UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 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 0-27808
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)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 17, 1998 was $59,671,125 based upon the closing
price on the Nasdaq National Market(R) reported for such date. This calculation
does not reflect a determination that persons whose shares are excluded from the
computation are affiliates for any other purpose.
The number of shares outstanding of the registrant's common stock as of
December 17, 1998 was 12,494,029.
---------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the following document are incorporated herein by reference:
Portions of the registrant's definitive proxy statement to be issued in
connection with registrant's annual stockholders' meeting to be held in 1999.
<PAGE>
TABLE OF CONTENTS
Page
PART I
ITEM 1. BUSINESS......................................................... 3
ITEM 2. PROPERTIES....................................................... 19
ITEM 3. LEGAL PROCEEDINGS................................................ 20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 20
EXECUTIVE OFFICERS OF THE REGISTRANT............................. 20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.............................................. 23
ITEM 6. SELECTED FINANCIAL DATA.......................................... 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK ....... 33
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................... 33
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.............................. 33
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............... 33
ITEM 11. EXECUTIVE COMPENSATION........................................... 33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT... 33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................... 33
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K......................................................... 34
SIGNATURES................................................................... 43
Forward-Looking Statements
Statements in this Form 10-K, including those concerning the Registrant's
expectations regarding its business, and certain of the information presented in
this report, constitute forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. As such, actual results may
vary materially from such expectations. For a discussion of the factors that
could cause actual results to differ from expectations, please see the caption
entitled "Forward Looking Statements" in Item 1 and 7 hereof. There can be no
assurance that the Registrant's results of operations will not be adversely
affected by such factors. Registrant undertakes no obligation to revise or
publicly release the results of any revision to these forward looking
statements. Readers are cautioned not to place undue reliance on these forward
looking statements, which reflect management's opinion only as of the date
hereof.
2
<PAGE>
PART I
ITEM 1. BUSINESS
The Company
Covol Technologies Inc. is a technology development company focused on
"Recycling Yesterday's Waste into Tomorrow's Resources."(TM)
Company History
Covol was originally incorporated in Nevada in 1987 under the name
Cynsulo, Inc. Subsequently, the company acquired all of the issued and
outstanding shares of McParkland Corporation and changed its name to McParkland
Properties, Inc. The purchase of McParkland was rescinded in February 1989, and
the company's name was changed to Riverbed Enterprises, Inc. In 1991, the
company acquired technology consisting of binding agents used to make
briquettes. From 1991 to 1995 the company focused on the research and
development of binding agents principally for iron, coal and coke waste
particles. The company's name was changed to Enviro-Fuels Technology in 1991, to
Environmental Technologies Group International in 1994, and to Covol
Technologies, Inc. in 1995, at which time the company was reincorporated in
Delaware.
In 1995, management of Covol recognized the applicability of its
technology to the production of synthetic fuel. Since 1996, the primary focus of
Covol has been on developing and commercializing the synthetic fuel technology.
Background
As a result of efforts by government and business to balance
environmental concerns with the needs of business and recognize the need to
efficiently use diminishing resources, the recycling industry has developed and
pursued many endeavors to recycle, recover and/or enhance the usefulness of
wastes and by-products. Covol has developed a family of binder technologies used
to form fine materials from wastes and by-products into briquettes to capture
their inherent resource value.
Coal mines, ferrous and non-ferrous metals producers, and other
industries produce waste and other by-products. Cost-effective processes have
not been implemented generally to capture and use many such wastes, despite
their potential usefulness and potential value. Storage and disposal of many of
these by-products is costly and can be environmentally harmful. Covol's binder
technologies are designed to enable the conversion of by-products from the coal
and metals industries into valuable fuels and resources. Covol's primary focus
over the past two years has been the commercialization of the application of its
binder technologies to coal fines.
Covol's binder technologies are being used to transform coal fines into
a usable fuel. Coal fines are small particles of coal produced as a waste
by-product of coal production. Coal fines can be found throughout coal producing
regions of the United States and the world. A recent study of the coal industry
estimated that there are more than 2 billion tons of coal fines residing in
waste ponds and landfills in the United States alone. Millions of tons are added
to this amount each year. Although coal fines have inherent fuel value, they
present recovery and handling challenges that make it difficult to capture that
value. Covol's binder technologies molecularly bond the coal fines into a formed
fuel. Because this process is accomplished through a significant chemical
reaction, the resulting product has been classified as a "synthetic fuel" within
the meaning of Section 29 of the U.S. Internal Revenue Code. Sales of the fuel
therefore qualify for a significant tax credit. The resulting fuel is more
easily handled and transported than are coal fines. The composition of the
resulting fuel varies in its potential heat, ash and sulfur content and other
characteristics, depending primarily upon the composition of the coal fines used
as feedstock, and secondarily on the processing of the feedstock. The possible
end markets for the resulting synthetic fuel are as diverse as the markets for
coal. Different end users have different requirements for fuel type and quality,
whether the fuel be synthetic or coal. The application of Covol's binder
technologies can be customized to address the specific needs of prospective
customers.
3
<PAGE>
The Covol binder technologies can also be used to transform coke dust
into formed coke. Coke, which is processed metallurgical coal, is primarily used
in the iron making process as a reducing agent and also as an economical fuel
source. Coke dust, also known as "coke breeze," is a fine residue by-product
resulting from the production, handling and storage of coke and is marketable in
its "dust" state because of its high carbon and energy content. In tests, Covol
has succeeded in aggregating coke dust into hard briquettes designed to
withstand the weight, heat and other environmental factors inside of metal
making furnaces, which appear potentially marketable at prices above briquette
production costs.
The Covol binder technologies can also be used to convert iron rich
wastes into usable iron. Mill scale, bag-house dust, furnace sludge, blast
furnace dust and other iron rich materials, are all waste by-products created by
steel producers. These by-products present environmental problems for the steel
industry. Because of their high iron content, they also have high potential
value. Approximately 775 million tons of finished steel are consumed annually in
the world with the U.S. producing approximately 100 million tons. The capture of
even a fraction of the waste and other by-products of this steel production in
the U.S. alone could provide millions of tons of feedstock material for
processing. On a test basis, the Covol binder technologies have been
demonstrated to be capable of producing briquettes from such steel production
wastes. Such briquettes can be further processed in metal reducing furnaces to
form high grade pig iron, a common form of feed material used in the steel
industry.
Additional fuel or resource by-products to which the Covol binder
technologies appear applicable after initial testing include: molybdenum,
silicon carbide, grinding swarf, lead dross, zinc oxide, titanium dioxide,
phosphorous, and charcoal. Briquettes containing these by-products appear
potentially marketable to ferrous and non-ferrous metals producers and to other
industrial consumers.
Except for synthetic fuel production, the Covol binder technologies
listed above have not been commercially applied. No assurance can be given that
Covol will be able to implement these applications profitably.
Covol Binder Technologies
The Covol binder technologies are designed to aggregate and process
wastes and other by-products that are in a fine particulate state into usable
fuels and resources in the form of briquettes, pellets or extrusions. These
technologies also provide a way to "engineer" fuels or resources with
value-added qualities, such as moisture reduction, elimination or neutralization
of pollutants such as sulfur dioxide and nitric oxide, improvement of handling
strength, reduction of impurities, and formation into uniform shapes and sizes
to maximize efficiencies in combustion or in processing. The resulting products
manufactured using the Covol binder technologies are broadly categorized as
"engineered fuels" and "engineered resources" and can be marketed to utilities,
ferrous and non-ferrous metal producers, and other major industrial users.
The Covol binder technologies chemically bond together fines, sludge,
and dust such as coal fines, iron production wastes and coke dust that up to now
have been considered by-products and waste materials. The process, in simplified
terms, mixes the resource-rich wastes or other by-products with a chemical
formula. The mixed materials are conveyed into a briquetter, a pelletizer or an
extruder which utilizes pressure together with a chemical reaction to bond and
shape the materials into the desired size and density required for the specific
application. The materials may be processed further to meet specific market
requirements.
Covol has licensed its technology to other parties to produce and sell
the products manufactured with the Covol binder technologies. Covol has
contracted with Dow Chemical Company to produce chemical binder materials for
the production of synthetic fuel made from coal fines. Substantially all of the
equipment and machinery used for producing synthetic fuel is considered standard
or "off-the-shelf" and is commercially available both domestically and
internationally.
Covol has been issued seven U.S. patents and four foreign patents and
has other U.S. and foreign patents pending. The patented technology principally
relates to the application of Covol's binder technologies to iron production
wastes, coke, coal and other carbon based materials. Covol is in the process of
expanding the existing patents and applying for new patents related to waste
recovery applications. See "ITEM 1. BUSINESS - Proprietary Protection" for a
discussion of Covol's patents, trademarks and other intellectual property.
4
<PAGE>
Business Strategy
The Covol binder technologies represent the foundation for Covol's
business strategy. Covol believes that its success depends upon its ability to
engineer industrial wastes and other by-products into value-added fuels and
resources. Covol has divided its strategy into four general approaches:
engineered fuels, engineered resources, licensing and technology transfers and
strategic acquisitions.
Engineered Fuels. Engineered fuels include fuels recovered or enhanced
primarily from carbon based materials. The Covol binder technologies provides a
use for fuel-rich wastes and by-products by aggregating them into a solid form
for improved handling and processing, and by making such modifications as may be
required for a given application of the resulting fuel, for example, reduced
moisture, increased hardness or enhanced energy content. Covol's engineered
fuels include the production of fuel from briquetted coal fines, coke dust and
silicon carbide.
For the past two years Covol's business strategy has been focused
almost exclusively upon synthetic fuel from coal fines. There are currently 24
synthetic fuel facilities located in 8 states that are utilizing Covol's
synthetic fuel technology. Twenty of the facilities are owned by unaffiliated
third parties and four are currently owned by Covol. Two of the four facilities
owned by Covol are under options to sell to licensees that would be expected to
pay royalties to Covol. Covol does not expect one of the options to be
exercised. Covol is actively pursuing the sale of the four facilities. Covol
intends to sell all or part of each facility that Covol owns. Covol has no
current ability to use the potential tax benefits that Covol's facilities can
produce.
Most of the synthetic fuel facilities were initially placed into
operation in the second calendar quarter of 1998 and Covol and its licensees are
currently in the process of ramping up production and entering into contracts
for product sales. Covol is working with its licensees to secure coal fines
feedstock, improve production and refine its chemical formulas. Covol and its
licensees are also negotiating sales and marketing contracts for the synthetic
fuel. Several of the owners of facilities are building or contemplating building
wash plants to wash the coal fines which are then processed into synthetic fuel.
Feedstock supply, production and product quality and the marketing of the
synthetic fuel all directly affect the amount and timing of royalties to be
received by Covol from the synthetic fuel facilities. Accordingly, assisting
licensees to optimize the production from these facilities is currently Covol's
highest priority.
Covol has received one-time advance license fees with respect to most
of the synthetic fuel facilities. In the future, most of the revenues related to
such facilities are expected to come from royalties that are tied to production
and sale of synthetic fuel pursuant to licensing agreements in place. Such
royalties are generally not based on the sales price of the coal briquettes, but
rather the amount of Section 29 credit generated. Covol also expects to generate
net revenues from the sale of binder materials to the facilities. Generally,
Covol does not expect to receive revenues based on the sales price of the
synthetic fuel product.
Covol believes that the Covol binder technologies may also be applied
profitably without the benefit of a tax credit. To do this Covol and its
licensees must develop the market for synthetic fuel and reduce the cost of
production. To date, our experience has been that facility owners are recovering
their investments only from realization of Section 29 tax credits and operating
loss deductions. There are millions of tons of coal fines in the U.S. and
internationally that could be washed and briquetted, and, in the opinion of
Covol, sold at a reasonable profit above the fines purchase and processing
costs. Additionally, the Covol binder technologies are well-adapted to the
processing of "ultra fines," the face powder sized coal fines created in
preparing coal for industrial use. Ultra fines can be recovered by equipping
coal preparation facilities with modern float cell technology. These ultra fines
have historically been slurried into waste ponds and, depending upon the
preparation facility, might constitute as much as 10% of the processed coal. The
Covol binder technologies allow for the recovery of such fines by removing the
high levels of moisture they contain and forming them into a solid product that
can be handled and sold. Finally, there are certain coals with high inherent
moisture levels, such as Powder River Basin coals. The processing of these coals
with the Covol binder technologies may reduce the moisture levels, thus
increasing heat content, improving combustion efficiencies, and reducing
transportation costs because of the reduced weight. Covol intends to
aggressively pursue these and other similar synthetic fuel applications.
5
<PAGE>
Another engineered fuel application Covol is pursuing is coke. Coke is
processed metallurgical coal which serves as both a fuel and a reducing agent in
iron and steel making. The production and handling of coke produces fine
particles of coke dust. The aggregation of coke dust into briquettes that are
designed to withstand the rigors of handling, heat and weight in metal making
furnaces results in a useable fuel. Covol has patented technology and is in the
process of patenting additional technology related to coke dust processing.
Covol has acquired property where coke and coke dust has been landfilled. Covol
intends to recover this coke and to briquette a portion of it for use as a fuel
as described above.
Silicon carbide is a product manufactured from a blend of carbon based
materials and high silica sand. In addition to its principle use in the
abrasives industry, silicon carbide is also used as an alloy and a high-quality
fuel in specialized metal making applications. This application is covered under
existing and applied-for patents. Covol has not yet applied the aggregation of
silicon carbide in a full-scale operation.
Engineered Resources. Steel mills, nonferrous metal producers and other
mineral industries produce wastes and other by-products that may contain
valuable unrecovered resources. These wastes often create environmental
compliance, storage and disposal problems. The Covol binder technologies provide
a way to solve disposal problems, extract the inherent resources, process the
materials with current industrial methods, and enhance the materials with
qualities that add value and that customize the materials for alternative uses.
The resulting products are collectively referred to as "engineered resources."
Covol has not yet commercially applied the Covol binder technologies in
engineered resources. However, Covol has devoted significant research and
development resources to improving and perfecting its technology for these
applications, particularly in the processing of iron production wastes.
During the steel-making process, steel mills produce, among other waste
by-products, small particles of iron-rich materials. The Covol binder
technologies are able to bind such particles into briquettes which can be
further processed in reducing furnaces to reclaim the iron and other materials.
Covol believes that products produced from such wastes could be marketed at
prices which are competitive with other sources of iron and that this technology
will be attractive in addressing the environmental issues surrounding the
disposal of waste by-products generated in the steel making process.
Covol will seek to enter into collaborative arrangements with steel and
iron producers to build, equip and operate briquetting and processing plants at
the producers' facilities. Covol believes that such arrangements will benefit
both Covol and the metal producers because they will:
o provide Covol with an ongoing supply of inexpensive iron
tailing materials while ensuring a ready customer for the
briquettes produced;
o provide the steel producer with an economical means to dispose
of waste materials while providing a ready source of
briquettes and/or iron feedstock; and
o minimize transportation costs for waste by-products, raw
materials and briquettes, thereby increasing the economic
competitiveness of Covol's products.
Covol has developed and tested its technologies with other fine
particulate wastes and other by-products, including: molybdenum, titanium
dioxide, grinding swarf, lead dross, zinc oxide and phosphorous. Covol intends
to continue to evaluate these and other engineered resource applications.
Licensing and Technology Transfer. Covol believes that the Covol binder
technologies include valuable intangible properties in the form of patents,
processes, formulations and know-how. Covol intends to devote significant human
and capital resources in the continued development and refinement of various
applications of these technologies. Covol hopes to augment its own efforts with
technical support from major suppliers of binding materials. Covol has entered
into licensing agreements with third parties for the use of its synthetic fuel
technology. Covol intends to actively pursue additional licensing, joint venture
and other collaborative arrangements with coal, coke, ferrous and non-ferrous
metals producers and other resource producers to utilize Covol's technologies in
recycling, recovering or enhancing fuels and resources from wastes and other
by-products, both domestically and worldwide.
6
<PAGE>
Strategic Acquisitions. Covol believes that it has a unique opportunity
to pursue acquisitions that are synergistic with Covol's financial and
environmental objectives and initiatives. The Covol binder technologies may be
applied to waste streams that are otherwise of little or no value. Covol intends
to pursue possible acquisitions of businesses aligned to the industries in which
the Covol binder technologies may be applied.
Covol intends to broaden its position in the synthetic fuel industry
and other resource industries through the acquisition or licensing of
technologies that are complementary to the Covol binder technologies.
Subsidiaries
Covol has organized various special purpose entities to facilitate some
of the transactions relating to the 24 synthetic fuel facilities. The entities
are listed with Covol's position and interest in the entity as of December 31,
1998 described as follows:
o Alabama Synfuel #1 Ltd., a Delaware limited partnership of
which Covol serves as general partner and owns 98%
o Utah Synfuel #1 Ltd., a Delaware limited partnership of which
Covol serves as general partner and owns 100%
o Flat Ridge Corporation, a Utah corporation, a wholly-owned
subsidiary of Covol
o Commonwealth Synfuel, L.L.C., a Utah limited liability company
of which Covol is managing member and owns 100%
The following chart illustrates Covol's corporate structure. Covol's
ownership of each subsidiary is 100% unless otherwise indicated.
COVOL TECHNOLOGIES,
INC.
Alabama
Synfuel #1, Utah Synfuel #1, Flat Ridge Commonwealth
Ltd. Ltd. Corporation Synfuel, L.L.C.
Tax Credits
Section 29 of the U.S. Internal Revenue Code provides a credit against
regular federal income tax with respect to sales of qualified fuel to an
unrelated party. Where more than one person has an interest in a qualified
facility, the Section 29 Credits generated by the facility are allocated
pursuant to the proportional interests of such persons in the facility.
7
<PAGE>
In order to qualify as a solid synthetic fuel produced from coal for
purposes of the Section 29 credit, the fuel produced must differ significantly
in chemical composition, as opposed to physical composition, from the raw
material used to produce it. Covol has received a Private Letter Ruling, or PLR,
from the IRS in which the IRS, based on representations made to it by Covol,
ruled that the synthetic fuel technology produces a significant chemical change
compared to coal fines and this qualifies the end product as a solid synthetic
fuel. Accordingly the IRS has ruled, based on the facts presented to it, that:
o Covol, with the use of its patented process, produces a
"qualified fuel" within the meaning of Section 29 of the tax
code; and
o assuming the other requirements of Section 29 are met, the
sale of the "qualified fuel" will entitle Covol to claim the
Section 29 credit in the taxable year of sale.
In its ruling, the IRS noted that no temporary or final regulations
pertaining to one or more of the issues addressed in the PLR have been adopted
and that the PLR would be modified or revoked by the adoption of temporary or
final regulations to the extent the regulations are inconsistent with any
conclusions in the PLR. The IRS notes, however, that a PLR is not revoked or
modified retroactively, except in rare and unusual circumstances, provided that:
o there has been no misstatement or omission of material facts,
o the facts at the time of the transaction are not materially
different from the facts on which the PLR was based,
o there has been no change in the applicable law,
o the PLR was originally issued for a proposed transaction and
o the taxpayer directly involved in the PLR acted in good faith
in relying on the PLR, and revoking the PLR retroactively
would be to the taxpayer's detriment.
Covol received its PLR in September 1995. At least six other PLRs
covering twelve of the synthetic fuel facilities have been obtained by third
parties in connection with licenses of Covol's synthetic fuel technology.
However, all PLRs are only binding with respect to the specific projects
addressed in the PLR and may only be relied on by the party that has obtained
the PLR. The Section 29 credit is subject to the passive activity rules of
Section 469, and therefore may not be available to individuals and closely held
corporations.
The Section 29 credit is equal to approximately $6.10 in 1997 dollars
for each oil barrel equivalent of the qualifying fuel produced and sold. This
equates to approximately $20.00-$28.00 per ton of synthetic fuel briquettes,
depending upon the recoverable heat content. The oil barrel equivalent is
defined generally as an amount of fuel having a recoverable heat content of 5.8
million Btu's. The Section 29 credit allowed may not exceed the taxpayer's
regular tax liability reduced by certain other credits. The credit cannot be
utilized to offset the Alternative Minimum Tax.
The Section 29 credit was designed to provide protection for qualifying
fuels against market price declines, and it is therefore subject to a phase out
after the unregulated oil price reaches specified levels under an annually
adjusted formula. In 1997 dollars, the credit would have phased out had the
reference price for oil exceeded $47.78 per barrel, but the reference price
determined for 1997 was $18.92 and no phase out occurred. There presently is no
reference price for 1998. However, the average price of oil in the U.S. was
lower in 1998 than 1997. The credit is also subject to reduction insofar as an
otherwise qualifying facility benefits from grants or subsidized financing
provided by federal, state or local governments, or from tax-exempt bond
financing.
8
<PAGE>
Section 29 of the tax code contains no provision for carryback or
carryforward of Section 29 credits. Once earned, the credits are not subject to
subsequent recapture. By virtue of the various limitations and other factors
described above, there can be no assurances that any particular amount of
Section 29 credit will be allowable and usable.
During 1996, certain of the time periods applicable to the Section 29
credit were extended. The Section 29 credit will, under present law, be
available for sales of qualified fuels completed before January 1, 2008. The
qualified fuels sold must be produced at facilities placed in service by June
30, 1998. The synthetic fuel facilities must have been constructed pursuant to a
binding written contract in effect as of December 31, 1996.
Synthetic Fuel Manufacturing Facilities
The following table represents a summary of the 24 synthetic fuel
manufacturing facilities constructed and placed in operation before June 30,
1998 by Covol and its licensees.
<TABLE>
<CAPTION>
SYNTHETIC FUEL MANUFACTURING FACILITIES
No. of Annual Rated
Name of Facility Plants1 Location Owner/Licensee2 Operator Capacity (tons)3
<S> <C> <C> <C> <C> <C>
Utah Synfuel #1 1 Price, Utah Coaltech No. 1 Company 360,000
L.P.4
Carbon Synfuel 1 Price, Utah Company5 Company 360,000
Mohave Synfuels 1 Laughlin, Savage Industries Flyash Haulers, 280,000
Nevada Inc. Inc.
Birmingport 1 Mulga, Alabama Birmingham Syn Birmingham Syn 360,000
Fuel, L.L.C.7 Fuel, L.L.C.
Brookwood 1 Brookwood, PacifiCorp Syn PacifiCorp Syn 360,000
Alabama Fuel, L.L.C8 Fuel, L.L.C.
Pumpkin Center 2 Flat Creek, PacifiCorp Syn PacifiCorp Syn 720,000
#1 & #2 Alabama Fuel, L.L.C. Fuel, L.L.C.
Norton 1 Norton, PC Virginia Constellation 600,000
Virginia Synthetic Fuel #1,
L.L.C.
