September 30, 2003. In 2004, Headwaters wrote-off
the balance of one of these notes and recorded a write-down of the other note
receivable, which has a carrying value at June 30, 2004 of approximately $1.5
million. This note receivable is supported by collateral; however, Headwaters
could incur additional losses if the remaining balance on the note is not repaid
or if the collateral value declines.
Financing Activities. Headwaters has an effective universal shelf
registration statement on file with the SEC that can be used for the sale of
common stock, preferred stock, convertible debt and other securities. In
December 2003, Headwaters filed a prospectus supplement to the shelf
registration statement and issued 4.8 million shares of common stock under this
shelf registration statement in an underwritten public offering. In January
2004, an additional 0.2 million shares of common stock were issued upon exercise
of the underwriters' over-allotment option. In total, proceeds of $90.3 million
were received, net of offering costs of $6.4 million. Following these issuances
of common stock, approximately $53.0 million remains available for future
offerings of securities under the shelf registration statement. A prospectus
supplement describing the terms of any additional securities to be issued is
required to be filed before any future offering would commence under the
registration statement.
New Senior Secured Credit Agreement - In March 2004, Headwaters entered
into a credit agreement with a syndication of lenders under which a total of
$50.0 million was borrowed under a term loan arrangement and which, as amended
in June 2004, provides for an additional $75.0 million to be borrowed under a
revolving credit arrangement. The initial $50.0 million of proceeds were used to
repay in full the remaining balance due under Headwaters' former Term B senior
secured credit agreement.
The current $48.8 million term loan is secured by all assets of
Headwaters, bears interest at a variable rate (approximately 3.6% at June 30,
2004), and is repayable in quarterly installments of $1.25 million through
September 2007. The remaining principal at that time of $32.5 million is
repayable in November 2007, the termination date of the credit agreement.
Optional prepayments of the term loan can be made at Headwaters' discretion,
subject to certain minimum amount requirements specified in the credit
agreement. Beginning December 31, 2004 and continuing each year thereafter,
Headwaters must make mandatory prepayments to the extent of 50% of Headwaters'
fiscal year "excess cash flows," as defined. Once repaid in full or in part, no
further borrowings under the term loan arrangement can be made.
Former Senior Secured Credit Agreement - In connection with the ISG
acquisition in 2002, Headwaters entered into a $175.0 million senior secured
credit agreement with a syndication of lenders, under which a total of $155.0
million was borrowed as a term loan on the acquisition date. During the quarter
ended December 31, 2003, principal repayments totaling $39.7 million were made,
including $33.5 million of optional prepayments. During the quarter ended March
31, 2004, the remaining balance was repaid in full using available cash and
$50.0 million of proceeds from the new senior debt facility described above. In
connection with the full repayment of this debt, non cash interest expense
totaling approximately $5.0 million was recognized in the March 2004 quarter,
representing amortization of all of the remaining debt discount and debt issue
costs related to this debt.
Senior Subordinated Debentures - In connection with the ISG
acquisition, Headwaters also entered into a $20.0 million subordinated loan
agreement, under which senior subordinated debentures were issued. ISG
management participated in one-half, or $10.0 million, of the $20.0 million of
debt issued. The other half was issued to a corporation. The debentures were due
in 2007; however, in December 2003, the debentures were repaid in full,
including a 4%, or $0.4 million, prepayment charge paid to the corporation
holding $10.0 million of the debentures. This charge, along with all remaining
unamortized debt discount and debt issue costs, is included in interest expense
in the consolidated statement of income.
Convertible Senior Subordinated Notes - In connection with the Eldorado
acquisition, Headwaters issued $172.5 million of 2 ?% convertible senior
subordinated notes due 2016. Holders of the notes may convert the notes into
shares of Headwaters' common stock at a conversion rate of 33.3333 shares per
$1,000 principal amount ($30 conversion price), or approximately 5.75 million
aggregate shares of common stock, contingent upon certain events. The conversion
rate adjusts for events related to Headwaters' common stock, including common
25
stock issued as a dividend, rights or warrants to purchase common stock issued
to all holders of Headwaters' common stock, and other similar rights or events
that apply to all holders of common stock.
