UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 1999
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______ to ______
Commission file number 0-27803
COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
Not applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
The number of shares outstanding of the Registrant's common stock as of May 14,
1999 was 12,471,985.
<PAGE>
COVOL TECHNOLOGIES, INC.
TABLE OF CONTENTS
Page No.
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
Consolidated Balance Sheets - As of September 30, 1998
and March 31, 1999............................................. 3
Consolidated Statements of Operations - For the three
months ended March 31, 1998 and 1999 and the six months
ended March 31, 1998 and 1999.................................. 5
Consolidated Statement of Changes in Stockholders' Equity -
For the six months ended March 31, 1999........................ 6
Consolidated Statements of Cash Flows - For the six months
ended March 31, 1998 and 1999.................................. 7
Notes to Consolidated Financial Statements....................... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS........................................ 20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 27
ITEM 2. CHANGES IN SECURITIES............................................ 28
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 28
ITEM 5. OTHER INFORMATION................................................ 29
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 29
SIGNATURES................................................................. 30
Certain statements in this Report, constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. As such,
actual results may vary materially from current expectations. For a discussion
of certain of the factors that could cause actual results to differ from
expectations, please see the information set forth under the caption entitled
"Forward Looking Statements" in ITEM 2 hereof. There can be no assurance that
Covol's results of operations will not be adversely affected by such factors.
Covol 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>
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, March 31,
(thousands of dollars) 1998 1999
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 727 $6,879
Receivables 2,879 2,707
Due from related party 1,012 1,706
Inventories 1,645 2,039
Advances on inventories, current 2,522 473
Facilities held for sale 28,405 28,389
Prepaid expenses and other current assets 682 664
--------------- ----------------
Total current assets 37,872 42,857
--------------- ----------------
Property, plant and equipment, net of accumulated depreciation 14,986 14,083
--------------- ----------------
Other assets:
Restricted investments 748 698
Advances on inventories, non-current -- 2,825
Facility-dependent notes and accrued interest receivable, non-current 7,646 7,859
Facility transferred under note receivable arrangement 3,166 2,904
Intangible assets, net of accumulated amortization 3,118 3,976
Deposits and other assets 525 1,678
--------------- ----------------
Total other assets 15,203 19,940
--------------- ----------------
Total assets $68,061 $76,880
=============== ================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
3
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, March 31,
(thousands of dollars and shares) 1998 1999
- -------------------------------------------------------------------------------------------- --------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
<S> <C> <C>
Accounts payable $3,036 $2,616
Due to related party 1,609 2,029
Accrued liabilities 2,858 2,544
Notes payable, current 22,049 16,689
--------------- ---------------
Total current liabilities 29,552 23,878
--------------- ---------------
Long-term liabilities:
Notes payable, non-current 13,930 25,612
Accrued interest payable, non-current 566 206
Notes and accrued interest payable - related parties, non-current 147 69
Deferred revenues from advance license fees 8,377 7,924
Deferred compensation 236 202
--------------- ---------------
Total long-term liabilities 23,256 34,013
--------------- ---------------
Total liabilities 52,808 57,891
--------------- ---------------
Minority interest in consolidated subsidiaries 507 109
--------------- ---------------
Commitments and contingencies (Note 8)
Redeemable convertible preferred stock, $.001 par value, issued and outstanding
0 shares at September 30, 1998 and 60 shares at March 31, 1999 (aggregate
liquidation preference of $6,016 at March 31, 1999) (Note 6) -- 4,354
--------------- ---------------
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 316 shares at September 30, 1998 and 31 shares at
March 31, 1999 (aggregate liquidation preference of $4,514 at March 31, 1999) 1 1
Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding
11,272 shares at September 30, 1998 and 12,472 shares at March 31, 1999 11 12
Capital in excess of par value 69,284 77,763
Accumulated deficit (43,002) (52,776)
Notes and interest receivable - related parties, from issuance of, or collateralized
by, common stock, net of allowance (7,773) (7,024)
Deferred compensation from stock options (3,775) (3,450)
--------------- ---------------
Total stockholders' equity 14,746 14,526
--------------- ---------------
Total liabilities and stockholders' equity $68,061 $76,880
=============== ===============
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (Note 1)
(Unaudited)
Three Months Ended March 31, Six Months Ended March 31,
(thousands of dollars, except per-share amounts) 1998 1999 1998 1999
- -------------------------------------------------------------- ---------------- ---------------- ---------------- ---------------
Revenues:
<S> <C> <C> <C> <C>
License fees $ 146 $546 $202 $1,247
Binder sales -- 423 -- 956
Binder and coal fine sales - related party 1,989 42 1,996 183
Other 36 132 70 139
--------------- --------------- --------------- --------------
Total revenues 2,171 1,143 2,268 2,525
--------------- --------------- --------------- --------------
Operating costs and expenses:
Cost of coal briquetting operations 643 2,353 1,093 5,821
Cost of binder -- 274 -- 650
Cost of binder and coal fines - related party 1,964 10 1,972 35
Asset impairment charge -- 556 -- 556
Selling, general and administrative 1,150 1,233 1,891 2,162
Research and development 72 190 228 343
Compensation expense from stock options, stock
warrants and issuance of common stock 239 163 446 325
--------------- --------------- --------------- --------------
Total operating costs and expenses 4,068 4,779 5,630 9,892
--------------- --------------- --------------- --------------
Operating loss (1,897) (3,636) (3,362) (7,367)
--------------- --------------- --------------- --------------
Other income (expense):
Interest income 101 234 140 990
Interest expense (1,180) (1,377) (2,292) (2,413)
Minority interest in net losses of consolidated
subsidiaries 52 -- 138 --
Write-up (write-down) of notes receivable - related
parties, collateralized by common stock 270 (178) 563 (749)
Other 93 (100) 107 (76)
--------------- --------------- --------------- --------------
Total other income (expense) (664) (1,421) (1,344) (2,248)
--------------- --------------- --------------- --------------
Net loss $(2,561) $(5,057) $(4,706) $(9,615)
=============== =============== =============== ==============
Basic and diluted loss per common share $(.28) $(.41) $(.51) $(.80)
=============== =============== =============== ==============
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
5
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Six Months Ended March 31, 1999
(Unaudited)
Notes and interest
receivable -
Convertible Preferred related parties,
Stock Common Stock from issuance of, Deferred
------------------------ ------------------ or collateralized compensation
(thousands of dollars Capital in excess Accumulated by, common from stock
and shares) Shares Amount Shares Amount of par value deficit stock options
- ---------------------- ----------- ---------- -------- -------- ----------------- ------------- ---------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at
September 30, 1998 316 $1 11,272 $11 $69,284 $(43,002) $(7,773) $(3,775)
Common stock issued
to purchase minority
interests in subsidiaries 70 -- 519
Common stock issued
for cash, including
exercise of stock options 776 1 3,774
Value of common stock
warrants issued under
terms of existing debt
agreement -- -- 247
Common stock issued
for rights to technology 60 -- 375
Common stock issued on
conversion of preferred stock
and in payment of accrued but
undeclared dividends (286) -- 308 -- 159 (159)
Return of previously issued
common stock by a director (14) -- --
Value of common stock
options issued in connection
with debt financing -- -- 175
Preferred stock issued
for cash, net of offering
costs 1 -- 899
Value of common stock
warrants issued in connection
with redeemable convertible
preferred stock and
convertible debt 2,331
Write-down of notes
receivable - related parties 749
Amortization of deferred
compensation from stock
options 325
Net loss for the six months
ended March 31, 1999 (9,615)
----------- ---------- -------- -------- ----------------- ------------- ---------------- ------------
Balances at
March 31, 1999 31 $1 12,472 $12 $77,763 $(52,776) $(7,024) $(3,450)
=========== ========== ======== ======== ================= ============= ================ ============
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
6
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended March 31,
(thousands of dollars) 1998 1999
- ------------------------------------------------------------------------------------------------- ----------------- -------------
Cash flows from operating activities:
<S> <C> <C>
Net loss $(4,706) $(9,615)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization 150 845
Write-down (write-up) of notes receivable - related parties (563) 749
Interest expense related to amortization of debt discount and debt issuance costs 2,266 326
Amortization of deferred compensation from stock options 446 325
Minority interest in net losses of consolidated subsidiaries (138) --
Loss (gain) on disposition of equipment (78) 103
Asset impairment charge -- 556
Increase (decrease) from changes in assets and liabilities, net of effects from
investing and financing activities 2,466 (3,141)
---------------- -------------
Net cash used in operating activities (157) (9,852)
---------------- -------------
Cash flows from investing activities:
Purchase of property, plant and equipment and facilities held for sale (21,916) (323)
Proceeds from sale of equipment -- 170
Purchase of rights to technology -- (128)
Issuance of notes receivable (1,257) --
Proceeds from facility transferred under note receivable arrangement 284 261
Advances on binder facility 791 --
Decrease in restricted investment -- 50
----------------- -------------
Net cash provided by (used in) investing activities (22,098) 30
----------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants 16,338 10,498
Payments on notes payable -- (4,602)
Payments on notes payable - related parties (342) (90)
Proceeds from issuance of preferred stock and warrants, net 90 6,394
Proceeds from issuance of common stock, net 1,072 3,774
Proceeds from receivable - stock subscriptions 577 --
Proceeds from notes receivable - related parties, collateralized by common stock 302 --
Other (3) --
---------------- -------------
Net cash provided by financing activities 18,034 15,974
---------------- -------------
Net increase (decrease) in cash and cash equivalents (4,221) 6,152
Total cash and cash equivalents, beginning of period 4,780 727
----------------- -------------
Total cash and cash equivalents, end of period $ 559 $ 6,879
================ =============
Supplemental schedule of non-cash investing and financing activities:
Common stock issued for purchase of minority interests in subsidiaries $ -- $ 519
Common stock issued on conversion of preferred stock and undeclared dividends -- 2,159
Common stock issued for rights to technology -- 375
Notes payable issued for rights to technology -- 427
Notes payable issued for equipment 1,153 213
Common stock issued on conversion of notes payable and related accrued interest 7,000 --
Common stock issued for notes receivable - related parties 45 --
Facility-dependent note receivable issued for sale of synthetic fuel facility 6,500 --
Preferred stock dividends not accrued or paid 155 126
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
7
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
1. Nature of Operations and Basis of Presentation
Covol Technologies, Inc. and Subsidiaries ("Covol") primary business is to
commercialize its binder technologies which are used to recycle waste
by-products from the coal, steel and other industries into marketable fuel
and resources. Through June 30, 1998, Covol's focus was on the construction
of facilities and the licensing of its binder technologies to companies
that constructed facilities that convert coal fines into synthetic fuel
briquettes. At March 31, 1999, Covol and its licensees were operating 28
facilities in ten states at various levels of production, including four
facilities which are using a technology that Covol acquired during the six
months ended March 31, 1999. The four Covol-owned facilities are expected
to be sold in 1999. Covol has no current plans to construct additional
synthetic fuel facilities.