Chelyan 1 Chelyan, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #1,
L.L.C.
Muddlety 1 Muddlety, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #2,
L.L.C.
Eckman 1 Eckman, West PC West Virginia Constellation 600,000
Virginia Synthetic Fuel #3,
L.L.C.
Appalachian 2 Peccus, West Appalachian AT Massey 720,000
Synfuel Virginia Synfuel, L.L.C.
Mountaineer 1 Tallmansville, Company6 Savage 360,000
Synfuel West Virginia Industries Inc.
Pocahontas 1 North Fork, Company Company 360,000
Synfuel West Virginia
Ginger Hill 1 Ginger Hill, Ginger Hill Maple Creek 300,000
Pennsylvania Synfuels, L.L.C. Mining
9
<PAGE>
<CAPTION>
No. of Annual Rated
Name of Facility Plants1 Location Owner/Licensee2 Operator Capacity (tons)3
<S> <C> <C> <C> <C> <C>
Robena 1 Paisley, Robena, L.L.C. Consolidation 580,000
Pennsylvania Coal
Commonwealth 1 Karthaus, Company River Hill Coal 360,000
Synfuel Pennsylvania
Pennsylvania 1 Somerset, Somerset Fuels, Somerset Fuels, 600,000
Synfuel Project Pennsylvania L.L.C. L.L.C.
USA Coal, #1, 4 Pawnee, Illinois A.J.G. Financial USA Coal 1,440,000
#2, #3, & #4 Services, Inc.
Pleasant Ridge 1 Alledonia, Ohio Pleasant Ridge Ohio Valley Coal 340,000
--- ----------
Synfuels, L.L.C.
Total 24 9,900,000
==== =========
</TABLE>
1 A plant is a finished synthetic fuel manufacturing facility constructed
pursuant to a binding construction agreement entered into on or before
December 31, 1996.
2 Most owners/licensees are special purpose entities owned by one or more
other companies.
3 This is an amount as engineered and determined by equipment manufacturers.
Most facilities are not yet operating at rated capacity. There is no
assurance that the facilities will operate at rated capacity in the future.
4 Coaltech No. 1 L.P. consists of AJG Financial Services, Inc., a
wholly-owned subsidiary of Arthur J. Gallagher & Co., and Square D Company,
a wholly-owned subsidiary of Groupe Schneider, as limited partners, and
Covol as 1% general partner. Covol has entered into an operating agreement
with Coaltech to operate the Utah Synfuel #1 facility.
5 Covol granted Coaltech an option to purchase the facility, but does not
expect the option to be exercised.
6 Covol granted Mountaineer Synfuel, L.L.C. an option to purchase the
facility, which option expires in January 1999. The purchase option
transaction for the Mountaineer facility provides that Covol is the
managing member of Mountaineer Synfuel, L.L.C.
7 Birmingham Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial
Services, Inc.
8 PacifiCorp Syn Fuel, L.L.C. is an affiliate of PacifiCorp Financial
Services, Inc.
Covol Contracts. Consistent with the requirements for obtaining Section
29 tax credits, in December 1996 Covol entered into fourteen design and
construction agreements for the design and construction of new synthetic fuel
manufacturing facilities each having capacity of approximately 360,000 tons per
year. Depending upon the specific agreement, the contractor was either TIC,
CEntry Constructors & Engineers, PICOR or Centerline Engineering Corporation.
The PICOR contracts were part of a joint venture with Savage Industries. The
construction agreements, among other things, required that the plants be placed
in service no later than June 30, 1998.
Covol obtained financing and successfully constructed five facilities
from its construction agreements. Of these, one was built by TIC for Covol and
sold to Birmingham Syn Fuel, L.L.C., a special purpose entity owned by
PacifiCorp Financial Services, Inc., two were built for Covol by Centerline and
are under option for sale to Mountaineer Synfuel, L.L.C. and to Coaltech No. 1
L.P., and two were built by TIC and are held for sale by Covol.
Covol assigned four other construction agreements to licensees and
those licensees successfully constructed four facilities as follows:
Fluor Corporation. Covol assigned two of its fourteen construction
agreements to Appalachian Synfuel L.L.C., a wholly owned subsidiary of Fluor
Corporation. The facilities were built at A.T. Massey Coal Company, Inc.'s
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Marfork Prep Plant Site near Peccus, in Boone County, West Virginia. In
conjunction with the assignment of the two contracts, Covol entered into a
license agreement with Appalachian for the use of the Covol binder technologies.
Under the agreement, Covol was paid an advance license fee. A quarterly license
fee is also to be paid based upon the Btu of product produced and sold up to a
prescribed amount of production per year. Covol also granted Appalachian the
right to pay a lump sum payment for the facilities, in lieu of quarterly license
fees over the term of the agreement. Covol will provide binder to the facility
on a cost plus basis.
Pelletco Corporation. Covol assigned two of its construction agreements
with Centerline to affiliates of Pelletco Corporation. One contract was assigned
to Pleasant Ridge Synfuels, L.L.C. which constructed a facility in Alledonia,
Ohio. One contract was assigned to Ginger Hill Synfuels, L.L.C. which
constructed a facility at Ginger Hill, Pennsylvania. In connection with these
two facilities, Covol entered into technology license and agreements to supply
Covol's chemical binder, providing Covol with advanced license fees and
quarterly license fees equal to 50% of the licensees' net cash flow. Covol will
provide binder to the two facilities on a cost plus basis.
Unused Contracts. Covol did not build facilities under five of its
fourteen construction agreements, including the two PICOR contracts as part of a
joint venture with Savage Industries. The construction agreements provided for
penalties if the construction was not pursued by Covol. Covol accrued this
liability during the fiscal year ended September 30, 1997, of which the
remaining liability at September 30, 1998 is $755,000. Covol believes that
construction under any of the five unused contracts is not likely.
Additional Licensed Facilities. In addition to the nine facilities
constructed under Covol's construction agreements, Covol licensed its technology
to eight licensees for use at fifteen facilities constructed by these licensees.
These licensees entered into their own construction agreements prior to December
31, 1996, in compliance with Section 29.
In total, Covol has licensed or constructed plants using the Covol
binder technologies at 24 synthetic fuel facilities that operate at 18 locations
in the Rocky Mountain region, Southern Appalachia, Central Appalachia, Northeast
Appalachia, Northwest Appalachia, and the Illinois Basin, which are the primary
coal supply regions of the United States. For all facilities, the construction
agreements were entered into prior to December 31, 1996. In most instances,
Covol entered into a construction contract which was either fulfilled by Covol
or later assigned to a licensee. In certain instances, the licensees entered
into their own construction contracts.
A facility generally consists of a conditioner and binder additive and
mixing system, briquetting or aggregating equipment, a product dryer, and other
supporting systems. However, each facility was individually engineered and
constructed, including systems and components specially selected by the
respective owners, so that there is variation in features from facility to
facility. Covol has manufactured and sold binder mixing plants for installation
at synthetic fuel manufacturing facilities. Six such plants were manufactured
and sold in 1998.
License and Binder Supply Agreements. All non-Covol entities that have
constructed or own facilities using the Covol binder technologies have entered
into a technology license and binder supply agreement with Covol. Most license
agreements provide for an advance license fee of $1.39 per ton of rated
capacity, payable upon reaching project milestones. Covol has received most of
the advance license fees related to these facilities. In addition, pursuant to
the license agreement, the licensee pays a quarterly earned license fee at a
prescribed dollar amount multiplied by the recoverable heat denominated in Btu's
in the product produced and sold during the calendar quarter. The prescribed
dollar amount is subject to adjustment based upon the "inflation adjustment
factor" as set forth in Section 29 of the tax code. In some cases, the amount to
be paid is subject to adjustment to the extent that licensees incur an operating
loss on the production and sale of synthetic fuel, exclusive of the amount
licensees pay as a license fee for the use of the technology. Some license
agreements also provide for a goal fee based on time schedules and production
amounts. In most cases, the fees paid to Covol under the license agreements are
not based on the sales price of the synthetic fuel product. The license
agreements generally have a term until the later of January 1, 2008 or the
corresponding date after which tax credits may not be claimed or are not
otherwise available under Section 29 of the tax code.
Covol also agreed, pursuant to the binder supply agreements, to provide
binder material to licensees for the manufacture and production of synthetic
fuel. The price for the binder sold to the licensees falls into two categories:
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o a fixed price, or
o an amount equal to Covol's cost plus a prescribed mark-up.
In some cases, the mark-up may be reduced to the extent the licensee
incurs a loss on the production and sale of synthetic fuel, but not below
Covol's cost for such binder materials. The binder is currently manufactured by
Dow Chemical Corporation for Covol utilizing Covol's patented and proprietary
technology. Covol arranges with Dow for shipping of the binder directly to the
facilities.
Pace Loan. In December of 1996 Covol entered into license agreements
with affiliates of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use
of the Covol binder technologies at four synthetic fuel manufacturing facilities
owned 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 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. Pace has requested a
loan of $750,000 for the November 1998 quarter. Covol believes that its current
loan obligation to Pace is limited to the earned license fees payable to Covol
for the quarter ended September 30, 1998, which is believed to be approximately
$300,000. Pace and Covol are negotiating in an attempt to resolve their
differences.
Covol Synthetic Fuel Facility Operations
Covol is the operator at three facilities: Utah Synfuel #1, Carbon
Synfuel, and Pocahontas Synfuel. Of these facilities, Utah Synfuel #1 is not
owned by Covol, and Covol operates the facility under agreement with the owner,
Coaltech. The operating agreement provides that Covol will act as operator of
the facility for a quarterly fee based upon the amount of synthetic fuel
produced and sold per year. Covol cannot predict with any certainty the amount
of fees that may be generated under its operating agreement.
Covol has contracts with independent operators to operate Covol's
Commonwealth Synfuel and Mountaineer Synfuel facilities. River Hill Coal Company
operates the Commonwealth facility and Savage Industries Inc. operates the
Mountaineer facility. Both operating contracts compensate the operator with a
prescribed fee plus reimbursement of costs.
Supply of Raw Materials
The synthetic fuel manufacturing facilities use coal fines as the
primary feedstock to produce synthetic fuel. Accordingly, a supply of coal fines
is essential to the feasibility of a synthetic fuel manufacturing facility.
Historically, lower quality coal and mining refuse and fine particles
of coal were discarded into refuse piles or impoundments. Today, coal
preparation and material handling technologies have reduced the amount of coal
that is discarded, but coal fines generated by coal mining and preparation are
still problematic for the industry. With some variation, most consumers of coal
only purchase coal with an ash content of 12% or less. Discarded coal fines are
typically too high in ash content to be used as-is in making marketable
synthetic fuel. To make use of fine coal refuse, owners of synthetic fuel plants
must either blend the refuse with "clean" coal in appropriate proportions to
yield an acceptable ash content, and/or clean the coal refuse itself. Clean coal
can be purchased from traditional coal marketers and is available to all
synthetic fuel facility owners that have a clean coal/coal refuse blending
strategy. Covol's strategy at all of the facilities it owns or operates includes
clean coal/coal refuse blending.
Coal fines cleaning is a distinct technology and to implement it
successfully requires analysis of the particular coal refuse to determine
appropriate plant design and to determine whether feedstock can be economically
produced. Capital requirements for coal cleaning or preparation plants adequate
to supply a synthetic fuel plant can be in excess of $4 million. Coal cleaning
plants require six months or more to design and construct. A feasibility
analysis must be performed to determine whether the savings achieved by the
plant justify the capital costs of construction together with operational costs,
which can vary between approximately $5-10 per ton. The costs of a cleaning
plant are compared to the alternative of purchasing clean coal for blending. The
decision to construct a coal cleaning plant
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does not delay delivery of synthetic fuel to market because in all cases clean
blending coal is available to purchase as an immediate alternative. The decision
to construct a coal cleaning plant is based on how a facility most economically
obtains clean feedstock. Covol constructed a coal cleaning plant to supply Utah
Synfuel #1 and Carbon Synfuel and is reviewing the feasibility of coal cleaning
plants at two other synthetic fuel facilities.
In facilities owned and operated by licensees, the licensee secures its
own supply of coal fines. Licensees that are also coal producers utilize their
own feedstock sources. Nonproducer licensees secure deposits of coal fines to
supply their facilities. Covol has arranged for the supply of coal fines for the
following facilities it owns or operates:
Utah Synfuel #1 and Carbon Synfuel. In February 1997, Covol entered
into a contract with a non-affiliated party, Earthco, to acquire coal fines and
to lease property to conduct fines recovery and preparation activities at a
location near Wellington, Utah, approximately six miles from the Utah Synfuel
plant site. Covol paid an initial amount to Earthco upon execution of the lease
agreement to acquire the fines and lease the associated land and will continue
to make quarterly payments through May 2000. Covol constructed a preparation
plant at the site which became operational in May 1998 and which produces
feedstock from the acquired raw fines for the Utah Synfuel #1 and Carbon Synfuel
facilities. The estimated quantity of coal fines at this site is in excess of 2
million tons although the recoverable amount may be less. Additional fines will
be required to supply the longer term requirements of Utah Synfuel #1 and Carbon
Synfuel.
Pocahontas Synfuel. In May 1997, Covol entered into a joint venture with
Black Diamond Enterprises, Inc. under which Black Diamond has certain rights to
market the synthetic fuel produced at the facility and to a percentage of the
net proceeds received by Covol from the project. In addition, Black Diamond is
to provide coal fines to the Pocahontas Synfuel facility. Black Diamond owns the
land in McDowell County, West Virginia upon which the Pocahontas facility is
located and which land includes a fines pond and other coal refuse containing an
estimated 1.2 million tons of recoverable clean fines. Black Diamond and Covol
plan to construct a preparation plant to clean the raw Black Diamond fines. To
date, neither Covol nor Black Diamond have begun construction of a preparation
plant. In addition to the fines at the Pocahontas site, an affiliate of Black
Diamond operates a waste coal recovery operation with an estimated 350,000 tons
of recoverable clean fines. Covol has also acquired waste coal on a site near
the project with an estimated 500,000 tons of recoverable clean fines. After
cleaning, the coal fines from these reserves are high in recoverable heat, low
in ash, and low in sulfur. Until a preparation plant can be permitted, financed
and constructed at Pocahontas, Covol is purchasing coal fines from local sources
for processing at the facility.
Commonwealth. The Commonwealth Synfuel facility is located on property
owned by River Hill Coal Company, Inc. River Hill has approximately 6 million
tons of leased and permitted coal reserves which it actively mines. River Hill
has agreed to provide up to 400,000 tons per year of coal fines from its mining
and preparation plant operations to the Commonwealth facility. Covol intends to
assign this supply agreement to the entity that acquires this facility, which is
currently being offered for sale.
Mountaineer. The Mountaineer Synfuel facility is located on property
owned by Upshur Property, Inc., an affiliate of Anker Energy Corporation. Anker
has agreed to provide the feedstock requirements of Mountaineer Synfuel, L.C.
for a period of ten years, up to 480,000 tons of feedstock per year. Anker will
supply the feedstock from various sources owned or controlled by Anker,
including preparation plant operations and fines ponds. The price for the
feedstock varies based upon the source of the coal fines and the costs of
recovery. The site contains a fines refuse pond which is serving as a partial
source for feedstock and a preparation plant is planned to increase the quality
and amount of feedstock coming from the site refuse pond. Covol does not yet
have financing for the preparation plant. If Mountaineer Synfuel, L.L.C.
exercises its option to purchase the Mountaineer facility, Covol proposes to
assign this supply agreement to Mountaineer.
Alabama Inventory. In March of 1997 Covol entered into a coal fines
supply agreement (the Supply Agreement") with K-Lee Processing Inc. and Concord
Coal Recovery Limited Partnership (collectively "K-Lee"). Covol purchased coal
fines under the Supply Agreement through February of 1998 at which time Covol
sold its inventory of coal fines and assigned the Supply Agreement to Birmingham
Syn Fuel, L.L.C. Birmingham Syn Fuel removed the coal fines inventory and
asserted that the inventory was approximately 11,000 tons less than K-Lee had
invoiced and received payment from Covol. Covol is currently in negotiations
attempting to resolve the dispute.
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Supply of Binder. Covol purchases its patented and proprietary binder
from Dow Chemical Company under a ten year agreement under which Covol pays a
prescribed price per pound of binder. Covol arranges with Dow for the delivery
of the binder from Dow's manufacturing plants to each of the synthetic fuel
facilities owned, operated, or licensed by Covol.
Sale of Facilities
Covol and its affiliates have developed and sold or have granted an
option to sell four synthetic fuel facilities. The following is a summary of
each option or sale:
Utah Synfuel #1. On March 10, 1997, Utah Synfuel #1 Ltd., a Delaware
limited partnership in which Covol was at the time a 64% owner and general
partner, sold the Utah synthetic fuel facility for $3.5 million, in the form of
a nonrecourse promissory note bearing interest at 9.6552% per annum and payable
in 44 equal quarterly installments, all in accordance with the Utah Project
Purchase Agreement, dated as of March 7, 1997, between Covol, Utah Synfuel #1
and Coaltech No. 1 L.P. The sale of the Utah facility resulted in a loss of
approximately $582,000 to Utah Synfuel #1. The promissory note is collateralized
by a security interest in the Utah facility, and in the event of a default under
the promissory note, Covol's and Utah Synfuel #1's sole right to recovery is
limited to the Utah facility without recourse against Coaltech.
Covol granted Coaltech a put option to require Covol to purchase the
Utah facility from Coaltech if:
1. all of the Coaltech limited partners are unable to utilize the
federal income tax credits under Section 29 of the tax code,
2. the economic benefits accruing to or experienced by all of the
Coaltech limited partners differ significantly from what was
initially projected, or
3. there is a permanent force majeure or material damage or
destruction of the Utah facility.
If the put option is exercised prior to the third anniversary date of
the facility sale, the option price will be equal to the fair market value of
the limited partnership interests of the optionees on a going concern basis, but
in no event will the option price exceed 50% of the capital contributions made
by the optionees to fund payments due under the promissory note, the Utah
License Agreement and broker fees. If the put option is exercised on or after
the third anniversary date, the option price will be $10 and the optionees will
not be entitled to any other payments.
As part of the sale of the Utah facility, Covol and Utah Synfuel #1
entered into a Supply and Purchase Agreement with Coaltech. Under the agreement,
Covol agreed to provide coal fines to the Utah facility for processing into
synthetic fuel at an amount equal to Covol's per ton costs, including any wash
costs. Utah Synfuel #1 also agreed to purchase from Coaltech the synthetic fuel
produced at Coaltech's cost plus one dollar per ton. Coaltech has the right to
market its synthetic fuel to a third party, with Utah Synfuel #1 having a right
of first refusal to purchase such synthetic fuel. Covol has incurred a loss each
quarter in connection with this agreement and expects that these losses will
continue into the foreseeable future.
Carbon Synfuel. In connection with the Utah Project Purchase Agreement,
dated March 10, 1997 Covol entered into an option agreement with Coaltech to
sell a second facility, identified as Carbon Synfuel and located at the Utah
Synfuel #1 facility. If Coaltech exercises its option, Covol will sell the
second line of synthetic fuel manufacturing equipment including the building,
binder plant, and other equipment that were not part of the Utah Synfuel #1
facility sale. The terms of the option provide that Coaltech would purchase
Carbon Synfuel on the same terms as Coaltech's purchase of Utah Synfuel #1
facility. Covol does not expect the option to be exercised. Covol is actively
seeking an alternative buyer for the Carbon Synfuel facility, however there is
no assurance that a sale will be completed.
Since the Utah Synfuel #1 facility and Carbon Synfuel facility were
first placed in service they have experienced several problems, including
inadequate clean coal fines as feedstock, inadequate end product strength, and
inability to market to end-consumers the synthetic fuel product produced from
the feedstock. Covol continues to improve the synthetic fuel product quality and
believes that the improvements will achieve the results necessary for successful
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marketing. Covol also has begun to see some success in marketing the product
from these two facilities to a power plant and an industrial manufacturer. Covol
is seeking a long term purchase commitment from these consumers.
The Utah Synfuel #1 and Carbon Synfuel facility are currently operating
at well below their rated capacity. Covol and its licensee have incurred a loss
on the production of synthetic fuel at the Utah Synfuel #1 and Carbon Synfuel
facilities.
In order to provide coal fines to the Utah Synfuel #1 facility, Covol
entered into a purchase agreement with Earthco to acquire the coal fines located
at Wellington, Utah. The estimated amount of coal fines at the Wellington site
is in excess of 2 million tons. The Wellington fines require washing. Covol has
constructed a wash plant at the Wellington site which supplies coal fines to
Utah Synfuel #1 and Carbon Synfuel. The cost for the plant was approximately $8
million. The financing for the construction of the wash plant was provided in
part by AJG Financial Services, Inc., and is evidenced by a debenture of Covol
to AJG which is collateralized by the wash plant assets. The debenture bears
interest at 6% per annum with principal and interest being due and payable in
October 1999. As additional consideration to AJG for financing the wash plant,
Covol, in October 1997, agreed to grant to AJG warrants to purchase
approximately 430,000 shares of Covol common stock, with fifty percent of the
shares having a purchase price of $10 per share and fifty percent of the shares
having a purchase price of $20 per share. The warrants expire two years from
issuance.
Birmingham Syn Fuel. Alabama Synfuel #1 Ltd., a Delaware limited
partnership in which Covol was at the time a 74% owner and general partner, sold
the Birmingham Syn Fuel/Birmingport facility to Birmingham Syn Fuel, L.L.C., a
wholly-owned subsidiary of PacifiCorp Financial Services, Inc., on March 6,
1998. The purchase price for the Birmingport facility was $6,500,000 payable in
the form of a nonrecourse promissory note collateralized by certain portions of
the Birmingport facility.
Mountaineer Synfuel. On May 5, 1998 Covol entered into a purchase
agreement to sell the Mountaineer synthetic fuel facility to Mountaineer
Synfuel, L.L.C., a Delaware limited liability company. The agreement is subject
to numerous conditions, including but not limited to, the obtaining of a PLR
from the IRS, and the production of product meeting certain specifications.
There is no assurance that Mountaineer will exercise its option with respect to
the purchase of this facility. Covol also entered into a financing agreement
with Mountaineer to finance up to $9.75 million for project construction and
operations working capital. Covol's obligation to repay the financing will be
extinguished if Mountaineer exercises its purchase option; otherwise, Covol will
be required to repay the loan with ten percent interest in monthly installments
of interest only payments for the months January through June 1999 and monthly
installments thereafter of $350,000 and a balloon payment on June 30, 2000.
