| HEADWATERS INC ITEM 1A RISK FACTORS 14 ITEM 1A RISK FACTORS Risks Relating to Our Business Section 45K (formerly Section 29) of the Internal Revenue Code (“Section 45K”) tax credits are subject to phase-out if the unregulated average annual oil price reaches the IRS established phase-out range |
| Tax credits claimed by an alternative fuel facility owner are reduced prior to their scheduled expiration on December 31, 2007 if the “reference price” of oil exceeds the lower end of a phase-out range, and are eliminated entirely if the reference price exceeds the higher end of that range, with the beginning and end of the range being adjusted annually for inflation |
| The reference price of oil is defined as the US Energy Information Agency’s estimate of the annual average wellhead price per barrel for all domestic crude oil not subject to regulation by the United States |
| In April of each year, the IRS announces the reference price and the phase-out range of oil prices for the prior calendar year |
| For example, in April 2006, the IRS announced that the reference price for calendar 2005 was dlra50dtta26 per barrel and that the phase-out range for 2005 began at dlra53dtta20 per barrel and ended with a dlra0 tax credit at dlra66dtta78 per barrel |
| Because the calendar year 2005 reference price did not fall within the range, there was not a phase-out of the credit for qualified fuel sold in 2005 |
| For calendar 2006, Headwaters estimates that the phase-out range (computed by increasing the 2005 inflation adjustment factor by 2prca) begins at dlra54dtta27 and completes phase-out at dlra68dtta12 per barrel |
| While the calendar 2006 phase-out percentage can not be finalized at the current time, Headwaters estimates that based on actual oil prices for January through September 2006 and published NYMEX oil prices for October through December 2006, a 42prca phase-out would result |
| If the Section 45K tax credits are phased out in whole or in material part, the amounts and timing of recognition of Headwaters’ revenue, net income and cash flow will be severely affected |
| The rising price of oil has had a significant impact on the decisions of facility owners concerning alternative fuel production beginning with the first quarter of calendar year 2006 |
| Headwaters and its licensees and customers closely watch oil price trends and will continue to consider whether or not to operate facilities depending upon their respective views of future oil prices |
| Some facility owners have attempted to protect their positions by purchasing oil futures hedges and have requested that Headwaters share the cost of such hedges, while others have considered these actions too risky and expensive, and have elected to simply curtail or eliminate production based upon an assessment that high oil prices indicate phase-out likelihood |
| In 2006, many of Headwaters’ licensees and reagent customers temporarily idled production at their alternative 14 _________________________________________________________________ fuel facilities during the peak months of oil prices, severely adversely affecting Headwaters’ revenues from license fees and reagent sales for the year |
| During 2007, licensees and reagent customers will continue to evaluate their particular circumstances in light of volatile oil prices and anticipated phase-out of credits |
| Headwaters must also make assessments with respect to the continued operation of its own synthetic fuel production facilities |
| Headwaters’ effective tax rate for 2006 was increased because of its decision to temporarily stop production at its own facilities |
| Additionally, because Headwaters believes that the 2006 reference price will be within the phase-out range, the effective tax rate was further increased as a result of the estimated phase-out percentage |
| Decisions to stop operation of Headwaters’ own synthetic fuel production facilities during 2007 will increase its tax rate for the year |
| Decisions by Headwaters or our licensees or customers to curtail or eliminate production during 2007 will severely affect profitability and cash flow, including the timing of recognition of revenue |
| A significant increase in the price of petrochemical feedstocks used to make latex materials which are in turn used in the production of HES reagents that cannot be passed on to customers could have a significant adverse effect on net income |
| Further, HES depends upon a single supplier for the production of reagents, the interruption of which would materially disrupt HES’s ability to supply products to its customers, resulting in lost revenues and the potential loss of customers |
| HES reagents, which provide a majority of HES’s revenues, are manufactured from latex by a single supplier, Dow Reichhold LLC The price of latex is primarily a function of manufacturing capacity, demand and the prices of petrochemical feedstocks, crude oil and natural gas liquids |
| Historically, the market price of latex has fluctuated, and significantly increased in 2006 |
| Some contracts allow cost pass through |
| Further significant increases in the price of latex that cannot be passed on to customers could have a significant adverse effect on our net income |
| HES does not inventory reagents for sale to customers and alternative sources meeting HES’s requirements would be difficult to arrange |
| Therefore, HES’s ability to provide reagents to its customers could be materially disrupted if the supply of reagents or feedstock latex materials were interrupted for any reason |
| Such an interruption and the resulting inability to supply HES’s customers with reagents could adversely impact HES’s revenues and potentially our relationships with HES’s customers |
| If the tax credits under Section 45K of the Internal Revenue Code are repealed or adversely modified, HES’s profitability will be severely affected |
| HES’s license fees and revenues from sales of chemical reagents depend on the ability of our licensees and customers to manufacture and sell qualified alternative fuels that generate tax credits |
| By law, Section 45K tax credits are not available for alternative fuel sold after December 31, 2007 |
| In addition, there have been initiatives from time to time to consider the early repeal or modification of Section 45K For example, in February 2005, a bill was reintroduced in the United States House of Representatives that would repeal the Section 45K credit for alternative fuel produced from coal |
| If Section 45K expires at the end of 2007 or if it is repealed or adversely modified, alternative fuel facilities would probably either close or substantially curtail production |
