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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2000,
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
(formerly Covol Technologies, Inc.)
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11778 S. Election Drive, Suite 210
Draper, Utah 84020
(Address of principal executive offices) (Zip Code)
(801) 984-9400
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 1, 2000 was $57,893,307 based upon the closing
price on the Nasdaq National Market(SM) reported for such date. This calculation
does not reflect a determination that persons whose shares are excluded from the
computation are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock as of
December 1, 2000 was 23,391,473.
---------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated herein by reference:
Portions of the registrant's definitive proxy statement to be issued in
connection with registrant's annual stockholders' meeting to be held in 2001.
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS..........................................................3
ITEM 2. PROPERTIES........................................................9
ITEM 3. LEGAL PROCEEDINGS................................................10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..............11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS..............................................11
ITEM 6. SELECTED FINANCIAL DATA..........................................15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................16
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK........22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA......................22
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..............................22
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT...............22
ITEM 11. EXECUTIVE COMPENSATION...........................................23
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...23
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...................23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K.........................................................23
SIGNATURES..................................................................27
Forward-Looking Statements
Statements in this Form 10-K, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Item 7 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
2
PART I
ITEM 1. BUSINESS
The Company
Headwaters has developed an innovative chemical technology wherein
chemical reagents interact with coal based feedstock to produce an alternative
fuel. Through its existing chemical-based fuels business, Headwaters earns a
stable and growing revenue stream that provides the capital needed to develop
synergistic business opportunities.
Headwaters was incorporated in Delaware in 1995 under the name Covol
Technologies, Inc. In September 2000, the Company's name was changed to
Headwaters Incorporated. Headwaters' stock trades under the Nasdaq symbol HDWR.
Company History
Headwaters' technologies are being used to transform coal, coal fines,
coal refuse and other coal derivatives into a special qualified fuel. The
technologies molecularly bind coal derivatives into a formed fuel through a
significant chemical reaction. The resulting product has been classified as a
"qualified fuel" within the meaning of Section 29 of the U.S. Internal Revenue
Code. Sales of the fuel therefore qualify for a significant tax credit. By
licensing its technology to owners of production facilities, Headwaters earns
royalties based upon the sale of qualified fuel. Headwaters also earns revenues
from chemical reagent sales to these producers.
Although not proven commercially, the Headwaters technologies have
broader potential applications. For example, the technologies can also be used
to transform coke dust into formed coke. Coke, which is processed metallurgical
grade coal, is primarily used in the iron making process as a reducing agent and
also as a fuel source. Coke dust, also known as "coke breeze," is a fine residue
by-product resulting from the production, handling and storage of coke. In
tests, Headwaters has successfully aggregated coke dust into briquettes designed
to withstand the weight, heat and other factors inside of metal making furnaces.
The Headwaters technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Within controlled, small scale laboratory settings, the Headwaters
technologies have been demonstrated to be capable of producing briquettes from
such steel production wastes. Such briquettes can be further processed in metal
reducing furnaces to form high grade pig iron, a common form of feed material
used in the steel industry.
Additional fuel or resource by-products to which the Headwaters
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.
Except for alternative fuel production, the Headwaters technologies
described above have not been commercially applied. No assurance can be given
that Headwaters will be able to implement these applications profitably or that
the development of these alternative applications will be the most profitable
use of Headwaters' limited financial and managerial resources.
Current and Future Business Strategy
Headwaters intends to grow its business by increasing chemical reagent
sales and maximizing royalty income. The growth of alternative fuel production
and sales by licensees results in increased royalty payments and increased
chemical sales for Headwaters. Headwaters hopes to diversify its operations in
related businesses, building on its core competencies in specialty chemicals,
energy, and in resource recovery.
3
For the past four years, Headwaters' business strategy has been focused
almost exclusively upon alternative fuels from coal derivatives. There are 28
facilities owned by unaffiliated third parties located in nine states that are
licensed to use Headwaters' alternative fuel technology.
Headwaters and its licensees are in the process of increasing
production levels and product sales. An industry report estimates that the
optimum potential production level for the Headwaters' alternative fuels
technology is 23,000,000 tons per year. Licensees' reports of alternative fuel
sales for the quarter ended September 30, 2000 yield annualized sales of
approximately 9,800,000 tons. Headwaters is working with its licensees to
optimize production levels and quality though laboratory testing and field work.
These efforts result in improved Headwaters products, services and techniques.
Feedstock supply, production, product quality and the marketing of the
alternative fuel all directly affect the amount and timing of royalties to be
received by Headwaters. Accordingly, assisting licensees to optimize the
production from these facilities is one of Headwaters' highest priorities.
Headwaters has received one-time initial license fees with respect to
most of the facilities. These initial license fees are being amortized into
revenue over the life of the license agreements. Future revenues related to such
facilities are expected to come from royalties earned from Headwaters'
licensees' ongoing production and sale of alternative fuel pursuant to existing
licensing agreements.
Headwaters also expects to generate significant revenues from future
sales of chemical reagent materials. Headwaters hopes to increase sales of its
chemical materials, first, by increased purchases by licensees as alternative
fuel production increases, and second, by marketing these chemicals to existing
non-licensee facility owners that have not used the Headwaters chemical reagent
materials before.
Headwaters has a contract to operate one alternative fuel facility
located in Pennsylvania. This operation provides Headwaters with manufacturing
experience to add to its ongoing laboratory experience. Headwaters also receives
a small operating fee for these services.
Strategic Acquisitions. Headwaters believes that it may have unique
opportunities to pursue acquisitions that are synergistic with Headwaters'
financial and operational objectives. Headwaters intends to pursue possible
acquisitions of complementary businesses aligned to the chemical, mineral, or
energy industries in which Headwaters does business. If suitable candidates are
not found in these industries, Headwaters intends to pursue possible acquisition
candidates in other fragmented, growing industries where promising financial
returns exist.
Emerging Business Investments. Headwaters has made some limited
investments in emerging businesses. These investments are in the form of secured
loans and equity purchases. As of December 1, 2000, Headwaters and its
wholly-owned subsidiary, Kwai Financial, Inc., have loaned or committed to loan
approximately $4.1 million to nine businesses. Kwai Financial normally
participates with other lenders in bridge loans with terms of approximately 120
to 180 days until equity financing is obtained, at which time the bridge loans
are repaid.
As of December 1, 2000, Headwaters has also invested approximately $5
million to purchase minority equity interests in five emerging businesses.
Headwaters' goal is to maximize the return on these investments and identify a
liquidity event for the equity investment. Headwaters does not intend to
increase the funds committed to these investment types in the future.
Alternative Fuel Tax Credits
Headwaters' technology royalties and chemical reagent sales ultimately
derive from each licensee's ability to manufacture and sell qualified fuels that
generate tax credits for the facility owner. Section 29 of the U.S. Internal
Revenue Code provides for a credit against regular federal income tax with
respect to sales of qualified fuel to an unrelated party. The Section 29 credit
equates to approximately $20.00-$28.00 per ton of alternative fuel, depending
upon the recoverable heat content.
In order to qualify as "solid synthetic fuels produced from coal" for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. In September 1995 Headwaters received a Private
Letter Ruling, or PLR, from the IRS in which the IRS, based on representations
made to it by Headwaters, ruled that the alternative fuel technology produces a
significant chemical change compared to the parent feedstocks and this qualifies
the end product as a solid synthetic fuel.
4
Because Headwaters currently does not sell fuel from an alternative
fuel facility, Headwaters does not claim Section 29 tax credits. However,
licensees of Headwaters' alternative fuel technology do claim Section 29 tax
credits. At least 11 PLRs covering 17 alternative fuel facilities have been
obtained by third parties in connection with licenses of Headwaters' alternative
fuel technology. All PLRs are only binding with respect to the specific projects
addressed in the PLR and may only be relied on by the party that obtained the
PLR. Also, in its rulings to licensees the IRS notes that no temporary or final
regulations pertaining to one or more of the issues addressed in the PLRs have
been adopted and that the PLRs would be modified or revoked by the adoption of
temporary or final regulations to the extent the regulations are inconsistent
with any conclusions in the PLRs. The IRS notes, however, that a PLR is not
revoked or modified retroactively, except in rare and unusual circumstances,
provided that:
* there has been no misstatement or omission of material facts,
* the facts at the time of the transaction are not materially different
from the facts on which the PLR was based,
* there has been no change in the applicable law,
* the PLR was originally issued for a proposed transaction and
* the taxpayer directly involved in the PLR acted in good faith in
relying on the PLR, and revoking the PLR retroactively would be to the
taxpayer's detriment.
The Section 29 credit is subject to a phase out after the unregulated
oil price reaches specified levels under an annually adjusted formula. The
credit would begin to phase out if the reference price for oil exceeds
approximately $48.00 per barrel. The credit is also subject to reduction insofar
as an otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state or local governments, or from tax-exempt bond
financing.
Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, the credits are not subject to
subsequent recapture. By virtue of the various limitations and other factors
described above, there can be no assurances that any particular amount of
Section 29 credit will be allowable and usable. The alternative fuel facilities
must have been constructed pursuant to a binding written contract in effect as
of December 31, 1996, and placed in service before July 1, 1998. The Section 29
credit will, under present law, be available for sales of qualified fuels
completed before January 1, 2008.
Because of the significance of the Section 29 tax credit, constituents
have communicated with their congressional representatives about the benefits
and burdens of the credit. Congress continues to periodically entertain
legislation to further extend Section 29 deadlines particularly in times of
heightened energy dependence awareness. However, the Department of the Treasury
and the IRS have ongoing oversight programs and are currently reviewing taxpayer
use of the credit for possible abuses, including whether there should be
restrictions on the availability of credits.
Licensees
Headwaters derives most of its revenue from the owners of alternative
fuel facilities who have licensed Headwaters' technology and who purchase
chemical reagent from Headwaters.
In total, Headwaters has licensed or constructed plants using the
Headwaters technologies at 24 alternative fuel facilities that operate at
various locations in the primary coal supply regions of the United States. For
all facilities, the construction agreements were entered into prior to December
31, 1996. In some instances, Headwaters entered into a construction contract
that was either fulfilled by Headwaters or later assigned to a licensee. In
certain instances, the licensees entered into their own construction contracts.
License and Chemical Supply Agreements. All entities that have
constructed or own facilities using the Headwaters technologies have entered
into a technology license and chemical reagent supply agreement with Headwaters.
Many license agreements provided for an initial license fee, payable upon
reaching project milestones.