Covol's obligation to repay the amounts borrowed is collateralized by the assets
of the project, and income streams from the Ginger Hill and Pleasant Ridge
facilities. Under a license agreement, Covol will provide use of its technology
and Mountaineer will pay a quarterly license fee based upon the synthetic fuel
product produced and sold during the quarter. Covol will also supply binder
material to the project on a cost plus basis.
In addition to the four facilities discussed above, Covol owns and
operates two synthetic fuel manufacturing facilities that Covol has for sale.
One facility is referred to as Commonwealth Synfuel, located near Karthaus,
Pennsylvania. The other Covol-owned facility for sale is referred to as
Pocahontas Synfuel located near North Fork, West Virginia. Several entities have
expressed interest in purchasing the facilities and Covol expects the facilities
to be sold in early 1999. However, Covol cannot give assurance that it will
successfully sell either or both facilities.
Research and Development
Covol has devoted and continues to commit significant human and capital
resources to the development, refinement and commercialization of the Covol
binder technologies in the engineered fuel and engineered resource applications.
Covol is currently focusing its research and development efforts principally on
the synthetic fuel technology, including refinements to the chemical formula and
process, enhancements to the base binder formulations to address product quality
issues, and continued testing and development of other binder materials for the
production of synthetic fuel. Covol is also currently conducting research and
development related to application of the Covol binder technologies to iron
tailing materials, coke breeze, silicon carbide and other waste product or
resource materials.
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Covol's intellectual property base consists of seven U.S. and four
international patents relating to the Covol binder technologies as applied to
coal, iron tailings, coke and other carbon based materials. Covol's research and
development efforts will be directed toward perfecting and expanding these
technologies and the filing for patents for proprietary intangible property
developed. See "ITEM 1. BUSINESS - Proprietary Protection" for a discussion of
Covol's patents, trademarks and other intellectual property.
Proprietary Protection
Covol has the following trade names and patents covering certain
aspects of Covol's technology:
Trade names:
Covol Technologies, Inc., Alabama Synfuel #1 Ltd., Utah Synfuel #1
Ltd., Flat Ridge Corporation and Engineered Fuel Technologies, Inc.
Trademarks and Service Marks:
United States Trademark Registration No. 2,038,742 for licensing
services identified by "Covol", "Recycling Yesterday's Waste Into
Tomorrow's Resources."
United States Patents:
United States Patent No. 5,453,103, which issued 26 September 1995.
United States Patent No. 5,487,764, which issued 30 January 1996.
United States Patent No. 5,589,118, which issued 31 December 1996.
United States Patent No. 5,599,361, which issued 4 February 1997.
United States Patent No. 5,738,694, which issued 14 April 1998.
United States Patent No. 5,752,993, which issued 19 May 1998.
United States Patent No. 5,807,420, which issued 15 September 1998.
Foreign Patents:
European Patent Office # 96905442.8-2307 filed May 1, 1998.
Australian #686624 filed on January 21, 1994; filed with U.S. Patent
Office as No. 184099 on May 28, 1998.
New Zealand #266060 filed on April 7, 1994; filed with U.S. Patent
Office on February 20, 1998.
Republic of Trinidad and Tobago #960038 filed on July 1, 1996 and
#970147 filed under PCT/US96/01798 on February 8, 1996.
Other United States, Patent Cooperative Treaty, and Foreign Patent
Applications are pending.
Covol's U.S. and foreign patents expire on January 21, 2014. There can
be no assurance as to the scope of protection afforded by the patents. In
addition, there are other industrial waste recycling technologies in use and
others may subsequently be developed, which do not, or will not utilize
processes covered by the patents or pending patents. There can be no assurance
that any patent issued will not be infringed or challenged by other parties,
infringe on patents held by other parties or that Covol will have the resources
to enforce any proprietary protection afforded by the patent or defend against
an infringement claim.
In addition to patent protection, Covol also relies on trade secrets,
know-how and confidentiality agreements to protect the Covol binder
technologies. However, such methods may not afford complete protection and there
can be no assurance that others will not independently develop such know-how or
obtain access to Covol's know-how, concepts, ideas, and documentation.
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Since Covol's proprietary information is important to its business,
failure to protect ownership of its proprietary information would likely have a
material adverse effect on Covol. Covol's current and expected revenues are
dependent upon license agreements by which licensees use the Covol binder
technologies to manufacture synthetic fuel and then pay license fees to Covol.
Covol expects that revenues will continue to be tied to future licensing
agreements in the application of Covol binder technologies to iron rich wastes,
coke dust, and other potentially useful wastes and by-products. Covol believes
that its patents, trade secrets, know-how and confidential information are the
basis upon which Covol is able to obtain licensing agreements.
Confidentiality Provisions
As part of its business, Covol typically enters into agreements
concerning its projects which contain confidentiality provisions. Covol is, on
occasion, required to disclose such agreements to the Securities and Exchange
Commission as part of its ongoing reporting requirements under the Securities
Exchange Act of 1934. In addition, disclosure of such agreements may be required
in connection with Covol's private placement of securities. Some of the
agreements do not contain the standard exceptions for the disclosure of
information which is required to be disclosed under law. Consequently, no
assurances can be given that Covol has not inadvertently disclosed information
regarding its various projects in violation of confidentiality covenants entered
into by Covol.
Government Regulation
Covol's and its licensees' synthetic fuel operations are subject to
federal, state and local environmental regulations that impose limitations on
the discharge of pollutants into the air and water and establish standards for
the treatment, storage and disposal of waste products. In order to establish and
operate the synthetic fuel plants, Covol and its licensees obtained various
state and local permits. Covol believes that it or its licensees have obtained
all required permits to construct and operate synthetic fuel facilities, and
that they are in substantial compliance with all relevant laws and regulations
governing the synthetic fuel operations.
Compliance with permits, regulations, and the approved processes does
not create pollution or contamination. Still the possibility exists that
regulatory noncompliance or accidental discharges, in spite of safeguards, could
create an environmental liability. Acid is the only stored raw material used in
the approved process that is classified as hazardous. Therefore, Covol's and its
licensees' synthetic fuel operations entail risk of environmental damage and
Covol or its licensees may incur liabilities in the future arising from the
discharge of pollutants into the environment or from waste disposal practices.
Failure by Covol or its licensees to maintain necessary permits to
operate synthetic fuel plants and to comply with permit requirements could have
a material adverse effect on Covol or its licensees. Other developments, such as
the enactment of more stringent environmental laws and regulations, could
require Covol or its licensees to incur significant capital expenditures. If
Covol or its licensees do not have the financial resources or is otherwise
unable to comply with such laws and regulations, such failure could also have a
material adverse effect on Covol.
Covol's goal is to establish itself as the provider of technologies
that will assist others in the processing and reclamation of their wastes and
by-products, and Covol seeks for itself and its licensees to avoid creating
waste streams or compounding environmental reclamation problems. Covol has not
assumed responsibility for environmental reclamation of coal refuse impoundments
from which Covol or its licensees obtain refuse for feedstock. Such liabilities
are and remain the responsibility of the impoundment owners or operators. In the
manufacture of synthetic fuel from coal refuse using Covol's binder
technologies, the synthetic fuel produced effectively completely consumes the
refuse. The synthetic fuel manufacturing process does not contribute to
environmental reclamation liabilities with respect to the coal refuse. However,
the synthetic fuel manufacturing process using Covol binder technologies
typically uses dilute acids. Covol and its licensees must comply with hazardous
material handling and storage regulations related to acid solutions and stored
concentrates.
Covol's and its licensees' synthetic fuel operations are also subject
to federal and state safety and health standards. Covol is committed to
providing effective management of worker safety and health protection. Covol
periodically contracts with independent safety and industrial hygiene inspectors
in order to measure a facility's regulatory compliance. In addition, Covol has
developed a safety policy designed to raise and maintain a high level of safety
awareness by both management and employees. Compliance to applicable safety and
health standards is verified through periodic inspections by regulatory
agencies. Failure to comply with safety and health standards could have a
material adverse affect on Covol, for example, a regulatory inspector could
close the operation until Covol meets the required standards.
Competition
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Products made using the Covol binder technologies compete with other
synthetic products as well as traditional source materials. Competitive factors
include price, quality, delivery cost and waste handling costs. Covol may
experience competition from other alternative fuel technology companies and
their licensees, particularly those companies with technologies to produce coal
based solid synthetic fuels. Competition may come in the form of the licensing
of the competing technologies to process coal fines or in the marketing of end
products qualifying as synthetic fuel. Competition includes, for example,
Carbontec, Krystal Bond, KFx Inc. and Startec Inc. Covol will also experience
competition from traditional coal and fuel suppliers and natural resource
producers in addition to those companies that specialize in the disposal and
recycling of waste products generated by coal, coke, steel and other resource
production. Many of these companies have greater financial, management and other
resources than Covol. Covol believes that it will be able to compete effectively
although there can be no assurance that it will do so successfully.
Employees
Covol currently employs approximately 80 persons full-time.
Approximately 30 of such persons are in corporate administration including
research, development and marketing, and 50 are in synthetic fuel and coal
washing operations. None of these employees are covered by a collective
bargaining agreement.
Forward Looking Statements
Statements regarding Covol's expectations as to the financing,
development, construction and operation of facilities utilizing the Covol binder
technologies, the marketing of products, the receipt of licensing fees and other
information presented in this Annual Report on Form 10-K that are not purely
historical by nature, including those statements regarding Covol's future
business plans, the operation of facilities, the estimated capacity of
facilities, the availability of coal fines, the marketability of the synthetic
fuel and other briquettes and the financial viability of the proposed
facilities, 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 industry or the economy generally,
factors which could cause actual results to differ from expectations stated in
these forward looking statements include, among others, the following:
(1) The commercial success of the Covol binder technologies.
(2) Procurement of necessary equipment to maintain facilities'
operations.
(3) Securing of necessary sites, including permits and raw
materials, for facilities to be constructed and operated.
(4) Completion of facilities, in particular the synthetic fuel
manufacturing facilities, by the placed in service date.
(5) Ability to obtain needed additional capital on terms
acceptable to Covol.
(6) Changes in governmental regulations or failure to comply with
existing regulations which may result in operational shutdowns
of Covol or licensee facilities.
(7) The availability of tax credits under Section 29 of the tax
code.
(8) The commercial feasibility of the Covol binder technologies
upon the expiration of Section 29 tax credits.
(9) Ability to meet financial commitments under existing
contractual arrangements.
(10) Ability to commercialize the non-synthetic fuel related Covol
binder technologies which have only been tested in the
laboratory and not in full-scale operations.
(11) Dependence on licensees to successfully implement Covol binder
technologies.
(12) The market acceptance of products manufactured with Covol
binder technologies in the face of competition from
traditional products.
(13) Ability to produce products with Covol binder technologies
with acceptable hardness, moisture level, and other
characteristics.
(14) Success in the face of competition by others producing
synthetic fuel and other recycled products. (15) Sufficiency
of intellectual property protections.
ITEM 2. PROPERTIES
Covol leases an approximately 5,000 square-foot building in Lehi, Utah,
which houses its executive offices ("Corporate Headquarters"). In August 1997,
Covol entered into a triple-net lease dated August 1, 1997 (the "Headquarters
Lease"). The Headquarters Lease provides for a monthly rent of $5,000 during the
initial term which expires on July 31, 2000. Thereafter, the Headquarters Lease
will automatically extend indefinitely for successive one-year periods at the
sole option of Covol, and the monthly rent will increase by 5% per year.
In October 1997, Covol purchased an 8,000 square-foot site located in
Price, Utah, on which Covol's prototype briquetting plant is located, for
$150,000. Included in the purchase was a 1,400 square-foot office and warehouse
18
<PAGE>
building which houses equipment. The property is subject to a 10-year $100,000
mortgage held by the seller. The equity in the property was pledged as part of
the collateral for a $2.9 million loan to Covol from AJG Financial Services,
Inc.
In May 1995, Covol entered into a lease with Geneva Steel Company for a
9,000 square foot building in Vineyard, Utah. Covol pays no cash rent on these
facilities. Subsequent to the execution of the Geneva Agreements, the lease with
Geneva expired resulting in a tenancy-at-will between the parties. Covol may use
the Geneva briquetting facility in the manufacture of synthetic fuel or for
testing purposes at the Geneva site or some other location.
In June 1996, Covol entered into a land lease of approximately 12 acres
in Price, Utah with a non-affiliated party at a monthly rental of $600. The
lease term commenced on June 20, 1996 and expires on December 31, 2007 but may
be extended. In 1996 Covol constructed a 22,000 square-foot building to house
the Utah Synfuel #1 and Carbon Synfuel facilities. In March 1997, this building
was subleased by Covol to Coaltech as part of the sale of the Utah Synfuel #1
facility. However, Covol retained responsibility for operations of the property
pursuant to an Operations and Maintenance Agreement between Covol and Coaltech.
Covol has constructed an ancillary building, a 1,650 square-foot binder plant.
Coaltech has an option to purchase the Carbon Synfuel facility, and if
exercised, Coaltech will take ownership of the buildings.
In February 1997, Covol entered into a lease agreement with Earthco for
two contiguous parcels located in Wellington, Utah (approximately 6 miles from
the Utah Synfuel #1 site). The first parcel covers approximately 30 acres and
has a lease term of 15 years. On this parcel, Covol constructed a 3,400
square-foot wash plant. The second parcel covers approximately 357 acres and has
a lease term of 5 years. On this parcel, Covol conducts fines recovery
operations. Covol has the option to extend or purchase either or both parcels
upon the satisfaction of certain conditions. Total obligations to lease the
parcels and acquire the associated fines are approximately $5.5 million, of
which $700,000 was paid at the time of lease execution and Covol has and will
make payments 4 times each year until May of 2002 for the balance.
In 1997, Covol entered into a 5 year, $850 per month sublease with
Combustion Resources, Inc. for approximately 2,400 square feet of building space
in Provo, Utah.
In 1997, Covol entered into a one year, $9,000 lease with Stephen
Mallory for approximately 2,000 square feet of office and residential space in
Dunbar, West Virginia. This property serves as Covol's Eastern Region office.
In 1998, Covol entered into a one year, $1,500 per month lease with
Mobile Auto & Storage for approximately 4,000 square feet of building space in
Lehi, Utah. This property provides office and laboratory facilities for some of
Covol's research and development personnel.
In May 1998, Covol entered into a 10 year, $1,000 per year lease with
Upshur Property, Inc., for approximately 10 acres of property in Tallmansville,
Upshur County, West Virginia. The property is the site of the Mountaineer
Synfuel facility. The lease is assignable to Mountaineer Synfuel, L.L.C., in
connection with its facility purchase option.
In May 1998, Covol purchased approximately 80 acres of undeveloped
property near Sunnyside, Utah for $100,000. In June of 1998 Covol entered into a
five year lease with an option to purchase approximately 40 acres of property
with office and warehouse improvements. The lease payments are $2,000 per month,
escalating to $3,500 per month over time. The leased property is adjacent to the
purchased property. Covol plans to conduct some operations on the two properties
in the future.
None of Covol's subsidiaries have interests in real property.
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<PAGE>
ITEM 3. 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 of 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 of 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 its
resolution 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Covol held its Annual Meeting of Stockholders on August 27, 1998. At
the meeting, the following actions were approved by the stockholders:
James A. Herickhoff was elected a director of Covol for a three year
term to expire in 2001, by a vote of 7,703,272 in favor and 50,992 against.
John P. Hill was elected a director of Covol for a three year term to
expire in 2001, by a vote of 7,694,872 in favor and 58,992 against.
Selection by the Board of Directors of PricewaterhouseCoopers LLP as
independent auditors of Covol for the 1998 fiscal year was ratified by a vote of
7,690,463 in favor, 15,610 opposed and 43,938 abstaining.
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE POSITION
Brent M. Cook 38 Chief Executive Officer and Director
Stanley M. Kimball 44 President and Director
Steven G. Stewart 50 Chief Financial Officer
George W. Ford, Jr. 53 Principal Scientist and Vice President
of Science and Technology
Steven R. Brown 40 Senior Vice President of Engineering
and Development
Max E. Sorenson 49 Senior Vice President of Engineered
Resources
Dee J. ("D.J.") Priano 53 Senior Vice President of Synfuel
Engineered Fuels
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<PAGE>
Asael T. Sorensen, Jr. 44 Secretary and Corporate Counsel
Harlan M. Hatfield 38 Vice President and General Counsel
Kenneth R. Frailey 45 Vice President of Operations
Stephanie R. Black 36 Vice President of Research and
Development
Brent M. Cook has served as Chief Executive Officer and Director since November
1996, as President from October 1996 until July 1998, and served as Chief
Financial Officer from June 1996 until December 1996. Mr. Cook is a Certified
Public Accountant. Prior to joining Covol, Mr. Cook was Director of Strategic
Accounts-Utah Operations, for PacifiCorp, Inc. ("PacifiCorp"). His
responsibilities included the management of revenues of approximately $128
million per year, and seeking out and evaluating strategic growth opportunities
for PacifiCorp, including joint ventures and other transactions. Mr. Cook spent
more than 12 years with PacifiCorp.
Stanley M. Kimball was appointed President in July 1998 and has been a Director
since January 1997. He served as Chief Financial Officer from January 1997 to
July 1998. Prior to joining Covol, Mr. Kimball was employed by Huntsman
Corporation ("HC"). From 1989 to early 1995, Mr. Kimball served as the Director
of Tax for Huntsman Chemical Corporation ("HCC"). In May 1995, Mr. Kimball was
appointed as an officer of HCC, serving as Vice President, Tax. In July 1995,
Mr. Kimball was appointed as Vice President, Administration for HC. In this
position, he had numerous responsibilities, both for HC and for Mr. Jon M.
Huntsman personally, which included financial accounting, tax and estate
planning, and cash and investment management. In this position, Mr. Kimball also
served as Mr. Huntsman's Chief of Staff. In 1980, Mr. Kimball received a Master
of Accountancy, with emphasis in taxation, from Brigham Young University and is
a Certified Public Accountant. Between 1980 and 1989, he was employed by Arthur
Andersen & Co., and was serving as a Senior Tax Manager prior to his employment
with HCC.
Steven G. Stewart was appointed Chief Financial Officer of Covol in July 1998,
and served as Vice President of Finance and Treasurer from April 1998 through
July 1998. Prior to joining Covol, Mr. Stewart was a partner for 11 years with a
"Big Five" accounting firm, an audit partner with Ernst & Young (formerly Arthur
Young) and was the Salt Lake City office Director of High Technology and
Entrepreneurial Services. From January 1994 through September 1996, Mr. Stewart
was self-employed and provided consulting services to high technology companies,
established strategic alliances, advised companies on alternative valuation
methods applicable to acquisition targets and negotiated acquisition/sale
transactions. From October 1996 through March 1998, Mr. Stewart was a business
assurance partner at PricewaterhouseCoopers, LLP (formerly Coopers & Lybrand
LLP), with primary responsibility for public companies operating in the high
technology, mining and extractive industries. Mr. Stewart is a Certified Public
Accountant.
George W. Ford, Jr. has served as Vice President of Research and Development of
Covol since August 1993. From August 1993 to February 1997, Mr. Ford served as a
Director of Covol. From 1982 to 1993, Mr. Ford was employed at Ballard Medical
Products, Inc. in research and development, principally in the biomedical field.
Mr. Ford holds 17 national and international patents covering a wide variety of
technologies. Mr. Ford has functioned as an independent consultant working on
projects in computer programming, medical product device design and process
polymer chemistry design for the energy industry. Mr. Ford is a member of the
American Association for the Advancement of Science and the Iron and Steel
Society.
Steven R. Brown was appointed Senior Vice President of Engineering and
Development in December 1998. Since July 1998 he served as Vice President -
Synfuel Operations. Previously he served as Vice President of Engineering and
Construction of Covol since February 1995. Mr. Brown served as a Director of
Covol from September 1995 to March 1997. From 1993 to 1995, Mr. Brown was
President of Construction Management Service, Inc. Mr. Brown is a licensed
professional engineer and a licensed general contractor.
Max E. Sorenson was appointed Senior Vice President of Engineered Resources in
December 1998. He served as Vice President of Covol since April 1997. Prior to
Mr. Sorenson's employment with Covol, Mr. Sorenson was
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Senior Vice President of Operations, Engineering and Technology of Geneva Steel
Company. Mr. Sorenson began his employment with Geneva Steel Company in October
1989. During his employment with Geneva Steel Company, Mr. Sorenson also had
responsibility for raw materials, transportation contracts and information
systems and also served as Chief Engineer of Coke, Iron and Steel, and Vice
President of Engineering. Prior to joining Geneva Steel Company, Mr. Sorenson
worked for 16 years for Inland Steel, Inc., one of the largest steel companies
in the United States, where he served in various operational and technology
management positions in ironmaking and steelmaking. Mr. Sorenson obtained a B.S.
degree in Metallurgical Engineering from the University of Utah in 1973 and a
Master of Science degree in Industrial Management from Purdue University in
1978.
Dee J. "DJ" Priano was appointed Senior Vice President of Synfuel Engineered
Fuels in December 1998. Prior thereto, he served as Vice President of Covol
since August 1997. Mr. Priano had been employed by Kennecott Corporation for
more than 32 years prior to that time. Mr. Priano worked in several different
positions at Kennecott including Principal Planning Engineer for Kennecott's
Bingham Canyon mine, Manager of Operations Analysis, Controller of Kennecott's
Bingham Canyon mine as well as the Controller of Kennecott's U.S. Mines
Division. In addition to managing general accounting and financial reporting
activities, he was responsible for the administration of purchasing, MIS and
land and water management functions. Mr. Priano received a BS degree and Master
of Business Administration from the University of Utah.
Asael T. Sorensen, Jr. joined Covol as its legal Counsel in September 1995. He
has also served as Corporate Secretary since June 1996. From 1982 to 1995, Mr.
Sorensen was an in-house attorney for the Church of Jesus Christ of Latter-Day
Saints in Salt Lake City, Utah and practiced law primarily in the area of
contract negotiations and administration. Mr. Sorensen graduated from Brigham
Young University with a joint Juris Doctor and Master of Business
Administration. He is admitted to practice law in the State of Utah.
Harlan M. Hatfield has served as Vice President and General Counsel since July
1998 and Corporate Counsel since October 1996. His primary activities with Covol
have been the development of synthetic fuel projects, including licensing,
financing, permitting, construction, feedstocks, site selection, and other
aspects of project development. As General Counsel he oversees the legal staff
and outside legal counsel, litigation, regulatory disputes, contracts, and other
legal matters. Prior to his employment with Covol, he was in private practice at
the Seattle law firm of Oles, Morrison and Rinker for more than nine years where
he was a partner.
