UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended December 31, 1998
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______ to ______
Commission file number 0-27803
COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
The number of shares outstanding of the Registrant's common stock as of
February 12, 1999 was 12,494,029.
<PAGE>
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
Consolidated Balance Sheets - As of September 30, 1998
and December 31, 1998.................................... 3
Consolidated Statements of Operations - For the three
months ended December 31, 1997 and 1998.................. 5
Consolidated Statement of Changes in Stockholders' Equity -
For the three months ended December 31, 1998............. 6
Consolidated Statements of Cash Flows - For the three
months ended December 31, 1997 and 1998.................. 7
Notes to Consolidated Financial Statements.................... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.....................................17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.............................................20
ITEM 2. CHANGES IN SECURITIES.........................................21
ITEM 3. DEFAULTS UPON SENIOR SECURITIES...............................22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........22
ITEM 5. OTHER INFORMATION.............................................22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..............................23
SIGNATURES.................................................................24
Statements in this Report, including those concerning the Registrant's
expectations regarding its business, and certain of the other information
presented in this report, constitute forward looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. As such, actual
results may vary materially from such expectations. For a discussion of certain
of the factors that could cause actual results to differ from expectations,
please see the caption entitled "Forward Looking Statements" in ITEM 2 hereof.
There can be no assurance that the Registrant's results of operations will not
be adversely affected by such factors. The Registrant undertakes no obligation
to revise or publicly release the results of any revision to these forward
looking statements. Readers are cautioned not to place undue reliance on these
forward looking statements, which reflect management's opinion only as of the
date hereof.
2
<PAGE>
<TABLE>
<CAPTION>
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
September 30, December 31,
(thousands of dollars) 1998 1998
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 727 $ 675
Receivables 2,879 2,891
Due from related party 1,012 1,337
Inventories 1,645 1,805
Advances on inventories, current 2,522 990
Notes receivable - related parties, current 229 235
Facilities held for sale 28,405 28,415
Prepaid expenses and other current assets 682 811
---------------- -----------------
Total current assets 38,101 37,159
---------------- -----------------
Property, plant and equipment, net of accumulated depreciation 14,902 14,976
---------------- -----------------
Other assets:
Restricted investments 748 891
Advances on inventories, non-current --- 1,914
Notes and accrued interest receivable, non-current 7,646 7,829
Notes receivable - related parties, non-current 2,869 2,809
Intangible assets, net of accumulated amortization 3,118 3,617
Deposits and other assets 525 846
---------------- -----------------
Total other assets 14,906 17,906
---------------- -----------------
Total assets $67,909 $70,041
================ =================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
3
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
As of As of
September 30, December 31,
(thousands of dollars and shares) 1998 1998
- -------------------------------------------------------------------------------------------- --------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
<S> <C> <C>
Accounts payable $3,036 $3,366
Due to related party 1,609 1,870
Accrued liabilities 2,858 3,310
Notes payable, current 22,049 23,065
--------------- ----------------
Total current liabilities 29,552 31,611
--------------- ----------------
Long-term liabilities:
Notes payable, non-current 13,930 13,973
Notes and accrued interest payable - related parties, non-current 147 69
Accrued interest payable, non-current 566 157
Deferred revenues from advance license fees 1,400 1,400
Deferred compensation 236 239
--------------- ----------------
Total long-term liabilities 16,279 15,838
--------------- ----------------
Total liabilities 45,831 47,449
--------------- ----------------
Minority interest in consolidated subsidiaries 507 109
--------------- ----------------
Commitments and contingencies (Note 7)
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 316 shares at September 30, 1998 and 30 shares at
December 31, 1998
(aggregate liquidation preference of $3,454 at December 31, 1998) 1 1
Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding
11,272 shares at September 30, 1998 and 12,494 shares at December 31, 1998 11 12
Capital in excess of par value - preferred 5,184 3,184
Capital in excess of par value - common 64,100 71,174
Accumulated deficit (36,177) (41,073)
Notes and interest receivable - related parties, from issuance of, or collateralized
by, common stock, net of allowance (7,773) (7,202)
Deferred compensation from stock options (3,775) (3,613)
--------------- ----------------
Total stockholders' equity 21,571 22,483
--------------- ----------------
Total liabilities and stockholders' equity $67,909 $70,041
=============== ================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended December 31,
(thousands of dollars, except per-share amounts) 1997 1998
- ---------------------------------------------------------------------------------- --------------------- ---------------------
Revenues:
<S> <C> <C>
License fees $1,000 $ 474
Binder sales -- 533
Binder and coal fine sales - related party 7 141
Other 34 7
--------------------- ---------------------
Total revenues 1,041 1,155
--------------------- ---------------------
Operating costs and expenses:
Cost of coal briquetting operations 457 3,520
Cost of binder -- 376
Selling, general and administrative 741 929
Research and development 156 153
Compensation expense on stock options, stock warrants and
issuance of common stock 207 162
--------------------- ---------------------
Total operating costs and expenses 1,561 5,140
--------------------- ---------------------
Operating loss (520) (3,985)
--------------------- ---------------------
Other income (expense):
Interest income 122 831
Interest expense (1,112) (1,036)
Minority interest in net losses of consolidated subsidiaries 86 --
Write-up (write-down) of notes receivable - related parties,
collateralized by common stock 293 (571)
Other 15 24
--------------------- ---------------------
Total other income (expense) (596) (752)
--------------------- ---------------------
Net loss $(1,116) $(4,737)
===================== =====================
Basic and diluted net loss per common share $(.13) $(.40)
===================== =====================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
5
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Notes and interest
receivable -
related parties,
Convertible Preferred Stock Common Stock from issuance of,
-------------------------------- ---------------------------- or collater- Deferred
Capital in Capital in alized compensation
(thousands of excess of excess of Accumulated by, common from stock
dollars and shares) Shares Amount par value Shares Amount par value deficit stock options
- --------------------- ------ --------- --------- -------- ------- ---------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
September 30, 1998 316 $1 $5,184 11,272 $11 $64,100 $(36,177) $(7,773) $(3,775)
Common stock
issued to purchase
minority interests in 92 -- 519
subsidiaries
Common stock
issued for cash,
including exercise of 776 1 3,774
stock options
Value of common
stock warrants
issued under
terms of
existing debt
agreement -- -- 247
Common stock
issued for
rights to
certain technology 60 -- 375
Common stock
issued on
conversion of
preferred stock
and accrued but
undeclared dividends (286) -- (2,000) 308 -- 2,159 (159)
Return of
previously
issued common
stock by a director (14) -- --
Write-down of
notes receivable -
related parties 571
Amortization of
deferred
compensation from
stock options 162
Net loss for
the quarter ended
December 31, 1998 (4,737)
------ --------- --------- -------- ------- ---------- ----------- --------- -----------
Balances at
December 31, 1998 30 $1 $3,184 12,494 $12 $71,174 $(41,073) $(7,202) $(3,613)
====== ========= ========= ======== ======= ========== =========== ========= -----------
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
6
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended December 31,
(thousands of dollars) 1997 1998
- ----------------------------------------------------------------------------------------- ------------------- -------------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $(1,116) $(4,737)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 65 436
Write-down (write-up) of notes receivable - related parties (293) 571
Interest expense related to amortization of value of common stock warrants -- 82
Interest expense based upon issuance of convertible debt and warrants at a 1,112 --
discount
Amortization of deferred compensation from stock options 207 162
Losses applicable to minority interests in subsidiaries (86) --
Decrease from changes in assets and liabilities, net of effects from investing
and financing activities (858) (660)
------------------- -------------------
Net cash used in operating activities (969) (4,146)
------------------- -------------------
Cash flows from investing activities:
Purchase of property, plant and equipment and facilities held for sale (4,978) (410)
Purchase of rights to technology -- (100)
Issuance of notes receivable (812) --
Payments on notes receivable - related parties, current -- 54
Purchase of restricted investment -- (143)
------------------- -------------------
Net cash used in investing activities (5,790) (599)
------------------- -------------------
Cash flows from financing activities:
Proceeds from issuance of notes payable 3,095 1,049
Payments on notes payable - related parties (56) (78)
Proceeds from issuance of preferred stock, net 90 --
Proceeds from issuance of common stock, net 836 3,774
Proceeds from receivable - stock subscriptions 577 --
Other 2 (52)
------------------- -------------------
Net cash provided by financing activities 4,544 4,693
------------------- -------------------
Net decrease in cash and cash equivalents (2,215) (52)
Total cash and cash equivalents, beginning of period 4,780 727
------------------- -------------------
Total cash and cash equivalents, end of period $2,565 $ 675
=================== ===================
Supplemental schedule of non-cash investing and financing activities:
Common stock issued for purchase of minority interests in subsidiaries $ -- $ 519
Common stock issued on conversion of preferred stock and accrued but undeclared
dividends -- 2,159
Common stock issued for rights to technology -- 375
Note payable issued for inventory 400 --
Note payable issued for equipment 1,971 --
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
7
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
1. Nature of Operations and Basis of Presentation
Covol's primary business is to commercialize its binder technologies used
to recycle waste by-products from the coal, steel and other industries into
marketable fuel and resources. Through June 30, 1998, Covol's focus was on
the construction of facilities and the licensing of its binder technologies
to companies that constructed facilities that convert coal fines into
synthetic fuel briquettes. At December 31, 1998, Covol and its licensees
were operating 24 of these facilities in eight states at various levels of
production. The four Covol-owned facilities are expected to be sold in
1999. Covol has no current plans to construct additional synthetic fuel
facilities.
Covol anticipates that earned license fees or royalties from the production
and sale of synthetic fuel will continue to increase during 1999. As
production levels increase, sales of the binder materials by Covol to its
licensees are expected to increase proportionately. Covol also anticipates
receiving the final amounts of advance license fees totaling approximately
$4,000,000 during 1999. Funds received by Covol from these activities are
not expected to be sufficient to cover Covol's operating costs and expenses
until the third quarter of 1999. Covol anticipates that these operating
activities will be producing operating cash flow by the end of 1999.
To provide funding for Covol's operations and debt repayment requirements
during early 1999, Covol will utilize proceeds from financing transactions
and excess proceeds from the sale of facilities. During November 1998,
Covol issued common stock and common stock warrants for total net proceeds
of approximately $3,729,000. During January 1999, Covol issued convertible
preferred stock and warrants for total net proceeds of approximately
$900,000. Covol is presently negotiating and finalizing definitive
agreements with respect to previously negotiated term sheets for the sale
of up to $16,000,000 of additional convertible preferred stock, which
financing is expected to close in February 1999. Covol believes the funds
raised in these financings and others, if necessary, excess proceeds from
the sale of facilities, and payments for license fees and binder sales will
be sufficient to fund Covol's operations and debt repayment requirements
until its operating activities begin producing positive cash flow.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for a
fair presentation have been included. The results of operations for the
periods presented are not necessarily indicative of the results to be
expected for the full year. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted. It
is suggested that these financial statements be read in conjunction with
the consolidated financial statements and notes thereto included in Covol's
Annual Report on Form 10-K for the year ended September 30, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
Certain prior period amounts have been reclassified to conform to the
December 31, 1998 presentation. These reclassifications had no effect on
net loss or total assets.
8
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
2. Advances on Inventories
During 1997, Covol entered into an agreement to purchase coal fines and
through December 31, 1998 has made payments totaling approximately
$3,125,000, of which $221,000 has been transferred to cost of coal
briquetting operations. The net amount paid has been recorded as advances
on inventories. Covol expects to utilize some of these coal fines during
1999, at which time the related costs will be expensed.
Under the agreement, Covol is obligated to pay a total of $5,500,000
between February 1997 and May 2000 for the removal of 2 million tons of
coal fines (a price of $2.75 per ton) from the property. Quarterly payments
of approximately $396,000 are required under the agreement. The agreement
also provides for removal of an additional 500,000 tons at $2.75 per ton.
No payment is required for removal of any coal fines in excess of 2.5
million tons.
3. Change in Carrying Value of Note Receivable
During the three months ended December 31, 1998, Covol increased the
allowance on the $5,000,000 face value note receivable from a stockholder
received from the 1996 sale of certain construction companies by
approximately $571,000, which adjusted the carrying value to $1,038,000 as
of December 31, 1998. During the three months ended December 31, 1997,
Covol decreased the allowance by approximately $293,000. The changes in the
allowance were based solely on changes in the market value of Covol's
common stock and common stock options held as collateral for the note
receivable. The note is guaranteed by the buyer, who is the sole
stockholder of the construction companies, by 150,625 shares of Covol's
common stock held by Covol, and by options expiring in January 2006 to
acquire 25,000 shares of Covol's common stock committed by the stockholder
to be provided to Covol. The allowance is subject to future fluctuations in
the value of Covol's common stock. In February 1999, Covol received an
interest payment of $75,000 from the Note holder.
4. Notes Payable
<TABLE>
<CAPTION>
Notes payable consist of the following:
September 30, December 31,
(thousands of dollars) 1998 1998
---------------------------------------------------------------------------------------- ------------------ ------------------
<S> <C> <C>
Note payable to a corporation bearing interest at prime (7.75% at December 31,
1998) plus 2%, collateralized by plant and equipment, principal and interest
due December 1999. $ 2,900 $2,900
Note payable to the same corporation referred to in the preceding paragraph,
bearing interest at 6%, principal and interest due October 1999,
collateralized by a coal wash plant in Utah. 4,263 4,276
Notes payable to a corporation, bearing interest at 6%. 50% of accrued
interest due February 1999 and balance of accrued interest and principal due
February 2001. Collateralized by a synthetic fuel facility in West Virginia,
held for sale. 6,680 6,680
</TABLE>
9
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
4. Notes Payable, continued
<TABLE>
<CAPTION>
September 30, December 31, 1998
(thousands of dollars, except per-share data) 1998
------------------------------------------------------------------------------------- ------------------ -------------------
<S> <C> <C>
Note payable to a limited liability company issued in conjunction with funds
advanced for the construction of a synthetic fuel facility in West Virginia,
held for sale. As of September 30, 1998, the loan was collateralized by the
facility, bore no interest and was originally due at the earlier of the sale
of the facility or January 1999. In December 1998, this entity modified the
terms of the note and agreed to loan to Covol additional amounts up to
$1,500. This entity had an option to purchase the facility, which expired
unexercised in January 1999 (see Note 8). Covol agreed to pay interest on
all outstanding amounts at a rate of 10%, payable monthly through June 1999.