Covol anticipates that recurring license fees or royalties from the
production and sale of synthetic fuel will continue to increase during
1999. As production levels increase, sales of the binder materials by Covol
to its licensees are expected to increase proportionately. Funds received
by Covol from these activities are not expected to be sufficient to cover
Covol's operating costs and expenses until late 1999. Any extended delay in
the sale of facilities held for sale may require Covol to seek additional
debt or equity financing.
To provide funding for Covol's operations and debt repayment requirements
until late 1999, Covol expects to utilize existing working capital and
excess proceeds from the sale of facilities. During November 1998, Covol
issued common stock and common stock warrants for total net proceeds of
approximately $3,729,000. During January 1999, Covol issued convertible
preferred stock and warrants for total net proceeds of approximately
$900,000. During March 1999, Covol issued convertible secured debt,
convertible redeemable preferred stock and common stock warrants for total
net proceeds of approximately $14,800,000. Covol believes current working
capital, excess proceeds from the sale of facilities, payments for license
fees and binder sales, and funds raised in additional financings, if
necessary, will be sufficient to fund Covol's operations until its
operating activities begin producing positive cash flow. The ability of
Covol to repay its debt as it matures is dependent primarily upon Covol's
ability to sell the facilities which are held for sale. Covol believes the
sale of facilities or extensions of existing debt repayment terms will
enable it to meet these debt requirements.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included. All
adjustments, except as described in the following paragraph, consist of
normal recurring adjustments. The results of operations for the periods
presented are not necessarily indicative of the results to be expected for
the full year. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. It is
suggested that these financial statements be read in conjunction with the
consolidated financial statements and notes thereto included in Covol's
Annual Report on Form 10-K for the year ended September 30, 1998 and in
Covol's Quarterly Report on Form 10-Q for the quarter ended December 31,
1998.
In May 1995, Covol entered into an agreement with Geneva Steel Company to
build and operate a commercial briquetting facility. The facility never
reached commercial operating levels, but was held for other uses, including
potential relocation to another site for use in the production of synthetic
fuel or in other applications. In early 1999, Geneva filed a voluntary
petition for relief under Chapter 11 of the United States Bankruptcy Code
due to a lack of sufficient liquidity. Primarily as a result of this event,
Covol moved a substantial portion of the equipment comprising the facility
from the Geneva site to another location where it is being used in a
different application of Covol's technology. Certain assets at the Geneva
site, primarily consisting of leasehold improvements on the property where
the facility was located, were abandoned. The
8
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
carrying value of these assets, totaling approximately $556,000, was
written off during the quarter ended March 31, 1999.
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 and any differences could be material.
Restatements and Reclassifications
After discussion with the staff of the Securities and Exchange Commission
("SEC") in September 1999, the Company has restated its 1999 and 1998
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. All note payments, including interest,
reduce the carrying amount of the recorded asset.
o To reverse depreciation expense recorded on assets not in use and
reflect an asset impairment in an earlier period (March 31, 1999) than
originally reported.
The combined effect of all of the above items is to increase the net loss
for the six months ended March 31, 1999, by $196,000 and to increase the
net loss for the six months ended March 31, 1998 by $4,521,000, as shown in
the following table.
<TABLE>
<CAPTION>
(thousands of dollars) 1998 1999
---------------------------------------------------------------------------------------------------------------------
As As As As
Reported Restated Reported Restated
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Total revenues $6,652 $2,268 $2,072 $2,525
Operating costs and expenses 5,656 5,630 9,390 9,892
------------------------------- -------------------------------
Operating income (loss) 996 (3,362) (7,318) (7,367)
Other income (expense) (1,181) (1,344) (2,101) (2,248)
------------------------------- -------------------------------
Net loss ($185) ($4,706) ($9,419) ($9,615)
=============================== ===============================
Basic and diluted loss per common share ($0.03) ($0.51) ($0.78) ($0.80)
=============================== ===============================
</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.
9
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
2. Advances on Inventories
During 1997, Covol entered into an agreement to purchase coal fines and
through March 31, 1999 has made payments totaling approximately $3,520,000,
of which $222,000 has been transferred to cost of coal briquetting
operations. The net amount paid has been recorded as advances on
inventories. Covol expects to either utilize or sell these coal fines, at
which time the related costs will be expensed.
Under the agreement, Covol is obligated to pay a total of $5,500,000
between February 1997 and May 2000 for the removal of 2 million tons of
coal fines (a price of $2.75 per ton) from the property. Quarterly payments
of approximately $396,000 are required under the agreement. The agreement
also provides for removal of an additional 500,000 tons at $2.75 per ton.
No payment is required for removal of any coal fines in excess of 2.5
million tons.
3. Change in Carrying Value of Note Receivable
During the three and six months ended March 31, 1999, Covol increased the
allowance on the $5,000,000 face value note receivable from a stockholder
by approximately $178,000 and $749,000, respectively, resulting in an
adjusted carrying value of $860,000 as of March 31, 1999. During the three
and six months ended March 31, 1998, Covol decreased the allowance by
approximately $270,000 and $563,000, respectively. The changes in the
allowance were based solely on changes in the market value of Covol's
common stock and common stock options held as collateral for the note
receivable. The note is personally guaranteed by the buyer of certain
construction companies sold by Covol to him in 1996, and is collateralized
by 150,000 shares of Covol's common stock held by Covol, and also by
options expiring in January 2006 to acquire 25,000 shares of Covol's common
stock at $1.50 per share. The allowance is subject to future fluctuations
in the value of Covol's common stock. During the three months ended March
31 1999, Covol received interest payments totaling $225,000 from the Note
holder.
4. Notes Payable
<TABLE>
<CAPTION>
Notes payable consist of the following:
September 30, March 31,
(thousands of dollars) 1998 1999
-------------------------------------------------------------------------------------------- ----------------- ---------------
<S> <C> <C>
Note payable to a corporation, bearing interest at 15%, collateralized by a
synthetic fuel facility in Pennsylvania, held for sale, with all unpaid
principal and interest due at the earlier of the sale of the facility or
August 1999. $5,800 $5,800
Note payable to a corporation bearing interest at prime (7.75% at March 31,
1999) plus 2%, collateralized by plant and equipment, principal and
interest due December 1999. 2,900 2,900
Note payable to the same corporation referred to in the preceding
paragraph, bearing interest at 6%, principal and interest due January 2000,
collateralized by a coal wash plant in Utah. 4,263 4,288
</TABLE>
10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
4. Notes Payable, continued
<TABLE>
<CAPTION>
September 30, March 31,
(thousands of dollars) 1998 1999
-------------------------------------------------------------------------------------------- ----------------- ---------------
<S> <C> <C>
Notes payable to the same corporation referred to in the preceding
paragraphs, bearing interest at 6%. 50% of accrued interest due February
2000 with remaining accrued interest and principal due February 2001.
