8-K 1 form8k081401.txt 8-K DATED AUGUST 14, 2001 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 8-K CURRENT REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 August 14, 2001 ---------------- Date of Report (Date of earliest event reported) HEADWATERS INCORPORATED ------------------------ (Exact name of Registrant as specified in its charter) Delaware 0-27808 87-0547337 -------- ------- ---------- (State or other jurisdiction of (Commission File Number) (IRS Employer incorporation) Identification No.) 11778 South Election Road, Suite 210 Draper, UT 84020 ---------------- (Address of principal executive offices) (Zip Code) (801) 984-9400 --------------- (Registrant's telephone number, including area code) Not Applicable -------------- (Former name or former address, if changed since last report.) Certain statements 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 certain of the factors that could cause actual results to differ from expectations, please see the information set forth under the caption entitled "Forward-Looking Statements" in PART I, ITEM 2 of Headwaters' Quarterly Report on Form 10-Q for the quarter ended June 30, 2001. There can be no assurance that Headwaters' results of operations will not be adversely affected by such factors. Headwaters 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. Item 2. Acquisition of Hydrocarbon Technologies, Inc. Headwaters announced on August 29, 2001 that it completed the acquisition of Hydrocarbon Technologies, Inc., effective as of August 28, 2001. Share and dollar amounts included in that press release were based upon reasonable estimations made at that time. The final amounts paid to HTI varied somewhat from those amounts although the differences are immaterial. Shares and dollars actually paid are reflected in the pro forma information included in this Form 8-K. The complete text of the August 29, 2001 announcement follows. Headwaters Incorporated (Nasdaq: HDWR), today announced that the acquisition of Hydrocarbon Technologies, Inc. ("HTI") has been completed. HTI will be a wholly owned subsidiary of Headwaters Incorporated ("Headwaters"). Consideration at closing consists of $1.5 million in cash, assumption of $1.5 million of HTI debt, the issuance of approximately 605,000 shares of Headwaters' common stock and the assumption of approximately 121,000 options, now convertible into Headwaters' stock. Up to an additional $1.5 million in cash and 605,000 shares of Headwaters' stock is issuable upon HTI's accomplishment of certain milestones over the next two years. These milestones are based on execution of certain significant contracts and achievement of certain EBITDA levels. Based on the current stock price of Headwaters, the acquisition has a total potential purchase price of approximately $17 million. Initially formed in 1943, HTI and its predecessor have a long history of being in the forefront of developing catalysts and catalytic processes for energy related applications such as Gas to Liquids, Heavy Oil Upgrading, Coal Liquefaction, Gasification and Syngas Synthesis. According to the Department of Energy, "Catalysis and catalytic processes are responsible for about 20% of the U.S. gross domestic product (all goods and services), and are the keys to future gains in energy efficiency, environmental stewardship and attendant economic prosperity for the country." HTI offers Headwaters opportunities in ongoing projects in China with Coal and Heavy Oil Conversion as well as opportunities in the U.S. and throughout the world, including the introduction of "nano-catalysis." HTI's nano-catalysis technology can improve performance and reduce precious metal consumption in many applications including petrochemical processes and automotive emissions control. The technology is still early stage, but has the potential to be deployed in a variety of commodity chemical and energy markets. The catalysis market has a current global revenue base of over $10 billion. Nano-technology is perhaps the single greatest advancement in catalysis in the last 20 years and HTI is in the forefront of this development. Kirk A. Benson, Chairman and CEO, stated, "We are pleased to complete this acquisition and to be able to combine the resources of Headwaters and HTI for the continued development and expansion of these catalytic processes. HTI's technologies and accomplishments align well with Headwaters' skill at commercial deployment of alternative fuel technology and will advance the development and commercialization of alternative fuels, carbon based fuels and related technologies well into the future. The completion of this acquisition marks a major milestone for Headwaters in being able to create new opportunities for growth and diversification." About Headwaters Incorporated Headwaters Incorporated is the world leader in developing and deploying alternative fuel and related technologies. It is focused on converting fossil fuels such as coal and heavy oils to alternative energy products. Through its 2 existing alternative fuels business, the Company earns a growing royalty stream that provides the capital needed to acquire and expand synergistic business opportunities. Headwaters Incorporated trades under the Nasdaq symbol HDWR. About Hydrocarbon Technologies, Inc. Hydrocarbon Technology, Inc. is on the forefront in the development and commercialization of coal and heavy oil conversion, catalysis and catalytic processes that produce alternate fuels and chemicals while improving energy efficiency and reducing environmental risks. HTI is a wholly owned subsidiary of Headwaters. Certain statements contained in this document may be deemed to be forward-looking statements under federal securities laws, and Headwaters intends that such forward-looking statements be subject to the safe-harbor created thereby. Such forward-looking statements relate to: i) the growth of Headwaters' revenues, earnings, or earnings per share; ii) the ability of Headwaters to sustain the earnings stream from its alternative fuels business; iii) the expectation that Headwaters' stock is undervalued or will increase in value in the future; iv) the completion of any future acquisitions and the expectation that the value of such acquisitions will increase, v) the commercialization of any technology acquired or developed. Headwaters cautions that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements contained herein. Such factors include, but are not limited to: a) the availability of tax credits to our licensees under the tax code; b) our dependence on licensees to use our technology; c) collection of payments outstanding; d) limitations in the capital available to Headwaters to execute on its business plan, and the cost of that capital; e) the ability of Headwaters to locate and close on attractive acquisition opportunities; f) the Company's limited operating history with its new business strategy and its ability to sustain and manage its growth under that strategy; f) the success of the Company in replacing and growing its financial performance before its legacy alternative fuels business declines; and other risks as detailed in Headwaters' annual report on Form 10-K, quarterly report on Form 10-Q, and other filings from time to time with the Securities and Exchange Commission. Item 5. Other Events - Restatement of Certificate of Incorporation Headwaters restated its Certificate of Incorporation on August 14, 2001. The restated Certificate is filed as Exhibit 3.1.9 hereto. Item 7. Financial Statements and Exhibits (a) The following consolidated financial statements of Hydrocarbon Technologies, Inc. and subsidiaries are included herein: Audited Financial Statements: Independent Auditors' Report Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Operations for the Years Ended December 31, 2000 and 1999 Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended December 31, 2000 and 1999 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000 and 1999 Notes to Consolidated Financial Statements Unaudited Financial Statements: Accountants' Review Report Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 Consolidated Statements of Operations for the Six Months Ended June 30, 2001 and 2000 Consolidated Statements of Stockholders' Equity (Deficit) for the Six Months Ended June 30, 2001 and 2000 Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2001 and 2000 Notes to Consolidated Financial Statements 3 (b) The following unaudited pro forma financial information is included herein: Introduction to Pro Forma Financial Information Pro Forma Condensed Combined Balance Sheet as of June 30, 2001 Pro Forma Condensed Combined Statement of Income for the Year Ended September 30, 2000 Pro Forma Condensed Combined Statement of Income for the Nine Months Ended June 30, 2001 Notes to Pro Forma Condensed Combined Financial Information (c) The following exhibits are included herein: 3.1.9 Restated Certificate of Incorporation of Headwaters dated August 14, 2001 10.72.2 Amendment No. 1 to Agreement and Plan of Reorganization between Headwaters and Hydrocarbon Technologies, Inc. dated August 21, 2001 10.72.3 Amendment No. 1 to Share Exchange Agreement between Headwaters and Hydrocarbon Technologies, Inc. dated August 21, 2001 10.72.4 Certificate of Merger between Headwaters and Hydrocarbon Technologies, Inc. dated August 29, 2001 23 Consent of Independent Auditors 23.1 Consent of Accountants 4 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. HEADWATERS INCORPORATED ----------------------------- Registrant Date: September 11, 2001 /s/ Kirk A. Benson ----------------------------- Kirk A. Benson Chief Executive Officer and Principal Executive Officer 5 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES Consolidated Financial Statements Years Ended December 31, 2000 and 1999 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES Table of Contents Years Ended December 31, 2000 and 1999 Page Number ---- INDEPENDENT AUDITORS' REPORT............................................... 1 FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS........................................ 2 CONSOLIDATED STATEMENTS OF OPERATIONS ............................. 3 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY.......... 4 CONSOLIDATED STATEMENTS OF CASH FLOWS ............................. 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................... 6-21 i DRUKER, RAHL & FEIN CERTIFIED PUBLIC ACCOUNTANTS BUSINESS CONSULTANTS A Member of The Mercadien Group INDEPENDENT AUDITORS' REPORT To The Board of Directors and Stockholders of HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES Donald F. Conway, CPA o Conrad L. Druker, CPA We have audited the accompanying consolidated balance Esmond S. Druker, CPA sheets of HYDROCARBON TECHNOLOGIES, INC. AND Eugene J. Elias, CPA, RMA SUBSIDIARIES as of December 31, 2000 and 1999, and Jack H. Fein, CPA * the related consolidated statements of operations, Robert J. Rahl, CPA * stockholders' (deficit) equity and cash flows for the David L. Stafford, CPA * years then ended. These consolidated financial Richard S. Willinger, CPA statements are the responsibility of the Company's __________________________ management. Our responsibility is to express an Peter A. Inverso, CPA opinion on these financial statements based on our audits. * CPA in NJ and PA o CPA in NY We conducted our audits in accordance with auditing standards generally accepted in the United States of OTHER OFFICE America. Those standards require that we plan and 86 Buck Road perform the audit to obtain reasonable assurance Holland, PA 18966 about whether the financial statements are free of 215-355-4860 material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit o National Associated also includes assessing the accounting principles CPA Firms used and significant estimates made by management, as well as evaluating the overall financial statement o American Institute of presentation. We believe that our audits provide a Certified Public reasonable basis for our opinion. Accountants In our opinion, the consolidated financial statements o New Jersey Society of referred to above present fairly, in all material Certified Public respects, the financial position of HYDROCARBON Accountants TECHNOLOGIES, INC. AND SUBSIDIARIES as of December 31, 2000 and 1999, and the results of its operations o Pennsylvania Institute ofand its cash flows for the years then ended in Certified Public conformity with accounting principles generally Accountants accepted in the United States of America. o Private Companies As discussed in Note N to the financial statements, Practice Section the Company pursuant to APB 20 Accounting Changes has made changes to the recognition of intangibles in o SEC Practice Section connection with an initial public distribution of securities by a closely held company. March 20, 2001 (Except as to Note N, which is as of April 23, 2001 and Note O, which is as of August 28, 2001) /s/ Druker, Rahl & Fein DRUKER, RAHL & FEIN P.O. Box 7648 o Princeton, NJ 08543-7648 o 609.689.9700 o FAX 609.689.9720 www.mercadien.com 1
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, --------------------------- 2000 1999 ------------ ------------ ASSETS Current Assets Cash $ 61,091 $ 92,384 Accounts receivable, net of allowance for uncollectible accounts of $10,200 (2000) and (1999) 235,038 707,257 Unbilled costs and fees 72,055 137,657 Other receivables 40,558 19,386 Inventories 558,439 646,145 Prepaid expenses and other current assets 161,290 89,333 Prepaid income taxes 51,740 - ------------ ------------ Total Current Assets 1,180,211 1,692,162 Property, plant and equipment 1,068,639 1,242,419 Other assets 93,448 136,578 ------------ ------------ Total Assets $ 2,342,298 $ 3,071,159 ============ ============ LIABILITIES AND STOCKHOLDERS'(DEFICIT) EQUITY Current Liabilities Current portion of capitalized lease obligation $ - $ 4,060 Line of credit payable 1,000,000 450,000 Current portion of long-term debt 185,746 107,342 Accounts payable 865,396 498,764 Accrued expenses 144,229 114,095 Accumulated employee vacation 111,323 133,510 Income taxes payable 600 17,960 Deferred revenue and other current liabilities 62,504 847,874 ------------ ------------ Total Current Liabilities 2,369,798 2,173,605 Long-term debt 30,295 145,969 Excess of net assets acquired over cost 386,491 436,152 ------------ ------------ Total Liabilities 2,786,584 2,755,726 ------------ ------------ Stockholders'(Deficit) Equity Common stock, 10,000,000 shares authorized; 1,501,112 (2000) and 1,222,877 (1999) shares issued 15,011 12,229 Additional paid-in capital 990,415 806,777 Accumulated deficit (1,449,712) (503,573) ------------ ------------ Total Stockholders'(Deficit) Equity (444,286) 315,433 ------------ ------------ Total Liabilities and Stockholders' (Deficit) Equity $ 2,342,298 $ 3,071,159 ============ ============
See notes to consolidated financial statements. 2
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, --------------------------- 2000 1999 ------------ ------------ Revenue Contract revenue $ 6,897,048 $ 7,951,640 Retail sales 240,789 212,259 ------------ ------------ Total revenue 7,137,837 8,163,899 ------------ ------------ Direct costs Labor costs 1,450,663 1,403,474 Fringe benefits 550,218 577,038 Other direct costs 1,609,280 1,493,617 Applied overhead 2,289,388 2,081,800 Depreciation and amortization 186,370 203,543 ------------ ------------ Total direct costs 6,085,919 5,759,472 ------------ ------------ Gross profit 1,051,918 2,404,427 ------------ ------------ Operating expenses Marketing 514,626 553,342 Research and development 558,999 782,769 Bid proposal 217,054 136,269 General and administrative 671,679 733,167 ------------ ------------ Total operating expenses 1,962,358 2,205,547 ------------ ------------ (Loss) income from operations (910,440) 198,880 ------------ ------------ Other income (expense) Interest income 7,887 12,087 Rental income 14,976 13,431 Miscellaneous income - 11,884 Interest expense (74,334) (122,493) Amortization of goodwill (43,130) (43,130) Amortization of negative goodwill 49,661 49,661 ------------ ------------ Total other expense (44,940) (78,560) ------------ ------------ (Loss) income before (benefit of) provision for income taxes (955,380) 120,320 (Benefit of) provision for income taxes (9,241) 50,691 ------------ ------------ Net (loss) income $ (946,139) $ 69,629 ============ ============
