UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended June 30, 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 0-27808
COVOL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 87-0547337
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3280 North Frontage Road
Lehi, Utah 84043
(Address of principal executive offices) (Zip Code)
(801) 768-4481
(Registrant's telephone number, including area code)
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 August
9, 1999 was 12,722,492.
<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 June 30, 1999............................................ 3
Consolidated Statements of Operations - For the three
months ended June 30, 1998 and 1999 and the nine months
ended June 30, 1998 and 1999................................. 5
Consolidated Statement of Changes in Stockholders' Equity -
For the nine months ended June 30, 1999...................... 6
Consolidated Statements of Cash Flows - For the nine
months ended June 30, 1998 and 1999.......................... 7
Notes to Consolidated Financial Statements..................... 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...................................... 16
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.............................................. 24
ITEM 2. CHANGES IN SECURITIES.......................................... 24
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................ 25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 25
ITEM 5. OTHER INFORMATION.............................................. 25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................... 25
SIGNATURES.................................................................. 26
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 PART I, 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
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<CAPTION>
ITEM 1. CONSOLIDATED FINANCIAL INFORMATION (Unaudited)
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, June 30,
(thousands of dollars) 1998 1999
- ------------------------------------------------------------------------------------------- ---------------- -----------------
ASSETS
Current assets:
<S> <C> <C>
Cash and cash equivalents $ 727 $ 1,932
Receivables 2,879 2,200
Due from related party 1,012 2,271
Inventories 1,645 1,683
Advances on inventories, current 2,522 935
Facilities held for sale 28,405 28,542
Prepaid expenses and other current assets 682 439
---------------- -----------------
Total current assets 37,872 38,002
---------------- -----------------
Property, plant and equipment, net of accumulated depreciation 14,986 14,402
---------------- -----------------
Other assets:
Restricted investments 748 717
Advances on inventories, non-current -- 2,742
Facility-dependent notes and accrued interest receivable 7,646 8,054
Facility transferred under note receivable arrangement 3,166 2,774
Intangible assets, net of accumulated amortization 3,118 3,875
Deposits and other assets 525 1,809
---------------- -----------------
Total other assets 15,203 19,971
---------------- -----------------
Total assets $ 68,061 $ 72,375
================ =================
</TABLE>
(continued)
The accompanying notes are an integral
part of the consolidated financial statements
3
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<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, continued
(Unaudited)
September 30, June 30,
(thousands of dollars and shares) 1998 1999
- -------------------------------------------------------------------------------------------- --------------- ----------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
<S> <C> <C>
Accounts payable $ 3,036 $ 1,265
Due to related party 1,609 2,377
Accrued liabilities 2,858 3,023
Notes payable, current 22,049 20,359
---------------- -----------------
Total current liabilities 29,552 27,024
---------------- -----------------
Long-term liabilities:
Notes payable, non-current 13,930 22,695
Accrued interest payable, non-current 566 255
Notes and accrued interest payable - related parties, non-current 147 --
Deferred revenues from advance license fee 1,155 1,050
Deferred compensation 236 205
---------------- -----------------
Total long-term liabilities 16,034 24,205
---------------- -----------------
Total liabilities 45,586 51,229
---------------- -----------------
Minority interest in consolidated subsidiaries 507 109
---------------- -----------------
Commitments and contingencies (Note 6)
Redeemable convertible preferred stock, $.001 par value, issued and outstanding
0 shares at September 30, 1998 and 60 shares at June 30, 1999 (aggregate
liquidation preference of $7,623 at June 30, 1999) -- 4,332
---------------- -----------------
Stockholders' equity:
Convertible preferred stock, $0.001 par value; authorized 10,000 shares,
issued and outstanding 316 shares at September 30, 1998 and 18 shares at
June 30, 1999 (aggregate liquidation preference of $4,170 at June 30, 1999) 1 1
Common stock, $0.001 par value; authorized 25,000 shares, issued and outstanding
11,272 shares at September 30, 1998 and 12,586 shares at June 30, 1999 11 12
Capital in excess of par value 69,284 78,091
Accumulated deficit (35,780) (51,674)
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) (2,701)
---------------- -----------------
Total stockholders' equity 21,968 16,705
---------------- -----------------
Total liabilities and stockholders' equity $ 68,061 $ 72,375
================ ================
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
4
<PAGE>
<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30, Nine Months Ended June 30,
(thousands of dollars, except per-share amounts) 1998 1999 1998 1999
- -------------------------------------------------------------- ---------------- ---------------- ---------------- ---------------
Revenues:
<S> <C> <C> <C> <C>
License fees $ 3,185 $ 661 $ 7,841 $ 1,565
Synthetic fuel sales -- 242 5 242
Binder sales -- 409 -- 1,365
Binder and coal fine sales - related party 1,248 50 3,243 233
Binder plant sales 1,298 -- 1,298 --
Other 4 23 70 122
---------------- ---------------- ---------------- ---------------
Total revenues 5,735 1,385 12,457 3,527
---------------- ---------------- ---------------- ---------------
Operating costs and expenses:
Cost of coal briquetting operations 1,409 2,866 2,457 8,687
Cost of binder -- 291 -- 941
Cost of binder and coal fines - related party 1,056 7 3,073 42
Cost of binder plants 1,095 -- 1,095 --
Asset impairment charge -- 556 -- 556
Selling, general and administrative 1,111 1,338 3,003 3,500
Research and development 81 154 309 497
Compensation expense from stock options, stock
warrants and issuance of common stock 286 749 732 1,074
---------------- ---------------- ---------------- ---------------
Total operating costs and expenses 5,038 5,961 10,669 15,297
---------------- ---------------- ---------------- ---------------
Operating income (loss) 697 (4,576) 1,788 (11,770)
---------------- ---------------- ---------------- ---------------
Other income (expense):
Interest income 224 308 363 1,298
Interest expense -- (1,981) (2,292) (4,394)
Minority interest in net losses of consolidated
subsidiaries 183 -- 321 --
Write-up (write-down) of notes receivable - related
parties, collateralized by common stock 532 -- 1,095 (749)
Other (38) (26) 71 (102)
---------------- ---------------- ---------------- ---------------
Total other income (expense) 901 (1,699) (442) (3,947)
---------------- ---------------- ---------------- ---------------
Net income (loss) $ 1,598 $ (6,275) $ 1,346 $ (15,717)
================ ================ ================ ===============
Basic income (loss) per common share $ .15 $ (.54) $ .11 $ (1.33)
================ ================ ================ ===============
Diluted income (loss) per common share $ .12 $ (.54) $ .09 $ (1.33)
================ ================ ================ ===============
</TABLE>
The accompanying notes are an integral
part of the consolidated financial statements
5
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<TABLE>
<CAPTION>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
For the Nine Months Ended June 30, 1999
(Unaudited)
Notes and
interest
receivable
-related
parties, from
Convertible Preferred Common Stock issuance of,
Stock or collater- Deferred
----------------------------------------------- alized 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 $(35,780) $(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 (299) -- 422 -- 177 (177)
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 2,435
Value of common
stock warrants
issued in connection