The notes are convertible if any of the following five criteria are
met: 1) satisfaction of a market price condition which becomes operative if the
common stock trading price reaches $39 per share for a certain period of time
prior to June 1, 2011 and at any time after that date; 2) a credit rating, if
any, assigned to the notes is three or more rating subcategories below the
initial rating, if any; 3) the notes trade at 98% of the product of the common
stock trading price and the number of shares of common stock issuable upon
conversion of $1,000 principal amount of the notes, except this provision is not
available if the closing common stock price is between 100% and 130% of the
current conversion price of the notes; 4) Headwaters calls the notes for
redemption; and 5) certain corporate transactions occur, including distribution
of rights or warrants to all common stock holders entitling them to purchase
common stock at less than the current market price or distribution of common
stock, cash or other assets, debt securities or certain rights to purchase
securities where the distribution has a per share value exceeding 5% of the
closing common stock price on the day immediately preceding the declaration date
for such distribution. In addition, the notes are convertible if Headwaters
enters into an agreement pursuant to which Headwaters' common stock would be
converted into cash, securities or other property.
Headwaters may call the notes for redemption at any time on or after
June 1, 2007 and prior to June 4, 2011 if the closing common stock price exceeds
130% of the conversion price for 20 trading days in any consecutive 30-day
trading period (in which case Headwaters must provide a "make whole" payment of
the present value of all remaining interest payments on the redeemed notes
through June 1, 2011). Headwaters may redeem any portion of the notes at any
time on or after June 4, 2011. In addition, the holder of the notes has the
right to require Headwaters to repurchase all or a portion of the notes on June
1, 2011 or if a fundamental change in common stock has occurred, including
termination of trading. Subsequent to June 1, 2011, the notes require an
additional interest payment equal to 0.40% of the average trading price of the
notes if the trading price equals 120% or more of the principal amount of the
notes.
Headwaters has not included the additional shares of common stock
contingently issuable under the notes in diluted earnings per share as none of
the contingencies have been met. Had Headwaters included the shares in the June
30, 2004 calculation using the if-converted method, diluted earnings per share
would have been reduced by $0.02 per share to $0.45 and $1.36 for the three- and
nine-month periods ended June 30, 2004, respectively.
Notes Payable to Former VFL Stockholders - In connection with the VFL
acquisition, Headwaters issued $19.0 million of notes payable to the VFL
stockholders, $13.0 million of which was repaid prior to June 30, 2004 and $6.0
million of which was repaid in July 2004.
Short-term Borrowings with an Investment Bank - Headwaters has an
arrangement with an investment bank under which Headwaters can borrow up to 90%
of the value of the portfolio of Headwaters' short-term investments with the
investment bank, limited to a maximum amount of $20.0 million. Headwaters
borrowed $10.0 million under this arrangement during June 2004, all of which was
repaid prior to June 30, 2004. In July, Headwaters borrowed $6.0 million under
this arrangement, which was repaid prior to July 31, 2004.
In 2004, cash proceeds from the exercise of options, warrants and
employee stock purchases totaled $7.4 million, compared to $2.1 million in 2003.
Option exercise activity is largely dependent on Headwaters' stock price and is
not predictable. To the extent non-qualified stock options are exercised, or
there are disqualifying dispositions of shares obtained upon the exercise of
incentive stock options, Headwaters receives an income tax deduction generally
equal to the income recognized by the optionee. Such amounts, reflected in cash
flows from operations in the consolidated statements of cash flows, were $1.7
million in 2003 and $3.3 million in 2004. These income tax deductions do not
affect income tax expense and the effective income tax rate; rather they are
reflected as increases in capital in excess of par value in the consolidated
balance sheet.
Working Capital. In 2004, Headwaters' working capital increased by
$41.2 million, to $55.4 million as of June 30, 2004. Several of the significant
changes in the components of working capital were the result of the 2004
acquisitions, most notably Eldorado. Headwaters expects operations to produce
positive cash flows in future periods, which, combined with current working
capital, is expected to be sufficient for operating needs for the next 12
months.