Collateralized by a synthetic fuel facility in West Virginia, held for
sale. $6,680 $6,500
Note payable to a limited liability company issued in conjunction with
funds advanced for the construction of a synthetic fuel facility in West
Virginia, held for sale. As of September 30, 1998, the loan was
collateralized by the facility, bore no interest and was originally due at
the earlier of the sale of the facility or January 1999. In December 1998,
this entity modified the terms of the note and agreed to loan to Covol
additional amounts up to $1,500. This entity had an option to purchase the
facility, which expired unexercised in January 1999. Covol agreed to pay
interest on all outstanding amounts at a rate of 10%, payable monthly
through June 1999. Beginning July 1999 through May 2000, monthly payments
of $350 will be required, with all unpaid principal and interest due in
June 2000. Alternatively, if Covol sells the facility before the loan
repayment date, Covol must repay the loan from sale proceeds. Also, Covol
granted additional collateral to the corporation in the form of certain
license fees receivable by Covol from other synthetic fuel facilities. 8,242 9,191
Convertible secured note payable to an investment company issued at a
discount, bearing a stated interest rate of 2.5% on the $20,000 face
amount. The note is due March 2004 if not earlier redeemed or converted
into common stock. Interest is payable semiannually on January 1 and July
1, beginning July 1, 1999. The note is collateralized by license fees
payable to Covol from the production and sale of synthetic fuel from four
synthetic fuel facilities located in Virginia and West Virginia. See Note
6. -- 8,921
Note payable to a corporation originally due June 1999, collateralized by a
promissory note receivable and by certain future license fees receivable by
Covol. Warrants to purchase 100,000 shares of common stock were granted in
October 1998 based on the outstanding principal balance. The warrants
originally had an exercise price of $7.44 per share, expired in October
2000 and were valued at approximately $247. The terms of this note were
amended in May 1999 to provide that $1,000 of principal is due in December
1999 and $3,000 of principal is due in April 2000. Accordingly, $3,000 has
been classified as long-term in the balance sheet. Interest is payable at a
rate of 22% through the original due date of June 12, 1999. Thereafter
interest is payable monthly at a rate of 14%. The terms of existing
warrants for the purchase of 185,713 shares of common stock were amended to
extend the exercise periods for one year and to lower the exercise prices
to market value of Covol's common stock. A member of Covol's Board of
Directors is affiliated with this corporation. 4,000 4,000
</TABLE>
11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
4. Notes Payable, continued
<TABLE>
<CAPTION>
September 30, March 31,
(thousands of dollars) 1998 1999
-------------------------------------------------------------------------------------------- ----------------- ---------------
<S> <C> <C>
Note payable to the same corporation referred to in the preceding
paragraph, bearing interest at 14%. Principal and accrued interest were
paid in March 1999. $ 4,000 $ --
Other 94 701
----------------- ---------------
35,979 42,301
Less: current portion 22,049 16,689
================= ===============
Total non-current $13,930 $25,612
================= ===============
</TABLE>
Substantially all of Covol's property, plant and equipment and facilities
held for sale are collateral for the notes payable. The weighted average
interest rate on notes payable was 8.5% at September 30, 1998 and 16.8% at
March 31, 1999.
Interest Costs
During the six months ended March 31, 1999, Covol incurred total interest
cost of approximately $2,413,000 (including approximately $326,000 of
amortization of debt discount and debt issuance costs, none of which was
capitalized. During the six months ended March 31, 1998, Covol incurred
total interest cost of approximately $2,983,000 (including approximately
$2,266,000 of non-cash interest expense resulting from issuance of
convertible debt and warrants at a discount), of which approximately
$691,000 was capitalized.
5. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
March 31, March 31,
(thousands of dollars and shares, except per-share data) 1998 1999 1998 1999
---------------------------------------------------------- -------------- --------------- ---------------- ---------------
Numerator:
<S> <C> <C> <C> <C>
Net loss $(2,561) $(5,057) $(4,706) $(9,615)
Preferred stock dividends (undeclared) (85) (77) (85) (137)
Imputed preferred stock dividends -- (40) -- (40)
============== =============== ================ ===============
Net loss attributable to common
stockholders $(2,646) $(5,174) $(4,791) $(9,792)
============== =============== ================ ===============
Denominator - weighted-average shares
outstanding 9,574 12,472 9,382 12,224
============== =============== ================ ===============
Basic and diluted loss per common share $(.28) $(.41) $(.51) $(.80)
============== =============== ================ ===============
</TABLE>
6. Financing Transaction
On March 17, 1999, Covol completed a financing transaction (the
"Financing") with OZ Master Fund, Ltd., an affiliate of the Och-Ziff
Capital Management Group. The Financing consisted of the issuance of
$20,000,000 face value of convertible secured debt, issued at a 50%
discount, and the issuance of $6,000,000 of cumulative convertible
preferred stock, for total gross proceeds of $16,000,000. Costs related to
the Financing totaled approximately $1,200,000, and consisted of private
placement fees of $800,000, legal expenses of approximately $350,000 and
other expenses of approximately $50,000. Warrants for the purchase of
common stock were also issued as part of the Financing. Covol received net
cash proceeds of approximately $14,800,000, which are being
12
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
6. Financing Transaction, continued
used to retire maturing short-term debt and related accrued interest of
approximately $4,900,000, for working capital uses and other general
corporate purposes. So long as any debt or preferred stock issued in
connection with this Financing is outstanding, the holders have the right,
as a group, to elect one director to Covol's Board of Directors.
Convertible Secured Note Payable
The convertible secured debt has a five-year term and bears interest at a
stated rate of 2.5% per annum on the $20,000,000 face amount, with interest
payable semiannually on January 1 and July 1, beginning July 1, 1999. After
consideration of the 50% discount and the value assigned to warrants, the
imputed interest rate is approximately 38%. The debt is redeemable by Covol
at any time prior to September 17, 2001 for an amount equal to the face
amount of the debt. The debt is redeemable by Covol from September 18, 2001
and prior to March 17, 2002 for an amount equal to 109.85% of the face
amount of the debt. The debt is convertible into common stock of Covol at
the option of the noteholder at a discount to the market price at the time
of conversion as described below. The debt is not convertible by the holder
until after March 17, 2002 except upon the occurrence of an event of
default. If converted, the number of shares into which the debt can be
converted would be calculated based on a price per share of common stock
equal to 33% of the then market price at the time of conversion, but not
less than $6.67 per share nor more than $10.00 per share. Covol's present
intent is to redeem the debt prior to March 17, 2002, assuming sufficient
cash from operations or future equity or debt financing is available.
A deferred asset was recorded for the portion of financing costs allocated
to the debt. This asset is being amortized over 30 months, the most likely
period of time over which the debt is expected to remain outstanding.
Amortization is computed using the straight-line method. Paid-in capital
was credited for the relative value of the warrants directly related to the
issuance of debt and the warrants allocated to the issuance of debt, as
compared to the total combined fair values of the warrants and debt. A
liability was recorded for $20,000,000, the face value of the debt. Debt
discount was recorded so as to yield a level interest rate on the net
amount of debt outstanding between the issue date and 30 months from the
issue date. Each period, interest expense is recorded consisting of the
total of 1) interest expense based on the stated interest rate and the face
value of the debt; 2) amortization of debt discount; and 3) amortization of
debt issue costs.
Covol will be in default of the provisions of the debt agreement if certain
events occur. These events include, in addition to events commonly
considered defaults, incurring one or more judgments in excess of
$5,000,000, which judgments are not discharged, stayed or otherwise
satisfied within 30 days of the judgments, and the failure to meet certain
earnings targets. The earnings targets apply initially to the quarter
ending December 31, 1999, and then to subsequent quarterly periods.
Consolidated earnings of $5,000,000 or more before interest, taxes,
depreciation, and amortization, and certain other adjustments as defined in
the applicable agreement, are required for the quarter ending December 31,
1999. In subsequent quarters, earnings targets increase incrementally up to
$6,500,000 for the quarter ending December 31, 2001 and subsequent
quarters. There are provisions for the carryover of earnings which exceed
the targets to subsequent quarters, if necessary, subject to certain
limitations. The debt is collateralized by license fees payable to Covol
from the production and sale of synthetic fuel from four synthetic fuel
facilities located in Virginia and West Virginia. The owner of these
facilities has entered into licensing agreements to use Covol's
technologies in return for a royalty based on the production and sale of
synthetic fuel, subject to prescribed adjustments.