with extension of
note payable due date -- -- 206
Write-down of
notes receivable -
related parties 749
Amortization of
deferred compensation
from stock options 1,074
Net loss for the
nine months ended
June 30, 1999 (15,717)
--------------------------------------------------------------------------------------------------------------
Balances at
June 30, 1999 18 $1 12,586 $12 $78,091 $(51,674) $(7,024) $(2,701)
==============================================================================================================
</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)
Nine Months Ended June 30,
(thousands of dollars) 1998 1999
- ------------------------------------------------------------------------------------------------- -------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,346 $ (15,717)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization 256 1,432
Write-down (write-up) of notes receivable - related parties (1,095) 749
Interest expense related to amortization of debt discount and debt issuance costs 2,266 1,160
Amortization of deferred compensation from stock options 732 1,074
Minority interest in net losses of consolidated subsidiaries (321) --
Loss (gain) on disposition of equipment (26) 153
Asset impairment charge -- 556
Decrease from changes in assets and liabilities, net of effects from investing
and financing activities (4,277) (3,795)
-------------- -------------
Net cash used in operating activities (1,119) (14,388)
-------------- -------------
Cash flows from investing activities:
Purchase of property, plant and equipment and facilities held for sale (33,716) (685)
Proceeds from sale of equipment -- 170
Purchase of rights to technology -- (127)
Issuance of notes receivable (1,257) --
Proceeds from facility transferred under note receivable arrangement 288 392
Deposits collateralizing letters of credit (588) --
Proceeds from decrease in restricted investment -- 50
-------------- -------------
Net cash used in investing activities (35,273) (200)
-------------- -------------
Cash flows from financing activities:
Proceeds from issuance of notes payable and warrants 32,570 10,453
Payments on notes payable (6) (4,655)
Payments on notes payable - related parties (342) (147)
Proceeds from issuance of preferred stock and warrants, net 90 6,367
Proceeds from issuance of common stock, net 1,761 3,775
Proceeds from receivable - stock subscriptions 577 --
Proceeds from notes receivable - related parties, collateralized by common stock 314 --
-------------- -------------
Net cash provided by financing activities 34,964 15,793
-------------- -------------
Net increase (decrease) in cash and cash equivalents (1,428) 1,205
Total cash and cash equivalents, beginning of period 4,780 727
-------------- -------------
Total cash and cash equivalents, end of period $ 3,352 $ 1,932
============== =============
Supplemental schedule of non-cash investing and financing activities:
Common stock issued to purchase minority interests in subsidiaries $ -- $ 519
Common stock issued on conversion of preferred stock and undeclared dividends -- 2,444
Common stock issued for rights to technology -- 375
Notes payable issued for rights to technology -- 426
Property, plant and equipment acquired through reduction of accounts receivable -- 413
Notes payable issued for equipment 702 424
Common stock issued on conversion of notes payable and related accrued interest 8,179 --
Common stock issued for notes receivable - related parties 45 --
Notes receivable issued for sale of synthetic fuel facility 6,500 --
Notes payable and accrued interest that were refinanced 2,040 --
Preferred stock dividends not accrued or paid 233 284
</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 entities that
constructed facilities that convert coal fines into synthetic fuel
briquettes. At June 30, 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 past
nine months. Covol is actively seeking to sell its four owned facilities.
Although there can be no assurance that the facilities will be sold, Covol
has entered into a non-binding letter of intent for the sale of one of
these facilities. Covol has entered into a separate non-binding letter of
intent to sell Covol's synthetic fuel business, including the remaining
three Covol-owned facilities and royalty interests from third-party
licensees. Covol has no current plans to construct additional synthetic
fuel facilities.
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. Covol anticipates that earned license fees or royalties
from the production and sale of synthetic fuel will continue to increase
during 1999 and in 2000. 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 early 2000.
In order for operating activities to produce significant positive cash
flows, Covol and its licensees must successfully address certain operating
issues and marketing difficulties. These problems have delayed Covol's
expected growth in license fees, and have resulted in lower than expected
cash flows and higher than expected capital requirements. Operating issues
which must be addressed include, but are not limited to, feedstock
availability, 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.
Covol's short-term existence depends on the procurement of additional
financing and the extensions of existing debt repayment terms in order to
enable it to maintain adequate liquidity until it can sell its facilities
held for sale or consummate the transactions contemplated by the letters of
intent.
8
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
During November 1998, Covol issued common stock and common stock warrants
for total net proceeds of approximately $3,730,000. 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
is currently in discussions with creditors to whom debt is owed in August
1999 and is also in discussions with several potential lenders with regard
to its short-term financing needs. Covol is using all available resources
to remain solvent and will continue to pursue the extension of due dates of
debt, additional financing, the sale of its facilities held for sale, and
consummation of the transactions contemplated in the letters of intent.
Covol believes it will be able to extend the repayment terms of its debt
and that the funds raised in additional financings and excess proceeds from
the sale of facilities will be sufficient to fund Covol's operations until
its operating activities begin producing positive cash flow or it can
consummate the transactions contemplated by the letters of intent.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the rules and regulations of the Securities and
Exchange Commission for quarterly reports on Form 10-Q. In the opinion of
management, all adjustments considered necessary for a fair presentation
have been included. All adjustments except for those described in the
following two paragraphs 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 Reports on
Form 10-Q for the quarters ended December 31, 1998 and March 31, 1999.
During the three months ended June 30, 1999, Covol terminated three
employees to whom compensatory stock options were granted in prior years.
These stock options were not forfeited upon termination. During the three
months ended June 30, 1999, total amortization of deferred compensation
from stock options approximated $749,000, of which approximately $600,000
was for the write off of the unamortized deferred compensation related to
these individuals.
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 carrying value of these
assets, totaling approximately $556,000, was written off during the quarter
ended June 30, 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 these differences could be material.
9
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
Restatements and Reclassifications
In accordance with generally accepted accounting principles and after
discussion with the staff of the Securities and Exchange Commission in
August 1999, the Company has restated its 1998 and 1999 financial
statements for the following items:
o To amortize a $1.4 million advance license fee paid by Coaltech on
a straight-line basis over the contractual term of the license
agreement which is through 2007. This fee had previously been
deferred because Covol deemed the sale of the Utah facility, the
license agreement, and the other related agreements to be one
single integrated transaction, and because the agreement to
purchase and remarket Coaltech's production at cost plus $1 per
ton was currently resulting in losses which effectively eliminated
the normal profit margin associated with binder sales to Coaltech.