Beginning July 1999 through May 2000, monthly payments of $350 will be
required, with all unpaid principal and interest due June 2000. Also, Covol
granted additional collateral to the corporation in the form of certain
license fees receivable by Covol from other synthetic fuel facilities.
8,242 8,895
Note payable to a corporation, bearing interest at 15%, collateralized by a
synthetic fuel facility in Pennsylvania, held for sale, and due at the
earlier of the sale of the facility or August 1999. 5,800 5,800
Note payable to a corporation bearing interest at 22%, due June 1999,
collateralized by a promissory note receivable and by certain future license
fees receivable by Covol. Warrants to purchase 100,000 shares of common
stock were granted in October 1998 based on the outstanding principal
balance. The warrants have an exercise price of $7.44 per share, expire in
October 2000 and were valued at approximately $247,000. A member of Covol's
Board of Directors is affiliated with this corporation. 4,000 4,000
Note payable to the same corporation referred to in the preceding paragraph,
bearing interest at 14%. Principal and accrued interest due March 1999,
collateralized by certain future license fees receivable by Covol. 4,000 4,000
Other 94 487
------------------- ------------------
35,979 37,038
Less: current portion 22,049 23,065
=================== ==================
Total non-current $13,930 $13,973
=================== ==================
</TABLE>
Substantially all of Covol's property, plant and equipment and facilities
held for sale are collateral for the notes payable. The weighted average
interest rate on notes payable was 8.5% at September 30, 1998 and 11.4% at
December 31, 1998.
10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
4. Notes Payable, continued
Interest Costs
During the three months ended December 31, 1998, Covol incurred total
interest costs of approximately $1,036,000 (including approximately $82,000
of amortization of value of common stock warrants issued under terms of an
existing agreement), none of which were capitalized. During the three months
ended December 31, 1997, Covol incurred total interest costs of approximately
$1,397,000 (including approximately $1,112,000 of non-cash interest expense
resulting from issuance of convertible debt at a discount), of which
approximately $285,000 was capitalized.
5. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
(thousands of dollars and shares, except per-share data) 1997 1998
----------------------------------------------------------------------------------- ------------------- ------------------
Numerator:
<S> <C> <C>
Net loss $(1,116) $(4,737)
Preferred stock dividends (undeclared) (88) (60)
=================== ==================
Net loss attributable to common stockholders $(1,204) $(4,797)
=================== ==================
Denominator - weighted average shares outstanding 9,194 11,976
=================== ==================
Basic and diluted net loss per share $(.13) $(.40)
=================== ==================
</TABLE>
6. Equity Transactions
Purchase of Limited Partners' Interests in Subsidiaries
In 1996, Covol formed two limited partnerships, Alabama Synfuel #1 Ltd. and
Utah Synfuel #1 Ltd., to assist with the financing of construction at two
synthetic fuel manufacturing facilities. These two facilities have been sold
and are now owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. In
September 1998, Covol offered the limited partners in Alabama Synfuel #1 and
Utah Synfuel #1 an exchange of Covol's common stock for their limited
partnership interests. The exchange ratio was based in part on an independent
valuation of the limited partnerships' assets and other factors including but
not limited to current and future expected cash flows of the partnerships and
the market value of Covol's common stock at the date of the offer, which was
$9.00 per share. As of November 10, 1998, all of the limited partners in Utah
Synfuel #1 and all but one of the limited partners in Alabama Synfuel #1 had
agreed to exchange their limited partnership interests for shares of Covol's
common stock, and accordingly Utah Synfuel #1 became a wholly-owned
subsidiary of Covol and Alabama Synfuel #1 became a 98%-owned subsidiary of
Covol. Covol recorded this exchange using the market values of Covol's common
stock on the dates the limited partners tendered acceptance of Covol's offer.
These market values ranged from $6.75 to $11.13 per share. The excess of the
value of the consideration paid for the purchase of the limited partners'
interests in subsidiaries over the fair values of the related assets, which
fair values approximated their carrying cost, was recorded as an intangible
asset.
11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
6. Equity Transactions, continued
Sale of Common Stock
During November and December 1998, Covol completed a sale of 745,875 units
at $5.00 per unit, for total proceeds of approximately $3,729,000. Each unit
consisted of one share of restricted common stock, plus a warrant to
purchase one additional share of restricted common stock at an exercise
price of $7.50 per share. The warrants expire in November 1999 if not
exercised. Covol provided piggyback registration rights for the restricted
common shares and the shares issuable upon exercise of the warrants.
Technology Acquisition
Effective in November 1998, Covol acquired a coal-based synthetic fuel
technology, and related licensing and patent rights for $100,000 in cash,
60,000 shares of restricted common stock valued at $375,000 and a commitment
to make installment payments of $5,000 per month for 60 months if certain
events occur. This acquisition transferred to Covol patent ownership and
licensor rights and obligations to existing license agreements with a
company that sublicensed the technology to a developer of four synthetic
fuel facilities. In connection with the acquisition of the technology, Covol
entered into a consulting agreement with the previous owner of the patent
rights to provide consulting services related to iron revert, coke,
charcoal, waste recycling, and other related applications. The consulting
agreement provides for monthly payments of $7,500 through November 2001. The
total cost of $475,000 is being amortized on a straight-line basis over
approximately nine years.
Preferred Stock Conversion
In October 1998, a total of approximately 308,000 shares of the common stock
were issued on conversion of approximately 286,000 shares of series B
preferred stock and related accrued but unpaid dividends.
Return of Stock Issued to Director
Covol previously issued 34,000 shares of common stock to a director as
compensation for services and financial assistance. Following negotiations
between Covol and this director, 14,000 shares of stock were cancelled in
December 1998. Reference is made to paragraph 7 in "Recent Sales of
Unregistered Securities" in Part II, Item 1. for a more detailed description
of this transaction.
Stock Options
During the quarter ended December 31, 1998, Covol granted options for the
purchase of a total of 322,000 shares of common stock. Options for the
purchase of 150,000 shares of common stock were granted to three officers
and options for the purchase of 172,000 shares were granted to four
independent directors. In addition to these grants, in January 1999, Covol
granted options for the purchase of 60,000 shares of common stock to four
individuals for services rendered in connection with the financing of a
synthetic fuel facility pursuant to a consulting arrangement originally
entered into in 1997 and revised in August 1998. In December 1998, three
officers exercised options for the purchase of 30,000 shares of common
stock, for which Covol received proceeds of $45,000.
12
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
7. Commitments and Contingencies
Commitments and contingencies as of December 31, 1998 not disclosed
elsewhere, are as follows:
Letters of Credit
During fiscal 1998, Covol entered into letter of credit arrangements with a
bank that provide for the issuance of letters of credit totaling up to
$938,000. As of December 31, 1998, there was $698,000 of outstanding letters
of credit. Certificates of deposit totaling $698,000 that are included in
restricted investments in the accompanying balance sheet collateralize these
arrangements.
Legal or Contractual Matters
Included in accrued liabilities at September 30, 1998 and December 31, 1998
is $755,000 related to construction contracts that contain a "failure to
proceed" liability clause.
In December 1996, Covol entered into indemnification agreements in
connection with construction contracts for certain synthetic fuel facilities
entered into between the construction contractor and independent third
parties. These contracts call for liquidated damages of $750,000 per
contract if construction of the facilities were not completed by June 1,
1998. Covol indemnified the contractor for these potential liabilities. The
maximum contingent liability Covol may have under these indemnification
agreements would be $2,250,000. The contractor and the contracting party
have initiated arbitration against each other including claims for
liquidated damages. Covol is closely monitoring the arbitration and believes
that payment of a material amount by Covol is unlikely.
In March 1997, Covol sold the Utah Synfuel #1 facility to Coaltech. In
connection with this sale, Utah Synfuel #1 licensed Coaltech to use Covol's
binder technologies for an advance license fee of $1,400,000 and an earned
license fee that is payable quarterly and is based upon briquette production
and sales from the Utah Synfuel #1 facility. Covol contracted with Coaltech
to operate the facility for which Covol receives a quarterly fee, which is
also based upon briquettes produced and sold. Coaltech has an option wherein
they can require Covol to purchase this facility under certain conditions
for a price equal to fair market value, but not to exceed 50% of the amounts
paid to Covol by Coaltech. Additionally, Covol entered into a supply and
purchase agreement wherein Covol agreed to provide coal fines to Coaltech
for processing into synthetic fuel at a price equal to its cost. Covol
agreed to purchase from Coaltech the synthetic fuel produced at Coaltech's
cost plus one dollar per ton. Based upon expected manufacturing costs and
current coal prices, Covol expects to incur a loss under this supply and
purchase agreement which will reduce the earned license fees received. Covol
believes that in total the earned license fees will exceed the losses
incurred under the supply and purchase agreement. Because of the initial
expected losses under this supply and purchase agreement, revenue
recognition of the advance license fee has been deferred as of September 30,
1998 and December 31, 1998.
In June 1996, Covol formed Alabama Synfuel #1 to construct a synthetic fuel
facility. In connection with the construction of this facility, Covol
entered into a supply agreement for coal fines to be used at the facility,
under which Covol was obligated to purchase a minimum of 20,000 tons of coal
fines per month through December 2001. Covol assigned this agreement to the
purchaser of the facility and accordingly, has no ongoing obligation. Covol
has a dispute with the provider of the coal fines, the resolution of which
is not expected to have a material impact on Covol.
In May 1995, Covol entered into an agreement with Geneva Steel Company to
build and operate a commercial briquetting plant. The facility is not
currently operational and is expected to be moved from the Geneva site in
the near future. Covol may use this equipment for the production of
synthetic fuel or for testing purposes.
13
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
7. Commitments and Contingencies, continued
Legal or Contractual Matters, continued
In December 1996, Covol entered into license agreements with affiliates of
Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of Covol's
binder technologies at four synthetic fuel manufacturing facilities
developed by Pace. In 1998 Pace requested a reduction in the license fees
payable to Covol under the license agreements. Upon condition of immediate
payment by Pace of advance license fees, Covol agreed to a reduction in
future earned license fees. This reduction was accomplished by a ten-year
loan agreement whereby Covol would loan to Pace up to $750,000 each quarter
beginning in November 1998. Covol's loan to Pace will be repaid at the end
of the ten years only if the Pace projects have accumulated sufficient
prescribed earnings. Revenues from earned license fees will be recognized by
Covol only to the extent that amounts exceed the loan commitment. Pace has
requested two quarterly loans totaling $1,500,000. Covol believes that its
current loan obligation to Pace is limited to the earned license fees
receivable by Covol for the quarters ended September 30, 1998 and December
31, 1998, which amounts are believed to be approximately $612,000 in total.
In January 1996, a manager of Covol entered property owned by Nevada
Electric Investment Company, a subsidiary of Nevada Power Corporation, in
connection with an offer by Covol to purchase the property, and with certain
other employees of Covol, removed some asbestos over a two-day period. In
May 1996, Covol received a notice of violation and order for compliance from
the State of Utah, Division of Air Quality alleging that asbestos was
improperly handled, removed, and disposed of. Covol complied with the order
and in September 1996 entered into a settlement agreement with the State of
Utah and paid a fine in the amount of $11,000. In late 1997, the U.S.
Environmental Protection Agency began its own investigation, referring the
matter to the U.S. Attorney's office which proceeded with a grand jury
inquiry. Covol was served in September 1998 with a grand jury subpoena for
records, with which Covol has complied. Covol does not know the results of
the grand jury inquiry or whether the inquiry is completed. Covol does not
believe that the resolution of this matter will have a material adverse
effect on Covol.
As of September 30, 1998 and December 31, 1998, Covol has recorded
liabilities to The Industrial Company ("TIC") totaling approximately
$735,000. In November 1998, Covol was served with liens from TIC in amounts
totaling approximately $1,150,000 for construction payments TIC claims are
due for certain synfuel facilities. Covol is negotiating with TIC for the
settlement and release of the liens and believes that payment of a material
amount beyond what has been accrued by Covol is unlikely.
In September 1996, Covol entered into an agreement with Coalco Corporation
whereby Coalco was to advise Covol with respect to the financing and sale of
certain synthetic fuel manufacturing facilities. To date, Covol has paid
Coalco approximately $347,000 pursuant to the agreement. A dispute has
arisen between Covol and Coalco about services rendered or to be rendered by
Coalco and the amount and timing for payment for such services. Covol and
Coalco are negotiating to attempt to resolve their differences. The
potential liability to Covol, if any, is not known. While Covol's management
believes the dispute will be resolved and will not have a significant
financial impact, it can give no assurance as to the ultimate effect on
Covol. Pelletco, an affiliate of Coalco, is a licensee of Covol.
Covol is also involved in several legal proceedings that have arisen out of
the normal course of business. Covol believes that many of these claims are
without merit and in all cases intends to vigorously defend their position.
Management does not believe that the outcome of these activities will have a
significant effect upon the operations or the financial position of Covol.
14
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
7. Commitments and Contingencies, continued
Employment Contract
In January 1999, Covol entered into an employment agreement with an officer.
This agreement has a term of three years and provides for annual salaries
and benefits ranging from approximately $107,000 to $142,000. The agreement
provides for termination benefits under specific conditions of an amount
equal to one year's annual base salary.
8. Events Subsequent to December 31, 1998
Events subsequent to December 31, 1998 not disclosed elsewhere are as
follows:
Sale of Series C Convertible Preferred Stock
During January 1999, Covol completed a financing transaction with a
stockholder that consisted of the sale of 1,000 shares of a new series of
non-voting preferred stock, designated as Series C 7% Convertible Preferred
Stock. Covol received $900,000 in net proceeds from the issuance of this
preferred stock, which has the following rights and privileges:
o Dividends on the preferred stock are cumulative and accrue whether
or not they have been declared or whether Covol has any profits.