5
Headwaters has received most of the initial license fees related to these
facilities, which amounts are being amortized into revenue by Headwaters over
the life of the license agreements. In addition, pursuant to many of the license
agreements, the licensee pays a quarterly earned license fee generally at a
prescribed dollar amount or a percentage of the tax credits earned by the
licensee. In some cases, the amount to be paid is subject to adjustment to the
extent that licensees incur operating losses on the production and sale of
alternative fuel, exclusive of the amount licensees pay as a license fee for the
use of the technology. The fees paid to Headwaters under the license agreements
are not based on the sales price of the alternative fuel product but rather the
tax credits earned. The license agreements generally have a term continuing
through the later of January 1, 2008 or the corresponding date after which tax
credits may not be claimed or are not otherwise available under Section 29 of
the tax code.
Headwaters has also agreed, pursuant to chemical supply agreements, to
provide chemical reagent to licensees for the manufacture and production of
alternative fuel. The price for the chemical sold to the licensees falls into
two categories: a fixed price, or an amount equal to Headwaters' cost plus a
prescribed mark-up.
The chemical reagent is currently manufactured by Dow Chemical
Corporation for Headwaters utilizing Headwaters' patented and proprietary
technology. Headwaters does not inventory any chemical material but instead
arranges with Dow for shipping of the chemical reagent directly to the
facilities.
Major Licensees. Approximately 15% of revenues in 1998, 15% of revenues
in 1999 and 34% of revenues in 2000 were from PacifiCorp affiliated licensees;
approximately 21% of revenues in 1998, 40% of revenues in 1999 and 7% of
revenues in 2000 were from a Fluor Corporation affiliated licensee; and 21% of
revenues in 1998, 13% of revenues in 1999 and 6% of revenues in 2000 were from
Pace Carbon Fuels, L.L.C. affiliated licensees. Also, in 2000 approximately 27%
of revenues were from DTE Energy Services, Inc. affiliated licensees and 19% of
revenues were from TECO Coal Corporation affiliated licensees, most of which
related to non-recurring gains on sales of facilities. No other single customer
accounted for over ten percent of total revenues in the years presented.
Licensees' Coal Feedstock. The alternative fuel facilities use coal,
coal refuse, and coal fines as the primary feedstocks to produce alternative
fuel. Licensees secure their own supply of coal feedstocks. Many licensees that
are also coal producers utilize their own feedstock sources. Nonproducer
licensees purchase coal feedstocks to supply their facilities. While a supply of
coal derivatives is essential to the feasibility of an alternative fuel
facility, such feedstocks are available for purchase by licensees.
Supply of Chemicals. Headwaters purchases its patented and proprietary
chemical reagent from Dow Chemical Company under an agreement through 2007 under
which Headwaters pays a prescribed price per pound of chemical. Headwaters
arranges with Dow for the delivery of the chemical reagent from Dow's
manufacturing plants directly to each of the alternative fuel facilities
licensed by Headwaters.
Sale of Facilities
Headwaters has constructed and sold six alternative fuel facilities.
The following summarizes each sale:
Utah Synfuel #1. In March 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Headwaters was at the time a 64% owner and general
partner, sold the Utah alternative fuel facility to Coaltech No. 1, L.P. for
$3.5 million payable in 44 quarterly installments, all in accordance with the
Utah Project Purchase Agreement among Headwaters, Utah Synfuel #1 and Coaltech.
In June 2000, Headwaters and Coaltech negotiated a termination of the Utah
Project Purchase Agreement and a new licensee and chemical reagent purchase
agreement calling for payment to Headwaters of a specified percentage of the
ongoing net benefits received by the Coaltech partners.
Alabama Synfuel #1. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Headwaters was at the time a 74% owner and general partner,
sold its facility to Birmingham Syn Fuel, L.L.C., a wholly-owned subsidiary of
PacifiCorp Financial Services, Inc. in March 1998. The purchase price for the
Birmingport facility was $6,500,000 payable in the form of a nonrecourse
promissory note collateralized by certain portions of the Birmingport facility.
In May 2000 Headwaters and Birmingham Syn Fuel negotiated a termination of the
purchase transaction documents and replaced them with a reduced interest but
otherwise substantially similar amended and restated $6,500,000 note. At the
same time, Headwaters, Birmingham Syn Fuel and PacifiCorp negotiated four new
license and chemical reagent purchase agreements calling for payment to
Headwaters of specified ongoing royalties and chemical reagent sales.
6
River Hill. Headwaters and its subsidiaries, Commonwealth Synfuel,
L.L.C. and Synfuel Investments, Inc., sold the River Hill facility to DTE River
Hill L.L.C., an affiliate of DTE Energy Services, Inc., in August 1999. The
purchase price for the River Hill facility consisted of a cash payment to
Headwaters of $1,250,000, assumption of $5,000,000 of facility debt, completion
of capital improvements to the facility and an eight-year royalty arrangement
with both Headwaters and the construction lender, plus contingent payments based
upon facility production performance. Headwaters subsequently received all
production performance payments. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.
Carbon Synfuel. Headwaters and its subsidiaries, Carbon Synfuel, L.L.C.
and Synfuel Investments, Inc., sold the Carbon Synfuel facility for $10 million
cash to DTE Kentucky, LLC, an affiliate of DTE Energy Services, Inc., in
December 1999. Headwaters also entered into a license and chemical reagent
supply agreement which calls for ongoing royalties and chemical reagent sales.
Pocahontas Synfuel. Headwaters and its subsidiaries Pocahontas Synfuel,
L.L.C. and Synfuel Investments, Inc. sold the Pocahontas Synfuel facility for $8
million cash and an additional net payment of $2.5 million contingent upon the
buyer's placing the facility into commercial operation at a new site to Premier
Elkhorn Coal Company, an affiliate of TECO Coal Corporation in January 2000.
Headwaters subsequently received the contingent payment. Headwaters also entered
into a license and chemical reagent supply agreement which calls for ongoing
royalties and chemical reagent sales.
Mountaineer Fuels. Headwaters and its subsidiaries Mountaineer Fuels,
L.L.C. and Synfuel Investments, Inc. sold the Mountaineer Fuels facility for
$9.7 million cash and an additional $300,000 payment contingent upon successful
reassembly at the owner's new site to DTE Kentucky, LLC, an affiliate of DTE
Energy Services, Inc., in April 2000. Headwaters also entered into a license and
chemical reagent supply agreement which calls for ongoing royalties and chemical
reagent sales.
Proprietary Protection
Trademarks and Service Marks:
United States Trademark Registration No. 2,038,742 issued February 18,
1997 for mark "Covol."
United States Trademark/Service Mark Application No. 78/018,501 filed
July 26, 2000 for mark "Headwaters."
Patents. Headwaters has eight U.S. patents that expire on January 21,
2014 and one U.S. patent that expires on August 9, 2011. There can be no
assurance as to the scope of protection afforded by the patents. In addition,
there are other technologies in use and others may subsequently be developed,
which do not, or will not utilize processes covered by the patents. There can be
no assurance that Headwaters' patents will not be infringed or challenged by
other parties, that Headwaters will not infringe on patents held by other
parties or that Headwaters will have the resources to enforce any proprietary
protection afforded by the patent or defend against an infringement claim.
In addition to patent protection, Headwaters also relies on trade
secrets, know-how and confidentiality agreements to protect the Headwaters
technologies. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to Headwaters' know-how, concepts, ideas, and documentation.
Since Headwaters' proprietary information is important to its business,
failure to protect ownership of its proprietary information would likely have a
material adverse effect on Headwaters. Headwaters' current and expected revenues
are dependent upon license agreements by which licensees use the Headwaters
technologies to manufacture alternative fuel and then pay license fees to
Headwaters. Headwaters believes that its patents, trade secrets, know-how and
confidential information are the basis upon which Headwaters is able to obtain
licensing agreements.
7
Government Regulation
Headwaters' and its licensees' alternative fuel operations are subject
to federal, state and local environmental regulations that impose limitations on
the discharge of pollutants into the air and water and establish standards for
the treatment, storage and disposal of waste products. In order to establish and
operate the alternative fuel plants, Headwaters and its licensees obtained
various state and local permits. Headwaters believes that it or its licensees
obtained all required permits to construct and operate alternative fuel
facilities, and that they are in substantial compliance with all relevant laws
and regulations governing the alternative fuel operations.
Compliance with permits, regulations, and the approved processes helps
protect against pollution or contamination. Acid is the only stored raw material
used in the approved process that is classified as hazardous. Still the
possibility exists that regulatory noncompliance or accidental discharges, in
spite of safeguards, could create an environmental liability. Therefore,
Headwaters' and its licensees' alternative fuel operations entail risk of
environmental damage and Headwaters or its licensees may incur liabilities in
the future arising from the discharge of pollutants into the environment or from
waste disposal practices.
Failure by Headwaters or its licensees to maintain necessary permits to
operate alternative fuel plants and to comply with permit requirements could
have a material adverse effect on Headwaters or its licensees. Other
developments, such as the enactment of more stringent environmental laws and
regulations, could require Headwaters or its licensees to incur significant
capital expenditures. If Headwaters or its licensees do not have the financial
resources or are otherwise unable to comply with such laws and regulations, or
if compliance substantially increases production costs, these results could also
have a material adverse effect on Headwaters.
Headwaters' goal is to establish itself as the provider of technologies
that will assist others in the processing and reclamation of their wastes and
by-products, and Headwaters seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. However, the
alternative fuel manufacturing process using Headwaters' technologies typically
uses dilute acids. Headwaters and its licensees must comply with hazardous
material handling and storage regulations related to acid solutions and stored
concentrates.
Headwaters' and its licensees' alternative fuel operations are also
subject to federal and state safety and health standards. Headwaters is
committed to providing effective management of worker safety and health
protection. In addition, Headwaters has developed a safety policy designed to
raise and maintain safety awareness by both management and employees. Failure to
comply with safety and health standards could have a material adverse affect on
Headwaters. For example, a regulatory inspector could close the operation until
a licensee meets the required standards.
Competition
Alternative fuels made using the Headwaters technologies compete with
other alternative fuel products as well as traditional fuels. Competitive
factors include price, quality, delivery cost and handling costs. Headwaters may
experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce coal
based solid alternative fuels. Competition may come in the form of the licensing
of the competing technologies to process coal derivatives, marketing of
competitive chemical reagents or in the marketing of end products qualifying as
synthetic fuel. Competition includes, for example, Startec in the project
development business and Nalco Chemical Company in the chemical reagent sales
business. Headwaters will also experience competition from traditional coal and
fuel suppliers and natural resource producers in addition to those companies
that specialize in the recycling of waste products generated by coal, coke,
steel and other resource production. Many of these companies have greater
financial, management and other resources than Headwaters. Headwaters believes
that it will be able to compete effectively although there can be no assurance
that it will do so successfully.