The de-recognition of the sale discussed in the following
paragraph effectively separated these transactions.
o To de-recognize the sale of the Utah facility in 1997 and account
for this transaction under SEC guidelines for divestiture of a
business operation, as outlined under Staff Accounting Bulletin
(SAB) Topic 5:E. The note receivable related to this transaction
has been classified as a facility transferred under note
receivable arrangement and the loss on sale ($582,000) was
reversed. All note payments received, including interest, reduce
the carrying amount of the recorded asset.
o To reverse depreciation expense recorded on assets not in use.
The combined effect of all of the above items is to decrease net income for
the nine months ended June 30, 1998 by $83,000 and to increase the net loss
for the nine months ended June 30, 1999 by $201,000.
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.
Covol has currently filed two 1933 Act filings on Form S-3 Registration
Statements, which are currently being reviewed by the SEC. In connection
with that review, the SEC has raised questions which could result in
further restatements.
2. Change in Carrying Value of Note Receivable
During the nine months ended June 30, 1999, Covol increased the allowance
on the $5,000,000 face value note receivable from a stockholder by
approximately $749,000, resulting in an adjusted carrying value for the
note of $860,000 as of June 30, 1999. None of this adjustment in the
allowance was attributable to the three-month period ended June 30, 1999.
During the three and nine months ended June 30, 1998, Covol decreased the
allowance by approximately $532,000 and $1,095,000, 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 allowance is subject to future fluctuations in the
value of Covol's common stock. During the nine months ended June 30, 1999,
Covol received payments totaling $515,000 from the note holder. This amount
represented the scheduled payments as required under the note.
10
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
<TABLE>
<CAPTION>
3. Notes Payable
Notes payable consist of the following:
September 30, June 30,
(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 31, 1999. $5,800 $5,800
Note payable to a corporation bearing interest at prime (8.0% at June 30,
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 4,301
Notes payable to the same corporation referred to in the preceding two
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,
and license fees payable to Covol from the production and sale of synthetic
fuel from four synthetic fuel facilities. 6,680 6,500
Note payable to a limited liability company bearing interest at 10%,
collateralized by a synthetic fuel facility in West Virginia, held for sale,
and license fees payable to Covol from the production and sale of synthetic
fuel from two synthetic fuel facilities. Beginning July 1999 through May
2000, monthly payments of $350 are required, with all unpaid principal and
interest due June 2000. Alternatively, if Covol sells the facility before the
loan repayment date, Covol must repay the loan from sale proceeds. 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, but is expected to be redeemed or converted into
common stock by the note holder prior to maturity if not redeemed earlier by
Covol. Interest is payable semiannually on January 1 and July 1. 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. -- 9,503
Note payable to a corporation, bearing interest at 14%, collateralized by a
promissory note receivable and by certain future license fees receivable by
Covol. Interest is payable monthly and $1,000 of principal is due December
1999 and $3,000 of principal is due April 2000. 4,000 4,000
Note payable to the same corporation referred to in the preceding paragraph,
bearing interest at 14%, paid in March 1999. 4,000 --
Other 94 859
------------ -----------
35,979 43,054
Less: current portion 22,049 20,359
============ ===========
Total non-current $13,930 $22,695
============ ===========
</TABLE>
11
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
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 15.9% at
June 30, 1999.
Interest Costs
During the nine months ended June 30, 1999, Covol incurred total interest
cost of approximately $4,394,000 (including approximately $1,160,000 of
amortization of debt discount and debt issuance costs), none of which was
capitalized. During the nine months ended June 30, 1998, Covol incurred total
interest cost of approximately $3,682,000 (including approximately $2,266,000
of non-cash interest expense resulting from issuance of convertible debt and
warrants at a discount), of which approximately $1,390,000 was capitalized.
4. Basic and Diluted Loss per Share
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
(thousands of dollars and shares, except per-share data) 1998 1999 1998 1999
---------------------------------------------------------- -------------- --------------- ---------------- ---------------
Numerator:
<S> <C> <C> <C> <C>
Net income (loss) $1,598 $(6,275) $1,346 $(15,717)
Preferred stock dividends (undeclared) (85) (170) (279) (307)
Imputed preferred stock dividends -- (313) -- (353)
============== =============== ================ ===============
Net income (loss) attributable to common
stockholders $1,513 $(6,758) $1,067 $(16,377)
============== =============== ================ ===============
Denominator:
Denominator for basic income (loss) per share -
weighted-average shares outstanding 10,400 12,512 9,720 12,320
-------------- --------------- ---------------- ---------------
Effect of dilutive securities:
Common stock options 1,292 1,274
Common stock warrants 655 644
Convertible preferred stock 741 742
-------------- --------------- ---------------- ---------------
Dilutive potential common shares 2,688 -- 2,660 --
-------------- --------------- ---------------- ---------------
Denominator for diluted income (loss) per
share - weighted-average shares and
assumed conversions 13,088 12,512 12,380 12,320
============== =============== ================ ===============
Basic income (loss) per common share $.15 $(.54) $.11 $(1.33)
============== =============== ================ ===============
Diluted income (loss) per common share $.12 $(.54) $.09 $(1.33)
============== =============== ================ ===============
</TABLE>
5. Equity Transactions during the Quarter Ended June 30, 1999 and Subsequent to
June 30, 1999
Conversion of Preferred Stock
In May and June 1999, approximately 114,000 shares of common stock were
issued on conversion of 12,858 shares of Series B preferred stock and 300
shares of Series C preferred stock and related accrued but unpaid dividends.
Subsequent to June 30, 1999, approximately 137,000 shares of common stock
were issued on conversion of 500 shares of Series C preferred stock and
related accrued but unpaid dividends.
12
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
Warrants for the Purchase of Common Stock
In connection with the extension of the due date of the $4,000,000 note
payable described in Note 3, 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 current market
value of Covol's common stock. The extended, repriced warrants were valued
at approximately $244,000, which value is being amortized as interest over
the revised term of repayment. A member of Covol's Board of Directors is
affiliated with this corporation.
Stock Options
During the three months ended June 30, 1999, Covol granted an option for the
purchase of a total of 250,000 shares of common stock to a director and
officer. The exercise price was equal to the market value of Covol's common
stock on the date of grant.
6. Commitments and Contingencies
Commitments and contingencies as of June 30, 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 June 30, 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 June 30, 1999 is
$755,000 related to construction contracts that contain a "failure to
proceed" liability clause.
During 1997, Covol entered into an agreement to purchase coal fines and
through June 30, 1999 has made payments totaling approximately $3,916,000,
of which $239,000 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. Covol is seeking to amend
the agreement.
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 an advance license fee of $1,400,000,
which is being recognized as income over the contractual term of the license
agreement of 2007, and an earned 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) none of the limited partners are able
to utilize the federal income tax credits under Section 29 of the tax code,
13
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
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 discussion with the staff of the Securities and
Exchange Commission, this transaction has not been reflected as a sale for
accounting purposes. The original cost of the facility less cash payments
received from Coaltech, is reflected in the consolidated balance sheet as a
facility transferred under note receivable arrangement.