Long-term Debt. Management currently believes Headwaters has the
ability, if needed, to obtain additional amounts of long-term debt in the
future, either by amendment to the current senior secured credit facility or
through issuance of other debt securities. Headwaters may, in the future, make
optional prepayments of the senior debt depending on actual cash flows,
Headwaters' current and expected cash requirements and other factors deemed
significant by management.
The senior secured credit agreement contains restrictions and covenants
common to such agreements, including limitations on the incurrence of additional
debt, investments, merger and acquisition activity, asset liens, capital
expenditures in excess of $26.0 million in any fiscal year and the payment of
26
dividends, among others. In addition, Headwaters must meet minimum net worth
requirements and maintain certain financial ratios, including leverage ratios
and a fixed charge coverage ratio, as those terms are defined in the credit
agreement. The initial net worth requirement is $200.3 million and is increased
by 50% of Headwaters' consolidated net income earned subsequent to March 31,
2004. Headwaters must maintain a total leverage ratio of 2.5:1.0 or less and a
senior debt leverage ratio of 1.5:1.0 or less. Headwaters is in compliance with
all debt covenants as of June 30, 2004.
Borrowing terms under the revolving credit arrangement are generally
the same as those described in the preceding paragraphs except that reborrowings
of any available portion of the $75.0 million revolver can be made at any time.
Finally, the credit agreement allows for the issuance of letters of credit,
provided there is capacity under the revolving credit arrangement. Currently,
two letters of credit totaling $2.0 million are outstanding, with expiration
dates in November 2004 and June 2005. In connection with the purchase of
Eldorado in June 2004, a total of $44.0 million was borrowed under the revolving
credit arrangement, all of which was repaid prior to June 30, 2004. In
connection with the purchase of SCP in July 2004, a total of $20.0 million was
borrowed under the revolving credit arrangement, which remains outstanding
currently. Headwaters currently pays a fee of 0.375% on the unused portion of
the revolving credit arrangement.
Income Taxes. As discussed previously, cash payments for income taxes
are reduced for disqualifying dispositions of shares obtained upon the exercise
of stock options, which totaled $3.3 million in 2004. Headwaters' cash
requirements for income taxes in fiscal 2004 are expected to approximate the
income tax provision, with some lag due to the seasonality of operations and
because estimated income tax payments are typically based on annualizing the
fiscal year's income based on year-to-date results.
Summary of Future Cash Requirements. Significant future cash needs, in
addition to operational working capital requirements and acquisition-related
funding requirements, are currently expected to consist primarily of debt
service payments on outstanding long-term debt, income taxes and capital
expenditures.
Section 29 Matters
Covol Fuels' license fees and revenues from sales of chemical reagents
depend on the ability of licensees and customers to manufacture and sell
qualified synthetic fuels that generate tax credits. From time to time, issues
arise as to the availability of tax credits, including the items discussed
below.
Legislation. Under current law, Section 29 tax credits for synthetic
fuel produced from coal expire on December 31, 2007. In addition, there have
been initiatives from time to time to consider the early repeal or modification
of Section 29. This year, a bill was 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, Headwaters does not believe that
production of synthetic fuel will be profitable absent the tax credits. In
addition, if Headwaters' 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 annual average
unregulated oil price reaches $50.14 per barrel (the NYMEX one-day trading price
on August 9, 2004 was $44.84 per barrel), adjusted annually for inflation, with
tax credits fully phased out at $62.94 per barrel.