Kenneth R. Frailey joined Covol in August 1998, and in December 1998, was
appointed Vice President of Operations. Until August 1998, Mr. Frailey was
employed by Kennecott Corporation and General Electric for a total of
approximately 20 years. Mr. Frailey's Kennecott experience related to mining and
electrical power generation, and particularly managerial assignments in plant
operations and engineering.
Stephanie E. Black joined Covol in March of 1998 as Director of Research and
Development, and in December 1998, was appointed Vice President of Research and
Development. She was employed as a Strategic Account Manager with PacifiCorp
from June of 1995 until joining Covol. For the approximately 11 years prior to
June 1995, Ms. Black was employed with Hercules, Inc. (now Alliant Techsystems).
While with Hercules, Ms. Black acted at various times as engineer, analyst,
supervisor, and subcontract manager.
Covol's Executive Officers are elected annually by the Board of
Directors and serve at the discretion of the Board.
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<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of common stock of Covol trade on The Nasdaq National(R)
Market under the symbol "CVOL".
The following table sets forth, for the periods presented, the high and
low trading prices of Covol's common stock as reported by Nasdaq from April
1998, to September 1998, and bid quotations as reported by National Quotation
Bureau, Inc. from October 1996 through March 1998. The quotations do not reflect
adjustments for retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions. Since Covol has several market
makers, the bid prices among the different market makers will generally vary.
Accordingly, the bid price may not be representative of actual trades. The
following prices may not be considered valid indications of market value due to
the limited and sporadic trading in the shares of common stock.
Low High
Fiscal 1997
Quarter ended December 31, 1996 $7.50 $14.38
Quarter ended March 31, 1997 7.88 15.75
Quarter ended June 30, 1997 6.75 8.88
Quarter ended September 30, 1997 6.25 10.13
Fiscal 1998
Quarter ended December 31, 1997 $8.88 $13.94
Quarter ended March 31, 1998 10.50 14.06
Quarter ended June 30, 1998 12.25 17.44
Quarter ended September 30, 1998 9.00 17.25
As of December 17, 1998, there were approximately 625 shareholders of
record of Covol's common stock.
Covol has not paid dividends on its common stock to date and does not
intend to pay dividends on its common stock in the foreseeable future. Covol
intends to retain earnings, if any, to finance the development and expansion of
its business and to pay debt service and dividends on preferred stock. Payment
of common stock dividends in the future will depend, among other things, upon
Covol's ability to generate earnings, its need for capital and its overall
financial condition.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past
fiscal year without registration under the Securities Act of 1933, as amended.
No underwriters were involved in any stock issuances nor were any commissions
paid in connection therewith. However, Covol did pay finders fees in the form of
cash, stock or warrants in connection with various securities 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,
notes, debentures and other securities were exempt from the registration
requirements of the Securities Act of 1933, as amended, pursuant to the
exemption set forth in Section 4(2) thereof. Each security was issued subject to
transfer restrictions. Each certificate for each security bears a restricted
legend. Each investor made representations to Covol that it was accredited as
that term is defined in Regulation D and that the security was acquired for
investment purposes.
In September and October 1997, Covol accepted subscriptions from 49
accredited investors for the purchase of 119,557 units (the "Units") pursuant to
a Confidential Private Placement Memorandum, dated August 28, 1997 (the
"Memorandum"), at a price of $35.00 per Unit, with an aggregate purchase price
of approximately $4,200,000.
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Each Unit consisted of five shares of common stock of Covol together with a
warrant to purchase one additional share of common stock at the price of $8.00,
expiring April 30, 1998. Pursuant to the terms of the Memorandum, Covol granted
to purchasers of the Units piggyback registration rights on the shares of common
stock included in the Units and the shares of common stock which were issuable
upon the exercise of the warrants. A total of 597,850 shares of common stock and
119,557 warrants were issued in the offering. Of the 119,557 warrants issued to
investors, 96,357 were exercised and 23,300 expired. In connection with the sale
of the Units under the Memorandum, Covol issued to three accredited investors
finder fees in the form of warrants to acquire an aggregate of up to 199,262
shares of Covol's common stock at a purchase price of $8.00 per share at any
time prior to October 31, 1999, none of which had been exercised as of September
30, 1998.
On November 25, 1997, Covol issued 1,500 shares of Covol common stock
to a single investor upon exercise of warrants at $8.00 per share, paid in cash.
The warrants were originally issued with Units privately placed in September and
October 1997.
On December 8, 1997, Covol issued 1,500 shares of Covol common stock to
a single investor upon exercise of warrants at $8.00 per share, paid in cash.
The warrants were originally issued with Units privately placed in September and
October 1997.
On January 9, 1998 Covol issued warrants for 216,272 shares of Covol
common stock at a per share exercise price of $10.00 to AJG Financial Services,
Inc. ("AJG"). Also, on January 9, 1998 Covol issued warrants for 216,272 shares
of Covol common stock at a per share exercise price of $20.00 to AJG. Covol
issued these warrants as partial consideration for AJG's loan to Covol of
$4,367,351 under Covol's debenture to AJG dated January 9, 1998.
On March 4, 1998 Covol issued 1,000,000 shares of Covol common stock to
PacifiCorp Financial Services, Inc., pursuant to PacifiCorp Financial's
conversion of its Convertible Loan and Security Agreement dated March 20, 1997
("Agreement"). On April 7, 1998 Covol issued an additional 27,000 shares of
Covol common stock to PacifiCorp Financial as satisfaction of the adjustment
provisions of the Agreement.
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 Utah Synfuel #1 and
Alabama 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 partnership's 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 partnership's 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 September 1998 Covol completed a financing of $1,500,000 that
consisted of the sale of 55,555 units at $27.00 per unit to an investor. A unit
consisted of three shares of restricted common stock of Covol plus one warrant
to purchase one share of restricted common stock at a price of $12.00. The
warrants expire September 16, 2000 if not exercised.
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
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
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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.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are derived from the consolidated
financial statements of Covol. This information should be read in conjunction
with the consolidated financial statements, related notes and other financial
information included herein. As more fully described in Note 15 to the
consolidated financial statements, Covol sold its construction subsidiaries in
1996. All construction - related operations have been reflected as discontinued
operations in the 1996, 1995 and 1994 financial statements. The construction
subsidiaries include one business which was acquired on September 30, 1994 and
therefore is included in discontinued operations in 1996 and 1995 only. The note
receivable received by Covol as consideration for the sale is "marked to market"
each quarter based on the market value of Covol's stock held as collateral, and
the resulting adjustments are reflected in Covol's statement of operations. The
selected financial data as of and for the nine months ended September 30, 1994,
as of and for the year ended September 30, 1995 and as of September 30, 1996 are
derived from audited financial statements not included herein. The selected
financial data for the year ended September 30, 1996, and as of and for the
years ended September 30, 1997 and 1998 were derived from the financial
statements of Covol which have been audited by PricewaterhouseCoopers LLP
included elsewhere herein.
<TABLE>
<CAPTION>
Nine Months
Year Ended September 30, Ended
----------------------------------------------------------- September 30,
(thousands of dollars, except per-share data) 1998 1997 1996 1995 1994
- ----------------------------------------------- ------------ --------------- --------------- -------------- -------------
OPERATING DATA:
<S> <C> <C> <C> <C> <C>
Total revenues $5,617 $ 356 $ 295 $ 129 $ 20
Loss from continuing operations (11,308) (10,498) (12,955) (4,524) (498)
Net loss (11,308) (10,498) (13,836) (5,654) (143)
Basic and diluted net income (loss) per
common share:
Loss per share from continuing
operations (1.17) (1.32) (1.86) (1.00) (.13)
Net income (loss) per share (1.17) (1.32) (1.99) (1.25) 0.04
Purchase of property, plant and
equipment and facilities
held for sale 36,963 7,194 5,055 694 100
September 30,
------------------------------------------------------------------------
(thousands of dollars) 1998 1997 1996 1995 1994
- ------------------------------------------------ ----------- --------------- --------------- -------------- ------------
BALANCE SHEET DATA:
Working capital (deficit) $ 8,320 $ (3,471) $(3,482) $ (480) $ (620)
Net property, plant and equipment 14,986 13,619 7,125 1,330 748
Total assets 68,061 26,590 8,072 2,660 4,853
Long-term obligations 23,256 5,362 364 177 852
Total stockholders' equity (deficit) 14,746 6,426 (233) 1,183 2,990
</TABLE>
25
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
26
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The following discussion and analysis should be read in conjunction
with the information set forth under the caption entitled "ITEM 6. SELECTED
FINANCIAL DATA" and the financial statements and notes thereto for Covol
included elsewhere herein. Covol has restated its 1998 and 1997 financial
statements as described in Note 1 to the financial statements, Summary of
Significant Accounting Policies, Restatements and Reclassifications.
Year Ended September 30, 1998 Compared to Year Ended September 30, 1997
The information set forth below compares Covol's operating results for
1998 with its operating results for 1997.
Revenues. Total revenues for the year ended September 30, 1998
increased by $5,261,000 to $5,617,000 as compared to $356,000 for 1997. During
1998 Covol recognized license fees totaling $860,000 while $105,000 of license
fees were recognized during 1997. These fees consisted of the straight-line
amortization of one-time non-refundable advance license fees of $654,000, and
recurring license fees or royalty payments of $206,000. The fees in 1997 related
solely to amortization of the Coaltech non-refundable advance license fee.
Advance license fees are normally received when construction of the related
synthetic fuel facility begins, when construction is completed, or when certain
construction milestones or other conditions are met, but are recognized on a
straight-line basis over the period covered by Covol's license agreements with
licensees. Recurring license fees or royalty payments are due quarterly based
upon synthetic fuel produced and sold as reported to Covol by its licensees.
Covol had sales of binder and coal fines to a related party during 1998 totaling
$2,543,000 compared to $209,000 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. Substantially all of
the fines purchased by Covol have now been sold so sales of coal fines are not
expected to be material during 1999. Covol sold six binder mixing plants to
licensees during 1998 for $1,088,000, generating a gross profit of $200,000.
Covol does not expect sales of binder mixing plants during 1999. Covol provides
binder material to its licensees either at a fixed price or at Covol's cost plus
a contracted markup. Covol purchases the binder materials under a long-term
contract with a large chemical company. Total binder sales during 1998 were
$994,000 with a corresponding direct cost to Covol of $642,000. Covol expects a
significant increase during 1999 of production of synthetic fuel by its
licensees as licensees move toward full production levels with 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, now and in the future. Covol believes that its
licensees have made significant progress in these areas, but continued success
cannot be assured.
Synthetic fuel is a relatively new product and competes with standard
coal products. Industrial coal users must be satisfied that the synthetic fuel
is a suitable substitute for standard coal products. Moisture content, hardness,
special handling requirements and other characteristics of the synthetic fuel
product may affect its marketability, including sales price. Many industrial
coal users are also limited in the amount of synthetic fuel product they can
purchase because they have committed to purchase a substantial portion of their
coal requirements through long-term contracts. Reliance on spot markets and the
overall downward trend in coal prices have generally produced lower sales prices
compared to long-term coal supply contracts in the utility industry. To date,
Covol owned facilities and licensees have secured contracts for the sale of only
a portion of their production. The suitability of synthetic fuel as a coal
substitute, particularly the quality characteristics of synthetic fuel, and the
traditional long-term supply contract practices of fuel buying in the utility
industry have made the identification of purchasers of synthetic fuel difficult.
Because synthetic fuel is a coal substitute, the market and price are as broad
and varied as the coal market itself. The US coal market exceeds one billion
tons annually, and the prices range from approximately $12 to $35 per ton in the
areas where facilities using the Covol technology are located. Prices are
dependent on many factors, including Btu content, ash and sulfur content,
moisture, location, etc. Covol believes that once initial market resistance is
overcome long-term contracts will be secured for the synthetic fuel, and that
Covol and its licensees will be able to market all synthetic fuel produced at
prices similar to coal.
Section 29 of the Internal Revenue Code provides a tax credit for the
production and sale of qualified synthetic fuel. Covol received a private letter
ruling from the IRS in which the IRS agrees that synthetic fuel manufactured
using Covol's technology qualifies for the Section 29 tax credits. The IRS has
issued at least seven other private letter rulings to licensees of Covol's
technology. Based upon the language of Section 29 and private
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letter rulings issued by the IRS to Covol and Covol's licensees, Covol believes
the synthetic fuel facilities were built and completed by June 30, 1998 and are
therefore eligible for Section 29 tax credits. See ITEM 1. BUSINESS - Tax
Credits for an explanation of qualifications for Section 29 tax credits.
The synthetic fuel facilities that qualify for tax credits under
Section 29 of the tax code receive economic benefits from the tax credits in
addition to the benefits, if any, from operations. It is possible that synthetic
fuel facilities built after June 30, 1998 that are not eligible for tax credits
could not be operated profitably. Section 29 expires on December 31, 2007 after
which tax credits will not apply to the synthetic fuel facilities. In order to
remain competitive and commercially viable after 2007, Covol and its licensees
must manage their costs of production and feedstock, and must also develop the
market for synthetic fuel with prices comparable to coal. Covol has developed
and patented technologies related to the briquetting of wastes and by-products
from the coal, coke and steel industries and has also tested in the laboratory
the briquetting of other materials. However, to date, Covol has only
commercialized the coal-based synthetic fuel application. The other applications
have not been commercialized or proven out in full-scale operations. The level
of success Covol has in commercializing these other applications will directly
impact Covol's ability to grow its business in the long term.
Our accounting and valuation procedures assume all of the Covol owned
facilities qualify for section 29 tax credits so that synthetic fuel production
will continue to be the highest and best use of our equipment and facilities. If
the facilities lost their qualification under Section 29, the equipment and
facilities' carrying value would likely be higher than the fair value based on
the alternative highest and best use, which could result in an impairment charge
at that time.
Operating Costs and Expenses. Operating costs and expenses increased by
$4,706,000 or 45% to $15,231,000 during 1998 from $10,525,000 during 1997. Cost
of coal briquetting operations increased $4,411,000 from $4,805,000 during 1997
to $9,216,000 during 1998. This increase included $4,121,000 relating to the
costs associated with binder plant sales, binder sales and coal fine sales as
discussed above. During 1997, Covol recorded an expense for $1,477,000 relating
to construction penalties for failure to proceed under several contracts Covol
had entered into. There was no similar expense in 1998. However, during 1998
Covol incurred significantly higher operating expenses in connection with the
continued refinement and implementation of the briquetting process, and the
commercialization of this process in connection with the 24 facilities placed in
service during 1998, including the four facilities held for sale. Covol expects
to continue incurring losses into 1999 until these facilities are sold. Covol
expects to realize a gain when the facilities are sold. These expenses related
in part to the construction and operation of four synthetic fuel facilities
built by Covol that are currently held for sale, costs incurred in providing
assistance to Covol's licensees during the ramp-up of their synthetic fuel
facilities, and increased personnel costs. These increases during 1998
effectively offset the 1997 construction penalty expenses. 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 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 significantly in excess of the
current market value. These costs and the corresponding write-down of this
inventory to its market value are included in the cost of coal briquetting
operations. The write-down was approximately $1,400,000 during 1998 and
$1,548,000 during 1997. Covol expects the excess cost per ton to decrease as
production volumes increase, but still expects a similar loss during 1999. Covol
believes that it can limit or stop the amount of production at the Utah facility
at any time to production amounts that Covol is able to sell to independent
third parties.
Covol has operated the Utah facility at a loss because of the need to
gain operating experience (it was the first synthetic fuel facility Covol built
and operated), test alternative production methods, maintain operational status
for Section 29 qualification, maintain the relationship with AJ Gallagher, an
owner of the Utah facility who is a major licensee and partner of Covol, and
other related business reasons.
Research and development costs decreased during 1998 as a result of
Covol's continued focus on the commercialization of the synthetic fuel
technology and the utilization of certain research and development resources
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in this endeavor. Covol expects that research and development costs will
increase in 1999 as Covol focuses resources on further refinement of its
technology relative to the synthetic fuel / coal industry and the application of
the technology into other areas.
Selling, general and administrative expenses increased $1,438,000 or
48% to $4,436,000 during 1998 from $2,998,000 for 1997. Approximately $500,000
of this increase related to a substantial increase in travel and related costs
as Covol's employees spent a significantly greater amount of time at Covol and
licensee-owned facilities. Covol believes that travel and related expenses will
decrease during 1999, but will continue to run at levels higher than 1997 due to
the ongoing activities that will be required at the 24 synthetic fuel facilities
utilizing Covol's patented technology. The balance of the increase in expenses
relates to approximately $250,000 of commissions incurred in connection with the
placement of synthetic fuel license agreements, $175,000 in increased
professional fees and a $500,000 increase in payroll and related costs,
resulting from additional employees hired.
Compensation expense on stock options, stock warrants, or issuance of
common stock decreased $1,119,000 or 54% to $939,000 for 1998 from $2,058,000
for 1997. This decrease is attributable to a change in policy to only grant
stock options at strike prices that are not "in-the-money", for the purpose of
providing an incentive to the recipient of the options to create shareholder
value. The majority of the 1998 expense relates to options granted in prior
years that vest over several years and the compensation value that is being
recognized as an expense over the vesting period.
In 1998, Covol sold the facility owned by Alabama Synfuel #1 Ltd. for
$6,500,000, in exchange for a note receivable due not later than February 2003.
A loss of $218,000 was incurred from the sale of this facility. Covol believes
the note receivable, which is classified as a facility-dependent note receivable
in the consolidated balance sheet, is collectible from the debtor, or in the
event of the debtor's failure to satisfy the obligation, by the debtor's parent,
the company that will ultimately utilize the tax credits generated from the
synthetic fuel facility. In 1997, Utah Synfuel #1 transferred its facility to
Coaltech for $3,500,000, evidenced by a promissory note payable in 44 quarterly
installments of $130,000 starting March 31, 1997. The actual cost to construct
the Utah Synfuel #1 facility was $4,082,000. In accordance with generally
accepted accounting principles and after discussion with the staff of the
Securities and Exchange Commission, this transaction has not been reflected as a
sale for accounting purposes. The original cost of the facility, less cash
payments received from Coaltech, is reflected in the consolidated balance sheet
as a facility transferred under note receivable arrangement.
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 collateralized by stock and
stock options of Covol and is reflected in the balance sheet at the underlying
value of the collateral. Accordingly, the Note is "marked to market" each
quarter based upon the market value of Covol's common stock. This adjustment
resulted in income of $19,000 being recognized during 1998, compared to an
expense of $60,000 recognized during 1997. The Note is guaranteed by the buyer
of the construction companies and there has been no event of default or past due
payment on the Note. Covol is scheduled to receive a $515,000 payment on the
Note in January 1999. Covol does not accrue interest on this Note and as of
September 30, 1998 the Note has a carrying value of $1,609,000 in Covol's
balance sheet.
Other Income and Expense. During 1998, Covol had net other expenses of
$1,694,000 compared to $329,000 for 1997. This increase of $1,365,000 relates
primarily to an increase of $618,000 in net interest expense and a decrease of
$853,000 in minority interest in the net losses of consolidated subsidiaries
(Utah Synfuel #1 and Alabama Synfuel #1). Interest expense in 1999 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 an exchange of their limited partnership interests for common
stock of Covol. These exchanges, most of which were accounted for in September
1998, were substantially completed in 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. Covol believes the combined operations of these
partnerships will result in operating losses in the near-term future which will
be included in Covol's statement of operations.
Loss from Continuing Operations. For 1998, the loss from continuing
operations increased by $810,000 from $10,498,000 for 1997 to $11,308,000. The
increase is primarily due to increased operating costs and other
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expenses as discussed previously. Covol did not recognize any income tax benefit
in 1998 or 1997 since the realization of its deferred tax assets, consisting
primarily of net operating loss carryforwards, depends on generation of future
taxable income.
Year Ended September 30, 1997 Compared to Year Ended September 30, 1996
The information set forth below compares Covol's operating results for
1997 with its operating results for 1996.
Continuing Operations
Revenues. For 1997, total revenues increased by $61,000 to $356,000
from $295,000 for 1996. There was $105,000 in license fees recognized in 1997 as
compared to $100,000 recognized in 1996. Covol received a $1,400,000 one-time
advance license fee paid by Coaltech, a partnership for which Covol serves as
the general partner, upon the sale of the Utah Synfuel #1 facility. The advance
license fee is being amortized over the ten year term of the license agreement.
Covol also received a $250,000 one-time license fee in 1997 from Birmingham Syn
Fuel, L.L.C. ("BSF"), which will be recognized as revenue upon completing the
construction and sale of the synthetic fuel facility to BSF. Net proceeds from
the sale of briquettes decreased in 1997 by $153,000 to $42,000 from $195,000 in
1996. Notwithstanding the Utah Synfuel #1 facility having been placed in service
in early 1997, its production and sales of synthetic fuel were significantly
curtailed due to the lack of adequate quality feed stock for production. Covol
did produce approximately 18,000 tons of synthetic fuel during 1997; however,
due to high levels of ash in the feedstock and hence in the end product, the
synthetic fuel was difficult to market. Covol received revenues from binder
sales in the amount of $209,000 in 1997. No sales of binder were made in 1996.
Operating Costs and Expenses. Operating costs and expenses decreased
$48,000 to $10,525,000 for 1997 from $10,573,000 for 1996. Operating costs and
expenses attributable to briquetting operations increased $3,945,000 to
$4,805,000 for 1997 from $860,000 for 1996. On or before December 31, 1996,
Covol entered into several contracts to construct synthetic fuel facilities. In
order for the contracts to be binding for purposes of qualification for Section
29 treatment, Covol agreed to pay a penalty of 6% of the expected contract price
for the facilities if Covol did not proceed with construction. As of September
30, 1997, there were several contracts that were not expected to be completed by
June 30, 1998. Accordingly, Covol recorded the liability for the penalty for
these facilities in 1997 in the amount of $1,477,000. Covol also incurred costs
of $1,548,000 which were attributable to the start-up and operation of the Utah
Synfuel #1 facility for Coaltech, a partnership for which Covol is the general
partner. When Utah Synfuel #1 and Covol sold the Utah Synfuel #1 facility to
Coaltech, Utah Synfuel #1 entered into an agreement to purchase synthetic fuel
produced at the Utah Synfuel #1 facility for costs incurred plus $1 per ton. The
Utah Synfuel #1 facility incurred significant costs for coal fines, labor,
binder materials, repairs and maintenance, equipment rental and other costs to
work through various operational issues. These costs are included in the
synthetic fuel purchase commitment and therefore are included in the cost of
coal briquetting operations. The remaining costs for briquetting operations in
1997 were more than in 1996 due to material and labor costs for the continuing
refinement and implementation of the briquetting process and is reflective of
the phase of commercialization and operation Covol was in for 1997 as compared
to 1996.