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 90% of the amount Covol has paid
for the synthetic fuel. Based upon expected manufacturing costs and current
coal prices, Covol expects to incur a loss under this supply and purchase
agreement which will reduce the earned license fees received. Covol believes
that over the life of this arrangement, total earned license fees will
exceed total losses incurred under the supply and purchase agreement. Also,
Covol believes Coaltech cannot require Covol to purchase product for which
Covol does not have third party sales, limiting 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 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 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 an adjustment in the license fees
payable to Covol under the license agreements. Upon condition of immediate
payment by Pace of amounts due under the original license agreement, 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 through June 30, 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.
14
<PAGE>
COVOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
----------
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.
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 is not known. Covol's
management believes the resolution of this dispute could have a significant
financial impact on Covol, which impact is most likely to be a reduction of
future revenues. Pelletco, an affiliate of Coalco, is a licensee of Covol.
In March 1999, Covol entered into a financing transaction involving the
issuance of convertible preferred stock and a convertible secured note. The
transaction requires, among other things, (1) stockholder approval of the
transaction, (2) registration of common stock into which the securities
issued may be converted, and (3) achievement of earnings targets beginning
in the first quarter of Covol's fiscal year 2000. Covol is preparing for a
special stockholder meeting to seek approval of the financing transaction.
Covol has filed registration statements on Form S-3 to register the common
stock into which the securities issued in the March 1999 financing
transaction are convertible as well as to fulfill other registration
commitments. The SEC has engaged in a review of the registration statements
and Covol's periodic reports under the Securities Exchange Act of 1934, and
accordingly effectiveness of the registration statements has been delayed
beyond what Covol expected while Covol responds to SEC staff comments. Covol
is also marketing its owned synthetic fuel manufacturing facilities and is
assisting licensees with synthetic fuel production issues in order to
improve the likelihood of reaching the required earnings targets. Failure to
comply with these covenants could have serious adverse effects, including
default under the financing agreements.
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis should be read in conjunction
with the accompanying unaudited consolidated financial statements and notes
thereto.
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Revenues. Total revenues for the three months ended June 30, 1999 ("1999")
decreased by $4,350,000 to $1,385,000 as compared to $5,735,000 for the three
months ended June 30, 1998 ("1998"). During 1999, Covol recognized license fees
totaling $661,000 while license fees of $3,185,000 were recognized during 1998.
The license fees in 1999 consisted of earned license fees or royalty payments of
$626,000 and $35,000 of amortization related to the $1,400,000 advance license
fee from Coaltech. The license fees in 1998 consisted of one-time advance
license fees of $3,150,000 and $35,000 of amortization related to the $1,400,000
advance license fee from Coaltech. Earned license fees or royalty payments are
due quarterly based upon synthetic fuel produced and sold as reported to Covol
by its licensees. Advance license fees are normally due when construction of the
related synthetic fuel facility begins, when construction is completed, or when
certain construction milestones or other specified conditions are met. Covol may
receive additional advance license fees during 1999 upon the sale of synthetic
fuel facilities currently owned by Covol or upon the achievement of certain
production levels at two other synthetic fuel facilities. Earned license fees or
royalty payments are expected to increase at moderate levels in the near term.
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 $409,000, with a corresponding direct cost
to Covol of $291,000, 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 $50,000 compared to $1,248,000 during
1998. These revenues resulted primarily from coal fines that were sold at
Covol's cost to a related party under a non-recurring contractual obligation, as
provided for under the binder and license agreement with this entity. Covol
received revenues from binder plant sales of $1,298,000, with a corresponding
cost of $1,095,000, during 1998, while no such sales occurred during 1999.
Synthetic fuel sales were $242,000 in 1999 compared to $0 in 1998 and represent
the sale of product from Covol-owned facilities. This revenue is not expected to
increase significantly because Covol is expecting to sell all of its owned
facilities in the near-term future.
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 June 30, 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, and 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 in the utility industry have generally
produced lower sales prices compared to long-term coal supply contracts. To
date, Covol owned facilities and licensees have secured contracts for the sale
of only a portion of their production. Convincing buyers of 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
16
<PAGE>
synthetic fuel difficult. Because synthetic fuel is a coal substitute, the
market and price are as broad and varied as the coal market itself. The US coal
market exceeds one billion tons annually, and the prices range from
approximately $12 to $35 per ton in the areas where facilities using the Covol
technology are located. Prices are dependent on many factors, including Btu
content, ash and sulfur content, moisture, location, etc. Covol believes that
once initial market resistance is overcome long-term contracts will be secured
for the synthetic fuel, and that Covol and its licensees will be able to market
all synthetic fuel produced at prices similar to coal.
Our accounting and valuation procedures are based on all of the Covol-owned
facilities qualifying for section 29 tax credits so that synthetic fuel
production will continue to be the highest and best use of this equipment and
facilities. If the facilities were used in an alternative application, 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 $923,000
to $5,961,000 during 1999 from $5,038,000 during 1998. Cost of coal briquetting
operations increased $1,457,000 from $1,409,000 during 1998 to $2,866,000 during
1999, and cost of binder and coal fines - related parties decreased $1,049,000
from $1,056,000 during 1998 to $7,000 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 realize a gain from the sale of the four facilities
held for sale. Covol expects to continue incurring operating losses from the
facilities until they are sold.
Covol operates one of the synthetic fuel facilities for Coaltech, a partnership
for which Covol is the general partner and 1% owner. 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
$800,000 during 1999 and $900,000 during 1998. The excess cost per ton should
decrease in the remainder of 1999 as production volumes at the Coaltech facility
increase.
Covol believes Coaltech cannot require Covol to purchase product for which Covol
does not have third party sales, limiting such losses. 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 Coaltech partners, 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 $227,000 or 20% to
$1,338,000 during 1999 from $1,111,000 for 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 $148,000 from 1998 to 1999 due to increased headcount. Changes in
the other categories from year to year were not material. Amortization of
17
<PAGE>
intangible assets increased from $0 in 1998 to approximately $113,000 in 1999,
primarily as a result of the late 1998 exchange of common stock of Covol for
limited partnership interests.
Research and development costs increased $73,000 to $154,000 from 1998 to 1999
primarily because Covol has focused additional personnel and 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 increased $463,000 to $749,000 for 1999 from $286,000 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. During 1999, Covol terminated three employees to whom
compensatory stock options were granted in prior years. These stock options were
not forfeited upon termination. In 1999, approximately $600,000 of expense was
for the write off of the unamortized deferred compensation related to these
individuals.
Other Income and Expense. During 1999, Covol had net other expenses of
$1,699,000 compared to $901,000 of net other income for 1998. This increase of
$2,600,000 in net expense relates primarily to an increase in interest expense
of $1,981,000 and a change between periods of $532,000 in the mark-to-market
adjustment of the carrying value of the related party note receivable
collateralized by common stock.