In the event of default, the interest rate on the debt increases
immediately by 1% and increases automatically by 1% at the end of each
succeeding 90-day period, to the extent permitted by law, until the event
is cured.
13
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
6. Financing Transaction, continued
Depending on the nature of the event of default, in most instances, either
1) all unpaid principal and interest become immediately due and payable; or
2) the note and accrued interest become immediately convertible into common
stock and the conversion price is subject to adjustment, based on the
market price of Covol's common stock and other factors, as provided for in
the loan agreement.
Redeemable Cumulative Convertible Preferred Stock
The preferred stock consists of 60,000 shares of a new series of preferred
stock, Series D Cumulative Convertible Preferred Stock, with a liquidation
value of $100 per share. This series of preferred stock is senior, with
respect to dividend rights, payments upon liquidation, or redemption, to
all other capital stock of Covol, including the other series of preferred
stock which are outstanding or which may be issued in the future. Dividends
accrue at a rate of 7% per annum whether or not declared or paid. At
Covol's option, dividends can be paid in additional shares of preferred
stock in lieu of cash. Dividends are payable quarterly beginning July 1,
1999. Holders of the preferred stock have voting rights as to all matters
voted on by the holders of common stock and are entitled to one vote for
each share of common stock issuable upon conversion of the preferred stock.
In addition, holders of the preferred stock and debt vote as a group for
one director.
The preferred stock is redeemable at Covol's option through March 17, 2002
at 125% of its liquidation value, subject to adjustment for changes in the
value of Covol's common stock. The preferred stock is redeemable at the
option of the preferred stockholder only upon occurrence of a change in
control. The preferred stock is convertible at the option of the
stockholders beginning June 15, 1999, up to a maximum of 20% of the
outstanding shares of preferred stock. Each month thereafter, the amount of
preferred stock that can be converted increases by 20% until October 13,
1999, at which time all of the preferred stock can be converted into common
stock. On March 17, 2002, all outstanding preferred stock automatically
converts to common stock. The number of shares of common stock into which
the preferred stock is convertible is determined by multiplying the number
of preferred shares by $100 and dividing by the lesser of $5.25 or 90% of
the market value of Covol's common stock on the date of conversion.
The portion of financing costs allocated to the preferred stock were netted
against proceeds. Paid-in capital was credited for the relative value of
the warrants directly related to the issuance of preferred stock and the
warrants allocated to the issuance of preferred stock, as compared to the
total combined fair values of the warrants and preferred stock. Because the
preferred stock can be redeemed by the preferred stock holders (only upon
the occurrence of a change in control), it has been classified outside the
equity section in the balance sheet. Because the conversion price of the
preferred stock was less than the fair market value of Covol's common stock
on the date of issuance, an imputed dividend will affect the earnings per
share calculation as it is amortized over the period from issue date to
date of first conversion.
14
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
6. Financing Transaction, continued
Warrants
Warrants for the purchase of a total of approximately 1,300,000 shares of
common stock were issued in connection with the Financing. The number of
shares issuable upon exercise of the warrants is subject to certain
antidilution provisions including but not limited to the issuance of common
stock at prices below the market price of Covol's common stock. Warrants to
purchase 400,000 shares of common stock are initially exercisable at prices
of $5.00 per share for 200,000 shares and $10.00 per share for 200,000
shares, for the period of time beginning on March 17, 2002 through March
17, 2004, subject to adjustment upon the occurrence of certain events.
Warrants to purchase 883,626 shares of common stock are initially
exercisable at prices ranging from $5.25 to $6.56 per share for the period
of time beginning on September 13, 1999 through March 17, 2002, subject to
adjustment upon the occurrence of certain events.
The warrants issued in this transaction were valued at approximately
$3,000,000 using the Black-Scholes option valuation model. Some warrants
were issued in connection with the convertible debt, some were issued in
connection with the convertible preferred stock and some were issued in
connection with both the debt and equity securities. The value of the
warrants issued in connection with both the debt and equity securities was
allocated between debt and preferred stock on a pro-rata basis, based on
the debt and equity portions of the total financing.
Registration Rights
The restricted common stock issuable pursuant to the conversion of the
convertible secured debt and related interest, convertible preferred stock,
preferred stock dividends, and exercise of approximately 971,000 warrant
shares have been provided demand and piggyback registration rights. The
remaining warrants have been provided piggyback registration rights.
Other Significant Obligations or Restrictions
Terms of the agreements entered into by Covol in connection with the
Financing provide for limits and restrictions common to such financing
arrangements, as well as certain additional specific limitations or
restrictions.
7. Equity Transactions
Technology Acquisition
Effective in November 1998, Covol acquired a coal-based synthetic fuel
technology, and related licensing and patent rights for $128,000 in cash,
60,000 shares of restricted common stock valued at $375,000 and a
commitment to make installment payments ranging from $5,000 to $12,500 per
month for 60 months with interest imputed at 15%. This acquisition
transferred to Covol patent ownership and licensor rights and obligations
to existing license agreements with a company that sublicensed the
technology to a developer of four synthetic fuel facilities. The total cost
of approximately $930,000 is being amortized on a straight-line basis over
approximately nine years.
15
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
7. Equity Transactions, continued
Sale of Series C Convertible Preferred Stock
During January 1999, Covol completed a financing transaction with a
previous stockholder that consisted of the sale of 1,000 shares of a new
series of non-voting preferred stock, designated as Series C 7% Convertible
Preferred Stock. Covol received $900,000 in net proceeds from the issuance
of this preferred stock, which has the following rights and privileges:
o Dividends on the preferred stock are cumulative and accrue whether or
not they have been declared or whether Covol has any profits. The
dividend rate is 7% per year of the liquidation value of $1,000 per
share.
o The preferred stock is convertible into common shares in incremental
stages beginning April 1999 through July 1999, at which time all of
the outstanding shares may be converted to common stock. The number of
common shares to be received upon conversion is determined by
multiplying the number of preferred shares by $1,000 and dividing that
number by the conversion price (currently $5.50 per share, subject to
adjustment). Upon conversion, all accrued and unpaid dividends will be
paid or converted into shares of common stock.
o Covol may at its option redeem the outstanding preferred stock
beginning July 1999 for a redemption price equal to 125% of the
liquidation value plus any accrued and unpaid dividends thereon.
Warrants for the purchase of 72,727 shares of common stock were issued in
conjunction with this preferred stock. These warrants are exercisable from
April 1999 through July 2001 at an exercise price of $6.88 per share,
subject to adjustment. The exercise deadline for certain other warrants
with an exercise price of $7.00 per share held by this stockholder were
extended to June 2000 and certain additional warrants with an exercise
price of $30.00 per share were relinquished and have been cancelled. Covol
granted registration rights for the restricted common shares issuable upon
conversion of the preferred stock or upon exercise of the common stock
warrants.
The new and extended warrants were valued at approximately $500,000.
Issuance costs were netted against proceeds and paid-in capital was
credited for the relative value of the warrants, as compared to the total
combined fair values of the warrants and preferred stock.
Stock Options
During the six months ended March 31, 1999, Covol granted options for the
purchase of a total of 382,000 shares of common stock. Options for the
purchase of 150,000 shares of common stock were granted to three officers
and options for the purchase of 172,000 shares were granted to four
independent directors. Covol also granted options for the purchase of
60,000 shares of common stock to four individuals for services rendered in
connection with the financing of a synthetic fuel facility pursuant to a
consulting arrangement originally entered into in 1997 and revised in
August 1998. These options were assigned a value of approximately $175,000
which is being amortized over the life of the related financing. In
December 1998, three officers exercised options for the purchase of 30,000
shares of common stock, for which Covol received proceeds of $45,000.
16
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
8. Commitments and Contingencies
Commitments and contingencies as of March 31, 1999 not disclosed elsewhere,
are as follows:
Letters of Credit
During fiscal 1998, Covol entered into letter of credit arrangements with a
bank that provide for the issuance of letters of credit totaling up to
$938,000. As of March 31, 1999, there were $698,000 of outstanding letters
of credit. Certificates of deposit totaling $698,000 that are included in
restricted investments in the accompanying balance sheet collateralize
these arrangements.
Legal or Contractual Matters
Included in accrued liabilities at September 30, 1998 and March 31, 1999 is
$755,000 related to construction contracts that contain a "failure to
proceed" liability clause.
In December 1996, Covol entered into indemnification agreements in
connection with construction contracts for certain synthetic fuel
facilities entered into between the construction contractor and independent
third parties. These contracts called for liquidated damages of $750,000
per contract if construction of the facilities were not completed by June
1, 1998. Covol indemnified the contractor for these potential liabilities.
The maximum contingent liability Covol may have had under these
indemnification agreements would have been $2,250,000. The contractor and
the contracting party initiated claims in arbitration against each other
but have settled their claims, including a release of claims against Covol
for liquidated damages.
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,
17
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
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.