| Given current prices of coal and costs of alternative fuel production, we do not believe that production of alternative fuel will be profitable absent the tax credits |
| In addition, if our licensees close their facilities or materially reduce production activities (whether after 2007, upon earlier repeal or adverse modification of Section 45K or for any other reason such as the potential phase out of tax credits described above), it would have a material adverse effect on the recognition and timing of our revenues and net income |
| If our licensees’ demand for Section 45K tax credits decreases, HES’s revenues will decrease |
| HES’s business depends upon the ability of our licensees and chemical reagent customers to utilize Section 45K tax credits as payments under our contracts are ultimately based on our customers’ production of alternative fuels |
| Their ability to utilize tax credits depends upon their taxable income |
| A decline in the profitability of our licensees could reduce their ability to utilize tax credits, and, in turn, could lead to a reduction in the production of alternative fuel at their facilities |
| Such licensees could sell their facilities to a taxpayer with more capacity to utilize the tax credits, but any such transfer could result in short-term or long-term disruption of operations, and therefore adversely affect our revenues and net income |
| As discussed in the first Risk Factor above, in 2006 many of our customers temporarily idled production at their alternative fuel facilities, with the result that our license fees and reagent sales have been materially adversely affected |
| IRS reviews under Section 45K may adversely affect our licensees’ production of alternative fuel and therefore may adversely affect HES’s profitability |
| 15 _________________________________________________________________ The issuance of private letter rulings (“PLRs”) under Section 45K by the IRS is important to the willingness of the owners of alternative fuel facilities to operate, and to their ability to transfer ownership, of those facilities |
| Any issued PLRs may be modified or revoked by the IRS The IRS has suspended the issuance of PLRs to alternative fuel facility owners several times in the past, including most recently in 2003, and the IRS may suspend the issuance of PLRs in the future |
| In 2003, following an IRS announcement that it would suspend issuance of PLRs because it questioned the scientific validity of procedures and tests performed by alternative fuel facility operators to determine that the fuel satisfied the requirements of Section 45K, certain of our licensees reduced or ceased production, which resulted in a material adverse impact on our revenue and net income |
| While the IRS later indicated it would resume the issuance of PLRs, it has continued to express concerns regarding the sampling and data/record retention practices prevalent in the alternative fuels industry and subsequent PLRs have required taxpayers (i) to maintain sampling and quality control procedures that conform to the American Society for Testing and Materials or other appropriate industry guidelines at the alternative fuel facilities, (ii) to obtain regular reports from independent laboratories that have analyzed the fuel produced in such facilities to verify that the coal used to produce the fuel undergoes a significant chemical change and (iii) to maintain records and data underlying the reports that taxpayers obtain from independent laboratories including raw Fourier Transform InfraRed (“FTIR”) data and processed FTIR data sufficient to document the selection of absorption peaks and integration points |
| The expression of IRS concern regarding current practices in the industry may adversely affect the willingness of buyers to engage in transactions or the willingness of current owners to operate their facilities |
| If current owners are unable to sell their facilities or are unwilling to operate them, production will not be maximized, thereby materially decreasing our revenues and net income |
| We cannot predict whether the IRS may conduct reviews or investigations of Section 45K tax credits in the future, or whether the outcome of IRS audits involving licensees would be favorable |
| Senate investigation of Section 45K tax credits may adversely affect production by our licensees and decrease the profitability of HES On October 30, 2003, the Permanent Subcommittee on Investigations of the Government Affairs Committee of the United States Senate (the “Subcommittee”) issued a notification of pending investigations |
| The notification listed, among others, the alternative fuel tax credit as a new item to be reviewed |
| If the pending investigation or any future Congressional action results in findings or announcements negative to the industry, it may adversely affect the willingness of buyers to engage in transactions to purchase alternative fuel facilities or the willingness of current owners to operate their facilities, which would have a direct, negative impact on our revenues and net income |
| In February 2006, the Subcommittee described its investigation as follows: The Subcommittee is continuing its investigation [of] tax credits claimed under Section 29 [now Section 45K] of the Internal Revenue Code for the sale of coal-based synthetic fuels |
| This investigation is examining the utilization of these tax credits, the nature of the technologies and fuels created, the use of these fuels, and others [sic] aspects of Section 29 |
| The investigation will also address the IRS’ administration of Section 29 tax credits |
| The Subcommittee conducted numerous interviews and received large volumes of data between December 2003 and March 2004 |
| Since that time, to our knowledge, there has been little activity regarding the investigation |
| If the IRS challenges or disallows Section 45K tax credits claimed by our licensees, HES’s profitability may decrease because future production by these licensees may decrease |
| Licensees are subject to audit by the IRS The IRS may challenge whether HES’s licensees satisfy the requirements of Section 45K, or applicable PLRs, including placed-in-service requirements, or may attempt to disallow Section 45K tax credits for some other reason |
| The IRS has initiated audits of certain licensee-taxpayers who claimed Section 45K tax credits, and the outcome of any such audit is uncertain |
| In the event that tax credits are disallowed, licensees may seek recovery from HES for operational or other reasons, although we believe there would be no basis for such claims |