The dividend rate is 7% per year of the liquidation value of
$1,000 per share.
o The preferred stock is convertible into common shares in
incremental stages beginning April 1999 through July 1999, at
which time all of the outstanding shares may be converted to
common stock. The number of common shares to be received upon
conversion is determined by multiplying the number of preferred
shares by $1,000 and dividing that number by the conversion price
(currently $5.50 per share, subject to adjustment). Upon
conversion, all accrued and unpaid dividends will be paid or
converted into shares of common stock.
o Covol may at its option redeem the outstanding preferred stock
beginning July 1999 for a redemption price equal to 125% of the
liquidation value plus any accrued and unpaid dividends thereon.
Warrants for the purchase of 72,727 shares of common stock were issued in
conjunction with this preferred stock. These warrants are exercisable from
April 1999 through July 2001 at an exercise price of $6.88 per share,
subject to adjustment. The exercise deadline for certain other warrants with
an exercise price of $7.00 per share held by this stockholder were extended
to June 2000 and certain additional warrants with an exercise price of
$30.00 per share were relinquished and have been cancelled. Covol granted
registration rights for the restricted common shares issuable upon
conversion of the preferred stock or upon exercise of the common stock
warrants.
15
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
7. Commitments and Contingencies, continued
Other
Covol is presently finalizing definitive agreements with respect to
previously negotiated term sheets for the sale of up to $16,000,000 of
additional convertible preferred stock, which financing is expected to close
in February 1999.
In May 1998, Covol entered into a construction and operation financing
agreement and a purchase option agreement to sell the Mountaineer synthetic
fuel facility to Mountaineer Synfuel, L.L.C., a Delaware limited liability
company. The purchase option expired unexercised on January 29, 1999. Under
the financing agreement, Covol is obligated to repay the loan (approximately
$8,895,000 at December 31, 1998 and $9,191,000 at January 29, 1999) with ten
percent interest in monthly interest only installments through June 1999 and
monthly principal and interest installments thereafter of $350,000, with a
balloon payment on June 30, 2000. Alternatively, if Covol sells the facility
before the loan repayment date, Covol must repay the loan from sale
proceeds. Covol continues to operate the project under contract with Savage
Industries Inc. Anker Energy Corporation supplies the facility with
feedstock and provides marketing services for the synthetic fuel produced.
Covol is actively seeking a purchaser for the Mountaineer facility and
expects the facility to be sold in its fiscal year 1999. However, Covol
cannot give assurance that it will successfully sell the facility.
16
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis should be read in
conjunction with the accompanying unaudited consolidated financial statements
and notes thereto.
Three Months Ended December 31, 1998 Compared to Three Months Ended December 31,
1997
Revenues. Total revenues for the three months ended December 31, 1998
("1998") increased by $114,000 to $1,155,000 as compared to $1,041,000 for the
three months ended December 31, 1997 ("1997"). During 1998, Covol recognized
license fees totaling $474,000 while license fees of $1,000,000 were recognized
during 1997. The license fees in 1998 consisted solely of earned license fees or
royalty payments, substantially all of which were from a single licensee, while
the license fees in 1997 consisted solely of one-time advance license fees.
Earned license fees or royalty payments are due quarterly based upon synthetic
fuel produced and sold as reported to Covol by its licensees. Advance license
fees are normally due when construction of the related synthetic fuel facility
begins, when construction is completed, or when certain construction milestones
or other specified conditions are met. Covol expects to receive approximately
$4,000,000 of additional advance license fees during 1999 upon the sale of
certain synthetic fuel facilities currently owned by Covol and upon the
achievement of certain production levels at two of the synthetic fuel
facilities. Earned license fees or royalty payments are expected to increase at
a moderate level in the near term with significant increases expected during mid
to late 1999.
Covol provides binder material to its licensees either at a fixed price
or at Covol's cost plus a contracted markup. Covol purchases binder material
under a long-term contract with a large chemical company. Total binder sales
during 1998 were $533,000 with a corresponding direct cost to Covol of $376,000.
Covol had sales of binder and coal fines to a related party during 1998 totaling
$141,000 compared to $7,000 during 1997. These revenues resulted primarily from
coal fines that were sold to the related party at Covol's cost as provided for
under the binder and license agreement with this party.
Covol expects an increase during 1999 of production of synthetic fuel
by its licensees as licensees improve production capability and establish
marketing agreements for end product. This will result in a corresponding
increase in earned license fees or royalty payments and sales of binder
products. However, Covol cannot assure increases in license fees, royalty
payments, and binder sales because Covol licensees must successfully obtain
adequate feedstock coal fines, process fines into synthetic fuel, and develop
markets for synthetic fuel. Covol believes that its licensees have made
significant progress in these areas during the quarter ended December 31, 1998,
but continued success cannot be assured.
Operating Costs and Expenses. Operating costs and expenses increased by
$3,579,000 to $5,140,000 during 1998 from $1,561,000 during 1997. Cost of coal
briquetting operations accounted for most of this variance as these costs
increased $3,063,000 from $457,000 during 1997 to $3,520,000 during 1998. During
1998, Covol incurred significantly higher operating expenses in connection with
the continued refinement and commercialization of the briquetting process in
connection with the 24 facilities placed in service during 1998, and in
particular the four facilities owned by Covol which are currently held for sale.
These expenses primarily related to labor and operating expenses at the four
Covol synthetic fuel facilities and the wash plant and synthetic fuel plant
located in Utah, discussed below, costs incurred in providing assistance to
Covol's licensees during the ramp-up of their synthetic fuel facilities, and
increased personnel costs. Covol expects to continue incurring losses into 1999
until the four facilities which it owns are sold, but expects to realize a gain
from these sales.
Covol operates one of the synthetic fuel facilities for Coaltech, a
partnership for which Covol is the general partner. Under this operating
agreement, Covol is contractually obligated to purchase all of the synthetic
fuel produced by Coaltech at cost plus $1 per ton. Production of synthetic fuel
from this facility during 1998 was not significant and accordingly, the cost per
ton is well in excess of the current market value. These costs and the
corresponding write-down of this inventory to its market value are included in
the cost of coal briquetting operations. The write-down was approximately
$1,150,000 during 1998 and $240,000 during 1997. Covol expects the excess cost
per ton to decrease in 1999 as production volumes increase.
17
<PAGE>
Selling, general and administrative expenses increased $188,000 or 25%
to $929,000 during 1998 from $741,000 for 1997. The largest components of
selling, general and administrative expenses for both periods were payroll,
professional services and travel expenses. Payroll costs increased approximately
$45,000 and professional services increased approximately $172,000, while travel
costs decreased approximately $37,000. Most of the increase in professional
services was due to increased legal costs.
Research and development costs decreased marginally during 1998. Covol
expects that research and development costs will increase in 1999 as Covol
focuses resources on further refinement of its binder technologies relative to
the synthetic fuel industry and the application of its binder technologies into
other areas.
Compensation expense on stock options, stock warrants, and issuance of
common stock decreased $45,000 to $162,000 for 1998 from $207,000 for 1997. This
expense relates to options granted in prior periods that vest over several years
and the compensation value that is being recognized as an expense over the
vesting period. This amount is expected to remain relatively level.
Other Income and Expense. During 1998, Covol had net other expenses of
$752,000 compared to $596,000 for 1997. This increase of $156,000 relates
primarily to a change between periods of $864,000 in the mark-to-market
adjustment of the carrying value of related party notes receivable
collateralized by common stock, offset in part by an increase in interest income
of $709,000.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note") with interest at 6% payable
over five years. It was determined that the Note should be discounted to an
appropriate market rate and accordingly, the Note was discounted at 10.25%
resulting in a discount of $1,281,000. The Note is guaranteed by the buyer of
the construction companies and is collateralized by stock and stock options of
Covol. Accordingly, the Note is "marked to market" each quarter based upon the
market value of Covol's common stock and is reflected in the balance sheet at
the underlying value of the collateral. This adjustment resulted in a write-down
of $571,000 during 1998, compared to a write-up of $293,000 during 1997. A
$515,000 payment on the Note was due in January 1999, of which $75,000 was
received. The balance of the January payment is expected to be received in the
quarter ending March 31, 1999. As of December 31, 1998 the Note had a carrying
value of $1,038,000. Included in interest income for 1998 is $515,000 related to
this Note.
Interest expense in 1997 consisted solely of expense based upon the
issuance of convertible debt and warrants at a discount. During December 1997,
Covol executed an amendment to a loan agreement with a licensee, which provided
funding for completing construction of a synthetic fuel facility in Alabama and
acquiring coal fines and for other purposes related to the facility. The
modification increased the amount available for borrowing with a provision that
borrowings were convertible into common stock under the same terms as the
original agreement. Based on the revised terms, an expense of approximately
$714,000 was recognized during the quarter for conversion rights issued at a
price below market. In October 1997, Covol entered into an agreement with
another licensee whereby the licensee agreed to finance a wash plant being
constructed by Covol to provide washed coal fines to a synthetic fuel facility
in Utah. As additional consideration to the licensee for the financing
arrangement, Covol granted warrants to purchase Covol common stock, resulting in
the recognition of approximately $398,000 of interest expense in that quarter.
Interest expense in 1998 consists of interest accrued on notes payable used to
finance the construction of synthetic fuel facilities held for sale and for
operating needs and includes $82,000 of amortization of value of common stock
warrants issued under terms of an existing debt agreement. Interest expense is
expected to decrease after the repayment of debt related to facilities held for
sale.
During September 1998, Covol offered the limited partners of Utah
Synfuel #1 and Alabama Synfuel #1 common stock of Covol in exchange for their
limited partnership interests. These exchanges, most of which were accounted for
in September 1998, were substantially completed by November 1998, at which time
Utah Synfuel #1 became a wholly-owned subsidiary of Covol and Alabama Synfuel #1
became a 98%-owned subsidiary of Covol. As a result of these exchanges, minority
interest in the losses of consolidated subsidiaries decreased from approximately
$86,000 in 1997 to approximately $0 in 1998. Covol believes the combined
operations of these partnerships will result in operating losses in the
near-term future, which losses will be included in Covol's statement of
operations.
18
<PAGE>
Net loss. For 1998, the net loss increased by $3,621,000 from
$1,116,000 for 1997 to $4,737,000. The increase is primarily due to the
significant increase in the cost of briquetting operations, which was partially
offset by increased interest income as discussed previously. Covol did not
recognize any income tax benefit in 1998 or 1997 since the realization of its
deferred tax asset, consisting primarily of net operating loss carryforwards,
depends on generation of future taxable income.
Liquidity and Capital Resources
Liquidity. During the fiscal year 1998, Covol and its licensees
completed the construction of and began operations at 24 synthetic fuel
facilities. Covol currently owns four facilities which it constructed and which
are either under option to purchase or are being offered for sale. Covol
anticipates sale of these facilities during the year ending September 30, 1999.
The majority of the funds received from sale of these facilities will be used to
retire debt that was incurred principally in connection with the construction
and operation of these facilities and activities relative to the completion of
the other synthetic fuel facilities.
Net cash used in operating activities increased by $3,177,000 to
$4,146,000 during 1998 from $969,000 during 1997. Covol was able to fund its
operating activities, including the continued refinement and commercialization
of its patented binder technologies, through the incurrence of debt and the
issuance of convertible preferred stock, common stock and related common stock
warrants. During 1998, proceeds from the issuance of notes payable totaled
approximately $1,049,000 and issuances of common stock totaled $3,774,000.
Capital Resources. During the quarter ended December 31, 1998, Covol
used net cash in its investing activities totaling $599,000 compared to
$5,790,000 for 1997. These uses consisted principally of purchases of property,
plant and equipment. In 1997, a major portion of the purchases related to the
four facilities currently held for sale. Covol believes that funds required for
investing activities will be significantly less during 1999 because the
construction of facilities that produce synthetic fuel that qualifies for
federal income tax credits under Section 29 of the IRC were completed during
fiscal 1998.
Covol anticipates that earned license fees or royalties from the
production and sale of synthetic fuel will continue to increase during 1999. As
production levels increase, sales of the binder materials by Covol to its
licensees are expected to increase proportionately. Covol also anticipates
receiving the final amounts of advance license fees totaling approximately
$4,000,000 during 1999. Funds received by Covol from these activities are not
expected to be sufficient to cover Covol's operating costs and expenses until
the third quarter of 1999. Covol anticipates that these operating activities
will be producing operating cash flow by the end of 1999.
To provide funding for Covol's operations and debt repayment
requirements during early 1999, Covol will utilize proceeds from financing
transactions and excess proceeds from the sale of facilities. During November
1998, Covol issued common stock and common stock warrants for total net proceeds
of approximately $3,729,000. During January 1999, Covol issued convertible
preferred stock and warrants for total net proceeds of approximately $900,000.
Covol is presently negotiating and finalizing definitive agreements with respect
to previously negotiated term sheets for the sale of up to $16,000,000 of
additional convertible preferred stock, which financing is expected to close in
February 1999. Covol believes the funds raised in these financings and others,
if necessary, excess proceeds from the sale of facilities, and payments for
license fees and binder sales will be sufficient to fund Covol's operations and
debt repayment requirements until its operating activities begin producing
positive cash flow.
Forward Looking Statements
Statements in this Item 2 regarding Covol's expectations as to the
financing, development and operation of facilities utilizing Covol's binder
technologies, the receipt of licensing and royalty fees, revenues, the receipt
of fees for sale of binder materials, and other information presented herein
that are not purely historical by nature, constitute forward looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
Although Covol believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its business and operations,
there can be no assurance that actual results will not differ materially from
its expectations. In addition to matters affecting Covol's industry or the coal
19
<PAGE>
industry or the economy generally, factors which could cause actual results to
differ from expectations set forth in the above-identified forward looking
statements include in part, the following:
o the ability of licensees to produce and sell synthetic fuel at or
near the rated capacity of the synthetic fuel facilities;
o ability to obtain needed additional capital on terms acceptable to
Covol;
o changes in governmental regulation or failure to comply with existing
regulations which may result in operational shutdowns of its
facilities; and
o the availability of tax credits under Section 29 of the tax code.
See "ITEM 1. BUSINESS--Forward Looking Statements" in Covol's Annual
Report on Form 10-K for the year ended September 30, 1998 for a description of
additional factors which could cause actual results to differ from expectations.