8
Employees
Headwaters and its subsidiaries currently employ 51 persons full-time.
Of these employees, 35 are in alternative fuel operations and technical support
services and 16 are in corporate administration and miscellaneous operations and
project development. None of these employees are covered by a collective
bargaining agreement.
Forward Looking Statements
Statements in this Annual Report on Form 10-K regarding Headwaters'
expectations as to the operation of facilities utilizing Headwaters'
technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of non-alternative fuel technologies and other strategic business
opportunities and acquisitions and other information about Headwaters that is
not purely historical by nature, including those statements regarding
Headwaters' future business plans, the operation of facilities, the availability
of tax credits, the availability of feedstocks, the marketability of the
alternative fuel and the financial viability of the facilities, constitute
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although Headwaters believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. For a discussion of
the factors that could cause actual results to differ from expectations, please
see the caption entitled "Forward Looking Statements" in Item 7.
ITEM 2. PROPERTIES
Headwaters leased in October 2000 for a five year term approximately
7,000 square-feet of office space in Draper, Utah, which houses its executive
offices. The lease provides for a monthly rent of approximately $8,000 with
certain adjustments for inflation plus expenses.
In October 1997, Headwaters purchased for $150,000 an 8,000 square-foot
site located in Price, Utah, on which Headwaters' prototype plant is located.
Included in the purchase was a 1,400 square-foot office and warehouse building
which houses equipment. The property is subject to a 10-year $100,000 mortgage
held by the seller. Headwaters has been leasing the property and is also
considering selling the property.
In June 1996, Headwaters entered into a land lease of approximately 12
acres in Price, Utah with a current monthly rental of $600. The lease term
commenced on June 20, 1996 and expires on December 31, 2007 but may be extended.
In 1996, Headwaters constructed a 22,000 square-foot building to house a synfuel
facility. In March 1997, this building was subleased by Headwaters to Coaltech
as part of the sale of the Utah Synfuel #1 facility. Headwaters has also
constructed a 1,650 square-foot chemical mixing plant, on the property.
In February 1997, Headwaters entered into a lease agreement with
Earthco for two contiguous parcels located in Wellington, Utah. On one 30 acre
parcel, Headwaters constructed a 3,400 square-foot wash plant. The second parcel
covers approximately 357 acres to be used as a fines recovery operation. In
September 2000, Headwaters agreed to terminate the lease agreement with Earthco
which has relinquished its rights in the property to Nevada Electric Investment
Company ("NEICO") as a part of a settlement. At the same time, Headwaters leased
the first parcel from NEICO and entered into a sublease with a third party that
wishes to use the wash plant. The lease and sublease are each for a concurrent
one year term, with the sublessee performing all of Headwaters' lease
obligations to NEICO. The sublessee has an option to purchase the wash plant at
the end of the one year sublease.
In 1997, Headwaters entered into a five-year, $850 per month sublease
with Combustion Resources, Inc. for approximately 2,400 square feet of office
and laboratory space in Provo, Utah. Headwaters is currently renegotiating this
lease.
In May 1998, Headwaters purchased approximately 80 acres of undeveloped
property near Sunnyside, Utah for $100,000. In June 1998, Headwaters entered
into a five-year lease with an option to purchase approximately 40 acres of
property with office and warehouse improvements. The lease payments are $2,500
per month, escalating to $3,500 per month over time. The leased property is
adjacent to the purchased property.
None of Headwaters' subsidiaries have significant interests in real
property.
9
ITEM 3. LEGAL PROCEEDINGS
Headwaters has ongoing litigation that it incurs in the normal course
of business including the items discussed herein. Headwaters intends to
vigorously defend and/or pursue it's rights in these actions. Headwaters does
not currently believe that the outcome of these actions will have a material
adverse effect on the Company's financial position.
NEICO/Earthco. In February 1997, Headwaters entered into a contract on
a parcel of real property located near Price, Utah, in which Headwaters obtained
certain possessory and related interests, Headwaters' primary purpose being to
obtain a source of coal fines to serve as feedstock for a nearby alternative
fuel facility. In August 1999, Headwaters alleged that Earthco had breached a
material provision of the contract because Earthco did not have title to the
property. Headwaters refused to tender its August 1999 payment because of
Earthco's breach. In addition, Headwaters contended that the quantity and/or
quality of recoverable coal fines was substantially less than what Headwaters
had understood. Earthco subsequently countered with allegations that Headwaters
had breached its obligations under the contract, including failure to make the
August 1999 payment.
In November 1999, Headwaters was served with a complaint from the
Seventh Judicial District Court of Carbon County, Utah styled Nevada Electric
Investment Company v. Earthco, et al. In the complaint, Nevada Electric
Investment Company ("NEICO") alleged that it is the lawful owner of the property
near Wellington, Utah described in Headwaters' lease from Earthco. NEICO sought
a declaratory judgement that Headwaters is not entitled to possession of the
property due to the lack of ownership by Earthco. The complaint also sought
further relief from Earthco.
Headwaters received Earthco's answer, counterclaims and cross-claim in
December 1999. Earthco's cross-claim against Headwaters alleged breach of
contract and prayed for substantial damages in an amount to be proven at trial
but alleged to be in excess of $5 million. Headwaters filed its reply and
cross-claim against Earthco in January 2000 denying Earthco's claims and
asserting claims of misrepresentation, breach of lease, unjust enrichment, and
related claims and for general and consequential damages in an amount to be
proven at trial.
NEICO, Earthco and Headwaters have settled their disputes. Earthco and
Headwaters entered into a mutual release of claims. Earthco confirmed title to
the property in NEICO. In September 2000, Headwaters entered into a one-year
lease for the wash plant parcel directly with NEICO and otherwise confirmed
title to the property in NEICO. The parties are awaiting an order of dismissal
from the court.
K-Lee Processing. In March 1997, Headwaters entered into an Amended and
Restated Supply Agreement for the purchase of coal fines from K-Lee Processing,
Inc. and Concord Coal Recovery Limited Partnership (together "K-Lee").
Headwaters periodically purchased coal fines from K-Lee throughout 1997. K-Lee
invoiced Headwaters for a total of 108,000 tons of fines and Headwaters paid for
those fines. However, K-Lee failed to deliver 11,059 tons valued at $320,716.
K-Lee has refused to refund the overpayment for non-delivered fines. In July
2000 Headwaters filed a complaint against K-Lee Processing, Inc. and Concord
Coal Recovery Limited Partnership in the United States District Court for the
Northern District of Alabama seeking damages in the amount of $320,716 for the
coal fines purchased but not delivered. Because the litigation is at an early
stage and resolution is uncertain, legal counsel cannot express an opinion as to
the ultimate amount, if any, that might be recovered.
Adtech. In October 1998, Headwaters entered into a technology purchase
agreement with James G. Davidson and Adtech, Inc. The transaction transferred
certain patent and royalty rights to Headwaters related to an alternative fuel
technology invented by Davidson. (This technology is distinct from the
technology developed by Headwaters.) In September 2000, Headwaters received a
summons and complaint from the United States District Court for the Western
District of Tennessee filed by Adtech, Inc. against Davidson and Headwaters. In
the action certain purported officers and directors of Adtech allege that the
technology purchase transaction was an unauthorized corporate action and that
Davidson and Headwaters conspired together to effect the transfer. The complaint
asserts related causes of action in fraud, conversion, patent infringement,
conspiracy and unfair competition seeking unspecified money damages to be proven
at trial, accounting, disgorgement, recission of contracts, punitive damages,
and other relief. Headwaters denies these allegations and is asking the court to
dismiss the action. Because the litigation is at an early stage and resolution
is uncertain, legal counsel cannot express an opinion as to the ultimate amount,
if any, of Headwaters' liability.
10
Levy. In March 1999, Headwaters sold convertible preferred stock,
warrants, and a convertible promissory note to OZ Master Fund, Ltd. In September
2000, Headwaters received a summons and complaint from the United States
District Court for the Southern District of New York filed by Mark Levy against
OZ Master Fund and related entities ("OZ") and Headwaters. In the action, a
purported shareholder of Headwaters alleges that OZ violated section 16(b) of
the Securities Exchange Act of 1934 by converting preferred stock into
Headwaters common stock and then selling the same within a six month period, and
further, that Headwaters' redemption of the preferred stock and the note
constituted a sale of common stock for which OZ is liable under section 16(b).
The complaint seeks on behalf of Headwaters from OZ unspecified money damages to
be proven at trial, attorney fees, and other relief. Because the litigation is
at an early stage and resolution is uncertain, legal counsel cannot express an
opinion as to the ultimate amount, if any, that might be recovered.
AJG. In December 1996, Headwaters entered into a technology license and
proprietary chemical sale agreement with AJG Financial Services, Inc. The
agreement called for AJG to pay royalties and to purchase proprietary chemical
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 has
failed to make payments and to perform other obligations under the agreement.
Headwaters asserts claims including breach of contract, declaratory judgment,
unjust enrichment, and accounting and seeks money damages in the amount of
$750,000 plus other damages to be proven at trial, as well as other relief. AJG
has answered the complaint denying Headwaters' claims and asserting
counter-claims based upon allegations of misrepresentation and breach. AJG seeks
unspecified compensatory damages as well as punitive damages. Headwaters denies
the allegations of AJG's counter-claims. Because the litigation is at an early
stage and resolution is uncertain, legal counsel cannot express an opinion as to
the ultimate amount of recovery or liability.
Nalco. In October 2000, Headwaters filed a complaint in the United
States District Court for the District of Utah against Nalco Chemical Company
("Nalco"). Headwaters alleges that Nalco, by its sale and marketing of materials
for use in creating alternative fuel, breached a non-disclosure agreement,
misappropriated trade secrets, and violated patent rights of Headwaters.
Headwaters seeks by its complaint injunctive relief and damages to be proven at
trial. Nalco filed an answer denying the allegations in the complaint and
asserting counter-claims alleging patent invalidity. Headwaters denies the
counter-claims; however, if Nalco prevails on its counter-claims, the result
could have a material adverse effect on Headwaters' business. Because the
litigation is at an early stage and resolution is uncertain, legal counsel
cannot express an opinion as to the ultimate amount, if any, that might be
recovered by Headwaters.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of stockholders was held on September 6, 2000.