In June 1996, Covol formed Alabama Synfuel #1, Ltd. to construct a
synthetic fuel facility. In connection with the construction of this
facility, Covol entered into a supply agreement for coal fines to be used
at the facility, under which Covol was obligated to purchase a minimum of
20,000 tons of coal fines per month through December 2001. Covol assigned
this agreement to the purchaser of the facility and accordingly, has no
ongoing obligation. Covol has been paid for most of the coal fines
purchased but has a dispute with the provider of the coal fines for a
portion of the coal fines Covol paid for. The resolution of this dispute is
not expected to have a material impact on Covol.
In May 1995, Covol entered into an agreement with Geneva Steel Company to
build and operate a commercial briquetting plant. The facility never
reached commercial operating levels and the equipment has been moved from
the Geneva site. Covol intends to use this equipment for the production of
synthetic fuel, for testing purposes, or other potential applications of
Covol's technology.
In December 1996, Covol entered into license agreements with affiliates of
Pace Carbon Fuels, L.L.C. (collectively "Pace") for the use of Covol's
binder technologies at four synthetic fuel manufacturing facilities
developed by Pace. In 1998 Pace requested a reduction in the license fees
payable to Covol under the license agreements. Upon condition of immediate
payment by Pace of advance license fees, Covol agreed to a reduction in
future earned license fees. This reduction was accomplished by a ten-year
loan agreement whereby Covol would loan to Pace up to $750,000 each quarter
beginning in November 1998. This loan will be repaid to Covol at the end of
the ten years only if the Pace projects have accumulated sufficient
prescribed earnings. Revenues from earned license fees will be recognized
by Covol only to the extent that amounts exceed the loan commitment. Pace
has requested three quarterly loans totaling $2,250,000. Covol believes
that its current loan obligation to Pace is limited to the earned license
fees receivable by Covol for the quarters ended September 30, 1998 and
through March 31, 1999, which amounts are estimated at $854,000 in total.
Pace and Covol are renegotiating their license agreements, which
negotiations could result in a reduction and/or deferral of the receipt of
future license royalty payments. Covol expects revised agreements to
replace the ten-year loan arrangements.
In January 1996, a manager of Covol entered property owned by Nevada
Electric Investment Company, a subsidiary of Nevada Power Corporation, in
connection with an offer by Covol to purchase the property, and with
certain other employees of Covol, removed some asbestos over a two-day
period. In May 1996, Covol received a notice of violation and order for
compliance from the State of Utah, Division of Air Quality alleging that
asbestos was improperly handled, removed, and disposed of. Covol complied
with the order and in September 1996 entered into a settlement agreement
with the State of Utah and paid a fine in the amount of $11,000. In late
1997, the U.S. Environmental Protection Agency began its own investigation,
referring the matter to the U.S. Attorney's office which proceeded with a
grand jury inquiry. Covol was served in September 1998 with a grand jury
subpoena for records, with which Covol has complied. Covol does not know
the results of the grand jury inquiry or whether the inquiry is completed.
Covol does not believe that the resolution of this matter will have a
material adverse effect on Covol.
As of September 30, 1998 and December 31, 1998, Covol had recorded
liabilities to The Industrial Company ("TIC") totaling approximately
$735,000. In November 1998, Covol was served with two liens from TIC in
amounts totaling approximately $1,150,000 for construction payments TIC
claimed were due for certain synfuel facilities. Covol increased the
recorded liability to TIC to $945,000 as of March 31, 1999, which amount
was paid in April 1999 for the settlement and release of both liens.
18
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued
(Unaudited)
----------
In September 1996, Covol entered into an agreement with Coalco Corporation
whereby Coalco was to advise Covol with respect to the financing and sale
of certain synthetic fuel manufacturing facilities. To date, Covol has paid
Coalco approximately $347,000 pursuant to the agreement. A dispute has
arisen between Covol and Coalco about services rendered or to be rendered
by Coalco and the amount and timing for payment for such services. There
have been ongoing discussions between Covol and Coalco in an attempt to
resolve their differences. The potential liability to Covol, if any, is not
known. While Covol's management believes the dispute will be resolved and
will not have a significant financial impact, it can give no assurance as
to the ultimate effect on Covol. Pelletco, an affiliate of Coalco, is a
licensee of Covol.
19
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto. Covol has restated its 1999 and 1998 financial statements as described
in Note 1 to the financial statements, Nature of Operations and Basis of
Presentation, Restatements and Reclassifications.
Three Months Ended March 31, 1999 Compared to Three Months Ended March 31, 1998
Revenues. Total revenues for the three months ended March 31, 1999 ("1999")
decreased by $1,028,000 to $1,143,000 as compared to $2,171,000 for the three
months ended March 31, 1998 ("1998"). During 1999, Covol recognized license fees
totaling $546,000 while license fees of $146,000 were recognized during 1998.
The license fees in 1999 consisted of recurring license fees or royalty payments
of $320,000 and the straight-line amortization of one-time non-refundable
advance license fees of $226,000, while the license fees in 1998 consisted
solely of amortization of one-time non-refundable advance license fees from
several licensees. Recurring license fees or royalty payments are due quarterly
based upon synthetic fuel produced and sold as reported to Covol by its
licensees. Advance license fees are normally received when construction of the
related synthetic fuel facility begins, when construction is completed, or when
certain construction milestones or other specified conditions are met but are
recognized on a straight-line basis over the period covered by Covol's license
agreements with licensees. Covol expects to receive additional advance license
fees during 1999 upon the sale of synthetic fuel facilities currently owned by
Covol and upon the achievement of certain production levels at two other
synthetic fuel facilities. Recurring license fees or royalty payments are
expected to increase at a moderate level in the near term with increases
expected in late 1999.
Covol provides binder material to its licensees either at a fixed price or at
Covol's cost plus a contracted markup. Covol purchases binder material under a
long-term contract with a large chemical company. Total binder sales to
non-related parties during 1999 were $423,000, with a corresponding direct cost
to Covol of $274,000, excluding related labor and overhead. In 1998, Covol had
no binder sales to non-related parties. Covol had sales of binder and coal fines
to related parties during 1999 totaling $42,000 compared to $1,989,000 during
1998. These revenues resulted primarily from coal fines that were sold to a
related party under a non-recurring contractual obligation at Covol's cost, as
provided for under the binder and license agreement with this entity.
Covol expects an increase during 1999 of production and sales of synthetic fuel
by its licensees as they improve production capability and establish marketing
agreements for the synthetic fuel produced. This will result in a corresponding
increase in earned license fees or royalty payments and sales of binder
products. However, Covol cannot assure increases in license fees, royalty
payments, and binder sales because Covol's licensees must successfully obtain
adequate feedstock or coal fines, process fines into synthetic fuel, and develop
markets for synthetic fuel. Covol believes that its licensees have made progress
in these areas during the quarter ended March 31, 1999, but significant
improvement is still needed and continued progress and eventual 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
20
<PAGE>
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.
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 $155,000
to $4,223,000 during 1999 from $4,068,000 during 1998. Cost of coal briquetting
operations increased $1,710,000 from $643,000 during 1998 to $2,353,000 during
1999, and cost of binder and coal fines - related parties decreased $1,954,000
from $1,964,000 during 1998 to $10,000 during 1999. During 1999, Covol incurred
significantly higher operating expenses in connection with the continued
refinement and commercialization of the briquetting process in connection with
the 24 facilities placed in service during 1998, and in particular the four
facilities owned by Covol which are currently held for sale. These expenses
primarily related to labor and operating expenses at the four Covol synthetic
fuel facilities and the wash plant located in Utah, losses related to the
write-down of Coaltech inventory, and costs incurred in providing assistance to
Covol's licensees in resolving ramp-up issues at their synthetic fuel
facilities. Covol expects to continue incurring operating losses during 1999
until the four facilities held for sale are sold, even though it expects to
realize a gain from these sales.
Covol operates one of the synthetic fuel facilities for Coaltech, a partnership
for which Covol is the general partner. Under this operating agreement, Covol is
contractually obligated to purchase the synthetic fuel produced by Coaltech at
cost plus $1 per ton. Production of synthetic fuel from this facility during
1999 and 1998 was not significant and accordingly, the cost per ton is well in
excess of the current market value. These costs and the corresponding write-down
of this inventory to its market value are included in the cost of coal
briquetting operations. The write-down was approximately $650,000 during 1999
and $250,000 during 1998. The excess cost per ton should decrease in the
remainder of 1999 as production volumes at the Coaltech facility increase. 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.