See notes to consolidated financial statements. 3
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY Common Stock $.01 Par Value ------------------------------ Additional (Accumulated Shares Amount Paid-in Capital Deficit) Total ------------ ------------- --------------- ------------- ------------ Balance, January 1, 1999 $ 984,729 $ 9,848 $ 649,599 $ (573,202) $ 86,245 Shares repurchased from former employees (83,543) (835) (55,138) - (55,973) Shares purchased through Employee Stock Purchase Plan 280,391 2,803 185,058 - 187,861 Other stock subscribed during the period 41,300 413 27,258 - 27,671 Net income for the year - - - 69,629 69,629 --------- ----------- ----------- ----------- ------------ Balance, December 31, 1999 1,222,877 12,229 806,777 (503,573) 315,433 Shares repurchased from former employees (11,368) (114) (7,502) - (7,616) Shares purchased through Employee Stock Purchase Plan 248,115 2,481 163,757 - 166,238 Other stock subscribed during the period 41,488 415 27,383 - 27,798 Net loss for the year - - - (946,139) (946,139) --------- ----------- ----------- ----------- ------------ Balance, December 31, 2000 1,501,112 $ 15,011 $ 990,415 $(1,449,712) $ (444,286) ========= =========== =========== =========== ============
See notes to consolidated financial statements. 4
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, 2000 1999 ------------ ------------ Cash Flows from Operating Activities Net (loss) income $ (946,139) $ 69,629 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities Depreciation and amortization 229,500 246,673 Amortization of negative goodwill (49,661) (49,661) Allowance for uncollectible accounts - 9,000 Changes in current assets and liabilities Accounts receivable 472,219 41,963 Unbilled costs and fees 65,602 (58,097) Other receivables (21,172) 5,105 Inventories 87,706 119,253 Prepaid expenses and other current assets (71,957) 82,444 Prepaid income taxes (51,740) 8,298 Accounts payable 366,632 179,522 Accrued expenses 30,134 46,895 Accumulated employee vacation (22,187) 12,991 Income taxes payable (17,360) 17,960 Deferred revenue and other current liabilities (785,370) (272,412) ------------ ------------ Net cash (used in) provided by operating activities (713,793) 459,563 ------------ ------------ Cash Flows from Investing Activities Purchase of property, plant and equipment (12,590) (81,066) ------------ ------------ Cash Flows from Financing Activities Proceeds from borrowing - notes payable 179,874 - Proceeds from line of credit 1,000,000 450,000 Principal payments under capital lease obligations (4,060) (4,390) Principal payments on notes payable (217,144) (1,117,710) Principal payments on line of credit (450,000) (225,000) Subscription and issuance of common stock 194,036 215,532 Repurchase of stock from former employees (7,616) (55,973) ------------ ------------ Net cash provided by (used in) financing activities 695,090 (737,541) ------------ ------------ Net decrease in cash (31,293) (359,044) Cash, beginning of year 92,384 451,428 ------------ ------------ Cash, end of year $ 61,091 $ 92,384 ============ ============ Supplemental Disclosures of Cash Flow Information Cash paid during the year for Interest $ 65,642 $ 122,493 ============ ============ Income taxes $ 59,768 $ 24,433 ============ ============
See notes to consolidated financial statements. 5 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business The Company provides research and development services for converting, upgrading and cleaning fossil fuels and for recycling waste organics (plastics) for the US Department of Energy ("DOE") as well as other commercial customers. The Company's commercial customer base, predominantly within the oil and gas industry, is throughout the United States. Organization and Basis of Consolidation The consolidated financial statements include the accounts of Hydrocarbon Technologies Canada, Inc. incorporated on December 19, 1995 for purposes of performing joint research and development activities utilizing intellectual property with a university in Canada. The Company also has established a wholly owned subsidiary, Hydrocarbon Environmental Technology, Inc. for the purpose of performing research into converting scrap tires and waste oil into a more refined oil and carbon based solid material. The Company also has a wholly owned subsidiary which was established during 1998, Chemsampco, Inc., which is also based in New Jersey. This subsidiary is a chemical manufacturer and supplier. All intercompany transactions have been eliminated. Ownership The Company is owned entirely by its employees. The initial stockholders were the Company's president, vice-president, treasurer, and secretary. As discussed in the Employee Stock Purchase Plan note, the Company subsequently developed the plan in which all the Company's employees may purchase at their option, shares in the Company's stock. Currently, substantially all of the employees are participating in this plan. Cash For the purpose of the statements of cash flows, cash includes time deposits and all highly liquid debt instruments with original maturities of three months or less. Inventories Inventories consist of custom repair parts for the equipment used and the supplies consumed in the various tests the Company performs. Since substantially all of this inventory is repair parts, consumable supplies and chemicals, they are valued at their specific historical cost and are not for resale to customers. There are no raw materials or work in process. The inventory related to the subsidiary Chemsampco, Inc. is comprised of reagent chemicals of varying degrees of purity and is available for resale to customers. Inventory maintained by the subsidiary is valued at the lower of cost (determined on a first in first out basis) or market. Research and Development Costs Current operations are charged with all internal research and development expenses, (including overhead allocations), which amounted to $558,999 and $782,769 for the years ended December 31, 2000 and 1999, respectively. 6 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Property and Equipment and Depreciation Property and equipment is stated at cost and is depreciated for financial reporting purposes on a straight-line basis over the estimated useful lives of the respective assets which lives range from three to thirty nine and one-half years. Building improvements are depreciated over their estimated useful lives. Repairs and maintenance expenditures which do not extend the useful lives of the related assets are expensed as incurred. Excess of Net Assets Acquired Over Cost (Negative Goodwill) Effective January 17, 1995 (the transaction was completed on April 17, 1995, retroactively effective to January 17, 1995), the Company purchased the location, the existing equipment, inventory, DOE contracts and other assets from Husky Oil, Ltd. of Canada ("Husky"). (This purchase was arranged since Husky was planning to close the facility.) The Company agreed to purchase the assets and assume various liabilities from Husky in exchange for the funds Husky estimated it would need to expend for the site closing. In accordance with accounting principles generally accepted in the United States of America requirements related to below market value business combinations, the non-current assets (land, building, equipment, and customer list) have been written down to the lower of their proportionate share of the purchase price or zero. As a result, a credit balance in goodwill (negative goodwill) resulted. The figure is being amortized into income over 15 years using the straight-line method and amounted to $49,661 for both years ended December 31, 2000 and 1999. Goodwill Effective March 1998, the Company purchased the assets of another entity and created a wholly owned subsidiary, Chemsampco, Inc. Goodwill represents the excess of the purchase price of the assets purchased over the fair market value at the date of acquisition and is being amortized on the straight line method over 60 months and is included in other assets. Amortization expense charged to operations was $43,130 for both years ended December 31, 2000 and 1999. Income Taxes In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under the asset and liability method of Statement No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement No. 109, the effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date. 7 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes (Continued) The Company also qualifies as a "Personal Service Corporation" (PSC) as defined in the Internal Revenue Service Regulations. Accordingly, for income tax purposes, the Company is entitled to report its income and expenses using the cash receipts and disbursements method of accounting instead of the accrual method (Generally Accepted Accounting Principles) used for financial statement reporting. The Company has elected to file a consolidated federal tax return including its Canadian subsidiary as if it was a domestic corporation. Major Customers The Company generally extends unsecured credit in connection with its testing sales, however a significant portion of the business (7% and 16% for 2000 and 1999, respectively) is from the DOE. The Company has made, in its opinion, appropriate estimated provisions (which are $10,200 at December 31, 2000 and 1999) for credit losses on accounts receivable from commercial customers based upon information currently available. The Company, like other governmental contractors, is subject to annual appropriations by Congress to continue funding for these programs. A significant portion of the Company's revenue (67% and 71% for 2000 and 1999, respectively) is from one commercial customer. Included in accounts receivable and unbilled costs and fees is $22,875 and $493,831 at December 31, 2000 and 1999, respectively. Revenue Recognition Revenue from cost reimbursement contracts is recorded as the costs associated with that revenue are incurred. During 2000 and 1999, the Company used provisional rates when invoicing for overhead and general and administrative expenses under its DOE contracts. These provisional rates are based on the Company's budget for the respective year. Adjustments to these rates are made monthly when the actual rates can be calculated after allowing for anticipated unallowable expenses. Final adjustments will be made after year end rates are approved by the Defense Contract Audit Agency "DCAA" (usually one to two years after the close of the fiscal year). All of these rates are subject to audit by various government authorities, principally the DCAA. Revenue from other contracts (fixed price) is also recognized as the costs associated with that revenue are incurred. Estimated losses will be accrued when the facts indicating that a loss will occur become known. The Company has a liquification process contract which will also produce approximately 317,000 pounds of material. Revenue recognition applicable to this contract is based upon the percentage of completion method of accounting. Accordingly, income is recognized in the ratio that labor hours incurred bears to estimated total labor hours. Adjustments to labor hour estimates are made periodically, and losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. 8 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Revenue Recognition (continued) The Company reflects earnings in excess of billings as unbilled costs and fees in the consolidated balance sheet as a current asset. Conversely, billings in excess of earnings are reflected as deferred revenue in the consolidated balance sheet as a current liability. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. B. CONCENTRATIONS OF CREDIT RISK The Company maintains cash balances which may exceed federally insured limits. The Company historically has not experienced any related cash in bank losses. The Company provides credit in the normal course of business to its customers and performs ongoing credit evaluations of its customers, historical trends and other information. C. PENSION PLAN The Company sponsors a 401(k) retirement plan for its employees that allows the employees to contribute a portion of their salary to their retirement. The Company currently matches the employees' contribution up to 5% of the employees' compensation. The board of directors also has the option of making discretionary contributions (in addition to the matching contributions) in any amount subject to Internal Revenue limitations. For 2000 and 1999, the Company's total contribution was $164,181 and $144,953, respectively. D. PROPERTY , PLANT AND EQUIPMENT Property, plant and equipment, which is stated at cost less accumulated depreciation and amortization, is summarized as follows:
December 31, -----------=--------------- 2000 1999 ------------ ------------ Machinery and equipment $ 997,250 $ 984,660 Building improvements 652,626 652,626 Equipment under capital leases 56,076 56,076 ------------ ------------ Subtotal 1,705,952 1,693,362 Less accumulated depreciation and amortization 637,313 450,943 ------------ ------------ $ 1,068,639 $ 1,242,419 ============ ============
Depreciation and amortization expense aggregated $186,370 and $203,543 for the years ended December 31, 2000 and 1999, respectively. 9 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS E. OTHER RECEIVABLES As discussed previously, the Company purchased its facility from Husky. The facility has various environmental problems that are in various stages of remediation under the supervision of the New Jersey Department of Environmental Protection (NJ DEP). A former owner of the facility is responsible for the clean up of the site (for contamination prior to the purchase by Husky) and has invested over $4,000,000 to date in the clean up project. Part of the terms of the sale of the facility to the Company is that the former owner of the site remain fully responsible, and further, that Husky guarantee the former owner's continuing compliance with the terms of its environmental remediation plan agreed to with the NJ DEP. The Company has from time to time needed to expend funds in order to maintain the remediation program and is seeking reimbursement from the former owner. Accordingly, $34,026 and $6,640 is due from the former owner as of December 31, 2000 and 1999, respectively. This amount is included in the current assets section under the caption "Other receivables." F. DEBT Credit line payable consist of the following:
December 31, --------------------------- 2000 1999 ------------ ------------ A $1,000,000 credit line for general corporate and working capital purposes as well as other debt paydown, with interest at prime plus 1% and expires May 31, 2001. Prime at December 31, 2000 was 9.5%. The bank has a security interest in all assets of the Company and a junior lien on the inventory of the subsidiary, Chemsampco, Inc. There are financial covenants relating to tangible net worth and minimum debt service coverage which commence December 31, 2000, for which waivers have been obtained. The credit line is personally guaranteed by the three original officers/stockholders of the Company up to 62% of the credit line. $ 1,000,000 $ 450,000 ------------ ------------ Total $ 1,000,000 $ 450,000 ============ ============