Research and development costs decreased $380,000 or 36% during 1997
from $1,044,000 for 1996. This decrease is due to Covol's focus of resources and
efforts on the commercialization of its synthetic fuel technology through: the
construction and start-up of its first full scale briquetting facilities, the
Utah and Birmingport plants; the licensing of the Briquetting Technology to
other licensees; and the development of other projects that will utilize the
Briquetting Technology in the manufacture of synthetic fuels. The majority of
the 1997 costs were principally attributable to research and development efforts
related to Covol's synthetic fuels technology.
Selling, general and administrative expense decreased $798,000 or 21%
to $2,998,000 for 1997 from $3,796,000 for 1996. The decrease related
principally to reductions in costs for administrative labor, outside
professional services and travel expenses. The reduction in these expenses is
due to Covol's use of personnel, resources and efforts on the commercialization
of the Covol binder technologies.
Compensation expense on stock options, stock warrants and issuance of
common stock decreased $2,815,000 or 58% to $2,058,000 for 1997 from $4,873,000
for 1996. The decrease is attributable to reduction in
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the use of stock options in compensating employees and consultants of Covol. The
reduction is also reflective of a general change in Covol philosophy regarding
the strike price for options granted. Generally, fewer stock options granted by
Covol have been "in-the-money", thus serving as an incentive to the recipient of
the options to add value to Covol.
In 1997, Utah Synfuel #1 transferred its facility to Coaltech for
$3,500,000, evidenced by a promissory note payable in 44 quarterly installments
of $130,000 starting March 31, 1997. The actual cost of Utah Synfuel #1 to
construct the facility was $4,082,000. In accordance with generally accepted
accounting principles and after discussion with the staff of the Securities and
Exchange Commission, this transaction has not been reflected as a sale for
accounting purposes. The original cost of the facility, less cash payments
received from Coaltech, is reflected in the consolidated balance sheet as a
facility transferred under note receivable arrangement.
Other Income and Expense. In 1996, Covol had net other expense of
$2,654,000 and in 1997 had net other expense of $329,000 for a net decrease in
other expense of $2,325,000. In 1996, Covol was required, under generally
accepted accounting principles, to write down the discounted $5,000,000 6%
promissory note (the "Note") from the sale of the construction companies to the
ascertainable value of the property collateralizing the Note. This accounting
treatment resulted in a write-down of $2,700,000 in 1996. The additional
write-down in 1997 of $60,000 resulted from the change in the value of the
property collateralizing the Note. The Note is guaranteed by the buyer of the
construction companies and there has been no event of default or past due
payment on the Note. The remaining difference in net other expense is made up
principally of interest expense of $1,645,000, of which $1,438,000 was booked as
a result of the transaction Covol entered into with PacifiCorp with respect to
the $5,000,000 convertible debt instrument (see discussion below). This expense
is partially offset by the net change in the addback for minority interest in
net losses of consolidated subsidiaries of $1,241,000 ($4,000 in 1996 compared
to $1,245,000 in 1997). The increase is attributable to the minority interest in
the loss incurred by Utah Synfuel #1 in 1997. The current period represents the
first full year of operations of Utah Synfuel #1. Utah Synfuel #1 incurred
losses in 1997 due to: the sale of the Utah Synfuel #1 facility at an amount
less than its cost (after adjustment for the installation of the new dryer),
start-up costs for the facility, expense incurred for license fees, and the
obligation to purchase synthetic fuels produced at a price equal to cost plus $1
per ton.
In July 1996, Covol negotiated with PacifiCorp the general terms of the
sale of the Birmingport facility, including an arrangement for convertible debt
in the amount of up to $5,000,000 to fund working capital and construction costs
needed to complete the Birmingport facility. At the time of these negotiations,
Covol agreed to a conversion price of $7 per share, the trading price of Covol's
stock at the time the deal was initially negotiated. The actual documents
completing this agreement were not finalized until March 20, 1997, at which time
the bid price of the common stock of Covol was approximately $9 per share.
Notwithstanding the fact that at the time Covol initially negotiated the
conversion price there was no discount, because there was a discount as of the
date the documents for the transaction were completed and signed, Covol was
required to reflect as interest expense the deemed discounted value, the
difference at the date of issue of the convertible debt security between the
conversion price and the fair market value of the common stock into which the
security is convertible, multiplied by the number of shares into which the
security is convertible. The expense did not require an actual cash payment nor
did it impact the net equity of Covol. This accounting treatment is consistent
with guidance issued by the Securities and Exchange Commission and with guidance
issued as of March 13, 1997 by the Emerging Issues Task Force of the AICPA
(Statement EITF D-60: Accounting for the Issuance of Convertible Preferred Stock
and Debt Securities with a Nondetachable Conversion Feature).
Loss from Continuing Operations. For 1997, Covol had a net decrease of
$2,457,000 in loss from continuing operations. The decrease is principally due
to: reductions in research and development costs and selling, general and
administrative costs; reductions in expenses for compensation expense from stock
options, stock warrants and issuance of common stock; and reduction in the
write-down of notes receivable. These reductions were partially offset by:
increases in costs for briquetting operations, including losses attributable to
the Utah Synfuel #1 facility and penalties for failure to proceed with
construction contracts; loss from the sale of the Utah Synfuel #1 facility, and
interest expense booked on the PacifiCorp convertible debt. Covol did not
recognize any income tax benefit in 1997 or 1996 related to net operating loss
carryforwards since the realization of the deferred tax assets depends on
generation of future taxable income.
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Discontinued Operations
For 1996, Covol incurred losses from discontinued operations in the
total amount of $881,000. No additional losses were recorded from discontinued
operations in subsequent years.
Liquidity and Capital Resources
Liquidity. During 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 that 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 $974,000 to
$5,366,000 during 1998 from $4,392,000 during 1997. Covol was able to fund its
operating activities, including the continued refinement and commercialization
of it patented briquetting technology, through the incurrence of debt and the
issuance of convertible preferred stock, common stock and related common stock
warrants.
Capital Resources. During 1998, Covol used net cash in its investing
activities totaling $38,064,000 compared to $6,991,000 for 1997. These uses
consisted principally of purchases of property, plant and equipment, a major
portion of which related to the four facilities currently held for sale. During
1998, proceeds from the issuance of notes payable and convertible debentures
totaled $35,454,000 and issuance of common stock totaled $3,257,000. 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 1998.
Covol anticipates that earned license fees or royalties from the
production and sale of synthetic fuel will continue to increase during 1999.
Covol believes that most of the synthetic fuel facilities will reach production
levels approaching capacity by the end of 1999. As production levels increase,
sales of the binder materials by Covol to its licensees are expected to increase
proportionately. While 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 does expect that these operating activities
will be producing significant operating cash flow by the end of 1999.
In order for operating activities to produce significant positive cash
flows, Covol and its licensees must successfully address certain operating
issues and marketing difficulties which have negatively affected cash flows and
increased capital requirements. Operating issues which must be addressed
include, but are not limited to, feedstock availability, cost, moisture content,
Btu content, correct application of binder formulation, operability of
equipment, product durability, resistance to water absorption and overall costs
of operations, which in many cases to date have resulted in unit costs in excess
of synthetic fuel sale prices. Marketing difficulties which must be addressed
relate to market acceptance of products manufactured using our technology.
Industrial coal users must be satisfied that the synthetic fuel is a suitable
substitute for standard coal products. Moisture content, hardness, special
handling requirements and other characteristics of the synthetic fuel product
may affect its marketability and its sales price. Many industrial coal users are
also limited in the amount of synthetic fuel product they can purchase from us
and our licensees because they have committed to purchase a substantial portion
of their coal requirements through long-term contracts. Reliance on spot markets
and the overall downward trend in coal prices have generally produced lower sale
prices compared to long-term coal supply contracts in the utility industry. To
date, our owned facilities and licensees have secured contracts for the sale of
only a portion of their production. The suitability of synthetic fuel as a coal
substitute, particularly the quality characteristics of synthetic fuel, and the
traditional long-term supply contract practices of fuel buying in the utility
industry have made the identification of purchasers of synthetic fuel difficult.
Covol believes that once initial market resistance is overcome, long term
contracts will be secured for the synthetic fuel, and that Covol and its
licensees will be able to market all synthetic fuel produced at prices similar
to coal.
To provide funding for Covol's operations and debt repayment
requirements during early 1999, Covol will utilize proceeds from the issuance of
debt and equity securities and excess proceeds from the sale of facilities.
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During November 1998, Covol issued common stock and common stock warrants for
total proceeds of approximately $3,500,000 and incurred debt totaling $400,000.
Covol has received term sheets for the sale of up to $10,000,000 of convertible
preferred stock. This financing is expected to close in January 1999. Covol has
received correspondence from the lender holding notes payable due March 1999 and
June 1999 indicating a willingness to extend the due dates for 90 days if so
requested by the Company. If such a request is made, Covol has agreed to issue
warrants for the purchase of common stock to the lender as consideration for the
extension. Covol believes the funds raised in this financing 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 7 regarding Covol's expectations as to the
financing, development and construction of facilities utilizing Covol's binder
technologies, the receipt of licensing and royalty fees, revenues, the receipt
of operation and maintenance fees, 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 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 regulation 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" 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 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. The costs incurred
during 1998 to upgrade the network operating systems was approximately $25,000
and is included in selling, general and administrative expenses.
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Impact of Inflation
During 1998, cost increases to Covol were not materially impacted by
inflation.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
None.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial data required by
this Item 8 are set forth in Item 14 of this Form 10-K. All information which
has been omitted is either inapplicable or not required.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no changes in or disagreements with Accountants on accounting
or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information to be set forth under the caption "Item 1: Election of
Directors" in Covol's Proxy Statement dated on or about January 25, 1999, for
the Annual Meeting of Shareholders to be held on or about March 18, 1999 (the
"Proxy Statement"), and the information to be set forth under the caption
"Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement
are incorporated herein by reference. The information set forth under "Executive
Officers of Covol" in Part I hereof is also incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information to be set forth under the caption "Executive
Compensation" in the Proxy Statement is incorporated herein by reference;
provided, however, that Covol specifically excludes from such incorporation by
reference any information set forth under the captions "Compensation Committee
Report on Executive Compensation" and "Stock Price Performance Graph" in the
Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security ownership of certain beneficial owners and management to be
set forth under the caption "Security Ownership of Directors, Nominees and
Principal Stockholders" in the Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information to be set forth under the caption "Transaction with
Related Parties" in the Proxy Statement is incorporated herein by reference.
34
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Consolidated Financial Statements of Covol Technologies, Inc.
Report of Independent Accountants................................. F-1
Consolidated Balance Sheets as of September 30, 1998 and 1997..... F-2
Consolidated Statements of Operations
for the years ended September 30, 1998, 1997 and 1996........... F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended September 30, 1998, 1997 and 1996........... F-5
Consolidated Statements of Cash Flows
for the years ended September 30, 1998, 1997 and 1996........... F-9
Notes to Consolidated Financial Statements........................ F-11
2. Financial Statement Schedules
All financial statement schedules for which provision is made in the
applicable accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable, and therefore
have been omitted.
3. Listing of Exhibits
Certain other instruments which would otherwise be required to be
listed below have not been so listed because such instruments do not authorize
securities in an amount which exceeds 10% of the total assets of Covol and its
subsidiaries on a consolidated basis and Covol agrees to furnish a copy of any
such instrument to the Commission upon request.
There is included a Restated Financial Data Schedule for the years
ended September 30, 1997 and 1996.
35
<PAGE>
Exhibit No. Description Location
2.1 Agreement and Plan of Reorganization, dated July 1, 1993 (1)
between Covol and the Stockholders of R1001
2.2 Agreement and Plan of Merger dated August 14, 1995 between (1)
Covol and Covol Technologies, Inc., a Delaware corporation
2.3 Stock Purchase Agreement, dated July 1, 1993, among Covol, (1)
Lloyd C. McEwan, Michael McEwan, Dale F. Minnig and Ted C.
Strong regarding the purchase of Industrial Management &
Engineering, Inc. and Central Industrial Construction, Inc.
2.4 Stock Sale Transaction Documentation, effective as of (1)
September 30, 1994, between Covol and Farrell F. Larson
regarding Larson Limestone Company, Inc.
2.5 Stock Purchase Agreement dated February 1, 1996 by and (1)
among Covol, Michael McEwan and Gerald Larson regarding the
sale of State, Inc., Industrial Engineering & Management,
Inc., Central Industrial Construction, Inc., and Larson
Limestone Company, Inc.
2.5.1 Amendment to Share Purchase Agreement regarding the sale of (1)
the Construction Companies
2.5.2 Amendment No. 2 to Share Purchase Agreement regarding the (2)
sale of the Construction Companies
3.1 Certificate of Incorporation of Covol (1)
3.1.1 Certificate of Amendment of the Certificate of Incorporation (1)
of Covol dated January 22, 1996
3.1.2 Certificate of Amendment of the Certificate of Incorporation (6)
dated June 25, 1997
3.1.3 Certificate of Designation, Number, Voting Powers, Preferences (7)
and Rights of Covol's Series A 6% Convertible Preferred Stock
(Originally designated as Exhibit No. 3.1.2)
3.1.4 Certificate of Designation, Number, Voting Powers, Preferences (8)
and Rights of Covol's Series B Convertible Preferred Stock
(Originally designated as Exhibit No. 3.1.3)
3.2 By-Laws of Covol (1)
3.2.1 Certificate of Amendment to Bylaws of Covol dated January (1)
31, 1996
3.2.2 Certificate of Amendment to the Bylaws dated May 20, 1997 (6)
designated as Exhibit No. 3.2.1)
3.2.3 Certificate of Amendment to the Bylaws dated June 25, 1997 (6)
(Originally designated as Exhibit No. 3.2.2)
4.1 Promissory Note between Covol and Mountaineer Synfuel, (12)
L.L.C. dated May 5, 1998 (filed as Exhibit 10.52.2 hereto)
36
<PAGE>
Exhibit No. Description Location
4.2 Promissory Note dated December 8, 1998 of Covol to (13)
Mountaineer Synfuel, L.L.C. (filed as Exhibit 10.52.4 hereto)
4.3 Security Agreement dated December 8, 1998 between Mountaineer (13)
Synfuel, L.L.C. and Covol (filed as Exhibit 10.52.5 hereto)
9.1 Special Powers of Attorney Coupled With an Interest dated (1)
February 1, 1996 between Covol, Gerald Larson and Michael
McEwan
10.1 License Agreement, dated June 30, 1995, between Covol and (1)
Greystone Environmental Technologies, relating to the
Greystone Joint Venture
10.1.1 First Amendment dated January 3, 1996 to the License (1)
Agreement dated June 30, 1995 between Covol and Greystone
Environment Technologies
10.2 Briquetting Services Agreement, dated May 5, 1995, between (1)
Geneva Steel Company and Covol
10.2.1 Amended and Restated Briquetting Service Agreement, dated (3)
May 14, 1996, between Covol and Geneva Steel Company
10.3 Lease Agreement, dated May 5, 1995 between Geneva Steel (1)
Company, as landlord, and Covol, as tenant
10.3.1 First Amendment to Lease Agreement, dated May 14, 1996 (3)
between Geneva Steel Company, as landlord, and Covol, as tenant
10.4 Master Equipment Lease Agreement, dated May 4, 1995, (1)
between Keycorp Leasing Ltd. and Covol
10.5 1995 Stock Option Plan (1)
10.5.1 First Amendment to the 1995 Stock Option Plan (1)
10.6 Employment Agreement, dated January 1, 1992, with (1)
Kenneth M. Young
10.7 Employment Agreement, dated July 1, 1992, with Russell Madsen (1)
10.8 Lease Agreement, dated May 31, 1994, between Covol and (1)
Byrleen Hanson regarding Carbon County, Utah
10.9 Standard Form of Agreement between Owner and Design (1)
Builder dated December 28, 1995 between Covol and Lockwood
Greene Engineers, Inc.
10.9.1 Notice to Proceed from Covol to Lockwood Greene Engineers, (1)
Inc. dated January 14, 1996
10.9.2 Letter Agreement with Lockwood Greene Engineers, Inc. to (1)
extend notice dates.
10.9.3 Letter dated July 26, 1996 from Lockwood Greene Engineers, (3)
Inc. and the Memorandum of Understanding between Covol
Technology, Inc. and Lockwood Greene Engineers, Inc. dated
August 28, 1996
37
<PAGE>
Exhibit No. Description Location
10.9.4 Amendment to Standard Form of Agreement between Owner and (3)
Design/Builder dated December 28, 1995, dated September
16, 1996, between Covol and Lockwood Greene Engineers, Inc.
10.10 Engagement Letter dated December 18, 1995 by and between (1)
Covol and Smith Barney
10.10.1 Termination Letter, dated July 8, 1996, from Smith Barney (3)
10.11 Letter of Understanding dated January 30, 1996 between (1)
Covol and CoBon Energy, LLC
10.11.1 Modification of Letter of Understanding dated August 20, (3)
1996 between Covol and CoBon Energy, LLC
10.11.2 License Agreement dated September 10, 1996, between Covol (3)
and CoBon Energy, LLC
10.11.3** Project Development Agreement, dated December 30, 1996, (9)
between Covol and CoBon Energy LLC
10.11.4** Modification of Project Development Agreement, dated (9)
December 31, 1996, between Covol and CoBon Energy, LLC
10.12 [Intentionally Omitted]
10.13 Promissory Note dated February 15, 1996 in favor of Covol (1)
from Michael McEwan and Gerald Larson
10.14 [Intentionally Omitted]
10.15 Agreement between Alabama Power Company and Covol for the (3)
Sale and Purchase of Coal, dated April 16, 1996, between
Covol and the Alabama Power Company
10.16 Employment Agreement, dated June 1, 1996 with Brent M. Cook (3)
10.16.1 Stock Option Agreement dated June 1, 1996 with Brent M. Cook (3)
10.18 Letter dated July 19, 1996 from Covol canceling the Site (3)
Identification Agreement
10.19 Term Sheet, dated August 22, 1996, from Covol common stock (3)
to Byrleen Hanson regarding purchase of Price, Utah office
building
10.20 Primary Agreement, dated November 6, 1996, between Covol (3)
and Savage Industries Inc.
10.20.1 Mojave Agreement, dated November 6, 1996, between Covol (3)
and Savage Industries Inc.
10.21 Release to all claims, dated September 13, 1996, executed (3)
by Maynard Moe
10.22 Letter of Understanding, dated September 13, 1996, between (3)
Covol and E.J. Hodder & Associates, Inc. regarding the sale
of the Port Hodder facility to Covol
38
<PAGE>
Exhibit No. Description Location
10.23 Sublease, dated September 9, 1996, between Covol and Parker (3)
Towing Company, Inc. regarding the lease of approximately 16
acres located in Tuscaloosa County, Alabama
10.24 Supply Agreement, dated September 11, 1996, among Covol, (3)
K-Lee Processing, Inc. and Concord Coal Recovery Limited
Partnership
10.25 PacifiCorp Financial Services, Inc. Letter of Intent (Covol (3)
Technologies) dated September 12, 1996
10.26 Exclusive Financial Advisor Agreement, dated September 16, (3)
1996, between Covol and Coalco Corporation
10.27 Settlement Agreement, dated September 17, 1996, among Covol, (3)
Environmental Technologies Group International, Inc.,
Larson Limestone Company, Inc., Michael M. Midgley, Mark
Hardman, Kenneth M. Young, Irene Larson, Farrell Larson,
Gary Burningham and Burningham Enterprises, Inc.
10.28 Debenture Agreement and Security Agreement, dated December (3)
20, 1996, between AJG Financial Services, Inc. and Covol
10.29 Arthur J. Gallagher & Co. Letter of Intent, dated November (3)
13, 1996
10.30 Lease Agreement, dated December 12, 1996, between Covol and (3)
UPC, Inc regarding Price City, Utah property
10.31 1996 Standard Form of Agreement between Owner and (3)
Design/Contractor
10.32 Form of Limited Partnership Agreements for Alabama Synfuel (3)
#1, Ltd. ("AS #1") and Utah Synfuel #1, Ltd. ("US #1")
10.33 Utah Project Purchase Agreement, dated as of March 7, 1997, (4)
by and among Covol, US #1, a Delaware limited partnership,
and Coaltech No. 1, L.P., a Delaware limited partnership
("Coaltech")
10.34 License and Binder Purchase Agreement, dated as of March 7, (4)
1997, by and among Covol, US #1 and Coaltech
10.35 Operation and Maintenance Agreement, dated as of March 7, (4)
1997, by and between Covol and Coaltech
10.36 Purchase and Supply Agreement, dated as of March 7, 1997, (4)
by and among Covol, US #1 and Coaltech
10.37 Abandonment Option Agreement, dated as of March 7, 1997, (4)
by and among Covol and the limited partners of Coaltech
10.38 Convertible Loan and Security Agreement, dated as of March (5)
20, 1997, by and between Covol and PacifiCorp Financial
Services, Inc. ("PacifiCorp")
10.38.1 Amendment to Convertible Loan and Security Agreement, (9)
dated December 12, 1997 by and between Covol and PacifiCorp
39
<PAGE>
Exhibit No. Description Location
10.39 Alabama Project Purchase Agreement ("Alabama Agreement") (5)
dated as of March 20, 1997, by and among Covol, AS #1 and
Birmingham Syn Fuel, L.L.C.
10.39.1 Letter Amendment, dated June 27, 1997, to Alabama Agreement. (9)
10.39.2 ** Letter Amendment, dated July 7, 1997, to Alabama Agreement. (9)
10.39.3 Letter Amendment, dated August 28, 1997, to Alabama Agreement. (9)
10.39.4 Letter Amendment, dated December 12, 1997, to Alabama (9)
Agreement.
10.39.5 ** Amended and Restated License Agreement, and Binder Purchase (9)
dated December 12, 1997, by and among Covol, AS #1 and
Birmingham Syn Fuel.
10.39.6** Letter Amendment dated February 20, 1998, to the Alabama (10)
Project Purchase Agreement dated as of March 20, 1997, by
and among Covol, AS #1, and Birmingham Syn Fuel.
10.39.7 Call Option Agreement date February 20, 1998, between (10)
Birmingham Syn Fuel and Covol.
10.39.8** Letter Amendment dated February 20, 1998, to the Amended (10)
and Restated License and Binder Purchase Agreement dated as
of December 12, 1997, by and among Covol. AS #1 and
Birmingham Syn Fuel.