Reference is made to Headwaters' Form 8-K filed September 19, 2000 for a
description of the matters voted on and the results of the voting.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The shares of common stock of Headwaters trade on the Nasdaq Stock
Market(SM) under the symbol "HDWR." The following table sets forth, for the
periods presented, the high and low trading prices of Headwaters' common stock
as reported by Nasdaq. The following prices may not be considered valid
indications of market value due to the limited and sporadic trading in the
shares of common stock during certain periods.
11
Fiscal 1999 Low High
- ----------- --- ----
Quarter ended December 31, 1998 $4.25 $9.38
Quarter ended March 31, 1999 4.13 8.13
Quarter ended June 30, 1999 3.25 7.00
Quarter ended September 30, 1999 2.50 6.06
Fiscal 2000
- -----------
Quarter ended December 31, 1999 $0.50 $3.25
Quarter ended March 31, 2000 0.78 2.31
Quarter ended June 30, 2000 1.25 2.13
Quarter ended September 30, 2000 2.06 4.75
As of December 1, 2000, there were approximately 547 stockholders of
record of Headwaters' common stock.
Headwaters has not paid dividends on its common stock to date and does
not intend to pay dividends on its common stock in the foreseeable future.
Headwaters intends to retain earnings to finance the development and expansion
of its business. Payment of common stock dividends in the future will depend,
among other things, upon Headwaters' ability to generate earnings, its need for
capital, investment opportunities and its overall financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Headwaters within the
past three years without registration under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances nor were any
commissions paid in connection therewith. However, Headwaters did pay finders
fees in the form of cash, stock or warrants in connection with various
securities issuances.
Headwaters believes that the following issuances of shares of common
stock, notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Headwaters that it was accredited
as that term is defined in Regulation D and that the security was acquired for
investment purposes. However, Headwaters has effective five registration
statements filed on Form S-3. These registration statements have registered many
of the securities described in this section.
In 1996, Headwaters formed two limited partnerships, Alabama Synfuel #1
Ltd. and Utah Synfuel #1 Ltd., to assist with the financing of construction at
two alternative fuel facilities. These two facilities have been sold and are now
owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On September 9,
1998, Headwaters offered the limited partners in Utah Synfuel #1 and Alabama
Synfuel #1 an exchange of Headwaters' common stock for their limited partnership
interests. The exchange ratio was based in part on an independent valuation of
the limited partnerships' assets and other factors including but not limited to
current and future expected cash flow of the partnerships and current market
values of Headwaters' common stock as quoted on NASDAQ. The exchange ratio for
Utah Synfuel #1 was 112.828 shares of common stock for each limited partnership
unit and for Alabama Synfuel #1 was 125.97 shares for each limited partnership
unit. The limited partnerships' units originally sold for $1,000 per unit.
As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one of the limited partners in Alabama Synfuel #1 had agreed to
exchange their limited partnership interests for shares of Headwaters' common
stock, and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of
Headwaters. In November 1999, the last limited partner in Alabama Synfuel #1
exchanged its limited partnership interest as a part of a licensing agreement so
that Alabama Synfuel #1 also became a wholly-owned subsidiary of Headwaters.
During November 1998, Headwaters completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt, which had a twelve-month term, has been
12
repaid. The equity transaction consisted of the sale of a unit at a price of
$5.00. A unit consisted of one share of restricted common stock of Headwaters
plus a warrant to purchase one additional share of restricted common stock at an
exercise price of $7.50. The warrants expired on June 30, 2000 if not exercised.
However, during 2000 the exercise period for the purchase of approximately
183,000 of these warrant shares was extended for approximately seven months. The
stock and shares issuable pursuant to the related warrants bear "piggyback"
registration rights.
During January 1999, Headwaters completed a financing transaction with
a major shareholder and lender to Headwaters, that consisted of the sale of
1,000 shares of a new series of non-voting preferred stock, designated as Series
C 7% Convertible Preferred Stock. Headwaters received approximately $900,000 in
net proceeds from the issuance of this preferred stock, which had the following
rights and privileges:
* Dividends on the preferred stock were cumulative and accrued whether or
not they had been declared or whether Headwaters had any profits. The
dividend rate was 7% per year of the liquidation value of $1,000 per
share.
* The preferred stock was convertible into common shares in incremental
stages beginning April 1999 through July 1999, at which time all of the
outstanding shares became convertible to common stock. The number of
common shares to be received upon conversion was determined by
multiplying the number of preferred shares by $1,000 and dividing that
number by the conversion price (originally $5.50 per share, subject to
market adjustment). Upon conversion, all accrued and unpaid dividends
were to be paid or converted into shares of common stock.
* Headwaters had the option to redeem the outstanding preferred stock
beginning July 1999 for a redemption price equal to 125% of the
liquidation value plus any accrued and unpaid dividends thereon.
Warrants for the purchase of 72,727 shares of common stock were issued
in conjunction with this preferred stock. The warrants are exercisable from
April 1999 through July 2001 at an exercise price of $6.88 per share. The
exercise deadline for certain other warrants with an exercise price of $7.00 per
share held by the shareholder were extended to June 2000 and certain additional
warrants with an exercise price of $30.00 per share were relinquished and
canceled. Headwaters granted registration rights for the restricted common
shares issuable upon conversion of the preferred stock or upon exercise of the
common stock warrants.
During January 2000, all of the remaining shares of Series C preferred
stock were converted. Approximately 237,000 shares of common stock were issued
on conversion of the preferred stock and related accrued but unpaid dividends.
There are no outstanding shares of Series C preferred stock.
On March 17, 1999, Headwaters completed a financing transaction with a
large investment fund. The financing consisted of the issuance of $20,000,000
face value of convertible secured debt, issued at a 50% discount, and the
issuance of 60,000 shares of cumulative convertible preferred stock (Series D)
for $6,000,000, for total gross proceeds of $16,000,000. Warrants for the
purchase of common stock were also issued as part of the financing and were
valued at approximately $3,000,000. Net cash proceeds were used to retire
maturing short-term debt and related accrued interest, for working capital and
other general corporate purposes. This transaction is described in detail in the
Form 8-K filed March 24, 1999 and in the Form 10-Q/A for the quarterly period
ended March 31, 1999. Beginning in November 1999 and through March 2000,
Headwaters issued approximately 2,632,000 shares of common stock on conversion
of 24,369 shares of Series D preferred stock. The preferred stock was
convertible at $5.00 or 90% of market, whichever was less. By May 2000,
Headwaters had redeemed all of the investment fund's $20,000,000 face value
convertible debt and incurred early prepayment costs of approximately
$6,037,000. By March 2000, Headwaters had redeemed the investment fund's
35,631remaining Series D preferred shares for $4,454,000 including a redemption
premium of approximately $1,882,000. There are no outstanding shares of Series D
preferred stock.
In September 1999, Headwaters entered into a transaction with an
affiliate of a major shareholder and lender to Headwaters, to provide financing
of up to $4,000,000 in the form of convertible secured debt. Headwaters received
$850,000 at the time of closing, less a placement fee of 10%, and subsequent to
September 30, 1999 received a total of $1,650,000, less a placement fee of 10%.
The debt was convertible at $3.00 per share, or market, whichever is less, and
was convertible at the rate of 25% every 30 days beginning 30 days from the date
of closing, subject to certain restrictions. Headwaters could redeem all
outstanding debt at a rate of 125% of face value by providing 30 days notice.
Borrowings were due in March 2001, if not converted earlier, and interest
payments were
13
due quarterly beginning December 1999. Headwaters assigned the royalties to be
received from a licensed alternative fuel facility as collateral for the
financing. In November and December 1999, approximately 2,532,000 shares of
common stock were issued on conversion of $1,280,000 of the convertible debt. In
January 2000, Headwaters redeemed all of the remaining convertible debt for
redemption consideration of approximately $1,300,000 plus 8,565 shares of common
stock.
The agreement required the issuance of warrants to purchase Headwaters
shares equal to 40% of the shares issuable under any borrowings under this
financing arrangement. The warrants have a three-year exercise period and an
exercise price of $3.60 per share. Warrants for the purchase of a total of
approximately 350,000 shares of common stock were issued.
In December 1999, Headwaters placed $1,500,000 of financing less a 10%
placement fee with an investor rather than drawing the entire $4,000,000 of
funding as provided under the September financing arrangement. The terms and
conditions of this financing were similar to the September financing. The debt
was convertible at $0.73 per share, the market price at closing, or market price
on the conversion date, whichever was less. In January 2000, Headwaters redeemed
all of this convertible debt for redemption consideration of approximately
1,900,000 plus 205,435 shares of common stock.
The agreement required the issuance of warrants to purchase Headwaters
shares equal to 40% of the shares issuable under the debt agreement. Warrants
for the purchase of approximately 923,000 shares were issued. The warrants have
a three-year exercise period and an exercise price of $0.88 per share.
In March 2000, Headwaters completed a private placement financing
transaction by selling to 49 investors approximately 3,629,000 shares of
restricted Headwaters common stock, $0.001 par value, at a price of $1.36 per
share, yielding to Headwaters $4,666,000, net of $270,000 in placement costs.
The investors received registration rights for the stock purchased.
In April 2000, Headwaters completed a private placement financing
transaction by selling to one of its directors and three officers a total of
approximately 379,000 shares of restricted Headwaters common stock, $0.001 par
value, at a price of $1.56 per share and warrants for the purchase of
approximately 133,000 shares of common stock, for net cash proceeds to
Headwaters of approximately $588,000. The warrants are exercisable through March
2005 at a price of $1.56 per share. The investors received registration rights
for the stock purchased and the warrant shares.
In April 2000, an investor acquired from a third party a Headwaters'
14% note due in April 2000 with an approximate $3,000,000 balance and at the
same time also acquired from the third party warrants to purchase 100,000 shares
of Headwaters' common stock. Headwaters and the investor agreed to extend for
one year the repayment date for $1,000,000 of the principal amount of the note.
Headwaters and the investor further agreed to the satisfaction of $2,000,000 of
the note in exchange for 1,185,818 shares of Headwaters restricted common stock,
$0.001 par value, and warrants to purchase 296,000 shares of Headwaters' common
stock. The warrants are exercisable through April 2005 at a price of $2.10 per
share. In July 2000, Headwaters repaid the $1,000,000 note balance which was
accruing interest at 14%. A director of Headwaters is a manager and 2.5% owner
of the investor. The director disclaims any beneficial interest in the
investor's securities in Headwaters.