In March 1998, the Company purchased certain assets of another entity and created a wholly owned subsidiary named Chemsampco, Inc. and signed a $400,000 promissory note. This note is subordinate to the line of credit although the seller has a security interest in the inventory, machinery and equipment, manufacturing procedures and production records, trade name and goodwill acquired in the asset purchase. HTI (parent) as surety, has guaranteed to the Seller that the value of the inventory purchased shall be equal to or greater than the principal outstanding on the promissory note. 10 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F. DEBT (CONTINUED) The line of credit contains covenants pertaining to tangible net worth and minimum debt service coverage which commence December 31, 2000. The Company is required to maintain minimum tangible net worth as defined, of $750,000 as of December 31, 2000. The Company is also required to maintain a minimum debt service coverage ratio as defined, of 1.15. The Company's tangible net worth and debt service coverage ratio are negative as of December 31, 2000. The bank has waived these covenant violations as of and for the year ended December 31, 2000. Debt is comprised of the following:
December 31, --------------------------- 2000 1999 ------------ ------------ Insurance premium note payable in monthly installments of $6,509 inclusive of interest at 11.95% commencing May 2000 through October 2001. The note is secured by the unused portion of the underlying policies. $ 61,664 $ - Insurance premium note payable in monthly installments of $8,481 inclusive of interest at 10.50% commencing May 2000 through January 2001. The note is secured by the unused portion of the underlying policies. 8,407 - Promissory note payable in equal monthly installments of $10,225 inclusive of interest at 7.5% through April 2002. The note is secured by certain assets of the Company. 145,970 253,311 ------------ ------------ Total 216,041 253,311 Less current portion 185,746 107,342 ------------ ------------ Debt, net of current portion $ 30,295 $ 145,969 ============ ============= Total maturities of debt are as follows: Year Ending December 31, 2001 $ 185,746 2002 30,295 ------------ $ 216,041 ============
G. INCOME TAXES As previously discussed, the Company follows FASB Statement No. 109 for the accounting for income taxes and for income tax purposes, reports its income and expenses on the cash receipts and disbursements method of accounting. Therefore, the Company has significant deferred tax assets and liabilities resulting from the different methods of income recognition. 11 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. INCOME TAXES (CONTINUED) Components of income tax (benefit) expense for 2000 and 1999 are as follows:
Year Ended December 31, 2000 Federal State Total ------------ ------------ ------------ Current $ (14,396) $ 5,155 $ (9,241) Deferred - - - ------------ ------------ ------------ Total $ (14,396) $ 5,155 $ (9,241) ============ ============ ============ Year Ended December 31, 1999 Federal State Total ------------ ------------ ------------ Current $ 27,572 $ 23,119 $ 50,691 Deferred - - - ------------ ------------ ------------ Total $ 27,572 $ 23,119 $ 50,691 ============ ============ ============
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2000 and 1999 are presented below:
December 31, --------------------------- 2000 1999 ------------ ------------ Deferred tax assets: Tax effect of realization of Accounts payable $ 292,000 $ 158,634 Accrued expenses 78,000 65,830 Deferred revenue 21,300 271,319 Net operating loss 342,000 - ------------ ------------ Subtotal 733,300 495,783 Less valuation allowance (567,800) (194,900) ------------ ------------ Total deferred tax assets 165,500 300,883 ------------ ------------ Deferred tax liabilities: Tax effect of realization of Accounts receivable (109,600) (264,107) Prepaid expenses (55,900) (36,776) ------------ ------------ Total deferred tax liabilities (165,500) (300,883) ------------ ------------ Net deferred tax asset $ - $ - ============ ============
12 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. INCOME TAXES (CONTINUED) As discussed in the "Summary of Significant Accounting Policies," the Company uses the cash receipts and disbursements method of accounting for income tax purposes. Management has deemed a valuation allowance necessary since anticipated profits in future years cannot be predicted. As of December 31, 2000, the Company has net operating loss carryforwards of approximately $1,000,000 and $1,500,000 for federal and state purposes, respectively. The losses expire beginning in 2020 and 2005 for federal and state purposes, respectively. Federal and state tax laws impose significant restrictions on the utilization of net operating loss carryforwards in the event of a change in ownership as defined by the Internal Revenue Service Code Section 382. H. EMPLOYEE STOCK PURCHASE PLAN As previously discussed, the Company is owned by its employees. Each employee has the option of allocating up to 15% of their payroll to purchase shares of stock in the Company at a price set by the board of directors. At the end of a six month period (June 30 and December 31), the Company will apply the withheld funds to the purchase of the shares and issue the shares. As of December 31, 2000 and 1999, substantially all the employees participated in this plan. As a result, during the year ended December 31, 2000, 248,115 shares of stock with a par value of $2,481 and an additional paid in capital of $163,757 were subscribed under this plan. During the year ended December 31, 1999, 280,391 shares of stock with a par value of $2,803 and an additional paid in capital of $185,058 were subscribed under this plan. Further, the board of directors may extend the Employees Stock Purchase Plan and announce new enrollment periods. I. STOCK OPTION PLAN In September 1997, the shareholders of the Company approved the adoption of the Company 1997 Stock Option Plan and the reservation of 500,000 shares of Common Stock for issuance upon the exercise of options granted. The Company granted 6,500 stock options to two employees with an exercise price of $0.67 per option, the fair market value of the stock as of December 31, 1996. The Company also granted 150,000 stock options to three officers/shareholders with an exercise price of $0.01 per option. The Company granted 15,000 stock options to three employees with an exercise price of $0.67 per option on January 14, 2000. During May 2000, the Company admitted five new Advisory Board members whose compensation for each meeting attended would be $1,000 plus expenses plus 500 options to purchase stock at $.67 per share. 13 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) The Company currently accounts for its stock based compensation plans using the accounting method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Since the Company is not required to adopt the fair value based recognition provisions prescribed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, it has elected only to comply with the disclosure requirements set forth in the Statement, which includes disclosing pro forma net income as if the fair value based method of accounting had been applied. The Company granted stock options to two employees as follows: Options granted 6,500 Option exercise date February 27, 1997 Option exercise price $0.67 per option Option term 3 years Vesting One month from date of grant Weighted-average remaining contractual life None The Company granted stock options to three employees as follows: Options granted 15,000 Option exercise date January 14, 2000 Option exercise price $0.67 per option Option term 3 years Vesting One month from date of grant Weighted-average remaining contractual life 2 years The Company granted stock options to three officers/shareholders as follows: Options granted 150,000 Option exercise date December 15, 1997 Option exercise price $0.01 per option Option term 10 years Vesting Immediately Weighted-average remaining contractual life 7 years 14 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) The Company granted stock options to five Advisory Board members as follows: Options granted 2,500 Option exercise date September 12, 2000 Option exercise price $0.67 per option Option term 10 years from date of grant Vesting Immediately Weighted-average remaining contractual life 9 years 3 months The fair value of each option grant is estimated on the grant date using an option-pricing model (Black-Scholes) with the following weighted-average assumptions used for the 1997 and 2000 grants: dividend yield of 0%, risk-free interest of 5.98%, and expected lives of the options of 3 and 10 years, respectively and future stock volatility of 0% since the Company is not publicly traded. A summary of the status of the Company's stock option plan as of December 31, 2000 and 1999, and the changes during the years then ended is presented below: Options granted to two employees:
Weighted- Average Number of Exercise Shares Price ---------- ------------- Outstanding at January 1, 1999 6,500 $ 0.67 Granted - - Exercised - - Forfeited - - ---------- ------------- Outstanding at December 31, 1999 6,500 0.67 Granted - - Exercised - - Expired 6,500 0.67 Forfeited - - ---------- ------------- Outstanding at December 31, 2000 - $ - ========== ============= Exercisable at December 31, 2000 - $ - ========== ============= 15 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) Options granted to officers/shareholders: Weighted- Average Number of Exercise Shares Price ---------- ------------- Outstanding at January 1, 1999 139,500 $ 0.01 Granted - - Exercised - - Forfeited - - ---------- ------------- Outstanding at December 31, 1999 139,500 0.01 Granted - - Exercised - - Forfeited - - ---------- ------------- Outstanding at December 31, 2000 139,500 $ 0.01 ========== ============= Exercisable at December 31, 2000 139,500 $ 0.01 ========== ============= Options granted to three employees: Weighted- Average Number of Exercise Shares Price ---------- ------------- Outstanding at January 1, 2000 - $ - Granted 15,000 0.67 Exercised - - Expired - - Forfeited 5,000 0.67 ---------- ------------- Outstanding at December 31, 2000 10,000 $ 0.67 ========== ============= Exercisable at December 31, 2000 10,000 $ 0.67 ========== ============= Weighted-average fair value of options granted during the year ended December 31, 2000 $ 0.11 ========== Options granted to Advisory Board members: Weighted- Average Number of Exercise Shares Price ---------- ------------- Outstanding at January 1, 2000 - $ - Granted 2,500 0.67 Exercised - - Expired - - Forfeited - - ---------- ------------- Outstanding at December 31, 2000 2,500 $ 0.67 ========== ============= Exercisable at December 31, 2000 2,500 $ 0.67 ========== ============= Weighted-average fair value of options granted during the year ended December 31, 2000 $ 0.30 ==========
16 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS J. CAPITAL LEASES PAYABLE During 1996, the Company entered into a capital lease arrangement where they would lease equipment for sixty months for $386 a month. Amortization of assets under the capital lease is included in depreciation expense and aggregated $3,724 and $11,215 for years ended December 31, 2000 and 1999, respectively. Capitalized lease payable consists of the following: December 31, --------------------- 2000 1999 -------- ---------- Total capital lease $ - $ 4,275 Less amounts representing interest - 215 -------- ---------- Total obligation under capital lease - 4,060 Less current portion of lease obligation - 4,060 -------- ---------- Lease obligation, long-term $ - $ - ======== ========== The interest rate on the capital lease is based upon the lessor's implicit rate of return of 8.9%. Interest expense under the capital lease approximated $215 and $590 for the years ended December 31, 2000 and 1999, respectively. K. PURCHASE OF SITE Effective January 17, 1995 (the transaction was completed on April 17, 1995, retroactive to January 17, 1995), the Company purchased the location, the existing equipment, inventory, DOE contracts, and other assets from Husky Oil, Ltd. of Canada. (This purchase was arranged since Husky was planning to close the facility.) The Company agreed to purchase the assets and assume various liabilities from Husky in exchange for the funds Husky estimated it would need to expend for the site closing. The major terms of the purchase agreement were that the Company would purchase the site, equipment, real estate, and liability to perform certain DOE contracts Husky had entered into, for $150,000 (fair market value is approximately $2,500,000) and Husky would provide $760,000 in cash (the estimated cost to close the facility) in order to fund the initial operations and the Company would assume a portion of the DCAA rate adjustments for prior years. APB No. 13 indicates that assets purchased for below market value should be recorded at the actual cost of the non current assets or zero if the current assets' fair market value exceeds the purchase price. Accordingly, the initial cost of the site, equipment, etc. is not reflected on the books since they have been written down to zero. As a result, a credit balance in goodwill (negative goodwill) of $817,517 resulted as of December 31, 1995. The figure is being amortized into income over 15 years using the straight-line method. 17 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS K. PURCHASE OF SITE (CONTINUED) The DCAA has completed its audit of the billing rates used for 1992, 1993 and 1994 which resulted in an adjustment higher than estimated at the time of purchase. Since this adjustment was a function of the purchase of the business and not the result of the Company's operations, management reduced goodwill for the excess of the final DOE adjustment over the estimated provision made in 1995. The adjustment amounts to $54,601 at December 31, 1998. The net balance in negative goodwill will be amortized over its estimated remaining life (13 years). At December 31, 2000 and 1999 the balance in the negative goodwill account was as follows: December 31, ----------------------- 2000 1999 ---------- ---------- Negative goodwill $ 744,923 $ 744,923 Less accumulated amortization and adjustment 358,432 308,771 ---------- ---------- Negative goodwill, net $ 386,491 $ 436,152 ========== ========== Amortization of negative goodwill aggregated $49,661 for both years ended December 31, 2000 and 1999. L. COMMITMENTS AND OPERATING LEASES On January 23, 1996, the Company entered into an agreement with a Canadian enterprise to acquire certain chemical process technology and related intellectual property. The technology represents interesting concepts but considerable development and research work remains to be done in order for them to be commercially viable. In the event the technology is viable, the Company is obligated to pay royalty fees to the interested parties based on future revenue generated by the specific technology. The amount of liability cannot be reasonably estimated as of December 31, 2000 and 1999. During 1998, the Board of Directors authorized the issuance of one year warrants to purchase common stock to all holders of common stock as of June 30, 1998 for 25% of the common shares outstanding as of that date, at an exercise price of $0.67 per share. These warrants expired on September 23, 1999 and were extended until March 31, 2000. On March 22, 2000 the Board of Directors unanimously approved an extension on these warrants until October 31, 2000. 18 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS L. COMMITMENTS AND OPERATING LEASES (CONTINUED) A summary of the status of the warrants as of December 31, 2000 and 1999 and the changes during the years then ended is presented below.