Interest expense in 1998 was $0 because all interest costs were capitalized as
part of the costs of construction of synthetic fuel facilities. Interest expense
of $1,981,000 in 1999 consisted of interest accrued on notes payable used to
finance the construction of synthetic fuel facilities held for sale and for
operating purposes. Interest expense has increased by approximately $850,000 per
quarter as a result of the debt issued in March 1999. Interest expense will
decrease as a result of any future repayments of debt related to the sale of
facilities held for sale.
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 consolidated balance sheet at the underlying value of the
collateral. This adjustment resulted in a write-up of $532,000 during 1998,
compared to no adjustment during 1999 for a net change of $532,000 between
periods. As of June 30, 1999, the Note had a carrying value of $860,000.
Net loss. For 1999, the net loss of $6,275,000 represented a change of
$7,873,000 from net income of $1,598,000 reported for 1998. This is primarily
due to the significant decrease in one-time advance license fee revenues, the
increase in cost of briquetting operations, the asset impairment charge, the
increase in amortization of deferred compensation from stock options, and the
increase in interest expense in 1999. Covol did not recognize any income tax
benefit in 1999 or 1998 since the realization of its deferred tax asset of
approximately $16,000,000, consisting primarily of net operating loss
carryforwards, is dependent on generation of future taxable income.
Nine Months Ended June 30, 1999 Compared to Nine Months Ended June 30, 1998
Revenues. Total revenues for the nine months ended June 30, 1999 ("1999")
decreased by $8,930,000 to $3,527,000 as compared to $12,457,000 for the nine
months ended June 30, 1998 ("1998"). During 1999, Covol recognized license fees
totaling $1,565,000 while license fees of $7,841,000 were recognized during
1998. The license fees in 1999 consisted of earned license fees of $1,460,000
and $105,000 of amortization related to the $1,400,000 advance license fee from
Coaltech. The license fees in 1998 consisted of one-time advance license fees of
$7,736,000 and $105,000 of amortization related to the $1,400,000 advance
license fee from Coaltech.
Total binder sales to non-related parties during 1999 were $1,365,000, with a
corresponding direct cost to Covol of $941,000. 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 $233,000 compared to $3,243,000 during
1998. These revenues resulted primarily from coal fines that were sold at
Covol's cost to a related party under a non-recurring contractual obligation, as
18
<PAGE>
provided for under the binder and license agreement with this entity. Covol
received revenues from binder plant sales of $1,298,000, with a corresponding
cost of $1,095,000, during 1998, while no such sales occurred during 1999.
Synthetic fuel sales were $242,000 in 1999 compared to $5,000 in 1998 and
represent the sale of product from Covol-owned facilities. This revenue is not
expected to increase significantly because Covol is expecting to sell all of its
owned facilities in the near-term future.
Operating Costs and Expenses. Operating costs and expenses increased by
$4,628,000 to $15,297,000 during 1999 from $10,669,000 during 1998. Cost of coal
briquetting operations increased $6,230,000 from $2,457,000 during 1998 to
$8,687,000 during 1999, and cost of binder and coal fines - related parties
decreased $3,031,000 from $3,073,000 during 1998 to $42,000 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 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
$2,700,000 during 1999 and $1,900,000 during 1998. The excess cost per ton
should decrease as 1999 production volumes at the Coaltech facility increase.
Covol expects to realize a gain from the sale of the four facilities held for
sale. Covol expects to continue incurring operating losses until the facilities
are sold.
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 $497,000 or 17% to
$3,500,000 during 1999 from $3,003,000 for 1998. Except for amortization of
intangible assets during 1999 and commissions in 1998, the largest components of
selling, general and administrative expenses for both 1999 and 1998 were
payroll, professional services, and travel expenses. Payroll costs increased
approximately $320,000, professional services increased approximately $110,000
and travel increased approximately $50,000 from 1998 to 1999, due primarily to
increased headcount and higher legal costs. Amortization of intangible assets
increased approximately $305,000 related to the late 1998 exchange of common
stock of Covol for limited partnership interests. Commission expense decreased
approximately $320,000 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 $188,000 to $497,000 from 1998 to 1999
primarily because Covol has focused additional personnel and 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 increased $342,000 to $1,074,000 for 1999 from $732,000 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. During 1999, Covol terminated three employees to whom
compensatory stock options were granted in prior years. These stock options were
19
<PAGE>
not forfeited upon termination. In 1999, approximately $600,000 of expense was
for the write off of the unamortized deferred compensation related to these
individuals.
Other Income and Expense. During 1999, Covol had net other expenses of
$3,947,000 compared to $442,000 for 1998. This increase of $3,505,000 relates
primarily to a change between periods of $1,844,000 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 $2,102,000,
and a decrease in minority interest in losses of consolidated subsidiaries of
$321,000, partially offset by an increase in interest income of $935,000.
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 $1,095,000 during 1998 for a net change of $1,844,000. A $515,000
payment on this Note during 1999 was included in interest income for 1999.
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
$4,394,000 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 $1,160,000 of amortization of debt discount. Interest
expense has increased by approximately $850,000 per quarter as a result of the
debt issued in March 1999. Interest expense will decrease as a result of any
future repayments of debt related to the sale of 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
$321,000 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, all of which losses will now be included in Covol's statement
of operations.
Net loss. For 1999, the net loss of $15,717,000 represented a change of
$17,063,000 from net income of $1,346,000 in 1998. This is primarily due to the
significant decrease in one-time advance license fee revenues, the increase in
cost of briquetting operations, the asset impairment charge, the increase in
interest expense, and the change between periods of $1,844,000 in the
mark-to-market adjustment of the carrying value of the related party note
receivable collateralized by common stock. 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, is dependent 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 and has entered into a non-binding letter of intent for the sale of one
of these facilities. Covol anticipates sale of the facilities before December
31, 1999. Proceeds from the 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 for working capital needs. Total operating expenses
associated with the four owned facilities cost approximately $700,000 per month
during the most recent quarter. These operating expenses fluctuate depending on
the level of activity at the owned facilities.
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Net cash used in operating activities for the nine months ended June 30, 1999
("1999") was $14,388,000 compared to $1,119,000 of cash used during the nine
months ended June 30, 1998 ("1998). Substantially all of this change in cash
flow from operations is attributable to the 1999 net loss of $15,717,000 as
compared to $1,346,000 of net income in 1998. Covol has been 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
$10,453,000, proceeds from the issuance of preferred stock totaled $6,367,000
and proceeds from the issuance of common stock totaled $3,775,000.
Capital Resources. During 1999, Covol's investing activities were not
significant. Investing activities in 1998 were significant and 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 ($32,570,000) 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
synthetic fuel facilities that qualified 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 a
facility placed in service by June 30, 1998.