| The inability of a licensee to claim Section 45K tax credits also would reduce our future revenue from such licensee |
| In addition, IRS audit activity may have adversely affected the willingness of buyers to engage in transactions to purchase alternative fuel facilities or the willingness of current owners to operate their facilities |
| If current owners are unable to sell their facilities or are unwilling to operate them at full capacity, production will not be maximized, which could have a significant negative effect on our revenues and net income |
| If our licensees’ demand for Section 45K tax credits is adversely influenced by negative publicity involving the industry or transactions principally motivated by the reduction of taxes, HES’s profitability will decrease |
| 16 _________________________________________________________________ There has been public scrutiny of Section 45K by the media and policymakers |
| Outside the Section 45K context, there has been public scrutiny of transactions motivated principally by the reduction of federal income taxes |
| Our licensees could determine that the risk of negative publicity or public scrutiny associated with the Section 45K tax credits exceeds the financial benefits from the utilization of the credits |
| Such licensees may seek to mitigate or eliminate such risk by reducing or ceasing production of alternative fuel or disposing of their facilities, resulting in short-term or long-term disruption of operations, in which case our revenues and profitability would decrease |
| HES’s revenues are derived from a small number of licensees and customers; therefore, any short-term or long-term decisions by one or a small number of such licensees and customers to decrease or halt production would cause our profitability to decrease |
| HES has 28 licensed facilities using its coal-based synthetic fuel technologies |
| In addition, HES sells reagents used at approximately 35 facilities owned by our licensees and other customers |
| License fees and reagent sales accounted for approximately 19prca of our total revenues in the fiscal year ended September 30, 2006 and a higher percentage of our net income |
| Under law, facilities must have been placed into service prior to July 1, 1998 to be eligible for Section 45K tax credits, so HES’s business primarily depends on existing licensees and chemical reagent customers |
| If any of HES’s significant licensees or chemical reagent customers shuts down its facilities, operates its facilities at low production levels or sells its facilities resulting in short-term or long-term disruption of operations, our revenues and net income could be materially adversely affected |
| HES’s licensees must address all operational issues including, but not limited to, feedstock availability, cost, moisture content, British thermal unit (“Btu”) content, correct chemical reagent formulation and application, operability of equipment, product durability and overall costs of operations |
| In some cases, licensees may be forced to relocate plants and enter into new strategic contracts to address marketing and operational issues |
| Licensee plant relocations disrupt production and delay generation of license fees paid to us |
| As discussed in the first Risk Factor above, in 2006 some of our customers temporarily idled production at their alternative fuel facilities, with the result that our license fees and reagent sales were materially adversely affected |
| Headwaters Resources, or HRI, primarily sells fly ash for use in concrete; if use of fly ash does not increase, Headwaters Resources may not grow |
| HRI’s growth has been and continues to be dependent upon the increased use of fly ash in the production of concrete |
| HRI’s marketing initiatives emphasize the environmental, cost and performance advantages of replacing portland cement with fly ash in the production of concrete |
| If HRI’s marketing initiatives are not successful, HRI may not be able to sustain its growth |
| If portland cement or competing replacement products are available at lower prices than fly ash, our sales of fly ash as a replacement for portland cement in concrete products could suffer, causing a decline in HRI’s revenues and net income |
| An estimated 73prca of HRI’s revenues for the fiscal year ended September 30, 2006 were derived from the sale of fly ash as a replacement for portland cement in concrete products |
| At times, there may be an overcapacity of cement in regional markets, causing potential price decreases |
| The markets for HRI’s products are regional, in part because of the costs of transporting CCPs, and HRI’s business is affected by the availability and cost of competing products in the specific regions where it conducts business |
| If competing products become available at prices equal to or less than fly ash, HRI’s revenues and net income could decrease |
| Because demand for CCPs sold by HRI is affected by fluctuations in weather and construction cycles, HRI’s revenues and net income could decrease significantly as a result of unexpected or severe weather or slowdowns in the construction industry |
| HRI manages and markets CCPs and uses CCPs to produce construction materials |
| Utilities produce CCPs year-round |
| In comparison, sales of CCPs are generally keyed to construction market demands that tend to follow national trends in construction with predictable increases during temperate seasons and decreases during periods of severe weather |
| HRI’s CCP sales have historically reflected these seasonal trends, with the largest percentage of total annual revenues being realized in the quarters ended June 30 and September 30 |
| Low seasonal demand normally results in reduced shipments and revenues in the quarters ended December 31 and March 31 |
| The CCP industry is cyclical because of its dependence on building construction and highway construction, including infrastructure repair, and is also affected by changes in general and local economic conditions |
| State construction budgets are affected adversely by economic downturns |
| HRI’s sales could significantly decrease as a result of a downturn in the economy in one or more markets that it serves |
| 17 _________________________________________________________________ If HRI’s coal-fueled electric utility industry suppliers fail to provide HRI with high-value CCPs on a timely basis, HRI’s costs could increase and our growth could be hindered |