10.39.9** Non-negotiable Promissory Note dated February 20, 1998, in (10)
favor of AS #1, executed by Birmingham Syn Fuel as debtor.
10.39.10 Security Agreement dated February 20, 1998, by and among (10)
Covol, AS #1 and Birmingham Syn Fuel.
10.40 Conditional Option Agreement, dated as of March 20, 1997, (5)
by and among Birmingham Syn Fuel I, Inc., Birmingham Syn
Fuel II, Inc., PacifiCorp, AS #1 and Covol
10.41 Registration Rights Agreement, dated as of March 20, 1997, (5)
by and between Covol and PacifiCorp
10.42** Amended and Restated Agreement Concerning Additional (9)
Facilities, dated December 12, 1997, by and between
PacifiCorp., Birmingham Syn Fuel, LLC and Covol
10.43 Lease Agreement between Industrial Management Engineering, (9)
Inc. and Covol
10.44 Employment Agreement, dated January 1, 1997 with Stanley (9)
M. Kimball
10.45** License and Binder Purchase Agreement, dated December 14, (9)
1997, between Appalachian Synfuel, LLC and Covol
10.46** Financing Agreement, dated November 14, 1997, between (9)
Covol and CoBon Energy, L.L.C.
10.47** License Agreement, dated as of August 5, 1997, by and (9)
between Pelletco Corporation and Covol
40
<PAGE>
Exhibit No. Description Location
10.48** Preparation Plant and Find Ponds Lease (Wellington, Utah), (9)
dated February 21, 1997, between Earthco and Covol
10.49** Agreement Concerning Additional Facilities, dated December (9)
27, 1996, between AJG Financial Services, Inc. and Covol
10.50** Form of Agreement for Technology Licensing of Facilitation, (9)
dated December 31, 1996, between PC West Virginia Synthetic
Fuel #1, LLC and Covol
10.50.1** Form of Amended and Restated License and Binder Purchase (11)
Agreement dated February 3, 1998, between PC Virginia
Synthetic Fuel #1, PC West Virginia synthetic Fuel #2, PC
West Virginia Synthetic Fuel #3 and Covol.
10.50.2** Loan Agreement between C.C. Pace Capital, L.L.C. and (11)
Carbon Resources, Inc. and Covol dated April 21, 1998.
10.50.3 Security Agreement between C.C. Pace Capital, L.L.C. and (11)
Carbon Resources, Inc. and Covol dated April 21, 1998.
10.51 Employment Agreement, dated March 20, 1997 with Max E. (9)
Sorenson
10.52** Technology License and Binder Purchase Agreement between (12)
Mountaineer Synfuel, L.L.C., Licensee, and Covol, Licensor
10.52.1 Asset Purchase Agreement between Mountaineer Synfuel, (12)
L.L.C. as Purchase and Covol as Seller dated May 5, 1998
10.52.2 Promissory Note between Covol and Mountaineer Synfuel, (12)
L.L.C. dated May 5, 1998
10.52.3 Deed of Ground Lease between Upshur Property, Inc. and Covol (12)
dated May 5, 1998
10.52.4 Promissory Note dated December 8, 1998 of Covol (13)
Technologies, Inc. to Mountaineer Synfuel, L.L.C.
10.52.5 Security Agreement dated December 8, 1998 between (13)
Mountaineer Synfuel, L.L.C. and Covol Technologies, Inc.
10.52.6 Leasehold Credit Line Deed of Trust and Security Agreement (13)
dated December 8, 1998 by Covol Technologies, Inc. for
Mountaineer Synfuel, L.L.C. as Beneficiary.
10.52.7 Amendment No. 1 to Deed of Ground Lease dated December 8, (13)
1998 between Upshur Property, Inc. and Covol Technologies,
Inc.
10.53.1 Debenture Agreement and Security Agreement dated as of (13)
January 9, 1998, between Covol and AJG Financial Services,
Inc.
10.53.2 Debenture dated as of January 9, 1998 between Covol and (13)
AJG Financial Services, Inc.
10.53.3 Warrant A dated as of January 9, 1998, issued by Covol in (13)
favor of AJG Financial Services, Inc.
41
<PAGE>
Exhibit No. Description Location
10.53.4 Warrant B dated as of January 9, 1998, issued by Covol in (13)
favor of AJG Financial Services, Inc.
10.53.5 Registration Rights Agreement dated as of January 9, 1998, (13)
between Covol and AJG Financial Services, Inc.
10.54 Employment Agreement effective May 1, 1998 with Steven (13)
G. Stewart
10.55 Employment Agreement effective August 1, 1997 with Dee (13)
J. Priano
16.1 Letter to Securities and Exchange Commission, dated March (1)
24, 1995, from Jones, Jensen & Orton & Company, certified
public accountants
21.1 List of Subsidiaries of Covol (13)
23.1 Consent of PricewaterhouseCoopers LLP (13)
27.1 Restated Financial Data Schedule for the fiscal years ended *
September 30, 1998 and 1997
27.2 Restated Financial Data Schedule for the fiscal year ended (13)
September 30, 1996
- -----------------------
* Filed herewith.
** Confidential treatment has been granted to certain portions of this exhibit,
which portions have been deleted and filed separately with the Securities and
Exchange Commission.
Unless another exhibit number is indicated as the exhibit number for the exhibit
as "originally filed," the exhibit number in the filing in which any exhibit was
originally filed and to which reference is made hereby is the same as the
exhibit number assigned herein to the exhibit.
(1) Incorporated by reference to the indicated exhibit filed with Covol's
Registration Statement on Form 10, filed February 26, 1996.
(2) Incorporated by reference to the indicated exhibit filed with Covol's
Registration Statement on Form 10/A, Amendment No. 2, dated April 24,
1996.
(3) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K for the fiscal year ended September 30,
1996.
(4) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, dated March 10, 1997.
(5) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1997.
(6) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended June 30,
1997.
(7) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, dated August 19, 1997.
(8) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, for event dated September 18, 1997, filed
October 28, 1997.
(9) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K for the fiscal year ended September 30,
1997.
42
<PAGE>
(10) Incorporated by reference to the indicated exhibit filed with Covol's
Current Report on Form 8-K, for event dated March 3, 1998, filed March
23, 1998.
(11) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q, for the quarterly period ended March 31,
1998.
(12) Incorporated by reference to the indicated exhibit filed with Covol's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1998.
(13) Incorporated by reference to the indicated exhibit filed with Covol's
Annual Report on Form 10-K for the fiscal year ended September 30,
1998.
Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended September
30, 1998.
Exhibits
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) (3) above.
Financial Statement Schedules
The response to this portion of Item 14 is submitted as a separate
section of this report. See Item 14 (a) (2)
above.
43
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
By:/s/ Kirk A. Benson
---------------------------------------
Kirk A. Benson
Chief Executive Officer and Principal
Executive Officer
By:/s/ Steven G. Stewart
---------------------------------------
Steven G. Stewart, Principal Financial
Officer
Date: October 6, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
/s/ Kirk A. Benson Chief Executive Officer
- ------------------------ (Principal Executive Officer) and October 6, 1999
Kirk A. Benson Director
/s/ Steven G. Stewart Chief Financial Officer
- ------------------------- (principal Financial and October 6, 1999
Steven G. Stewart Accounting Officer)
/s/ Brent M. Cook President and Director October 6, 1999
- -------------------------
Brent M. Cook
/s/ DeLance W. Squire Director October 6, 1999
- -------------------------
DeLance W. Squire
/s/ James A. Herickhoff Director October 6, 1999
- -------------------------
James A. Herickhoff
/s/ Raymond J. Weller Director October 6, 1999
- -------------------------
Raymond J. Weller
/s/ John P. Hill, Jr. Director October 6, 1999
- -------------------------
John P. Hill, Jr.
44
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
Report of Independent Accountants
To the Board of Directors
Covol Technologies, Inc. and Subsidiaries
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity, and cash flows
present fairly in all material respects, the consolidated financial position of
Covol Technologies, Inc. and Subsidiaries (the "Company") as of September 30,
1998 and 1997, and the consolidated results of their operations and their cash
flows for the years ended September 30, 1998, 1997 and 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the last paragraph of Note 1 to the financial statements, the
Company has restated its 1998 and 1997 financial statements.
PRICEWATERHOUSECOOPERS LLP
Salt Lake City, Utah
December 22, 1998, except for the last paragraph of Note 1,
as to which the date is October 5, 1999
F-1
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of September 30,
(thousands of dollars) 1998 1997
- ----------------------------------------------------------------------------------- -------------- ----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 727 $4,780
Receivables 2,879 13
Receivable - stock subscriptions --- 577
Due from related party 1,012 509
Inventories 1,645 1,819
Advances on inventories 2,522 1,087
Facilities held for sale 28,405 ---
Prepaid expenses and other current assets 682 52
-------------- ----------------
Total current assets 37,872 8,837
-------------- ----------------
Property, plant and equipment, net of accumulated depreciation 14,986 13,619
-------------- ----------------
Other assets:
Restricted investments 748 ---
Facility-dependent note and accrued interest receivable, non-current 7,646 ---
Facility transferred under note receivable arrangement 3,166 3,813
Investment in licensee facility 340 ---
Intangible assets 3,118 ---
Deposits and other assets 185 321
-------------- ----------------
Total other assets 15,203 4,134
-------------- ----------------
Total assets $68,061 $26,590
============== ================
</TABLE>
continued
The accompanying notes are an integral
part of the consolidated financial statements
F-2
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
As of September 30,
(thousands of dollars and shares) 1998 1997
- ------------------------------------------------------------------------------------ -------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
<S> <C> <C>
Accounts payable $3,036 $3,013
Due to related party 1,609 1,548
Accrued liabilities 2,858 2,500
Notes payable and convertible debentures, current 22,049 5,247
-------------- ----------------
Total current liabilities 29,552 12,308
-------------- ----------------
Long-term liabilities:
Notes payable and convertible debentures, non-current 13,930 2,900
Notes payable - related parties, non-current 147 489
Accrued interest payable, non-current 566 204
Deferred revenues from advance license fees 8,377 1,545
Deferred compensation 236 224
-------------- ----------------
Total long-term liabilities 23,256 5,362
-------------- ----------------
Total liabilities 52,808 17,670
-------------- ----------------
Minority interest in consolidated subsidiaries, net
of notes receivable - related parties, collateralized
by minority interest in consolidated subsidiaries of
$672 in 1997. 507 2,494
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized
10,000 shares, issued and outstanding 316 shares at
September 30, 1998 and 303 shares at September 30, 1997
(aggregate liquidation preference of $5,465 at September 30, 1998) 1 1
Common stock, $0.001 par value; authorized 25,000 shares, issued and
outstanding 11,272 shares at September 30, 1998 and 8,627 shares at
September 30, 1997 11 9
Common stock to be issued, 0 shares at September 30, 1998 and 462
shares at September 30, 1997 --- 1
Capital in excess of par value - preferred 5,184 5,094
Capital in excess of par value - common 64,100 41,818
Capital in excess of par value - common stock to be issued --- 3,291
Accumulated deficit (43,002) (31,694)
Notes and interest receivable -- related parties, from issuance of, or
collateralized by, common stock, net of allowance (7,773) (7,411)
Deferred compensation from stock options (3,775) (4,683)
-------------- ----------------
Total stockholders' equity 14,746 6,426
-------------- ----------------
Total liabilities and stockholders' equity $68,061 $26,590
============== ================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-3
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended September 30,
(thousands of dollars and shares, except per-share data) 1998 (Note 1) 1997 (Note 1) 1996
- --------------------------------------------------------------------- ----------------- ------------------ ------------------
Revenues:
<S> <C> <C> <C>
License fees $ 860 $ 105 $ 100
Binder and coal fine sales - related party 2,543 209 ---
Binder sales 994 --- ---
Binder plant sales 1,088 --- ---
Synthetic fuel sales, net 32 42 195
Other 100 --- ---
----------------- ------------------ ------------------
Total revenues 5,617 356 295
----------------- ------------------ ------------------
Operating costs and expenses:
Cost of coal briquetting operations 9,216 4,805 860
Selling, general and administrative 4,436 2,998 3,796
Research and development 422 664 1,044
Compensation expense on stock options, stock warrants and
issuance of common stock 939 2,058 4,873
Loss on sale of facility 218 --- ---
----------------- ------------------ ------------------
Total operating costs and expenses 15,231 10,525 10,573
----------------- ------------------ ------------------
Operating loss (9,614) (10,169) (10,278)
----------------- ------------------ ------------------
Other income (expense):
Interest income 580 98 302
Interest expense (2,745) (1,645) (94)
Minority interest in net losses of consolidated subsidiaries 392 1,245 4
Write-up (write-down) of notes receivable - related parties,
collateralized by common stock 19 (60) (2,700)
Other 60 33 (166)
----------------- ------------------ ------------------
Total other income (expense) (1,694) (329) (2,654)
----------------- ------------------ ------------------
Loss from continuing operations before income taxes (11,308) (10,498) (12,932)
Income tax provision --- --- (23)
----------------- ------------------ ------------------
Loss from continuing operations (11,308) (10,498) (12,955)
----------------- ------------------ ------------------
Discontinued operations (Note 15):
Loss from discontinued operations --- --- (590)
Loss on disposal of discontinued operations --- --- (291)
----------------- ------------------ ------------------
Loss from discontinued operations --- --- (881)
================= ================== ==================
Net loss $(11,308) $(10,498) $(13,836)
================= ================== ==================
Basic and diluted net loss per common share:
Loss per share from continuing operations $(1.17) $(1.32) $(1.86)
Loss per share from discontinued operations --- --- (.13)
----------------- ------------------ ------------------
Basic and diluted net loss per common share $(1.17) $(1.32) $(1.99)
================= ================== ==================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Notes and
interest
receivable
-related
parties,
from
issuance
Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred
---------------------------- ------------------------ ------------------------- collater- compen-
Capital in Capital in Capital in Accum- alized sation
(thousands of excess of excess of excess of ulated by, common from stock
dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances
at
October 1, 1995 --- $--- $--- 5,260 $6 $9,617 119 $1 $582 $(7,360) $(240) $(1,422)
Common stock
issued for
services 114 --- 769 (50) --- (322)
Common stock
issued for
notes receivable
from related
parties,
including
exercise of
stock options 1,010 1 6,283 (6,284)
Common stock
issued for
cash, including
exercise of
stock options
and warrants 1,226 1 7,479 (69) --- (260)
Common stock
to be issued
for cash
received 44 --- 350
Common stock
to be issued
for property
acquired 60 --- 585
Payment on
notes receivable
- - related parties 171
Issuance of notes
receivable -
related parties,
collateralized
by common stock
(net of $2,700
write-down and
$650 imputed interest) (1,650)
Services received
in lieu of
payments on
notes receivable
- - related parties 688
Compensation
expense related
to the
issuance of
stock options
at below
market value 3,863
Deferred
compensation
related to the
issuance of
stock options
at below market
value to officers,
directors,
employees and
consultants, net of
cancellations 4,668 (4,668)
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-5
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued
Notes and
interest
receivable
-related
parties,
from
issuance
Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred
---------------------------- ------------------------ ------------------------- collater- compen-
Capital in Capital in Capital in Accum- alized sation
(thousands of excess of excess of excess of ulated by, common from stock
dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Amortization of
deferred
compensation from
stock options 910
Interest earned
on notes receivable
- - related parties (265)
Compensation
expense related
to the issuance
of stock for
services at below
market value 101
Net loss for
the year ended
September 30, 1996 (13,836)
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
Balances at
September 30, 1996 --- --- --- 7,610 8 32,780 104 1 935 (21,196) (7,580) (5,180)
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
Common stock
issued for cash
received in
the prior period 104 --- 935 (104) (1) (935)
Common stock
issued for cash,
including
exercise of stock
options and warrants 603 1 2,773
Deferred compensation
related to the
issuance of stock
options at below
market value to
officers, directors
and employees 1,178 (1,178)
Common stock
issued for services 98 --- 789
Inducement related
to conversion of notes
payable into common stock 323
Common stock issued
to repay note payable
- - related parties 21 --- 136
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-6
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued
Notes and
interest
receivable
-related
parties,
from
issuance
Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred
---------------------------- ------------------------ ------------------------- collater- compen-
Capital in Capital in Capital in Accum- alized sation
(thousands of excess of excess of excess of ulated by, common from stock
dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Common stock issued
on conversion of note 141 --- 1,125
payable
Common stock issued
under a subscription 50 --- 350
agreement for cash
received in
October 1997
Common stock to be
issued for cash
received
in the current
period, including
exercise 400 1 2,798
Common stock to
be issued for
distribution 30 -- 266
rights
Common stock to
be issued under
subscription
agreements for
cash received 32 --- 227
in October 1997
Amortization of
deferred
compensation from 1,675
stock options
Interest expense
related to issuance
of convertible
debt at a discount 1,429
Payment on notes
receivable - related 109
parties
Write-down of notes
receivable - related 60
parties
Preferred stock
issued for cash, net
of offering costs 303 1 5,094
Net loss for the
year ended
September 30, 1997 (10,995)
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
Balances at
September 30, 1997 303 1 5,094 8,627 9 41,818 462 1 3,291 (32,191) (7,411) (4,683)
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
Common stock issued
for cash received in
the previous period 462 -- 3,291 (462) (1) (3,291)
Common stock issued
to purchase minority
interests in subsidiaries 540 1 5,383
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-7
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY, continued
Notes and
interest
receivable
-related
parties,
from
issuance
Convertible Preferred Stock Common Stock Common Stock to be Issued of, or Deferred
---------------------------- ------------------------ ------------------------- collater- compen-
Capital in Capital in Capital in Accum- alized sation
(thousands of excess of excess of excess of ulated by, common from stock
dollars and shares) Shares Amount par value Shares Amount par value Shares Amount par value deficit stock options
- ------------------- ------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Common stock issued
for cash, including
exercise of stock
options 533 --- 3,257
Preferred stock
issued for cash,
net of offering
costs 13 --- 90
Common stock
issued on
conversion of
notes payable
and accrued
interest to
common stock 1,107 1 8,178
Interest expense
related to
issuance of
convertible debt
at a discount 2,046
Payment received
on notes receivable -- 329
related parties
Amortization of
deferred
compensation from
stock options 908
Write-up of
notes receivable
- -- related (19)
parties
Compensation expense
related to issuance
of stock options
for services 3 -- 127
Reclassification
of notes receivable
- - related parties (672)
Net loss for the
year ended
September 30, 1998 (3,986)
------- ------ --------- ------ ------ --------- ------ ------ --------- ------- --------- ---------
Balances at
September 30, 1998 316 $1 $5,184 11,272 $11 $64,100 0 $0 $0 $(36,177) (7,773) $(3,775)
======= ====== ======== ====== ===== ======== ====== ===== ======== ======== ======= ==========
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-8
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended September 30,
(thousands of dollars) 1998 1997 1996
- ---------------------------------------------------------------------------------------------- ----------- ------------ ------------
Cash flows from operating activities:
<S> <C> <C> <C>
Net loss $(11,308) $(10,498) $(13,836)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 523 193 187
Losses applicable to minority interests in subsidiaries (392) (1,245) (4)
Loss on disposal of discontinued operations --- --- 291
Deferred income taxes --- --- 23
Loss on sale of facility 218 --- ---
Interest expense related to issuance of convertible debt at a discount 2,046 1,429 ---
Amortization of deferred compensation and compensation expense on stock options 1,035 1,675 4,773
Common stock issued or to be issued for services and distribution rights, and
compensation expense related to common stock issued below market --- 1,055 547
Write-down (write-up) of notes receivable - related parties (19) 60 2,700
Inducement expense related to conversion of notes payable into common stock --- 323 ---
Services received in lieu of payments on notes receivable issued for common stock --- --- 687
Interest earned on notes receivable - related parties --- --- (265)
Notes payable issued for services --- --- 160
Increase (decrease) from changes in assets and liabilities, net of effects
from investing and financing activities:
Receivables (2,866) 65 (55)
Due from related party (503) (509) ---
Inventories 174 (61) (162)
Advances on inventories (1,435) (1,087) ---
Prepaid expenses and other current assets (630) (7) (32)
Accrued interest receivable - non-current (486) --- ---
Deposits and other assets 136 (121) 24
Accounts payable 23 (1,138) 1,436
Due to related party 61 1,548 ---
Accrued liabilities 851 2,166 47
Accrued interest payable, non-current 362 204 ---
Deferred revenues from advance license fees 6,832 1,545 ---
Deferred compensation 12 11 10
Discontinued operations non-cash charges and working capital changes --- --- 894
----------- ------------ ------------
Net cash used in operating activities (5,366) (4,392) (2,575)
----------- ------------ ------------
Cash flows from investing activities:
Purchase of property, plant and equipment and facilities held for sale (36,963) (7,194) (5,055)
Investment in licensee facility (340) --- ---
Increase in restricted investments (748) --- ---
Issuance of note receivable (660) --- ---
Issuance of notes receivable -- related parties --- --- (704)
Proceeds from facility transferred under note receivable arrangement 647 235 ---
Increase in cash surrender value of life insurance --- (32) (13)
----------- ------------ ------------
Net cash used in investing activities (38,064) (6,991) (5,772)
----------- ------------ ------------
</TABLE>
continued
The accompanying notes are an integral
part of the consolidated financial statements
F-9
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
Year ended September 30,
(thousands of dollars) 1998 1997 1996
- -------------------------------------------------------------------------------------------- ----------- ----------- ------------
Cash flows from financing activities:
<S> <C> <C> <C>
Proceeds from issuance of notes payable and convertible debentures $35,454 $6,070 $ 700
Payment on notes payable (330) (1,109) (159)
Proceeds from issuance of notes payable -- related parties --- 595 ---
Payment on notes payable -- related parties --- (756) (3,539)
Proceeds from receivable -- stock subscriptions 577 --- ---
Proceeds from issuance of common stock, net 3,257 5,573 7,570
Proceeds from issuance of preferred stock, net 90 5,095 ---
Proceeds from notes receivable -- related parties, from issuance of, or
collateralized by common stock 329 109 171
Proceeds from issuance of minority interests in subsidiaries --- 302 4,385
Cash distribution to minority interest limited partners --- (206) ---
Financing activities of discontinued operations --- --- (1,582)
----------- ----------- ------------
Net cash provided by financing activities 39,377 15,673 7,546
----------- ----------- ------------
Net increase (decrease) in cash and cash equivalents (4,053) 4,290 (801)
Cash and cash equivalents, beginning of year 4,780 490 1,291
----------- ----------- ------------
Cash and cash equivalents, end of year $ 727 $ 4,780 $ 490
=========== =========== ============
Supplemental schedule of non-cash investing and financing activities:
Common stock issued on conversion of notes payable and accrued interest $8,179 $ --- $ ---
Facility dependent note receivable issued for sale of facility 6,500 --- ---
Facility transferred under note receivable arrangement --- 4,082 ---
Common stock issued for purchase of minority interests in subsidiaries 5,384 --- ---
Note payable issued for inventory --- 1,595 ---
Accounts payable for facilities held for sale 588 1,968 ---
Common stock issued for notes receivable --- 577 6,284
Common stock issued to repay notes payable and accrued interest -- related party --- 1,261 ---
Note payable issued for equipment --- 1,607 ---
Distribution to minority limited partners offset against note receivable --- 66 ---
Obligations assumed in connection with sale of subsidiaries --- --- 4,636
Note receivable received for subsidiaries (net of imputed interest) --- --- 4,350
Note payable issued and common stock to be issued to acquire land --- --- 927
Note payable issued for services --- --- 160
Supplemental disclosure of cash flow information: Cash paid for interest,
net of amounts capitalized:
Continuing operations $49 $208 $111
Discontinued operations --- --- 98
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
F-10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
----------
1. Summary of Significant Accounting Policies
Business Organization and Nature of Operations
Covol Technologies, Inc. (the Company) was originally incorporated in Nevada
in 1987 and was reincorporated in Delaware in August 1995. In 1991, the
Company acquired a coal briquetting technology (the "Briquetting
Technology"). In 1992, the Company constructed a pilot briquetting plant in
Price, Utah. During 1993, the Company refined the technology to briquette
waste by-products of the steel manufacturing industry. In June 1996, the
Company formed Utah Synfuel #1 Ltd. ("Utah Synfuel #1") and Alabama Synfuel
#1 Ltd. ("Alabama Synfuel #1"), each a Delaware limited partnership
(collectively the "Partnerships"). The Company is both the general partner
and a limited partner in the Partnerships (see Note 14).