Year 2000 Issues
The year 2000 issue results from computer programs and electronic
circuitry that do not differentiate between the year 1900 and year 2000 because
they are written using two-digit rather than four-digit dates to define the
applicable year. Many computer applications and date-sensitive devices could
fail or produce erroneous results when processing data after December 31, 1999.
Covol does not have any computer applications that it believes are
mission critical to the operation of synthetic fuel facilities that it operates.
While Covol has not formally verified Year 2000 compliance with licensees that
utilize Covol's technology in their synthetic fuel facilities, it is believed
that the computer applications used in the operations of these facilities are
not mission critical. Accordingly, it is believed that Year 2000 issues will not
be significant to these computer applications and accordingly, upgrading or
modifications to these applications to make them Year 2000 compliant will not be
significant.
During fiscal year 1998, Covol upgraded its network operating system
and believes that system is Year 2000 compliant and that any additional
upgrading to that system will not be significant. Covol utilizes computer
applications in the finance and accounting departments and in the corporate
office that utilize a two-digit date that will need to be upgraded in order to
be Year 2000 compliant. Covol has contacted the providers of this software and
they have indicated that Year 2000 compliant software will be available in early
1999. Covol believes the cost to purchase this upgraded software and to convert
the applicable applications to this new software will be less than $50,000.
Covol anticipates that this conversion will be completed by June 30, 1999.
Other Items
Covol has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of Covol. Based on that review, Covol believes
that none of these pronouncements will have any significant effects on current
or future financial position or results of operations.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Asbestos Investigation. In January 1996, a manager of Covol entered
property owned by Nevada Electric Investment Company, a subsidiary of Nevada
Power Corporation, in connection with an offer by Covol to purchase the
property, and with certain other employees of Covol, removed some asbestos over
a two-day period. In May 1996, Covol received a notice of violation and order
for compliance from the State of Utah, Division of Air Quality alleging that
asbestos was improperly handled, removed, and disposed of. Covol complied with
the order and in September 1996 entered into a settlement agreement with the
State of Utah and paid a fine in the amount of $11,000. In late 1997, the U.S.
20
<PAGE>
Environmental Protection Agency began its own investigation, referring the
matter to the U.S. Attorney's office which proceeded with a grand jury inquiry.
Covol was served in September 1998 with a grand jury subpoena for records, with
which Covol has complied. Covol does not know the results of the grand jury
inquiry or whether the inquiry is completed. Covol does not believe that the
resolution of this matter will have a material adverse effect on Covol.
Indemnification to Centerline. In December 1996, Covol entered into six
indemnification agreements with Centerline whereby Covol agreed to indemnify
Centerline should it be required to pay liquidated damages to PacifiCorp under
various design and construction agreements for six synthetic fuel facilities.
Under the original terms of the various design and construction agreements, if
the facilities were not completed by June 1, 1998 then $750,000 in liquidated
damages for each facility would be due and payable by Centerline. The
indemnification agreement only applied if PacifiCorp actually decided to build
the facilities with Centerline as the design/builder. PacifiCorp elected to not
build three of the projects, and therefore the indemnity agreement with respect
to those facilities no longer applies. Accordingly, the maximum amount of
contingent liability to Covol under the indemnification agreements is $2,250,000
($750,000 per design and construction agreement). Counsel for Centerline has
notified Covol that a dispute exists between Centerline and PacifiCorp, which
may require indemnification by Covol. Covol has been advised that the dispute is
proceeding to arbitration.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past
fiscal quarter and subsequent to December 31, 1998 without registering the
securities under the Securities Act of 1933, as amended. No underwriters were
involved in any stock issuances.
The issuance of qualified options is required to be based on market
value. Accordingly, the exercise price is set based on the market price of
Covol's common stock, even though the options convert into restricted stock.
Covol believes that the following issuances of shares of common stock
or securities for contingently issuable common stock were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
the exemption set forth in Section 4(2) or 4(6) thereof or Regulation D
promulgated thereunder and the certificate for each security bears a restrictive
legend. Each investor made representations to Covol that it was accredited as
that term is defined in Regulation D and that the security was acquired for
investment purposes.
In 1996, Covol formed two limited partnerships, Alabama Synfuel #1 Ltd.
and Utah Synfuel #1 Ltd., to assist with the financing of construction at two
synthetic fuel manufacturing facilities. These two facilities have been sold and
are now owned by Birmingham Syn Fuel, L.L.C. and Coaltech No. 1 L.P. On
September 9, 1998, Covol offered the limited partners in Alabama Synfuel #1 and
Utah Synfuel #1 an exchange of Covol's common stock for their limited
partnership interests. The exchange ratio was based in part on an independent
valuation of the limited partnerships' assets and other factors including but
not limited to current and future expected cash flow of the partnerships and
current market values of Covol's common stock as quoted on NASDAQ. The exchange
ratio for Utah Synfuel #1 was 112.828 shares of common stock per each limited
partnership unit and 125.97 shares for each Alabama Synfuel #1 limited
partnership unit. The limited partnerships' units originally sold for $1,000 per
unit.
As of November 10, 1998, all of the limited partners in Utah Synfuel #1
and all but one of the limited partners in Alabama Synfuel #1 had agreed to
exchange their limited partnership interests for shares of Covol's common stock,
and accordingly Utah Synfuel #1 became a wholly-owned subsidiary of Covol and
Alabama Synfuel #1 became a 98%-owned subsidiary of Covol.
During November 1998, Covol completed a financing transaction that
consisted of $400,000 of debt and approximately $3,500,000 of equity issued to
28 investors. The debt had a term of twelve months, bears interest at 15% per
annum, with an interest only payment due in six months and with the balance of
interest and principal due at maturity. The debt is collateralized by certain
assets of Covol and is due prior to maturity upon the placement of long-term
21
<PAGE>
financing by Covol. The equity transaction consisted of the sale of a unit at a
price of $5.00. A unit consisted of one share of restricted common stock of
Covol plus a warrant to purchase one additional share of restricted common stock
at an exercise price of $7.50. The warrants expire in twelve months if not
exercised. The stock and shares issuable pursuant to the related warrants bear
"piggyback" registration rights.
In March 1996, Raymond G. Weller made a personal loan of $459,250 to
Covol at the request of Covol's then CEO and CFO at a time when Covol was in
great financial need. This loan was repaid in 1996 through the issuance of Covol
common stock to Mr. Weller. It appears that the then management committed Covol
to issue to Mr. Weller up to 34,000 shares of Covol common stock as compensation
for the personal risk taken by Mr. Weller. The CEO and CFO left Covol in October
1996 before the transaction was completed. Mr. Weller continued to support Covol
and provided leadership and guidance as a director through the period of
transition between prior and current management. After confirming the
circumstances surrounding the transaction, Covol's current management negotiated
a resolution of the matter with Mr. Weller, and approved the issuance of 20,000
shares of restricted stock in complete satisfaction of any obligation Covol may
have to Mr. Weller with respect to this transaction. The Board has approved the
resolution.
On December 3, 1998, Covol issued 60,000 shares of Covol common stock
to a single investor as partial consideration for the purchase of a patent and
related intellectual property rights with respect to an alternative method of
production of solid synthetic fuel.
In January 1999, Covol issued to four accredited investors, pursuant to
a consulting compensation agreement dated August 1998, options to purchase an
aggregate of 60,000 shares of Covol common stock, at an exercise price of $12.75
per share. The exercise price will be reduced to $8.58 per share if a consulting
fee is not paid to the accredited investors as set forth in the consulting
compensation agreement. The options are nontransferable and include piggy-back
registration rights, which may be exercised two times. The options are
exercisable until August 2003, after which any unexercised options will expire.
Reference is made to the sale of series C convertible preferred stock
described in Note 8 to the consolidated financial statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Technology Acquisition
Effective as of November 10, 1998, Covol acquired a coal-based
synthetic fuel technology known as Carbontite(R), along with related licensing
and patent rights owned by Dr. James G. Davidson and Adtech, Inc., including
U.S. Patent No. 5,238,692. This acquisition transferred to Covol, in exchange
for $100,000 and the issuance of 60,000 shares of Covol common stock, patent
ownership and licensor rights and obligations to existing license agreements
with Carbontech Energy Corporation ("CEC"), which in turn has sublicensed the
technology to Carbontronics, the developer of the following synthetic fuel
facilities:
Location Rated Annual Capacity
Gibraltar, KY 600,000 tons
Lynnville, IN 600,000 tons
Metropolis, IL 1,200,000 tons
22
<PAGE>
The Gibraltar, Kentucky and Lynnville, Indiana synthetic fuel
facilities are located at Peabody coal mine sites and are operated by Peabody.
The Metropolis facilities are located at the Cook coal terminal operated by
American Electric Power.
As the owner of the Carbontite(R) technology and related license
rights, Covol is to receive from CEC a share of the license fees paid to
Carbontec by sublicensees, plus a prescribed royalty per ton of the finished
product sold in plants operated by CEC or its sublicensees. The existing
assigned license agreements do not provide for sale of chemical binder to
licensees.
In connection with the acquisition of the Carbontite(R) technology,
Covol entered into a consulting agreement with Dr. Davidson to provide
consulting services related to iron revert, coke, charcoal, waste recycling, and
other related applications. In addition, Dr. Davidson granted rights to Covol
for implementation of other technologies related to the business activities of
Covol.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
3.1.5 Certificate of Designation, Number, Voting Powers,
Preferences and Rights of Covol's Series C 7% Convertible
Preferred Stock.
10.56 Employment Agreement effective April 21, 1998 with Brent M.
Cook.
10.57 Employment Agreement effective January 1, 1999 with Steven
R. Brown.
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the three months ended December 31,
1998.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
Date: February 12, 1999 By: /s/ Brent M. Cook
--------------------------
Brent M. Cook, Chief Executive
Officer and Principal
Executive Officer
Date: February 12, 1999 By: /s/ Steven G. Stewart
--------------------------
Steven G. Stewart, Chief
Financial Officer and
Principal Financial Officer
24
Certificate of Designation, Number, Voting Powers,
Preferences and Rights of the Series of the Preferred Stock
of
COVOL TECHNOLOGIES, INC.
To be Designated
Series C 7% Convertible Preferred Stock
Covol Technologies, Inc., a Delaware corporation (the "Corporation"),
pursuant to authority conferred on the Board of Directors of the Corporation by
its Certificate of Incorporation, as amended, and in accordance with the
provisions of Section 151 of the General Corporation Law of Delaware ("DGCL"),
certifies that the Board of Directors of the Corporation, at a meeting duly
called and held pursuant to Section 141 of the DGCL, duly adopted the following
resolution providing for the establishment and issuance of a series of Preferred
Stock to be designated as "Series C 7% Convertible Preferred Stock" and to
consist of 1,500 shares as follows:
RESOLVED, that, pursuant to the authority expressly granted and vested
in the Board of Directors of this Corporation in accordance with the provisions
of its Certificate of Incorporation, as amended, a series of Preferred Stock of
the Corporation be and hereby is established, consisting of 1,500 shares, to be
designated as "Series C 7% Convertible Preferred Stock" (the "Series C 7%
Preferred"); the Board of Directors be and hereby is authorized to issue such
shares of Series C 7% Preferred Stock from time to time and for such
consideration and on such terms as the Board of Directors shall determine; and
subject to the limitations provided by law and by the Certificate of
Incorporation, as amended, the powers, designations, preferences and relative,
participating, option or other special rights of, and the qualifications,
limitations or restrictions upon, the Series C 7% Preferred shall be as follows:
Section 1. Definitions.
"Common Stock" means, collectively, the Corporation's common stock, par
value $.001 per share.
"Conversion Stock" means shares of the Corporation's Common Stock;
provided that if there is a change such that the securities issuable upon
conversion of the Series C 7% Preferred are issued by an entity other than the
Corporation or there is a change in the class of securities so issuable, then
the term "Conversion Stock" shall mean one share of the security issuable upon
conversion of the Series C 7% Preferred if such security is issuable in
<PAGE>
shares, or shall mean the smallest unit in which such security is issuable if
such security is not issuable in shares.
"Junior Securities" means any of the Corporation's Common Stock.
"Liquidation Value" of any Share (as defined in Section 2A hereof) as
of any particular date shall be equal to One Thousand Dollars ($1,000.00).
"Market Price" of any security means (i) the average of the closing
prices of such security's sales on all securities exchanges on which such
security may at the time be listed, or, if there has been no sales on any such
exchange on any day, the average of the highest bid and lowest asked prices on
all such exchanges at the end of such day, or, (ii) if on any day such security
is not so listed, the reported closing price on the Nasdaq National Market
("NNM"), or, if the security is listed on the NNM but there has been no sales on
such market on any day, the average of the highest bid and lowest asked prices
on the NNM at the end of such day, or (iii) the average of the representative
bid and asked prices quoted in the Nasdaq Smallcap Market as of 4:00 P.M., New
York time, or, if on any day such security is not quoted in the Nasdaq SmallCap
Market, the average of the highest bid and lowest asked prices on such day in
the domestic over-the-counter market as reported by the National Quotation
Bureau, Incorporated, or any similar successor organization. If at any time such
security is not listed on any securities exchange, the NNM, or quoted in the
Nasdaq Smallcap Market or the over-the-counter market, the "Market Price" shall
be the fair value thereof determined jointly by the Corporation and the holders
of a majority of the Series C 7% Preferred. If such parties are unable to reach
agreement within a reasonable period of time, such fair value shall be
determined by an independent appraiser experienced in valuing securities jointly
selected by the Corporation and the holders of a majority of the Series C 7%
Preferred. The determination of such appraiser shall be final and binding upon
the parties, and the Corporation shall pay the fees and expenses of such
appraiser.
"Person" means an individual, a partnership, a corporation, an
association, a joint stock company, a trust, a joint venture, an unincorporated
organization and a governmental entity or any department, agency or political
subdivision thereof.
"Redemption Date" as to any Share means the date specified in the
notice of any redemption at the Corporation's option or the applicable date
specified herein in the case of any other redemption; provided that no such date
shall be a Redemption Date unless the Liquidation Value of such Share (plus all
accrued and unpaid dividends thereon) is actually paid in full on such date, and
if not so paid in full, the Redemption Date shall be the date on which such
amount is fully paid.