| HRI has occasionally experienced delays and other problems in obtaining high-value CCPs from its suppliers and may in the future be unable to obtain high-value CCPs on the scale and within the time frames required by HRI to meet its customers’ needs |
| If HRI is unable to obtain CCPs or if it experiences a delay in the delivery of high-value or quality CCPs, HRI may be forced to incur significant unanticipated expenses to secure alternative sources or to otherwise maintain supply to its customers |
| Moreover, its revenues could be adversely affected if these customers choose to find alternatives to HRI’s products |
| Because the markets for our construction materials products are heavily dependent on the residential construction and remodeling market, our revenues could decrease as a result of events outside our control that impact home construction and home improvement activity |
| With rising interest rates, there has been a slowing in 2006 of new housing starts and in home sales generally |
| While our construction materials business relies upon the home improvement and remodeling markets as well as new construction, we have experienced a slow down in sales activity in 2006 |
| If interest rates continue to rise and affect customers’ desire or ability to engage in construction or remodeling, or if there is a limit on availability of credit for homeowners which results in a slowdown in new construction or remodeling and repair activities, our revenues could be materially adversely affected, The construction markets are seasonal |
| The majority of our construction materials sales are in the residential construction market, which tends to slow down in the winter months |
| If there is more severe weather than normal, or other events outside of our control, there may be a negative effect on our revenues if we are not able to increase market share |
| A significant increase in the price of materials used in the production of our construction materials products that cannot be passed on to customers could have a significant adverse effect on our net income |
| Furthermore, we depend upon limited sources for certain key production materials, the interruption of which would materially disrupt our ability to manufacture and supply products, resulting in lost revenues and the potential loss of customers |
| Eldorado’s architectural stone manufacturing processes require key production materials including cement, oxides, packaging materials, and certain types of rubber-based products |
| The suppliers of these materials to Eldorado may experience capacity or supply constraints in meeting market demand that limit Eldorado’s ability to obtain needed production materials on a timely basis or at expected prices |
| Eldorado has no long-term contracts with suppliers |
| Eldorado does not currently maintain large inventories of production materials and alternative sources meeting Eldorado’s requirements could be difficult to arrange in the short term |
| A significant increase in the price of these materials that cannot be passed on to customers could have a significant adverse effect on our net income |
| Additionally, Eldorado’s manufacturing and ability to provide products to its customers could be materially disrupted if this supply of materials was interrupted for any reason |
| Such an interruption and the resulting inability to supply Eldorado’s customers with products could adversely impact Eldorado’s revenues and our relationships with Eldorado’s customers |
| Certain of Tapco’s products, which provide a majority of Tapco’s revenues, are manufactured from polypropylene, which material is sold to Tapco by a single supplier |
| The price of polypropylene is primarily a function of manufacturing capacity, demand and the prices of petrochemical feedstocks, crude oil and natural gas liquids |
| Historically, the market price of polypropylene has fluctuated, and significantly increased in 2006 |
| A significant increase in the price of polypropylene that cannot be passed on to customers could have a significant adverse effect on our net income |
| There is no long-term contract with Tapco’s polypropylene supplier |
| Tapco does not maintain large inventories of polypropylene and alternative sources meeting Tapco’s requirements could be difficult to arrange in the short term |
| Therefore, Tapco’s manufacturing and ability to provide products to its customers could be materially disrupted if this supply of polypropylene was interrupted for any reason |
| Such an interruption and the resulting inability to supply Tapco’s customers with products could adversely impact Tapco’s revenues and potentially our relationships with Tapco’s customers |
| Interruption of Tapco’s ability to immediately ship individual or custom product orders could harm Tapco’s reputation and result in lost revenues if customers turn to other sources for products |
| Tapco’s construction materials business is highly dependent upon rapid shipments to contractors and distributors throughout the United States of individual orders, a large portion of which orders are manufactured upon demand to meet customer specifications |
| If there is significant interruption of business at any of Tapco’s manufacturing plants or with Tapco’s computer systems that track customer orders and production, Tapco is at risk of harming its reputation for speed and reliability with important customers and losing short-term and long-term revenues if these customers turn to other sources |
| 18 _________________________________________________________________ Tapco’s revenues would be materially adversely affected if it lost one or more of its three major customers |
| Three of Tapco’s customers together accounted for approximately 30prca of its revenues in its fiscal year ended September 30, 2006 |
| There are no long-term contracts in place with these customers |
| Accordingly, a loss of or significant decrease in demand from these customers would have a material adverse effect on Tapco’s business |
| Our growth requires continued investment of capital |
| If we cannot invest additional capital into new and existing businesses, we may not be able to sustain or increase ourgrowth |
| Our operations require both maintenance and growth capital |
| A key part of our business strategy has been to expand through complementary acquisitions, which has required significant capital |
| In addition, commercialization of our energy technologies, such as coal cleaning, coal drying and heavy oil upgrading, has required and will require significant debt and equity commitments |