14
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of Headwaters. This information should be read in
conjunction with the consolidated financial statements, related notes and other
financial information included herein. In 1996, Headwaters sold its construction
subsidiaries. All construction - related operations were reflected as
discontinued operations in the 1996 financial statements. The note receivable
received by Headwaters as consideration for the sale is "marked to market" each
quarter based on the market value of Headwaters' stock held as collateral, and
the resulting adjustments are reflected in Headwaters' statement of operations.
As more fully described in Notes 14 and 15 to the consolidated financial
statements, in 1998, 1999 and 2000, Headwaters recorded approximately $200,000,
$0 and $17,949,000, respectively, of gains on sale of facilities and other
non-recurring transactions, and approximately $218,000, $9,234,000 and
$17,758,000, respectively, of losses on sale of facilities, asset write-offs and
other non-recurring charges. Additionally, as more fully described in Note 5 to
the consolidated financial statements, in 2000 Headwaters recorded an
extraordinary loss on early extinguishment of debt of $7,860,000.
The selected financial data as of and for the years ended September 30,
1996 and 1997 and as of September 30, 1998 are derived from audited financial
statements not included herein. The selected financial data for the year ended
September 30, 1998, and as of and for the year ended September 30, 1999 were
derived from the financial statements of Headwaters which have been audited by
PricewaterhouseCoopers LLP included elsewhere herein. The selected financial
data as of and for the year ended September 30, 2000 were derived from the
financial statements of Headwaters which have been audited by Arthur Andersen
LLP included elsewhere herein.
Year Ended September 30,
--------------------------------------------------------------------
(thousands of dollars, except per-share data) 1996 1997 1998 1999 2000
- ------------------------------------------------- ------------ ------------- ------------ ------------- ------------
OPERATING DATA:
Total revenue $ 295 $ 147 $ 2,186 $ 6,719 $45,835
Income (loss) from continuing operations (12,955) (10,498) (11,308) (28,393) 3,682
Net income (loss) (13,836) (10,498) (11,308) (28,393) 3,682
Diluted net income (loss) per
common share:
Income (loss) per share from
continuing operations (1.86) (1.32) (1.17) (2.39) .15
Net income (loss) per share (1.99) (1.32) (1.17) (2.39) .15
As of September 30,
-------------------------------------------------------------------
(thousands of dollars) 1996 1997 1998 1999 2000
- ------------------------------------------------ ------------- ------------- ------------ ------------- ------------
BALANCE SHEET DATA:
Working capital (deficit) $(3,482) $(3,471) $ 7,497 $(1,799) $11,225
Net property, plant and equipment 7,125 13,619 15,809 14,182 552
Total assets 8,072 26,590 68,061 58,095 33,441
Long-term obligations:
Long-term liabilities 364 3,817 14,879 18,422 5,235
Deferred revenue -- 1,545 8,377 7,501 10,513
Redeemable convertible preferred
stock -- -- -- 4,332 --
Total long-term obligations 364 5,362 23,256 30,255 15,748
Total stockholders' equity (deficit) (233) 6,426 14,746 (1,028) 10,747
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the consolidated financial statements and notes thereto
included elsewhere herein.
Year Ended September 30, 2000 Compared to Year Ended September 30, 1999
The information set forth below compares Headwaters' operating results
for 2000 with its operating results for 1999.
Revenues. Total revenue for the year ended September 30, 2000 ("2000")
increased by $39,116,000 to $45,835,000 as compared to $6,719,000 for the year
ended September 30, 1999 ("1999"). The major components of this revenue are
discussed in the sections below.
License Fees. During 2000, Headwaters recognized license fees totaling
$17,315,000 while $3,526,000 of license fees were recognized during 1999. The
license fees in 2000 consisted of the straight-line amortization of one-time
non-refundable initial and prepaid license fees of $1,003,000, reduced by a
one-time adjustment of $201,000, and recurring earned license fees or royalty
payments of $16,513,000. License fees in 1999 consisted of the straight-line
amortization of one-time non-refundable initial license fees of $875,000 and
recurring license fees or royalty payments of $2,651,000. Initial license fees
were normally received when construction of the related alternative fuel
facility began, when construction was completed, or when certain construction
milestones or other conditions were met. These license fees are recognized on a
straight-line basis over the period covered by Headwaters' license agreements
with licensees. Recurring earned license fees or royalty payments are due
quarterly based upon alternative fuel produced and sold as reported to
Headwaters by its licensees. The increase in 2000 earned license fees was due
primarily to a significant increase from a licensee that owns and operates four
alternative fuel facilities in addition to less significant increases from other
licensees.
Chemical Sales. Headwaters provides chemical reagent to its licensees
either at a fixed price or at Headwaters' cost plus a contracted markup.
Headwaters purchases the chemical materials under a long-term contract with a
large chemical company. Chemical sales during 2000 were $9,757,000 with a
corresponding direct cost of $6,617,000. Chemical sales during 1999 were
$2,140,000 with a corresponding direct cost of $1,695,000. The increase in
chemical sales in 2000 over 1999 was due to increased alternative fuel
production by Headwaters' licensees.
Gains on Sale of Facilities. In 1999, Headwaters sold a facility
located in Pennsylvania on which a loss of approximately $1,839,000 was
recognized. Headwaters also entered into an agreement under which it operates
this facility on behalf of the owner. In 2000, upon achieving specified
operating performance milestones, Headwaters received additional cash payments
related to the sale of this facility. The cash proceeds from these payments, net
of obligations to third parties, approximated $7,377,000. Of the net amount
received, Headwaters recognized $4,400,000 as revenue because there were no
ongoing obligations associated with those payments. Headwaters deferred the
recognition of $2,977,000 which amount was characterized as prepaid royalties.
This amount is being recognized as revenue on a straight-line basis through
December 2007.
In 2000, Headwaters sold the three remaining alternative fuel
facilities it owned plus an option to acquire a licensee facility. One of these
sold facilities was located in Utah, two of these facilities were located in
West Virginia, and the facility under option was located in Nevada. Headwaters
reported net gains on these transactions totaling approximately $12,470,000.
Headwaters also entered into its standard supply agreements with the new owners
of the facilities to sell proprietary chemical material used at the facilities.
Headwaters also receives ongoing royalties based upon the sale of alternative
fuel from the facilities.
Gains on Non-recurring Transactions. In 2000, Headwaters recorded
non-recurring gains of approximately $1,079,000 related to the satisfaction of a
$755,000 contingent contract liability and a $324,000 gain recognized on a note
receivable transaction.
Cost of Operations decreased by $9,258,000 to $3,821,000 during 2000
from $13,079,000 during 1999. During 2000, Headwaters incurred significantly
lower operating expenses in connection with the continued
16
refinement and implementation of the briquetting process associated with the 24
facilities placed in service during 1998, and in particular the operating costs
associated with the four facilities owned by Headwaters which have now been
sold. In 1999, cost of operations consisted primarily of labor and operating
expenses at the owned alternative fuel facilities and the wash plant located in
Utah, losses related to the write-down of inventory purchased from Coaltech, and
costs incurred in providing assistance to Headwaters' licensees in resolving
ramp-up issues at their alternative fuel facilities. Headwaters expects future
costs of operations to remain significantly below 1999 levels.
Selling, General and Administrative Expenses increased $237,000, or 5%,
to $5,361,000 during 2000 from $5,124,000 for 1999. The increase in expenses in
2000 is due to an increase in payroll and other compensation-related costs,
partially offset by decreases in nearly all other cost categories.
Asset Write-offs and Other Non-recurring Charges. In 2000, Headwaters
recorded an impairment charge of approximately $14,804,000 related to assets
located in Utah and Alabama. This impairment charge consisted of an approximate
$12,615,000 write-down to net realizable value of certain plant and equipment
which remained on the sites when the facilities were sold and was idled, plus an
approximate $2,189,000 write-off of an intangible asset which was no longer
considered recoverable due to the relocation of a licensee facility. Headwaters
also recorded employee severance and other non-cash charges from incremental
amortization of deferred compensation from stock options (resulting from the
termination of employees whose stock options became fully vested upon
termination) totaling approximately $1,443,000. Other non-recurring settlement
charges ($979,000) and asset write-downs ($532,000) were recorded in 2000. All
of these asset write-offs and non-recurring charges totaled approximately
$17,758,000.
Other Income and Expense. During 2000, Headwaters reported net other
expenses of $3,636,000 compared to $5,980,000 for 1999. This decrease of
$2,344,000 relates primarily to a decrease of $1,439,000 in interest expense and
a positive variance of $1,275,000 in the mark-to-market adjustment of the
carrying value of a related party note receivable collateralized by Headwaters
common stock, offset by $746,000 of losses recorded in 2000 in the carrying
value of equity investments.
Interest expense decreased in 2000 primarily due to the lower average
levels of outstanding borrowings which existed in 2000 as compared to 1999, most
notably as a result of the debt repayments during 2000. Interest expense is
expected to significantly decrease in the future as a result of repayment of
debt related to the sale of Company-owned facilities and the complete redemption
of outstanding convertible debt in 2000.
During 1996, Headwaters sold certain construction companies and
received as consideration a $5,000,000 note receivable ("Note"). The Note is
"marked to market" each quarter based upon the market value of Headwaters'
common stock held as collateral and is reflected in the consolidated balance
sheet at the underlying value of this collateral, $466,000 at September 30,
2000. This adjustment resulted in a write-up of $66,000 during 2000, compared to
a write-down of $1,209,000 during 1999 for a net change of $1,275,000.
During 2000, Headwaters made investments in several less than 50%-owned
affiliates. Allowances are provided, on a case-by-case basis, when management
determines that the investment or equity in earnings is not realizable. During
2000, the provision for such allowances totaled approximately $646,000. In
addition, Headwaters recognized approximately $100,000 of losses related to its
equity in investments accounted for using the equity method.
Income Taxes. In 2000, Headwaters reported an income tax benefit of
$2,900,000, consisting of the recognition of $3,000,000 of its deferred tax
asset, reduced by $100,000 of alternative minimum tax. Headwaters believes it is
more likely than not that the portion of the total deferred tax asset recognized
in 2000 will be realized as a result of income to be recognized from the
amortization of deferred revenue in subsequent periods.
Extraordinary Item. In January 2000, Headwaters redeemed all of the
convertible debt issued from September 1999 through December 1999 not previously
converted into common stock. The redemption consideration given included
approximately $1,000,000 in redemption premiums plus approximately 214,000
shares of common stock. The loss recognized as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs totaled approximately $1,823,000. This loss is
reflected as an extraordinary item in the consolidated statements of operations.