In June 1999, Covol announced that it had entered into two non-binding letters
of intent with an affiliate of a major U.S. electric utility company. One letter
of intent is for the sale of a single synthetic fuel facility. The other letter
of intent, if fully consummated, would result in the sale of Covol's synthetic
fuel business, including the remaining three Covol-owned facilities and royalty
interests from third-party licensees. Covol's long-term existence depends on the
ability of Covol's licensees to produce and sell synthetic fuel at sufficient
levels to generate earned license fees or royalties to Covol in amounts greater
than operating expenses.
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. Covol anticipates that
earned license fees or royalties from the production and sale of synthetic fuel
will continue to increase during 1999 and in 2000. 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 early 2000.
In order for operating activities to produce significant positive cash flows,
Covol and its licensees must successfully address certain operating issues and
marketing difficulties. These problems have delayed Covol's expected growth in
license fees, and have resulted in lower than expected cash flows and higher
than expected capital requirements. Operating issues which must be addressed
include, but are not limited to, feedstock availability, 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.
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Covol's short-term existence depends on the procurement of additional financing
and the extensions of existing debt repayment terms in order to enable it to
maintain adequate liquidity until it can sell its facilities held for sale or
consummate the transactions contemplated by the letters of intent.
During November 1998, Covol issued common stock and common stock warrants for
total net proceeds of approximately $3,730,000. 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 is currently in discussions
with creditors to whom debt is owed in August 1999 and is also in discussions
with several potential lenders with regard to its short-term financing needs.
Covol is using all available resources to remain solvent and will continue to
pursue the extension of due dates of debt, additional financing, the sale of its
facilities held for sale, and consummation of the transactions contemplated in
the letters of intent. Covol believes it will be able to extend the repayment
terms of its debt and that the funds raised in additional financings and excess
proceeds from the sale of facilities will be sufficient to fund Covol's
operations until its operating activities begin producing positive cash flow or
it can consummate the transactions contemplated by the letters of intent.
In connection with the financing Covol obtained in March 1997, 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. It is not known whether or
not Covol will be able to comply with this provision. Covol's current operations
are at levels below this requirement; however, the sale of Covol-owned
facilities held for sale is expected to result in a gain. Additionally,
operating expenses will decrease as a result of the sale of the facilities.
Operation of the synthetic fuel facilities at or near capacity should result in
EBITDA at levels in excess of this requirement. 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 would
become immediately convertible. Upon the second event of non-compliance with
this provision, Covol will be 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. There are other provisions and covenants in these loan documents that
may restrict or prohibit certain activities.
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 unforeseen
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.
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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 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, based on notification from the suppliers, 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 product due to
unforeseen 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 calendar
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.
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, possible transactions, 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
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knowledge of its business and operations, there can be no assurance that actual
results will not differ materially from its expectations. There are a number of
business factors which singularly or combined may affect Covol's future
operating results. 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:
o Ability to successfully negotiate terms and consummate proposed
transactions,
o Ability to sell Company-owned synthetic fuel facilities on favorable terms,
o Ability to obtain necessary capital or financing,
o Ability to comply with covenants in financing agreements, including
financial performance criteria,
o Ability to conserve capital through cost reductions until operating
revenues exceed expenses,
o Ability of licensees to market synthetic fuel produced, generating
royalties for Covol,
o Ability of licensees to achieve expected production levels at synthetic
fuel facilities,
o Favorable IRS tax treatment,
o Availability of natural resources and suitable raw materials,
o Ability to locate appropriate sites for facilities,
o Ability of Covol to complete specific research and development projects,
and
o Commercial viability of technologies.
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 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.
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.
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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 shares of 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.
Reference is made to the conversions of series B and series C preferred stock,
to the amendments to the terms of certain warrants for the purchase of common
stock, and the issuance of an option for the purchase of common stock, all as
described in Note 5 to the consolidated financial statements.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are included herein:
10.60 Employment Agreement effective April 20, 1999 with
Kirk A. Benson
27.1 Financial Data Schedule
(b) No reports on Form 8-K were filed during the three months ended
June 30, 1999. A Form 8-K was filed on July 7, 1999 relating to an
event dated June 23, 1999.
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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: August 13, 1999 By: /s/ Kirk A. Benson
---------------------------------------
Kirk A. Benson, Chief Executive Officer
and Principal Executive Officer
Date: August 13, 1999 By: /s/ Steven G. Stewart
----------------------------------------
Steven G. Stewart, Chief Financial Officer
and Principal Financial Officer
26
EMPLOYMENT AGREEMENT
By and Between
COVOL TECHNOLOGIES, INC.
And
KIRK A. BENSON
Effective as of April 20, 1999
<PAGE>
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT (this Agreement") is made and entered into as
of May 18, 1999, and effective as of April 20, 1999 (the "Effective
Date") by and between Covol Technologies, Inc., a Delaware Corporation
(the "Company"), and Kirk A. Benson ("Executive"). The Company and
Executive are sometimes later in this Agreement collectively referred
to as the "Parties."
1. Employment and Position. The Company employs Executive and
Executive accepts employment by the Company as Chief Executive Officer
of the Company for the Period of Employment specified in Paragraph 3
("Period of Employment").
2. Services to be Rendered. The Executive shall, during the
Period of Employment, serve the Company in the position set forth in
Paragraph 1 diligently, competently, and in conformance with the
corporate policies of the Company. Executive shall provide leadership
in areas of financial planning and performance, long range corporate
planning, legal and regulatory compliance, operations planning and
implementation, and new business planning and implementation. Executive
shall be free to conduct personal business and investment activities
that do not conflict or interfere with the performance of his duties
under this Agreement. Executive shall have the responsibility to always
act in the best interest of the Company and recognizes opportunities,
ideas, and intellectual property relating to the business of the
Company that are developed while an officer or employee of the Company
or any of its affiliates, remain the property of Company.
In fulfilling his duties and responsibilities under
this Agreement, Executive shall report to the Board of Directors and
shareholders of the Company.
3. Period of Employment. Executive's employment by the Company
pursuant to this Agreement shall, unless sooner terminated, begin as of
the Effective Date and continue for a period of three (3) years from
the Effective Date ("Period of Employment").
4. Base Salary. Executive shall be paid an annual base salary
of an amount determined by the Board of Directors. Base salary shall be
paid in semi monthly installments during the Period of Employment.
Effective as of the Effective Date, Executive shall be paid a gross
salary of $15,000 per month until such base salary is adjusted by the
Board of Directors.
5. Incentive Bonus. The Board of Directors will determine any
incentive bonus guidelines during the Period of Employment. Bonus plans
are intended to establish linkage between Executive's compensation and
the Company's performance.
6. Performance Criteria. Executive's performance will be
measured according to achievement based on progress towards the
Company's strategic business plan, financial results, compliance with
law and regulation, organizational development, and other factors which
provide impact to the Company.