Asset Impairment Charge. In May 1995, Covol entered into an agreement with
Geneva Steel Company to build and operate a commercial briquetting facility. The
facility never reached commercial operating levels, but was held for other uses,
including potential relocation to another site for use in the production of
synthetic fuel or in other applications. In February 1999, Geneva filed a
voluntary petition for relief under Chapter 11 of the United States Bankruptcy
Code due to a lack of sufficient liquidity. Primarily as a result of this event,
Covol moved a substantial portion of the equipment comprising the facility from
the Geneva site to another location where it is being used in a different
application of Covol's technology. Certain assets at the Geneva site, primarily
consisting of leasehold improvements on the property where the facility was
located, were abandoned. The carrying value of these assets, totaling
approximately $556,000, was written off during 1999.
Selling, general and administrative expenses increased $83,000 or 7% to
$1,233,000 during 1999 from $1,150,000 for 1998. Except for amortization of
intangible assets in 1999 and commissions in 1998, the largest components of
selling, general and administrative expenses for 1999 and 1998 were payroll,
professional services, and travel expenses. Payroll costs increased
approximately $115,000 from 1998 to 1999 due to increased headcount.
Amortization of intangible assets increased approximately $96,000 related to the
late 1998 exchange of common stock of Covol for limited partnership interests.
Commission expense decreased $250,000 due to a nonrecurring commission in 1998
related to a licensee relationship. Changes in the other categories from year to
year were not material.
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Research and development costs increased $118,000 to $190,000 from 1998 to 1999
primarily because Covol has focused additional resources on further refinement
of its binder technologies relative to the synthetic fuel industry and to a
lesser extent as a result of the application of its binder technologies into
other areas.
Compensation expense from stock options, stock warrants, and issuance of common
stock decreased $76,000 to $163,000 for 1999 from $239,000 for 1998. This
expense relates to options granted in prior periods that vest over several years
and the compensation value that is being recognized as an expense over the
vesting period. This amount is expected to remain relatively level for the
remainder of 1999.
Other Income and Expense. During 1999, Covol had net other expenses of
$1,421,000 compared to $664,000 for 1998. This increase of $757,000 relates
primarily to a change between periods of $448,000 in the mark-to-market
adjustment of the carrying value of the related party note receivable
collateralized by common stock, an increase in interest expense of $197,000; and
a loss on disposition of equipment in 1999 of $103,000.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note"). The Note is "marked to
market" each quarter based upon the market value of Covol's common stock and is
reflected in the balance sheet at the underlying value of the collateral. This
adjustment resulted in a write-down of $178,000 during 1999, compared to a
write-up of $270,000 during 1998 for a net change of $448,000. As of March 31,
1999, the Note had a carrying value of $860,000.
Interest expense in 1998 of $1,180,000 consisted primarily of expense based upon
the issuance of convertible debt and warrants at a discount. Interest expense of
$1,377,000 in 1999 consisted of interest accrued on notes payable used to
finance the construction of synthetic fuel facilities held for sale and for
operating needs and includes only $121,000 of amortization of debt discount.
Interest expense is expected to increase by approximately $900,000 per quarter
as a result of the debt issued in March 1999, which increase will be offset by
reduced interest as a result of any future repayments of debt related to
facilities held for sale.
Net loss. For 1999, the net loss of $5,057,000 represented a change of
$2,496,000 from the net loss of $2,561,000 reported for 1998. This is primarily
due to the increase in cost of briquetting operations. Covol did not recognize
any income tax benefit in 1999 or 1998 since the realization of its deferred tax
asset of approximately $14,000,000, consisting primarily of net operating loss
carryforwards, is dependent on generation of future taxable income.
Six Months Ended March 31, 1999 Compared to Six Months Ended March 31, 1998
Revenues. Total revenues for the six months ended March 31, 1999 ("1999")
increased by $257,000 to $2,525,000 as compared to $2,268,000 for the six months
ended March 31, 1998 ("1998"). During 1999, Covol recognized license fees
totaling $1,247,000 while license fees of $202,000 were recognized during 1998.
The license fees in 1999 consisted of recurring license fees or royalty payments
of $794,000 and the straight-line amortization of one-time non-refundable
advance license fees of $453,000, while the license fees in 1998 consisted
solely of amortization of one-time non-refundable advance license fees from
several licensees.
Total binder sales to non-related parties during 1999 were $956,000, with a
corresponding direct cost to Covol of $650,000. In 1998, Covol had no binder
sales to non-related parties. Covol had sales of binder and coal fines to
related parties during 1999 totaling $183,000 compared to $1,996,000 during
1998. These revenues resulted primarily from coal fines that were sold to a
related party under a non-recurring contractual obligation at Covol's cost as
provided for under the binder and license agreement with this entity.
Operating Costs and Expenses. Operating costs and expenses increased by
$3,706,000 to $9,336,000 during 1999 from $5,630,000 during 1998. Cost of coal
briquetting operations increased $4,728,000 from $1,093,000 during 1998 to
$5,821,000 during 1999, and cost of binder and coal fines - related parties
decreased $1,937,000 from $1,972,000 during 1998 to $35,000 during 1999. During
1999, Covol incurred significantly higher operating expenses in connection with
the continued refinement and commercialization of the briquetting process in
connection with the 24 facilities placed in service during 1998, and in
particular the operating costs of the four facilities owned by Covol which are
currently held for sale. These expenses primarily related to labor and operating
expenses at the four Covol synthetic fuel facilities and the wash plant located
in Utah, losses related to
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the writedown of Coaltech inventory, and costs incurred in providing assistance
to Covol's licensees in resolving ramp-up issues at their synthetic fuel
facilities.
Covol is contractually obligated to purchase the synthetic fuel produced by
Coaltech at cost plus $1 per ton. Production of synthetic fuel from this
facility during 1999 and 1998 was not significant and accordingly, the cost per
ton is well in excess of the current market value. These costs and the
corresponding write-down of this inventory to its market value are included in
the cost of coal briquetting operations. The write-down was approximately
$1,800,000 during 1999 and $500,000 during 1998. The excess cost per ton should
decrease as 1999 production volumes at the Coaltech facility increase.
Asset Impairment Charge. In May 1995, Covol entered into an agreement with
Geneva Steel Company to build and operate a commercial briquetting facility. The
facility never reached commercial operating levels, but was held for other uses,
including potential relocation to another site for use in the production of
synthetic fuel or in other applications. In February 1999, Geneva filed a
voluntary petition for relief under Chapter 11 of the United States Bankruptcy
Code due to a lack of sufficient liquidity. Primarily as a result of this event,
Covol moved a substantial portion of the equipment comprising the facility from
the Geneva site to another location where it is being used in a different
application of Covol's technology. Certain assets at the Geneva site, primarily
consisting of leasehold improvements on the property where the facility was
located, were abandoned. The carrying value of these assets, totaling
approximately $556,000, was written off during 1999.
Selling, general and administrative expenses increased $271,000 or 14% to
$2,162,000 during 1999 from $1,891,000 for 1998. Except for amortization of
intangible assets during 1999 and commissions in 1998, the largest components of
selling, general and administrative expenses for 1999 and 1998 were payroll,
professional services, and travel expenses. Payroll costs and professional
services each increased approximately $150,000 from 1998 to 1999 due to
increased headcount and higher legal costs, respectively. Amortization of
intangible assets increased approximately $192,000 related to the 1998 exchange
of common stock of Covol for limited partnership interests. Commission expense
decreased approximately $305,000 due primarily to a nonrecurring commission in
1998 related to a licensee relationship. Changes in the other categories from
year to year were not material.
Research and development costs increased $115,000 to $343,000 from 1998 to 1999
primarily because Covol has focused additional resources on further refinement
of its binder technologies relative to the synthetic fuel industry and to a
lesser extent as a result of the application of its binder technologies into
other areas.
Compensation expense from stock options, stock warrants, and issuance of common
stock decreased $121,000 to $325,000 for 1999 from $446,000 for 1998. This
expense relates to options granted in prior periods that vest over several years
and the compensation value that is being recognized as an expense over the
vesting period. This amount is expected to remain relatively level for the
remainder of 1999.
Other Income and Expense. During 1999, Covol had net other expenses of
$2,248,000 compared to $1,344,000 for 1998. This increase of $904,000 relates
primarily to a change between periods of $1,312,000 in the mark-to-market
adjustment of the carrying value of the related party note receivable
collateralized by common stock, partially offset by an increase in interest
income of $850,000. Also contributing to the net increase in other expenses was
an increase in interest expense of $121,000, a decrease in minority interest in
losses of consolidated subsidiaries of $138,000, and a loss on disposition of
equipment in 1999 of $103,000.
During 1996, Covol sold certain construction companies and received as
consideration a $5,000,000 note receivable ("Note"). The Note is "marked to
market" each quarter based upon the market value of Covol's common stock and is
reflected in the balance sheet at the underlying value of the collateral. This
adjustment resulted in a write-down of $749,000 during 1999, compared to a
write-up of $563,000 during 1998 for a net change of $1,312,000. A $515,000
payment on the Note was due in January 1999, of which $225,000 has been
received. The balance of the January payment is expected to be received in the
quarter ending June 30, 1999. Included in interest income for 1999 is $515,000
related to this Note.