2000 1999 ------------------------- ----------------------- Weighted- Weighted- Average Average Number of Exercise Number of Exercise Shares Price Shares Price --------- ----------- --------- ----------- Outstanding at beginning of year 187,978 $ 0.67 229,278 $ 0.67 Granted - - - - Exercised 86,232 0.67 41,300 0.67 Expired 101,746 0.67 - - ------- --------- ------- --------- Outstanding at end of year - $ - 187,978 $ 0.67 ======= ========= ======= =========
The Company entered into a four year lease agreement commencing September 1, 1998 for space applicable to the subsidiary Chemsampco. The rent under this agreement is $3,800 per month plus utilities. The lease contains a contingent rental payment based upon increases in taxes, as well as, a renewal option for an additional two years. The following is a schedule of future minimum rental payments required under an operating lease that has initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2000: Year Ending December 31, 2001 $ 45,600 2002 30,400 ------------ Total minimum future rental payments $ 76,000 ============ Rent expense aggregated $45,600 for both years ended December 31, 2000 and 1999. On July 1, 1998, one of the Company's subsidiaries entered into an agreement with a vendor to market certain scrap tire and waste oil technology which involves the conversion of scrap tire and waste oil into a more refined oil and carbon based solid material. Under the terms of the agreement, the Company is obligated to pay $9,250 per month, of which $2,250 per month is deferred until the contract is completed or terminates on December 31, 2000. At the end of this agreement the vendor has the option to accept the deferred cash or convert the cash to common stock of the Company's subsidiary. During June 1999, the Company terminated the agreement and the subsidiary will pay to the vendor the unpaid portion of the consulting fee through the date of termination and the deferred portion of the consulting fee will be paid in cash. The termination was in accordance with the agreement. The deferred portion included in accrued expenses at December 31, 2000 and 1999 is $0 and $4,500, respectively. 19 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS L. COMMITMENTS AND OPERATING LEASES (CONTINUED) During 2000, the Company entered into an agreement with a foreign entity to sell a 15% interest in HTI's Coal Process Technology for $750,000. A separate agreement for a feasibility study relating to the technology was signed for $1,600,000 along with a Licensing Agreement in Principle for $8,200,000. The formal Licensing Agreement is to be signed at the conclusion of the feasibility study, with 85% of the licensing fee applicable to HTI. The licensing fee is to be paid out over several years based on obtaining specific milestones as stated in the Agreement in Principle. The first payment approximates $2,000,000 and is payable upon signing of the Licensing Agreement. HTI received payment of $1,300,000 subsequent to December 31, 2000 towards the feasibility agreement. M. CONTINGENCY During October 2000, the Board of Directors approved a measure whereby terminated employees of the Company could elect to retain their stock in the Company for a period of up to five years after termination. The measure provides that the Company will purchase the shares from the former employees at the greater of $0.67 per share or the fair market value of the shares at the repurchase date. As of December 31, 2000, the number of shares held by former employees of the Company was 133,812. N. SUBSEQUENT EVENTS During April 2001, the Company entered into an agreement with an unrelated entity to enter into a business combination transaction whereby this unrelated entity will acquire substantially all of the issued and outstanding shares of stock of HTI and subsidiaries for cash and stock in the acquirer. In addition, the acquirer will repay the line of credit outstanding as of December 31, 2000 in the amount of $1,000,000 and an additional line of credit, which was obtained from the same bank during April 2001 in the amount of $500,000. The Company in order to effect the aforementioned business combination has decided to restate the financial statements to reflect the acquirer's accounting principles. The Company has written off Intellectual Property and Organization Costs, which the Company had previously capitalized and amortized over a period of time. The restatement is effective December 31, 1998. The cost of the intangible assets and the related accumulated amortization as of December 31, 1998 have been removed from the Company's balance sheet and is summarized as follows: December 31, 1998 ----------------- Intellectual Property $ 175,000 Less accumulated amortization 52,500 --------------- $ 122,500 =============== Organization costs $ 127,022 Less accumulated amortization 29,770 --------------- $ 97,252 =============== 20 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS N. SUBSEQUENT EVENTS (CONTINUED) The Company has also recorded a valuation allowance applicable to the deferred tax asset which amounted to $176,500 as of December 31, 1998. The Company has also restated inventory in relation to the acquisition of Chemsampco, Inc. and has reclassified $210,428 from inventory to goodwill. The restatement is as of December 31, 1998 and the restated goodwill will be amortized over a sixty month period. The cumulative effect of the above restatements for each of the three years ended December 31, 2000, 1999 and 1998 is as follows:
2000 1999 1998 ----------- ----------- ----------- Net (loss) income as originally reported $ (935,491) $ 98,677 $ (730,681) Adjustment for effect of a change in accounting principle that is applied retroactively (10,648) (29,048) (431,322) ----------- ----------- ----------- Net (loss) income as adjusted $ (946,139) $ 69,629 $(1,162,003) =========== =========== ===========
HTI and the subsidiary HETI became a 53% member in a limited liability company and entered into an exclusive sublicensing agreement to commercialize the Company's waste oil and waste tire processing technology. O. SALE OF COMPANY The aforementioned business combination was consummated on August 28, 2001 whereby all of the shares issued and outstanding were acquired by an unrelated entity. It is the intention of the acquirer to provide ongoing financial support to HTI and subsidiaries. 21 HYDROCARBON TECHNOLOGIES INC. AND SUBSIDIARIES Consolidated Financial Statements Six Months Ended June 30, 2001 and 2000 HYDROCARBON TECHNOLOGIES INC. AND SUBSIDIARIES Table of Contents Six Months Ended June 30, 2001 and 2000 Page Number ------ ACCOUNTANTS' REPORT.........................................................1 FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS .............................................2 CONSOLIDATED STATEMENTS OF OPERATIONS....................................3 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY ...............4 CONSOLIDATED STATEMENTS OF CASH FLOWS...................................5-6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .............................7-23 DRUKER, RAHL & FEIN CERTIFIED PUBLIC ACCOUNTANTS BUSINESS CONSULTANTS A Member of The Mercadien Group To The Board of Directors and Stockholders of HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES Donald F. Conway, CPA o We have reviewed the accompanying consolidated Conrad L. Druker, CPA balance sheet of HYDROCARBON TECHNOLOGIES, INC. AND Esmond S. Druker, CPA SUBSIDIARIES as of June 30, 2001 and the related Eugene J. Elias, CPA, RMA consolidated statements of operations, stockholders' Jack H. Fein, CPA * (deficit) equity, and cash flows for the six months Robert J. Rahl, CPA * ended June 30, 2001 and 2000, in accordance with David L. Stafford, CPA * Statements on Standards for Accounting and Review Richard S. Willinger, CPA Services issued by the American Institute of __________________________ Certified Public Accountants. All information Peter A. Inverso, CPA included in these financial statements is the representation of the management of HYDROCARBON * CPA in NJ and PA TECHNOLOGIES, INC. AND SUBSIDIARIES. o CPA in NY OTHER OFFICE A review consists principally of inquiries of Company 86 Buck Road personnel and analytical procedures applied to Holland, PA 18966 financial data. It is substantially less in scope 215-355-4860 than an audit in accordance with auditing standards generally accepted in the United States of America, o National Associated the objective of which is the expression of an CPA Firms opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not o American Institute of express such an opinion. Certified Public Accountants Based on our reviews, we are not aware of any material modifications that should be made to the o New Jersey Society of accompanying consolidated financial statements in Certified Public order for them to be in conformity with accounting Accountants principles generally accepted in the United States of America. o Pennsylvania Institute of Certified Public The consolidated balance sheet as of December 31, Accountants 2000 was audited by us, and we expressed an unqualified opinion on it in our report dated March o Private Companies 20, 2001, but we have not performed any auditing Practice Section procedures since that date. o SEC Practice Section July 17, 2001 (Except as to Note P, which is as of August 28, 2001) /s/ Druker, Rahl & Fein DRUKER, RAHL & FEIN P.O. Box 7648 o Princeton, NJ 08543-7648 o 609.689.9700 o FAX 609.689.9720 www.mercadien.com 1
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, December 31, 2001 2000 (Reviewed) (Audited) ------------ ------------ ASSETS Current Assets Cash $ 103,699 $ 61,091 Accounts receivable, net of allowance for uncollectible accounts of $10,200 (2001) and (2000) 184,522 235,038 Unbilled costs and fees 22,875 72,055 Other receivables 18,142 40,558 Inventories 522,972 558,439 Prepaid expenses and other current assets 257,245 161,290 Prepaid income taxes 51,740 51,740 ------------ ------------ Total Current Assets 1,161,195 1,180,211 Property, plant and equipment 1,069,165 1,068,639 Other assets 71,883 93,448 ------------ ------------ Total Assets $ 2,302,243 $ 2,342,298 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current Liabilities Current portion of capitalized lease obligation $ 18,597 $ - Credit lines payable 1,450,000 1,000,000 Current portion of long-term debt 419,587 185,746 Accounts payable 974,242 865,396 Accrued expenses 139,683 144,229 Accumulated employee vacation 139,510 111,323 Deferred revenue and other current liabilities 878,114 62,504 Income taxes payable 160 600 ------------ ------------ Total Current Liabilities 4,019,893 2,369,798 ------------ ------------ Obligation under capital lease 15,000 - Long-term debt - 30,295 Excess of net assets acquired over cost 361,660 386,491 ------------ ------------ Total Liabilities 4,396,553 2,786,584 ------------ ------------ Stockholders' Deficit: Common stock, 10,000,000 shares authorized; 1,599,611 (2001) and 1,501,112 (2000) shares issued 15,996 15,011 Additional paid in capital 1,055,424 990,415 Accumulated deficit (3,165,730) (1,449,712) ------------ ------------ Total Stockholders' Deficit (2,094,310) (444,286) ------------ ------------ Total Liabilities and Stockholders' Deficit $ 2,302,243 $ 2,342,298 ============ ============
See notes to consolidated financial statements and accountants' report. 2
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Six Month Ended June 30, ---------------------------------- 2001 2000 ------------ ------------ Revenue Contract revenue $ 1,905,970 $ 4,542,463 Retail sales 123,678 127,865 ------------ ------------ Total revenue 2,029,648 4,670,328 ------------ ------------ Direct costs Labor costs 735,546 835,967 Fringe benefits 317,968 302,637 Other direct costs 312,650 989,020 Applied overhead 1,073,388 1,044,634 Depreciation and amortization 93,681 93,753 ------------ ------------ Total direct costs 2,533,233 3,266,011 ------------ ------------ Gross (loss) profit (503,585) 1,404,317 ------------ ------------ Operating Expenses Marketing 191,887 285,917 Research and development 131,109 315,211 Bid proposal 62,064 124,797 General and administrative 340,887 341,444 ------------ ------------ Total operating expenses 725,947 1,067,369 ------------ ------------ (Loss) income from operations (1,229,532) 336,948 ------------ ------------ Other income (expense) Interest income 3,099 4,437 Rental income 7,037 7,999 Costs incurred and accrued in connection with merger (449,474) - Interest expense (50,414) (33,770) Amortization of goodwill (21,565) (21,565) Amortization of negative goodwill 24,831 24,831 ------------ ------------ Total other expenses (486,486) (18,068) ------------ ------------ (Loss) income before provision for income taxes (1,716,018) 318,880 Provision for income taxes - 27,439 ------------ ------------ Net (loss) income $ (1,716,018) $ 291,441 ============ ============
See notes to consolidated financial statements and accountants' report. 3
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY Six Months Ended June 30, 2001 and 2000 Common Stock $.01 Par Value Additional Accumulated Shares Amount Paid In Capital Deficit Total ------ ------ --------------- ------- ----- Balance January 1, 2000 1,222,877 $ 12,229 $ 806,777 $ (503,573) $ 315,433 Shares purchased through Employee Stock Purchase Plan 135,906 1,359 89,698 - 91,057 Other stock subscribed during the period 15,712 157 10,371 - 10,528 Stock repurchased during the period (11,368) (114) (7,502) - (7,616) Net income for the period - - - 291,441 291,441 ---------- --------- ------------ ----------- ------------ Balance June 30, 2000 1,363,127 $ 13,631 $ 899,344 $ (212,132) $ 700,843 ========== ========= ============ =========== ============ Balance January 1, 2001 1,501,112 $ 15,011 $ 990,415 $(1,449,712) $ (444,286) Shares purchased through Employee Stock Purchase Plan 108,812 1,088 71,816 - 72,904 Other stock subscribed during the period - - - - - Stock repurchased during the period (10,313) (103) (6,807) - (6,910) Net loss for the period - - - (1,716,018) (1,716,018) ---------- --------- ------------ ----------- ------------ Balance June 30, 2001 1,599,611 $ 15,996 $ 1,055,424 $(3,165,730) $ (2,094,310) ========== ========= ============ =========== ============
See notes to consolidated financial statements and accountants' report. 4
HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, -------------------------------- 2001 2000 ------------ ------------ Cash Flows from Operating Activities Net (loss) income $ (1,716,018) $ 291,441 Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities Depreciation and amortization 115,246 115,318 Amortization of negative goodwill (24,831) (24,831) Changes in current assets and liabilities Accounts receivable 50,516 (677,008) Unbilled costs and fees 49,180 76,309 Other receivables 22,416 (56,170) Inventories 35,467 11,172 Prepaid expenses and other current assets (95,955) (152,249) Accounts payable 108,846 (88,771) Accrued expenses (4,546) (32,406) Accumulated employee vacation 28,187 25,871 Income taxes payable (440) (15,050) Deferred revenue and other current liabilities 815,610 570,132 ------------ ------------ Net cash (used in) provided by operating activities (616,322) 43,758 ------------ ------------ Cash Flows from Investing Activities Purchase of property and equipment (60,610) - ------------ ------------ Cash Flows from Financing Activities Proceeds from borrowing - notes payable 334,112 179,874 Proceeds from borrowing - credit line 450,000 - Principal payments under capital lease obligation - (2,095) Principal payments on notes payable (130,566) (79,365) Principal payments on line of credit - (250,000) Subscription and issuance of common stock 72,904 101,585 Repurchase of stock from former employees (6,910) (7,616) ------------ ------------ Net cash provided by (used in) financing activities 719,540 (57,617) ------------ ------------ Net increase (decrease) in cash 42,608 (13,859) Cash, beginning of period 61,091 92,384 ------------ ------------ Cash, end of period $ 103,699 $ 78,525 ============ ============ See notes to consolidated financial statements and accountants' report. 5 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Six Months Ended June 30, -------------------------------- 2001 2000 ------------ ------------ Supplemental Disclosures of Cash Flow Information Cash paid during the period for Interest $ 43,584 $ 33,770 ============ ============ Income taxes $ 440 $ 42,490 ============ ============ Supplemental Schedule of Non-Cash Investing and Financing Activities Capitalized lease obligation incurred for purchase of equipment $ 33,597 $ - ============ ============