7. Expense Reimbursement. The Executive shall be entitled to
prompt
2
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reimbursement for reasonable expenses incurred by the Executive in
performing services for the Company. Executive shall be required to
provide documentation of such expenditures.
8. Grant of Options. The Company shall grant to the Executive,
in accordance with the terms of the Stock Option Agreement attached
hereto as Exhibit A, the right and option to purchase shares of the
Company's Common Stock.
(a) Stock Options Pursuant to Stock Option Plan. The
Stock Option ("Stock Option") shall be issued pursuant and subject to
the provisions of the Company Executive Stock Option Plan.
(b) Purchase Price. The purchase price per share for
the shares subject to the Stock Option will be $4.125, the closing
share price on May 18, 1999.
(c) Number of Shares. The Stock Options will be for
250,000 shares of the Company's Common Stock (the "Optioned Shares").
(d) Exercise Periods. The Optioned Shares will vest
and be exercisable on the beginning of each 12 month anniversary of the
Effective Date on a one-third per anniversary basis for the three (3)
anniversaries following the Effective Date, provided that vesting will
continue so long as the Executive is still in the employ of the
Company. Once vested, the Optioned Shares may be exercised in whole or
in part at any time, subject to the limitations within which the
exercise of the Options must occur. The Optioned Shares must be
exercised in their entirety prior to April 20, 2009, also known as the
expiration date.
(e) Vesting of Options in Event of Full and Complete
Disability or Death. In the event of full disability or death of the
Executive any unvested Stock Options shall vest effective as of the
date of the full and complete disability or the death of Executive. In
the event of Executive's full and complete disability or death, the
Executive, heirs or estate of Executive, as the case may be, may
exercise any unexecuted options at any time subject to the time
limitations within which exercise of option must occur.
(f) Vesting of Options in Event of Ownership Change.
In the event a third party purchases a controlling interest of the
total outstanding shares of the Company, or substantially all of the
assets of the Company, if Executive is not retained as an officer, all
non-vested Stock Options shall vest as of the date immediately prior to
such stock or asset purchase. The intent of this section is to allow
the Executive to vote the shares represented by the Stock Options and
at the Executive's discretion exercise any unexecuted options.
(g) Additional Stock Options. Executive shall also be
eligible to receive additional stock options during the Period of
Employment pursuant to a stock options plan as may from time to time be
in effect and as approved by the Board of Directors.
9. Other Benefits. In addition to the benefits previously
set forth in this Agreement, Executive shall, during the Period of
Employment, be entitled to the benefits
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described below or as may be implemented by the Company, and as
concerns all such benefit programs where years of service are a factor,
to the extent permitted by law, Executive shall be given credit for his
years of service with Covol Technologies, Inc. prior to the
implementation of any benefit program.
(a) Vacation. During the Period of Employment,
Executive shall be entitled to not less than six (6) weeks of paid
vacation during each calendar year occurring during the Period of
Employment. The vacation may be carried over from year to year. At the
end of the term of this Agreement, the Employee shall be entitled to be
paid for the pro rated portion of the accrued salary attributable to
unused vacation.
(b) Sick Leave. Leave time will be granted to the
Executive that is reasonable under the circumstances and that is
consistent with the Company's policies and procedures, as the same may
be changed, modified or terminated for all participants from time to
time.
(c) Insurance. Participation in the group insurance
program of the Company as concerns life, disability, medical and dental
or other insurance currently available to other Executive's as the same
may be implemented, changed, modified or terminated for all
participants from time to time. Executive shall be required to pay that
portion of the premiums for coverage under such insurance that is
payable by other Executive's of the Company for their insurance
coverage.
(d) Retirement Plan. The Executive shall participate
in the Company's Retirement Plans in accordance with the terms and
provision and applicable law as the same may be implemented, changed,
amended, or terminated from time to time. Executive shall become
eligible to participate in the Company's Retirement Plans at date of
hire or as the effective date of the implementation of such plans,
whichever is later.
(e) Automobile Allowance. The Company will provide
the Executive a monthly automobile allowance. This allowance is to
compensate the Executive for the use of his personal automobile in the
amount of $550.00 per month during the Employment Period.
(f) Other Miscellaneous Benefits. The Company shall
pay or reimburse Executive for the following miscellaneous benefits:
(i) Annual dues for association membership for
relevant professional groups.
(ii) Subscription and purchase of books, journals, publications which
relate to job duties and responsibilities.
10. Term of Employment.
(a) Term. The Company hereby agrees to continue the
Executive in its employ, and the Executive hereby agrees to remain in
the employ of the Company, in accordance with the terms and provisions
of paragraph 3 of this Agreement, for the Period of
4
<PAGE>
Employment, thus terminating on the third anniversary of the Effective
Date of this Agreement, upon thirty (30) days prior written notice from
the Company to the Executive. If such written notice of termination is
not given, then the Executive's employment under this Agreement shall
continue under the terms of this Agreement, until the Executive is
terminated by the Company upon thirty (30) days prior written notice.
(b) During the Period of Employment .
(i) The Executive's position, authority,
duties and responsibilities shall be commensurate in all material
respects with those held, exercised and assigned at the time of the
Effective Date.
(ii) The Executive's services shall be
performed at the location which is the headquarters of the Company.
11. Termination of Agreement.
(a) Termination of Employment by Employer. Anything
in this Agreement to the contrary notwithstanding, the Company shall
have the following rights with respect to termination of Executive's
employment.
(i) At Will. The Company may terminate
Executive's employment under this Agreement upon the determination of
the Board of Directors.
(ii) Disability. The Company may terminate
Executive's employment under this Agreement if Executive shall become
unable to fulfill his duties under this Agreement, as measured by the
Company's usual business activities, by reason of any medically
determinable physical and/or mental disability.
(iii) Cause. Executive's employment may be
terminated for Cause. For purpose of the Agreement, "Cause" shall mean
and refer to a determination made in good faith by the Company's Board
of Directors that:
(1) Executive has been convicted
of or has entered a plea of guilty or nolo contendere to a felony or to
any other crime, which other crime is punishable by incarceration for a
period of one (1) year or longer, or which is a crime involving moral
turpitude;
(2) there has been a theft,
embezzlement, or other criminal misappropriation of funds by Executive,
whether from Company or any other person;
(3) Executive has failed or
refused to follow reasonable written policies or directives established
by the Board of Directors of the Company, or Executive has failed to
attend to material duties or obligations of Executive's office (other
than any such failure resulting from Executive's incapacity due to
physical or mental illness, which is a cause or manifestation of
Executive's disability), which failure or refusal continues for thirty
(30) days
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<PAGE>
following delivery of a written demand from the Company's Board of
Directors for performance to Executive identifying the manner in which
Executive has failed to follow such policies or directives or to
perform such duties.