Interest expense in 1998 of $2,292,000 consisted primarily of expense based upon
the issuance of convertible debt and warrants at a discount. Interest expense of
$2,413,000 in 1999 consisted of interest accrued on notes payable
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used to finance the construction of synthetic fuel facilities held for sale and
for operating needs and includes only $203,000 of amortization of debt discount.
Interest expense is expected to increase by approximately $900,000 per quarter
as a result of the debt issued in March 1999, which increase will be offset by
reduced interest as a result of any future repayments of debt related to
facilities held for sale.
During September 1998, Covol offered the limited partners of Utah Synfuel #1 and
Alabama Synfuel #1 common stock of Covol in exchange for their limited
partnership interests. These exchanges, most of which were accounted for in
September 1998, were substantially completed by November 1998, at which time
Utah Synfuel #1 became a wholly-owned subsidiary of Covol and Alabama Synfuel #1
became a 98%-owned subsidiary of Covol. As a result of these exchanges, minority
interest in the losses of consolidated subsidiaries decreased from approximately
$138,000 in 1998 to approximately $0 in 1999. Covol believes the combined
operations of these partnerships will result in operating losses in the
near-term future, which losses will be included in Covol's statement of
operations.
Net loss. For 1999, the net loss increased $4,909,000 from $4,706,000 to
$9,615,000. The increase is primarily due to the increase in cost of briquetting
operations. Covol did not recognize any income tax benefit in 1999 or 1998 since
the realization of its deferred tax asset, consisting primarily of net operating
loss carryforwards, depends on generation of future taxable income.
Liquidity and Capital Resources
Liquidity. During the fiscal year 1998, Covol and its licensees completed the
construction of and began operations at 24 synthetic fuel facilities. Covol
currently owns four facilities which it constructed and which are 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.
Operating expenses associated with the owned facilities currently cost
approximately $600,000 per month.
Net cash used in operating activities for the six months ended March 31, 1999
("1999") was $9,852,000. During the six months ended March 31, 1998 ("1998"),
net cash of $157,000 was used in operations. Much of this change in cash flow
from operations is attributable to the increase in net loss from $4,706,000 in
1998 to $9,615,000 in 1999. Covol was able to fund its operating activities,
including the continued refinement and commercialization of its patented binder
technologies, through the incurrence of debt and the issuance of convertible
preferred stock, common stock and common stock warrants. During 1999, proceeds
from the issuance of notes payable totaled approximately $10,498,000, proceeds
from the issuance of preferred stock totaled $6,394,000 and proceeds from the
issuance of common stock totaled $3,774,000.
Capital Resources. During 1999, Covol's investing activities were not
significant. Investing activities in 1998 consisted primarily of the purchase of
property, plant and equipment and the four facilities held for resale, with most
of the funds for these activities coming from the issuance of notes payable
($16,338,000) and from working capital. Covol believes that funds required for
investing activities will continue to be significantly lower during 1999 as
compared to 1998 because the construction of facilities that produce synthetic
fuel that qualifies for federal income tax credits under Section 29 of the IRC
were completed during fiscal 1998. In order to receive tax credits under IRC
Section 29, the synthetic fuel sold must be produced at facilities placed in
service by June 30, 1998.
Covol's long term existence depends on the ability of Covol's licensees to
produce and sell synthetic fuel which will generate license fees to Covol. There
are 24 synthetic fuel plants that utilize Covol's patented technology and from
which Covol intends to earn license fees. These facilities do not presently
operate at levels needed to generate significant revenues to Covol. Improved
operations at each of these plants depend on the ability of the plant owner to
produce synthetic fuel that meets market specifications in order for the plant
owner to market the synthetic fuel. Covol is assisting the plant owners in their
efforts to overcome production and marketing problems.
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Covol anticipates that earned license fees or royalties from the production and
sale of synthetic fuel will continue to increase during 1999. As production
levels increase, sales of the binder materials by Covol to its licensees are
expected to increase proportionately. Funds received by Covol from these
activities are not expected to be sufficient to cover Covol's operating costs
and expenses until late 1999. Any extended delay in the sale of facilities held
for sale may require Covol to seek additional debt or equity financing.
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 until
late 1999, Covol expects to utilize existing working capital and excess proceeds
from the sale of facilities. During November 1998, Covol issued common stock and
common stock warrants for total net proceeds of approximately $3,729,000. During
January 1999, Covol issued convertible preferred stock and warrants for total
net proceeds of approximately $900,000. During March 1999, Covol issued
convertible secured debt, convertible redeemable preferred stock and common
stock warrants for total net proceeds of approximately $14,800,000. Covol
believes current working capital, excess proceeds from the sale of facilities,
payments for license fees and binder sales, and funds raised in additional
financings, if necessary, will be sufficient to fund Covol's operations until
its operating activities begin producing positive cash flow. The ability of
Covol to pay its debt as it matures is dependent primarily upon Covol's ability
to sell the facilities which are held for sale. Covol believes the sale of
facilities or extensions of existing debt repayment terms will enable it to meet
these debt requirements.
Covol has agreed to certain covenants contained in the recently completed
financing documents. One covenant requires Covol to meet certain earnings
targets for the quarter ending December 31, 1999 and for subsequent quarters.
Consolidated earnings before interest, taxes, depreciation and amortization
(EBITDA) and certain other adjustments, of $5,000,000 is required for the
quarter ending December 31, 1999. The EBITDA target increases in subsequent
quarters. Covol's current operations are at levels below this requirement. It is
not known whether or not Covol will be able to comply with this provision;
however, there are currently no known operational trends or events that would
currently make non-compliance probable. Non-compliance with this provision would
result in an increase in the debt coupon rate by one percentage point
immediately and each 90 days thereafter until cured. Also, the debt becomes
immediately convertible. Upon the second event of non-compliance with this
provision, Covol is required to deposit approximately $3,000,000 into an escrow
account. Failure to make payments into the escrow account results in royalty
payments from the related collateral being made directly to the debt holders.
Operation of the synthetic fuel facilities at or near capacity should result in
EBITDA at levels in excess of this requirement. There are other provisions and
covenants in these loan documents that will restrict or prohibit certain
activities.
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Covol May Be Adversely Affected By Year 2000 Non-Compliance of Computer
Applications
The Year 2000 issue is the result of computer programs being written to define
the applicable year using two digits rather than four digits. Thus, programs
that are date sensitive may recognize a date using "00" as the year 1900 rather
than 2000. This could result in a systems failure or miscalculations causing
disruptions of operations including a temporary inability to engage in normal
business activities. This systems issue creates risk for Covol from unforseen
problems in its own computer systems and electronic equipment and from third
parties with which Covol conducts business. Such failures of Covol's and third
parties' computer systems could potentially have a material adverse impact on
Covol's business and results of operations. While the risks discussed in this
section have a possible material impact, management believes the actions and
contingency plans that are being developed and implemented will significantly
reduce the probability and potential impact of these identified risks.
The information systems and electronic equipment utilized in Covol's business
include a computer network system utilized for intra-company communication and
Internet access and an accounting software package utilized for billing,
procurement, payroll and accounting. Non-information technology electronic
equipment includes programmable logic controllers, micro-controllers,
specialized software packages for operations activities and miscellaneous
systems for lab equipment.
As a part of the information technology systems mentioned above, Covol's
computer network system was upgraded in 1998 with year 2000 compliant equipment.
The provider of the accounting software has indicated that this software package
is not currently compliant but can be upgraded at nominal cost. This work will
be undertaken during the third quarter of fiscal 1999 and tested prior to the
close of the fiscal year.
All of the synthetic fuel facilities constructed by Covol and its licensees were
completed and placed in service between December 1996 and June 30, 1998, with
the majority being completed during 1998. As such, the electronic equipment
utilized in the facilities is of recent vintage (within 18 months of the June 30
date) and is year 2000 compliant. Suppliers of the major electronic equipment
for Covol's four owned synthetic fuel facilities have notified Covol that their
equipment is compliant. This includes critical programmable logic controllers,
micro-controllers and software operating packages.
Licensees utilize proprietary technology provided by Covol including flow sheets
and equipment recommended by Covol in the construction of their facilities.
These licensees have represented to Covol that equipment within these facilities
is compliant or that operations will not be impacted in the event of an
equipment failure due to the Year 2000 issue. Malfunctions occurring in the
synthetic fuel operations could potentially have an adverse material effect to
Covol by reducing the sale of binder formulation materials to the facilities by
Covol and the collection by Covol of royalties on the production of synthetic
fuel.