Also in 2000, Headwaters redeemed all of the $20,000,000 face value convertible
debt issued in March 1999. Early prepayment costs of approximately $6,037,000
were recognized as an extraordinary item as a result of the redemption
consideration paid plus the acceleration of amortization of the unamortized debt
discount and debt issuance costs in excess of the debt carrying value.
17
Net Income. For 2000, net income of $3,682,000 represents an
improvement of $32,075,000 from the net loss of $28,393,000 in 1999. This is
primarily due to substantially increased revenue, including gains on the sale of
facilities, and decreased cost of operations, partially offset by increased
asset write-offs and other non-recurring charges and an extraordinary loss.
Year Ended September 30, 1999 Compared to Year Ended September 30, 1998
The information set forth below compares Headwaters' operating results
for 1999 with its operating results for 1998.
Revenues. Total revenue for the year ended September 30, 1999 ("1999")
increased by $4,533,000 to $6,719,000 as compared to $2,186,000 for the year
ended September 30, 1998 ("1998"). The major components of this revenue are
discussed in the sections below.
License Fees. During 1999, Headwaters recognized license fees totaling
$3,526,000, while $860,000 of license fees were recognized during 1998. The
license fees in 1999 consisted of the straight-line amortization of one-time
non-refundable initial license fees of $875,000 and recurring earned license
fees or royalty payments of $2,651,000. License fees in 1998 consisted of the
straight-line amortization of one-time non-refundable initial license fees of
$654,000 and recurring license fees or royalty payments of $206,000.
Chemical Sales. Total chemical sales during 1999 were $2,140,000 with a
corresponding direct cost to Headwaters of $1,695,000. Total chemical sales
during 1998 were $994,000 with a corresponding direct cost to Headwaters of
$642,000. Alternative fuel sales were $767,000 in 1999 compared to $32,000 in
1998 and represent the sale of product from Headwaters-owned facilities.
Headwaters sold six chemical mixing plants to licensees during 1998 for
$1,088,000, generating a gross profit of $200,000. There were no sales of
chemical mixing plants during 1999.
Cost of Operations increased $6,878,000 from $6,201,000 during 1998 to
$13,079,000 during 1999. During 1999, Headwaters incurred significantly higher
operating expenses in connection with the continued refinement and
implementation of the briquetting process in connection with the 24 facilities
placed in service during 1998, and in particular the operating costs of the four
facilities owned by Headwaters which were held for sale. These expenses
primarily related to labor and operating expenses at the four Headwaters-owned
alternative fuel facilities and the wash plant located in Utah, losses related
to the write-down of inventory purchased from Coaltech, and costs incurred in
providing assistance to Headwaters' licensees in resolving ramp-up issues at
their alternative fuel facilities.
Until October 1999, Headwaters operated one of the alternative fuel
facilities for Coaltech, a partnership for which Headwaters was the general
partner. Under the operating agreement, Headwaters was contractually obligated
to purchase all of the alternative fuel produced at cost plus $1 per ton.
Production of alternative fuel from this facility during 1999 and 1998 was not
significant and accordingly, the cost per ton was significantly in excess of the
current market value. These costs and the corresponding write-down of this
inventory to its market value are included in the cost of operations. The
write-down was approximately $1,815,000 during 1999 and $1,400,000 during 1998.
Headwaters operated the Coaltech Utah facility at a loss because of the need to
gain operating experience (it was the first alternative fuel facility Headwaters
built and operated), test alternative production methods, maintain operational
status for Section 29 qualification, maintain the relationship with AJ
Gallagher, an owner of the Utah facility who is a major licensee and partner of
Headwaters, and other related business reasons.
Selling, General and Administrative Expenses increased $385,000, or 8%,
to $5,124,000 during 1999 from $4,739,000 for 1998. The largest components of
selling, general and administrative expenses for both 1999 and 1998 were
payroll, professional services and travel expenses. Payroll-related costs
increased approximately $540,000, due primarily to increased headcount, salary
costs and amortization of deferred compensation from stock options; professional
services increased approximately $20,000; and travel decreased approximately
$50,000 from 1998 to 1999. Also, there was approximately $250,000 of commissions
incurred in connection with the placement of alternative fuel license agreements
in 1998 while there were no such commissions in 1999. Changes in the other
categories from year to year were not material.
18
Asset Write-offs and Other Non-recurring Charges. In 1999, certain
assets, primarily consisting of leasehold improvements on the property where a
small alternative fuel facility was located, were abandoned. The carrying value
of these assets, totaling approximately $556,000, was written off during 1999.
Based on the uncertainty of recovering certain advances on coal fine inventories
paid from 1997 through May 1999, Headwaters wrote off $3,677,000 of advances on
inventories in 1999. In addition, in 1999 Headwaters wrote off a $660,000 note
receivable and recorded a liability for approximately $469,000 related to a
settlement agreement with a company that had provided Headwaters with advice
with respect to the use of certain alternative fuel technology, certain
financing obtained and the sale of certain alternative fuel manufacturing
facilities. Finally, Headwaters recorded approximately $2,033,000 of non-cash,
incremental amortization of deferred compensation from stock options, resulting
from the termination of employees whose stock options became fully vested upon
termination. All of these 1999 write-offs and provisions total approximately
$7,395,000, which amount is recorded as asset write-offs and other non-recurring
charges in the consolidated statement of operations.
Loss on Sale of Facility. In March 1998, Headwaters sold an alternative
fuel facility located in Alabama on which a loss of $218,000 was recognized. The
sales price was $6,500,000 payable in the form of a nonrecourse promissory note
collateralized by the facility. In 1999, Headwaters sold a facility located in
Pennsylvania on which a loss of approximately $1,839,000 was recognized. As more
fully described in Note 14 to the consolidated financial statements, Headwaters
received additional cash payments in 2000, some of which were recognized as
revenue in 2000, related to the 1999 facility sale.
Other Income and Expense. During 1999, Headwaters had net other
expenses of $5,980,000 compared to $1,694,000 for 1998. This increase of
$4,286,000 relates primarily to an increase in interest expense of $3,508,000, a
change between periods of $1,228,000 in the mark-to-market adjustment of the
carrying value of the related party note receivable collateralized by common
stock, and a decrease in minority interest in losses of consolidated
subsidiaries of $401,000, partially offset by an increase in interest income of
$1,006,000.
A $515,000 payment on the related party note receivable during 1999 was
included in interest income for 1999, while no interest income on the note was
recognized in 1998. Another reason for the increase in interest income in 1999
over 1998 relates to a full year's interest being recognized on the $6,500,000
note receivable from the sale of the Alabama facility in March 1998.
Interest expense in 1998 of $2,745,000 consisted primarily of
amortization of the discount incurred upon the issuance of convertible debt and
warrants at a discount. Interest expense of $6,253,000 in 1999 consisted of
interest accrued on notes payable used to finance the construction of
alternative fuel facilities held for sale and for operating needs and $2,075,000
of amortization of debt discount and debt issue costs. Interest expense
increased significantly as a result of the debt issued during March 1999.
During September 1998, Headwaters offered the limited partners of Utah
Synfuel #1 and Alabama Synfuel #1 common stock of Headwaters in exchange for
their limited partnership interests. These exchanges, most of which were
accounted for in September 1998, were substantially completed by November 1998,
at which time Utah Synfuel #1 became a wholly-owned subsidiary of Headwaters and
Alabama Synfuel #1 became a 98%-owned subsidiary of Headwaters. As a result of
these exchanges, minority interest in the losses of consolidated subsidiaries
decreased from approximately $392,000 in 1998 to $0 in 1999.
Net Loss. For 1999, the net loss of $28,393,000 represents an increase
of $17,085,000 from the net loss of $11,308,000 in 1998. This is primarily due
to the increase in cost of operations, the asset write-offs and other
non-recurring charges, and the increase in interest expense. Headwaters did not
recognize any income tax benefit in 1999 or 1998 since the realization of its
deferred tax asset of approximately $21,800,000, consisting primarily of net
operating loss carryforwards, was dependent on generation of future taxable
income.
Liquidity and Capital Resources
Liquidity. During 1998, Headwaters and its licensees completed the
construction of and began operations at 24 alternative fuel facilities.
Headwaters owned four facilities which were sold during 1999 and 2000. Proceeds
from the sale of facilities were used primarily to retire debt that was incurred
in connection with the construction and operation of the facilities, and to a
lesser extent, for working capital needs.
19
Net cash provided by operating activities during the year ended
September 30, 2000 was $6,608,000 compared to $17,516,000 of cash used during
the year ended September 30, 1999. Most of this change in cash flow from
operating activities is attributable to the 2000 net income of $3,682,000 as
compared to the 1999 net loss of $28,393,000, augmented by the non-cash nature
of some of the material expenses included in results of operations for 2000.
During 2000, proceeds from the sale of facilities were approximately
$42,334,000, net proceeds from the issuance of notes payable and related common
stock warrants totaled approximately $6,980,000, and net proceeds from the
issuance of common stock and related common stock warrants totaled approximately
$5,254,000. Approximately $43,995,000 of notes payable were repaid during 2000
and approximately $4,454,000 of cash was used for preferred stock redemptions.
Capital Resources. In addition to the sale of facilities in 2000,
Headwaters' investing activities consisted of the purchase of short-term
investments and investments in non-affiliated companies. Headwaters has no
current plans to construct additional synthetic fuel facilities or to incur
significant costs to acquire property, plant and equipment, but may increase its
strategic investments and lending activities as opportunities arise. As of
September 30, 2000, Headwaters owns from 1% to 27% of the voting securities of
five non-public high-risk investee companies. Current investments range from
approximately $130,000 to $1,400,000. Through December 1, 2000, Headwaters made
additional equity investments of approximately $1,558,000 under the same general
terms as the investments made in fiscal 2000. Headwaters also has notes
receivable representing short-term loans to nine private, emerging growth
companies in order to bridge the period between seed funding and the close of
first and second rounds of equity financing. Notes receivable from these
companies range from $200,000 to $500,000 each. From October 1, 2000 to December
1, 2000, Headwaters made additional loans of approximately $1,050,000 under the
same general terms as the loans made in fiscal 2000. Headwaters does not intend
to increase the funds committed to these investment types in the future, but
could incur losses if the loans are not repaid or if the investments are not
recoverable.
As described in Note 5 to the consolidated financial statements,
Headwaters began acquiring shares of its common stock in connection with a stock
repurchase plan announced during 2000. The program authorizes Headwaters to
purchase stock in the open market or through negotiated transactions referred to
as block trades. Purchases under the plan are at the discretion of Headwaters'
management. Through September 30, 2000, Headwaters purchased approximately
586,000 shares for approximately $1,897,000, and continues to purchase stock
subsequent to September 30, 2000. Headwaters continually evaluates financial
alternatives to the stock repurchase program but currently expects the program
to continue through fiscal 2001 subject to market conditions and available cash.