(iv) Termination pursuant to this
Paragraph 10 shall be effective as of the effective date of the notice
by the Board of Directors to Executive that it has made the required
determination, or at such other subsequent date, if any specified in
such notice.
(v) Death. If the Employee dies during
the term of this Agreement, his personal representative or designated
survivor shall be entitled to receive all of the salary and benefits
provided hereunder for the remaining term of this Agreement.
(b) Termination by Executive.
(i) With Good Reason. Executive shall
have the right to terminate his employment under this Agreement at any
time for Good Reason, provided Executive has delivered written notice
to the Company which briefly describes the facts underlying Executive's
belief that "Good Reason" exist and the Company has failed to cure such
situation within thirty (30) days after effective date of such notice.
For purposes of the Agreement, "Good Reason" shall mean and consist of:
(1) a material breach by the
Company of its obligations under this Agreement;
(2) the assignment to Executive
of duties that are materially inconsistent with, or that constitute a
material alteration in the status of his responsibilities set forth in
this Agreement, as an Executive of the Company;
(3) a non-voluntary reduction
by the Company of Executive's Base Salary below the Base Salary set
forth in Paragraph 4;
(4) without Executive's consent,
the transfer or relocation of Executive's place of employment to any
place other than the Salt Lake City/Provo metropolitan area, except for
reasonable travel on the business of the Company; or
(5) upon the consummation of a
sale of all or substantially all of the assets of the Company not in
the usual or regular course of the business of the Company in which
sale the acquiring company did not assume all of the obligations of the
Company under this Agreement.
12. Confidential Information. The Executive shall hold in a
fiduciary capacity for the benefit of the Company all secret or
confidential information, knowledge or data relating to the Company or
any of its affiliated companies and their respective businesses, which
have been obtained by the Executive during the Executive's employment
by the Company or any of its affiliated companies and which shall not
be or become public knowledge (other than by acts by the Executive or
representatives of the Executive in violation of this Agreement). For a
period
6
<PAGE>
of five years after termination of the Executive's employment with the
Company, the Executive shall not, without prior written consent of the
Company or as may otherwise be required by law or legal process,
communicate or divulge any such information, knowledge or data to
anyone other than the Company and those designated by the Company. In
no event shall an asserted violation of the provisions of this Section
constitute a basis for deferring or withholding any amounts otherwise
payable to the Executive under the provisions of this Agreement.
13. Inventions.
(a) Assignment. Without further consideration, the
Executive shall fully and promptly report to the Company all ideas,
concepts, inventions, discoveries, formulas, and designs conceived or
produced by the Executive at any time during the Period of Employment
relating to the Company's trade or business, whether alone or with
others and whether patentable or unpatentable (collectively,
"Inventions" pertaining directly or indirectly to the business of the
Company as conducted by the Executive at any time during the Employment
Period) and shall assign and hereby does assign to the Company or its
nominee the Executive's entire right, title and interest in and to all
such Inventions.
(b) Cooperation. The Executive shall take all
reasonable action requested by the Company to protect or obtain title
to any and all United States and/or foreign patents on any such
Inventions, including execution and delivery of all applications,
assignments and other documents deemed necessary or desirable by the
Company, provided the Company shall reimburse the Executive for all
expenses incurred by the Executive in connection with such execution
and delivery.
14.Non-Competition after Termination.
(a) Acknowledgment. The Executive acknowledges that
his services and responsibilities are of a particular significance to
the Company and that his position with the Company does and will
continue to give him an intimate knowledge of its business. Because of
this, it is important to the Company that the Executive be restricted
from competing with the Company in the event of the termination of his
employment.
(b) Agreement. The Executive agrees that, in addition
to any other limitations, for a period of two (2) years after the
termination of his employment under this Agreement, the Executive will
not directly or indirectly compete with the Company or its business.
15. Severance Pay. Except in the case of (1) termination for
Cause under Paragraph 11(a)(iii) above or (2) upon 30 days notice at
the end of the Period of Employment under Paragraph 9(a) above, if the
Executive does not continue in the employ of the Company after the
termination of this Agreement, whether or not the Executive is offered
continued employment by the Company, Company shall pay to Executive, no
later than two months after termination, the sum of one year's annual
base salary and options will continue to vest as per the schedule set
forth in paragraph 7(d) above. The Executive shall not be required to
mitigate the amount of the payment provided for in this section by
seeking other employment or otherwise; nor shall the
7
<PAGE>
amount of the payment be reduced by any compensation earned by the
Executive as the result of employment by another employer after
termination or otherwise.
16. Indemnification. Subject to the Company's Certificate of
Incorporation, Articles, and By-Laws, as from time to time amended, the
Company shall release, indemnify and hold harmless the Executive
against and from any and all loss, claims, actions or suits, including
costs and attorney's fees, both at trial and on appeal, resulting from,
or arising out of or in any way connected with the Executive's acts as
an Executive of the Company. The Company shall keep in effect directors
and officers liability insurance comparable to the policy in effect as
of the Effective Date.
17. Miscellaneous. Any notice or other communications required
or permitted to be given to the parties hereto shall be deemed to have
been given when received, addressed as follows ( or at such other
address as the party addressed may have substituted by notice pursuant
to this Section):
(a) If to the Company:
3280 North Frontage Road
Lehi, Utah 84043
Attention: Compensation Committee Chairman
(b) If to Executive:
Kirk A. Benson
4184 West Alpine Cove Drive
Alpine, Utah 84004
18. Governing Law. This Agreement shall in all respects
be interpreted, construed and governed by and in accordance with the
laws of the State of Utah.
IN WITNESS WHEREOF, the parties have executed this
Agreement in duplicate as of the date written above.
Covol Technologies Inc.: Executive:
By: /s/ Raymond Weller /s/ Kirk A. Benson
Name: Raymond Weller Kirk A. Benson
Title: Compensation Committee / Director
8
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE NINE MONTHS ENDED JUNE 30,
1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,932
<SECURITIES> 0
<RECEIVABLES> 4,471
<ALLOWANCES> 0
<INVENTORY> 1,683
<CURRENT-ASSETS> 38,002
<PP&E> 16,653
<DEPRECIATION> 2,251
<TOTAL-ASSETS> 72,375
<CURRENT-LIABILITIES> 27,024
<BONDS> 22,695
0
1
<COMMON> 12
<OTHER-SE> 16,692
<TOTAL-LIABILITY-AND-EQUITY> 72,375
<SALES> 1,840
<TOTAL-REVENUES> 3,527
<CGS> 9,670
<TOTAL-COSTS> 9,670
<OTHER-EXPENSES> 2,127
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,394
<INCOME-PRETAX> (15,717)
<INCOME-TAX> 0
<INCOME-CONTINUING> (15,717)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (15,717)
<EPS-BASIC> (1.33)
<EPS-DILUTED> (1.33)
</TABLE>