| In 2006 we entered into joint ventures with Degussa AG for acquiring a hydrogen peroxide plant and with GRE to develop an ethanol plant, both of which were financed with equity investments and debt incurred at the project level, and we will consider making additional such investments in the future |
| If we do not have sufficient capital to make equity investments in new projects and/or cannot find acceptable sources of debt financing, our growth may suffer |
| Our construction materials and CCP businesses also require significant capital expenditures |
| Our senior secured credit facilities limit capital expenditures for all of Headwaters to approximately dlra100dtta0 million plus the carryover of dlra25dtta4 million from fiscal 2006 and prior years for fiscal year 2007 |
| We believe that we will need substantially all of this capital expenditure limitation in fiscal year 2007 for maintenance, growth of existing businesses and new growth initiatives |
| The availability and price of corn purchased by Blue Flint Ethanol, LLC (“BFE”) can be affected by weather, disease, government programs and other factors beyond BFE’s control |
| In addition, fluctuations in gasoline and diesel fuel prices could adversely affect BFE’s ethanol revenues |
| BFE, our joint venture with GRE to produce ethanol from corn, is expected to begin production in the first quarter of calendar 2007 |
| The availability and price of corn is subject to wide fluctuations due to unpredictable factors such as weather, plantings, crop disease, government farm programs and policies, changes in demand resulting from population growth, and production of similar and competitive crops |
| These factors have historically caused volatility in corn prices and supplies and, consequently, may cause volatility in BFE’s operating results |
| Reduced supply of corn could adversely affect our profitability by increasing the cost of raw materials used in BFE’s operations |
| In addition, the use of ethanol is closely related to, or may be substituted for, gasoline and diesel fuel |
| Therefore, the selling price of ethanol relates to the selling prices of gasoline and diesel fuel |
| A significant decrease in the price of gasoline or diesel fuel could result in a significant decrease in the selling price of BFE’s ethanol and could adversely affect BFE’s revenues and operating results |
| The ethanol and biodiesel industry in the US has grown rapidly over the last few years and our success will depend on whether demand for ethanol increases concurrently or if the increased production results in excess capacity |
| Our new businesses, processes and technologies may not be successfully developed, operated and marketed, which could affect our future profitability |
| Although we have developed or acquired many new businesses, processes and technologies (eg, ethanol, heavy oil upgrading and coal cleaning), commercialization of these businesses and technologies are in early stages |
| Commercial success of these new businesses and technologies will depend on our ability to enter into agreements with customers, licensees and/or joint venturers to further develop and provide adequate funding to commercialize the new businesses and technologies, as well as to develop markets for the products and technologies |
| We may not be able to enter into these agreements and adequate funding may not be available to fully develop and successfully commercialize our new businesses and technologies |
| Further, we may not be able to profitably operate our new businesses or market our technologies or products produced from them |
| 19 _________________________________________________________________ Headwaters is conducting business in China and other foreign countries, where intellectual property and other laws, as well as business conditions, may leave our intellectual property, products and technologies vulnerable to duplication by competitors and create uncertainties as to our legal rights against such competitors’ actions |
| Headwaters has and is expected to continue to license or otherwise make its technology, including its nanotechnology, heavy oil upgrading and coal liquefaction technology, available to entities in China, India and other foreign countries |
| There is a risk that foreign intellectual property laws will not protect our intellectual property to the same extent as under United States laws, leaving us vulnerable to competitors who may attempt to copy our products, processes or technologies |
| Further, the legal system of China is based on statutory law |
| Under this system, prior court decisions may be cited as persuasive authority but do not have binding precedential effect |
| Since 1979, the Chinese government has been developing a comprehensive system of commercial laws and considerable progress has been made in the promulgation of laws and regulations dealing with economic matters, such as corporate organization and governance, foreign investment, commerce, taxation and trade |
| As these laws, regulations and legal requirements are relatively new and because of the limited volume of published case law and judicial interpretations and the non-binding nature of prior court decisions, the interpretation and enforcement of these laws, regulations and legal requirements involve some uncertainty |
| These uncertainties could limit the legal protection or recourse available to us |
| In addition, dependence on foreign licenses and conducting foreign operations may subject us to increased risk from political change, ownership issues or repatriation or currency exchange concerns |
| Significant increases in energy and transportation costs that cannot be passed on to customers could have a significant adverse effect on net income |
| We purchase a significant amount of energy from various sources to conduct our operations, including fossil fuels and electricity for production of building products and diesel fuel for distribution of our products and for production-related vehicles |
| In addition, fuel cost increases have increased truck and rail carrier transportation costs for our products |
| Fuel cost increases have in the past and may in the future adversely affect the results of our operations and our financial condition |
| Prices and availability of all petroleum products are subject to political, economic and market factors that are generally outside of our control |
| We operate in industries subject to significant environmental regulation, and compliance with and changes in regulation could add significantly to the costs of conducting business |