Covol's relationships with its third-party suppliers and transportation
providers is critical to the operation of the synthetic fuel facilities. Covol
is also dependent upon its customers who purchase and consume the synthetic fuel
produced. Covol's suppliers have represented to Covol that their computer
systems and equipment are year 2000 compliant.
The most reasonably likely worst case scenarios would be the extended inability
of major suppliers to deliver binder formulation materials and other bulk
materials required for the operation of the synthetic fuel facilities and the
failure of customers to be able to receive synthetic fuel production due to
unforseen shutdown due to non-compliant equipment.
As a contingency plan for the reasonably likely worst case events, Covol intends
to stock up on bulk materials in the last half of the fourth quarter of 1999 so
that operations can continue for several days into the new year without
interruption. Covol has designed its facilities to accommodate bulk deliveries.
Electrical power suppliers have notified Covol that power interruptions are not
anticipated but that additional crews will be on hand to respond to problems as
they may occur at the change to the new year. Covol and its licensees are also
prepared to bypass automated controls and operate facility systems manually if
the automated control systems fail. As supply contracts are written for
operating materials, Covol is striving to negotiate terms such that year 2000
issues are not an excuse for non-performance.
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Costs attributable to Year 2000 issues are expected to be minimal. The only cost
anticipated to date is for the upgrade to Covol's accounting software package.
This cost is estimated to be less than $5,000. Costs associated with increased
levels of bulk materials simply redistributes normal operating costs but does
not affect the ultimate financial performance of Covol.
Covol plans to continue to monitor the Year 2000 issue throughout the remainder
of 1999. Should this monitoring reveal other developments, whether they be
internal or third party, or identify additional electronic equipment and
software that may be at risk, Covol will assess the situation and take
appropriate action. There can be no assurance that Covol will discover all Year
2000 issues in the course of the remainder of 1999 or that Covol will be able to
remedy any or all discoveries in a timely or cost effective manner such that the
Year 2000 issues will not have a material adverse impact on Covol's business,
financial condition and results of operations.
Forward Looking Statements
Statements in this Item 2 regarding Covol's expectations that relate to future
plans, financial results or performance and other information presented herein
that are not purely historical in 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 but are not limited to: Covol's ability to sell company-owned
synthetic fuel facilities, the ability of Covol to conserve its capital through
cost reductions until operating revenues exceed expenses, favorable IRS tax
treatment, the ability of Covol to complete specific research and development
projects, commercial viability of technologies, the availability of natural
resources and suitable raw materials, ability of Covol's licensees to achieve
expected production levels at the synthetic fuel and engineered resource
facilities, ability to market synthetic fuel and engineered resources produced,
market penetration by competing technologies, the ability of Covol to meet
performance criteria required in financing agreements, and the ability of Covol
to continue to find suitable partners and licensees.
See "ITEM 1. BUSINESS--Forward Looking Statements" in Covol's Annual Report on
Form 10-K for the year ended September 30, 1998 for a description of additional
factors which could cause actual results to differ from expectations.
Other Items
Covol has reviewed all recently issued, but not yet adopted, accounting
standards in order to determine their effects, if any, on the results of
operations or financial position of Covol. Based on that review, Covol believes
that none of these pronouncements will have any significant effects on current
or future financial position or results of operations.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Asbestos Investigation. In January 1996, a manager of Covol entered property
owned by Nevada Electric Investment Company, a subsidiary of Nevada Power
Corporation, in connection with an offer by Covol to purchase the property, and
with certain other employees of Covol, removed some asbestos over a two-day
period. In May 1996, Covol received a notice of violation and order for
compliance from the State of Utah, Division of Air Quality alleging that
asbestos was improperly handled, removed, and disposed of. Covol complied with
the order and in September 1996 entered into a settlement agreement with the
State of Utah and paid a fine in the amount of $11,000. In late 1997, the U.S.
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
27
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the results of the grand jury inquiry or whether the inquiry is completed. Covol
does not believe that the resolution of this matter will have a material adverse
effect on Covol.
Indemnification to Centerline. In December 1996, Covol entered into six
indemnification agreements with Centerline whereby Covol agreed to indemnify
Centerline should it be required to pay liquidated damages to PacifiCorp under
various design and construction agreements for six synthetic fuel facilities.
Under the original terms of the various design and construction agreements, if
the facilities were not completed by June 1, 1998 then $750,000 in liquidated
damages for each facility would be due and payable by Centerline. The
indemnification agreement only applied if PacifiCorp actually decided to build
the facilities with Centerline as the design/builder. PacifiCorp elected to not
build three of the projects, and therefore the indemnity agreement with respect
to those facilities no longer applies. Accordingly, the maximum amount of
contingent liability to Covol under the indemnification agreements was
$2,250,000 ($750,000 per design and construction agreement). Centerline and
PacifiCorp initiated claims in arbitration against each other but have settled
their claims, including a release of claims against Covol for liquidated
damages.
ITEM 2. CHANGES IN SECURITIES
Recent Sales of Unregistered Securities
The following sets forth all securities issued by Covol within the past fiscal
quarter without registering the securities under the Securities Act of 1933, as
amended. No underwriters were involved in any stock issuances.
The issuance of qualified options is required to be based on market value.
Accordingly, the exercise price is set based on the market price of Covol's
common stock, even though the options convert into restricted stock.
Covol believes that the following issuances of shares of common stock or
securities for contingently issuable common stock were exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
the exemption set forth in Section 4(2) or 4(6) thereof or Regulation D
promulgated thereunder and the certificate for each security bears a restrictive
legend. Each investor made representations to Covol that it was accredited as
that term is defined in Regulation D and that the security was acquired for
investment purposes.
In January 1999, Covol issued to four accredited investors, pursuant to a
consulting compensation agreement dated August 1998, options to purchase an
aggregate of 60,000 shares of Covol common stock, at an exercise price of $12.75
per share. The exercise price will be reduced to $8.58 per share if a consulting
fee is not paid to the accredited investors as set forth in the consulting
compensation agreement. The options are nontransferable and include piggy-back
registration rights, which may be exercised two times. The options are
exercisable until August 2003, after which any unexercised options will expire.
Reference is made to the sale of series C convertible preferred stock and common
stock warrants described in Note 7 to the consolidated financial statements and
to the sale of series D redeemable cumulative convertible preferred stock and
common stock warrants described in Note 6 to the consolidated financial
statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
An annual meeting of stockholders of Covol was held on March 17, 1999 for the
following purposes:
1. To elect three class II directors of Covol to serve until the 2002
annual meeting of stockholders, or until their successors are duly
elected and qualified;
2. To ratify a grant by the Board of options to purchase 250,000 shares
of common stock to Brent M. Cook at $12.97 per share to vest pro rata
over 60 months beginning on May 1, 1998;
3. To ratify the selection by the Board of PricewaterhouseCoopers LLP
as independent auditors of Covol for the fiscal year ending September
30, 1999.
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A total of 8,648,365 shares were voted. The results of voting on these matters
were as follows:
1. Mr. Raymond J. Weller as a class II director: for - 8,179,645;
withheld authority - 468,720.
Mr. DeLance W. Squire as a class II director: for - 8,098,345;
withheld authority - 550,020.
Mr. Kirk A. Benson as a class II director: for - 8,472,274; withheld
authority 176,091.
2. To approve the 250,000 share option grant to Mr. Cook: for -
7,855,106, against - 434,199; abstain -- 359,060.
3. To ratify the selection of PricewaterhouseCoopers LLP as auditors for
fiscal 1999: for - 8,334,938; against - 5,915, abstain - 307,512.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
27.1 Restated Financial Data Schedule
(b) A report on Form 8-K was filed on March 24, 1999.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COVOL TECHNOLOGIES, INC.
Date: October 6, 1999 By: /s/ Kirk A. Benson
----------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: October 6, 1999 By: /s/ Steven G. Stewart
----------------------------------------
Steven G. Stewart, Chief Financial
Officer and Principal Financial Officer
30
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE SIX MONTHS ENDED MARCH 31,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> MAR-31-1999
<CASH> 6,879
<SECURITIES> 0
<RECEIVABLES> 4,413
<ALLOWANCES> 0
<INVENTORY> 2,039
<CURRENT-ASSETS> 42,857
<PP&E> 16,314
<DEPRECIATION> 2,231
<TOTAL-ASSETS> 76,880
<CURRENT-LIABILITIES> 23,878
<BONDS> 25,681
0
1
<COMMON> 12
<OTHER-SE> 14,513
<TOTAL-LIABILITY-AND-EQUITY> 76,880
<SALES> 1,139
<TOTAL-REVENUES> 2,525
<CGS> 6,506
<TOTAL-COSTS> 6,506
<OTHER-EXPENSES> 1,224
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,413
<INCOME-PRETAX> (9,615)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,615)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,615)
<EPS-BASIC> (0.80)
<EPS-DILUTED> (0.80)
</TABLE>