IRS Audits. Licensees are subject to audit by the IRS. The IRS may
challenge whether Covol Fuels' licensees satisfy the requirements of Section 29,
or applicable Private Letter Rulings, including placed-in-service requirements,
or may attempt to disallow Section 29 tax credits for some other reason. The IRS
has initiated audits of certain licensee-taxpayers who claimed Section 29 tax
credits, and the outcome of any such audit is uncertain. Recently, a licensee
announced that IRS field auditors have issued a notice of proposed adjustment
challenging the placed-in-service date of three of its synthetic fuel
facilities. The licensee believes that the facilities meet the placed-in-service
requirement, however, the matter is at an early stage and the timing and final
results of the audit are unknown. The inability of a licensee to claim Section
29 tax credits would reduce Headwaters' future income from the licensee.
Senate Permanent Subcommittee on Investigations. On October 29, 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 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 other aspects of
Section 29. The investigation will also address the IRS' administration 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,
27
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
Headwaters' revenues and net income. The Subcommittee has not scheduled a
hearing as of this report. Headwaters cannot make any assurances as to the
timing or ultimate outcome of the Subcommittee investigation, nor can Headwaters
predict whether Congress or others may conduct investigations of Section 29 tax
credits in the future.
Recent Accounting Pronouncements and Other Accounting Developments
Headwaters has reviewed all recently issued accounting standards that
have not yet been adopted in order to determine their potential effect, if any,
on the results of operations or financial position of Headwaters. Based on that
review, Headwaters does not currently believe that any of these recent
accounting pronouncements will have a significant effect on its current or
future financial position, results of operations, cash flows or disclosures.
At a recent Emerging Issues Task Force meeting, the Task Force
discussed the accounting for contingently convertible debt instruments. As
discussed in Note 7 to the consolidated financial statements, Headwaters'
convertible senior subordinated notes have such features. Under current
interpretations of FASB Statement No. 128, "Earnings per Share," Headwaters
excludes the potential common shares underlying the notes from the calculation
of diluted earnings per share until such time as the contingent conversion
features are met. The Task Force reached a tentative conclusion that the
contingently issuable shares guidance in Statement No. 128 does not apply to
convertible debt. As a result, the dilutive effect of contingently convertible
debt would be included in the calculation of diluted earnings per share
immediately upon issuance of the debt instrument. If the Task Force's conclusion
is confirmed, Headwaters could be required to retroactively restate diluted
earnings per share to include the effect of the contingently convertible debt
from the issuance date forward as if it was converted. This restatement would
have the effect of reducing Headwaters' reported diluted earnings per share.
Forward-looking Statements
Statements in this Quarterly Report on Form 10-Q regarding Headwaters'
expectations as to the managing and marketing of coal combustion products,
operation of facilities utilizing alternative fuel technologies, the marketing
of synthetic fuels, the receipt of licensing fees, royalties, and product sales
revenues, the development, commercialization and financing of new technologies
and other strategic business opportunities and acquisitions and other
information about Headwaters that is not purely historical by nature, including
those statements regarding Headwaters' future business plans, the operation of
facilities, the availability of tax credits, the availability of feedstocks, and
the marketability of the coal combustion products and synthetic fuel, constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although Headwaters believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. In addition to matters
affecting the coal combustion products and synthetic fuel industries or the
economy generally, factors which could cause actual results to differ from
expectations stated in these forward-looking statements include, among others,
the Risk Factors described in "Risk Factors" in Item 7 of our Annual Report on
Form 10-K for the year ended September 30, 2003, and the Risk Factors described
in Item 5 of our Form 8-K dated May 25, 2004 and in our Form S-3 filed on July
20, 2004.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Headwaters is exposed to financial market risks, primarily related to
changes in interest rates. Headwaters does not use derivative financial
instruments for speculative or trading purposes and no material derivative
financial instruments were outstanding as of June 30, 2004 or subsequent
thereto.
The majority of Headwaters' short-term investments, all of which are
classified as trading securities, consist of fixed-rate U.S. government
securities or securities backed by the U.S. government. Changes in interest
rates can affect the market value of these investments, which are carried at
market value in the consolidated balance sheets. The periodic adjustments to
reflect changes in market value are included in interest and net investment
income in the consolidated statements of income. Based on the current amount of
short-term investments and expected near-term changes in the amount of
short-term investments, Headwaters does not expect any material near-term
investment losses to result from changes in interest rates.