| The coal-based solid alternative fuel operations of HES and the CCP operations of HRI and their respective customers and licensees, together with new projects such as coal cleaning, the ethanol plant and the acquisition of a hydrogen peroxide plant in Korea, are subject to federal, state, local and international environmental regulations that impose limitations on the discharge of pollutants into the air and water and establish standards for the treatment, storage and disposal of waste products, which add to the costs of doing business and expose us to potential fines for non-compliance |
| If the costs of environmental compliance increase for any reason, we may not be able to pass on these costs to customers |
| In order to establish and operate the alternative fuel plants, coal cleaning plants, power plants and operations to collect and transport CCPs and bottom ash, we, our licensees and customers have obtained various state and local permits and must comply with processes and procedures that have been approved by regulatory authorities |
| Any failure to comply could result in the issuance of substantial fines and penalties and cause us to incur environmental liabilities |
| Certain HCM manufacturing operations, including those of Eldorado and Tapco, are also subject to environmental regulations and permit requirements |
| If HCM and its subsidiaries and affiliates cannot obtain or maintain required environmental permits for their existing and planned manufacturing facilities in a timely manner or at all, they may be subject to additional costs and/or fines |
| The ethanol industry sector manufactures ethanol, principally from industrial corn |
| Ethanol production facilities can emit volatile organic compounds and carbon monoxide into the air |
| In 2002, EPA began investigating a suspected pattern of noncompliance with the Prevention of Significant Deterioration/New Source Review (PSD/NSR) requirements of the Clean Air Act within the ethanol industry |
| The Clean Air Act’s NSR program requires a source to install pollution controls and undertake other preconstruction obligations to control air pollution emissions |
| Subsequent investigations of several companies in the ethanol industry found them to be in violation for failure to obtain either PSD or minor source permits for new construction and/or modifications made at their facilities |
| EPA has negotiated consent decrees with several companies to bring their ethanol plants into compliance with the air pollution requirements |
| Our ethanol production facility to be located at the GRE Coal Creek pulverized coal electric power station near Underwood, North Dakota, may be subject to air pollution permitting and emission control regulatory requirements |
| If this facility cannot obtain or maintain required environmental permits or maintain compliance with environmental regulations, it may be subject to additional costs and/or fines |
| 20 _________________________________________________________________ HTI’s ordinary course of business requires using its facilities to perform research and development activities involving coal, oil, chemicals and energy technologies, including liquefaction of coal |
| As a result, petroleum and other hazardous materials have been and are present in and on HTI’s properties |
| Regulatory noncompliance or accidental discharges, fires, or explosions, in spite of safeguards, could create environmental or safety liabilities |
| Therefore, our operations entail risk of environmental damage and injury to people, and we could incur liabilities in the future arising from the discharge of pollutants into the environment, waste disposal practices, or accidents |
| We are involved in litigation and claims for which we incur significant costs and are exposed to significant liability |
| We are a party to some significant legal proceedings and are subject to potential claims regarding operation of our business |
| These proceedings will require that we incur substantial costs, including attorneys’ fees, managerial time and other personnel resources and costs in pursuing resolution, and adverse resolution of these proceedings could hurt our reputation |
| With respect to the cases referred to in “Business — Litigation,” the following amount of damages is being sought by the counter parties: McEwan: McEwan seeks declaratory relief as well as compensatory damages in the approximate amount of dlra3 million plus punitive damages |
| Boynton: Boynton seeks declaratory relief as well as compensatory damages in the approximate amount of dlra25 million plus punitive damages |
| We have ongoing litigation and claims incurred during the normal course of business, including the items referred to above |
| We intend to vigorously defend and/or pursue our rights in these actions |
| We do not currently believe that the outcome of these actions will have a material adverse effect on our operations, cash flows or financial position; however, it is possible that a change in the estimates of probable liability could occur, and the change could be significant |
| We have significant competition in our industries which may cause demand for our products and services to decrease |
| We experience significant competition in all of our segments and geographic regions |
| A failure to compete effectively or increased competition could lead to price cuts, reduced gross margins and loss of market share, which could decrease our profitability |
| Many of our competitors have greater financial, management and other resources than us and may be able to take advantage of acquisitions and other opportunities more readily |
| In certain instances we must compete on the basis of superior products and services rather than price, thereby increasing the costs of marketing our services to remain competitive |
| See ITEM 1, Competition, for more information on the competition faced by Headwaters in all of its segments |
| Our business strategy to diversify and grow through acquisitions may result in integration costs, poor performance and dilution to existing stockholders |
| An important aspect of our business strategy has been and continues to be diversification and growth through acquisitions |
| Our ability to successfully implement our strategy is subject to a number of risks, including difficulties in identifying acceptable acquisition candidates, consummating acquisitions on favorable terms and obtaining adequate financing, which may adversely affect our ability to develop new products and services and to compete in our markets |
| In addition, if we consummate acquisitions through an exchange of our securities, our existing stockholders could suffer dilution |