The Company's primary business is to commercialize the Briquetting Technology
used to recycle waste by-products from the coal and steel industries into a
marketable source of fuel and revert materials. Through June 30, 1998, the
Company's focus was on the construction of facilities and the licensing of
its Briquetting Technology to companies that constructed facilities that
convert coal fines into synthetic fuel briquettes. At September 30, 1998, the
Company and its licensees were operating 24 of these facilities in eight
states at various levels of production. The four Company-owned facilities are
expected to be sold in 1999. The Company has no current plans to construct
additional synthetic fuel facilities.
The Company anticipates that earned license fees or royalties from the
production and sale of synthetic fuel will continue to increase during 1999.
The Company believes that most of the synthetic fuel facilities will reach
production levels approaching capacity by the end of 1999. As production
levels increase, sales of the binder materials by the Company to its
licensees are expected to increase proportionately. While funds received by
the Company from these activities are not expected to be sufficient to cover
the Company's operating costs and expenses until the third quarter of 1999,
the Company does expect that these operating activities will be producing
significant operating cash flow by the end of 1999.
To provide funding for the Company's operations and debt repayment
requirements during early 1999, the Company will utilize proceeds from the
issuance of debt and equity securities and excess proceeds from the sale of
facilities. During November 1998, the Company issued common stock and common
stock warrants for total proceeds of approximately $3,500,000 and incurred
debt totaling $400,000. The Company has received term sheets for the sale of
up to $10,000,000 of convertible preferred stock. This financing is expected
to close in January 1999. The Company has received correspondence from the
lender holding notes payable due March 1999 and June 1999 indicating a
willingness to extend the due dates for 90 days if so requested by the
Company. If such a request is made, the Company has agreed to issue warrants
for the purchase of common stock to the lender as consideration for the
extension. The Company believes the funds raised in this financing will be
sufficient to fund the Company's operations and debt repayment requirements
until its operating activities begin producing positive cash flow.
Construction Businesses
In 1993 and 1994, the Company acquired four construction companies. In
September 1995, the Company's Board of Directors approved a plan to
discontinue the Company's construction businesses, which were sold effective
February 1, 1996. (See Note 15, "Discontinued Operations").
Principles of Consolidation
The 1996 consolidated financial statements include the accounts of the
Company and its 100% owned construction company subsidiaries, until the time
of their sale in February 1996. The consolidated financial statements for all
years presented include the accounts of the Company and its two majority
owned subsidiaries, Utah Synfuel #1 and Alabama Synfuel #1, from their
inception in 1996. All significant intercompany transactions and accounts are
eliminated in consolidation.
F-11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
1. Summary of Significant Accounting Policies, continued
Principles of Consolidation, continued
During 1997, the Company became a 1% general partner of Coaltech No. 1 L.P.
("Coaltech"), a Delaware limited partnership, for $10. Based upon the
Company's lack of effective control over Coaltech and the limited partners'
financial responsibility for its operations, the Company's investment in
Coaltech is accounted for using the equity method of accounting with
proportional elimination of intercompany revenues and expenses.
Stock Split
The Company implemented a two-for-one stock split effective January 23, 1996.
All information set forth herein has been adjusted to give effect to this
stock split.
Revenue and Cost Recognition
Revenues from the licensing of the Company's technology are recognized in the
period when earned. Non-refundable advance license fees are received when
certain synthetic fuel facility construction milestones are met or when the
facilities are certified operational for their intended use. Non-refundable
advance license fees are deferred and recognized on a straight-line basis
over the period covered by the related license agreement. Recurring license
fees or royalty payments are recognized in the period synthetic fuel is
produced and sold by licensees. $3,336,000 of advance license fees received
in 1998 were from a single licensee and $1,500,000 were from a second
licensee. Revenues from the sale of coal briquettes are recognized as product
is shipped. Collateral is not required for receivables and allowances are
provided for uncollectible accounts.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments with an original
maturity of three months or less to be cash equivalents. Cash and cash
equivalents are deposited with financial institutions located in Utah.
Restricted Investments
Restricted investments consist primarily of highly liquid interest bearing
deposits held as collateral for certain Company obligations.
Inventories
Inventories are stated at the lower of cost or market with cost determined
using an average cost method, and consist primarily of coal fines, available
for sale. Covol has a lease arrangement that provides for the purchase and
removal of coal fines which are used as feedstock for a synthetic fuel
facility. Payments made under the lease arrangement prior to removal of the
coal fines are recorded as advances on inventories (see Note 2).
Facilities Held for Sale
Facilities held for sale consist of four synthetic fuel facilities, and are
stated at the lower of cost or estimated net realizable value. The facilities
were constructed to be sold to licensees of the Company's technology at or
slightly above their cost. Two of the four facilities are under option for
purchase by the licensees of those facilities, and the Company is actively
pursuing the sale of all four facilities. The Company anticipates completing
the sale of these facilities in 1999. The Company recognizes a gain or loss
on facilities held for sale when the sale is consummated. The gain or loss
represents the difference between the carrying value and the sales price and
is reflected as a component of operating costs and expenses.
F-12
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
1. Summary of Significant Accounting Policies, continued
Property, Plant and Equipment
Property, plant and equipment is recorded at cost, including interest on
funds borrowed during the construction period, and is depreciated using the
straight-line method over its estimated useful life. Maintenance, repairs and
minor replacements are charged to expense as incurred. Upon the sale or
retirement of property, plant and equipment, any gain or loss on disposition
is reflected in the statement of operations and the related asset cost and
accumulated depreciation are removed from the respective accounts.
Intangible Assets
Intangible assets consist of the excess of the value of the consideration
paid for the purchase of certain limited partners' interests in subsidiaries
over the fair values of the related assets, which fair values approximated
their carrying cost (see Note 14). They are being amortized on the
straight-line method over approximately ten years.
Valuation of Long-Lived Assets
The Company periodically evaluates the carrying value of long-lived assets,
including intangible assets, when events and circumstances warrant such a
review. The carrying value of a long-lived asset is considered impaired when
the anticipated cumulative undiscounted cash flow from that asset is less
than its carrying value. In that event, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the
long-lived asset. No impairment-related losses have been recognized in the
Company's financial statements for any period presented.
Common Stock and Options
Common stock issued for services is accounted for using the fair value of the
shares of common stock, determined at the time the shares are issued. The
measurement date used to value non-employee option grants is the option grant
date. Such options are valued using the Black-Scholes model.
Loss per Share Calculation
In 1998, the Company adopted Statement of Financial Accounting Standards No.
128 "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is similar to the previous fully
diluted earnings per share. Loss per share amounts for all periods presented
conform to SFAS 128 requirements and no restatements were necessary (see Note
9).
For all periods presented, options, warrants and convertible securities (as
disclosed in Notes 7 and 13) were not included in the calculation of loss per
share because the effect would have been antidilutive.
Use of Estimates
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.
F-13
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
1. Summary of Significant Accounting Policies, continued
Restatements and Reclassifications
After discussion with the staff of the Securities and Exchange Commission
("SEC") in September 1999, the Company has restated its 1998 and 1997
financial statements for the following items:
o To recognize cash received for non-refundable advance license fees on a
straight-line basis over the contractual term of the license agreements,
which is through 2007. Previously, the Company recognized non-refundable
advance license fees when received which was normally when certain
synthetic fuel facility construction milestones were met or when the
facilities were certified operational for their intended use. This change
in accounting policy does not affect the timing of cash flows, and all
amounts which have been received are non-refundable. Also, the Company
believes prior disclosures concerning the amount and nature of these
one-time fees were complete and accurate and accordingly, no changes are
being made to those disclosures. The total amount of revenue ultimately
recognized over the period covered by the Company's license agreements
with licensees will not change, only the period in which the revenue is
recognized.
o To de-recognize the sale of the Utah facility in 1997 and account for this
transaction in a manner similar to SEC guidance for the divestiture of a
business operation, as outlined under Staff Accounting Bulletin (SAB)
Topic 5:E. The note receivable related to this transaction has been
classified as a facility transferred under note receivable arrangement and
the loss on sale ($582,000) was reversed. All note payments, including
interest, reduce the carrying amount of the recorded asset.
o To reverse depreciation expense recorded on assets not in use.
The combined effect of all of the above items is to increase the 1998 net
loss by $7,322,000 and to decrease the 1997 net loss by $497,000, as shown in
the following table.
<TABLE>
<CAPTION>
(thousands of dollars) 1998 1997
---------------------------------------------------------------------------------------------------------------------
As Reported As Restated As Reported As Restated
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Total revenues $12,699 $5,617 $251 $356
Operating costs and expenses 15,310 15,231 11,105 10,525
------------------------------- -------------------------------
Operating loss (2,611) (9,614) (10,854) (10,169)
Other income (expense) (1,375) (1,694) (141) (329)
------------------------------- -------------------------------
Net loss $(3,986) $(11,308) $(10,995) $(10,498)
=============================== ===============================
Basic and diluted loss per common share $(0.43) $(1.17) $(1.38) $( 1.32)
=============================== ===============================
</TABLE>
In addition to the above restatements, certain prior year amounts were
reclassified to conform with the current year's presentation. The
reclassifications had no effect on net loss or total assets.
2. Advances on Inventories
During 1997, the Company entered into an agreement to purchase coal fines and
made payments totaling approximately $1,146,000, of which $59,000 was
transferred to cost of coal briquetting operations. During 1998, additional
payments totaling approximately $1,583,000 were made, of which $148,000 was
transferred to cost of coal briquetting operations. The net amount paid has
been recorded as advances on inventories. The Company expects to utilize the
majority of these coal fines during 1999, at which time the costs will be
expensed.
Under the agreement, the Company 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.
F-14
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
3. Due From/To Related Party
Due from related party consists of amounts receivable from Coaltech for
operating expenses in 1998 and for operating expenses and interest in 1997.
Due to related party represents amounts due to Coaltech for the purchase of
synthetic fuel briquettes.
4. Notes Receivable
<TABLE>
<CAPTION>
Notes receivable consist of the following at September 30:
(thousands of dollars) 1998 1997
---------------------------------------------------------------------------------------------- -------------- --------------
Facility-dependent Note and Accrued Interest Receivable, Non-current
<S> <C> <C>
Note receivable from a corporation, bearing interest at 12%, principal and
interest due not later than February 2003, collateralized by a synthetic fuel
facility in Alabama, which was sold by the Company. This note receivable is
recorded at an amount which does not exceed its fair value. $6,500 $---
Accrued interest receivable from the above corporation 486 ---
Unsecured note receivable from a corporation, bearing interest at 10%,
receivable in quarterly principal installments of $55 beginning September
1999 660 ---
-------------- --------------
Notes and interest receivable $7,646 $---
============== ==============
Facility transferred under Note Receivable Arrangement
Facility transferred under note receivable arrangement with Coaltech, bearing
interest at 9.7%, principal and interest payments of $130 due quarterly
through December 2007, collateralized by a synthetic fuel facility in Utah.
All note payments, including principal and interest reduce the carrying
amount of this asset (See Note 16). $3,166 $3,813
============== ==============
Notes Receivable - Related Parties, Collateralized by Minority Interest
Notes receivable from seven officers of the Company, bearing interest at
prime (8.5% at September 30, 1997) plus 2%, principal and interest due August
2000, originally collateralized by interests in Utah Synfuel #1 and Alabama
Synfuel #1. Classified as a reduction in minority interest in consolidated
subsidiaries in 1997. Classified in 1998 as notes receivable - related
parties, collateralized by common stock due to an exchange of partnership
interests for common stock (See Note 10). No interest income has been
recognized for any period. $ --- $672
============== ==============
</TABLE>
All of the above notes receivable were recorded initially at their fair
value.
F-15
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
5. Property, Plant and Equipment
Property, plant and equipment consists of the following at September 30:
<TABLE>
<CAPTION>
(thousands of dollars) Range of estimated useful 1998 1997
lives
--------------------------------------------------------------- ------------------------------- -------------- --------------
<S> <C> <C> <C>
Land $ 153 $ ---
Buildings and improvements 10 - 20 years 11,154 1,083
Machinery and equipment 5 - 10 years 4,749 2,102
Construction in progress --- 11,030
-------------- --------------
16,056 14,215
Less accumulated depreciation 1,070 596
============== ==============
Net property, plant and equipment $14,986 $13,619
============== ==============
</TABLE>
Depreciation expense was $474,000 in 1998, $193,000 in 1997 and $187,000 in
1996.
6. Investment in Licensee Facility
Investment in licensee facility represents payments made to the licensee of a
synthetic fuel facility located in Pennsylvania in exchange for a 10%
interest in the net cash flows from operation of the facility. The investment
is being accounted for at cost. Cash received by the Company will first be
applied as a reduction of the carrying amount of the investment.
7. Long-term Liabilities
Notes Payable and Convertible Debentures
Notes payable and convertible debentures consist of the following at
September 30:
<TABLE>
<CAPTION>
(thousands of dollars 1998 1997
------------------------------------------------------------------------------------------------- ------------- -------------
<S> <C> <C>
Note payable to a corporation bearing interest at prime (8.25% at September
30, 1998) plus 2%, collateralized by plant and equipment, principal and
interest due December 1999. $ 2,900 $ 2,900
Note payable to a corporation bearing interest at 6%, principal and interest
due October 1999, collateralized by a coal wash plant in Utah. 4,263 945
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. Subsequent to September 30, 1998, this
entity modified the terms of the note and agreed to loan to the Company
additional amounts up to $1,500. This entity has an option to purchase the
facility. If it is not purchased, the Company has agreed to pay interest on
all outstanding amounts at a rate of 10%, payable monthly beginning January
1999 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, subsequent to September 30, 1998 the Company granted
additional collateral to the corporation in the form of certain license fees
receivable by the Company from other synthetic fuel facilities. 8,242 --
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 ---
</TABLE>
F-16
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
7. Long-term Liabilities, continued
<TABLE>
<CAPTION>
(thousands of dollars 1998 1997
------------------------------------------------------------------------------------------------- ------------- -------------
<S> <C> <C>
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 ---
Note payable to a corporation bearing interest at 18% until October 1998, at
which time it increased to 22%, due June 1999, collateralized by a promissory
note receivable and by certain future license fees receivable by the Company.
Warrants to purchase 100,000 shares of common stock were granted in October
1998 based on the outstanding principal balance. A member of the Company's
Board of Directors is affiliated with this corporation. 4,000 ---
Note payable to a corporation, bearing interest at 13% until December 1998,
at which time it increases to 14%. Principal and accrued interest due March
1999, collateralized by certain future license fees receivable by the
Company. A member of the Company's Board of Directors is affiliated with this
corporation. 4,000 ---
Convertible note payable to a corporation bearing interest at prime plus 2%.
Principal of $6,686 plus accrued interest of $314 was converted to common
stock at $7.00 per share in March 1998. --- 3,302
Convertible debenture payable to two individuals and one trust bearing
interest at prime plus 2%. Converted to common stock at $11.00 per share in
June 1998. --- 1,000
Other 94 ---
------------- -------------
35,979 8,147
Less: current portion 22,049 5,247
============= =============
Total non-current $13,930 $2,900
============= =============
</TABLE>
Substantially all of the Company's property, plant and equipment and
facilities held for sale are collateral for the notes payable. The weighted
average interest rate on notes payable and convertible debentures was 8.5% at
September 30, 1998 and 10.5% at September 30, 1997. Future maturities of
notes payable at September 30, 1998 are as follows:
<TABLE>
<CAPTION>
Year ending September 30, (thousands of
dollars)
--------------------------- ---------------------
<S> C> <C>
1999 $22,049
2000 7,173
2001 6,757
=====================
Total $35,979
=====================
</TABLE>
Notes Payable - Related Parties, Non-current
Notes payable - related parties represents unsecured amounts due to two
officers of the Company which bear interest at prime (8.25% at September 30,
1998) plus 2%. Principal and interest are due November 2002.
Deferred Compensation
In 1993, the Company assumed a liability to pay a current stockholder of the
Company $40,000 per year for seven years beginning February 1999. The present
value of this liability, discounted at approximately 5%, is reflected as
deferred compensation in the consolidated balance sheet.
F-17
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
7. Long-term Liabilities, continued
Interest Costs
During 1998, the Company incurred total interest costs of approximately
$4,266,000 (including approximately $2,046,000 of non-cash interest expense
resulting from issuance of convertible debt at a discount), of which
approximately $1,390,000 was capitalized. During 1997, the Company incurred
total interest costs of approximately $2,023,000 (including approximately
$1,429,000 of non-cash interest expense resulting from issuance of
convertible debt at a discount), of which approximately $378,000 was
capitalized. During 1996, the Company incurred total interest costs of
approximately $94,000, of which approximately $33,000 was capitalized.
8. Income Taxes
The Company accounts for income taxes using the asset and liability approach
in accordance with Statement of Financial Accounting Standards (SFAS) No.
109, "Accounting for Income Taxes". The Company files a consolidated tax
return with its 100% owned subsidiaries. Both majority-owned limited
partnerships file separate tax returns, as required.
As of September 30, 1998, the Company has net operating loss carryforwards of
approximately $21,400,000 which can be used to offset future taxable income.
The net operating loss carryforwards expire from 2005 to 2018. The Company
also has approximately $190,000 in research and development tax credit
carryforwards which can be used to offset future tax liabilities. The tax
credit carryforwards expire from 2007 to 2013. The utilization of these
carryforwards against future taxable income may become subject to an annual
limitation due to changes in ownership of the Company's common stock.
The provision for income taxes from continuing operations for the years ended
September 30, 1998, 1997 and 1996, all of which represents deferred income
taxes, differs from the statutory federal income tax rate due to the
following:
<TABLE>
<CAPTION>
(thousands of dollars) 1998 1997 1996
--------------------------------------------------------------------------- --------------- --------------- --------------
<S> <C> <C> <C>
Tax benefit at statutory rates $1,355 $ 3,738 $3,810
Change in valuation allowance (1,377) (3,840) (4,007)
State income taxes, net of federal tax effect 39 101 363
Other, including redetermination of prior years' tax estimates (17) 1 (189)
--------------- --------------- --------------
Deferred federal income tax provision $ 0 $ 0 $ (23)
=============== =============== ==============
The components of the net deferred tax asset as of September 30, 1998 and
1997 are as follows:
<CAPTION>
(thousands of dollars) 1998 1997
------------------------------------------------------------------------------------------- -------------- ---------------
<S> <C> <C>
Deferred tax assets (liabilities):
Net operating loss carryforwards $7,995 $ 6,282
Research and development tax credit carryforwards 189 189
Compensation expense related to common stock options 2,084 2,003
License fee revenue recognition 315 104
Write-down of notes receivable 304 712
Estimated liabilities 356 551
Depreciation (88) (111)
Other 40 88
-------------- ---------------
Total deferred tax assets 11,195 9,818
Valuation allowance (11,195) (9,818)
-------------- ---------------
Net deferred tax asset $ 0 $ 0
============== ===============
</TABLE>
F-18
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
8. Income Taxes, continued
The valuation allowance increased by $1,377,000 during 1998, representing the
additional amount of deferred tax assets at September 30, 1998 not considered
recoverable through the reversal of taxable temporary differences, or the
generation of future taxable income. The valuation allowance increased by
$3,840,000 during 1997 and by $4,007,000 during 1996. SFAS No. 109 requires
that a valuation allowance be provided if it is more likely than not that
some portion or all of a deferred tax asset will not be realized. The
Company's ability to realize the benefit of its deferred tax assets will
depend on the generation of future taxable income through its continuing
operations or through the sale of assets. Because the Company has not
generated significant revenues to date relating to the Briquetting
Technology, the Company believes that a valuation allowance of $11,195,000
should be provided as of September 30, 1998. This estimate may change in the
near term depending on the level of earned license fees received in 1999.
9. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
(thousands of dollars and shares, except per-share data) 1998 1997 1996
--------------------------------------------------------------------------- ---------------- --------------- ---------------
Numerator:
<S> <C> <C> <C>
Loss from continuing operations $(11,308) $(10,498) $(12,955)
Loss from discontinued operations --- --- (881)
---------------- --------------- ---------------
Net loss (11,308) (10,498) (13,836)
Preferred stock dividends (337) (189) ---
================ =============== ===============
Net loss attributable to common stockholders $(11,645) $(10,687) $(13,836)
================ =============== ===============
Denominator - weighted average shares outstanding 9,969 8,080 6,941
================ =============== ===============
Loss per share from continuing operations $(1.17) $(1.32) $(1.86)
Loss per share from discontinued operations --- --- (.13)
================ =============== ===============
Basic and diluted net loss per share $(1.17) $(1.32) $(1.99)
================ =============== ===============
</TABLE>
For 1998 and 1997, the Company's loss per common share was determined after
taking into account undeclared cumulative preferred stock dividends of
$337,000 and $24,000, respectively and, in 1997 approximately $165,000 of
preferred stock dividends imputed based upon the price of the Company's
common stock at the date the convertible preferred shares were issued.