See notes to consolidated financial statements and accountants' report. 6 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business The Company provides research and development services for converting, upgrading and cleaning fossil fuels and for recycling waste organics (plastics) for the US Department of Energy ("DOE") as well as other commercial customers. The Company's commercial customer base, predominantly within the oil and gas industry, is throughout the United States. Organization and Basis of Consolidation The consolidated financial statements include the accounts of Hydrocarbon Technologies Canada, Inc. incorporated on December 19, 1995 for purposes of performing joint research and development activities utilizing intellectual property with a university in Canada. The Company also has established a wholly owned subsidiary, Hydrocarbon Environmental Technology, Inc. for the purpose of performing research into converting scrap tires and waste oil into a more refined oil and carbon based solid material. The Company also has a wholly owned subsidiary which was established during 1998, Chemsampco, Inc., which is also based in New Jersey. This subsidiary is a chemical manufacturer and supplier. All intercompany transactions have been eliminated. Ownership The Company is owned entirely by its employees. The initial stockholders were the Company's president, vice-president, treasurer, and secretary. As discussed in the Employee Stock Purchase Plan note, the Company subsequently developed the plan in which all the Company's employees may purchase at their option, shares in the Company's stock. Currently, substantially all of the employees are participating in this plan. Cash For the purpose of the statements of cash flows, cash includes time deposits, certificates of deposit and all highly liquid debt instruments with original maturities of three months or less. Inventories Inventories consist of custom repair parts for the equipment used and the supplies consumed in the various tests the Company performs. Since substantially all of this inventory is repair parts, consumable supplies and chemicals, they are valued at their specific historical cost and are not for resale to customers. There are no raw materials or work in process. The inventory related to the subsidiary Chemsampco, Inc. is comprised of reagent chemicals of varying degrees of purity and is available for resale to customers. Inventory maintained by the subsidiary is valued at the lower of cost (determined on a first in first out basis) or market. Research and Development Costs Current operations are charged with all internal research and development expenses, (including overhead allocations), which amounted to $131,109 and $315,211 for the six months ended June 30, 2001 and 2000, respectively. See notes to consolidated financial statements and accountants' report. 7 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Property and Equipment and Depreciation Property and equipment is stated at cost and is depreciated for financial reporting purposes on a straight-line basis over the estimated useful lives of the respective assets ranging from three to thirty nine and one-half years. Building improvements are depreciated over their estimated useful lives. Repairs and maintenance expenditures that do not extend the useful lives of the related assets are expensed as incurred. Excess of Net Assets Acquired Over Cost (Negative Goodwill) Effective January 17, 1995 (the transaction was completed on April 17, 1995, retroactively effective to January 17, 1995), the Company purchased the location, the existing equipment, inventory, DOE contracts and other assets from Husky Oil, Ltd. of Canada ("Husky"). (This purchase was arranged since Husky was planning to close the facility.) The Company agreed to purchase the assets and assume various liabilities from Husky in exchange for the funds Husky estimated it would need to expend for the site closing. In accordance with accounting principles generally accepted in the United States of America requirements related to below market value business combinations, the non-current assets (land, building, equipment, and customer list) have been written down to the lower of their proportionate share of the purchase price or zero. As a result, a credit balance in goodwill (negative goodwill) resulted. The figure is being amortized into income over 15 years using the straight-line method and amounted to $24,831 for both six months ended June 30, 2001 and 2000. Goodwill Effective March 1998, the Company purchased the assets of another entity and created a wholly owned subsidiary, Chemsampco, Inc. Goodwill represents the excess of the purchase price of the assets purchased over the fair market value at the date of acquisition and is being amortized on a straight line method over 60 months and is included in other assets. Amortization expense charged to operations was $21,565 for both six months ended June 30, 2001 and 2000. Income Taxes In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under the asset and liability method of Statement No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under Statement No. 109, the effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date. The Company also qualifies as a "Personal Service Corporation" (PSC) as defined in the Internal Revenue Service Regulations. Accordingly, for income tax purposes, the Company is entitled to See accountants' report on the consolidated financial statements. 8 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Income Taxes (Continued) report its income and expenses using the cash receipts and disbursements method of accounting instead of the accrual method (Generally Accepted Accounting Principles) used for financial statement reporting. The Company has elected to file a consolidated tax return including its Canadian subsidiary as if it was a domestic corporation. Major Customers The Company generally extends unsecured credit in connection with its testing sales, and a portion of the business (6% and 4% for the six months ended June 30, 2001 and 2000, respectively) is from the DOE. The Company has made, in its opinion, appropriate estimated provisions (which are $10,200 at June 30, 2001 and December 31, 2000) for credit losses on accounts receivable from commercial contracts based upon information currently available. The Company, like other governmental contractors, is subject to annual appropriations by Congress to continue funding for these programs. A significant portion of the Company's revenue, 68% for the six months ended June 30, 2001 is from two commercial customers and 73% of the Company's revenue for the six months ended June 30, 2000 is from one commercial customer. Included in accounts receivable and unbilled costs and fees is $22,875 at both June 30, 2001 and December 31, 2000. Revenue Recognition Revenue from cost reimbursement contracts is recorded as the costs associated with that revenue are incurred. During 2001 and 2000, the Company used provisional rates when invoicing for overhead and general and administrative expenses under its DOE contracts. These provisional rates are based on the Company's budget for the respective year. Adjustments to these rates are made monthly when the actual rates can be calculated after allowing for anticipated unallowable expenses. Final adjustments will be made after year end rates are approved by the Defense Contract Audit Agency "DCAA" (usually one to two years after the close of the fiscal year). All of these rates are subject to audit by various government authorities, principally the DCAA. Revenue from other contracts (fixed price) is also recognized as the costs associated with that revenue are incurred. Estimated losses will be accrued when the facts indicating that a loss will occur become known. The Company has a liquification process contract which will also produce approximately 317,000 pounds of material. Revenue recognition applicable to this contract is based upon the percentage of completion method of accounting. Accordingly, income is recognized in the ratio that labor hours incurred bears to estimated total labor hours. Adjustments to labor hour estimates are made periodically, and losses expected to be incurred on contracts in progress are charged to operations in the period such losses are determined. The Company reflects revenue in excess of billings as unbilled costs and fees in the consolidated balance sheet as a current asset. Conversely, billings in excess of revenue are reflected as deferred revenue in the consolidated balance sheets as a current liability. See accountants' report on the consolidated financial statements. 9 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Interim Reporting The consolidated financial statements reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the results of the six months ended June 30, 2001 and 2000. B. CONCENTRATION OF CREDIT RISK The Company maintains cash in bank balances which may exceed federally insured limits. The Company historically has not experienced any cash in bank losses. The Company provides credit in the normal course of business to its customers and performs ongoing credit evaluations of its customers and maintains allowances for uncollectible accounts based on factors surrounding the credit risk of specific customers, historical trends and other information. C. PENSION PLAN The Company sponsors a 401(k) retirement plan for its employees that allows the employees to contribute a portion of their salary to their retirement. The Company currently matches the employees' contribution up to 5% of the employees' compensation. The board of directors also has the option of making discretionary contributions (in addition to the matching contributions) in any amount subject to Internal Revenue limitations. For the six months ended June 30, 2001 and 2000, the Company's total contribution was $71,607 and $88,014, respectively. D. PROPERTY AND EQUIPMENT Property, plant and equipment, which is stated at cost less accumulated depreciation and amortization, is summarized as follows: June 30, December 31, 2001 2000 ------------ ------------ Machinery and equipment $ 1,038,266 $ 997,250 Building improvements 652,626 652,626 Equipment under capital lease 109,267 56,076 ------------ ------------ Subtotal 1,800,159 1,705,952 Less accumulated depreciation and amortization 730,994 637,313 ------------ ------------ $ 1,069,165 $ 1,068,639 ============ ============ Depreciation and amortization expense aggregated $93,681 and $93,753 for the six months ended June 30, 2001 and 2000, respectively. See accountants' report on the consolidated financial statements. 10 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS E. OTHER RECEIVABLES As discussed previously, the Company purchased its facility from Husky. The facility has various environmental problems that are in various stages of remediation under the supervision of the New Jersey Department of Environmental Protection (NJ DEP). A former owner of the facility is responsible for the clean up of the site (for contamination prior to the purchase by Husky) and has invested over $4,000,000 to date in the clean up project. Part of the terms of the sale of the facility to the Company is that the former owner of the site remain fully responsible, and further, that Husky guarantee the former owner's continuing compliance with the terms of its environmental remediation plan agreed to with the NJ DEP. The Company has from time to time needed to expend funds in order to maintain the remediation program and is seeking reimbursement from the former owner. Accordingly, $0 and $34,026 is due from the former owner as of June 30, 2001 and December 31, 2000, respectively. This amount is included in the current assets section under the caption "Other receivables". F. DEBT Credit lines payable consist of the following:
June 30, December 31, 2001 2000 ---------- ------------ A $1,000,000 credit line for general corporate and working capital purposes as well as other debt paydown, with interest at prime plus 1% expired May 31, 2001 but was extended until May 31, 2002. Prime at June 30, 2001 was 7%. The bank has a security interest in all assets of the Company and a junior lien on the inventory of the subsidiary, Chemsampco, Inc. There are financial covenants relating to tangible net worth and minimum debt service coverage which commence December 31, 2000, for which waivers have been obtained. The credit line is personally guaranteed by the three original officers/ stockholders of the Company up to 62% of the credit line. $ 950,000 $ 1,000,000 ---------- ------------ A $500,000 credit line for general corporate and working capital purposes, with interest at prime plus 1% and expires October 31, 2001. Prime at June 30, 2001 was 7%. The bank has a security interest in all assets of the Company and a junior lien on the inventory of the subsidiary, Chemsampco, Inc. The aforementioned financial covenants are also applicable to this credit line. The credit line is personally guaranteed by the three original officers/ stockholders of the Company up to 62% of the credit line. 500,000 - ---------- ------------ Total $1,450,000 $ 1,000,000 ========== ============
See accountants' report on the consolidated financial statements. 11 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS F. DEBT (CONTINUED) In March 1998, the Company purchased certain assets of another entity and created a wholly owned subsidiary named Chemsampco, Inc. and signed a $400,000 promissory note. This note is subordinate to the line of credit although the seller has a security interest in the inventory, machinery and equipment, manufacturing procedures and production records, trade name and goodwill acquired in the asset purchase. HTI (parent) as surety, has guaranteed to the Seller that the value of the inventory purchased shall be equal to or greater than the principal outstanding on the promissory note. The line of credit contains covenants pertaining to tangible net worth and minimum debt service coverage which commenced December 31, 2000. The Company is required to maintain minimum tangible net worth as defined, of $750,000 as of December 31, 2000. The Company is also required to maintain a minimum debt service coverage ratio as defined of 1.15. The Company's tangible net worth and debt service coverage ratio are negative as of June 30, 2001 and December 31, 2000. The bank has waived these covenant violations as of June 30, 2001 and December 31, 2000 and for the periods then ended. Debt is comprised of the following:
June 30, December 31, 2001 2000 ---------- ------------ Promissory note payable in equal monthly installments of $10,225 inclusive of interest at 7.5% through April 2002. The note is secured by certain assets of the Company. $ 89,214 $ 145,970 Insurance premium note payable in monthly installments of $8,481 inclusive of interest at 10.5% commencing May 2000 through January 2001. The note was secured by the unused portion of the underlying policies. - 8,407 Insurance premium note payable in monthly installments of $6,509 inclusive of interest at 11.95% commencing May 2000 through October 2001. The note is secured by the unused portion of the underlying policies. 25,401 61,664 Insurance premium note payable in monthly installments of $15,437 inclusive of interest at 8.54% commencing April 2001 through January 2002. The note is secured by the unused portion of the underlying policies. 104,972 - Promissory note payable from acquirer with interest at 8.5%. The note has a subordinated security interest to the lines of credit and is due May 2, 2002. 200,000 - ---------- ------------ Total 419,587 216,041 Less current portion 419,587 185,746 ---------- ------------ Debt, net of current portion $ - $ 30,295 ========== ============
See accountants' report on the consolidated financial statements. 12 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. INCOME TAXES As previously discussed, the Company follows FASB Statement No. 109 for the accounting of income taxes and for income tax purposes, reports its income and expenses on the cash receipts and disbursements method of accounting. Therefore the Company has significant deferred tax assets and liabilities resulting from the different methods of income recognition. Components of income tax expense for the six months ended June 30, 2001 and 2000 are as follows: 2001 2000 ---------- ---------- Current: Federal $ - $ 16,520 State - 2,700 ---------- ---------- - 19,220 ---------- ---------- Deferred: Federal - 2,518 State - 5,701 ---------- ---------- - 8,219 ---------- ---------- Total provision for income taxes $ - $ 27,439 ========== ========== The tax effects of temporary differences that give rise to significant portions of the deferred tax asset and deferred tax liability at June 30, 2001 and December 31, 2000 are presented below: June 30, December 31, 2001 2000 ----------- ----------- Deferred tax asset: Tax effect of realization of Accounts payable $ 331,300 $ 292,000 Accrued expenses 94,900 78,000 Deferred revenues 298,600 21,300 Net operating loss 306,000 342,000 ----------- ----------- Subtotal 1,030,800 733,300 Less valuation allowance (849,000) (567,800) ----------- ----------- Total deferred tax asset 181,800 165,500 ----------- ----------- Deferred tax liabilities: Tax effect of realization of Accounts receivable 76,700 (109,600) Prepaid expenses 105,100 (55,900) ----------- ----------- Total deferred tax liability 181,800 (165,500) ----------- ----------- Net deferred tax asset $ - $ - =========== =========== As discussed in the "Summary of Significant Accounting Policies," the Company uses the cash receipts and disbursements method of accounting for income tax purposes. Management has deemed a valuation allowance necessary since anticipated profits in future years cannot be predicted. See accountants' report on the consolidated financial statements. 13 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS G. INCOME TAXES (CONTINUED) As of June 30, 2001, the Company has net operating loss carryforwards of approximately $1,000,000 and $1,500,000 for federal and state purposes, respectively. The losses expire beginning in 2020 and 2005 for federal and state purposes, respectively. Federal and state tax laws impose significant restrictions on the utilization of net operating loss carryforwards in the event of a change in ownership as defined by the Internal Revenue Service Code Section 382. H. EMPLOYEE STOCK PURCHASE PLAN As previously discussed, the Company is owned by its employees. Each employee has the option of allocating up to 15% of their payroll to purchase shares of stock in the Company at a price set by the board of directors. At the end of a six month period (June 30 and December 31), the Company will apply the withheld funds to the purchase of the shares and issue the shares. As of June 30, 2001 and 2000, substantially all the employees participated in this plan. As a result, during the six month period ended June 30, 2001, 108,812 shares of stock with a par value of $1,088 and an additional paid in capital of $71,816 were subscribed under this plan. During the six month period ended June 30, 2000, 135,906 shares of stock with a par value of $1,359 and an additional paid in capital of $89,698 were subscribed under this plan. As of April 26, 2001 the Board discontinued further contributions to the Employees Stock Purchase Plan. I. STOCK OPTION PLAN In September 1997, the stockholders of the Company approved the adoption of the Company's 1997 Stock Option Plan and the reservation of 500,000 shares of Common Stock for issuance upon the exercise of options granted. The Company granted 6,500 stock options to two employees with an exercise price of $.67 per option, the fair market value of the stock as of December 31, 1996. The Company also granted 150,000 stock options to three officers/shareholders with an exercise price of $.01 per option. The Company granted 15,000 stock options to three employees with an exercise price of $.67 per option on January 14, 2000. During May 2000, the Company admitted five new Advisory Board members whose compensation for each meeting attended would be $1,000 plus expenses plus 500 options to purchase stock at $.67 per share. The Company currently accounts for its stock based compensation plans using the accounting method prescribed by Accounting Principals Board Opinion No. 25, Accounting for Stock Issued to Employees. Since the Company is not required to adopt the fair value based recognition provisions prescribed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, it has elected only to comply with the disclosure requirements set forth in the Statement, which includes disclosing proforma net income as if the fair value based method of accounting had been applied. See accountants' report on the consolidated financial statements. 14 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) The Company granted stock options to two employees as follows: Options granted 6,500 Option exercise date February 27, 1997 Option exercise price $ .67 per option Option term 3 years Vesting One month from date of grant Weighted-average remaining contractual life None The Company granted stock options to three employees as follows: Options granted 15,000 Option exercise date January 14, 2000 Option exercise price $ .67 per option Option term 3 years Vesting One month from date of grant Weighted-average remaining contractual life 1 year, 6 months The Company granted stock options to three officers/shareholders as follows: Options granted 150,000 Option exercise date December 15, 1997 Option exercise price $ .01 per option Option term 10 years Vesting Immediately Weighted-average remaining contractual life 6 years, 6 months The Company granted stock options to five Advisory Board members as follows: Options granted 2,500 Option exercise date September 12, 2000 Option exercise price $ .67 per option Option term 10 years from date of grant Vesting Immediately Weighted-average remaining contractual life 8 years, 9 months The fair value of the options granted is estimated on the grant date using an option-pricing model (Black-Scholes) with the following weighted average assumptions used for the 1997 and 2000 grants: dividend yield 0%, risk free interest of 5.98%, expected lives of the options of 3 and 10 years, respectively and future stock volatility of 0% since the Company is not publicly traded. See accountants' report on the consolidated financial statements. 15 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) A summary of the status of the Company's stock option plan as of June 30, 2001 and June 30, 2000 and the changes during the periods then ended is presented below. Options granted to two employees: Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2001 - $ - Granted - - Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2001 - $ - ========= ============ Exercisable at June 30, 2001 - $ - ========= ============ Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2000 6,500 $ 0.67 Granted - - Exercised - - Expired 6,500 0.67 Forfeited - - --------- ------------ Outstanding at June 30, 2000 - $ - ========= ============ Exercisable at June 30, 2000 - $ - ========= ============ Options granted to three employees: Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2001 15,000 $ 0.67 Granted - - Exercised - - Expired - - Forfeited 5,000 0.67 --------- ------------ Outstanding at June 30, 2001 10,000 $ 0.67 ========= ============ Exercisable at June 30, 2001 10,000 $ 0.67 ========= ============ See accountants' report on the consolidated financial statements. 16 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) Options granted to three employees (Continued): Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2000 - $ - Granted 15,000 0.67 Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2000 15,000 $ 0.67 ========= ============ Exercisable at June 30, 2000 15,000 $ 0.67 ========= ============ Weighted-average fair value of options granted during the period ended June 30, 2000 $ 0.11 ========= Options granted to officers/shareholders: Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2001 139,500 $ 0.01 Granted - - Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2001 139,500 $ 0.01 ========= ============ Exercisable at June 30, 2001 139,500 $ 0.01 ========= ============ Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2000 139,500 $ 0.01 Granted - - Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2000 139,500 $ 0.01 ========= ============ Exercisable at June 30, 2000 139,500 $ 0.01 ========= ============ See accountants' report on the consolidated financial statements. 17 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS I. STOCK OPTION PLAN (CONTINUED) Options granted to five Advisory Board members: Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2001 2,500 $ 0.67 Granted - - Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2001 2,500 $ 0.67 ========= ============ Exercisable at June 30, 2001 2,500 $ 0.67 ========= ============ Weighted- Number of Average Shares Exercise Price ------------- -------------- Outstanding at January 1, 2000 - $ - Granted - - Exercised - - Expired - - Forfeited - - --------- ------------ Outstanding at June 30, 2000 - $ - ========= ============ Exercisable at June 30, 2000 - $ - ========= ============ J. CAPITAL LEASE PAYABLE The Company leases certain equipment under capital leases expiring in 2000 and 2003. The assets and liabilities under the capital leases are recorded at the lower of the present value of the minimum lease payments or the fair value of the asset at the inception of the lease. The assets are amortized over the lower of their related lease terms or their estimated productive lives. Amortization of assets under the capital leases is included in depreciation and amortization expense and amounted to $1,772 and $1,862 for the six months ended June 30, 2001 and 2000, respectively. Properties held under capital leases are included in property and equipment are as follows: June 30, December 31, 2001 2000 ------------- ------------ Warehouse equipment $ 18,622 $ 18,622 Office equipment 37,482 37,482 Analytical equipment 53,163 - ------------- ------------ Subtotal 109,267 56,104 Less accumulated amortization 57,853 56,104 ------------- ------------ Total $ 51,414 $ - ============= ============ See accountants' report on the consolidated financial statements. 18 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS J. CAPITAL LEASE PAYABLE (CONTINUED) Minimum lease payments due under capital leases for the period ending: June 30, ----------------------- 2002 $ 19,968 2003 $ 16,720 -------- Total net minimum capital lease payments 36,688 Less amounts representing interest 3,091 -------- Present value of net minimum capital lease payments 33,597 Less current maturities of capital lease obligations 18,597 -------- Obligations under capital leases, excluding current maturities $ 15,000 ======== The interest rates on capitalized leases vary from 8.9% to 11.3% and are based on the lessor's implicit rate of return. Interest expense under the capital lease approximated $0 and $58 for six months ended June 30, 2001 and 2000, respectively. K. PURCHASE OF SITE Effective January 17, 1995 (the transaction was completed on April 17, 1995, retroactive to January 17, 1995), the Company purchased the location, the existing equipment, inventory, DOE contracts, and other assets from Husky Oil, Ltd. of Canada. (This purchase was arranged since Husky was planning to close the facility.) The Company agreed to purchase the assets and assume various liabilities from Husky in exchange for the funds Husky estimated it would need to expend for the site closing. The major terms of the purchase agreement were that the Company would purchase the site, equipment, real estate, and liability to perform certain DOE contracts Husky had entered into, for $150,000 (fair market value is approximately $2,500,000) and Husky would provide $760,000 in cash (the estimated cost to close the facility) in order to fund the initial operations and the Company would assume a portion of the DCAA rate adjustments for prior years. APB No. 13 indicates that assets purchased for below market value should be recorded at the actual cost of the non current assets or zero if the current assets' fair market value exceeds the purchase price. Accordingly, the initial cost of the site, equipment, etc. are not reflected on the books since they have been written down to zero. As a result, a credit balance in goodwill (negative goodwill) of $817,517 resulted as of December 31, 1995. The figure is being amortized into income over 15 years using the straight-line method. The DCAA has completed its audit of the billing rates used for 1992, 1993 and 1994 which resulted in an adjustment higher than estimated at the time of purchase. Since this adjustment was a function of the purchase of the business and not the result of the Company's operations, management reduced goodwill for the excess of the final DOE adjustment over the estimated provision made in 1995. The adjustment amounts to $54,601 at December 31, 1998. The net balance in negative goodwill will be amortized over its estimated remaining life (13 years). See accountants' report on the consolidated financial statements. 19 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS K. PURCHASE OF SITE (CONTINUED) At June 30, 2001 and December 31, 2000 the balance in the negative goodwill account was as follows: 2001 2000 ---------- ---------- Negative goodwill $ 744,923 $ 744,923 Less accumulated amortization and adjustment 383,263 358,432 ---------- ---------- Negative goodwill, net $ 361,660 $ 386,491 ========== ========== Amortization of negative goodwill aggregated $24,831 for both six months ended June 30, 2001 and June 30, 2000. L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS On January 23, 1996, the Company entered into an agreement with a Canadian enterprise to acquire certain chemical process technology and related intellectual property. The technology represents interesting concepts but considerable development and research work remains to be done in order for them to be commercially viable. In the event the technology is viable, the Company is obligated to pay royalty fees to the interested parties based on future revenue generated by the specific technology. The amount of liability cannot be reasonably estimated as of June 30, 2001 and December 31, 2000. During 1998, the Board of Directors authorized the issuance of one year warrants to purchase common stock to all holders of common stock as of June 30, 1998 for 25% of the common shares outstanding as of that date, at an exercise price of $.67 per share. These warrants expired on September 23, 2000 and were extended until June 30, 2000. On March 22, 2000 the Board of Directors unanimously approved an extension on these warrants until October 31, 2000. A summary of the status of the warrants as of June 30, 2001 and December 31, 2000 and the changes during the periods then ended is presented below.