Headwaters' working capital improved from a deficit position of
approximately $1,799,000 at September 30, 1999 to a positive working capital
position of approximately $11,225,000 as of September 30, 2000. Several factors
caused this change, most notably an increase in cash from the sale of facilities
and increased revenue. The most significant changes in working capital, in
addition to the increase in cash and short-term investments, were the reduction
of approximately $19,883,000 in facilities and equipment held for sale and the
reduction of approximately $20,418,000 in current notes payable. Both of these
changes resulted primarily from the sales of alternative fuel facilities in
2000.
Headwaters expects its operations to produce positive cash flows in
future periods. In addition to cash provided by operating activities, Headwaters
has borrowing capability under a revolving line of credit with a bank which was
obtained in October 2000. Borrowings under this line of credit, which expires
January 2002, were used to repay a $3,000,000 note payable to this bank which
was outstanding at September 30, 2000 and to repay a $1,838,000 note payable to
a corporation (see Notes 5 and 6 to the consolidated financial statements).
Subsequently, the line of credit was paid down and at October 31, 2000, there
were no outstanding borrowings under the line of credit. Borrowings under this
revolving line bear interest at prime plus 1% and are limited to the lesser of
$8,000,000 or the "borrowing base," as defined. At October 31, 2000, Headwaters'
notes payable totaled less than $500,000. Headwaters believes it will have
sufficient cash reserves to meet its obligations during the foreseeable future,
and also believes it has the ability to raise additional debt and equity capital
from other sources if necessary.
Forward Looking Statements
Statements in this Management's Discussion and Analysis regarding
Headwaters' expectations as to the operation of facilities utilizing Headwaters'
technologies, the marketing of products, the receipt of licensing fees,
royalties, and product sales revenues, the development, commercialization and
financing of non-alternative fuel
20
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 feedstocks, the marketability of
the alternative fuel and the financial viability of the facilities, constitute
forward looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Although Headwaters believes that its
expectations are based on reasonable assumptions within the bounds of its
knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. In addition to matters
affecting the alternative fuel industry or the economy generally, factors which
could cause actual results to differ from expectations stated in these forward
looking statements include, among others, the following:
(1) The commercial success of Headwaters' technologies.
(2) Operating issues for licensed facilities including feedstock
availability, moisture content, Btu content, correct application of
chemical reagent, significant chemical change, operability of
equipment, production capacity, product durability, resistance to water
absorption and overall costs of operations.
(3) Marketing issues relating to market acceptance of products manufactured
using Headwaters' technologies, including control of moisture content,
hardness, special handling requirements and other characteristics of
the alternative fuel product which affect its marketability and its
sales price.
(4) Securing of suitable facility sites, including permits and raw
materials, for relocation and operation of facilities and product
sales.
(5) The market acceptance of products manufactured with Headwaters'
technologies in the face of competition from traditional products.
(6) Dependence on licensees to successfully implement Headwaters' chemical
technologies and making license and other payments to Headwaters.
(7) Maintenance of placed-in-service requirements under Section 29 of the
tax code by alternative fuel manufacturing facilities.
(8) Changes in governmental regulations or failure to comply with existing
regulations that may result in operational shutdowns of licensee
facilities.
(9) The continued availability of tax credits to licensees under the tax
code.
(10) The commercial feasibility of Headwaters' alternative fuel technologies
upon the expiration of tax credits.
(11) Ability to meet financial commitments under existing contractual
arrangements.
(12) Ability to meet non-financial commitments under existing contractual
arrangements.
(13) Ability to commercialize the non-alternative fuel chemical technologies
which have only been tested in the laboratory and not in full-scale
operations.
(14) Ability to commercialize the technology of others and to implement
non-technology based business plans which are at an early stage of
investigation and investment and which will require significant time,
management, and capital investment.
(15) Success in the face of competition by others producing alternative fuel
and other products.
(16) Sufficiency of intellectual property protections.
Impact of Inflation
During 2000, cost increases to Headwaters were not materially impacted
by inflation.
Other Items
Headwaters has reviewed all recently issued, but not yet adopted,
accounting standards in order to determine their effects, if any, on the results
of operations or financial position of Headwaters. Based on that review,
Headwaters believes that none of these pronouncements will have any significant
effects on current or future financial position or results of operations.
21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data required by
this Item 8 are set forth in Item 14 of this Form 10-K. All information which
has been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On July 19, 2000, Headwaters dismissed PricewaterhouseCoopers LLP as
its independent accountants. The Registrant's audit committee participated in
and approved the decision to change independent accountants.
The reports of PricewaterhouseCoopers LLP on the financial statements
for the two fiscal years ended September 30, 1998 and 1999 contained no adverse
opinion or disclaimer of opinion and were not qualified or modified as to
uncertainty, audit scope or accounting principle.
In connection with its audits for the two fiscal years ended September
30, 1998 and 1999 and through July 19, 2000, there were no disagreements with
PricewaterhouseCoopers LLP on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements if not resolved to the satisfaction of PricewaterhouseCoopers LLP
would have caused them to make reference thereto in their reports on the
financial statements for such years.
During the two fiscal years ended September 30, 1998 and 1999 and
through July 19, 2000, there were no reportable events (as defined in Regulation
S-K Item 304(a)(1)(v)).
The Registrant requested that PricewaterhouseCoopers LLP furnish it
with a letter addressed to the Securities and Exchange Commission stating
whether or not it agrees with the above statements. A copy of such letter is
filed as Exhibit 16 to this Form 10-K.
On July 19, 2000, the audit committee appointed Arthur Andersen LLP as
Headwaters' auditors. Headwaters did not consult with Arthur Andersen LLP on any
application of accounting principles or any other matter during the two fiscal
years ended September 30, 1999 or subsequent thereto through July 19, 2000.
The appointment of Arthur Andersen LLP as independent auditors of
Headwaters for the fiscal year ended September 30, 2000 was ratified by the
stockholders at a special meeting held on September 6, 2000.
There have been no disagreements with accountants on accounting or
financial statement disclosure subsequent to the appointment of Arthur Andersen
LLP on July 19, 2000.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information to be set forth under the captions "Executive
Officers," "Section 16(a) Beneficial Ownership Reporting Compliance" and
"Proposal No. 1: Election of Directors" in Headwaters' Proxy Statement to be
filed in January 2001 for the Annual Meeting of Stockholders to be held in 2001
(the "Proxy Statement"), are incorporated herein by reference.
22
ITEM 11. EXECUTIVE COMPENSATION
The information to be set forth under the caption "Executive
Compensation and Related Information" in the Proxy Statement is incorporated
herein by reference; provided, however, that Headwaters specifically excludes
from such incorporation by reference any information set forth under the
captions "Compensation Committee Report on Executive Compensation" and
"Stockholder Return Performance Graph" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security ownership of certain beneficial owners and management to be
set forth under the caption "Security Ownership of Directors, Nominees and
Principal Stockholders" in the Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information to be set forth under the caption "Transactions with
Related Parties" in the Proxy Statement is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Consolidated Financial Statements of Headwaters Incorporated
Reports of Independent Public Accountants F-1
Consolidated Balance Sheets as of September 30, 1999 and 2000 F-2
Consolidated Statements of Operations
for the years ended September 30, 1998, 1999 and 2000 F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended September 30, 1998, 1999 and 2000 F-5
Consolidated Statements of Cash Flows
for the years ended September 30, 1998, 1999 and 2000 F-8
Notes to Consolidated Financial Statements F-10
2. Financial Statement Schedules
All financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.
3. Listing of Exhibits
Certain other instruments which would otherwise be required to be
listed below have not been so listed because such instruments do not authorize
securities in an amount which exceeds 10% of the total assets of Headwaters and
its subsidiaries on a consolidated basis and Headwaters agrees to furnish a copy
of any such instrument to the Commission upon request.
There is included a restated financial data schedule for the years
ended September 30, 1998 and 1999.
For convenience, the name Headwaters is used throughout this listing
although in some cases the name Covol was used in the original instrument.