Section 2. Dividends.
2A. General Obligation. When and as declared by the Corporation's Board
of Directors and to the extent permitted under the General Corporation Law of
Delaware, the Corporation shall pay preferential dividends monthly to the
holders of the Series C 7% Preferred Stock as provided in this Section. Except
as otherwise provided herein, dividends on each share of the Series C 7%
Preferred (a "Share") shall accrue on a daily basis at the rate of 7% per annum
of the sum of the Liquidation Value thereof, from and including the date of
issuance of such Share to and including the date on which the Liquidation Value
of
2
<PAGE>
such Share is paid or the date on which such Share is converted into shares of
Conversion Stock hereunder; provided, however, that no compounding of such
dividends shall be authorized thereon. Such dividends shall accrue whether or
not they have been declared and whether or not there are profits, surplus or
other funds of the Corporation legally available for the payment of dividends.
Such dividends shall be cumulative such that all accrued and unpaid dividends
shall be fully paid or declared with funds irrevocably set apart for payment
before any dividend, distribution or payment may be made with respect to any
Junior Securities. The date on which the Corporation initially issues any Share
shall be deemed to be its "date of issuance" regardless of the number of times
transfer of such Share is made on the stock records maintained by or for the
Corporation and regardless of the number of certificates which may be issued to
evidence such Share.
2B. Dividend Reference Date. To the extent not paid monthly on the 22d
day of the calendar month, commencing February 22, 1999, all dividends which
have accrued on each Share outstanding during the month (or other period in the
case of the initial Dividend Reference Date) ending upon each such Dividend
Reference Date shall be accumulated and shall remain accumulated dividends with
respect to such Share until paid.
2C. Distribution of Partial Dividend Payments. Except as otherwise
provided herein, if at any time the Corporation pays less than the total amount
of dividends then accrued with respect to the Series C 7% Preferred, such
payment shall be distributed ratably among the holders thereof based upon the
number of Shares held by each such holder.
2D. Payment of Stock Dividends. In the sole discretion of the
Corporation, any dividends accruing on Shares of Series C 7% Preferred may be
paid in lieu of cash dividends by the issuance of additional Shares of Series C
7% Preferred (including fractional Shares) having an aggregate Liquidation Value
at the time of such payment equal to the amount of the dividend to be paid;
provided that if the Corporation pays less than the total amount of dividends
then accrued on the Series C 7% Preferred in the form of additional Shares, such
payment in Shares shall be made pro rata to the holders of Series C 7% Preferred
based upon the aggregate accrued but unpaid dividends on the Shares of Series C
7% Preferred held by each such holder.
Section 3. Liquidation.
Upon any liquidation, dissolution or winding up of the Corporation,
each holder of Series C 7% Preferred shall be entitled to be paid, before any
distribution or payment is made upon any Junior Securities, an amount in cash
equal to the aggregate Liquidation Value (plus all accrued and unpaid dividends)
of all Shares held by such holder, and the holders of Series C 7% Preferred
shall not be entitled to any further payment. If at the time of such
liquidation, dissolution or winding up, other series of the Corporation's
preferred stock are outstanding, the Series C 7% Preferred will be considered to
have the same priority to receive payments, pari passu, as all other series of
preferred stock which are, by their terms, senior to the Junior Securities and
which do not provide by their terms that they are senior to, or junior to, the
Series C 7% Preferred. If upon any such liquidation, dissolution or winding up
of the Corporation, the Corporation's assets to be distributed among the holders
of the Series C 7% Preferred are insufficient to permit payment to such holders
of the aggregate amount which they are entitled to be paid, then the entire
assets to be so distributed shall be distributed ratably among such holders
based upon the aggregate
3
<PAGE>
Liquidation Value (plus all accrued and unpaid dividends) of the Series C 7%
Preferred held by each such holder. Prior to the liquidation, dissolution or
winding up of the Corporation, the Corporation shall declare for payment all
accrued and unpaid dividends with respect to the Series C 7% Preferred. The
Corporation shall mail written notice of such liquidation, dissolution or
winding up, not less than 60 days prior to the payment date stated therein, to
each record holder of Series C 7% Preferred. Neither the consolidation or merger
of the Corporation into or with any other entity or entities, nor the sale or
transfer by the Corporation of less than substantially all of its assets, nor
the reduction of the capital stock of the Corporation, shall be deemed to be a
liquidation, dissolution or winding up of the Corporation within the meaning of
this Section.
Section 4. Redemption.
4A. Optional Redemptions. The Corporation may at any time within 180
days after the date of initial issuance (as defined in Section 2A) redeem all or
any portion of Series C 7% Preferred then outstanding. On any such redemption,
the Corporation shall pay a price per Share equal to 125% of the Liquidation
Value thereof, plus 100% of all accrued and unpaid dividends thereon.
4B. Redemption Payment. For each Share which is to be redeemed, the
Corporation shall be obligated on the Redemption Date to pay to the holder
thereof (upon surrender by such holder at the Corporation's principal office of
the certificate representing such Share) an amount in immediately available
funds equal to 125% of the Liquidation Value of such Share (plus 100% of all
accrued and unpaid dividends thereon). If the funds of the Corporation legally
available for redemption of Shares on any Redemption Date are insufficient to
redeem the total number of Shares to be redeemed on such date, those funds which
are legally available shall be used to redeem the maximum possible number of
Shares ratably among the holders of the Shares to be redeemed based upon the
aggregate Liquidation Value of such Shares (plus all accrued and unpaid
dividends thereon) held by each such holder. At any time thereafter when
additional funds of the Corporation are legally available for the redemption of
Shares, such funds shall immediately be used to redeem the balance of the Shares
which the Corporation has become obligated to redeem on any Redemption Date but
which it has not redeemed.
4C. Notice of Redemption. The Corporation shall mail written notice of
each redemption of any Series C 7% Preferred to each record holder thereof not
less than 10 days prior to the date on which such redemption is to be made. If
on the redemption date specified in the notice, the Corporation fails to pay the
redemption payment on any Shares properly tendered for redemption, then as sole
remedy to the holder whose redemption price was not paid (the "Defaulted
Holder") the Corporation agrees that (i) the redemption notice shall be void
with respect to such unpaid Shares of the Defaulted Holder, (ii) the Conversion
Price of the Shares for which the redemption notice is void shall be reduced by
5%, (iii) the limitations on conversion contained in subparagraph 6A(ii) shall
no longer apply to any Shares held by the Defaulted Holder, and (iv) any of the
Corporation's warrants issued in connection with the initial issuance of the
Series C 7% Preferred held by the Defaulted Holder shall be and become
exercisable notwithstanding provisions therein restricting exercise thereof
prior to stated dates. In case fewer than the total number of Shares represented
by any certificate are redeemed, a new certificate representing the number of
4
<PAGE>
unredeemed Shares shall be issued to the holder thereof without cost to such
holder within ten (10) business days after surrender of the certificate
representing the redeemed Shares.
4D. Determination of the Number of Each Holder's Shares to be Redeemed.
Except as otherwise provided herein, the number of Shares of Series C 7%
Preferred to be redeemed from each holder thereof in redemptions hereunder shall
be the number of Shares determined by multiplying the total number of Shares to
be redeemed times a fraction, the numerator of which shall be the total number
of Shares then held by such holder and the denominator of which shall be the
total number of Shares then outstanding.
4E. Dividends After Redemption Date. No Share is entitled to any
dividends accruing after the date on which 125% of the Liquidation Value of such
Share (plus 100% of all accrued and unpaid dividends thereon) is paid to the
holder thereof. On such date all rights of the holder of such Share shall cease,
and such Share shall not be deemed to be outstanding.
4F. Redeemed or Otherwise Acquired Shares. Any Shares which are
redeemed or otherwise acquired by the Corporation shall be cancelled and shall
be deemed to be undesignated authorized and unissued preferred shares.
4G. Other Redemptions or Acquisitions. The Corporation shall not redeem
or otherwise acquire any Series C 7% Preferred, except as expressly authorized
herein or pursuant to a purchase offer made pro-rata to all holders of Series C
7% Preferred on the basis of the number of Shares owned by each such holder.
Section 5. Voting Rights. The Series C 7% Preferred
shall have no voting rights unless specifically authorized by the DGCL.
Section 6. Conversion.
6A. Conversion Procedure.
(i) Subject to and in compliance with the provisions of this
Certificate of Designation, any holder of Series C 7% Preferred may convert all
or any portion of the Series C 7% Preferred held by such holder into a number of
shares of Conversion Stock computed by multiplying the number of Shares to be
converted by $1,000 and dividing the result by the Conversion Price then in
effect.
(ii) The right of the holders to convert the Series C 7%
Preferred shall be subject to the following limitations:
(a) No Series C 7% Preferred may be converted on
or before April 15, 1999.
(b) Commencing April 16, 1999, each holder of the
Series C 7% Preferred may convert up to 10% of the Shares held by him at April
15, 1999, plus any Shares or fractional Shares issued in payment of dividends.
5
<PAGE>
(c) Commencing May 16, 1999, each holder of the
Series C 7% Preferred may convert up to an additional 10% of the Shares held by
him at April 15, 1999 (i.e. up to a total of 20% on a cumulative basis), plus
any Shares or fractional Shares issued in payment of dividends.
(d) Commencing June 16, 1999, each holder of the
Series C 7% Preferred may convert up to an additional 10% of the Shares held by
him at April 15, 1999 (i.e. up to a total of 30% on a cumulative basis), plus
any Shares or fractional Shares issued in payment of dividends.
(e) Commencing July 16, 1999, each holder of the
Series C 7% Preferred may convert his Shares without regard to limitations under
this subparagraph (ii).
(iii) Each conversion of Series C 7% Preferred shall be deemed
to have been effected as of the close of business on the date on which the
certificate or certificates representing the Series C 7% Preferred to be
converted have been surrendered at the principal office of the Corporation (the
"Conversion Date"). At such time as such conversion has been effected, the
rights of the holder of such Series C 7% Preferred as such holder shall cease
and the Person or Persons in whose name or names any certificate or certificates
for shares of Conversion Stock are to be issued upon such conversion shall be
deemed to have become the holder or holders of record of the shares of
Conversion Stock represented thereby.
(iv) The conversion rights of any Share subject to redemption
hereunder shall terminate on the Redemption Date for such Share unless the
Corporation has failed to pay to the holder thereof 125% of Liquidation Value
thereof (plus 100% of all accrued and unpaid dividends thereon).
(v) Within two business days after a conversion has been
effected, the Corporation shall make available to the converting holder at the
Corporation's transfer agent:
(a) a certificate or certificates representing the
number of shares of Conversion Stock issuable by reason of such
conversion in such name or names and such denomination or denominations
as the converting holder has specified;
(b) payment in an amount equal to all accrued
dividends with respect to each Share converted, which have not been
paid prior thereto, plus the amount payable under subparagraph (ix)
below with respect to such conversion; provided, however, that such
accrued dividends may, at the Corporation's option, be converted into
an additional number of shares of Conversion Stock by dividing the
amount of unpaid dividends by the Conversion Price; and
(c) a certificate representing any Shares of Series C
7% Preferred which were represented by the certificate or certificates
delivered to the Corporation in connection with such conversion but
which were not converted.
(vi) Upon conversion, the Corporation shall convert all
accrued and unpaid dividends on the Series C 7% Preferred being converted into
an additional number of shares of Conversion Stock (which will be delivered
within ten (10) business days) determined by
6
<PAGE>
dividing the amount of the unpaid dividends to be applied for such purpose, by
the Conversion Price.
(vii) The issuance of certificates for shares of Conversion
Stock upon conversion of Series C 7% Preferred shall be made without charge to
the holders of such Series C 7% Preferred for any issuance tax in respect
thereof or other cost incurred by the Corporation in connection with such
conversion and the related issuance of shares of Conversion Stock. Upon
conversion of each Share of Series C 7% Preferred, the Corporation shall take
all such actions as are necessary in order to insure that the Conversion Stock
issuable with respect to such conversion shall be validly issued, fully paid and
nonassessable.
(viii) The Corporation shall assist and cooperate with any
holder of Shares required to make any governmental filings or obtain any
governmental approval prior to or in connection with any conversion of Shares
hereunder (including, without limitation, making any filings required to be made
by the Corporation).
(ix) If any fractional interest in a share of Conversion Stock
would, except for the provisions of this subparagraph, be deliverable upon any
conversion of the Series C 7% Preferred, the Corporation, in lieu of delivering
the fractional share therefor, shall pay an amount to the holder thereof equal
to the Market Price of such fractional interest as of the date of conversion.
(x) The Corporation shall at all times reserve and keep
available out of its authorized but unissued shares of Conversion Stock, solely
for the purpose of issuance upon the conversion of the Series C 7% Preferred,
such number of shares of Conversion Stock issuable upon the conversion of all
outstanding Series C 7% Preferred. All shares of Conversion Stock which are so
issuable shall, when issued, be duly and validly issued, fully paid and
nonassessable and free from all taxes, liens and charges. The Corporation shall
take all such actions as may be necessary to assure that all such shares of
Conversion Stock may be so issued without violation of any applicable law or
governmental regulation or any requirements of any domestic securities exchange
upon which shares of Conversion Stock may be listed (except for official notice
of issuance which shall be immediately delivered by the Corporation upon each
such issuance).
(xi) If the shares of Conversion Stock issuable by reason of
such conversion of Series C 7% Preferred are convertible into or exchangeable
for any other stock or securities of the Corporation, the Corporation shall, at
the converting holder's option, upon surrender of the Shares to be converted by
such holder as provided above together with any notice, statement or payment
required to effect such conversion or exchange of Conversion Stock, deliver to
such holder or as otherwise specified by such holder a certificate or
certificates representing the stock or securities into which the shares of
Conversion Stock issuable by reason of such conversion are so convertible or
exchangeable, registered in such name or names and in such denomination or
denominations as such holder has specified.
6B. Conversion Price. The Conversion Price shall be $5.50,
which price shall be subject to adjustment as set forth in Section 6D.