As described in more detail in Note 7 to the consolidated financial
statements, Headwaters has outstanding $48.75 million of variable-rate long-term
debt as of June 30, 2004, which is repayable through November 2007. The interest
rate on this debt as of June 30, 2004 was approximately 3.6%. In June 2004,
Headwaters locked in this rate for one month and in July 2004, Headwaters locked
in a new rate for one month. Rates can be locked in for periods ranging from one
month to one year. A change in the interest rate of 1% would change interest
expense by approximately $0.5 million during the 12 months ended June 30, 2004,
considering required principal repayments.
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ITEM 4. CONTROLS AND PROCEDURES
Disclosure controls are procedures that are designed with an objective
of ensuring that information required to be disclosed in Headwaters' periodic
reports filed with the SEC, such as this Quarterly Report on Form 10-Q, is
recorded, processed, summarized and reported within the time periods specified
by SEC rules and forms. Disclosure controls include, without limitation,
controls and procedures designed to ensure that such information is accumulated
and communicated to Headwaters' management, including the Chief Executive
Officer ("CEO") and the Chief Financial Officer ("CFO"), in order to allow
timely consideration regarding required disclosures.
The evaluation of Headwaters' disclosure controls by the CEO and CFO
included a review of the controls' objectives and design, the operation of the
controls, and the effect of the controls on the information presented in this
Quarterly Report. Headwaters' management, including the CEO and CFO, does not
expect that disclosure controls can or will prevent or detect all errors and all
fraud, if any. A control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Also, projections of any evaluation of the disclosure
controls and procedures to future periods are subject to the risk that the
disclosure controls and procedures may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
Based on their review and evaluation as of June 30, 2004, and subject
to the inherent limitations as described above, Headwaters' CEO and CFO have
concluded that Headwaters' disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) are
effective. In addition, they are not aware of any change in Headwaters' internal
control over financial reporting during the quarter ended June 30, 2004 that has
materially affected, or is reasonably likely to materially affect, Headwaters'
internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See "Legal or Contractual Matters" in Note 10 to the consolidated
financial statements for a description of current legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
During the quarter ended June 30, 2004, pursuant to the exercise of
options, approximately 15,000 shares of Headwaters restricted common stock were
issued. Headwaters has several outstanding effective registration statements
filed on Forms S-3 and S-8. All but 2,500 of the shares of restricted common
stock issued during the quarter have been registered under one of these
registration statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
12 Computation of ratio of earnings to combined fixed *
charges and preferred stock dividends
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief *
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief *
Financial Officer
32 Section 1350 Certifications of Chief Executive *
Officer and Chief Financial Officer
______________
* Filed herewith.
(b) The following Forms 8-K were filed with the SEC during the quarter ended
June 30, 2004:
o Form 8-K filed April 14, 2004 to file a press release
announcing that Headwaters completed the acquisition of VFL
Technology Corporation.
o Form 8-K filed April 22, 2004 to file two press releases
announcing i) the execution of a purchase agreement to acquire
Eldorado Stone, LLC, and ii) Headwaters' results for the
quarter ended March 31, 2004.
o Form 8-K filed May 25, 2004 to i) disclose the probable
acquisition of Eldorado Stone, LLC and file the required
financial statements of Eldorado and pro forma financial
information; and ii) update the risk factors for outstanding
Forms S-3 and S-8.
o Form 8-K filed May 26, 2004 to file a press release announcing
the pricing of $150 million of convertible senior subordinated
notes.
o Form 8-K filed June 4, 2004 to file a press release announcing
that Headwaters completed the acquisition of Eldorado Stone,
LLC.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HEADWATERS INCORPORATED
Date: August 10, 2004 By: /s/ Kirk A. Benson
------------------------------------------
Kirk A. Benson, Chief Executive Officer
(Principal Executive Officer)
Date: August 10, 2004 By: /s/ Steven G. Stewart
------------------------------------------
Steven G. Stewart, Chief Financial Officer
(Principal Financial Officer)
31