23
Exhibit No. Description Location
3.1 Certificate of Incorporation of Headwaters (1)
3.1.1 Certificate of Amendment of the Certificate of Incorporation of Headwaters dated (1)
January 22, 1996
3.1.2 Certificate of Amendment of the Certificate of Incorporation dated June 25, 1997 (3)
3.1.3 Certificate of Designation, Number, Voting Powers, Preferences and Rights of (4)
Headwaters' Series A 6% Convertible Preferred Stock dated August 18, 1997
(originally designated as Exhibit No. 3.1.2)
3.1.4 Certificate of Designation, Number, Voting Powers, Preferences and Rights of (5)
Headwaters' Series B Convertible Preferred Stock dated September 18, 1997
(originally designated as Exhibit No. 3.1.3)
3.1.7 Certificate of Amendment of the Certificate of Incorporation dated March 1, 2000 (14)
3.1.8 Certificate of Amendment of the Certificate of Incorporation dated September 6, (19)
2000
3.2 By-Laws of Headwaters (1)
3.2.1 Certificate of Amendment to Bylaws of Headwaters dated January 31, 1996 (1)
3.2.2 Certificate of Amendment to the Bylaws dated May 20, 1997 (Originally designated (3)
as Exhibit No. 3.2.1)
3.2.3 Certificate of Amendment to the Bylaws dated June 25, 1997 (Originally (3)
designated as Exhibit No. 3.2.2)
9.1 Special Powers of Attorney Coupled With an Interest dated February 1, 1996 (1)
between Headwaters, Gerald Larson and Michael McEwan
10.8 Lease Agreement, dated May 31, 1994, between Headwaters and Byrleen Hansen (1)
regarding Carbon County, Utah property
10.11.2 License Agreement dated September 10, 1996, between Headwaters and CoBon Energy, (2)
LLC
10.13.1 Promissory Noted dated August 1996 in favor of Headwaters from Michael McEwan and *
Gerald Larson
10.13.2 Unlimited Guaranty of Gerald Larson and release of Michael McEwan dated April 29, *
1998
10.16.1 Stock Option Agreement dated June 1, 1996 with Brent M. Cook (2)
10.30 Lease Agreement, dated December 12, 1996, between Headwaters and UPC, Inc. (2)
regarding Price City, Utah property
10.45** License and Binder Purchase Agreement, dated December 14, 1997, between (6)
Appalachian Synfuel, LLC and Headwaters
10.47** License Agreement, dated August 5, 1997, between Pelletco Corporation and (6)
Headwaters
10.49** Agreement Concerning Additional Facilities, dated December 27, 1996, between AJG (6)
Financial Services, Inc. and Headwaters
10.50.1** Form of Amended and Restated License and Binder Purchase Agreement dated February (7)
3, 1998, between PC Virginia Synthetic Fuel #1, PC West Virginia Synthetic Fuel
#1, PC West Virginia Synthetic Fuel #2, PC West Virginia Synthetic Fuel #3
and Headwaters
10.50.1.1*** Form of First Amendment to Amended and Restated License and Binder Purchase *
Agreement, dated March 31, 1999, between PC
Virginia Synthetic Fuel #1; PC Virginia Synthetic Fuel #2; PC
West Virginia Synthetic Fuel #3 and Headwaters
10.54 Employment Agreement effective May 1, 1998 with Steven G. Stewart (8)
10.56 Employment Agreement effective April 21, 1998 with Brent M. Cook (9)
10.58.8 Series E Warrant in favor of Leeds Group dated March 17, 1999 (10)
10.58.9 Series E Warrant in favor of Howard L. Schwartz dated March 17, 1999 (10)
10.58.10 Series E Warrant in favor of Jack A. Schwebel dated March 17, 1999 (10)
10.58.11 Series E Warrant in favor of Brent M. Lockwood dated March 17, 1999 (10)
10.60 Employment Agreement effective April 20, 1999 with Kirk A. Benson (11)
10.61*** Purchase Agreement dated August 27, 1999 relating to the sale of the River Hill (12)
Project
10.61.1*** License and Binder Purchase Agreement dated August 27, 1999 relating to the River (12)
Hill Project
10.61.2*** Modification Agreement dated August 27, 1999 between the Purchaser of the River (12)
Hill Project, Fun Enterprises Pty Limited and Headwaters
10.64*** Utah #2 Asset Purchase Agreement dated December 23, 1999 between Headwaters and (13)
DTE Kentucky, LLC
10.64.1*** License and Binder Purchase Agreement dated December 29, 1999 between Headwaters *
and DTE Kentucky, LLC
10.65*** Asset Purchase Agreement dated January 18, 2000 among Headwaters, Pocahontas (13)
Synfuel, L.L.C., Synfuel Investments, Inc., Premier Elkhorn Coal Company, and
TECO Coal Corporation
10.65.1*** License and Binder Purchase Agreement dated January 18, 2000 between Headwaters and *
Premier Elkhorn Coal Company (related to the Pocahontas facility)
24
10.65.2*** License and Binder Purchase Agreement dated January 21, 2000 between Headwaters and *
Premier Elkhorn Coal Company (related to the Mohave facility)
10.67 Mountaineer Fuels Asset Purchase Agreement dated April 17, 2000 between DTE (15)
Kentucky, LLC and Headwaters
10.67.1*** License and Binder Purchase Agreement dated April 17, 2000 between DTE Kentucky, (15)
LLC and Headwaters
10.69*** Settlement Agreement and Mutual Release dated May 25, 2000 among Headwaters and (17)
Birmingham Syn Fuel, L.L.C., PacifiCorp Syn Fuel, L.L.C., and PacifiCorp
Financial Services, Inc.
10.69.1 Amended and Restated Promissory Note dated May 25, 2000 in favor of Headwaters, (17)
executed by Birmingham Syn Fuel, L.L.C. as debtor
10.69.2 Amended and Restated Security Agreement dated May 25, 2000 between Headwaters and (17)
Birmingham Syn Fuel, L.L.C.
10.69.3*** License and Binder Purchase Agreement dated May 25, 2000 between Birmingham Syn (17)
Fuel, L.L.C. and Headwaters
10.69.4*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (17)
Fuel, L.L.C. and Headwaters (related to the Brookwood facility)
10.69.5*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (17)
Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #1 facility)
10.69.6*** License and Binder Purchase Agreement dated May 25, 2000 between PacifiCorp Syn (17)
Fuel, L.L.C. and Headwaters (related to the Pumpkin Center #2 facility)
10.70*** Settlement Agreement and Release dated June 26, 2000 among Headwaters, Utah (17)
Synfuel #1, Ltd., Coaltech No. 1, L.P., AJG Financial Services, Inc. and Square D
Company
10.70.1*** License and Binder Supply Agreement dated June 26, 2000 among Coaltech No.1 L.P., (17)
Utah Synfuel #1 Ltd, and Headwaters
10.71 Loan Agreement dated October 18, 2000 between Headwaters and Zions First National *
Bank
10.71.1 Promissory Note dated October 18, 2000 between Headwaters as borrower and Zions *
First National Bank as lender
10.72 Employment Agreement effective as of January 1, 1999 with Kenneth R. Frailey *
10.73.1 Stock Purchase Agreement dated July 7, 2000 between StyleU4EA.com, Inc. and *
Headwaters
10.73.2 Loan Agreement dated October 6, 2000 between StyleU4EA.com, Inc. and Headwaters *
10.73.3 Stock Purchase Agreement dated October 16, 2000 between StyleU4EA.com, Inc. and *
Headwaters
10.73.4 Loan Agreement dated November 29, 2000 between NextStep Broadband Corporation and *
Headwaters
10.74 Credit Agreement dated October 20, 2000 between The H.B. Group, Inc. and *
Headwaters
10.74.1 Amendment to Credit Agreement dated October 20, 2000 between The H.B. Group, Inc. *
and Headwaters
10.74.2 Second Amendment to Credit Agreement dated December 1, 2000 between The H.B. *
Group, Inc. and Headwaters
16 Letter regarding change in certifying accountant (18)
21.1 List of Subsidiaries of Headwaters *
23.1 Consent of Arthur Andersen LLP *
23.2 Consent of PricewaterhouseCoopers LLP *
27.1 Financial Data Schedule for the fiscal year ended September 30, 2000 *
27.2 Restated Financial Data Schedule for the fiscal years ended September 30, 1998 *
and 1999
99.1 2000 Employee Stock Purchase Plan (16)
99.2 1995 Stock Option Plan (originally designated as Exhibit No. 10.5) (1)
99.2.1 First Amendment to the 1995 Stock Option Plan (originally designated as Exhibit (1)
10.5.1)
99.3 Headwaters Incentive Bonus Plan dated May 25, 2000 *
- -----------------------
* Filed herewith.
** Confidential treatment has been granted to certain portions of
this exhibit, which portions have been deleted and filed
separately with the Securities and Exchange Commission.
*** This exhibit contains confidential material that has been
omitted pursuant to a Confidential Treatment Request. The
omitted information has been filed separately with the
Securities and Exchange Commission.
Unless another exhibit number is indicated as the exhibit number for the exhibit
as "originally filed," the exhibit number in the filing in which any exhibit was
originally filed and to which reference is made hereby is the same as the
exhibit number assigned herein to the exhibit.
25
(1) Incorporated by reference to the indicated exhibit filed with
Headwaters' Registration Statement on Form 10, filed February 26, 1996.
(2) Incorporated by reference to the indicated exhibit filed with
Headwaters' Annual Report on Form 10-K for the fiscal year ended
September 30, 1996.
(3) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, dated March 10, 1997.
(4) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, dated August 19, 1997.
(5) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for event dated September 18,
1997, filed October 28, 1997.
(6) Incorporated by reference to the indicated exhibit filed with
Headwaters' Annual Report on Form 10-K for the fiscal year ended
September 30, 1997.
(7) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
ended March 31, 1998.
(8) Incorporated by reference to the indicated exhibit filed with
Headwaters' Annual Report on Form 10-K, for the fiscal year ended
September 30, 1998.
(9) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q, for the quarterly period
ended December 31, 1998.
(10) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated March 17,
1999, filed March 24, 1999.
(11) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
30, 1999.
(12) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K/A, for event dated August 27,
1999, filed September 28, 1999.
(13) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K/A, for the event dated December
31, 1999, filed March 16, 2000.
(14) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated February
29, 2000, filed March 2, 2000.
(15) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended March
31, 2000.
(16) Incorporated by reference to the indicated exhibit filed with
Headwaters' Registration Statement on Form S-8 (SEC file no.
333-39674), filed June 20, 2000.
(17) Incorporated by reference to the indicated exhibit filed with
Headwaters' Quarterly Report on Form 10-Q for the quarter ended June
30, 2000.
(18) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K/A, for the event dated July 19,
2000, filed July 28, 2000.
(19) Incorporated by reference to the indicated exhibit filed with
Headwaters' Current Report on Form 8-K, for the event dated September
6, 2000, filed September 19, 2000.
Reports on Form 8-K
The following reports on Form 8-K were filed during the quarter ended
September 30, 2000:
* Form 8-K filed on July 19, 2000, amended on July 28, 2000, for an event
dated July 19, 2000 (Change in Certifying Accountant).
* Form 8-K filed on September 19, 2000 for an event dated September 6,
2000 (Special Meeting of Stockholders).
Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 3 above.
Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) 2 above.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ Kirk A. Benson
-------------------------------
Kirk A. Benson
Chief Executive Officer and
Principal Executive Officer
By: /s/ Steven G. Stewart
-------------------------------
Steven G. Stewart, Chief Financial
Officer and Principal Financial
Officer
Date: December 20, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ Kirk A Benson Chief Executive Officer December 20, 2000
- --------------------- (Principal Executive Officer) and
Kirk A. Benson Director
/s/ Steven G. Stewart Chief Financial Officer December 20, 2000
- ------------------------ (Principal Financial and
Steven G. Stewart Accounting Officer)
/s/ Brent M. Cook President and Director December 20, 2000
- -----------------------
Brent M. Cook
/s/ DeLance W. Squire Director December 20, 2000
- -----------------------
DeLance W. Squire
/s/ James A. Herickhoff Director December 20, 2000
- -------------------------
James A. Herickhoff
/s/ Raymond J. Weller Director December 20, 2000
- -----------------------
Raymond J. Weller
/s/ John P. Hill, Jr. Director December 20, 2000
- -----------------------
John P. Hill, Jr.
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Headwaters Incorporated:
We have audited the accompanying consolidated balance sheet of Headwaters
Incorporated (formerly Covol Technologies, Inc.) and subsidiaries as of
September 30, 2000, and the related consolidated statements of operations,
changes in stockholders' equity (deficit) and cash flows for the year then
ended. The financial statements of the Company as of September 30, 1999 and for
the years ended September 30, 1999 and 1998 were audited by other auditors whose
report dated January 13, 2000, expressed an unqualified opinion on those
statements. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statem