7
<PAGE>
6C. Limitation on Conversion. Notwithstanding any other provisions
hereof, no holder of Shares shall be entitled to exercise the conversion rights
under this Section to acquire any share or shares of Common Stock if, as a
result of such conversion, such holder and its affiliates, directly or
indirectly, would own, control or have power to vote a greater quantity of
securities of any kind issued by the Corporation than such holder and its
affiliates would be permitted to own, control or have power to vote under any
law or under any regulation, rules or other requirement of any governmental
authority at any time applicable to such holder and its affiliates. For purposes
of this paragraph, a written statement of the holder involved, to the effect
that such holder is legally entitled to exercise its conversion rights under
this Section to acquire shares of Common Stock and that such holder shall not
violate the prohibitions set forth in the preceding sentence, shall be
sufficient evidence of the legality thereof and shall obligate the Corporation
to deliver certificates representing the shares of Common Stock so purchased in
accordance with the other provisions hereof.
6D. Anti-Dilution Provisions.
(a) If on the trading day immediately preceding the Conversion
Date, the Market Price of the Common Stock is less than $5.50 per share (or an
equivalent amount for Conversion Stock other than Common Stock), then the
Conversion Price for conversions on such Conversion Date shall be adjusted to
equal the average of the three lowest closing bid prices of the Conversion Stock
(or the closing prices if the Conversion Stock is listed on an exchange) during
the 15 trading days immediately preceding the Conversion Date.
(b) If, at any time or from time to time after the date
hereof, the Corporation shall distribute property or assets to all holders of
Common Stock (excluding (x) dividends paid in, or distributions of, the
Corporation's capital stock for which the number of Conversion Stock receivable
hereunder shall have been adjusted pursuant to Subsection 4(b), and (y)
dividends or distributions paid in cash if the Series C 7% Preferred is
converted into Conversion Stock prior to the record date therefor) (any of the
foregoing being hereinafter in this Subsection 4(a) called the "Property"),
then, in each such case, the Corporation shall reserve sufficient Property for
distribution upon conversion of Series C 7% Preferred so that, in addition to
the Conversion Stock to which a person owning Series C 7% Preferred ("Holder")
is entitled, the Holder will receive upon such conversion the amount and kind of
such Property which such Holder would have received if the Holder had,
immediately prior to the record date for the distribution of the Property,
converted the Series C 7% Preferred to the Conversion Stock. Notice of each such
distribution shall be given to the Holder concurrently with any notice given to
the holders of Common Stock regarding such distribution.
(c) In case the Corporation shall hereafter i) pay a dividend
or make a distribution on its Common Stock payable in shares of capital stock,
ii) subdivide its outstanding shares of Common Stock into a greater number of
shares, iii) combine its outstanding shares of Common Stock into a smaller
number of shares or iv) issue by reclassification of its Common Stock any shares
of capital stock of the Corporation, then, in any such event, the Holder shall
be entitled to receive the aggregate number and kind of shares which, if the
Holder had converted the Series C 7% Preferred to the Conversion Stock
immediately prior to the record date with respect to the dividend or
distribution or the effective date of the subdivision, combination or
reclassification, he would have been entitled to receive by virtue of such
dividend, distribution, subdivision, combination or
8
<PAGE>
reclassification, and the Conversion Price shall be appropriately adjusted. Such
adjustment shall be made successively whenever any event listed above shall
occur. An adjustment made pursuant to this subsection (b) shall become effective
immediately after the record date in the case of a dividend or distribution and
shall become effective immediately after the effective date in the case of a
subdivision, combination or reclassification. If, as a result of an adjustment
made pursuant to this subsection (b), the Holder shall become entitled to
receive shares of two or more classes of capital stock or shares of Common Stock
and other capital stock of the Corporation, then Series C 7% Preferred may
thereafter be converted to units consisting of whole number multiples of each
such securities, as designated by the Board of Directors.
(d) In case of any of the following events (each of which
shall be deemed a "Reorganization Event"): (i) any consolidation or merger to
which the Corporation is a party, other than a merger or consolidation in which
the Corporation is the continuing corporation, (ii) any sale or conveyance to
another entity of all or substantially all of the assets of the Corporation
(including a sale of all or substantially all of the assets of the Corporation
for a consideration consisting primarily of securities) or (iii) any statutory
exchange of securities with another corporation (including any exchange effected
in connection with a merger of a third party into the Corporation), the Holder
shall have the right thereafter to receive upon conversion of the Series C 7%
Preferred the kind and amount of securities, cash or other property which he
would have owned or have been entitled to receive immediately after such
Reorganization Event had such Series C 7% Preferred been converted immediately
prior to the effective date of such Reorganization Event and in any such case,
if necessary, appropriate adjustment shall be made in the application of the
provisions set forth in this Section with respect to the rights and interests
thereafter of the Holder to the end that the provisions set forth in this
Section shall thereafter correspondingly be made applicable, as nearly as may
reasonably be, in relation to any shares of stock or other securities or
property thereafter deliverable on the exercise of this Warrant. The foregoing
provisions of this Subsection shall similarly apply to successive Reorganization
Events. Notice of any Reorganization Event and of said provisions so proposed to
be made shall be mailed to the Holder not less than 30 days prior to the
effective date of such event.
(e) Notwithstanding any other provision of this Section, no
adjustment in the Conversion Price shall be required unless such adjustment
would require an increase or decrease of at least $0.05 per share of Common
Stock and no adjustment in the number of Conversion Stock issuable shall be
required if such adjustment would represent less than one percent of the number
of Conversion Stock to be so delivered; provided, however, that any adjustments
which by reason of this Subsection (d) are not required to be made shall be
carried forward and taken into account in any subsequent adjustment, and
provided further, however, that adjustments shall be required and made in
accordance with the provisions of this Section (other than this Subsection (d))
not later than such time as may be required in order to preserve the tax-free
nature of a distribution to the Holder. All calculations under this Section
shall be made to the nearest cent or to the nearest 1/100th of a share, as the
case may be. Anything in this Section to the contrary notwithstanding, the
Corporation shall be entitled to make such reductions in the Conversion Stock,
in addition to those required by this Section, as it in its discretion shall
deem to be advisable in order that any stock dividend, subdivision of shares, or
distribution of rights to purchase stock or securities convertible or
exchangeable for stock hereafter made by the Corporation to its shareholders
shall not be taxable.
9
<PAGE>
(f) Whenever the Conversion Price is adjusted as provided in
this Section and upon any modification of the rights of the Holder in accordance
with this Section, the Corporation shall promptly prepare a certificate of the
Corporation's Chief Financial Officer, setting forth the Conversion Price and
the number of Conversion Stock after such adjustment or the effect or such
modification, a brief statement of the facts requiring such adjustment or
modification and the manner of computing the same and cause a copy of such
certificate to be mailed to the Holder.
(g) If the Board of Directors of the Corporation shall declare
any dividend or other distribution in cash with respect to the Common Stock,
other than out of earned surplus, the Corporation shall mail notice thereof to
the Holder not less than 15 days prior to the record date fixed for determining
shareholders entitled to participate in such dividend or other distribution.
(h) The Corporation will, at its sole cost and expense,
(subject to the holder bearing the costs of commissions and independent legal
review) covenants that if at any time during the period in which the Series C 7%
Preferred may be converted the Corporation should file a registration statement
or offering statement pursuant to applicable federal and state securities laws
for a public offering of securities, (except on Form S-4 or S- 8 or their
successor forms) the Corporation will provide written notification to the holder
at least 10 days but not more than 60 days prior to the filing date of such
registration statement or offering statement and use its best efforts to seek to
register or qualify or cause to be registered or qualified, at the option of the
holder, the sale and resale of all, or such amounts as the Corporation may
legally and lawfully cause to be registered or on a pro-rata basis if limited by
the firm or persons underwriting such offering, of the Conversion Stock
underlying the Series C 7% Preferred (which are deliverable upon conversion of
the Series C 7% Preferred) and the Corporation will use its best efforts to seek
to maintain such registration statement or offering statement effective for all
periods during which the Series C 7% Preferred may be converted until such time
as the Corporation receives an opinion of counsel to the effect that the
underlying Conversion Stock may be publicly resold without registration. If no
other registration statement is being filed registering the Conversion Stock
underlying the Series C 7% Preferred, the Corporation will, at its sole cost and
expense, (subject to the holder bearing the costs of commissions and independent
legal review) cause a registration statement covering the Conversion Stock
underlying the Series C 7% Preferred to be effective within 90 days after
closing of the initial issuance of the Series C 7% Preferred. If a holder
tenders Series C 7% Preferred for conversion at a time when the Conversion Stock
underlying such Shares is not registered for sale, such failure of registration
is hereinafter referred to as an "Event", and the date on which such Event
occurs is hereinafter referred to as an "Event Date". If an Event has occurred
and not been cured, the converting holder shall be entitled to receive from the
Corporation on conversion of the Series C 7% Preferred so converted, as sole
remedy for the failure to register, (i) on the Event Date, additional Conversion
Stock equal to 10% of the Conversion Stock otherwise issuable on conversion of
such tendered Shares based on the Conversion Price in effect on the Event Date,
and (ii) every thirty calendar days following the Event Date until the Event is
cured, additional Conversion Stock equal to 10% of the Conversion Stock
otherwise issuable on conversion of such tendered Shares based on the Conversion
Price in effect on the Event Date. For purposes of this paragraph, each
determination of whether an Event has occurred will be independently determined
for each conversion request.
10
<PAGE>
Section 7. Registration of Transfer.
The Corporation shall keep at its principal office a register for the
registration of Series C 7% Preferred. Subject to compliance with applicable
securities laws, upon the surrender of any certificate representing Series C 7%
Preferred at such place, the Corporation shall, at the request of the record
holder of such certificate, execute and deliver (at the holder's expense) a new
certificate or certificates in exchange therefor representing in the aggregate
the number of Shares represented by the surrendered certificate. Each such new
certificate shall be registered in such name and shall represent such number of
Shares as is requested by the holder of the surrendered certificate and shall be
substantially identical in form to the surrendered certificate, and dividends
shall accrue on the Series C 7% Preferred represented by such new certificate
from the date to which dividends have been fully paid on such Series C 7%
Preferred represented by the surrendered certificate. All transfers of Shares
shall be subject to any restrictions imposed by applicable federal and state
securities laws.
Section 8. Replacement.
Upon receipt of evidence reasonably satisfactory to the Corporation (an
affidavit of the registered holder shall be satisfactory) of the ownership and
the loss, theft, destruction or mutilation of any certificate evidencing Shares
of any of the Series C 7% Preferred, and in the case of any such loss, theft or
destruction, upon receipt of indemnity reasonably satisfactory to the
Corporation, or, in the case of any such mutilation upon surrender of such
certificate, the Corporation shall (at the holder's expense) execute and deliver
in lieu of such certificate a new certificate of like kind representing the
number of Shares of such class represented by such lost, stolen, destroyed or
mutilated certificate and dated the date of such lost, stolen, destroyed or
mutilated certificate, and dividends shall accrue on the Preferred Stock
represented by such new certificate from the date to which dividends have been
fully paid on such lost, stolen, destroyed or mutilated certificate.
Section 9. Amendment and Waiver.
No amendment, modification or waiver shall be binding or effective with
respect to any provision of Sections 1 to 10 hereof without the prior written
consent of the holders of at least 51% of the Series C 7% Preferred outstanding
at the time such action is taken; provided that no such action shall change (a)
the rate at which or the manner in which dividends on the Series C 7% Preferred
accrue or the times at which such dividends become payable or the amount payable
on redemption of the Series C 7% Preferred or the times at which redemption of
Series C 7% Preferred is to occur, without the prior written consent of the
holders of at least 80% of the Series C 7% Preferred then outstanding, (b) the
Conversion Price of the Series C 7% Preferred or the number of shares or class
of stock into which the Series C 7% Preferred is convertible, without the prior
written consent of at least 80% of the Series C 7% Preferred then outstanding or
(c) the percentage required to approve any change described in clauses (a) and
(b) above, without the prior written consent of the holders of at least 80% of
the Series C 7% Preferred then outstanding. Notwithstanding the above,
Corporation, without the consent or approval of the holders, may amend the
provisions hereof solely for the purpose of increasing the number of authorized
Shares of Series C 7% Preferred.
11
<PAGE>
Section 10. Notices.
Except as otherwise expressly provided hereunder, all notices referred
to herein shall be in writing and shall be delivered by registered or certified
mail, return receipt requested and postage prepaid, or by reputable overnight
courier service, charges prepaid, and shall be deemed to have been given when so
mailed or sent (i) to the Corporation, at its principal executive offices and
(ii) to any stockholder, at such holder's address as it appears in the stock
records of the Corporation (unless otherwise indicated by any such holder).
IN WITNESS WHEREOF, the Corporation has caused its corporate seal to be
affixed hereto and this Certificate of Designation to be signed by its Chief
Executive Officer and attested by its Secretary this 22d day of January, 1999.
- ------------------------------------
Brent M. Cook
President and Chief Executive Officer
Covol Technologies, Inc.
ATTEST:
- ------------------------------------
Secretary
12
EMPLOYMENT AGREEMENT
By and Between
COVOL TECHNOLOGIES, INC.
And
BRENT M. COOK
Dated as of April 21, 1998
<PAGE>
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT ("this Agreement") is made and entered into
as of the 21st day of April, 1998 (the "Effective Date") by and between COVOL
TECHNOLOGIES, INC. a Delaware Corporation (the "Company"), and Brent M. Cook
("Employee"). The Company and Employee are sometimes later in this Agreement
collectively referred to as the "Parties."
RECITALS
This Agreement is entered into with reference to the following facts,
definitions, and objectives:
A. Employee is a certified public accountant and immediately prior to
Effective date, was employed by Covol Technologies, Inc., as Executive Vice
President and Chief Financial Officer.
B. Employee's services are deemed to be of value to the Company and it
is recognized that inducements must be offered to Employee in order that the
company may retain Employee's services.
NOW THEREFORE, in consideration of this Agreement and of the covenants
and conditions contained in this Agreement, the Parties agree as follows:
1. Employment and Positions.
(a) Positions. The Company employs Employee and
Employee accepts employment by the Company as Chief Executive Officer and
President of the Company for the Period of Employment specified in Paragraph 3
("Period of Employment").