| If we do not successfully integrate newly acquired businesses with our existing businesses, we may not realize the expected benefits of the acquisitions, and the resources and attention required for successful integration may interrupt the business activities of acquired businesses and our existing businesses |
| Successful management and integration of acquisitions are subject to a number of risks, including difficulties in assimilating acquired operations, loss of key employees, diversion of management’s attention from core business operations, assumption of contingent liabilities, incurrence of potentially significant write-offs, and various employee issues, such as issues related to human resource benefit plans, and an increase in employment and discrimination claims and claims for workers’ compensation |
| Each business acquisition also requires us to expand our operational and financial systems, which increases the complexity of our information technology systems |
| Implementation of controls, systems and procedures may be costly and time-consuming and may not be effective |
| This strategy may not improve our operating results and acquisitions may have a dilutive effect on existing stockholders |
| 21 _________________________________________________________________ If our internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act are not adequate, our reputation could be harmed and we could be subject to regulatory scrutiny, civil or criminal penalties or stockholder litigation |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires that we evaluate and report on our system of internal controls |
| If we fail to maintain the adequacy of our internal controls, we could be subject to regulatory scrutiny, civil or criminal penalties or stockholder litigation |
| Any inability to provide reliable financial reports could harm our business |
| Section 404 of the Sarbanes-Oxley Act also requires that our independent auditors report on management’s evaluation of our system of internal controls |
| We have documented and tested our system of internal controls to provide the basis for our report for the year ended September 30, 2006 |
| The growth and diversification of our business through acquisitions complicates the process of developing, documenting, maintaining and testing internal controls |
| No assurance can be given that in the future there may not be significant deficiencies or material weaknesses that would be required to be reported in the future |
| If we are unable to manage the growth of our business successfully, our revenues and business prospects could suffer |
| We have experienced significant growth recently, both internally and through acquisitions |
| We may not be able to successfully manage the increased scope of our operations or a significantly larger and more geographically diverse workforce as we expand |
| Any failure to successfully manage growth could harm our business and financial results |
| Additionally, growth increases the demands on our management, our internal systems, procedures and controls |
| To successfully manage growth, we must add administrative staff and periodically update and strengthen our operating, financial and other systems, procedures and controls, which will increase our costs and may reduce our profitability |
| We may be unable to successfully implement improvements to our information and control systems in an efficient or timely manner and may discover deficiencies in existing or future systems and controls |
| Unauthorized use of or infringement claims regarding our proprietary intellectual property could adversely affect our ability to conduct our business |
| We rely primarily on a combination of trade secrets, patents, copyright and trademark laws and confidentiality procedures to protect our intellectual property |
| Despite these precautions, unauthorized third parties may misappropriate, infringe upon, copy or reverse engineer portions of our technology or products |
| We do not know if current or future patent applications will be issued with the scope of the claims sought, if at all, or whether any patents issued will be challenged or invalidated |
| Our business could be harmed if we infringe upon the intellectual property rights of others |
| We have been, and may be in the future, notified that we may be infringing intellectual property rights possessed by third parties |
| If any such claims are asserted against us, we may seek to enter into royalty or licensing arrangements |
| There is a risk in these situations that no license will be available or that a license will not be available on reasonable terms, precluding our use of the applicable technology |
| Alternatively, we may decide to litigate such claims or attempt to design around the patented technology |
| To date, while no single patent or trademark is material to our business and the issues described in this paragraph have not resulted in significant cost or had an adverse impact on our business, future actions could be costly and would divert the efforts and attention of our management and technical personnel |
| Our capital structure affects our flexibility in responding to changing business and economic conditions and results in high interest costs |
| As of September 30, 2006, we had approximately dlra595dtta1 million of total debt outstanding, including dlra415dtta3 million of senior indebtedness under our senior secured credit facilities and dlra172dtta5 million of our 2dtta875prca convertible senior subordinated notes (the “Convertible Notes”) |
| Subject to restrictions in our senior secured credit facility, we may also incur significant amounts of additional debt for working capital, capital expenditures and other purposes |
| Our combined debt total could have important consequences, including the following: o we may have difficulty borrowing money for working capital, capital expenditures, acquisitions or other purposes because of our existing debt load and because our borrowings are secured by all of our assets; o we will need to use a large portion of our cash flow to pay interest and the required principal payments on our debt, which will reduce the amount of money available to finance our operations, capital expenditures and other activities; and 22 _________________________________________________________________ o over 70prca of our senior secured credit facilities has a variable rate of interest, which exposes us to the risk of increased interest rates |
| Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness depends on our future performance, which to a certain extent is subject to economic, financial, competitive and other factors beyond our control |