2001 2000 -------------------------- --------------------------- Weighted- Weighted- Average Average Number of Exercise Number of Exercise Shares price Shares price ----------- ----------- ----------- ------------ Outstanding at beginning of period - $ - 187,978 $ 0.67 Granted - - - - Exercised - - 86,232 0.67 Expired - - 101,746 0.67 ----------- ----------- ----------- ------------ Outstanding at end of period - $ - - $ - =========== =========== =========== ============
See accountants' report on the consolidated financial statements. 20 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS (CONTINUED) The Company entered into a four year lease agreement commencing September 1, 1998 for space applicable to the subsidiary Chemsampco. The rent under this agreement is $3,800 per month plus utilities. The lease contains a contingent rental payment based upon increases in taxes, as well as a renewal option for an additional two years. The following is a schedule of the future minimum rental payments required under this operating lease which has an initial or remaining non-cancelable lease term in excess of one year as of June 30, 2001: Period ending June 30, 2002 $ 45,600 2003 7,600 ----------- $ 53,200 =========== Rent expense aggregated $22,800 for both six months ended June 30, 2001 and 2000. On July 1, 1998, one of the Company's subsidiaries entered into an agreement with a vendor to market certain scrap tire and waste oil technology which involves the conversion of scrap tire and waste oil into a more refined oil and carbon based solid material. Under the terms of the agreement, the Company is obligated to pay $9,250 per month, of which $2,250 per month is deferred until the contract is completed or terminates on December 31, 2000. At the end of this agreement the vendor has the option to accept the deferred cash or convert the cash to common stock of the Company's subsidiary. During June 1999, the Company terminated the agreement and the subsidiary will pay to the vendor the unpaid portion of the consulting fee through the date of termination and the deferred portion of the consulting fee will be paid in cash. The termination was in accordance with the agreement. The deferred portion included in accrued expenses is $0 at both June 30, 2001 and December 31, 2000. During 2000, the Company entered into an agreement with a foreign entity to sell a 15% interest in HTI's Coal Process Technology for $750,000. A separate agreement for a feasibility study relating to the technology was signed for $1,600,000 along with a Licensing Agreement in Principle for $8,200,000. The formal Licensing Agreement is to be signed at the conclusion of the feasibility study, with 85% of the licensing fee applicable to HTI. The licensing fee is to be paid out over several years based upon obtaining specific milestones as stated in the Agreement in Principle. The first payment approximates $2,000,000 and is payable upon signing of the Licensing Agreement. HTI received payment of $1,300,000 applicable to the feasibility study during the six months ended June 30, 2001. During May 2001, the Company entered into an agreement with an unrelated entity to enter into a business combination transaction whereby this unrelated entity will acquire substantially all of the issued and outstanding shares of stock of HTI and subsidiaries for cash and stock in the acquirer. In addition, the acquirer will repay the two lines of credit outstanding as of June 30, 2001 in the amount of $1,450,000. See accountants' report on the consolidated financial statements. 21 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS L. COMMITMENTS, OPERATING LEASES AND RELATED PARTY TRANSACTIONS (CONTINUED) During May 2001, the aforementioned acquirer loaned the Company $200,000 with interest at 8.5% and is due May 2, 2002. The Company has accrued interest on the loan in the amount of $1,422 as of June 30, 2001. The Company has incurred and accrued costs associated with the aforementioned business combination which is comprised of legal, accounting and consulting fees amounting to $449,474 for the six months ended June 30, 2001. During the period ended June 30, 2001, the Company became a 53% equity member in a limited liability company, Carborex LLC ("LLC") and entered into an exclusive sublicensing agreement to commercialize the Company's waste oil and waste tire processing technology. The Company plans to record this investment under the equity method, that is the investment is recorded at cost and is adjusted periodically to recognize the LLC's share of earnings and losses. The Company anticipates that its equity membership in the LLC will be approximately 47% at December 31, 2001, therefore this LLC is not included in the consolidated financial statements of the Company at June 30, 2001. The Company's share of the LLC's losses for the period ended June 30, 2001 approximated $78,000. The Company has not guaranteed any obligations and is not committed to provide financial support to the LLC therefore the Company's investment and share of the LLC's loss have not been recorded in the accompanying consolidated financial statements. The Company received $205,000 from the LLC (a related party) during the period ended June 30, 2001, of which $147,600 is included in contract revenue and the balance which totals $57,400 is included in deferred revenue and other current liabilities as of June 30, 2001. M. CONTINGENCY During October 2000, the Board of Directors approved a measure whereby terminated employees of the Company could elect to retain their stock in the Company for a period of up to five years after termination. The measure provides that the Company will purchase the shares from the former employees at the greater of $0.67 per share or the fair market value of the shares at the repurchase date. As of June 30, 2001 and December 31, 2000, the number of shares held by former employees of the Company was 115,612 and 133,812, respectively. N. RESTATEMENT The Company in order to effect the aforementioned business combination has decided to restate the financial statements to reflect the acquirer's accounting principles. The Company has written off Intellectual Property and Organization Costs, which the Company had previously capitalized and amortized over a period of time. The restatement is effective December 31, 1998. The cost of the intangible assets and the related accumulated amortization as of December 31, 1998 have been removed from the Company's balance sheet and is summarized as follows: See accountants' report on the consolidated financial statements. 22 HYDROCARBON TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS N. RESTATEMENT (CONTINUED) December 31, 1998 ----------------- Intellectual Property $ 175,000 Less accumulated amortization 52,500 --------------- $ 122,500 =============== Organization costs $ 127,022 Less accumulated amortization 29,770 --------------- $ 97,252 =============== The Company has also recorded a valuation allowance applicable to the deferred tax asset which amounted to $176,500 as of December 31, 1998. The Company has also restated inventory in relation to the acquisition of Chemsampco, Inc. and has reclassified $210,428 from inventory to goodwill. The restatement is as of December 31, 1998 and the restated goodwill will be amortized over a sixty month period. The cumulative effect of the above restatements for the periods ended is as follows: Six Months Ended Year Ended June 30, December 31, ---------------- ------------ 2000 1998 ----------- ----------- Net income (loss) as originally reported $ 198,865 $ (730,681) Adjustment for effect of a change in accounting principle that is applied retroactively 92,576 (431,322) ----------- ----------- Net income (loss) as adjusted $ 291,441 $(1,162,003) =========== =========== O. SUBSEQUENT EVENT During July and August 2001, the acquirer loaned an additional $850,000 to the Company with interest at 8.5% and is due May 2, 2002. P. SALE OF COMPANY The aforementioned business combination was consummated on August 28, 2001 whereby all of the shares issued and outstanding were acquired by an unrelated entity. It is the intention of the acquirer to provide ongoing financial support to HTI and subsidiaries. See accountants' report on the consolidated financial statements. 23 HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. INTRODUCTION TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION (amounts in thousands of dollars and shares) On August 28, 2001, Headwaters completed a 100% acquisition of Hydrocarbon Technologies, Inc. ("HTI"). HTI has significant intellectual property that includes the technology to transform coal and heavy oil into ultra-clean diesel fuel, recycle waste oil into valuable carbon products, and nano-catalyst technology. Total consideration at closing is currently estimated to be approximately $10,618 and consists of cash of $1,447, direct costs incurred by Headwaters to consummate the acquisition of $860, the issuance of 593 shares of Headwaters common stock valued at $5,485, options to purchase 144 shares of Headwaters' common stock issued in exchange for outstanding vested HTI options valued at $1,325, plus the assumption and retirement of $1,501 of HTI debt. The value of Headwaters 593 shares of common stock issued was determined using the average market price of Headwaters' stock over a three-day period, consisting of the day the terms of acquisition were agreed to and one day prior to and one day subsequent to that day ($9.25). For purposes of computing the estimated fair value of the Headwaters stock options, the Black-Scholes option pricing model was used with the following assumptions: expected stock price volatility of .90, risk free interest rates of 3.5% to 4.0%, weighted average expected option lives of one to three years, no dividends, and a fair value of Headwaters' common stock of $9.25 per share. Additional contingent consideration can be earned by HTI's stockholders in future periods based on EBITDA targets and other milestones. As required by generally accepted accounting principles, a contingent liability of $2,287 was recorded representing the contingent incremental consideration for identified purchased assets in excess of the consideration paid at closing. A contingent liability was not recognized for the contingent incremental consideration that, if paid in the future, would be recorded as goodwill. These amounts will be adjusted in the future when the actual contingent consideration is known. The HTI acquisition has been accounted for using the purchase method of accounting as required by Statement of Financial Accounting Standards No.141, "Business Combinations." Assets acquired and liabilities assumed have been recorded at their estimated fair values as of the acquisition date. Approximately $9,700 of the purchase price was allocated to identifiable intangible assets consisting of existing patented technology with an estimated useful life of 15 years. Approximately $2,400 of the purchase price was allocated to purchased in-process research and development. This amount represents the estimated purchased in-process technology for projects that have not yet reached technological feasibility and have no alternative future use. The value of these projects was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from the sale of those products, and discounting the net cash flows back to their present value. Headwaters recorded a non-recurring charge for this purchased in-process research and development as of the closing date of acquisition. 1 The following pro forma combined balance sheet gives effect to the acquisition of HTI as if it had been completed as of June 30, 2001 and combines the historical June 30, 2001 balance sheets for both Headwaters and HTI. The pro forma combined statements of operations for the year ended September 30, 2000 and the nine months ended June 30, 2001 give effect to the acquisition as if it had occurred on October 1, 1999. The pro forma combined statement of operations for the year ended September 30, 2000 combines Headwaters' historical results for the year ended September 30, 2000 with HTI's historical results for the year ended December 31, 2000. Headwaters' historical consolidated statement of income for the year ended September 30, 2000 reflects the elimination of an extraordinary item for the early extinguishment of debt in the amount of $7,860. The pro forma combined statement of operations for the nine months ended June 30, 2001 combines both Headwaters' and HTI's historical results for that nine-month period. Accordingly, HTI's historical results for the three-month period from October 1, 2000 to December 31, 2000 are included in both the pro forma combined statement of operations for the year ended September 30, 2000 and the pro forma combined statement of operations for the nine months ended June 30, 2001. The pro forma combined financial statements are presented for illustrative purposes only. Such information does not purport to be indicative of the results of operations or financial position which actually would have resulted had the acquisition occurred on the dates indicated, nor is it indicative of the results that may be expected in future periods. The pro forma adjustments are based upon information and assumptions available at the time of filing this Form 8-K. The pro forma information should be read in conjunction with the accompanying notes thereto. 2
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET as of June 30, 2001 Historical -------------------------- Pro Forma Pro Forma (thousands of dollars) Headwaters HTI Adjustments Combined --------------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 218 $ 104 $ 322 Short-term investments 5,207 $(2,948) [A] 2,259 Trade receivables, net 6,542 185 6,727 Short-term notes and accrued interest receivable 1,180 (201) [B] 979 Other current assets 401 872 1,273 --------------------------------------- ----------- Total current assets 13,548 1,161 (3,149) 11,560 --------------------------------------- ----------- Property, plant and equipment, net of accumulated depreciation 631 1,069 1,109 [C] 2,809 --------------------------------------- ----------- Other assets: Notes and accrued interest receivable 8,716 8,716 Equity investments, net 4,210 4,210 Deferred income taxes 3,000 3,000 Intangible assets, net of accumulated amortization 1,094 9,700 [D] 10,794 Other assets 1,175 72 (860) [E] (72) [F] 315 --------------------------------------- ----------- Total other assets 18,195 72 8,768 27,035 --------------------------------------- ----------- Total assets $32,374 $2,302 $ 6,728 $41,404 ======================================= =========== (continued) See accompanying notes. 3 HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET, continued as of June 30, 2001 Historical -------------------------- Pro Forma Pro Forma (thousands of dollars) Headwaters HTI Adjustments Combined --------------------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY (NET CAPITAL DEFICIENCY) Current liabilities: Accounts payable $ 1,025 $ 974 $ 1,999 Accrued personnel costs 1,681 140 1,821 Other accrued liabilities 3,140 1,018 $ (1) [B] 4,157 Short-term borrowings 612 1,888 (1,501) [G] (200) [B] 799 -------------------------------------- ----------- Total current liabilities 6,458 4,020 (1,702) 8,776 -------------------------------------- ----------- Long-term liabilities: Notes payable, non-current 149 15 164 Other long-term liabilities 149 362 2,287 [H] (362) [I] 2,436 Deferred revenue 7,187 7,187 -------------------------------------- ----------- Total long-term liabilities 7,485 377 1,925 9,787 -------------------------------------- ----------- Total liabilities 13,943 4,397 223 18,563 -------------------------------------- ----------- Stockholders' equity (net capital deficiency): Common stock 23 16 1 [J] (16) [K] 24 Capital in excess of par value 78,521 1,055 (1,055) [K] 5,484 [J] 1,325 [L] 85,330 Accumulated deficit (55,978) (3,166) 3,166 [M] (2,400) [N] (58,378) Other, primarily treasury stock (4,135) (4,135) -------------------------------------- ----------- Total stockholders' equity (net capital deficiency) 18,431 (2,095) 6,505 22,841 -------------------------------------- ----------- Total liabilities and stockholders' equity (net capital deficiency) $ 32,374 $ 2,302 $ 6,728 $ 41,404 ====================================== ===========