2. Services to be Rendered. The Employee shall, during the Period of
Employment, serve the Company in the positions set forth in Paragraph 1
("Employment and Positions") diligently, competently, and in conformance with
the corporate policies of the Company. Employee shall be free to conduct
personal business and investment activities that do not conflict or interfere
with the performance of his duties under this Agreement. Employee shall have the
responsibility to always act in the best interest of the Company and recognizes
opportunities, ideas, and intellectual property relating to the business of the
Company that are developed as an officer or employee of Covol Technologies, Inc.
remain the property of Company.
In fulfilling his duties and responsibilities under this Agreement,
Employee shall report to the Board of Directors and shareholders of the Company.
<PAGE>
3. Period of Employment. Employee's employment by the Company pursuant
to this Agreement shall, unless sooner terminated, begin as of the 21st day of
April, 1998 (the "Effective Date") and continue for a period of five (5) years
from the Effective Date ("Period of Employment").
4. Base Salary. At the commencement of the Period of Employment,
Employee shall be paid a yearly base salary of an amount determined by the Board
of Directors consistent with an annual compensation review of comparable
positions of public companies. Base salary shall be paid in semi monthly
installments during the Period of Employment.
5. Incentive Bonus. The Board of Directors and Management will
determine any incentive bonus guidelines during the Period of Employment;
Employee shall be entitled to receive a bonus pursuant to the Company's bonus
plan, if any, as in effect from time to time. It is recognized that bonus plans
are dependent upon the Corporation income performance and general performance
evaluations.
6. Expense Reimbursement. The Employee shall be entitled to prompt
reimbursement for reasonable expense incurred by the Employee in performing
services for the Company. Employee shall be required to provide proof and
documentation of such expenditures as required by the Company.
7. Grant of Options. The Company shall grant to the Employee, in
accordance with the terms and the Stock Option Agreement attached hereto as
Exhibit A, the right and option to purchase shares of the Company's Common
Stock.
(a) Stock Options Pursuant to Stock Option Plan. The Stock
Option ("Stock Option") shall be issued pursuant and subject to the provisions
of the Company Employee Stock Option Plan (the "Stock Option Plan").
(b) Purchase Price. The purchase price per share for the
shares subject to the Stock Option will be $12 31/32 per share.
(c) Number of Shares. The Stock Options will be for 250,000
shares of the Company's Common Stock (the "Optioned Shares").
(d) Exercise Periods. The Optioned Shares will vest and be
exercisable on the beginning of each month on a pro rata basis during the next
five (5) years. Once vested, the Optioned Shares may be exercised in whole or in
part at any time, subject to the limitations within which the exercise of the
Options must occur. The Optioned Shares must be exercised in their entirety
prior to April 21, 2008, also known as the expiration date.
(e) Vesting of Options in Event of Full and Complete
Disability or Death. In the event of disability or death of the employee any
unvested Stock Options shall vest effective as of the date of the full and
complete disability or the death of Employee. In the event of Employee's full
and complete disability or death, the Employee, heirs or estate of Employee, as
the case may be, may exercise any unexecuted options at any time subject to the
time limitations within which exercise of option must occur.
<PAGE>
(f) Vesting of Options in Event of Ownership Change. In the
event a third party purchases a controlling interest of the total outstanding
shares of the Company, or substantially all of the assets of the Company, all
non-vested Stock Options shall vest as of the date immediately prior to such
stock or asset purchase. The intent of this section is to allow the Employee to
vote the shares represented by the Stock Options and the Employee's discretion
exercise any unexecuted options.
(g) Additional Stock Options. Employee shall also be eligible
to receive additional stock options during he Period of Employment pursuant to a
stock options bonus plan as may from time to time be in effect.
8. Other Benefits. In addition to the benefits previously set forth in
this Agreement, Employee shall, during the Period of Employment, be entitled to
the benefits described below, and as concerns all such benefit programs where
years of service are a factor, to the extent permitted by law, Employee shall be
given credit for his years of service with Covol Technologies, Inc. prior to the
implementation of any benefit program.
(a) Vacation. During the Period of Employment, Employee shall
be entitled to not less than six (6) weeks of paid vacation during each calendar
year occurring during the Period of Employment. The vacation may be carried over
from year to year. At the end of the term of this Agreement, the Employee shall
be entitled to be paid for the pro rated portion of the accrued salary
attributable to unused vacation.
(b) Insurance. Participation in the group insurance program
of the company as concerns life, disability, medical and dental insurance
currently available to other employee's as the same may be implemented, changed
modified or terminated for all participants from time to time. Employee shall be
required to pay that portion of the premiums for coverage under such insurance
that is payable by other employee's of the Company for their insurance coverage.
(c) Retirement Plan. The Employee shall participate in the
Company's Retirement Plans in accordance with the terms and provisions and
applicable law as the same may be implemented, changed, amended, or terminated
from time to time. Employee shall become eligible to participate in the
Company's Retirement Plans at date of hire or as the effective date of the
implementation of such plans, whichever is later.
(e) Automobile Allowance. The Company will provide the
Employee a monthly automobile allowance. This allowance is to compensate the
Employee for the us of his personal automobile in the amount of $550.00 per
month during the Employment Period.
(f) Dental Expense. The Company will provide the Employee
with an annual dental allowance of $4,500 or provide comparable coverage.
(g) Other Miscellaneous Benefits. The Company shall pay or
reimburse Employee for the following miscellaneous benefits:
<PAGE>
(i) Annual dues for association membership for
relevant professional groups.
(ii) Subscription and purchase of books, journals,
publications which relate to job duties and responsibilities.
9. Terms of Employment
(a) Term. The Company hereby agrees to continue the Employee
in its employ, an the Employee hereby agrees to remain in the employ of the
Company, in accordance with the terms and provisions of paragraph 3 of this
Agreement, for the Period of Employment, thus terminating on the fifth
anniversary of the Effective Date of this Agreement, upon thirty (30) days prior
written notice from the Company to the Employee. If such written notice of
termination is not given, then the Employee's employment under this Agreement
shall continue under the terms of this Agreement, until the Employee is
terminated by the Company upon thirty (30) days prior written notice.
(b) During the Period of Employment.
(i) The Employee's position, authority, duties and
responsibilities shall be commensurate in all material respects with those held,
exercised and assigned at any time during the ninety (90) day period immediately
preceding the Effective Date or at any office which is the headquarters of the
Company.
(ii) The Employee's services shall be performed at
the location where the Employee was employed immediately preceding the Effective
Date or at any office which is the headquarters of the Company.
10. Termination of Agreement.
(a) Termination of Employment by Employer. Anything in this
Agreement to the contrary notwithstanding, the Company shall have the following
rights with respect to termination of Employee's employment.
(i) Disability. The Company may terminate
Employee's employment under this Agreement if Employee shall become unable to
fulfill his duties under this Agreement, as measured by the Company's usual
business activities, by reason of any medically determinable physical and/or
mental disability.
(ii) Cause. Employee's employment may be
terminated for Cause. For purpose of the Agreement, "Cause" shall mean and refer
to a determination made in good faith by the Company's Board of Directors that:
<PAGE>
(1) Employee has been convicted
of or has entered a plea of guilty or nolo contendere to a felony or to any
other crime, which other crime is punishable by incarceration for a period of
one (1) year or longer, or which is a crime involving moral turpitude;
(2) there has been a theft,
embezzlement, or other criminal misappropriation of funds by Employee, whether
from Company or any other person;
(3) Employee has willfully
failed or refused to follow reasonable written policies or directives
established by the Board of Directors of the Company, or Employee has willfully
failed to attend to material duties or obligations of Employee's office (other
than any such failure resulting from Employee's incapacity due to physical or
mental illness, which is a cause or manifestation of Employee's disability),
which failure or refusal continues for thirty (30) days following delivery of a
written demand from the Company's Board of Directors for policies or directives
or to perform such duties.
(iii) Termination pursuant to this Paragraph 9 shall
be effective as of the effective date of the notice by the Board of Directors to
Employee that it has made the required determination, or at such other
subsequent date, if any specified in such notice.
(iv) Death. If the Employee dies during the term of
this Agreement, his personal representative or designated survivor shall be
entitled to receive all the salary and benefits provided hereunder for the
remaining term of this Agreement.
(b) Termination by Employee.
(i) With Good Reason. Employee shall have the
right to terminate his employment under this Agreement at any time for Good
Reason, provided Employee has delivered written notice to the Company which
briefly describes the facts underlying Employee's belief that "Good Reason"
exist and the Company has failed to cure such situation within thirty (30) days
after effective date of such notice. For purposes of the Agreement, "Good
Reason" shall mean and consist of:
(1) a material breach by the Company of
its obligations under this Agreement;
(2) the assignment to Employee of duties
that are materially inconsistent with, or that constitute a material alteration
in the status of his responsibilities set forth in this Agreement, as an
employee of the Company;
(3) a reduction by the Company of
Employee's Base Salary below the Base Salary set forth in Paragraph 5 ("Base
Salary");
(4) without Employee's prior written
consent, the transfer or relocation of Employee's place of employment to any
place other than the Salt Lake City/Provo metropolitan area, except for
reasonable travel on the business of the Company; or
<PAGE>
(5) upon the consummation of a sale of
all or substantially all of the assets of the Company not in the usual or
regular course of the business of the Company in which sale the acquiring
company did not assume all of the obligations of the Company under this
Agreement.
11. Confidential Information. The Employee shall hold in a fiduciary
for the benefit of the Company all secret or confidential information, knowledge
or data relating to the Company or any of its affiliated companies and their
respective businesses, which have been obtained by the Employee during the
Employee's employment by the Company or any of its affiliated companies and
which shall not be or become public knowledge (other than by acts by the
Employee or representatives of the Employee in violation of this Agreement).
After termination of the Employee's employment with the Company, the Employee
shall not, without prior written consent of the Company or as may otherwise be
required by law or legal process, communicate or divulge any such information,
knowledge or data to anyone other than the Company and those designated by the
Company. In no event shall an asserted violation of the provisions of this
Section constitute a basis for deferring or withholding any amounts otherwise
payable to the Employee under the provisions of this Agreement.
12. Inventions.
(a) Assignment. Without further consideration, the Employee
shall fully and promptly report to the Company all ideas, concepts, inventions,
discoveries, formulas, and designs conceived or produced by the Employee at any
time during the Period of Employment relating to the Company's trade or
business, whether alone or with others and whether patentable or unpatentable
(collectively, "Inventions" pertaining directly or indirectly to the business of
the company as conducted by the Employee at any time during the Employment
Period) and shall assign and hereby does assign to the Company or its nominee
the Employee's entire right, title and interest in and to all such Inventions.
(b) Cooperation. The Employee shall take all reasonable action
requested by the Company to protect or obtain title to any and all United States
and/or foreign patents on any such Inventions, including execution and delivery
of all applications, assignments and other documents deemed necessary or
desirable by the Company, provided the Company shall reimburse the Employee for
all expenses incurred by the Employee in connection with such execution and
delivery.
13. Non-Competition after Termination.
(a) Acknowledgment. The Employee acknowledges that his
services and responsibilities are of a particular significance to the Company
and that his position with the Company does and will continue to give him an
intimate knowledge of its business. Because of this, it is important to the
Company that the Employee be restricted from competing with the Company in the
event of the termination of his employment.
<PAGE>
(b) Agreement. The Employee agrees that, in addition to any
other limitations, for a period of two (2) years after the termination of his
employment under this Agreement, the Employee will not directly or indirectly
compete with the Company or its business.
14. Severance Pay. If the Employee does not continue in the employ of
the Company after the termination of this Agreement, whether or not the Employee
is offered continued employment by the Company, Company shall pay to Employee,
no later than two months after termination, the sum of one year's annual base
wages. The Employee shall not be required to mitigate the amount of the payment
provided for in this section by seeking other employment or otherwise; nor shall
the amount of the payment be reduced by any compensation earned by the Employee
as the result of employment by another employer after termination or otherwise.
15. Indemnification. The Company shall release, indemnify and hold
harmless the Employee against and from any and all loss, claims actions or
suits, including costs and attorney's fees, both at trial and on appeal,
resulting from, or arising out of or in any way connected with the Employees
acts as an employee of the Company.
16. Miscellaneous. Any notice or other communications required or
permitted to be given to the parties hereto shall be deemed to have been given
when received, addressed as follows (or at such other address as the party
addressed may have substituted by notice pursuant to this Section):
(a) If to the Company:
3280 North Frontage Road
Lehi, Utah
Attention: President and CEO
(b) If to Employee:
Brent M. Cook
5733 West 10040 North
Highland, UT 84003
17. Governing Law. This Agreement shall in all respects be interpreted,
construed and governed by and in accordance with the laws of the State of Utah.
IN WITNESS WHEREOF, the parties have executed this Agreement in
duplicate as of the date written above.
COVOL TECHNOLOGIES, INC.: EMPLOYEE:
By: Raymong J. Weller Brent M. Cook
------------------------- ----------------------
Title: Chairman of the Board
EMPLOYMENT AGREEMENT
By and Between
COVOL TECHNOLOGIES, INC.
And
Steven R. Brown
Effective as of
January 1, 1999
<PAGE>
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (this Agreement") is effective as of the
first day of January, 1999 (the "Effective Date") by and between COVOL
TECHNOLOGIES, INC. a Delaware Corporation (the "Company"), and Steven R. Brown
("Employee"). The Company and Employee are sometimes later in this Agreement
collectively referred to as the "Parties."
RECITALS
This Agreement is entered into with reference to the following facts,
definitions, and objectives:
A. Employee is Senior Vice President of Engineering and
Development and immediately prior to Effective Date, was
employed by the Company as a Vice President.
B. Employee's services are deemed to be of value to the Company
and it is recognized that inducements must be offered to
Employee in order that the company may retain Employee's
services.
NOW THEREFORE, in consideration of this Agreement and of the covenants
and conditions contained in this Agreement, the Parties agree as follows:
1. Employment and Positions. The Company employs Employee and
Employee accepts employment by the Company as an officer of
the Company with the title of "Senior Vice President of
Engineering and Development" for the Period of Employment
specified in Paragraph 3 ("Period of Employment"). Such
position and title including related duties and
responsibilities may be changed during the term of this
contract provided that such Employee continues as an officer
and provided further that compensation for services are not
reduced due to such title and/or position change.