| Our business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures |
| If unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive |
| Covenant restrictions under our senior secured credit facility may limit our ability to operate our business in a manner required to sustain profitability and generate growth |
| Our senior secured credit facilities, contain, among other things, covenants that may restrict our ability to finance future operations or capital needs, to acquire additional businesses or to engage in other business activities |
| The senior secured credit facilities impose specified limitations on joint venture investments and new acquisitions |
| In addition, our senior secured credit facilities set forth covenants requiring us to maintain specified financial ratios and to satisfy certain financial condition tests which may require that we take action to reduce our debt or to act in a manner contrary to our business objectives |
| A breach of any of these covenants could result in a default under our senior secured credit facilities, in which event our lenders could elect to declare all amounts outstanding to be immediately due and payable |
| If we are not able to repay our obligations when they become due or they are accelerated, the lenders could foreclose on our assets |
| The indenture for the notes does not restrict the amount of indebtedness, including senior indebtedness, that we may incur |
| Risks Related to our Common Stock The price of our common stock historically has been volatile |
| This volatility may affect the price at which you could sell your common stock, and the sale of substantial amounts of our common stock could adversely affect the price of our common stock |
| The market price for our common stock has varied between a high of dlra40dtta19 in March 2006 and a low of dlra20dtta54 in July 2006 in the twelve month period ended October 31, 2006 |
| This volatility may affect the price at which you could sell your common stock, and the sale of substantial amounts of our common stock could adversely affect the price of our common stock |
| Our stock price is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market and other factors, including the other factors discussed in “Risks Relating to Our Business;” variations in our quarterly operating results from our expectations or those of securities analysts or investors; downward revisions in securities analysts’ estimates; and announcement by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments |
| In the past, following periods of volatility in the market price of their stock, many companies have been the subject of securities class action litigation |
| If we became involved in securities class action litigation in the future, it could result in substantial costs and diversion of our management’s attention and resources and could harm our stock price, business, prospects, results of operations and financial condition |
| In addition, the broader stock market has experienced significant price and volume fluctuations in recent years |
| This volatility has affected the market prices of securities issued by many companies for reasons unrelated to their operating performance and may adversely affect the price of our common stock |
| In addition, our announcements of our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us, our affiliates or our competitors could cause the market price of our common stock to fluctuate substantially |
| In addition, the sale of substantial amounts of our common stock could adversely impact its price |
| As of September 30, 2006, we had outstanding approximately 42dtta3 million shares of our common stock and options to purchase approximately 2dtta4 million shares of our common stock (of which approximately 2dtta3 million were exercisable as of that date) |
| We also had outstanding approximately 3dtta1 million stock appreciation rights as of September 30, 2006, of which approximately 2dtta0 million were exercisable |
| The sale or the availability for sale of a large number of shares of our common stock in the public market could cause the price of our common stock to decline |
| Conversion of the Convertible Notes may cause volatility in our stock price and will dilute the ownership interest of existing stockholders |
| 23 _________________________________________________________________ Although our diluted earnings per share calculation treats the Convertible Notes as if they were already converted into common stock, sales in the public market of the common stock issuable upon such conversion could adversely affect prevailing market prices of our common stock |
| Anticipated conversion of the notes into shares of our common stock could depress the price of our common stock |
| In addition, the existence of the Convertible Notes may encourage short selling by market participants because the conversion of the notes could be used to satisfy short positions |
| Conversion of the Convertible Notes will dilute the ownership interests of existing stockholders, including holders who had previously converted their notes |
| We have never paid dividends and do not anticipate paying any dividends on our common stock in the future, so any short-term return on your investment will depend on the market price of our capital stock |
| We currently intend to retain any earnings to finance our operations and growth |
| The terms and conditions of our senior secured credit facility restrict and limit payments or distributions in respect of our capital stock |
| Delaware law and our charter documents may impede or discourage a takeover, which could cause the market price of our shares to decline |
| We are a Delaware corporation, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change in control would be beneficial to our existing stockholders |
| In addition, our board of directors has the power, without stockholder approval, to designate the terms of one or more series of preferred stock and issue shares of preferred stock, including the adoption of a “poison pill,” which could be used defensively if a takeover is threatened |
| The ability of our board of directors to create and issue a new series of preferred stock and certain provisions of Delaware law and our certificate of incorporation and bylaws could impede a merger, takeover or other business combination involving us or discourage a potential acquirer from making a tender offer for our common stock, which, under certain circumstances, could reduce the market price of our common stock |