10. Notes and Interest Receivable -- Related Parties, Collateralized by Common
Stock
Notes and interest receivable -- related parties, collateralized by common
stock, consist of the following at September 30:
<TABLE>
<CAPTION>
(thousands of dollars and shares) 1998 1997
---------------------------------------------------------------------------------------------- ------------- --------------
<S> <C> <C>
Note receivable from a shareholder, $5,000 face amount, bearing interest at
6% renegotiated in November 1997, principal and interest of $515 due in
annual installments beginning January 1999 through January 2004, with
remaining balance due January 2005, collateralized by 130 shares of the
Company's common stock held by the Company, options expiring in January 2006
to acquire 50 shares of the Company's common stock committed by the
shareholder to be provided to the Company, and a personal guarantee of the
shareholder. The carrying value is equal to the fair value of the 130 shares
and options to acquire 50 shares and is net of unamortized discount after
renegotiation of $1,281 based upon an imputed rate of 10.25%, and an
allowance for impairment of $2,110 in 1998 ($2,129 in 1997). No interest
income was recognized during 1998, 1997 or 1996. $1,609 $1,590
</TABLE>
F-19
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
10. Notes and Interest Receivable -- Related Parties, Collateralized by Common
Stock, continued
<TABLE>
<CAPTION>
<S> <C> <C>
Notes and interest receivable from 16 current and former officers and
employees, issued upon exercise of options to purchase 450 shares of common
stock at $5.31 to $8.38 per share, bearing interest at 5.7%, principal and
interest due in December 2000, collateralized by 900 shares of the Company's
common stock. No interest income was recognized during 1998 or 1997. 5,492 5,805
Notes receivable from seven officers of the Company, bearing interest at
prime (8.25% at September 30, 1998) plus 2%, principal and interest due
August 2000, originally collateralized by partnership interests which were
subsequently exchanged for 79 shares of the Company's common stock (see Note
14). Classified as notes receivable - related parties, collateralized by
minority interests in consolidated subsidiaries in 1997. No interest income
has been recognized for any period. 672 ---
Other --- 16
------------- --------------
$7,773 $7,411
============= ==============
</TABLE>
11. Fair Value of Financial Instruments
SFAS No. 107 requires that the fair market value of certain financial
instruments be disclosed in the financial statements. The Company has the
following financial instruments that are subject to the provisions of SFAS
No. 107:
* Cash and cash equivalents
* Receivables
* Notes receivable
* Notes receivable - related parties
* Notes payable and convertible debentures
* Notes payable - related parties
* Notes receivable - related parties, from issuance of, or
collateralized by, common stock
A substantial portion of the Company's financial instruments are of a
short-term nature. Accordingly, while the fair values of some of the
individual financial instruments vary somewhat from their carrying values,
the aggregate carrying values as reflected in the financial statements
approximate fair value.
12. Preferred and Common Stock
Preferred Series A - Non-Voting
As of September 30, 1998, there were 3,000 shares of Series A shares issued
and outstanding. The Series A preferred shares are non-voting and have the
following rights and privileges:
1. The holders of the shares are entitled to cumulative dividends at
the rate of 6% per year of the liquidation value of $1,000 per
share. These dividends accrue whether or not they have been declared
or whether the Company has any profits. Additional shares of Series
A preferred stock may be issued in lieu of cash to pay accrued
dividends on these shares.
2. Upon the liquidation of the Company, the holders of the Series A
preferred shares are entitled to receive $1,000 per share, together
with all accrued and unpaid dividends, if any.
3. Each share of Series A preferred stock includes a warrant to
purchase 28.571 shares of common stock or a total of 85,713 shares,
at a price of $8.00 per share. These warrants expire on August 31,
1999.
F-20
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
12. Preferred and Common Stock, continued
Preferred Series A - Non-Voting, continued
4. The holders of the shares are entitled to convert their shares to
common shares at any time. The number of common shares to be
received upon conversion is determined by multiplying the number of
preferred shares by $1,000 and dividing by the conversion price of
$7.00 per share. At any time after August 31, 1999, the Company has
the right to require any holder of the Series A preferred shares to
convert their shares into common stock.
5. No dividends have been declared through September 30, 1998.
Dividends in arrears at September 30, 1998 totaled approximately
$200,000, or $67 per share.
Preferred Series B - Non-Voting
As of September 30, 1998, there were 312,882 shares of Series B shares issued
and outstanding. The Series B preferred shares are non-voting and have the
following rights and privileges:
1. The holders of the shares are entitled to cumulative dividends at
the rate of approximately 7% per year of the liquidation value of $7
per share. These dividends accrue whether or not they have been
declared or whether the Company has any profits. Additional shares
of Series B preferred stock may be issued in lieu of cash to pay
accrued dividends on these shares.
2. Upon the liquidation of the Company, the holders of the Series B
preferred shares are entitled to receive $7 per share, together with
all accrued and unpaid dividends, if any.
3. Each unit (comprising 3 shares) of Series B preferred stock includes
a warrant to purchase one share of common stock at a price of $8.00
per share. These warrants expire on September 30, 1999.
4. The holders of the shares are entitled to convert their shares to
the same number of shares of common stock at any time, subject to
adjustment for dilution. Accrued dividends may be converted by the
Company into common stock at the conversion price of $7.00 per
share.
5. No dividends have been declared through September 30, 1998.
Dividends in arrears at September 30, 1998 totaled approximately
$162,000, or $.52 per share. Based upon the conversion price per
share at the date of issuance, a non-cash dividend of approximately
$165,000 was imputed upon issuance.
13. Stock Options and Warrants
Stock Options
At September 30, 1998, the Company had one stock option plan (the "Option
Plan") under which 2,400,000 shares of common stock are reserved for ultimate
issuance. A committee of the Company's Board of Directors, or in its absence,
the Board (the "Committee") administers and interprets the Option Plan. This
Committee is authorized to grant options and other awards both under the
terms of the Option Plan and outside the Option Plan to eligible employees,
officers, directors, and consultants of the Company. The Option Plan provides
for the granting of both incentive stock options and non-statutory stock
options. Terms of options granted under the Option Plan, including vesting
requirements, are determined by the Committee. Options granted under the
Option Plan vest over periods ranging from 0 to ten years, expire ten years
from the date of grant and are not transferable other than by will or by the
laws of descent and distribution. Incentive stock option grants must meet the
requirements of the Internal Revenue Code.
F-21
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
13. Stock Options and Warrants, continued
Stock Options, continued
The Company has elected to continue to apply Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related interpretations in accounting for its Option Plan. The alternative
fair value method of accounting prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation" ("SFAS 123"), requires the use of option valuation
models that were not developed for use in valuing employee stock options, as
discussed below. Accordingly, under APB 25, no compensation expense has been
recognized for stock option grants to employees, officers and directors when
the exercise price of stock options equals or exceeds the market price of the
Company's common stock on the date of grant.
When options are issued with terms considered compensatory, the related
compensation expense is amortized to expense over the specified vesting
period on a straight-line basis. Deferred compensation related to options
issued in 1998, 1997 and 1996 that vest over time was approximately $0,
$1,178,000 and $4,668,000, respectively. The amortized compensation expense
related to these options was approximately $908,000, $1,572,000 and $910,000
for 1998, 1997 and 1996, respectively. Compensation expense related to
options that vested immediately was approximately $127,000, $103,000 and
$3,863,000 for 1998, 1997, and 1996, respectively.
If the Company had elected to account for options granted in 1998, 1997 and
1996 based on their fair value, as prescribed by SFAS 123, net loss and net
loss per share would have been increased to the pro forma amounts shown in
the table below.
<TABLE>
<CAPTION>
(thousands of dollars, except per-share data) 1998 1997 1996
--------------------------------------------------------- ---------------- --------------- ---------------
<S> <C> <C> <C>
Net loss attributed to common stockholders - reported $(4,323) $(11,184) $(13,836)
- pro forma (7,245) (11,799) (14,530)
Basic and diluted net loss per share - reported (.43) (1.38) (1.99)
- pro forma (.73) (1.46) (2.09)
</TABLE>
The fair value of each stock option grant was determined using the
Black-Scholes option pricing model and the following assumptions: expected
stock price volatility of .67 to .70, risk-free interest rate of 4.4% to
7.8%, weighted average expected option lives of 10 years, and no dividends.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including expected stock price volatility.
Because the Company's stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value, in management's
opinion the existing models do not necessarily provide a reliable single
measure of the fair value of stock options.
F-22
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
13. Stock Options and Warrants, continued
Stock Options, continued
The following table is a summary of activity for all of the Company's stock
options for the years ended September 30:
<TABLE>
<CAPTION>
1998 1997 1996
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
(thousands of shares) Shares Price Shares Price Shares Price
------------------------------------------- ------------- ------------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 1,614 $2.85 1,367 $1.62 2,030 $2.37
Granted 850 12.34 445 6.08 1,612 3.51
Exercised (94) 1.93 (73) 1.84 (1,085) 5.92
Canceled --- --- (125) 1.50 (1,190) 1.54
============= ============= ============ ============ ============ =============
Outstanding at end of the year 2,370 $6.29 1,614 $2.85 1,367 $1.62
============= ============= ============ ============ ============ =============
Exercisable at end of year 1,038 $5.23 712 $2.04 463
============= ============= ============ ============ ============ =============
Weighted average fair value of options
granted during the year below market $10.21 $9.53 $12.66
Weighted average fair value of options
granted during the year at market $9.91 $5.57 $0
</TABLE>
The following table summarizes information about all stock options
outstanding at September 30, 1998:
<TABLE>
<CAPTION>
(thousands of shares) Options Outstanding Options Exercisable
------------------------ ------------------------------------------------------------- ------------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding at Remaining Average Exercisable at Average
Range of Exercise September 30, Contractual Life Exercise September 30, Exercise
Prices 1998 in Years Price 1998 Price
------------------------ ---------------------- ------------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C> <C>
$1.50 to $3.50 1,221 7.3 $1.58 602 $1.66
$7.00 to $9.00 397 8.5 8.22 257 8.20
$11.00 to $13.56 752 9.0 12.92 179 13.02
---------------------- ------------------- ------------------ ------------------ -----------------
2,370 1,038
====================== ==================
</TABLE>
Stock Warrants
As of September 30, 1998, there were warrants outstanding for the purchase of
approximately 2,033,000 shares of common stock at prices ranging from $7.00
to $30.00 per share and with expiration dates from October 1998 to September
2000. All of these warrants were issued in connection with private placements
of common and preferred stock or notes payable during the years 1996 through
1998.
In October 1998, the Company issued warrants for the purchase of 100,000
shares of common stock in accordance with the terms of a note payable to a
corporation (see Note 7).
F-23
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
14. Purchase of Limited Partners' Interests in Subsidiaries
In September 1998, the Company formally offered the limited partners in its
two consolidated subsidiaries, Utah Synfuel #1, and Alabama Synfuel #1, an
exchange of the Company'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 the Company's common stock at the date of the offer, $9.00
per share. As of September 30, 1998, substantially all of the limited
partners had elected to exchange their limited partnership interests for
shares of the Company's common stock. During October and November 1998, all
but one of the other limited partners exchanged their interests and Utah
Synfuel #1 became a wholly-owned subsidiary of the Company and Alabama
Synfuel #1 became a 98%-owned subsidiary of the Company. The Company recorded
this exchange using the market values of the Company's common stock on the
dates the limited partners tendered acceptance of the Company's offer. These
market values ranged from $6.75 to $11.13 per share.
15. Discontinued Operations
In 1995, the Company made a strategic decision to focus its efforts
exclusively on commercializing the Briquetting Technology and to divest
itself of its construction subsidiaries. In September 1995, the Board of
Directors approved a plan to dispose of the construction-related operations
and in February 1996 entered into a stock purchase agreement to sell all of
the common shares of the subsidiaries for a $5,000,000 face value promissory
note. The terms of the original agreement were clarified in November 1997 and
the financial effect is included in the change in the allowance to reduce the
promissory note to collateral value (discussed below). Because the note
includes a favorable interest rate for the buyer, the Company has calculated
the present value of the note using a market rate of 10.25% over the term of
the note. The effect of discounting the note at 10.25% was to reduce the note
to approximately $3,719,000 as of the renegotiation date. The original
discount on the note was included in the estimated loss on disposal of
discontinued operations in 1996.
Because the note is collateralized by the Company's common stock, it is
reflected in the consolidated financial statements as a reduction of
stockholders' equity. Additionally, the note is adjusted to reflect
subsequent increases or decreases in the fair value of the Company's stock
and stock options held as collateral. Subsequent changes in the value of the
collateral will be reflected in the statement of operations and as an
increase or decrease to the carrying value of the note.
Under the terms of the agreement, the Company agreed to pay $3,500,000 of
accounts payable and lines of credit outstanding in the subsidiaries.
Subsequently, the buyer also received reimbursement from the Company for
approximately $650,000 of additional expenses related to the discontinued
operations during the wind-down period which were paid by the buyer. The
Company has reflected those obligations in the loss on discontinued
operations in 1996. Revenues of the discontinued operations were
approximately $1,397,000 for the four months ended February 1, 1996, the date
of sale.
16. Commitments and Contingencies
Commitments and contingencies as of September 30, 1998 not disclosed
elsewhere, are as follows:
Leases
Rental expense was approximately $473,000, $318,000, and $330,000 for 1998,
1997 and 1996, respectively. The Company has a noncancellable operating lease
for equipment through the year 2000 and other operating leases for real
estate. At September 30, 1998, minimum rental payments due under these
leases, are as follows:
Year ending September 30: (thousands of dollars)
----------------------------- -----------------------
1999 $664
2000 496
2001 314
2002 113
2003 36
=======================
$1,623
=======================
F-24
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
16. Commitments and Contingencies, continued
Letters of Credit
During 1998, the Company entered into letter of credit arrangements with a
bank that provide for the issuance of letters of credit totaling up to
$938,000. These arrangements are collateralized by certificates of deposit
totaling $588,000 that are included in restricted investments in the
accompanying balance sheet. As of September 30, 1998, there was approximately
$560,000 of liabilities covered by these arrangements.
Legal or Contractual Matters
Included in accrued liabilities is $755,000 ($1,477,000 in 1997) related to
construction contracts that contained a "failure to proceed" liability
clause.
In December 1996, the Company entered into indemnification agreements in
connection with construction contracts for certain synthetic fuel facilities
entered into by independent third parties. These contracts call for
liquidated damages of $750,000 per contract if construction of the facilities
is not completed by June 1, 1998. The Company indemnified the contractor for
these potential liabilities. The contracting party did not construct three of
the facilities. Accordingly, the maximum contingent liability under these
indemnification agreements would be $2,250,000. The contractor and the owner
have initiated arbitration claims against each other including owner claims
for liquidated damages. The Company is closely monitoring the situation and
believes that payment of a material amount by the Company is unlikely.
In March 1997, Covol transferred the Utah Synfuel #1 facility to Coaltech. In
connection with this transaction, Utah Synfuel #1 licensed Coaltech to use
Covol's binder technologies for a non-refundable advance license fee of
$1,400,000, which is being recognized as income over the contractual term of
the license agreement of 2007, and a recurring license fee that is payable
quarterly and that is based upon synthetic fuel produced and sold at the Utah
facility by Coaltech. Covol contracted with Coaltech to operate the facility
for which Covol receives a quarterly fee, which is also based upon synthetic
fuel produced and sold. The limited partners of Coaltech have an option
wherein they can require Covol to repurchase this facility under certain
conditions. This put option can be exercised if 1) all of the limited
partners are unable to utilize the federal income tax credits under Section
29 of the tax code, 2) the economic benefits accruing to or experienced by
all of the Coaltech limited partners differ significantly from what was
initially projected, or 3) there is a permanent force majeure or material
damage or destruction of the Utah facility. If the put option is exercised
prior to March 2000, the option price will be equal to the fair market value
of the limited partnership interests of the optionees on a going concern
basis, but in no event will the option price exceed 50% of the capital
contributions paid to Covol by Coaltech. If the put option is exercised after
March 2000, the option price will be $10. In accordance with generally
accepted accounting principles and after discussions with the staff of the
Securities and Exchange Commission, this transaction has not been reflected
as a sale for accounting purposes. The original cost of the facility less
cash payments received from Coaltech, is reflected in the consolidated
balance sheet as a facility transferred under note receivable arrangement.
Additionally, Covol entered into a supply and purchase agreement with
Coaltech wherein Covol agreed to provide to Coaltech coal fines for
processing into synthetic fuel at a price equal to Covol's cost. Covol agreed
to purchase from Coaltech the synthetic fuel produced, at Coaltech's cost
plus one dollar per ton. As a result of this commitment to purchase
Coaltech's production, Covol has experienced losses related to the write-down
of the synthetic fuel purchased to the lower of cost or market. This
write-down to date has approximated 85% of the amount Covol has paid for the
synthetic fuel. 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. Also, Covol believes Coaltech can not
require Covol to purchase product for which Covol does not have outside third
party sales, and further, Covol believes it has the right to stop all
production at the Utah facility in order to limit or eliminate such losses.
F-25
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
16. Commitments and Contingencies, continued
Legal or Contractual Matters, continued
In June 1996, the Company formed Alabama Synfuel #1 to construct a synthetic
fuel facility. In connection with the construction of this facility, the
Company entered into a supply agreement for coal fines to be used at the
facility, under which the Company was obligated to purchase a minimum of
20,000 tons of coal fines per month through December 2001. The Company
assigned this agreement to the purchaser of the facility and accordingly, has
no ongoing obligation. The Company has a dispute with the provider of coal
fines, the resolution of which is not expected to have a material impact on
the Company.
In May 1995, the Company entered into an agreement with Geneva Steel Company
to build and operate a commercial iron revert briquetting plant. The facility
never reached commercial productivity levels and is not operational. The
Company may use this equipment for the production of synthetic fuel or for
testing purposes.
The Company entered into a letter of intent with Innovative Technologies
("Innovative") in July 1995 to apply the Company's Briquetting Technology to
certain metallic ores supplied by Innovative. The Company conducted numerous
tests of the ore through the fall of 1995, and concluded from the results
that the venture was not economically viable. Accordingly, final agreement to
process the ore was never reached. In March 1997, Innovative Holding Company,
Inc., filed a civil complaint against the Company alleging breach of the
letter of intent and damages in excess of $500,000. The Company successfully
defended this action which was dismissed with prejudice.
In December 1996, the Company entered into license agreements with affiliates
of Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of Company
technologies at four synthetic fuel manufacturing facilities owned by Pace.
In 1998 Pace requested a reduction in the license fees payable to the Company
under the license agreements. Upon condition of immediate payment by Pace of
advance license fees, the Company agreed to a reduction in future earned
license fees. This reduction was accomplished by a ten-year loan agreement
whereby the Company would loan to Pace up to $750,000 each quarter beginning
in November 1998. The Company'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 the Company
only to the extent that amounts exceed the loan commitment. Pace has
requested a loan of $750,000 for the November 1998 quarter. The Company
believes that its current loan obligation to Pace is limited to the earned
license fee receivable by the Company for the quarter ended September 30,
1998, which is believed to be approximately $300,000.
In January 1996, a manager of the Company entered property owned by Nevada
Electric Investment Company, a subsidiary of Nevada Power Corporation, in
connection with an offer by the Company to purchase the property, and with
certain other employees of the Company, removed some asbestos over a two-day
period. In May 1996, the Company 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. The Company
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. The Company does not know the results of
the grand jury inquiry or whether the inquiry is completed. The Company does
not believe that the resolution of this matter will have a material adverse
effect on the Company.
As of September 30, 1998, the Company has recorded liabilities to The
Industrial Company ("TIC") totaling approximately $735,000. In November 1998,
the Company was served with liens from TIC in amounts totaling approximately
$1,150,000 for construction payments TIC claims are due for certain synfuel
facilities. The Company 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 the Company is unlikely.
F-26
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS, continued
----------
16. Commitments and Contingencies, continued
Legal or Contractual Matters, continued
The Company is also involved in several legal proceedings that have arisen
out of the normal course of business. The Company 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 the Company.
Employment Contracts
The Company has entered into employment agreements with the Chief Executive
Officer, President, Chief Financial Officer and two vice presidents. The
agreements, which are renewable by the Company, generally have a term of
approximately three years and provide for annual salaries and benefits
ranging from approximately $80,000 to $190,000 annually per officer, and
currently totaling approximately $600,000 for all five officers combined. All
agreements provide for termination benefits under specific conditions ranging
up to 200% of the then current annual salaries.
17. Events Subsequent to September 30, 1998
Subsequent to September 30, 1998, a total of approximately 308,000 shares of
the Company's common stock were issued on conversion of approximately 285,000
shares of Series B preferred stock and related accrued but unpaid dividends
in arrears.
During November and December 1998, the Company completed financing
transactions that consisted of $400,000 of debt and approximately $3,500,000
of equity. The debt has a term of twelve months, bears interest at 15%, 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 the Company and is due prior to maturity upon the placement of long-term
financing by the Company. The equity transaction consisted of the sale of
units at a price of $5.00 per unit. A unit consists 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. The warrants expire in
twelve months if not exercised. The restricted stock and shares issuable
pursuant to the related warrants have been provided piggyback registration
rights.
The Company has received term sheets for the sale of up to $10,000,000 of
convertible preferred stock. This financing is expected to close in January
1999.
F-27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED SEPTEMBER 30,
1998 AND 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> SEP-30-1998 SEP-30-1997
<PERIOD-END> SEP-30-1998 SEP-30-1997
<CASH> 727 4,780
<SECURITIES> 0 0
<RECEIVABLES> 3,891 1,099
<ALLOWANCES> 0 0
<INVENTORY> 1,645 1,819
<CURRENT-ASSETS> 37,872 8,837
<PP&E> 16,056 14,215
<DEPRECIATION> 1,070 596
<TOTAL-ASSETS> 68,061 26,590
<CURRENT-LIABILITIES> 29,552 12,308
<BONDS> 14,077 3,389
0 0
1 1
<COMMON> 11 9
<OTHER-SE> 14,734 6,416
<TOTAL-LIABILITY-AND-EQUITY> 68,061 26,590
<SALES> 3,569 356
<TOTAL-REVENUES> 5,617 356
<CGS> 9,216 4,805
<TOTAL-COSTS> 9,216 4,805
<OTHER-EXPENSES> 1,579 2,782
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 2,745 1,645
<INCOME-PRETAX> (11,308) (10,498)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (11,308) (10,498)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (11,308) (10,498)
<EPS-BASIC> (1.17) (1.32)
<EPS-DILUTED> (1.17) (1.32)
</TABLE>