2. Services to be Rendered. The Employee shall, during the
Period of Employment, serve the Company in the positions set
forth in Paragraph 1 ("Employment and Positions") diligently,
competently, and in conformance with the corporate policies of
the Company. Employee shall have the responsibility to always
act in the best interest of the Company and recognizes
opportunities, ideas, and intellectual property relating to
the business of the Company that are developed as an officer
or employee of Covol Technologies, Inc. remain the property of
Company. In fulfilling his duties and responsibilities under
this Agreement, Employee shall report to the President of the
Company.
2
<PAGE>
3. Period of Employment. Employee's employment by the Company
pursuant to this Agreement shall, unless sooner terminated,
begin as of the Effective Date and continue for a period of
three (3) years from the Effective Date ("Period of
Employment").
4. Base Salary. At the commencement of the Period of Employment,
Employee shall be paid a base salary of $100,000 for the first
year, $130,000 for the second year, and $135,000 for the third
year, during the Period of Employment. Base salary shall be
paid in equal semi monthly installments during the Period of
Employment.
5. Incentive Bonus. During the Period of Employment, the Employee
shall be entitled to receive a bonus pursuant to the Company's
bonus plan, if any, as in effect from time to time. It is
recognized that a bonus plan, if any, is established at the
discretion of the Company and may be subject to variables and
conditions including income performance and general
performance evaluations.
6. Expense Reimbursement. The Employee shall be entitled to
prompt reimbursement for reasonable expenses incurred by the
Employee in performing services for the Company. Employee
shall be required to provide proof and documentation of such
expenditures as required by the Company.
7. Grant of Options. The Company may grant from time to time to
the Employee, in accordance with the terms of a stock option
agreement, the right and option to purchase shares of the
Company's Common Stock .
(a) Stock Options Pursuant to Stock Option Plan. Any
Stock Options ("Stock Option") issued shall be issued
pursuant and subject to the provisions of the Company
Employee Stock Option Plan (the "Stock Option Plan")
or as approved by the Board of Directors. Number of
options, purchase price, exercise periods and vesting
requirements shall be included in the stock option
document.
(b) Vesting of Options in Event of Full and Complete
Disability or Death. In the event of the full and
complete disability or the death of the employee any
unvested Stock Options shall vest effective as of the
date of the full and complete disability or the death
of Employee. In the event of Employee's full and
complete disability or death, the Employee, heirs or
estate of Employee, as the case may be, may exercise
any unexecuted options at any time subject to the
time limitations within which exercise of option must
occur.
(c) Vesting of Options in Event of Ownership Change. In
the event of a
3
<PAGE>
change in control, all non-vested Stock Options shall
vest immediately prior to such change in control. A
change in control shall be deemed to have taken place
if, as the result of a tender offer, merger,
consolidation, sale of substantially all assets, a
third party purchase of a controlling interest of the
total outstanding shares of the Company, contested
election, or any combination of the foregoing
transactions, the persons who were directors of the
Company immediately before the transaction shall
cease to constitute a majority of the board of
directors of the Company or any successor to the
Company. The intent of this section is to allow the
Employee to exercise any unexecuted options at the
Employees discretion.
8. Other Benefits. In addition to the benefits previously set
forth in this Agreement, Employee shall, during the Period of
Employment, be entitled to the benefits described below, and
as concerns all such benefit programs where years of service
are a factor, to the extent permitted by law, Employee shall
be given credit for his years of service with Covol
Technologies, Inc. prior to the implementation of any benefit
program.
(a) Vacation. During the Period of Employment, Employee
shall be entitled to not less than four (4) weeks of
paid vacation during each calendar year occurring
during the Period of Employment. Any unused vacation
will, at the Company's option, be paid for by the
Company at the end of each calendar year, or will
carry forward from year to year until taken by the
Employee or paid the Employee by the Company. Upon
termination of Employee's employment under this
Agreement, Employee shall be paid for any unused
vacation in the year in which the termination
occurred, proportionate to the amount of time
employed that year.
(b) Sick Leave. Leave time will be granted to the
Employee that is reasonable under the circumstances
and that is consistent with the Company's policies
and procedures, as the same may be changed, modified
or terminated for all participants from time to time.
(c) Insurance. Participation in the group insurance
program of the Company as concerns life, disability,
medical and dental insurance currently available to
other employee's as the same may be implemented,
changed, modified or terminated for all participants
from time to time. Employee shall be required to pay
that portion of the premiums for coverage under such
insurance that is payable by other employees of the
Company for their insurance coverage.
(d) Retirement Plan. The Employee shall participate in
the Company's Retirement Plans in accordance with the
terms and provisions and
4
<PAGE>
applicable laws as the same may be implemented,
changed, amended, or terminated from time to time.
Employee shall become eligible to participate in the
Company's Retirement Plans at date of hire or as of
the effective date of the implementation of such
plans, whichever is later.
(e) Automobile Allowance. The Company will provide the
Employee a monthly automobile allowance. This
allowance is to compensate the Employee for the use
of his personal automobile in the amount of $550.00
per month during the Employment Period.
(f) Disability Insurance. The Company shall reimburse the
Employee for disability insurance that is currently
being paid by the Employee until such time that the
Company implements a disability insurance program for
which the employee would be covered.
(g) Other Miscellaneous Benefits. The Company shall pay
or reimburse Employee for the following miscellaneous
benefits:
(i) Annual dues for association membership for
relevant professional groups.
(ii) Subscription and purchase of books,
journals, and publications which relate to
job duties and responsibilities.
Employee shall obtain authorization for payment or
purchases referred to in (i) and (ii) above from the
chief financial officer of the Company before
incurring such costs.
9, Terms of Employment.
(a) Term. The Company hereby agrees to continue the
Employee in its employ, and the Employee hereby
agrees to remain in the employ of the Company, in
accordance with the terms and provisions of paragraph
3 of this Agreement, for the Period of Employment,
thus terminating on the third anniversary of the
Effective Date of this Agreement, upon thirty (30)
days prior written notice from the Company to the
Employee. If such written notice of termination is
not given, then the Employee's employment under this
Agreement shall continue under the terms of this
Agreement, until the Employee is terminated by the
Company upon thirty (30) days prior written notice.
(b) During the Period of Employment. The Employee's
services shall be performed at the location where the
Employee was employed immediately
5
<PAGE>
preceding the Effective Date or at any office which
is the headquarters of the Company.
10. Termination of Agreement.
(a) Termination of Employment by Employer. Anything in
this Agreement to the contrary notwithstanding, the
Company shall have the following rights with respect
to termination of Employee's employment.
(i) Disability. The Company may terminate
Employee's employment under this Agreement
if Employee shall become unable to fulfill
his duties under this Agreement, as measured
by the Company's usual business activities,
by reason of any medically determinable
physical and/or mental disability.
(ii) Cause. Employee's employment may be
terminated for Cause. For purpose of the
Agreement, "Cause" shall mean and refer to a
determination made in good faith by the
Company's Board of Directors that:
(1) Employee has been convicted of or
has entered a plea of guilty or nolo
contendere to a felony or to any
other crime, which other crime is
punishable by incarceration for a
period of one (1) year or longer, or
which is a crime involving moral
turpitude; or
(2) there has been a theft,
embezzlement, or other criminal
misappropriation of funds by
Employee, whether from Company or
any other person; or
(3) Employee has willfully failed or to
follow reasonable written policies
or directives established by the
Board of Directors or the Chief
Executive Officer of the Company, or
Employee has willfully failed to
attend to material duties or
obligations of Employee's office
(other than any such failure
resulting from Employee's incapacity
due to physical or mental illness,
which is a cause or manifestation of
Employee's disability), which
failure or refusal continues for
thirty (30) days following delivery
of a written demand from the
Company's Chief Executive Officer
for performance to Employee
identifying the manner in which
Employee has failed to follow such
policies or directives or to perform
such duties.
6
<PAGE>
(iii) Termination pursuant to this Paragraph 10
shall be effective as of the effective date
of the notice by the Board of Directors or
Chief Executive Officer to Employee that it
has made the required determination, or at
such other subsequent date, if any specified
in such notice.
(iv) Death. If Employee dies during the Period of
Employment, Employee's employment shall be
terminated effective as of the end of the
calendar month during which Employee died.
(b) Termination by Employee.
(i) With Good Reason. Employee shall have the right to
terminate his employment under this Agreement at any
time for Good Reason, provided Employee has delivered
written notice to the Company which briefly describes
the facts underlying Employee's belief that "Good
Reason" exists and the Company has failed to cure
such situation within thirty (30) days after
effective date of such notice. For purposes of the
Agreement, "Good Reason" shall mean and consist of:
(1) a material breach by the Company of its
obligations under this Agreement;
(2) the assignment to Employee of duties that
are materially inconsistent with, or that
constitute a material alteration in the
status of his responsibilities set forth in
Paragraph 1 of this Agreement, as an
employee of the Company;
(3) a reduction by the Company of Employee's
Base Salary below the Base Salary set forth
in Paragraph 5 ("Base Salary");
(4) without Employee's prior written consent,
the transfer or relocation of Employee's
place of employment to any place other than
the Salt Lake City/Provo metropolitan area,
except for reasonable travel on the business
of the Company; or
(5) upon a change of control as defined in Paragraph
6(c) above.
11. Confidential Information. The Employee shall hold in a
fiduciary capacity for the benefit of the Company all secret
or confidential information, knowledge or data relating to the
Company or any of its affiliated companies and their
respective businesses, which has been obtained by the Employee
during the Employee's
7
<PAGE>
employment by the Company or any of its affiliated companies
and which shall not be or become public knowledge (other than
by acts by the Employee or representatives of the Employee in
violation of this Agreement). After termination of the
Employee's employment with the Company, the Employee shall
not, without prior written consent of the Company or as may
otherwise be required by law or legal process, communicate or
divulge any such information, knowledge or data to anyone
other than the Company and those designated by the Company. In
no event shall an asserted violation of the provisions of this
Section constitute a basis for deferring or withholding any
amounts otherwise payable to the Employee under the provisions
of this Agreement.
12. Inventions.
(a) Assignment. Without further consideration, the
Employee shall fully and promptly report to the
Company all ideas, writings, concepts, inventions,
discoveries, formulas, designs, and know-how
conceived or produced by the Employee at any time
during the Period of Employment relating to the
Company's trade or business, whether alone or with
others and whether or not patentable or subject to
copy or service rights or trademark (collectively,
"Inventions" pertaining directly or indirectly to the
business of the Company as conducted by the Employee
at any time during the Employment Period) and shall
assign and hereby does assign to the Company or its
nominee the Employee's entire right, title and
interest in and to all such Inventions.
(b) Cooperation. The Employee shall take all reasonable
action requested by the Company to protect or obtain
title to any and all United States and/or foreign
patents on any such Inventions, including execution
and delivery of all applications, assignments and
other documents deemed necessary or desirable by the
Company, provided the Company shall reimburse the
Employee for all expenses incurred by the Employee in
connection with such execution and delivery.
13. Non-Competition after Termination.
(a) Acknowledgment. The Employee acknowledges that his
services and responsibilities are of a particular
significance to the Company and that his position
with the Company does and will continue to give him
an intimate knowledge of its business. Because of
this, it is important to the Company that the
Employee be restricted from competing with the
Company in the event of the termination of his
employment.
(b) Agreement. The Employee agrees that, in addition to
any other
8
<PAGE>
limitations, for a period of two (2) years after the
termination of his employment under this Agreement,
the Employee will not directly or indirectly compete
with the Company or its business.
14. Severance Pay. Except for termination for Cause under
Paragraph 10(a)(ii) above, if the Employee does not continue
in the employ of the Company after the termination of this
Agreement, whether or not the Employee is offered continued
employment by the Company, Company shall pay to Employee, no
later than thirty (30) days, the sum of one year's annual base
wages. The Employee shall not be required to mitigate the
amount of the payment provided for in this section by seeking
other employment or otherwise; nor shall the amount of the
payment be reduced by any compensation earned by the Employee
as the result of employment by another employer after
termination or otherwise.
15. Indemnification. Subject to the Company's Certificate of
Incorporation, as amended, the Company shall release,
indemnify and hold harmless the Employee against and from any
and all loss, claims, actions or suits, including costs and
attorney's fees, both at trial and on appeal, resulting from,
or arising out of or in any way connected with the Employee's
acts as an employee of the Company.
16. Miscellaneous. Any notice or other communications required or
permitted to be given to the parties hereto shall be deemed to
have been given when received, addressed as follows (or at
such other address as the party addressed may have substituted
by notice pursuant to this Section):
(a) If to the Company:
3280 North Frontage Road
Lehi, Utah 84043
Attention: President and CEO
(b) If to Employee:
Steven R. Brown
1681 North 400 East
Orem, Utah 84097
17. Governing Law. This Agreement shall in all respects be
interpreted, construed and governed by and in accordance with
the laws of the State of Utah.
9
<PAGE>
Effective the first day of January, 1999.
Covol Technologies, Inc.: Employee
- -------------------- -------------------
By: Steven R. Brown
Title: Date:
Date:
10
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDED DECEMBER
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> DEC-31-1998
<CASH> 675
<SECURITIES> 0
<RECEIVABLES> 4,228
<ALLOWANCES> 0
<INVENTORY> 1,805
<CURRENT-ASSETS> 37,159
<PP&E> 16,456
<DEPRECIATION> 1,480
<TOTAL-ASSETS> 70,041
<CURRENT-LIABILITIES> 31,611
<BONDS> 14,042
0
1
<COMMON> 12
<OTHER-SE> 22,470
<TOTAL-LIABILITY-AND-EQUITY> 70,041
<SALES> 674
<TOTAL-REVENUES> 1,155
<CGS> 3,896
<TOTAL-COSTS> 3,896
<OTHER-EXPENSES> 315
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,036
<INCOME-PRETAX> (4,737)
<INCOME-TAX> 0
<INCOME-CONTINUING> (4,737)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,737)
<EPS-PRIMARY> (0.40)
<EPS-DILUTED> (0.40)
</TABLE>