See accompanying notes. 4
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME For the year ended September 30, 2000 Historical --------------------------------------- Pro Forma Pro Forma (thousands of dollars and shares, except per share amounts) Headwaters HTI Adjustments Combined ------------------------------------------------------------------------------------------------------------------------------------ (Year ended (Year ended September 30, 2000) December 31, 2000) Revenue: License fees $17,315 $17,315 Chemical sales 9,757 9,757 Contract revenue $6,897 6,897 Gains on non-recurring transactions 17,949 17,949 Other 814 241 1,055 ------------------------------------------------- ------------- Total revenue 45,835 7,138 52,973 ------------------------------------------------- ------------- Operating costs and expenses: Cost of chemical 6,617 6,617 Cost of operations 3,821 6,086 $ 86 [O] 647 [P] 10,640 Selling, general and administrative 5,361 1,403 6,764 Asset write-offs and other non-recurring charges 17,758 17,758 Research and development 559 559 ------------------------------------------------- ------------- Total operating costs and expenses 33,557 8,048 733 42,338 ------------------------------------------------- ------------- Operating income (loss) 12,278 (910) (733) 10,635 ------------------------------------------------- ------------- Other income (expense): Interest and investment income 1,775 8 1,783 Interest expense (4,814) (74) (4,888) Other, net (597) 21 (7) [Q] (583) ------------------------------------------------- ------------- Total other expense, net (3,636) (45) (7) (3,688) ------------------------------------------------- ------------- Income (loss) before income taxes 8,642 (955) (740) 6,947 Income tax benefit 2,900 9 2,909 ------------------------------------------------- ------------- Net income (loss) before extraordinary item $11,542 $ (946) $(740) $9,856 ================================================= ============= Basic net income per common share before extraordinary item $ 0.57 $ 0.47 =============== ========== Diluted net income per common share before extraordinary item $ 0.50 $ 0.42 =============== ========== Weighted-average shares outstanding: Basic 19,468 593 [R] 20,061 =============== ================= ========== Diluted 22,235 736 [R] 22,971 =============== ================= ==========
See accompanying notes. 5
HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME For the nine months ended June 30, 2001 Historical ---------------------------------------- Pro Forma Pro Forma (thousands of dollars and shares, except per share amounts) Headwaters HTI Adjustments Combined ------------------------------------------------------------------------------------------------------------------------------------ (Nine months ended (Nine months ended June 30, 2001) June 30, 2001) Revenue: License fees $15,770 $15,770 Chemical sales 15,432 15,432 Contract revenue $ 2,403 2,403 Other 1,566 185 1,751 ---------------------------------------------------- ------------ Total revenue 32,768 2,588 35,356 ---------------------------------------------------- ------------ Operating costs and expenses: Cost of chemical 9,889 9,889 Cost of operations 2,446 3,682 $ 65 [O] 485 [P] 6,678 Selling, general and administrative 3,828 970 4,798 Research and development 283 283 ---------------------------------------------------- ------------ Total operating costs and expenses 16,163 4,935 550 21,648 ---------------------------------------------------- ------------ Operating income (loss) 16,605 (2,347) (550) 13,708 ---------------------------------------------------- ------------ Other income (expense): Interest and investment income 511 4 (1) [S] 514 Interest expense (179) (84) 1 [S] (262) Other, net (1,859) (433) (5) [Q] 450 [T] (1,847) ---------------------------------------------------- ------------ Total other income (expense), net (1,527) (513) 445 (1,595) ---------------------------------------------------- ------------ Income (loss) before income taxes 15,078 (2,860) (105) 12,113 Income tax benefit (expense) (140) 37 (103) ---------------------------------------------------- ------------ Net income (loss) $14,938 $(2,823) $(105) $12,010 ==================================================== ============ Basic net income per common share $ 0.65 $ 0.51 ============= ============ Diluted net income per common share $ 0.61 $ 0.48 ============= ============ Weighted-average shares outstanding: Basic 22,723 593 [R] 23,316 ============= ================= ============ Diluted 24,525 736 [R] 25,261 ============= ================= ============
See accompanying notes. 6 HEADWATERS INCORPORATED AND HYDROCARBON TECHNOLOGIES, INC. NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS (dollars and shares in thousands, except per share amounts) 1. Basis of Presentation The pro forma condensed combined financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and certain footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations; however, management believes that the disclosures are adequate to make the information presented not misleading. 2. Acquisition of Hydrocarbon Technologies, Inc. On August 28, 2001, Headwaters completed a 100% acquisition of Hydrocarbon Technologies, Inc. ("HTI"). HTI has significant intellectual property that includes the technology to transform coal and heavy oil into ultra-clean diesel fuel, recycle waste oil into valuable carbon products, and nano-catalyst technology. Total consideration at closing is currently estimated to be approximately $10,618 and includes direct costs incurred by Headwaters to consummate the acquisition. The following table sets forth the estimated consideration paid at closing to acquire HTI: Estimated consideration at closing: Fair value of Headwaters stock (593 shares at $9.25 per share) $ 5,485 Fair value of options to purchase 144 shares of Headwaters' common stock issued in exchange for 152 outstanding vested HTI options 1,325 Cash paid to HTI stockholders 1,447 Cash paid to retire HTI note payable to bank 1,501 Estimated direct costs 860 --------- Total $ 10,618 --------- The value of Headwaters 593 shares of common stock issued was determined using the average market price of Headwaters' stock over a three-day period, consisting of the day the terms of acquisition were agreed to and one day prior to and one day subsequent to that day ($9.25). For purposes of computing the estimated fair value of the Headwaters stock options, the Black-Scholes option pricing model was used with the following assumptions: expected stock price volatility of .90, risk free interest rates of 3.5% to 4.0%, weighted average expected option lives of one to three years, no dividends, and a fair value of Headwaters' stock of $9.25 per share. Additional contingent consideration can be earned by HTI's stockholders in future periods based on EBITDA targets and other milestones. As required by generally accepted accounting principles, a contingent liability of $2,287 was recorded representing the contingent incremental consideration for identified purchased assets in excess of the consideration paid at closing. A contingent liability was not recognized for the contingent incremental consideration that, if paid in the future, would be recorded as goodwill. These amounts will be adjusted in the future when the actual contingent consideration is known. 7 The following table sets forth the allocation of the total estimated consideration at closing to the tangible and intangible assets acquired and liabilities assumed: Purchase price allocation: Tangible assets acquired, net of liabilities assumed $ 805 Intangible assets acquired: Existing patented technology 9,700 Acquired in-process research and development 2,400 Contingent liability for purchased assets in excess of consideration paid at closing (2,287) --------- Total consideration at closing $ 10,618 --------- The HTI acquisition has been accounted for using the purchase method of accounting as required by Statement of Financial Accounting Standards No.141, "Business Combinations." Assets acquired and liabilities assumed have been recorded at their estimated fair values as of the acquisition date. Approximately $9,700 of the purchase price was allocated to identifiable intangible assets consisting of existing patented technology with an estimated useful life of 15 years. Approximately $2,400 of the purchase price was allocated to purchased in-process research and development. This amount represents the estimated purchased in-process technology for projects that have not yet reached technological feasibility and have no alternative future use. The valuation of the in-process research and development included, but was not limited to, an analysis of the market for the acquired products and technologies, the completion costs for the projects, the expected cash flows attributed to the projects and the risks associated with achieving such cash flows. The estimated value of these projects was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from the sale of those products, and discounting the net cash flows back to their present value. The assumptions used in valuing the in-process research and development were based upon assumptions management believes to be reasonable, but which are inherently uncertain and unpredictable. For these reasons, actual results may vary from the estimated results. Headwaters recorded a non-recurring charge for this purchased in-process research and development as of the date of acquisition. Management believes that the acquired in-process research and development will be successfully developed; however, these technologies may not achieve commercial viability. HTI's current development efforts are focused primarily on three projects: the hydrogen peroxide project, the nano particle precious metal catalyst project and the acrylic acid project. Developing and enhancing these products is time-consuming, costly, and complex. There is a risk that the development will not produce commercially viable products. The hydrogen peroxide project, which is believed to represent a significant technical advancement in the production of hydrogen peroxide directly from hydrogen and oxygen, has been under development since 1997. To date, a lab-scale test has been successfully completed which led to a patent on the process that was received in January 2001. Presently, a continuous pilot test unit is under construction. When the pilot test unit is completed, a stability and optimization test will commence which is expected to take one year to complete. If the pilot test is successful, a commercial demonstration test will be undertaken. This test will also require approximately one year to complete. Total costs to complete the project are currently estimated to range from $500 to $1,000. 8 The nano particle precious metal catalyst project is a method of dispersing nano-sized particles over the surface of support material. Such a catalyst can improve performance and reduce precious metal consumption in numerous applications. This project is in the lab test stage. This stage is expected to take approximately one year to complete at a cost of about $500. It is anticipated the lab test stage will result in the development of multiple nano catalyst processes. At the completion of the lab test, each identified nano catalyst process will require approximately two years for both a pilot test and a commercial demonstration test. The cost for each nano catalyst process that completes the final two stages is expected to be approximately $1,000. The acrylic acid project is a one-step process for the production of acrylic acid. This project has completed the lab test stage and the pilot test stage. As a result of the pilot test, some additional refinements which will make the process more competitive need to be done before advancing to the next development stage. Current expectations are that this additional testing will take six months and cost approximately $150. If successful refinements are made, the project would then proceed to a commercial demonstration test. That test is estimated to take a year to complete at a cost of approximately $400. 3. Pro Forma Financial Statements and Adjustments The pro forma combined balance sheet gives effect to the acquisition of HTI as if it had been completed as of June 30, 2001 and combines the historical June 30, 2001 balance sheets for both Headwaters and HTI. The pro forma combined statements of operations for the year ended September 30, 2000 and the nine months ended June 30, 2001 give effect to the acquisition as if it had occurred on October 1, 1999. The pro forma combined statement of operations for the year ended September 30, 2000 combines Headwaters' historical results for the year ended September 30, 2000 with HTI's historical results for the year ended December 31, 2000. Headwaters' historical consolidated statement of income for the year ended September 30, 2000 reflects the elimination of an extraordinary item for the early extinguishment of debt in the amount of $7,860. The pro forma combined statement of operations for the nine months ended June 30, 2001 combines both Headwaters' and HTI's historical results for that nine-month period. Accordingly, HTI's historical results for the three-month period from October 1, 2000 to December 31, 2000 are included in both the pro forma combined statement of operations for the year ended September 30, 2000 and the pro forma combined statement of operations for the nine months ended June 30, 2001. The pro forma combined financial statements are presented for illustrative purposes only. Such information does not purport to be indicative of the results of operations or financial position which actually would have resulted had the acquisition occurred on the dates indicated, nor is it indicative of the results that may be expected in future periods. The pro forma adjustments are based upon information and assumptions available at the time of filing this Form 8-K. The pro forma condensed combined financial statements give effect to the following pro forma adjustments: A Cash component of purchase price paid at closing ($1,447), plus cash paid to retire HTI note payable to a bank assumed in the acquisition ($1,501). B Elimination of a note receivable and accrued interest due to Headwaters from HTI. 9 C Adjustment to increase HTI property, plant and equipment to fair value at acquisition date. D Identifiable intangible assets of HTI based on estimated fair value at acquisition date. E Reclassification of direct costs incurred by Headwaters to consummate acquisition of HTI. F Elimination of HTI goodwill. G Elimination of HTI's note payable to a bank which was assumed and retired by Headwaters at acquisition date. H Contingent liability recorded to reflect contingent incremental consideration for identified purchased assets in excess of consideration paid at closing. I Elimination of HTI negative goodwill. J Headwaters common stock issued at closing. K Elimination of HTI's capital accounts. L Fair value of options to acquire Headwaters common stock issued in exchange for outstanding vested HTI options. M Elimination of HTI's accumulated deficit. N Recognition of purchased in-process research and development. O Depreciation on increase in value of HTI buildings and equipment ($86 for the year ended September 30, 2000 and $65 for the nine months ended June 30, 2001). P Amortization of HTI identifiable intangible assets ($647 for the year ended September 30, 2000 and $485 for the nine months ended June 30, 2001). Q Elimination of HTI's historical amortization of goodwill and negative goodwill. R The pro forma combined net income per share amounts are based on (i) Headwaters' historical weighted-average number of common shares outstanding, plus (ii) the shares issued at the acquisition date (593) and, for the diluted per-share computation, (iii) the effect of the shares issuable upon exercise of the options to acquire Headwaters common stock issued in exchange for outstanding vested HTI options, using the treasury stock method (143). S Elimination of interest income and interest expense on note receivable due to Headwaters from HTI. T Elimination of HTI's non-recurring acquisition-related direct costs. 10